FIN 300 Exam 1 2023 with verified questions and answers

Investments Financial assets such as stocks and bonds Financial Institutions -Banks (commercial and investment), credit unions, savings and loans -Insurance companies -Brokerage firms -Mutual funds/Hedge funds Corporate Finance -Managing the firm's short/long-term investments -Financing the firm's growth -Returning capital to stakeholders Forms of Business Organization 1.) Sole Proprietorship 2.) Partnership --General --Limited 3.) Corporation Sole Proprietorship Definition: business owned by one person -ADVANTAGES: 1.) Easiest to start 2.) Least regulated 3.) Single owner keeps all of the profits 4.) Taxed once as personal income -DISADVANTAGES: 1.) Limited to life of owner 2.) Equity capital limited to owner's personal wealth 3.) Unlimited liability 4.) Difficult to sell ownership interest Partnership Definition: business owned by two or more persons -ADVANTAGES: 1.) Two or more owners 2.) More capital available 3.) Relatively east to start 4.) Income taxed once as personal income -DISADVANTAGES: 1.) Unlimited liability --General partnership --Limited partnership 2.) Partnership dissolves when one partner dies or wishes to sell 3.) Difficult to transfer ownership Corporation Definition: a legal "person" distinct from owners and a resident of a state -ADVANTAGES: 1.) Limited liability 2.) Unlimited life 3.) Transfer of ownership is easy 4.) Easier to raise capital -DISADVANTAGES: 1.) Separation of ownership and management (agency problem) 2.) Double taxation (income taxed at the corporate rate and then dividends taxed at personal rate, while dividends paid are not tax deductible) Goal of Financial Management Maximize the current value per share of the company's existing stock The Agency Problem -Agency Problem: conflict of interest between principal and agent Agency Relationship -Principal hires an agent to represent its interests -Stockholders (principals) hire managers (agents) to run the company -Stockholders elect a Board of Directors who appoint executives Managerial Compensation -Incentives can be used to align management and stockholder interests -Incentives need to be carefully structured to insure that they achieve their goal Corporate Control Threat of a takeover may result in better management The Balance Sheet Definition: a snapshot of the firm's assets and liabilities at a given point in time -Assets: left hand side; in order of decreasing liquidity -Liabilities and Owners' Equity: right hand side; in ascending order of when due to be paid Balance Sheet Identity Assets= Liabilities+Stockholders' Equity Total Value of Assets Current Assets+Fixed Assets (1. Tagible, 2. Intangible) Net Working Capital Current Assets-Current Liabilities (Usually positive for a healthy firm) Liquidity -Speed and ease of conversion to cash without significant loss of value -Valuable in avoiding financial distress Debt vs. Equity Shareholders' Equity= Assets-Liabilities Market vs. Book Value -Book value= the balance sheet value of the assets, liabilities, and equity -Market value= true value; the price at which the assets, liabilities, or equity can actually be bought or solf Income Statement -The income statement measures performance over a specified period of time (period, quarter, year) -Report revenues first and then deduct any expenses for the period -End result= Net Income= "Bottom line" --Dividends paid to shareholders --Addition to retained earnings -Income Statement Equation: Net Income= Revenue- Expenses Financial Statements -GAAP Matching Principle: --Recognize revenue when it is fullt earned --Match expenses required to generate revenue to the period of recognition -Noncash Items: --Expenses charged against revenue that do not affect cash flow --Depreciation= most important -Time and Costs --Fixed of variable costs --Not obvious on income statement -Earnings Management --Smoothing earnings --GAAP leaves "wiggle room" Taxes Marginal vs. Average tax rates -Marginal: % tax paid on the next dollar earned -Average: total tax bill/taxable income The Concept of Cash Flow -Cash flow= one of the most important pieces of information that can be derived from financial statements -The accounting Statement of Cash Flows does NOT provide the same information that we are interested in here -Our focus: how cash is generated from utilizing assets and how it is paid to those who finance the asset purchase Cash Flow from Assets Cash Flow From Assets (CFFA) =Operating Cash Flow (OCF) -Net Capital Spending (NCS) -Change in NWC (change in the difference between assets and liabilities) Operating Cash Flows (equation) OCF= EBIT (earnings before interest & taxes)+depreciation-taxes Net Capital Spending (equation) NCS= ending net fixed assets-beginning net FA+depreciation Standardized Financial Statements -Common-Size Balance Sheets: all accounts= percentage of total assets (%TA) -Common-Size Income Statement: all line items= percentage of sales or revenue (%SLS) -Standardized statements are useful for: --Comparing financial info year-to-year --Comparing compaines of different sizes particularly within the same industry Ratio Analysis -Allows for better comparison through time or between companies -Used bot internally and externally Categories of Financial Ratios 1.) Liquidity Ratios (short-term solvency) 2.) Financial Leverage Ratios (long-term solvency) 3.) Asset Management (turnover ratios) 4.) Profitability Ratios 5.) Market Value Ratios Profit Margin Measures firm's operating efficiency Total Asset Turnover Measures the firm's asset use efficiency Equity Multiplier -Measures the firm's financial leverage -EM= TA/TE= 1+D/E ratio Why Evaluate Financial Statements 1.) Internal Uses --Performance evaluation: compensation and comparison between divisions --Planning for the future: guide in estimating future cash flows 2.) External Uses --Creditors, suppliers, customers, stockholder Problems with Financial Analysis -Conglomerates -Global competitors -Different accounting procedures -Different fiscal year ends -Differences in capital structure -Seasonal variations and one-time events -Historic in nature Common Size Inventory Inventory/(CA+FA) Total Equity (Common Stock+Retained Earnings)