Intro To Financial Management Midterm 1

Front 1

What is the goal of financial management within a corporation.

Back 1

Maximize current stock price
Maximize shareholder wealth

Front 2

Agency Problem

Back 2

When a corporate manager owns < 100% of the outstanding common stock.
Result: Behavior that is NOT ultimately in the best interest of the shareholder.

Front 3

What makes managers act in shareholders best interests?

Back 3

Pos: Structure of compensation package
Neg: threat of being fired by shareholders, or a threat of hostile take over.

Front 4

Corporate Ethics and social responsibility

Back 4

Corporate scandals increased corporate, consumer, and investor focus on ethics and social responsibility.
CSR- Corporate social responsibility.
Socially responsible actions can be costly but it can still enhance the firms value. (Firms get money for doing the right thing)

Front 5

Financial Markets

Back 5

mechanism for bringing borrowers and lenders together.

Front 6

Money Market

Back 6

short-term debt securities

Front 7

Capital Market

Back 7

equity (stock) and longer- term debt securities

Front 8

Primary Market

Back 8

original sale of securities by governments and corporations

Front 9

Secondary Market

Back 9

sale of securities after initial issue. ( The originator is not involved in secondary markets.
Ex: If IBM passes the stock on, they are not involved in the second market. It is although important to have a secondary market. The value will drop if there isn't an active secondary market.

Front 10

What is the fundamental relationship characterized by the balance sheet?

Back 10

Assets= liabilities+ owners equity

Front 11

Liquidity

Back 11

the ability of an asset to be quickly converted to cash with little or no loss in value.
The more liquid your assets the easier it is to pay your bills. But, assets that are the most liquid are the least productive.

Front 12

What is the most liquid asset

Back 12

Cash

Front 13

Liquidity tradeoff

Back 13

liquid assets reduce probability of financial distress, but they yield smaller returns.

Front 14

Dividend Payout ratio

Back 14

dividends paid/ net income

Front 15

retention ratio

Back 15

1- DPR

Front 16

EPS- earnings per share

Back 16

Net income/ shares outstanding

Front 17

DPS- Dividends Per Share

Back 17

Dividends paid/ shares outstanding

Front 18

EBITDA

Back 18

EBIT (earnings before interest on taxes)+ depreciation expense

Front 19

EBT

Back 19

EBIT- interest expense

Front 20

NOPAT

Back 20

EBIT- Taxes
not a line on the income statement

Front 21

When will accounting income vs. cash flow differ?

Back 21

Recording of revenues and expenses might not match timing of cash flows.
Non cash items (depreciation expense) reduced account income but we don't actually pay it out.

Front 22

what are the sources of cash identified on the balance sheet as?

Back 22

Decreases in assets
Increase in equity and liabilities

Front 23

What are the uses of cash identified on the balance sheet?

Back 23

Increase in assets
decrease in equity and liabilities
Ex: Pay off a loan

Front 24

Cash flow identity
Cash flow from assets=

Back 24

CF to creditors+ CF to stockholders

Front 25

What does the cash flow from assets tell us?

Back 25

How much cash is needed above and beyond what is needed to operate a company.
Need 2 balance sheets and and income statement

Front 26

Cash flow from assets=

Back 26

Operating CF (OCF) - net capital spending- change in NWC

Front 27

net working capital=

Back 27

current assets- current liabilities

Front 28

OCF=

Back 28

find this first
EBIT + depreciation - taxes

Front 29

Net capital spending=

Back 29

end net fixed assets- beg. net fixed assets + depr. expense

Front 30

Change in NWC=

Back 30

end NWC- beg. NWC

Front 31

Cash flow to creditors/ bondholders=

Back 31

interest paid- net new borrowing
Net new borrowing= change in long term debt= this years- last years

Front 32

Cash flow to stockholders=

Back 32

dividends paid- net new equity raised
Net new equity raised= change in common stock and paid- in capital= this years equity- last years equity

Front 33

Sarbanes- Oxley Act of 2002
What is it?
Who promoted it?
What are some provisions?
Is it working?

Back 33

Public company accounting reform and investor protection act.
enron and other scandals
- CEO's and CFO's must verify financial statements
-no personal loans to company excess
- independent auditing committee
-rotate lead auditing firm at least every 5 years.

Front 34

liquidity ratios

Back 34

Current ratio
quick ratio
cash ratio

Front 35

current ratio

Back 35

CA/CL

Front 36

Quick ratio

Back 36

(CA - INV)/ CL

Front 37

Leverage ratios

Back 37

total debt ratio
debt- equity ratio
equity multiplier
times interest earned ratio
cash coverage
long- term debt ration

Front 38

Total debt ratio

Back 38

D/A
total liability/total assets

Front 39

debt- equity ratio

Back 39

D/E
total liability/ owners equity

Front 40

equity multiplier

Back 40

= Ttl assets / Ttl owners' equity

A/E= 1 + D/E
total assets/ owners equity= 1 + total liability + total liability/owners equity

Front 41

long-term debt ratio=

Back 41

long term debt/ total assets

Front 42

times interest earned ratio

Back 42

EBIT/ interest expense

The higher this is the more solvent we are

Front 43

cash coverage

Back 43

EBIT+ depreciation expense/ interest expense

Front 44

days sales outstanding

Back 44

AR/(Sales/365)

Front 45

fixed assets turnover

Back 45

sales/ net fixed assets

Front 46

total assets turnover

Back 46

sales/ assets

Front 47

capital intensity ratio

Back 47

assets/ sales

Front 48

profitability ratios

Back 48

profit margin
return on assets (ROA)
Return on Equity (ROE)

