BFIN300 Midterm Flashcards

What questions does corporate finance seek to answer?

• Long Term Investment

• Lines of Business

• Long Term Financing

• Management of daily activity 

• How financial decision will impact company

Capital Budgeting

identifying financial activities that are worth more to the business than they are to acquire.

Capital Structure

Financing decisions (Short-term debt, long-term debt, equity)

• What do we need to borrow, how are we raising money, who are we getting it from

Working Capital Management

Working Capital Management: Managing short-term assets and short-term liabilities. 

• ST Assets: Accounts receivable and some inventory

• ST Liabilities: Accounts Payable and short-term loans.

3 Types of Businesses

Sole Proprietorship, Partnership, Corporation

Sole Proprietorship

• Owned by single individual who keeps all profits and is responsible for all losses

  • Unlimited Personal Liability

Partnership

• Partnership: Similar to Sole Proprietorship, but with 2 or more owners.

  • Can be General (All partners are actively involved and share equal responsibility) or Limited (Some partners operate solely as investors, do not carry general partner risk). 

Corporation

 Considered a separate legal entity from its shareholders. Ownership can be easily transferred and shareholders can be subject to double taxation.

Double Taxation

Corporations pay taxes, shareholders pay taxes on dividends paid out to them.

The goal of financial management is to ____

maximize shareholder value

What is Corporate Finance?

The relationship between business decisions and maximizing the business's value. 

Sarbanes-Oxley Act

A law that requires a publicly traded company to give an assessment of their internal controls and financial reporting, and to be subject to independent auditing.

Agency relationship

Relationship between the management of a company and its shareholders. This can lead to conflicts of interest (agency problem).

Agency Problem- Conflicts Of Interest

Excessive expenses (ex: Private Jets0), excessive wages, dividends (Managers like to keep money that shareholders want to receive as dividends)

Stakeholder

Someone who has a claim to a company’s cash flows.

• Creditors, shareholders, employees, customers, suppliers, US government. 

Primary Market

Initial public offering of a stock

Secondary market

All selling/buying of stocks after an IPO.

• Auction Market & Dealer Market

Auction market

• Matching those wishing to buy securities with those wishing to sell securities. 

Dealer Market

Buying and selling securities for their own portfolios.

Which of the following is an example of an indirect agency cost?

• A. Unnecessary corporate expenditure

• B. Management auditing expense

• C. A lost opportunity

• D. All the above

C. A lost opportunity

Control of a firm ultimately rests with. . .

• A. The CEO

• B. The SEC

• C. The Stockholders

• D. The Founder

C. The Stockholders

On their own, an income statement, balance sheet, and cash flow statement tell us _____ about a business.

little to nothing

• Because they are snapshots of a company at a given point in time and don’t provide an entire picture of what’s going on, they can be manipulated. 

Balance Sheet

 Summary difference between assets and liabilities. 

• Assets= Liabilities + Shareholders Equity.

Income Statement

Measure of performance of a company for a period of time.

• Income = Revenue - Expenses

Cash Flow Statement

Measure difference between cash coming into a business and cash leaving a business.

• Source of funds - use of funds.

Fixed Asset

Has a life of more than one year. 

Tangible Asset

Something that can physically be touched.

Intangible Asset

Do not physically exist but have some form of intrinsic value.

• Trademark, patent, goodwill

The difference between liabilities and assets is ____

 equity. 

• The residual value of the company.

Net working capital

Difference between short-term assets and short-term liabilities.

Liquidity

Speed at which an asset can be converted to cash.

True Or False: Companies often fail due to insolvency (inability to pay debt)?

False; they often fail due to lack of liquidity.

A company is insolvent if ____

liabilities outnumber assets

Under US GAAP, assets are carried on the balance sheet at

• A. Book Value

• B. Market Value

A. Book Value

• Market values are dependent on asset risk and cash flow.

The last item on the income statement is ___

net income (bottom line, post-tax earnings)

Under US GAAP, revenues are shown when they ____

accrue (not necessarily when cash comes in).

The primary reason that accounting net-income differs from cash flow are ____ & _____

depreciation and amortization. 

Depreciation VS. Amortization

Deprecation- a reduction in the value of an asset with the passage of time, due in particular to wear and tear.

Amortization- a reduction in the book value of a loan or an intangible asset over a set period of time.

3 categories of cash flow

Operating, Financing, Investing

Operating vs. Financing vs. Investing Cash Flows

Operating: Business income

Investing: Investment purchases and sales and dividend received. 

Financing: Issuing and repaying Debt, Dividends paid to investors. 

Which financial statement shows the accounting value of a firm's equity as of a particular date?

Balance Sheet

At its most basic level, a company _____.

generates and spends cash.

By _________ financial statements, they become easier to utilize and analyze across different businesses.

standardizing

Financial ratios- 5 categories

1. Short Term Solvency (Liquidity)

2. Long-term solvency (Financial Leverage)

3. Turnover Ratios

4. Profitability Ratios

5. Market-based Ratios

Short-Term Solvency Ratios

Business’s liquidity information (ability to pay its bills in short run without undo stress)

• Current Ratio: Current Assets /Current Liabilities

• Quick Ratio: Current Assets minus Inventory /Current Liabilities

Long-Term Solvency Ratios

Business’s ability to meet its financial obligations and long-term debts

• Debt Ratio: Liabilities/Assets

• Interest Coverage: Earnings Before Interest & Taxes/ Interest Expense

Turnover Ratios

• How efficient a company’s assets will generate sales.

