WGU D076 Finance for Managers Questions And Answers 2024 Graded A+

WGU D076 Finance for Managers Questions And Answers 2024 Graded A+ Beta - Answer A variable that describes how the price of a security varies with the market. Business Finance - Answer An area of finance that deals with sources of funding, the capital structure of corporations, the actions that managers take to increase the value of the firm to its owners, and the tools and analysis used to allocate financial resources. Capital Budgeting Criteria - Answer Metrics and calculations used to determine whether a project or asset will add value and be a worthwhile investment. Capital Investment - Answer The sum of money invested in a business to purchase long-term assets to further its objective of maximizing owner wealth. Capital Structure - Answer The mixture of debt and equity used to finance a firm. Cumulative - Answer A feature of preferred stock specifying that if a company skips payment of a preferred stock dividend one year, it is still required to pay that dividend sometime in the future before paying any common dividends. Defensive Assets - Answer Companies or securities with beta less than 1. Discount Rate - Answer The name for interest rate when used in time value of money calculations. Dividend Discount Model - Answer A model used to evaluate common stock that calculates the value of a share of common stock today by taking the present value of future dividend cash flows. Efficient market - Answer A market in which prices fully relect all the available information about a specific security. Holding Period Return - Answer The return over the entire period that an investor owns a financial security. Internal Rate of Return (IRR) - Answer The rate of return that a firm earns on its capital projects. Market Risk - Answer Risk that is inherent in the economy as a whole and cannot be diversified away; also called systematic risk or nondiversifiable risk.Market-to-book Ratio (M/B Ratio) - Answer A market ratio found by market value of equity divided by book value of equity. Nonsystematic Risk - Answer Risk that results from factors at a particular firm and can be reduced through diversification; also called firm-specific risk or idiosyncratic risk. Perpetuity Model - Answer A formula used to value preferred stock that is based on the calculation of a perpetuity. Plowback Ratio - Answer The percent of net income retained in the firm; also called the retention ratio. Quick Ratio - Answer A liquidity ratio found by current assets less inventory, divided by current liabilities; also called the acid-test ratio. Return On Assets (ROA) - Answer A profitability ratio found by net income divided by total assets. Return - Answer The money gained or lost on an investment over a certain period of time. Risk Retention - Answer A decision to take responsibility for a particular risk. Securitization - Answer The process of combining several types of contractual debt (such as mortgages) and reselling them as a package to investors. Upside Potential - Answer The unlimited earnings potential of equity ownership. Variable Expenditures - Answer An expense that you have direct control over and that can change from period to period. Profitability - Answer Which type of ratio should be used to examine the cost efficiency of a firm's production? Current ratio - Answer Which ratio helps an analyst evaluate whether a company can cover its short-term obligations? Quick ratio - Answer Which ratio should an analyst use to consider the effect of a firm's inventory on a firm's ability to meet current obligations? Why is it important to consider the time value of money in an ideal evaluation method for capital investment? - Answer Because the value of a cash flow today is different from the value of a cash flow of the same dollar amount in 10 years Discretionary account - Answer What kind of account is Notes payable? Compound Interest equation - Answer Total Interest=Principal×(1+Interest Rate)^Number of Periods−PrincipalPresent Value of a Perpetuity equation - Answer Present Value=PMT/i What does the DuPont Framework tell us? - Answer One is that return on all the investors (debtholders and equity holders) is measured by the firm's profitability and asset usage efficiency. The effect of debt, or in other words, the effect of the capital structure of the firm, appears only on the return on equity. How can you reduce DFN? - Answer Slow Sales Growth Examine Capacity Constraints Lower Dividend Payout Increase Net Margin What are the advantages of NPV? - Answer NPV: Considers time value of money Calculates value added to the firm Considers risk and required return What should you be aware of when calculating IRR? - Answer The solution can only be obtained through trial and error (or interpolation). What assumptions does the Gordon Growth Model make in order to make the dividend discount model usable? - Answer Dividends are paid every year. Dividends grow at a constant rate forever What should you considering in the capital budgeting process of capital investment? - Answer For the capital budgeting process of capital investment, it is essential to consider the time value of money, the risk of a project, and all the cash flows of a project to evaluate whether the project is worthwhile. What is the ideal evaluation method for capital investment? - Answer It includes all cash flows that occur during the life of the project. It considers the time value of money. It incorporates the cost of capital—or in other words, the required rate of return on the project. What do market ratios measure? - Answer Market ratios are used to evaluate the current share prices of a public firm's stock. Debt-to-Equity Ratio=Total Liabilities/Total Owners' Equity - Answer Debt-to-Equity Ratio equation What are profitability ratios used for? - Answer Profitability ratios help you understand a company's performance and cost efficiency and thereby measure a company's profitability. What are the three main comparison methods used in ratio analysis? - Answer trend analysis, cross-sectional analysis, and progress measurement Accounting - Answer The system of recording, reporting, and summarizing past financial information and transactions.Accounts Receivable