FINN 2043 final

generally accepted accounting principles

the practice and procedure guidelines used to prepare and maintain financial records and reports

financial accounting standards board

authorizes accounting principles

public company accounting oversight board

a not-for-profit corporation established by the Sarbanes-Oxley Act to oversees auditors of public corporations in the preparation of informative, fair and independent audit reports

letter to stockholders

the first element of the annual stockholders' reports and the primary communication from management. discusses management philosophy, corporate governance issues, strategies and business plans for the coming year

key financial statements

income statement, balance sheet, statement of retained earnings, statement of cash flows

income statement

provide a financial summary of the firms operating results during a specified period

items on the income statement

sales revenue, gross profits, operating profits, net profits before tax, earnings available for common stockholders, EPS, and DPS

balance sheet

a summary statement of the firm's financial position at a given point in time. contains assets, liabilities, and stockholders equity

items on the balance sheet

total current assets, total gross fixed assets, accumulated depreciation, net fixed assets, total current liabilities, long-term liabilities, paid-in capital in excess of par on common stock, retained earnings, total stockholder's equity

statement of retained earnings

reconciles the net income earned during a given year and any cash dividends paid, with the change in retained earnings between the start and end of that year

statement of cash flows

summary of the firm's operating, investment and financing cash flows and reconciles them with changes in its cash and marketable securities during the period

Financial accounting standards board standard no. 52

mandates that US based companies translate their foreign-currency-denomiated assets and liabilities into US dollars for consolidation with the parent company's financial statements, by using the exchange rate prevailing at the fiscal year ending date

parties interested in financial ratios

shareholders, creditors, management

ratio comparisons

cross-sectional analysis, benchmarking, time-series analysis, combined analysis

cross-sectional analysis

comparison of different firms' financial ratios at the same point of time

benchmarking

a competitor or industry averages ratio values to be compared with

time-series analysis

evaluation of the firm's financial performance over time using financial ratio analysis

combined analysis

combines cross-sectional and time-series analysis together

liquidity ratios

measure a firms ability to satisfy its short term obligations as they come due. current ratio and quick (acid-test) ratio

current ratio

current assets/current liabilities

quick (acid-test) ratio

(current assets-inventory)/current liabilities

activity ratios

measure the speed with which various accounts are converted into sales or cash. inventory turnover, average age of inventory, average collection period and total asset turnover

inventory turnover

COGS/inventory

average age of inventory

365/inventory turnover

average collection period

accounts receivable/average sales per day

total asset turnover

sales/total assets

financial leverage

the magnification of risk and return through the use of fixed-cost financing, such as debt and preferred stock. gives an insight about how the structure or proportion of funds may affect the firms risk and return, tax effect of interest payment, velocity of risk and returns

debt ratio

total liabilities/total assets

debt-to-equity

total liabilities/common stock equity

profitability ratios

these measures evaluate the firm's profit with respect to its sales, assets, or the owners' investment (equity)

net profit margin

earnings available for common stockholders/sales

return on total assets (ROA)

earnings available for common stockholders/total assets

return on total equity (ROE)

earnings available for common stockholders/common stock equity

market ratios

relate a firms market value (current stock price) to certain accounting values

price/earnings (P/E) ratio

market price per share/earnings per share. measures the amount that investors are willing to pay for each dollar of a firm's earnings; the higher the P/E ratio, the greater the investor confidence about the firm

dupont system of analysis

system used to dissect the firm's financial statements and to assess its financial condition

dupont formula

multiplies the firms net profit margin by its toal asset turn-over to calculate the firm's return on total assets (ROA)

