Finance 300 Exam 1

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

Decisions made by Financial Management

- Capital budgeting decisions: Identifying the productive assets the firm should buy.

- Financing decisions: Determining how the firm should finance or pay for assets.

Working capital management decisions: - Determining how day-to-day financial matters should be managed so that the firm can pay its bills, and how surplus cash should be invested.

5 Principles of Finance

1. Money has a time value

2. There is a risk-return tradeoff

3. Cash flows are the source of value

4. Market prices reflect information

5. Individuals respond to incentives

Goals of Financial Manager

1. Survive

2. Avoid Bankruptcy

3. Beat the comp

4. Avoid Financial Stress

5. Max sales of market share

Working Capital

the managing of short-term assets and liabilities

day to day

working capital management decisions

Deal with day-to-day financial matters and affect current assets, current liabilities

Corporations

a legal entity authorized under a state charter. In a legal sense, it is a "person" distinct from its owners.

Public Market (Corporations)

large amounts of capital can be raised in public markets at a relatively low cost.

privately held, or closely held, corporations

whose stock/shares are not traded publicly

Goals of the firm

maximize the value of a firms stock

Agency Relationship

relationship between stockholders and management

Agency Conflict

Conflict of interest between principal and agent

Agency Costs

the cost arising from conflicts between principal and an agent

Sarbanes-Oxley Act of 2002 Regulations

1. Ensure greater board independence

2. establish internal acc controls

3. establish compliance programs

4. establish an ethics program

5. expand audit committees oversight program

Sarbanes-Oxley Act of 2002 Key takeaways

1. came out in response to highly publicized corp financial standards

2. act created strict new rules for acc., auditors, corp officers, and imposed more stringent record keeping requirements

3. added new criminal penalties for violating securities laws

4. attempted to restore ethical conduct within business sector

Information Asymmetry

situation in which one party is more informed than another because of the possession of private information

How funds flow through the Financial System

funds flow directly, through wholesale financial markets, as shown in the top route of the diagram, and indirectly, through financial institutions, as shown in the bottom route.

The system moves money from lender-savers (whose income exceeds their spending) to borrower-spenders (whose spending exceeds their income)

Role of investment banking firms

Specialize in helping companies sell new debt or equity, although they can also provide other services, such as the broker and dealer services

Types of Financial Markets

includes a number of different types of markets for the creation and exchange of financial assets, such as stocks and bonds

Primary Market

a financial market in which new security issues are sold by companies directly to investors

Secondary Market

a financial market in which the owners of outstanding securities can sell them to other investors

Money Market

markets where short-term debt instruments are traded

Capital Markets

Are markets where equity and debt instruments with maturities of greater than one year are traded.

Basics of Derivatives - Future + Option Markets

derive their value from some underlying asset

synthetic

Derivatives used for what

Hedging, leverage, speculation

Raising/Networking Capital

insurance of stock is selling partial ownership of the company to others

Insurance of bonds is creating a creditor relationship within investors

the dollar difference between total current assets and total current liabilities

Principal

the amount of moeny on which interest is paid

Simple Interest

interest earned on the original principal amount only

Interest on Interest

interest earned on interest that was earned in pervious periods

Compounding

the process of accumulating interest earned on an investment is REINVESTED so in future periods interest is earned on the interest as well as the original principle

Compound Interest

interest earned both on the original principal amount and on interest previously earned

Time Value of Money (TVM)

the difference in value between a dollar in hand today and a dollar promised in the future; a dollar today is worth more than a dollar in the future

Five major goals of the FED

1. Price stability (inflation target 2%)2. Full employment (views full employment at 4% unemployment rate, would like range of 4-6%)3. sustained economic growth (GDP range of 2-3%)4. Stable balance of payments vs the rest of the world5. protect the value of the dollar-moral suasion

Origination

the process of preparing a security for sale - what/how much capital needed, feaibility of issuance

Underwriting

the process by which the IB helps the company sell its new security issue

Nominal Rate of Interest

the rate of interest is unadjusted for inflation - before taking inflation into account

Real Interest Rates

an interest rate determined by absence of inflation - before taking inflation into account

impact of interest rates on economy

the fed funds the rate, the interest rate set by the fed , is the short-term nominal interest rate that is the basis for other interest rates charged by banks and financial institutions

to avoid purchasing power erosion through inflation, investors consider the real interest rate

Annual Reports

overview of the company & should include financial information. Divided into three sections: 1. financial tables 2. corp. public relations 3. audited financial statementscolorfulsell the future of the company to investors

Balance Sheet

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

Balance Sheet Equation

Total Assets = Total Liabilities + Total Stockholder's Equity

Net Working Capital

measure of a firm's ability to meet its short-term obligations as they come due.

Net Working Capital Equation

NWC = Current Assets - Current Liabilities

Retained Earning

represents earnings that have been retained and reinvested in the business over time rather than being paid out as cash dividends

RE = Net Income - Dividends Paid

Treasury Stock

stock that the firm has repurchased from investors

Market Value

the price at which property would sell

Book Value

the difference between an asset's account balance and its related contra account balance

Market to Book ratio

market price per share/book value per share

Income Statement

A financial statement showing the revenue, expenses, and profitability (or losses) of the firm over a period of time

Income Statement Equation

Net Income = Revenues - Expenses

Cash Flows

hows the company's cash inflows (receipts) and cash outflows (payments and investments) for a period of time.

Cash Flow to Investors

CFOA (cash flow from operating activity) = EBIT (earnings before interest + taxes) - Current taxes + Non-cash expenses

Operating Activities (Cash Flows)

re the net cash flows that are related to a firm's principal business activities.

The most important items are the firm's net income, depreciation and amortization expense, and working capital accounts (other than cash and short-term debt obligations, which are classified elsewhere).

