FIN 300 Exam 1 "Study Guide" Tsarsis

Role of Financial Manager

Make decisions on behalf of the firm's investors

For good decisions, the benefits exceed the costs

Stakeholder Theory

A theory that holds that social responsibility is paying attention to the interest of every affected stakeholder in every aspect of a firm's operation

Capital Budgeting

the process of analyzing the needs of the business and selecting the assets that will maximize its value

Financing decision/Capital structure decision

How will the company obtain investment capital to obtain its productive assets?

Financing Decision

How a firm builds the liability and equity side of the balance sheet to finance its investments. Whether the firm chooses to finance (pay) for its assets through using debt, or issuing equity.

equity

ownership of assets that may have debts or other liabilities attached to them

Goal of the firm

maximize profit

Agency Conflict

the possibility of conflict of interest between the stockholders and management of a firm

Agency Relationship

relationship between stockholders and management

Alignment of goals of shareholders to managers

Sarbanes-Oxley Act (SOX)

Regulations passed by Congress to reduce unethical corporate behavior.

FED

the Federal Reserve System (the nation's central banking organization)

FED goals

1) Maximum Employment

2) Price Stability

3) Financial Market Stability

FED tools

open market operations, discount rate, reserve requirement

open market operations

the buying and selling of government securities to change the supply of money

discount rate

rate the Federal Reserve charges for loans to commercial banks

Reserve Requirements (RR)

- affect how much money banks can create by making loans

- the fraction of deposits banks must hold in the vault or on deposit at the FED

Financial Markets

markets where financial securities, such as stocks and bonds, are bought and sold

Primary markets versus secondary markets

-Primary markets are the markets in which corporations raise new capital. The corporation selling a newly created stock receives the proceeds from the sale in a primary market transaction (Business/Gov to Investor)

-Secondary markets are markets in which existing, previously issued securities are traded among investors. (investor to investor)

EMH (efficient market hypothesis)

Theory describing the behavior of an assumed "perfect" market in which (1) securities are in equilibrium, (2) security prices fully reflect all available information and react swiftly to new information, and (3), because stocks are fully and fairly priced, investors need not waste time looking for mispriced securities.

Securities

stocks and bonds

real versus nominal interest rates

- a nominal interest rate makes no allowance for inflation

- the real interest rate is the amount of extra purchasing power a lender must be paid for the rental of his/her money

--- the ex ante real interest rate is adjusted for expected changes in the price level

---the ex post real interest rate is adjusted for actual changes in the price level

Fisher Equation

states that the real interest rate equals the nominal interest rate minus the inflation rate

real interest rate = nominal interest rate - inflation rate

nominal interest rate = real interest rate + inflation rate

real interest rate formula

= nominal interest rate - inflation rate

nominal interest rate formula

= real interest rate + inflation rate

Annual report

a yearly statement of the financial condition, progress, and expectations of an organization

annual report includes

1. Financial statements.

2. Management discussion and analysis.

3. Notes to the financial statements.

4. Auditor's report.

balance sheet

A financial statement that reports assets, liabilities, and owner's equity on a specific date.

income statement

A financial statement showing the revenue and expenses for a fiscal period.

RE statement

• The revision and publication of one or more of a company's previous financial statements

• Necessary when it is determined that a previous statement contains a material inaccuracy

• Company must file a form 8-K within four days to notify investors of non-reliance on previously issued financial statements

Beg RE

+ NI

-Dividends

End RE

Statement of Cash Flows

A financial statement that provides financial information about the cash receipts and cash payments of a business for a specific period of time.

Statement of Cash Flows Equation

Cash flows from operating activities + cash flows from investing activities + cash flows from financing activities = change in cash

CFO +/- CFI +/- CFF = Change in Cash

current assets

cash and other assets expected to be exchanged for cash or consumed within a year

current liabilities

debts of the business that must be paid within the next accounting period

Current Ratio Formula

= current assets/current liabilities

net working capital formula

= current assets - current liabilities

Current Ratio Definition

measures a company's ability to repay debt in the short term

Treasury Stock

A corporation's own stock that has been reacquired by the corporation and is being held for future use (later reaquired)

Market Value vs. Book Value

The balance sheet provides the book value of the assets, liabilities, and equity.

Market value is the price at which the assets, liabilities, or equity can actually be bought or sold.