ROA

net profit margin x total asset turnover

financial planning

begins with long-term (strategic) plans that in turn guide the formulation of short-term (operating) plans and budgets

long-term (strategic) financial plans

plans that lay out a company's financial actions and the anticipated impact of those actions over periods ranging from 2 to 10 years

short-term (operating) financial plans

pans that specify short-term (1 to 2 year periods) financial actions and the anticipated impact of those actions

depreciation

a portion of the costs of fixed assets charged against annual revenues over time

cash inflows

decrease in assets, increase in liability, net profits after taxes, depreciation and other noncash charges, sale of stock

cash outflows

increase in assets, decrease in liability, net loss after taxes, dividends paid to preferred and/or common stockholders, repurchase or retirement of stock

operating cash flow

the cash flow a firm generates from its normal operations; calculated as net operating profits after taxes (NOPAT)

free cash flow

the amount of cash flow available to investors (creditors and owners) after the firm has met all operating needs and paid for investments in net fixed assets and net current assets

coping with uncertainty of the cash budget

Scenario analysis, in which analysts prepare several cash budgets based on pessimistic, most likely, and optimistic forecasts, and Use several cash budgets based on differing scenarios, which also give financial manager a sense of the riskiness of various alternatives

preparing the pro forma income statement

based on preceding year's financial statements, start with sales forecast of next year, use percent-of-sales method

time value of money

the observation that it is better to receive money sooner than later. money invested today may earn a positive rate of return, producing more money. a dollar today is worth more than a dollar in the future

compounding

a technique used to find the future value of each cash flow at the end of investment's life then sums these values to find the investment's future value

discounting

a technique used to find the present value of each cash flow at time zero and then sums these values to find the investment's value today

basic patterns of cash flow

single amount, annuity, mixed stream

single amount

a lump sum amount either currently held or expected at some future date

annuity

a stream of equal periodic stream of cash flows over a specified time period

mixed stream

a stream of unequal periodic cash flows that reflect no particular pattern

future value

the value on some future date of money that you invest today

effect of interest rate and time on FV

higher interest rate, higher FV. longer money remains invested, higher FV

compound interest vs simple interest

simple interest is interest earned only on an investment's original principle and not on accumulated interest. money accumulates faster when an investment earns compound interest

present value

the value in today's dollars of some future cash flow

effect of interest rate and time on PV

the higher the discount rate, the lower the PV. the longer the waiting period, the lower the PV

ordinary annuity

an annuity for which the cash flow occurs at the end of each period

annuity due

an annuity for which the cash flow occurs at the beginning of each period

perpetuity

an annuity with an infinite life providing annual cash flow

nominal (stated) annual rate

contractual annual rate of interest charged by a lender or promised by a borrower

effective (true) annual rate (EAR)

the annual rate of interest actually paid or earned

corporate bond

a long-term debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under clearly defined terms

par value/face value/principal

the amount of money the borrower must repay at maturity, and the value on which periodic payments are based

coupon rate

the percentage of a bond's par value paid annually, typically in two equal semiannual payments, as interest

bond indenture

a legal document that specifies both the rights of the bond-holders and the duties of the issuing corporation

standard debt provisions

provisions in a bond indenture specifying certain record-keeping and general business practice that the bond issuer must follow

restrictive covenants

provisions in a bond indenture the place operating and financial constraints on the borrower

subordination

the stipulation that subsequent creditors agree to wait until all claims of the senior debt are satisfied

sinking-fund requirement

a restrictive provision the systematic retirement of bonds prior to their maturity

collateral

a specific asset against which bondholders have a claim in the event that a borrower defaults on a bond

secured bond

a bond backed by collateral

unsecured bond

a bond backed only by the borrower's ability to repay the debt (not backed by collateral)

trustee

a paid individual, corporation, or commercial bank trust department that acts as the third party to a bond indenture and can take specified actions on behalf of the bondholders in terms of the indenture are violated

costs of bonds to the issuer

impact of bond maturity, impact of offering size is two-fold, impact of issuer's risk, impact of the cost of money

general features of a bond issue

conversion feature, call feature, call price, stock purchase warrants, current yield, bond ratings

conversion feature

a feature of convertible bonds that allow bondholders to change each bond into a stated number of shares of a common stock

call feature

gives the issuer the opportunity to repurchase bonds at a stated call price prior to maturity

call premium

the amount to which a bonds call price exceeds its par value

stock purchase warrants

a financial option type of instruments that give their holders the right to purchase certain number of shares of the issuer's common stock at a specified pricer over a certain period of time

current yield (bond yield)

a measure of a bond's cash returns for the year; calculated by dividing the bond's annual interest payment by its current price

bond ratings

independent agencies that asses the riskiness of publicly traded bond issues

What are the differences between debt & equity?

