Fina 3001

Front 1

In this course, we assume that firms ultimately attempt to maximize

Back 1

Stock prices

Front 2

Projected earnings per share influence a firm's __________ ________.

Back 2

Stock Price

Front 3

The method of financing the firm influences a firm's ______ _______.

Back 3

Stock Price

Front 4

The timing of future _______ ____ _______ influences a firm's stock price.

Back 4

Earnings per share

Front 5

The risk of the firm influences a firm's _____ _____.

Back 5

Stock Price

Front 6

The amount of earnings paid as _________ influences a firm's stock price.

Back 6

dividends

Front 7

Both the price per share of a firm's common stock and the shareholder wealth of the firm's shareholders will be maximized when the earnings of the firm are maximized.

Back 7

FALSE: Both the price per share of a firm's common stock and the shareholder wealth of the firm's shareholders will not necessarily be maximized when the earnings of the firm are maximized.

Front 8

A corporation terminates when its owners die.

Back 8

FALSE

Front 9

Firm X has earnings of $5 million and 1 million shares of stock outstanding. Later, firm X sells 1 million shares of stock and invests the money in assets that create $1 million of profit. While Firm X's earnings have been raised, its EPS has actually been lowered.

Back 9

TRUE

Front 10

What do Income sheets and Balance sheets show?

Back 10

Income statements show what a firm sells (revenues), what it spends (expenses), and what is left over (profits or losses), whereas balance sheets show what a firm owns (assets), what it owes to creditors (liabilities), and what is left over and owed to the owners of the firm (equity).

Front 11

Two different varieties of working capital are...?

Back 11

(a) Operating Working Capital, which is just current assets, and (b) Net Operating Working Capital, which is current assets minus non-interest-bearing current liabilities.

Front 12

EBIT vs EBITDA

Back 12

EBIT is calculated as revenues minus all expenses except for Interest and taxes, whereas EBITDA is calculated as revenues minus all expenses except for Interest, taxes, depreciation, and amortization.

Front 13

What is the purpose of NOPAT?

Back 13

The NOPAT calculation is meant to show how a firm would perform after taxes if it had no debt, and therefore no interest expense.

Front 14

Operating Cash Flow

Back 14

The amount of cash that is generated by after-tax operating profits is called Operating Cash Flow, which is the amount of cash that is generated by after-tax profits excluding the effect of interest expense.

Front 15

What is deductible interest paid or dividends?

Back 15

Only interest paid is deductible, not dividends.

Front 16

Why do corporations have an incentive to withhold earnings that could be paid out as dividends?

Back 16

Corporations have an incentive to withhold earnings that could be paid out as dividends because dividends that are paid out by a corporation are taxable income to its shareholders.

Front 17

A corporation with a marginal tax rate of 30 percent owns a stock with a 12 percent before-tax dividend yield. What is this corporation's after-tax dividend yield from this stock?

Back 17

10.92%

Front 18

Depreciation for "tax" purposes is used on ___ _______, and depreciation for "book" purposes is used on _______ _______ and ______ ___________.

Back 18

Depreciation for "tax" purposes is used on tax returns, and depreciation for "book" purposes is used on income statements and balance sheets. A total of 100 percent of an asset's total cost will be depreciated for tax purposes, but only the total of the asset's cost less its estimated salvage value will be depreciated for "book" purposes.

Front 19

What would a firm owe in taxes if it earned $35,000 from operations, $12,000 from interest, and $50,000 from dividends and it paid only $15,000 in interest?

Back 19

$7050

Front 20

Internal and external ratio analysis look at how a firm compares to its _________.

Back 20

competitors

Front 21

Why must ratio analyses be done over a period of time?

Back 21

Because it is usually the trends in ratios that are important, not the actual ratio numbers themselves

Front 22

What does a current ratio measure?

Back 22

A firm's ability or inability to meet current obligations

Front 23

What does the inventory turnover ratio measure?

Back 23

How effectively a firm manages its inventory and whether the level of inventory owned is proper for the firm's sales

Front 24

In Year 1, Firm X had $10,000 in after-tax profits, $120,000 in sales, and $500,000 in assets. In Year 2, Firm X had $13,500 in after-tax profits, $135,000 in sales, and $564,950 in assets. Firm X's increasing ROA is attributable mostly to an ________ _________ ___________ on sales.