Long-Term Investing Activities (Cash Flow)

elate to the buying and selling of long-term assets

Financing Activities (Cash Flow)

financing occur when cash is obtained from or repaid to creditors or owners (stockholders)

Cash Reconciliation (Cash Flow)

reconciliation of the firm's beginning and ending cash positions.

Average tax rate

total taxes paid divided by taxable income

Marginal tax rate

the tax rate paid on the next dollar of income earned

Financial Statement Analysis

the use of financial statements to analyze a company's performance and assess its strengths and weaknesses

Financial Ratios

a number from a financial statement that has been scaled by dividing by another financial number

Perspectives on Financial Statement Analysis

stockholders, managers, creditors and other stakeholders

Financial Ratios can help determine

-the financial condition of an organization-the efficiency of its activities-its comparable profitability-the perception of investors as expressed by their behavior in the financial markets

Return on Equity (ROE)

relevant measure of financial performance for a stockholder might be net income scaled by the firm's stockholders' equity

ROE= Net Income/Stockholder's Equity

Current Ratio

CR = Current assets/ current liabilities

Quick Ratio

Accounts for the fact that inventory is often much less liquid than other current assets

QR = (Current assets - Inventory)/current liabilities

Inventory Turnover

firm's inventory fluctuates widely or is growing (or decreasing) over time, some analysts prefer to compute inventory turnover using the average inventory value for the time period.

cost of goods sold/inventory

Inventory Turnover

AVG Inventory = (beg invt - end invt) / 2

Accounts Receivable Turnover

Net Sales / Accounts Receivable

Total Assets Turnover

measures the dollar amount of sales generated with each dollar of total assets.

TAT=Net sales/ total assets

Total Debt Ratio

tells us the amount of debt for each dollar of total assets.

Total Debt / Total Assets

Or

(Total Assets - Total Equity) / Total Assets

Debt to Equity Ratio

tells us the amount of debt for each dollar of equity.

Debt to Equity = Debt/Total Equity

Gross Profit Margin

measures the percentage of net sales remaining after the cost of goods sold is paid.

gpm = (Net sales - COGS) / Net sales

Operating Profit Margin

gives an indication of the profitability of the firm's operations, independent of its financing policies or tax management strategies.

OPM = EBIT/Net Sales

Net Profit Margin

percentage of sales remaining after all of the firm's expenses, including interest and taxes, have been paid

NPM = Net income/ net sales

Return on Assets (ROA)

it tells us how efficiently management utilized the assets under their command, independent of financing decisions and taxes

ROA = Net income/ total assets

Earning per Share

net income/shares outstanding

Price/Earnings (P/E) Ratio

PE = Price per share/ Earnings per share

Dupont Formula

A mathematical break-down that breaks ROE into multiple components: profitability, efficiency, and leverage typically.

ROA = net income / total assets

= net profit margin x total asset turnover

Trend Analysis

analysis of trends in financial data over time

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

Future Value (FV)

the value of an investment after it earns interest for one or more periods

Future value at end of Year 1 = principal + interest earned

Multiple Period Investments

PV = (FV2)/(1+i)^2

Future Value Terms

FVn= future value of investment at the end of period n

PV= original principal (P0); this is often called the present value, or PV

i= the rate of interest per period

n= the number of periods; a period can be a year, a quarter, a month, a day, or some other unit of time

(1 + i)n= the future value factor

Future Value on Calculator

A savings account with $5,000 is earning is earning 5% interest annually at the end of the year. What is the Future Value of account after 20 years?

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-5000

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Two-Period Investment

FV2=P(1 + i)^2

Example:

$100 x (1+0.10)^2

$100 x 1.21 = $121

Compounding Interest

Makes money grow faster

total compound interest = total simple interest + total interest on interest

Continuous Compound Interest

Interest that is reinvested continuously so that there is no waiting period between interest payments

A=Pe^rt

FV = PV x e^i(n)

Future Value terms for calc

N is the number of periods. The periods can be years, quarters, months, days, or some other unit of time.

i is the interest rate per period, expressed as a percentage.

PV is the present value or the original principal (P0).

PMT is the amount of any recurring payment.4

FV is the future value.

Present Value

the current value of a future cash flow discounted at the appropriate discount rate

PV = (FV1)/1+i

Discounting

the process by which the present value of future cash flows is obtained

Discount Rate

the interest rate used in the discounting process to find the present value of future cash flows

Future Value of Multiple Cash Flows

calculate each stream separately and then discount it back to the present.

FV2 = PV x (1 + i)^2

Present Value of Multiple Cash Flows

Calculate present values of each cash flow and add up these present values.

PV = FV1 x ((1/(1+i)) +

PV = FV2 x ((1/(1+i)^2) +

PV = FV3 x ((1/(1+i)^3)

Annuity

a series of equally spaced and level cash flows extending over a finite number of periods

Perpetuity

a series of equally spaced and level cash flows that continues forever

Ordinary Annuity

an annuity in which payments are made at the end of each period

Present Value of Annuity

The sum of the present values of a series of equal cash flows to be received at fixed intervals.

Present Value of Annuity Terms

PVAn=present value of an n period annuity

CF=equally spaced and level cash flow

i=discount rate, or interest rate

n=number of periods (often called the annuity's maturity)

Present Value Factor

the value of 1/(1+r)^n used as a multiplier to calculate an amount's present value

PV Annuity factor = (1- present value factor) / i

Amortization Schedule

a table that shows the loan balance at the beginning and end of each period, the payment made during that period, and how much of that payment represents interest and how much represents repayment of principal

Amortizing Loan

a loan for which each loan payment contains repayment of some principal and a payment of interest that is based on the remaining principal to be repaid