Foundations of Business Finance (Peregrine)

True or false: The one fixed asset that is not depreciated is land because it seldom declines in value.

True

__________ liabilities are those due within one year.

Current

__________-__________ __________ liabilities are due after more than a year, and may include bonds, mortgages, and long-term loans.

Long-term debt

Name the three types of accounts listed as current liabilities on balance sheets.

(1) Accounts Payable

(2) Notes Payable

(3) Accrued Expenses

Accounts payable

The amounts owed for credit purchases by a firm

Notes payable

Outstanding short-term loans, typically from commercial banks

Accrued expenses

Costs that have been incurred by a firm which have not yet been paid; examples of accruals include taxes owed to the government and unpaid wages

The __________ __________ section of a balance sheet provides information about the claims against a firm held by investors who own preferred and common shares.

Stockholders' equity

The Stockholders' equity section of the balance sheet is reflected in four types of accounts. These include __________ __________, __________ __________, __________-__________-__________ __________ ___________ __________ __________, and __________ __________.

(1) preferred stock

(2) common stock

(3) paid-in-capital excess of par

(4) retained earnings

__________ __________ shows the total proceeds from the sale of preferred stock.

Preferred stock

__________-__________-__________ __________ __________ __________ __________ equals the number of shares outstanding multiplied by the original selling price of the shares, net of the par value.

Paid-in-capital in excess of par

__________ __________ equals the number of outstanding common shares multiplied by the par value per share.

Common stock

__________ __________ (often $1) is an artifact of earlier pre-computer accounting methods used to track the number of outstanding shares. It has no relation to the actual value of the shares.

Par value

__________ __________ are the cumulative total of the earnings that the firm has reinvested in its assets and operations since its inception.

Retained earnings

The combined value of __________ __________ and __________-__________-__________ equals the proceeds the firm received when it originally sold shares to investors (including initial public offerings and rights offerings).

common stock, paid-in-capital

The __________ __________ entry on a balance sheet records the value of common shares that a firm currently holds in reserve.

treasury stock

The __________ __________ __________ __________ provides a summary of what cash has gone into and out of a firm because of its operations, investments, and financing activities during a year. It isolates the firm's operating, investment, and financing cash flows and reconciles them with changes in its cash and marketable securities during the year.

statement of cash flows

A firm's total cash flows can be conveniently divided into three categories. These include __________ flows, __________ flows, and __________ flows.

operating, investment, financing

Operating flows

Cash inflows and outflows directly related to the production and sale of products or services

Investment flows

Cash flows associated with the purchase or sale of fixed assets and business equity

Financing flows

Cash flows which result from debt and equity financing transactions

__________ __________ __________ is the amount of cash flow available to investors - the providers of debt and equity capital. It represents the net amount of cash flow remaining after the firm has met all operating needs and has made all required payments on both long-term (fixed) and short-term (current) investments.

Free cash flow

__________ current liability changes occur automatically with changes in sales. They must, therefore, be deducted from current assets in order to find the net change in short-term investment for the determination of free cash flow.

Spontaneous

Can a firm have a net loss (negative NOPAT) and still have positive operating cash flow?

Yes, this can occur when depreciation and other noncash charges during the period are greater than the net loss. The statement of cash flows treats net income (or net losses) and depreciation and other noncash charges as separate entries.

A decrease in an asset (such as inventory) is an __________ of cash because cash that has been tied up in the asset is released and can be used for some other purpose, such as repaying a loan.

inflow

An increase in inventory (or any other asset) is an __________ of cash because additional inventory ties up more of the firm's cash.

outflow

Logic suggests that if net income is a cash __________, then a net loss (negative net profit after taxes) is a cash __________.

inflow, outflow

The __________ __________, one of the most commonly cited financial ratios, measures the firm's ability to meet its short-term obligations. It is defined as current assets divided by current liabilities.

current ratio

__________ __________ provides a measure of how quickly a firm sells its goods.

Inventory turnover

Inventory turnover can easily be converted into a(n) __________ __________ __________ __________ by dividing the turnover figure into 365 (the number of days in a year).

average age of inventory

Firms use the __________ __________ __________ or __________ __________ __________ __________ __________ in evaluating credit and collection policies.

average collection period, average age of accounts receivable

Firms use the __________ __________ __________ to evaluate their payment performance. This metric measures the average length of time it takes a firm to pay its suppliers.

average payment period

The __________ __________ __________ __________ measures the efficiency with which a firm uses its fixed assets. The ratio tells analysts how many dollars of sales a firm generates per dollar of investment in fixed assets.

fixed asset turnover ratio

The __________ __________ __________ __________ indicates the efficiency with which a firm uses all its assets to generate sales.

total asset turnover ratio

__________ __________ focus on income statement measures of a firm's ability to generate sufficient cash flow to make scheduled interest and principal payments.

Coverage ratios

__________ __________ measure the proportion of total assets financed by a firm's creditors. The higher this ratio, the greater is the firm's reliance on borrowed money to finance its activities.

Debt ratios

A close cousin of the debt ratio is the __________-__________-__________ __________, sometimes called the __________ __________. This ratio is calculated as total assets divided by common stock equity.

assets-to-equity ratio, equity multiplier

A high equity multiplier indicates __________ debt and __________ equity, whereas a low equity multiplier indicates __________ debt and __________ equity.