Back 24

increasing profit margin

Front 25

Ratios can be distorted at different times of the year. For example, a company might have poor inventory turnover during the peak of its season when its inventory is very high, but good inventory turnover six months later when its inventory is substantially lower.

Back 25

TRUE

Front 26

if a firm takes steps that improve its return on equity, or ROE, then the wealth of its shareholders must also increase.

Back 26

FALSE; While ROE is an important financial performance measure, it does not consider the risk that was incurred in order to generate the firm's ROE, and this risk could actually cause shareholder wealth to decrease.

Front 27

A company has $20 million of sales and $1 million of net income. Its total assets are $10 million, financed half by debt and half by common equity. If the firm used less leverage, then:

Back 27

its return on assets would increase.

Front 28

A company that leases fixed assets will have a better fixed asset turnover ratio than an identical company that buys its fixed assets.

Back 28

TRUE

Front 29

The percent-of-sales forecasting method is used to forecast a firm's _________ ______ given a sales forecast.

Back 29

balance sheet

Front 30

Lump sum vs. Annuity

Back 30

A lump sum means a single payment, deposit, etc., whereas an annuity means a stream of equal payments, deposits, etc.

Front 31

Someone deposits $1 per year at the end of each year in a 5 percent savings account for us. This is an annuity. How much would we pay for this if it is done for two years? (Round your answer to two decimal places.)

Front 32

Which amount is worth more today at 8 percent: $2000 today or $2160 in two years?

Back 32

$2000 today

Front 33

If money has time value, then what is the relationship between the future value of some amount of money and the amount that is invested today?

Back 33

The future value of some amount of money will always be bigger than the amount that is invested today in order to get it.

Front 34

An investor is considering the purchase of a two-year investment that would return $57.00 at the end of each year. If this investor requires a 5% return, then what should this investor be willing to pay for this investment? (Round your answer to two decimal places.)

Back 34

Anything up to $105.99

Front 35

In a term-loan amortization schedule, what amounts will increase each year, decrease each year, and remain the same each year until the loan matures?

Back 35

Increase each year: principal. Decrease each year: interest and remaining balance. Remain the same each year: payment.

Front 36

What happens to a present value amount as the discount rate increases without limit?

Back 36

As the discount rate increases without limit, the present value decreases, but it can never be negative if the number being discounted is positive.

Front 37

Assume you borrow $10,000 for two years at 10 percent interest under a term loan, with payments to be made at the end of each year. What is your yearly payment? (Round your answer to two decimal places.)

Back 37

$5762.03, calculated as follows:

$10,000 = (payment) (0.9091) + (payment) (0.8264)

$10,000 = (payment) (0.9091 + 08264)

$10,000 = (payment) (1.7355)

$10,000 = (payment) (1.7355)payment = $5762.03

Front 38

What is the maximum price that an investor should consider paying for 25 acres of land, assuming that the land will only produce one cash flow of $250,000 in one year and that the investor would require a return of 5 percent on investments of this type? (Round your answer to two decimal places.)

Back 38

$238,095.24

Front 39

Annuity

Back 39

A stream of equal payments that are equally spaced

Front 40

When you are calculating what the price of a bond or a share of stock should be, given the cash flows that a bondholder or shareholder should expect to receive from the bond or share of stock, then you are calculating the bond's or stock's _________ ______.

Back 40

intrinsic value

Front 41

The price of a bond or a share of stock should equal the present value of the ______ _____ that the bondholder or shareholder will receive.

Back 41

cash flow

Front 42

If a bond's current price is less than par, then it sells at a _________; if a bond's current price is greater than par, then it sells at a ________.

Back 42

discount;premium

Front 43

compound interest

Back 43

Interest that is earned on interest that is earned is called compound interest.

Front 44

What do you need to calculate the return that you would receive if you were to buy the bond and hold it until it matured?

Back 44

If you know the price of a bond, its interest payments, its par value, and its life, then you can calculate the return that you would receive if you were to buy the bond and hold it until it matured, and this return would be the bond's yield to maturity.

Front 45

The price of a bond is determined by the bond's interest payments, the bond's par value, the life of the bond, and the required rate of return on bonds of similar risk.

Back 45

TRUE

Front 46

As the required rate of return changes, so must the _____ of the bond. This sensitivity of price to changes in the required rate of return is called interest rate risk, and the longer the life of the bond, the greater will be the interest rate risk.

