Finance Final

Relevant Cash Flows alternate name Incremental cash flows
Relevant Cash Flows Any changes in the firms future cash flows that are a direct consequence of undertaking a project
Always ask this question “will this cash for occur ONLY if we accept this project?”If yes, include itIf no, avoid it
Common types of cash flows sunk costsopportunity costsexternalities (side effects)Changes in Net Operating Working Capital (NOWC)
Sunk Costs Costs that have accrued in the past.Irrelevant because they are not incremental
Opportunity Costs Cash flows lost or foregone by taking one action rather than another
Externalities (side effects) Positive externalities – benefits to other projects.negative externalities – costs to other projects
Changes in Net Operating working Capital (triangle NOWC) Current operating assets – current operating liabilitiesA project will generally require an initial increase in NOWC, which is assumed to be recovered when the project ends
When we evaluate projects, we should ignore all cash flows related to ______ . Financing (notes payable)
Operating Cash Flows formula EBIT – taxes + depreciation
NOWC increase is inflow or outflow? outflow
If liabilities decline, inflow or outflow? outflow
Should financing effects be included in cash flows? No
Should a $5000 improvement cost from the previous year be included in the analysis? No
If market value > book value, _______ pay tax
If book value < market value, _________ tax credit
Is CAPEX negative or positive? negative
NOPAT Net operating price after tax
NOPAT formula EBIT (1-tax) + depreciation
NOWC formula current assets – current operating liabilities
MVA difference between market value and book value of a firm’s common equity
EVA estimate of a business’ true economic profit for a given year
Account statements are ______ for evaluating managers’ performance because… insufficient; they do not reflect market values
Federal income tax system individual and corporate taxes both have a progressive structure
Business Risk definition the riskiness inherent in the firm’s operations if it uses no debt
What determines business risk? Competitionproduct obsolescenceforeign risk exposureoperating leverageregulatory risk and legal exposureuncertainty about demand (sales), output prices, costs
Operating leverage risk definition the use of fixed cost rather than variable cost
EBIT is basically …. revenues – cost
Breakeven Point formula Q = F/(P-V)
Financial leverage is… the use of debt and preferred stock
the use of debt…. concentrates the firms business risk on the stockholders
business risk depends on… business factors
Business risk is an important determinant of…. the optimal capital structure
capital structures vary between… industries and within
What is considered a use of cash for the firm? A net increase in inventoryA net increase in fixed assets
If compensation for senior management is based on short-term performance of the firm, in the short run the firm is likely to: overstate its earnings
How much cash is a firm generating through operating, investing, and financing activities?Is this a balance sheet or statement of cash flows question? Statement of cash flows
How much debt and equity has the firm issued to finance its assets?Is this a balance sheet or statement of cash flows question? Balance Sheet
Provides a quantitative summary of a company’s assets, liabilities, and new worth at a specific point in time Balance Sheet
Aggregates all cash inflows, which the company receives from its ongoing activities and investment sources, and all cash flows Statement of cash flows
Accounts for all revenues and expenses over an accounting period Income statement
Is issued once a year by a corporation and contains basic financial statements and an analysis of past performance and future prospects Annual report
The annual report is very important for investors, because the information contained in the annual report: helps investors forecast expected earnings and dividends
Does the firm generate enough internal funds to support anticipated investment, or does additional outside capital need to be raised?Is this a balance sheet or statement of cash flows question? Cash Flows
Can the firm meet all of its short term obligations using its current assets? Is this a balance sheet or statement of cash flows question? Balance sheet
Is divided into two important parts: operating and non operating sections; also known as the profit and loss statement income statement
summarizes a company’s assets, liabilities, and stockholders’ equity at a specific point in time balance sheet
Provides details about the flow of funds from operating, investing and financing activities statement of cash flows
explains the changes in a company’s retained earnings over the accounting year statement of retained earnings
Is required by the SEC and includes the audited documents that shows the company’s financial results for the past year and management’s discussion about the future outlook and plans. Annual report
As long as the information reported follows the generally accepted accounting principles guidelines, accountants in a firm have the liberty to use personal judgement to report transactions in the firm’s financial statements. T/F True
How profitable has the firm been?Is this an income statement or statement of retained earnings question? Income Statement
How much of the firm’s earnings are left as balance after the firm pays out dividends to its shareholders?Is this a income statement or statement of retained earnings question? Statement of retained earnings
Gives details about the company’s cash at the beginning of the year and what is left at the end of the year, including some details about where cash was generated and where it was used during the course of the year Statement of cash flows
Gives details about the firm’s sales, costs, and profits for the past accounting period income statement
has three segments that when analyzed together give an idea of what the company owns and what it owes balance sheet
Details changes in the capital received from investors in exchange for stock (paid-in capital), donated capital, and retained earnings statement of retained earnings
Company’s debts are listed in……. the order in which they are to be repaid
A company’s assets should be listed in….. the order in which they are to be converted to cash
A firm has $100 million in revenues. Does that mean it has generated a cash flow of $100 million? No
Yum brands distributes dividends to its common stockholders for the first time. Operating, Investing or Financing activity?? Financing
A company buys some common stock in its supplier’s firm with its extra cash. Operating, Investing or Financing activity?? Investing
Ruth Enterprises distributes a holiday bonus to all its employees. Operating, Investing or Financing activity?? Operating
A company records a decrease in its total raw materials inventory from the previous year. Operating, Investing or Financing activity?? Operating
Equity is the difference between… the company’s assets and liabilities
Equity is the sum of… shareholders/ capital provided by shareholders and retained earnings
Describe a free cash flow. The amount of a firm’s available cash that can be used without harming operation or the ability to produce future cash flows
Is ‘acquiring operating assets’ a use of free cash flow? no
Which performance measure evaluates to what extent managers perform their primary task-that is, to create shareholder wealth? Market value added
From a corporation’s point of view, does the tax treatment of dividends and interest paid favor the use of debt financing or equity financing? Debt financing
You bought 1,000 shares of Tund Corp. stock for $68.12 per share and sold it for $90.03 per share after a few years. How will your gain or loss be treated when you file your taxes? As a capital gain taxed at the long-term tax rate.