Front 49

Profit margin

Back 49

net income/ sales

Front 50

return on assets (ROA)

Back 50

net income/ assets

or

(NI/Sales) x (Sales/Assets)

or

Profit Margin x Ttl Asset Turnover

Front 51

return on equity (ROE)

Back 51

net income/ total owners equity

or

(NI/Sales) x (Sales/Assets) x (Assets/Equity)

or

Profit Margin x Ttl Asset Turnover x Equity Multiplier

Front 52

What are some problems regarding profitability ratios

Back 52

numerator (NI) can be misleading
ROE denominator (equity) can be altered by changing capital structure

Front 53

what is the alternative profitability measure

Back 53

Basic earning power: EBIT/ Assets

Front 54

market value ratios

Back 54

price/earnings ratio
market/book ratio

Front 55

price/ cash flow ratio

Back 55

Price per share / Cash flow per share

Cash flow per share = (NI + Dep)/Shares outstanding

Front 56

price/ sales ratio

Back 56

Price per share / Sales per share

Front 57

ROA

Back 57

NI/A= profit margin X total asset turnover

Front 58

ROE

Back 58

NI/Equity= Profit margin X Ttl Asset Turnover X equity multiplier

Front 59

How do we choose benchmark firms

Back 59

identify competitors (individual firms or groups of firms in the same industry)
SIC codes: standard industry classification (4- digits)
NAICS: North American Industry classification system ( 5-6 digits)
use various databases to find firms with matching industry codes
other sources provide industry wide ratios, broken down by industry code or description

Front 60

what are the standardized financial statements?

Back 60

Common size statements
common base year statements
They detect trends; compare across firms.

Front 61

common size statements

Back 61

balance sheet: express amounts as % of assets
Income statement: express amounts as % of sales

Front 62

common base year statements

Back 62

select your base year, express all amounts as % of base year values.
This helps you look at trends.
It is not in place of ratios, it is just a compliment.

Front 63

To evaluate a firms financial position

Back 63

break down cash flows OFC from assets, etc.
common base year statements/ trend analysis
common size statements/ benchmark comparisons
ratios--> evaluate over time and compare to benchmarks
careful choice of benchmarks is crucial to meaningful analysis.

Front 64

What is the most common forecasting approach?

Back 64

Percentage of Sales Approach

(What we used for Binky and Dora)

Front 65

What are the two types of forecasting for special case benchmarks?

Back 65

Internal growth rate
sustainable growth rate

Front 66

Internal growth rate

Back 66

maximize growth rate "g" in assets, and sales. A firm can achieve with no new external financing.

Front 67

What does the internal growth rate assume?

Back 67

Targeted ratios of DPR, NI/S, A/S
no new stock or debt issues

NI/S=> as sales go up cost goes up and NI stays constant
A/S=> total asset turnover

Front 68

sustainable growth rate

Back 68

max growth rate "g" in assets with NO new external equity financing

Front 69

what does the sustainable growth rate assume?

Back 69

Targeted rations of DPR, NI/S, A/S, D/E
no new stock issues
Sustainable growth rate should be higher than internal growth rate.

Front 70

Future value and compounding

Back 70

The amount of money on investment will be worth at a given point in the future at a given interest rate.

Front 71

What are the forecasting issues?

Back 71

Lumpy assets- not every asset can be added in whatever increment you want.
excess capacity- assets will be forecasted to increase at a smaller percentage than the sales increase, or perhaps not at all.

Front 72

What are the trends in forecasting and planning?

Back 72

Use the rolling forecast. Forecast rolls several months or quarters into the future with each new update.
use 12 months or 4 quarter horizons
able to adapt well in changing conditions

Front 73

Forecasting

Back 73

Frequency of updates of forecasts: about 1/3 each update.
-1X/ quarter
-1X/ monthly
-1X/ year or as events warrant

Front 74

What are the perceived benefits of Better forecasts?

Back 74

1. avoid performance surprises
2. managing working capital and profitability
3. Not so much to company regulations

Front 75

Time value of money

Back 75

a dollar in hand today is worth more than a dollar tomorrow.

Front 76

Simple interest

Back 76

You only earn investment on original principal

Front 77

compound interest

Back 77

earn interest on the principal and the interest.
we always assume compound interest

Front 78

Future value of a Lump Sum equation

Back 78

FV= PV( 1+i) ^n
i= interest rate per period
FV= future value
PV= present value (initial lump- sum investment)
n= number of periods

Front 79

annuity

Back 79

finite level stream of cash flows

Front 80

ordinary annuity

Back 80

also called "deferred" annuity. Cash flows occur at the END of each period.
Ex: You make end of month payments.

Front 81

Annuity due

Back 81

Cash flows occur at the beginning of each period.

Front 82

Present value of annuity equation

Back 82

PVA=pmt[1-1/(1+i)^n/i
assumes end of period payments

Front 83

PVA

Back 83

The PVA is 1 CF- period BEFORE the 1st pmt.
The present value of each payment should be getting smaller.

Front 84

Perpetuities

Back 84

series of level cash flows forever

Front 85

Present value of a perpetuity

Back 85

pmt/i
*formula assumes end-of-period Cash Flows.

Front 86

Effective annual rate
EAR=

Back 86

Compounds
(1+q/m)^m -1
where:
q= quoted rate per yer
m= number of compounding periods per year

Front 87

How do you find effective rates

Back 87

= (1+ APR per compounding period) ^ #compounding periods in the STP-1

Front 88

what effective IR do you use for annuities?

Back 88

Interest rate must correspond to timing of cash flows
Ex: annual cash flows=> use EAR