(1) high, low

(2) low, high

A measure that focuses solely on a firm's long-term debt is the __________-__________-__________ __________. It is calculated as long-term debt divided by stockholders' equity.

debt-to-equity ratio

Both the debt ratio and the debt-to-equity ratio use __________ __________ of debt, equity, and assets.

book values

The __________ __________ __________ __________ measures a firm's ability to make contractual interest payments. It equals earnings before interest and taxes divided by interest expense. A higher ratio indicates a greater capacity to meet scheduled payments.

times interest earned ratio

The __________ __________ __________ measures the percentage of each sales dollar remaining after a firm has paid for its goods.

gross profit margin

The __________ __________ __________ measures the percentage of each sales dollar remaining after deducting all costs and expenses including interest, taxes, and preferred stock dividends. These vary widely across industries, so comparing a company's figure to industry averages is an important part of the performance analysis.

net profit margin

__________ __________ __________ is probably the most closely watched financial ratio, which the investing public considers to be a primary indicator of corporate success. These represent the number of dollars earned on behalf of each outstanding share of common stock during the period.

Earnings per share

__________ __________ __________ __________, often called __________ __________ __________, measures management's overall effectiveness in using a firm's assets to generate returns to common stockholders.

Return on total assets, return on investment

__________ __________ __________ __________, captures the return earned on the common stockholders' (owners') investment in a firm.

return on common equity

The __________/__________ __________ measures the amount investors are currently willing to pay for each dollar of the firm's current earnings.

price/earnings ratio

Short-term debt

Debt with a maturity of 1 year or less

Treasury bills (T-bills)

Discounted securities issued by the U.S. government to finance operations

Repurchase agreement (repo)

An arrangement in which one firm sells some of its financial assets to another firm with a promise to repurchase the securities at a higher price at a later date

Commercial paper

A type of promissory note, or legal IOU, issued by large, financially sound firms

Eurodollar deposit

A deposit in a bank outside the United States that is not converted into the currency of the foreign country; instead, it is denominated in U.S. dollars

Long-term debt

Debt instruments with maturities greater than 1 year

Term loan

A contract under which a borrower agrees to make a series of interest and principal payments on specific dates to the lender

Term loans have three major advantages over public debt offerings, such as corporate bonds: __________, __________, and __________ __________ __________.

speed, flexibility, low issuance costs

Bond

A long-term contract under which a borrower agrees to make payments of interest and principal on specific dates to the bondholder

The periodic interest payments on bonds are determined by the __________ __________ and the __________, or __________ __________ of the bond.

coupon rate, principal, face value

Indenture

A legal document that spells out any legal restrictions associated with a bond as well as the rights of bondholders (lenders) and the corporation (bond issuer)

Most corporate bonds contain a __________ __________, which gives the issuing corporation the right to call the bonds for redemption prior to maturity.

call provision

Sinking fund

A provision that facilitates the orderly retirement of a bond issue

Derivatives

Financial assets that have values based on, or derived from, the values of other assets, such as stocks or bonds

Option

A contract that gives its holder the right to buy (sell) an asset at some predetermined price within a specified period of time

A __________ option gives the holder the right to purchase, or call in, shares of a stock for purchase at a predetermined price at any time during the option period.

call

A __________ option gives the holder the right to sell, or put out, shares of a stock at a specified price during the option period.

put

__________ __________ are bonds or preferred stocks that can be exchanged for, or converted into, common stock at the option of the holder.

Convertible securities

One of the most important provisions of a convertible security is the __________ __________, which is defined as the number of shares of stock that the convertible holder receives upon conversion.

conversion ratio

Conversion price

The effective price paid for the common stock obtained by converting a convertible security

Swap

An agreement to exchange, or swap, cash flows or assets at some time in the future

Foreign debt

Debt sold by a foreign borrower but denominated in the currency of the country in which the issue is sold

Eurodebt

Any debt sold in a country other than the one in whose currency the debt is denominated.

Eurocredits

Bank loans that are denominated in the currency of a country other than that where the lending bank is located

Four fundamental factors affect the cost of money. Name these.

(1) The firm's production opportunities

(2) Investors' time preferences for consumption

(3) Risk

(4) Inflation

The required (or nominal) interest rate on any security, r, is composed of a __________-__________ __________ __________ __________ plus a premium that reflects the riskiness of the security.

risk-free rate of interest

Liquidity

The ability to convert an asset into cash on short notice and "reasonably" capture the amount initially invested

Your uncle would like to restrict his interest rate risk and his default risk, but he still would like to invest in corporate bonds. Which of the possible bonds listed below best satisfies your uncle's criteria?

A. AA bond with 10 years to maturity

B. BBB perpetual bond

C. BBB bond with 10 years to maturity

D. AAA bond with 5 years to maturity

D. AAA bond with 5 years to maturity

Capital

Fixed assets used in production

Budget

A plan that details projected cash inflows and cash outflows during some future period

Capital budget

An outline of planned expenditures on fixed assets

Capital budgeting

The process of analyzing projects and deciding which are acceptable investments and which acceptable investments should be purchased

Incremental operating cash flows

The changes in day-to-day operating cash flows that result from the purchase of a capital project

The three most popular methods used by businesses to evaluate capital budgeting projects are __________ __________ __________, __________ __________ __________ __________ and __________ __________.

(1) net present value

(2) internal rate of return

(3) payback period

Internal rate of return

The rate of return the firm expects to earn if a project is purchased and held for its economic (useful) life

Payback period

The expected number of years required to recover the original investment (the cost of the asset)

Stand-alone risk

The risk an asset would have if it were a firm's only asset

Scenario analysis

A risk analysis technique that helps decision makers get an idea of the range of possible outcomes when a project is purchased

Political risk

Any action (or the chance of such action) by a host government that reduces the value of a company's investment