An increase in depreciation expense will lead to a ____ taxable income. It will ____ tax deducted from a company’s earnings, thus leading to a ____ operating cash flow. lower; decrease; higher
If a taxpayer is liable to pay $8950 under AMT law but $7500 according to the regular tax system, the taxpayer will need to pay taxes according to the __________. Alternative Minimum Tax (AMT) system
To offset taxable income in a given year, ordinary corporate operating losses can be: Carried back for 2 years and carried forward for 20 years
An example of externality that can have a negative effect on the firm cannibalization
The cash flow at the end of the life of the project Terminal cash flow
A risk analysis technique that measures change in the internal rate of return (IRR) and net present value (NPV) as individual variables are changed Sensitivity analysis
The risk of a project without factoring in the impact of diversification stand-alone risk
Creates value for a company because it gives the company the right but not the obligation to take future action to increase its cash flows real option
A cell phone company recently gave customers the ability to buy applications that they can download to their cell phones. Allowing customers to use these applications increased cell phone sales. This is an example of _____ externality. a positive within-firm
A cost that has been incurred and may be related to a project but should not be part of the decision to accept or reject a project sunk cost
the specific cash flows that should be considered in a capital budgeting decision relevant cash flows
the effects on other parts of the firm externalities
the cost of not choosing another mutually exclusive project by accepting a particular project opportunity cost
the cash flows that the asset or project is expected to generate over its life incremental cash flows
A large soft-drink company currently produces regular cola and diet cola. It is considering introducing a new soft drink that tastes like regular cola but has zero calories like the diet cola. The new zero-calorie drink that tastes like regular cola is most likely to produce ______ externality. a negative within-firm
Cost of new equipment = price of new equipment + ____ asset’s installation, shipping and delivery costs
Monte Carlo Simulation project is analyzed under a large number of scenarios. computer randomly selects and calculates NPVs. The mean is found and determines an expected profitability.
Evaluating risk is an important part of the capital budgeting process. What is measured by the variability of the project’s expected returns? Stand-alone risk
The problem with using __________ when trying to adjust for projects that are more risky or less risky than a firm’s average project is that these adjustments are extremely subjective and difficult to justify. a risk-adjusted cost of capital
When a project involves an entirely new product line, the firm may be able to obtain betas from ______ to calculate a weighted average cost of capital (WACC) for its new product line. pure-play companies in the new area
Certain real options allow companies to change capacity output in response to changing market conditions. T/F True
Which type of real option allows the output and/or inputs in the production process to be altered, depending on how market conditions change during a project’s life? Flexibility option
Sometimes real option can give managers the flexibility to decide to invest in a project or wait to make a more calculated decision. T/F True
Which type of real option allows a firm to postpone a project until it can gather more information? Timing option
Decision tree analysis is more commonly used in valuing securities than real assets. True
Which type of real option allows a firm to shut down a project if its cash flows are lower than expected? Abandonment option
As a firm raises more and more capital, its cost of debt and preferred stock will most likely _____ . increase
What is part of the post audit? The management team needs to compare the projected selling price to the actual selling price.The management team needs to explain the differences and why they occurred in the instances where the company’s estimated costs were different from the actual costs.