Debtholders are creditors, Shareholders are owners of the firm.

4 aspects of differences between debt & equity

1) Voice in Management2) Claims on income & assets3) Maturity4) Tax treatment

1) Voice in Management

Debtholders have no voting privileges; shareholders generally have voting rights.

2) Claims on income & assets

debtholders have higher priority on claims, therefore have lowest risk to get paid; preferred and common shareholders are subordinate to debtholders.

3) Maturity

Debts have stated maturity; stocks have no maturity.

4) Tax treatment

interest payments to debtholders are tax-deductible; dividends payment to shareholders are not tax-deductible.

What are the differences in required returns between creditors (debtholders) and equity owners (shareholders)? Why?

If bankruptcy happens to a firm, stockholder's claim on income and assets are secondary to the claims of creditors. Stockholders' claims on income cannot be paid until all the creditors' claims have been satisfied. Since stockholders expose higher risk than debtholders; therefore, required return of equity is generally higher than required return of debt.

What are major features of common and preferred stocks?

(1) Common stock• Preemptive rights - allows common stockholders to maintain their proportionate ownership in the corporation when new shares are issued, thus protecting them from dilution of ownership.• Authorized shares - shares of common stock that a firm's corporate charter allows it to issue.• Issued shares - shares that have been put into circulation.(d) Outstanding shares - issued shares held by private and public investors.• Treasury stock - issued shares held by the firm; often these shares have been repurchased by the firmIssued shares = Outstanding shares + Treasury stocks.• Supervoting shares - stock carries multiple votes per share rather than the single vote per share.
(2) Preferred stock• Cumulative - all passed (unpaid) dividends in arrears, along with the current dividend, must be paid before dividends can be paid to common stockholders.• Noncumulative - passed (unpaid) dividends do not accumulate.• Callable - allows the issuer to retire the shares within a certain period of time and at a specified price. • Conversion - allows shareholders to change each share into a stated number of shares of common stock.

What are the most commonly used stock valuation models? (3)

1) Zero-Growth2) Constant-Growth (Gordon Growth)3) Price/Earning (PE)

Based on Gordon Growth Dividend Model, what kinds of stock value effects could be predicted due to the firm managers' decision making?

(a) Any mgmt. action that would cause stockholders/market to raise their dividend expectations should increase the firm's value (stock price), & any action that decreases dividend expectations should decrease the firm's value (stock price).(b) Any action taken by the mgmt. decision that increases risk of the firm will also raise the risk premium required by shareholders and the required return (r). This will reduce share value P_0; any action that decreases firm's risk contributes to an increase in share value.

How many types of long-term capital sources there are?

Debt, preferred stock, common stock, and retained earnings.If we categorize them in two ways, then
(1) Internal source and external sources. Retained earnings is internal source of capital; then debt, preferred stock, and common stock are external sources.
(2) Debt financing and equity financing. Bond is debt financing; stocks and retained earnings are equity financing.

What is the weighted average cost of capital (WACC)?

a weighted average of a firm's cost of debt and equity financing, where the weights reflect the percentage of each type of financing used by the firm.

What is leverage?

refers to the effects that fixed costs have on the returns that shareholders earn; higher leverage generally results in higher but more volatile returns.

Operating leverage

relates to the relationship between the firm's sales revenue and its earnings before interest and taxes (EBIT). When costs of operations are largely fixed (buildings, machineries, equipment, salaries and wages, fixed operating expenses or administrative overheads), small changes in revenue will lead to much larger changes in EBIT, both positive and negative.

Financial leverage

the use of fixed financial costs to magnify the effects of changes in EBIT on the firm's earnings per share (EPS). Two most common fixed financial costs are(1) interest on debt and(2) preferred stock dividends.When there is a financial leverage, small changes in EBIT will lead to much larger changes in EPS, both positive and negative.