Back 46

price

Front 47

The length of time an investor holds a share of stock does not affect the value she or he would be willing to pay for the share of stock. However, the dividend an investor will receive while holding a share of stock does affect the value she or he would be willing to pay for the share of stock.

Back 47

TRUE

Front 48

A national manufacturer of sporting goods has recently experienced a number of unfortunate lawsuits. The firm has a bond issue currently outstanding with 10 years to maturity and a coupon rate of 5 percent (paid semiannually). Because of these lawsuits, the market's required rate on the bonds has now risen to 6 percent. What will now happen to the price of these bonds because of this change?

Back 48

The price will fall

Front 49

A stock is expected to pay a $2.00 per share annual dividend forever. If you would demand a 5% return from this stock, what is the most that you would be willing to pay for one share?

Front 50

In this course, do we assume that firms attempt to maximize shareholder wealth, stock price, earnings, or earnings per share? Why?

Back 50

We assume that firms attempt to maximize shareholder wealth, which means maximizing the firm’s stock price.

Front 51

Which of the following financial factors influence(s) a firm’s stock price?

projected earnings per share

methods of financing the firm

timing of future earnings per share

risk of the firm

amount of earnings paid as dividends

Back 51

All five items influence stock price.

Front 52

Will both the price per share of a firm’s common stock and the shareholder wealth of the firm’s shareholders be maximized when the earnings of the firm are maximized?

Back 52

No. Earnings by themselves ignore such important items as earnings per share, dividends, and investors' required rates of return given the risk of the firm.

Front 53

What is an operating loss, and what is its tax treatment?

Back 53

An operating loss means that the firm sold its goods or services for less than their cost; the firm is allowed to carry over (either backward or forward) these types of losses in order to offset past or future operating profits.

Front 54

What is the difference between a tax credit and a tax deduction?

Back 54

A tax credit is a subtraction from taxes due, and a tax deduction is a subtraction from taxable income. So, if a firm has $100,000 of taxable income and owes $10,000 in taxes, a $10,000 tax credit will reduce the firm’s tax bill to $0, whereas a $10,000 tax deduction will lower the firm’s taxable income to $90,000, and the firm will pay taxes on this new, lower taxable income amount.

Front 55

If a corporation receives a $1 dividend payment from another corporation, then how much of this $1 dividend must the receiving corporation include in its taxable income?

Back 55

$0.30, or 30 percent

Front 56

Last year, Firm X had $425,000 of income from operations, received interest of $10,000, paid interest of $15,000, received dividends of $50,000, and paid dividends of $150,000. What is Firm X’s tax bill for last year?

Back 56

$147,900. See Example 2 in the study notes.

Front 57

A corporation with a marginal tax rate of 30 percent owns a stock with a 15 percent before-tax dividend yield. What is this corporation’s after-tax dividend yield from this stock?

Back 57

he answer is 13.65 percent. Hint: The key is to remember that a corporate investor pays tax on only 30 percent of any dividends that it receives. Therefore, the corporation that receives this 15 percent before-tax dividend yield must only include 30 percent of it in its taxable income, and the corporation will owe 30 percent tax only on this (15% x 30%) amount. Thus, the corporation will pay (15% x 30% x 30%) in tax, or 1.35 percent, leaving 15 percent received – 1.35 percent paid in tax = 13.65 percent as its after-tax dividend yield.

Front 58

Over how many years is an asset actually depreciated for tax purposes if it is classified as a three-year asset under MACRS?

Back 58

Four

Front 59

What is the difference between depreciation for "tax" purposes and depreciation for "book" purposes? How much of an asset’s cost will be depreciated under each method?

Back 59

Depreciation for "tax" purposes is used on tax returns and depreciation for "book" purposes is used on income statements and balance sheets. A total of 100 percent of an asset’s total cost will be depreciated for tax purposes, but only the difference between the asset’s cost and its estimated salvage value will be depreciated for "book" purposes.

Front 60

Are interest and dividends that are paid by a corporation tax deductible by that corporation?

Back 60

No. Only interest payments are deductible.

Front 61

What would a firm owe in taxes if it earned $25,000 from operations, $10,000 from interest, and $50,000 from dividends and it paid only $15,000 in interest?

Back 61

$5250. See Example 2 in the study notes.