Turnover (AR Turnover) - Answer An activity ratio found by credit sales divided by accounts receivable. Activity Ratios - Answer A category of ratios that measure how well a company uses its assets to generate sales or cash, showing the firm's operational efficiency and profitability. Additional Funds Needed (AFN) - Answer Another name for the discretionary financing needed or external financing needed. It represents the additional financing needed given a firm's expectations for future growth. Affirmative Covenants - Answer A bond covenant that describes things the company pledges itself to do in order to protect bondholders. Agency Costs - Answer Costs that are incurred when management does not act in the best interest of shareholders. Agency Problem - Answer When the agent (the management) does not act in the best interest of the principle (the owners). Aggressive Assets - Answer Companies or securities with beta greater than 1. Annual Percentage Rate - Answer The annual interest rate that is charged for borrowing money or that is earned through investment. Annuity Due - Answer A series of equal payments made at the beginning of consecutive periods. Annuity - Answer A stream of cash flows of an equal amount paid every consecutive period. Asset Pricing - Answer The process of valuing assets. Auction Market - Answer A secondary market with a physical location and where prices are determined by investors' willingness to pay. Average Collection Period (ACP) - Answer An activity ratio found by the number of days in a year (365) divided by AR turnover. Balance Sheet Forecasting - Answer Using sales growth and the profit forecast to construct a pro forma balance sheet to understand the future implications of the sources and uses of finances. Banks and Credit Unions - Answer Receive deposits and extend loans to individuals and businesses. Benchmarking - Answer The process of completing a financial analysis to compare a firm's financial performance to that of other similar firms.Bid-ask Spread - Answer The difference between the bid and ask prices that compensate the specialist for the risk that he or she bears for willingness to provide liquidity. Board of Directors - Answer A group of people who jointly supervise the activities of an organization. Bond Indenture - Answer A legal contract that governs the relationship between a firm and its bondholders. Bondholders - Answer A person who loans a corporation money by buying debt securities. Cannibalization - Answer The reduction in sales of a company's own products due to introduction of another similar product. Capital Asset Pricing Model (CAPM) - Answer A model used to determine the riskreturn relationship for an asset. Capital Budgeting - Answer The process of evaluation and planning for purchases of long-term assets. Capital Markets - Answer A type of financial market used for long-term assets that are held for greater than one year. Capital - Answer A financial asset that can be used by a firm or individual. Examples of capital may be machinery or cash held by a firm. Capital-constrained Environment - Answer When a limited amount of funds are available. Cash Budgets - Answer A plan for controlling cash inflows and outflows business to balance income with expenditures. Cash Management - Answer Managing the day-to-day finance operations of a firm. Central Banks - Answer Ensure that a nation's economy remains healthy by controlling the amount of money circulating in the economy. Common Stock - Answer A type of stock that represents equity in a firm and confers the right to vote at shareholder meetings. Compounding Interest - Answer The interest on the principal plus the interest on earned interest. Compounding - Answer Finding a future value given a present value. Corporate Bonds - Answer A debt instrument that is issued by a corporation in order to raise capital.Corporate Governance - Answer The system of rules, practices, and processes by which a firm is directed and controlled. Correlation - Answer The measure of the relationship between two variables that move in relation to each other. Cost of Capital - Answer The cost to a firm to use an investor's capital; see interest rate. Coupon Rate - Answer The stated interest rate of a bond; also known as coupon yield. Coupon Yield - Answer The stated interest rate of a bond; also known as coupon rate. Covenants - Answer Statements in a bond indenture that outline things the company will obligate itself to do or not do in order to protect bondholders. Credit Analysts - Answer A commercial bank position with the responsibility to assess the riskiness of lending to borrowers and determining whether or not loans should be extended to potential bank clients. Cross-sectional Analysis - Answer Comparing a firm's financial ratios to other firms' ratios or industry averages. Current Market Value - Answer What someone would pay right now for an asset. Current Ratio - Answer A liquidity ratio found by current assets divided by current liabilities. Dealer Market - Answer A secondary market made up of multiple dealers that hold an inventory of securities and quote prices. Debt Ratio - Answer A financing ratio found by total liabilities divided by total assets. Debt-to-equity Ratio - Answer A financing ratios found by total liabilities divided by total equity. Default Risk - Answer The probability of a loss resulting from a borrower's failure to repay a contractual obligation; also called credit risk. Default - Answer Failure to meet a debt obligation. Discount Bond - Answer A bond whose price is below its par value. Discounting - Answer Finding a present value given a future value. Discretionary Accounts - Answer Accounts that do not vary automatically with sales but are left to the discretion of management.Discretionary Financing Needed (DFN) - Answer The additional financing needed given a firm's expectations for future growth. Diversification - Answer The process of "spreading" your money over many different assets. Dividends in Arrears - Answer A feature of preferred stock specifying that if a company ignores preferred stock dividends, it cannot pay anything to its common stockholders. DuPont Framework - Answer An expanded formula of the return of equity, net margin times