Managerial Finance exam #1

3 General Concepts of Finance 1: More value is preferred to less2: The sooner cash is received the more valuable it is3: Less-risky assets are more valuable that riskier assets
Proprietorship An unincorporated business owned by one individual.
Partnership An unincorporated business owned by 2 or more persons.
Corporation A legal entity created by a state, separate and distinct from its owners and managers, having unlimited life, easy transferability of ownership, and limited liability.
Corporate Charter A document filed with the secretary of the state in which a business is incorporated that provides information about the company, including its name, address, directors, and amount of capital stock.
Bylaws A set of rules drawn up by the founders of the corporation that indicates how the company is to be governed; includes procedures for electing directors, rights of stockholders, and how to change when necessary.
Limited Liability Partnership (LLP) A partnership wherein at least one partner is designated as a general partner with unlimited personal financial liability and the other partners are limited partners whose liability is limited to the amounts they invested in the firm.
Limited Liability Company (LLC) Offers the limited liability associated with a corporation; however, the company’s income is taxed like that of a partnership.
S Corporation A corporation with no more than 100 stockholders that elects to be taxed in the same way as proprietorships and partnerships, so that business income is only taxed once.
Stockholder Wealth Maximization The appropriate goal for management decisions; considers the risk and timing associated with expected cash flows to maximize the price of the firm’s common stock.
Value The present, or current, vale of the cash flows that an asset is expected to generate in the future.
Agency Problem A potential conflict of interest between outside shareholders (owners) and managers who make decisions about how to operate the firm.
Hostile Takeover The acquisition of a company over the opposition of its management.
Business Ethics A company’s attitude and conduct toward its stakeholders (employees, customers, stockholders, & community).
Corporate Governance Deals with the set of rules that a firm follows when conducting business; these rules identify the who is accountable for major financial decisions.
Stakeholders Those who are associated with a business, including managers, employees, customers, suppliers, creditors, stockholders, and other parties with an interest in the firm’s well-being.
Proxy Votes Voting power that is assigned to another party such as another stockholders or institution (often a bank).
Industrial Groups Organizations of companies in different industries with common ownership interests, which include firms necessary to manufacture and sell products; network of manufacturers, suppliers, marketing organizations, distributors, retailers, and creditors.
Multinational Companies Firms that operate in 2 or more countries.
Exchange Rates The price at which the currency of one country can be converted into the currencies of other countries.
Production Opportunity The return available within an economy from investment in a productive (cash-generating) asset.
Time Preference for Consumption The preference of a consumer for current consumption as opposed to saving for future consumption.
Risk In a financial market context, the change that a financial asset will not earn the return promised.
Inflation The tendency of prices to increase over time.
Nominal (quoted) Risk-free Rate (rRF) The rate of interest on a security that is free of all risk; proxied by the T-bill rate and includes an inflation premium.
Real Risk-free Rate of Interest (r*) The rate of interest that would exist on default-free U.S. Treasury securities if no inflation were expected.
Inflation Premium (IP) A premium for expected inflation that investors add to the real risk-free rate of return.
Default Risk Premium (DRP) The difference between the interest rate on a U.S. Treasury bond and a corporate bond of equal maturity and marketability; compensation for the risk that a corporation will not meet its debt obligations.
Liquidity Premium (LP) A premium added to the rate on a security if the security cannot be converted to cash on short notice at a price that is close to the original cost.
Maturity Risk Premium (MRP) A premium that reflects interest rate risk; bonds with longer maturities have greater interest rate risk.
Term Structure of Interest Rates The relationship between yields and maturities of securities.
Yield Curve A graph showing the relationship between yields and maturities of securities on a particular date.
“Normal” Yield Curve A upward-sloping yield curve.
Inverted (“Abnormal”) Yield Curve A downward-sloping yield curve.
Liquidity Preference Theory The theory that, all else being equal, lenders prefer to make short-term loans rather than long-term loans; hence, they will lend short-term funds at lower rates than they lend long-term funds.
Expectations Theory The theory that the shape of the yield curve depends on investors’ expectations about future inflation rates.
Market Segmentation Theory The theory that every borrower and every lender has a preferred maturity, and that the slope of the yield curve depends on the supply of and demand for funds in the long-term market relative to the short-term market.
Open Market Operations Operations in which the Federal Reserve buys or sells Treasury securities to expand or contract the U.S. money supply.
Annual Report A report issued by a corporation to its stockholders that contains basic financial statements, as well as the opinions of management about the past year’s operations and the firm’s future prospects.
Balance Sheet A statement that shows the firm’s financial position- assets and liabilities and equity- at a specific point in time.
Common Stockholders’ Equity (Net Worth) The funds provided by common stockholders- common stock, paid-in capital, and retained earnings.
Common Size Balance Sheet Dollar amounts on the balance sheet are states as a percent of total assets.
Retained Earnings The portion of the firm’s earning that have been reinvested in the firm rather than paid out as dividends.
Book Values Amounts reported in financial statements- accounting numbers.
Market Values Values of items- asset, liability, and equity- in the marketplace outside the firm.
Income Statement A statement summarizing the firm’s revenues and expenses over an accounting period, generally a quarter or a year.
Operating Cash Flows Those cash flows that arise from normal operations; the difference between cash collections and cash expenses associated with the manufacture and sale of inventory.
Accounting Profits A firm’s net income as reported on its income statement.
Statement of Cash Flows A statement that reports the effects of a firm’s operating, investing, and financing activities on cash flows over an accounting period.
Statement of Retained Earnings A statement reporting the change in the firm’s retained earnings as a result of the income generated and retained during the year. The balance sheet figure for retained earnings is the sum of the earnings retained for each year that the firm has been in business.
