COB 300 Finance- Final Exam

Preemptive right

a provision in the corporate charter or bylaws that gives common stockholders the right to purchase on a pro rata basis new issues of common stock

Market Price

the price at which a stock sells in the market

Growth Rate

the expected rate of growth in dividends per share

Required Rate of Return

the minimum rate of return on a common stock that a stockholder considers acceptable

Expected Rate of Return

the rate of return on a common stock that a stockholder expects to receive in the future

Dividend Yield

the expected dividend divided by the current price of a share of stock

Horizon Date

the date when the growth rate becomes constant

Horizon Value

the value at the horizon date of all dividends expected thereafter

Bond

a long-term debt instrument

Treasury Bonds

bonds issued by the federal government, sometimes referred to as government bonds

Corporate Bonds

bonds issued by corporations

Municipal Bonds

bonds issued by state and local governments

Par Value

the face value of a bond

Coupon Payment

the specified number of dollars of interest paid each year

Coupon Interest Rate

the stated annual interest rate on a bond

Call Provision

a provision in a bond contract that gives the issuer the right to redeem the bonds under specified terms prior to the normal maturity date

Sinking Fund Provision

a provision in a bond contract that requires the issuer to retire a portion of the bond issue each year

Discount Bond

a bond that sells below its par value

Premium Bond

a bond that sells above its par value

Yield to Maturity

the rate of return earned on a bond if it is held to maturity

Yield to Call

the rate of return earned on a bond when it is called before its maturity

Target Capital Structure

the mix of debt, preferred stock, and common equity the firm plans to raise to fund its future projects

Capital Components

one of the types of capital used by firms to raise funds

WACC

a weighted average of the component costs of debt, preferred stock and common equity

Flotation Cost

the percentage cost of issuing common stock

Capital

investors-supplied funds such as long- and short- term loans from individuals and institutions, preferred stock, common stock, and retained earnings

Optimal Capital Structure

the capital structure that maximizes a stock's intrinsic value

Business Risk

the riskiness inherent in the firm's operations if it uses no debt

Operating Leverage

the extent to which fixed costs are used in a firms operations

Operating Breakeven

the output quantity at which EBIT= 0

Financial Risk

an increase in stockholders risk, over and above the firms basic business risk, resulting from the use of financial leverage

Financial Leverage

the extent to which fixed-income securities are used in a firm's capital structure

Unlevered Beta

the firms beta coefficient if it has no debt

Trade-Off Theory

the capital structure theory that states that firms trade off the tax benefits of debt financing against problems caused by potential bankruptcy

Symmetric Information

The situation where investors and managers have identical information about firms' prospects

Asymmetric Information

the situation where investors and managers have identical information about firms prospects than do investors

Signal

an action taken by management that provides clues to investors about how management views the firms prospects

Pecking Order

the sequence in which firms prefer to raise capital: first spontaneous credit, then retained earnings, then other debt, and finally new common stock

Objective of financial management

maximize owners wealth

Disadvantage of a proprietorship

proprietor is exposed to unlimited liability

Adding a covenant to bond agreements....

reduces conflict between stockholders and bondholders

Most business are conducted in

corporations

4 Basic Financial Statements

the balance sheet, the income statement, statement of cash flows, statement of stockholders equity

What is finance and why should everyone understand basic financial concepts?

Finance is decisions about money

What event of the 20th century caused the most significant change in financial regulation in the nation's history?

The great depression

What is value? How do you maximize it?

value is the worth of the future cash flows, stated in current dollars that an asset is expected to generate during its life.
To maximize value, various strategies and techniques are utilized to increase the marker value of a firms assets, debt and equity

Which form of business offers the lowest owner liability and maximum ability to raise funds?

A Corporation

What is the most important thing finance analyzes?

cash flows

What is the risk reward relationship?

the greater the risk, the greater the expected return

Variance, standard deviation and beta are all measures of volatility, and this volatility is commonly referred to as.....

Risk

What is the process used to minimize risk in a portfolio?

Diversification

What is the formula for the expected return of a portfolio?

Summation of the weight of the portfolio times the return on that portfolio

What is the formula for correlation coefficient?

COVxy / standard deviation of x X standard deviation of y

What is capital structure?

Mix of debt, common equity and preferred equity that is used to finance a firm's assets

Relationship between operating earnings and fixed costs is called.....

Degree of operating leverage

The firms optimal capital structure is the point where....

value of the firm is maximized(highest stock price) and WACC is minimized

What type of financial assets dominate the Global Capital Markets?

Debt

What is the name of the following formula and what does it do?

z= 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 +.000X5

Altman Z-score
the score predicts bankruptcy probability of companies

What are the three main types of business organizations? Advantages and disadvantages?

Proprietorship-
easy to start, subject to few regulations, taxed as an individual, BUT limited to life of owner, unlimited personal liability, difficult to sell ownership interest
Partnership-
easy to form, subject to few regulations, taxed like 2 individuals BUT unlimited liability, partnership dissolves when one dies or wishes to sell, difficult to transfer ownership
Corporation-
long lifespan, ownership interest can be divided into stock shares, limited liability BUT double taxation

How do ethics play a role in successful business?

ethics allows you to avoid fines and legal expenses, builds public trusts, attracts customers that appreciate and support the company's policies and attracts employees and investors

Why is it important for a business to have a clear corporate governance policy?