Public sale of additional shares of common stock by a company that already has sold stock to investors is called SEO
In a public offering of common stock, the difference between public offer price and price paid by the underwriter is called spread
Under what form of underwriting does the underwriting bank syndicate bear all the risk of not being able to sell the entire issue for more than the cost? Firm commitment
Which market for securities issuance is more active for debt securities than for equities? Private placement
What type of security issuance provides underwriters the highest average percentage fee? Non-fund IPOs
In order to issue shares that have already been authorized, an additional vote by shareholders is required. T/F False
Dividends paid to common stock are a tax-deductible expense for the firm. T/F False
The firm cannot default on undeclared dividends. T/F True
Dividends are, for the most part, subject to individual income tax. T/F True
Creditors usually do not have voting power. T/F True
Debt is not an ownership interest in the firm. T/F True
The bond indenture usually lists the following features, EXCEPT rating
Relatively short-term (under 10 years) unsecured corporate debt is referred to as note
seniority of debt refers to whether the debt holder has priority over other lenders in the event of default
When a firm has no taxes, WACC = EBIT
The agency cost of financial distress Loss of value due to the shareholder incentive to take excessive risks
Under the tradeoff theory of capital structure, a firm with higher anticipated profits will take on… more debt, because it needs a higher tax shield and faces lower distress costs
Most of the surveyed executives believe that financing policy is very important. T/F True
Most of the surveyed executives say their firms have no target capital structure. T/F False
All corporations in the U.S. have some debt financing in their capital structure. T/F False
Which group of financial ratios help determine whether the firm can make required payments? Liquidity
What are areas of concern when using financial ratios? A firm may be a conglomerate that operates in many different industriesDifferent accounting practices across firms may distort comparisonssometimes it’s hard to tell if a ration is “good” or “bad”
During the 2008-2009 recession, which expenditures were cut to a greater extent by cash-constrained firms, relative to cash-unconstrained firms? Tech spendingcapital expendituresemploymentmarketing expenditures
The cash conversion cycle focuses on the length of time between when a company makes payments to its creditors and when a company receives payments from its customers. T/F True
What makes it convincing that the firm is likely to be inefficient in managing its cash cycle? DSO too high relative to industry average.inventory turnover too low relative to industry average.profits too low relative to industry average.
Which, on average, is much higher for firms in Italy than for firms in the U.S.? Accounts payable, accounts receivable, sales
An increase in accounts receivable is likely to reduce which cost to the firm? cost of lost sales due to overly restrictive credit policy
Most of the surveyed executives say that their firms have no target dividend policies. T/F False
In the U.S., dividends are taxable at a personal level, while capital gains are not taxed until realized. T/F True
Dividend omissions and cuts are usually met with a negative price reaction. T/F True
Capital gain on S&P 500 has been considerably more volatile over time, compared to dividend yield. T/F True
Dividends, historically, are about as volatile as corporate earnings. T/F False
The recession of 2008 had a bigger impact on share repurchases than it had on dividends. T/F True
Dividends are less risky than capital gains because firms intentionally smoothen out their dividend payouts over time. T/F False
Which of the following suggests that dividends convey important information to the market participants regarding the firm’s future earnings? Signaling hypothesis
If firms pile up cash and make fewer investments, shareholders may welcome dividends because… dividends reduce the free cash flow problem
The theory that suggest that firms may vary their dividend payouts in accordance with the changing preferences of investors is called… catering theory
What reason for share repurchases is indicated as important by the highest percentage of surveyed executives? Stock price is too low
Which statement is considered much truer for repurchases than for dividend payouts by surveyed executives? We make dividend/ repurchase decisions after our investment plans are determined.
How do you find owed financial obligations? Look at accruals
Cash and Equivalents account can be…. converted to cash immediately
Common stockholders are treated as… residual investors
When total current liabilities AND long term debt increase, the company relies more on _________ debt financing. long-term
Net book value is calculated by… subtracting accumulated depreciation expense from total historic and installation costs
Profit is determined by which account? retained earnings
book value = total common equity/number of outstanding shares of common stock
actual cash collected = net sales – increase in accounts receivable
Balance Sheet a “snapshot” of a firm’s position at a specific point in time
Income Statement shows the firm’s sales and costs during some past period (1 year, for example)
Statement of cash flows shows how much cash the firm began the year with, how much cash it ended up with, and what it did to increase or decrease its cash
statement of stockholders’ equity shows the amount of equity the stockholders had at the start of the year, the items that increased or decreased equity, and the equity at the end of the year
annual report most important report that corporations issue to stockholders. contains two types of info: verbal section describing the firm’s operating results during the past year and discussing new development; basic financial statements: balance sheet, income statement, statement of cash flows, statement of stockholders’ equity
Most tax payers pay ___% on capital gains 15
if an individual is making 400,000 or a couple making 450,000, they pay ___% on capital gains 20
capital gains the profits from the sale of assets not normally transacted in the normal course of business
Optimal Capital Structure is determined by… Highest Stock PriceLowest WACCHighest Shareholder WealthHighest Firm Value
Hamada Equation Beta Levered = beta unlevered x [1 + (1-T)(D/E)]
ROE Net income/shareholder equity

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