Bus 170 Sjsu Mid 1

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excludes inventory from current assets

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quick ratio is

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measures how a firm keeps costs of production and operating expenses low

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Operating Profit Margin

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how many dollars of income earned for each dollar invested by owners

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equity ratio

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how effective the firm is in using its fixed assets to generate sales

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asset turnover ratio

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how efficient the firm is in converting inventory into cost of goods sold

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inventory turnover ratio

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6. If the current ratio is 2.5 to 1, and the rule of thumb is 2.0 to 1, this means the firm

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c. Is more liquid; can pay off short term debt more easily

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7. The ratio that measures how long it takes the firm on average to collect its credit sales from its customers is called:

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b. The average collection period

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8. Return on assets can best be explained as

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b. how much income each dollar of assets generates

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9. A debt to total asset ratio of 75% means

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d. 75% of assets are financed by the firm’s lenders

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10. Given the following information for XYZ Corporation, calculate the price/earnings (P/E) ratio:
Earnings Per Share = $2.50 Book Value per Share = $7.00
Market price per share = $45.00 Shares outstanding = 100,000
Net Earnings = $250,000

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b. 18.0

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The more risk an investment has, the higher its expected return should be

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The Risk-Return Trade-off

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A dollar received today is worth more than a dollar received in the future
If you receive a dollar today, you can invest it and earn more

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The Time Value of Money

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You can not spend “profit” or “net income”. These are paper figures only
Cash is what is received by the firm and can be reinvested or used to pay bills
Cash flow does not equal net income; there are timing differences in accrual accounting between when you record a transaction and when you receive or pay the cash

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Cash is King

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It’s only the increase or decrease in cash that really counts
It’s the difference between cash flows if the project is done versus if the project is not done
Consider all related cash flows, i.e., equip., inventory, etc.
“Brief case” example

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Incremental Cash Flows

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It’s hard to find and maintain exceptionally profitable projects
High profits attract competition
How to keep very profitable projects
Product differentiation (Kleenex, Xerox)
Low cost (Costco, Honda)
Service and quality (Mercedes, Lexus)
Give examples for each of the above

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Curse of Competitive Markets

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The markets are quick and the prices are right
Information is incorporated into security prices at the speed of light!
Assuming the information is correct, then the prices will reflect all publicly available information regarding the value of the firm
Example: announcing a stock split

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6. Efficient Capital Markets

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Managers are typically not the owners of a company
Managers may make decisions that are in their best interests and not in line with the long term best interests of the owners
Example, cutting Research and Development costs on new products to maximize current income
Pay for performance; stock options

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7. The Agency Problem

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Because cash is king, we must consider the after-tax cash flow on an investment
The tax consequences of a business decision will impact (reduce) cash flow
Companies are given tax incentives by the government to influence their decisions
Examples : investment tax credit and environmental credits reduce taxes; purchase of Prius’

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8. Taxes Bias Business Decisions

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Some risk can be diversified away and some cannot
Don’t put all your eggs in one basket
Diversification creates offsets between good results and bad results
Example: drilling for oil wells

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All Risk is Not Equal

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Ethical Dilemmas are everywhere in finance; just read the news (back date stock options, Madoff)
Unethical behavior eliminates trust, results in loss of public confidence
Shareholder value suffers and it takes a long time to recover
Social responsibility means firms have to be responsible to more than just owners
- all stakeholders! i.e., BP

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Ethical Behavior Means Doing the Right Thing

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maximize the wealth of the firm’s owners (or the value of the firm).

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Basic Goal of the Business Firm

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The value of a firm is determined by what people are willing to pay for it.
The financial manager should make decisions that cause people to think more favorably about the firm.
Value depends on future prospects and risk.

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Maximizing the“value” of a firm

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Factors that affect the value of a firm’s stock price:

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Amount of cash flows
Timing of cash flows
Risk of cash flows

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Revenues - Expenses = Net Income

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Income Statement

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Assets = Liabilities + Owners’ Equity

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Balance Sheet

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Annual report includes:

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Balance sheet
Income statement
Statement of cash flows
Accompanying notes

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Market Value & Book Value can be very different.

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Changes in book value (depreciation) follow specified accounting rules.
Book Value is recorded initially at cost.
Book value rarely considers what you can sell the asset for, i.e., a car

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“the difference in the interest rates and the time until a liability must be paid off ”.

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The main factor that determines the difference
between market and book values for liabilities
of a healthy firm is:

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Market Book Value of Liabilities

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At maturity, the market value will equal the
book value.