Impact of taxes on corporations

Taxes of a Corporation

A corporation is a taxable entity; it must pay income taxes on its profits and also file a tax return, dollar is taxed twice before it is deposited by shareholder

corporate income tax (CIT)

The United States imposes a tax on the profits of US resident corporations up to a maximum rate of 35 percent. The corporate income tax is the third largest source of federal revenue

Financial Ratios

relationships determined from a firm's financial information and used for comparison purposes

financial ratio analysis

a technique for measuring the performance of a firm according to its balance sheet, income statement, and market valuation

financial performance

how successful or not a company is in a financial way

revenue recognition, cash flow, payment guarantees, credit rating, stock price

financial ratio interpretations

ROE (Return on Equity)

= Net Income/Total Equity

quick ratio

= (Current Assets - Inventory) / Current Liabilities

current ratio

= current assets - current liabilities

Quick Ratio Definition

The Quick Ratio is a measure of a business' ability to pay its short term obligations that is a more strict test than the current ratio.

inventory turnover formula

= cost of goods sold/average inventory

inventory turnover definition

Number of times inventory is sold and replaced

total asset turnover formula

= net sales/average total assets

total asset turnover definition

measures how efficiently a company's assets are being used to generate sales

debt ratio formula

= Total Liabilities/Total Assets x 100

Equity Multiplier (EM) formula

= Total Assets/Total Equity

Equity Multiplier definition

indicates the portion of a company's assets that are funded by equity

profit margin formula

= net income/net sales

profit margin definition

measure of the firm's operating efficiency - how well it controls costs

(measures the income earned on each dollar of sales)

ROA (Return on Total Assets)

= Net Income/Total Assets

ROA definition

indicator of how profitable a company is relative to its total assets

EPS (earnings per share)

= net income/# of shares

EPS definition

the portion of a company's profit allocated to each outstanding share of common stock

PE (Price Earnings)

the price of a share divided by the company's earnings in the past year

PE (price earnings ratio)

= price per share/earnings per share

Market to Book Ratio

= market value per share/book value per share

DuPont Formula (ROE)

= Net Profit Margin x Total Asset Turnover x Equity Multiplier

Enterprise Value (EV)

A measure of a company's total market value from which the value of cash and short-term investments have been subtracted.

Enterprise Value Formula

EV = Equity Value + Debt + Preferred Stock + Minority Interest - Cash

minority interest

a subsidiary company's equity that is held by stockholders other than the parent company

trend analysis

an analysis that focuses on aggregate sales data over a period of many years to determine general trends in annual sales

peer analysis

•using other firms in same period as benchmark

TVM (Time Value of Money)

Addresses the concept that a dollar today is better than a dollar tomorrow due to inflation

Future Value (FV)

the amount to which a cash flow or series of cash flows will grow over a given period of time when compounded at a given interest rate

Future Value Formula

FV=PV(1+r)^n

Present Value (PV)

the current value of future cash flows discounted at the appropriate discount rate

Present Value Formula

PV=FV/(1+r)^n

compounding

the process of accumulating interest on an investment over time to earn more interest

(the process in which interest is earned on both the principal and on any previously earned interest)

Continuous Compounding

Compounding interest literally all the time. Equivalent to compounding interest an infinite number of times per year.

continuous compound interest formula

A=Pe^rt

A: total amount after t years

P: original investment

r: interest rate per year

t: number of years

e is a mathematical constant where e ≈ 2.7183.

discounting

- the process of finding present value; the inverse of compounding to find future value

- The process of finding the present value of a cash flow or a series of cash flows; discounting is the reverse of compounding.

discounting formula

PV=FV/(1+r)^t

cash flows over time

Cash flows over a project's life should include _____.

depreciation and amortization expenses

Depreciation Expense

The portion of the cost of a fixed asset that is recorded as an expense each year of its useful life.

depreciation expense formula

= (cost - salvage value) / useful life

Amortization

the reduction of a loan balance through payments made over a period of time

Amortization Expense Formula

= (cost-residual value)/useful life

Amortization Expense

Operating Expense, Income Statement, Debit

PV of multiple cash flows

PV of Multiple Cash Flows Formula

Annuities

annual payments from the government

Annuities (Ordinary & Due)

PV of an annuity

=(PV) How much you should pay for the whole deal right now

PV of an Annuity Formula

= C*(1-(1/(1+r(^t)/r)

FV of an annuity

=What the annuity will be worth after all payments have been received

FV of Annuity Formula

=

perpetuities

an annuity that continues to pay forever

annuities with infinite lives

PV perpetuities = PMT/(discount rate)

Preferred Stock Dividends

Fixed. Have priority over common stock dividends.

stock dividend

Corporation's distribution of its own stock to its stockholders without the receipt of any payment.