  • Inventory Turnover: COGS/ Inventory

  • Inventory Days: 365 Days/ Inventory Turnover

Profitability Ratios

• How efficiently a business uses cash to manage obligations

  • Profit Margin: Net Income/ Sales

  • Return of assets: Net Income/Total Assets

  • Return of equity: Net Income/Equity

Market-based Ratios

• How much an investor is willing to pay

  • Price To Earnings: Price Per Share/ Earning Per Share

  • Price to Sales: Price Per Share/Sales Per Share

  • Price to Book Value: (Market) Price Per Share/ BVPS

“Window-Dressing”

Companies can- both legally and illegally- manipulate their financial statements to make the data look better than in actuality.

DuPont Identity

Breaks down ROE (Return on Equity) into 3 components. 

• Operating Efficiency (Profit Margin)

• Asset Turnover

• Financial Leverage (Equity Multiplier)

ROE can be exacerbated by adding ____

Debt

Time Value of Money

money is worth more now than at a future date based on its earning potential.

• A dollar today is worth more than a dollar in the future.

Assets have value because they generate ______.

expected future cash flow.

Compound Interest

Interest earned on both the initial principal and the interest reinvested from the prior period

Discount Rate

Interest rate to compute the present value of a future bonus

Annuity

A cash flow stream where a fixed amount is received every year during a set period.

• Perpetual Annuity (Perpetuity): Annuity without a set end date (continues forever)

Financial Markets exist so ___.

excess money from investors can be transferred quickly and efficiently to companies and individuals who need funding.

Economic variable that affect stock and bond market prices

• inflation

• interest rates

• exchange rates

• company performance

• performance of other companies in same industry

• unemployment rate

• major international events

Securities & Exchange Comission

The principal regulator of financial market activity in the United States.

• Responsible for collecting public disclosure information on companies.

• Responsible for enforcing the securities laws in the United States.

Investment Banks work to link ____ with ____.

investors with issuers of securities.

• Will advise the issuer of terms of the issue (price, timing, etc.)

• Underwrite securities (buy the issue from the issuer)

• Distribute and sell the issue to the general public.

Stock Broker

Buys and sells securities on behalf of their clients.

Money Markets

Involve the purchase and sale of large volumes of very short-term debt products.

Capital Markets

Involve the purchase of long-term securities (long-term bonds, common stock)

Spot Exchange

the cost of the currency exchanged instantly and without delay

Forward Exchange

the rate at which a bank or other financial institution agrees to exchange one currency for another at a future date.

Derivative Securities

 Value and payoff are predicated on the value of another security. 

• Futures, Forwards, Swaps, Options Contracts

• Traded in the “Over-the-counter market”

Financial Security

A claim against the assets or cash flows of a company

True or False: The SEC does NOT regulate all national banks in the US.

True; the OCC regulates national banks in the US.

Corporations raise-long term capital by ____.

issuing bonds and stocks.

______ usually have a claim on the businesses cash flows over _____.

Owners of debt securities; equity holders.

Coupon Rate/Payment

Interest rate/ periodic payment of a bond.

Zero Coupon Bond

A debt security that promises only 1 fixed payment at maturity. 

Variable Rate Bonds

Pay periodic coupons, but unlike a fixed coupon, the interest payment is variable based on the level of prevailing interest rate in the market.

Perpetual Bond

Fixed coupon rate forever, no date of maturity.

Convertible/Converse Bonds

Allows a security holder to convert the security to another security (usual equity) at a pre-specified conversion rate.

Callable Bond

Like a fixed-coupon bond, but the issuer has the right to repurchase it at a fixed price.

Sukuk Bond

Sukuks are a non-interest based investment that adheres to the principles of Sharia law.

Equity only generates cash flows if ___

 if the cash flows of the other creditors have been met.

True or False: Debt security holders are owners of the business and have a say in the operation of the business.

False; equity holders.

There is no guarantee of cash flow from _____.

Dividends, they are a residual cash flow.

In addition to dividends, equity holders also receive cash flow from ___.

the sale of their shares.

Preferred Stock has claim priority ____.

between debt and equity. 

Investment banks will tailor the price of the issue to _____.

the demands of the market.

Market indices (indexes)

a collection of investments that track the performance of a specific segment of the financial market.

2 Most Popular indices to describe the NYSE

DOW Jones and S&P 500.

_______ has the greatest preference in liquidation; ______ gets paid last.

Senior Debt; Equity

A fixed coupon bond has a ______ that is paid until maturity, and a _____ that is paid at maturity.

fixed interest rate; lump-sum.

4 Features of a Bond

• Coupon (interest payment)

• Face Value (Par Value)- paid at maturity 

• Coupon Rate (interest rate)

• Maturity (# of years until face value will be repaid)

To value a bond at a particular point in time, we need to know _____.

the face value, the coupon rate, the # of periods until maturity, and the market value of similar bonds.

Bond prices & interest rates are

inversely proportional. If rates go up, rates will decline and vice-versa. 

Companies have their debt rated by an agency, typically _______.

S&P, Moody’s, or Fitch.

Junk Bonds

Bonds that are rated less than BBB

Municipal bonds are exempt from _____.

federal taxes.

When long-term rates exceed short-term rates, the yield curve is considered to be _____.

upward-sloping or normal.

When short-term rates exceed long-term rates, the yield curve is considered to be _____.

downward-sloping or inverse.

True or False: The longer the term to maturity, the lower the interest rate risk. 

False; the higher the interest rate risk.

Bond yields are the combined effect of ______.

interest rate risk, inflation risk, and default risk.

A bond's coupon rate is equal to _____.

the annual interest rate divided by the face value.

The bond principal is repaid at _____.

the maturity date.