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is the market price per share times the number of shares outstanding.

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Total Market Value of Equity

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equity reflects the changes in the other asset and liability accounts.

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Book Value

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Depreciable basis of an asset:
Total amount to be depreciated over the
accounting life of the asset.
Equal to cost of the asset plus any setup
and delivery costs incurred.

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Depreciation

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Basis divided by accounting life with equal amounts of depreciation allocated to each time period

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Straight line depreciation

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Tax Rate on the next dollar of income. Used when evaluating investment proposals.

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Marginal

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Average tax rate increases with the level of taxable income.

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Progressive Tax System

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you can just use 34% as the tax rate

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Hint: Once taxable income is more than 335,000, up to 10,000,000

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Interest paid on corporate debt

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is a tax deductible expense.

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Dividends paid to common and preferred stockholders

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is not tax deductible.

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Financial managers use ratios

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to interpret the raw numbers on financial statements

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Measure the overall effectiveness of the firm’s management.
AND
Did management’s decisions result in satisfactory returns to the owners

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Profitability Ratios

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How effective is the firm at generating revenue in excess of its cost of goods sold?

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Gross Profit Margin

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How effective is the firm in keeping costs of production and administration low?

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Operating Profit Margin =

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How much net profit is being generated from each dollar of sales?

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Net Profit Margin =

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How effectively is the firm generating net income from its assets ?

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Return on Assets =

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How well is the firm generating return to its equity providers?

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Return on Equity

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Are there sufficient current assets to pay off current liabilities? What is the cushion of safety?

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Current Ratio

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What happens to the firm’s ability to repay current liabilities after what is usually the least liquid of the current assets (Inventory) is subtracted?

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Acid-Test Ratio

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Measure the ability of the firm to meet its short-term financial obligations.

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Liquidity Ratios

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Measure the relative size of the firm’s debt load and the firm’s ability to pay off the debt.

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Debt Ratios

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What proportion of the firm’s assets is financed with debt?

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Debt Ratios

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What is the proportion of debt relative to equity financing for the firm?

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Debt to
Equity Ratio

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What is the firm’s ability to repay interest payments from its operating income?

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Times Interest Earned Ratio

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Help assess how effectively the firm is using assets to generate sales

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Asset Activity Ratios

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How long does it take for the firm on average to collect its credit sales from customers?

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Average Collection Period

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How frequently is inventory being converted into product for sale?

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Inventory Turnover Ratio =

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How effective is the firm in using its fixed assets to help generate sales?

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Fixed Asset Turnover Ratio

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How effective is the firm in using its overall assets to generate sales?

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Total Asset Turnover Ratio

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How much are investors willing to pay per dollar of earnings of the firm?

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Price to Earnings Ratio

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How much are investors willing to pay per dollar of book value?

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Market to Book Ratio =

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Net income - Retained Earnings =

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Dividends

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After tax cash flow is used when making a decision on investing. Which tax rate is used to calculate after tax cash flow?

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Marginal

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Depreciation is

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a tax deductible non-cash expense

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Calculate operating/Income(loss) (EBIT) given the following information:
Depreciation 100
Marketing Expense 50
Revenue 600
Interest Exp. 25
COGS 250

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200
Rev 600
COGS -250 =
GP:350
Dep. -100
Mark Exp -50 =
200

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A use of cash that would appear on Statement of Cashflows:

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Decrease in Notes Payable
Lv-out

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Firms dividends are paid out of Ret Earn

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True
NI-RE=Divs

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Change in cash is $5000 Cash flow spent is $7500
Cash flowrasied from financing is $2500
What is CASH FLOW

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Cash $10000
Invest -7500
Financing 2500 =
Delta $5000

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As people take on new tasks it is hard to coordinate activities and know who is accountable.

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Design Challenge 1:

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Specified tasks/roles decrease coordination /communication.

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Design Challenge 2:

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Differentiation Balancing Integration

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Design Challenge 2:

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Miss opportunities & decision-making is slow because people don’t take risks/responsibility.

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Design Challenge 3:

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Centralization Balancing Decentralization

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Design Challenge 3:

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Too much emphasis is placed on the rules & company loses ability to adapt.

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Design Challenge 4:

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Standardization Balancing Adjustment

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Design Challenge 4:

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Process used to allocate resources, and establish task and authority relationships.

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Differentiation:

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Establishes: ___________, which controls level of specialization.

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Division of Labor

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Division of labor is Low
Differentiation is Low

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Simple Organization