Liquid Asset An asset that can be easily converted into cash without significant loss of the amount originally invested.
Liquidity Ratios Ratios that show the relationship of a firm’s cash and other current assets to its current liabilities; they provide an indication of the firm’s ability to meet its current obligations.
Asset Management Ratios A set of ratios that measure how effectively a firm is managing its assets.
Financial Leverage The use of debt financing.
Debt Management Ratios Ratios that provide an indication of how much debt the firm has and whether the firm can take on more debt.
Profitability Ratios A group of ratios showing the effect of liquidity, asset management, and debt management on operating results.
Market Value Ratios A set of ratios that relate to firm’s stock price to its earnings and book value per share.
Comparative Ratio Analysis An analysis based on comparison of a firm’s ratios with those of other firms in the same industry at the same point in time.
Trend Analysis An evaluation of changes in a firm’s financial position over a period of time, perhaps years.
“Window-dressing” Techniques Techniques employed by firms to make their financial statements look better than they actually are.
Financial Planning The projection of sales, income, and assets, as well as the determination of the resources needed to achieve these projections.
Financial Control The phase in which financial plans are implemented; deals with the feedback and adjustment process required to ensure adherence to plans and modification of plans because of unforeseen changes.
Sales Forecast A forecast of a firm’s unit and dollar sales for some future period; generally based on recent sales trends plus forecasts of the economic prospects of the nation, region, industry, and so forth.
Projected (Pro Forma) Balance Sheet Method A method of forecasting financial requirements based on forecasted financial statements.
Spontaneously Generated Funds Funds that are obtained from routine business transactions.
Additional Funds Needed (AFN) Funds that a firm must raise externally through new borrowing or by selling new stock.
Financing Feedbacks The effects on the income statement and balance sheet of actions taken to finance forecasted increases in sales.
Lumpy Assets Assets that cannot be acquired in small increments, but instead must be obtained in large, discrete amounts.
Operating Breakeven Analysis An analytical technique for studying the relationship between sales revenues, operating costs, and profits.
Operating Breakeven Point Represents the level of production and sales at which net operating income is zero; it is the point at which revenues from sales just equal total operating costs.
Operating Leverage The existence of fixed operating costs such that a change in sales will produce a larger change in operating income (EBIT).
Degree of Operating Leverage (DOL) The percentage change in NOI (or EBIT) associated with a given percentage change in sales.
Financial Breakeven Analysis Determining the minimum operating income (EBIT) the firm needs to cover all of its financing costs and produce earnings per share equal to zero.
Financial Breakeven Point The level of EBIT at which EPS equals zero.
Financial Leverage The existence of fixed financial costs such as interest and preferred dividends; occurs when a change in EBIT results in a larger change in EPS.
Degree of Financial Leverage (DFL) The percentage change in EPS that results from a given percentage change in EBIT.
Degree of Total Leverage (DTL) The percentage change in EPS that results from a 1% change in sales.
Common Stock at Par = = Total shares X Per share par value
Net Cash Flow = = Net income + Depreciation and amortization
Current Ratio = = Current assets / Current liabilities
Quick Ratio = = (Current assets-inventories) / Current liabilities
Inventory Turnover = = Cost of goods sold / Inventory
Days Sales Outstanding (DSO) = = Accounts receivable / (Annual sales/360)
Fixed Assets Turnover = = Sales / Net fixed assets
Total Assets Turnover = Sales / Total assets
Debt Ratio = = Total liabilities / Total assets
Times Interest Earned (TIE) = = EBIT / Interest charges
Fixed Charge Coverage = = (EBIT+Lease payments) / [Interest charges+Lease payments+(Sinking fund payments/1-tax rate)]
Net Profit Margin = = Net income / Sales
Return on Assets (ROA) = = Net income / Total assets
Return on Equity (ROE) = = Net income / Common equity
Price/Earnings (P/E) = = Market price per share / Earnings per share
Market/Book (M/B) = = Market price per share / Book values per share
Yield = = [Dollar income + (Ending value – Beginning value)] / Beginning value
Rate of Return = = Risk-free rate + Risk premium (RP = DRP+LP+MRP)
Yield on a 2-year Bond = = [Interest rate year 1 (R1) +Interest rate year 2 (R2)] / 2
Full Capacity Sales = = Sales level / Percent of capacity used to generate sales level
Symbols:S =VC = GP =F =NOI =P =Q = V = SalesVariable cost of goods soldGross profitFixed operating costsNet operating income (aka EBIT)Sales prices per unitNumber of units produced at soldVariable operating cost per unit
Quantity Operating Breakeven Point (Qopbe) = = Total fixed costs / (Sales price per unit – Variable operating cost per unit) [F / (P-V)]
Degree of Operating Leverage (DOL) = = Percent change in NOI / Percent change in sales
Degree of Operative Leverage at Particular Level of Operations (DOLq) = = [Q(P-V)] / [Q(P-V)-F] (aka Gross profit / EBIT)
Earnings per Share (EPS) = = [(EBIT-I)(1-T)-Dps] / Number of common shares outstanding
Sales Operating Breakeven Point (Sopbe) = = Total fixed costs / [1-(variable operating cost per unit/sales price per unit)] [F / 1-(V/P)]
Degree of Financial Leverage (DFL) = = Percent change in EPS / Percent change in EBIT
Degree of Financial Leverage at Particular Level of EBIT (DFLq) = = EBIT / (EBIT-I)
Degree of Total Leverage (DTL) = = Gross profit / (EBIT-EBITfinbe) (aka DOL x DFL)

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