Unit 2 — Extra Materiall

Balance Sheet

A snapshot of a firm's assets, liabilities, and stockholders' equity at a specific point in time.

In what order are assets listed on a balance sheet?

In order of liquidity.

Why can high liquidity be beneficial?

Liquid firms are less likely to experience financial distress.

What is a disadvantage of holding highly liquid assets?

Liquid assets generally earn lower returns.

Liquidity Trade-Off

A firm must balance the safety of liquid assets against the potentially higher returns of less-liquid assets.

Tangible Fixed Assets

Physical long-term assets, such as buildings, equipment, and machinery.

Intangible Fixed Assets

Nonphysical long-term assets, such as patents, trademarks, and goodwill.

Book Value

The value of assets, liabilities, or equity as reported on the balance sheet.

Market Value

The price at which assets, liabilities, or equity can actually be bought or sold.

Are book value and market value always the same?

No. They are often very different.

Which is generally more important for financial decision-making: book value or market value?

Market value, because financial decisions focus on the current economic value of assets and the firm.

Income Statement

A financial statement showing a firm's performance over a specified period of time.

Balance Sheet vs. Income Statement

A balance sheet is a snapshot at one point in time; an income statement shows performance over a period of time.

How is an income statement generally organized?

Revenues are reported first, followed by expenses that are deducted to determine income.

Matching Principle

Under GAAP, revenue is recognized when it accrues and the expenses required to generate that revenue are matched to it.

Noncash Items

Expenses charged against revenues that do not directly affect cash flows (CFs).

What is an example of a noncash expense?

Depreciation.

EBIT

Earnings Before Interest and Taxes.

EBT / Taxable Income

Earnings after interest expense but before taxes.

What tax rate should generally be used when evaluating a project that increases taxable income?

The marginal tax rate.

Why use the marginal tax rate when evaluating a new project?

Because it represents the tax rate applied to the additional income generated by the project.