Front 62

Firm X has sales of $100,000, cash operating expense of $60,000, and depreciation expenses of $10,000. If it pays 40 percent of its income in taxes, then what is Firm X’s NOPAT?

Back 62

$18,000. See Example 1 in the study notes.

Front 63

What is the difference between an internal and an external ratio analysis?

Back 63

Internal ratio analysis looks at the trends within a given firm over time, whereas an external ratio analysis looks at how a firm compares to its competitors over a period of time.

Front 64

Why must ratio analyses be done over a period of time?

Back 64

Ratio analyses must be done over a period of time because it is the trends that are important, rather than the actual ratio numbers themselves. In other words, you wouldn’t usually care whether a given ratio was 1.21 or 1.29, but you would usually care that a given ratio had increased from 1.21 to 1.29 over the past year, and you would therefore want to know why this trend had occurred.

Front 65

What do liquidity, asset management, debt management, profitability, and stock market ratios measure?

Back 65

Liquidity ratios measure a firm’s ability or inability to meet current obligations. The basic ratios are (a) the current ratio and (b) the quick ratio.Asset management ratios measure how effectively a firm manages all of its assets and whether the level of assets owned is proper for the firm’s sales.Debt management ratios measure how effectively a firm uses borrowed money and how risky the loans are to lenders.Profitability ratios measure the combined effects of liquidity, asset management, and debt management on the profitability of the firm.Stock market ratios measure how well or how badly the stockholders feel management has done in managing the liquidity, assets, and debt of the firm.

Front 66

What is a DuPont ratio analysis? What benefit does it provide when compared to "regular" ratio analysis?

Back 66

The DuPont format breaks ROA and ROE into profitability and turnover components so that an analyst can see whether poor ROA or poor ROE is caused by poor profit margins or poor turnover.

Front 67

What limitations must be taken into consideration when performing a ratio analysis?

Back 67

A corporation with a large number of divisions or products may have a hard time finding comparable companies to compare itself to.Comparing your company to average companies might make you complacent about being average, too.Ratios can be distorted at different times of the year. For example, a canning company might have poor inventory turnover during the peak of the canning season but good inventory turnover six months later.Differing operating policies can distort comparisons between companies. For example, a company that leases fixed assets will have a better fixed asset turnover ratio than a company that buys its fixed assets.It is sometimes difficult to say whether a given ratio is "good" or "bad."

Front 68

What is a cash flow cycle?

Back 68

A cash flow cycle measures the length of time it takes a firm to start with cash, do something with the cash in order to make a sale, and get the cash back from the customer after the sale.

Front 69

What is the percent-of-sales forecast method used for?

Back 69

To forecast a balance sheet

Front 70

If money has time value, then what is the relationship between the future value of some amount of money and the amount that is invested today?

Back 70

The future value of some amount of money will always be bigger than the amount that must be invested today in order to get it. In other words, the future value will always be bigger than the present value if money has time value.

Front 71

Why must an investor who requires a 10 percent return from a two-year annuity receive annual payments of $57.62 from the annuity if he or she is willing to pay $100 for it?

Back 71

Because the present value of two sequential annual payments of $57.62, discounted at a 10 percent rate, equals $100. (See challenge question 9 and the answer, below. These two questions are related.)

Front 72

In a term-loan amortization schedule, what amounts will increase each year, decrease each year, and remain the same each year until the loan matures? What does a term-loan amortization schedule show?

Back 72

Increase each year: principal. Decrease each year: interest and remaining balance. Remain the same each year: payment. A term-loan amortization schedule shows payment, interest, principal, and remaining balance each year for a term loan.

Front 73

What happens to a present value amount as the discount rate increases without limit? Can the present value amount ever be negative if the number being discounted is positive?

Back 73

As the discount rate increases without limit, the present value decreases toward $0, but it can never be negative if the number that is being discounted is positive. In other words, as the discount rate increases, the smallest present value that any positive number can have approaches $0.

Front 74

An investor in considering purchasing an investment. Her analysis is that the investment will produce a cash flow of $2,000 per year forever. If this investor requires a return of 5 percent on investments of this type, what is the most she should be willing to pay for this investment?

Back 74

$40,000

Front 75

Suppose the present value of a two-year annuity is $2,000. If the discount rate is 6 percent, what must be the annuity’s annual cash flow?