Set of rules a firm follows in conducting business, its the road map to dealing with transactions and to provide for a metric to assure accountability

The US tax structure is what type?

Progressive structure (higher rates for higher levels of taxable income)

What is a conflict between management and shareholders typically referred to as?

The agency problem

What are the three main financial statements firms publish? What information do they provide?

income statement- summarizes the firm's revenue and expense over a period of time
balance sheet- snap shot of the firms financial position at a specific time
cash flows- cash receipts and cash disbursement by a firm during a specific period

How do investors use those financial statements to their advantage?

to understand how the business is doing financially and to provide the investor with insight to a plethora of information in order to make an informed decision

What is ratio analysis? Why do we use ratios?

ratio analysis is designed to provide information from a firms financial statements in a meaningful manner. We use these ratios to get an overall impression of the firms financial health

What are the 5 primary categories used in financial statement analysis?

Liquidity
Asset management
debt management
profitability
market value

What is a pro forma? What are the steps to constructing one?

A pro forma is a projected financial statement
1. forecast the income statement
2. forecast the balance sheet
3. determine additional funds needed
4. accounting for financing feedbacks

What is the concept of leverage in financial terms? And what are the two most commonly used?

leverage is the concept that a small change is a financial component can have magnified impact on other areas
DOL- indicates how fixed costs can be leverage to increase sales
DFL- shows how the use of debt can increase ROE and EPS for a firm

Why is financial planning critical to business survival?

inadequate financial planning leads to business failure: lack of capital

When planning a budget what are some of the techniques used to assure the financial benefit to your firm?

scenario analysis
sensitivity analysis
simulation analysis

What are the names of the three primary types of Cash Flow patterns?

Lump sum- get paid out, all the money
Annuity- even cash flow paid out at beginning or end of the year
Uneven- random cash payouts each year, no pattern to the madness

What are FV and PV?

PV- discounting allows us to understand how much $X in the future is worth to us NOW
FV- compounding allows us to understand how much $ something is worth in the future

What is the difference between an Ordinary Annuity and an Annuity Due?

Ordinary Annuity- end
Annuity Due- beginning

What is APR? What is EAR? How are they different? What are they used for?

APR- the interest rate charges per period multiplied by the number of periods per year
EAR- the interest rate as if it were compounded once a year

The basic concept of the Time Value of Money is?

a dollar today has more value than a dollar tomorrow because you can invest it and earn interest

How are bond prices determined?

bond prices represent the PV of the future cash flows of the bond

How are bond/stock prices related to the market rate of return?

both bond and stock prices reflect the impact of the overall market in their determination of the return they offer.

What is the Dividend Growth Model? How do you compute the price of stock from it?

DGM is a method that shows investors how to place a present value to the future dividends they will earns
Value of stock is the summation of all the future cash flows from the stock discounted back at a required rate of return

What are the two most prevalent methods used for equity valuation?

Discounted cash flow approach
CAPM

What is the cost of capital?

the firms average cost of funds, which is the return required by the firm's investors; what must be paid to attract funds; the firms required rate of return
*an investors return is the firms cost

How do you compute the cost of capital for: debt, common equity, preferred equity, and common equity?

after tax component of debt= rd(1-T)
rd= YTM
preferred equity rps= D/P
common equity, either:
rs= rfr + b (rm-rfr) or rs= D1/Po + g

What is WACC? How is it utilized? How do you compute it?

Weighted average cost of capital- it represents the average cost of each dollar of financing that the firm uses to purchase its assets; minimum return the firm must earn to maintain the current level of wealth; the firms required rate of return

WACC= Wd x rd(1-t) + Wps x rps + Ws x Rs

What is the marginal cost of capital? How is it used to make financial decisions? How do you compute it?

the cost of obtaining another dollar of new capital; the weighted average cost of the last dollar of new capital raised

What is the difference between WACC and the investors' required rate of return?

same thing just different ways of saying it

What is an incremental cash flow?

cash flows that will change because the project is purchased; cash flows that need to be included in the capital budgeting evaluation

What is capital budgeting?

the process of planning expenditures on assets whose cash flows are expected to extend beyond one year

What are the differences between NPV and IRR? What happens if you get conflicting numbers?

NPV finds the present value of net cash flows
IRR forces the present value of the expected cash flows= cost
When numbers conflict, always go with the NPV. NPV shows the actual value being added to the firm

What is the formal name of a firm's capital structure? and what does it imply?

Static Theory of Optimal Capital Structure
identifies the capital mix of debt to equity where a firms value is maximized and its WACC is minimized

Operating Cycle is calculated as....

the number of days of inventory, plus the number of days of receivables.

Liquidity Ratios

Current Ratio and Acid Test Ratio
Working capital to total assets
working capital to sales

A measure of the extent that a firm finances its assets with debt obligations is referred to as

Financial Leverage Ratio

Cash conversion cycle

days sales outstanding, plus the days in inventory less the days payable outstanding

Bond ratings reflect

default risk