Back 75

$1090.87

Front 76

Assume you borrow $10,000 for ten years at 10 percent interest under a term loan, with payments to be made at the end of each year. What is your yearly payment? How much interest do you pay in the first year?

Back 76

Yearly payment = $1627.45; interest in the first year = $1000 from the amortization table

Front 77

What is the maximum price that an investor should consider paying for five acres of land, assuming that the land will only produce one cash flow of $110,000 in one year and that the investor would require a return of 10 percent on investments of this type?

Back 77

The present value of what will be received is the maximum price that an investor should consider paying. This present value = $100,000.

Front 78

What annual annuity cash flow amount would be required in order to make the present value of the two-year annuity equal to $100, using a discount rate of 10 percent?

Back 78

By trial and error, the answer is $57.62. (See challenge question 2 and the answer, above. These two questions are related.)

Front 79

How does an investor value an investment that returns the same dollar amount forever? How does an investor value an investment that returns different dollar amounts for a finite period of time?

Back 79

For an investment that returns the same dollar amount forever, the dollar amount is just divided by the investor’s required rate of return. For an investment that returns different dollar amounts for a finite period of time, each dollar amount is discounted by the investor’s required rate of return, and the results are added together.

Front 80

Why does an increase in overall interest rates cause prices on existing bonds to decrease?

Back 80

Because investors will want a higher return from any given bond when they see overall interest rates increasing, and since what they receive from any given bond is set and unchanging, the only way they can get a higher return from any given bond is to pay less for it.

Front 81

What is the yield to maturity (YTM), and what must an investor know in order to compute it?

Back 81

The yield to maturity is the return that the investor would receive if the bond were held until it matured. An investor must know the bond’s life, par value, and coupon rate in order to compute the yield to maturity.

Front 82

Does the length of time an investor holds a share of stock affect the amount she or he would be willing to pay for the share of stock? Does the dividend an investor will receive while holding a share of stock affect the amount she or he would be willing to pay for the share of stock?

Back 82

The length of time an investor holds a share of stock does not affect the amount she or he would be willing to pay for the share of stock. The dividend an investor will receive while holding a share of stock does affect the amount she or he would be willing to pay for the share of stock.

Front 83

A national manufacturer has experienced a number of lawsuits recently. The firm has a bond issue outstanding with twenty years to maturity and a coupon rate of 8 percent (paid semiannually). Because of these lawsuits, the market’s required rate on the bonds has now risen to 16 percent. What will therefore happen to the price of these bonds because of this change?

Back 83

Because investors will want a higher return from this bond, and since what they receive from this bond is set and unchanging, the only way they can get a higher return from this bond is to pay less for it. Therefore, the price will fall.

Front 84

If a bond sells at a discount, then is its yield to maturity more or less than its coupon rate?

Back 84

More

Front 85

Firm X last paid a dividend of $3.69, and dividends are expected to grow at 20 percent for the next three years and at 4 percent every year thereafter. If investors require an 18 percent return from Firm X stock, then what is one share of Firm X stock worth today?

Back 85

$40.31. See Example 4 in the study notes.

Front 86

A bond pays 6 percent annual interest and matures in five years, and you require a 6 percent annual return from it. Another bond pays interest of 6% compounded semiannually, and you require a 6 percent return compounded semiannually from it. What is the difference in value to you of these two bonds?

Back 86

$0, because if the bond pays x% return and you require an x% return, then it will sell for $1000 par. Since both bonds sell for $1000 par, there is no difference in price.

Front 87

Would the stock valuation models that have been discussed in this lesson be helpful in valuing the common stock of a firm that currently pays no dividends?

Back 87

Yes, because eventually the firm will have to start paying dividends, and we can use the supernormal growth model for this type of stock.

Front 88

Bond X pays 10 percent interest compounded semiannually for 10 years and you require a 3 percent return from this bond every six months. Bond Y pays 10 percent interest annually for 10 years and you require a 6 percent annual return from this bond. How much more should you be willing to pay for Bond X?

Back 88

The semi-annual bond price = $50(PVIFA 20,3%) + $1000(PVIF 20,3%) = $1297.58. The annual bond price = $100(PVIFA 10, 6%) + $1000(PVIF 10,6%) = $1294.41.The difference of $3.17 is the value of the compound interest, or the amount that Bond X’s value exceeds Bond Y’s value, and this is how much more you would be willing to pay.