total asset turnover times leverage multiplier, which represent the components of profitability, activity (efficiency), and financing. Estates - Answer Everything that a person owns or controls, especially at death. Ethical Dilemma - Answer An issue in the process of deciding between multiple options where no option is completely acceptable from an ethical standpoint. Ethics - Answer Following accepted standards of moral conduct. Expected Return - Answer A hypothesized estimate of future prices or returns under different scenarios based on expectational data. External Financing Needed (EFN) - Answer Another name for the discretionary financing needed or additional funds needed. It represents the additional financing needed given a firm's expectations for future growth. Face Value - Answer The sum of money that a corporation promises to pay at the expiration of a bond; also called par value. Finance - Answer The study of managing and allocating funds at the personal or business level. Financial Institutions - Answer An area of finance that includes firms or organizations that exist to accept a wide variety of deposits, to offer investment products to individuals and businesses, to provide loans, or to broker financial transactions. Financial Managers - Answer A person who makes strategic financial decisions in a corporation. Financial Policy Implementation - Answer Incorporating new finance ideas within a firm. Financial Risk - Answer Increased volatility in earnings as a result of using debt. Firm-specific Risk - Answer Risk that results from factors at a particular firm and can be reduced through diversification; also called nonsystematic risk or idiosyncratic risk.Fisher Effect - Answer An economic theory developed by Irving Fisher holding that the real interest rate is equivalent to the nominal interest rate minus the expected inflation rate. Fixed Asset Turnover (FAT) - Answer An activity ratio found by sales divided by fixed assets. Fixed Expenditures - Answer An expense that you do not have direct control over and that remains constant from period to period. Fixed-income Securities - Answer Another name for bonds; a financial security in which the borrower pays a fixed interest payment to investors each year. Future Value - Answer The worth of cash flows in terms of the dollar amount in the relative future. Gordon Growth Model - Answer A formula used to value common stock based on the assumptions that dividends are paid every year and grow at constant rate forever. Gross Margin - Answer A profitability ratio found by gross profit divided by sales. Harvest - Answer Generating cash or stock from the sales or IPO of companies in the portfolio of investments. Hurdle Rate - Answer The required rate of return that a company expects to earn in order to consider a project. Hybrid Security - Answer A security that has some elements that resemble equity and others that resemble debt. Idiosyncratic Risk - Answer Risk that results from factors at a particular firm and can be reduced through diversification; also called firm-specific risk or nonsystematic risk. Incremental Cash Flows - Answer Cash flows that result from accepting a project. Inflation - Answer The rate at which the average price level of a basket of chosen goods and services in an economy increases over a period of time. Initial Public Offering (IPO) - Answer When a privately held company first offers shares of stock to outside investors to raise capital, therefore becoming a publicly owned company. Insurance Companies - Answer Charge premiums to invest in bonds and stocks to pay claims. Interest Rate Risk - Answer The probability that changes in interest rates will impact the value of a bond.Interest Rate - Answer The percentage of the principal that a lender charges a borrower for the use of assets. Intrinsic Value - Answer The value of an asset as determined through fundamental analysis without referring to the asset's market value. Inventory Turnover - Answer An activity ratio found by COGS divided by inventory. Investment Bank - Answer A financial intermediary that offers complex financial transactions such as underwriting, facilitating mergers, and buying and selling financial securities on behalf of large institutions. Investments - Answer An area of finance that involves deciding which assets to invest in to create wealth in the future. Legal - Answer Following the laws and rules set by an authority. Leverage Ratios - Answer A category of ratios that consider how a firm is financed. Leverage - Answer Another name for debt or liability. Liquid Asset - Answer An asset that can be converted into cash quickly without the loss of significant value. Liquidity Ratios - Answer A category of ratios that measure a firm's ability to meet short-term obligations. Liquidity - Answer The ability to turn financial securities into cash easily without losing significant value. Market Capitalization - Answer The current market value of a publicly traded company's total outstanding shares, indicating the size of a company. Market Ratios - Answer A category of ratios that are used to evaluate the current share price of a public firm's stock. Marketing - Answer The business function responsible for generating sales. Maturity Date - Answer The date at which a bond expires. Money Market - Answer A type of financial market used for short-term assets that are held for less than one year. Morals - Answer Following one's standards of right and wrong behavior. Mutual Fund - Answer An investment company that continually offers investments and buys financial securities and instruments on behalf of investors. Mutually Exclusive - Answer When two or more events do not coincide.NASDAQ - Answer A computer network where stocks are bought and sold. It is the second-largest stock exchange in the world. Typically, technology-related companies will go public through this exchange. Negative Covenants - Answer A bond covenant that describes things the company pledges itself not to do in order to protect bondholders. Net Margin - Answer The percentage of sales remaining after all costs have been deducted from a company's total sales. Also known as net profit margin; indicates the profit earned by the firm. New York Stock Exchange (NYSE) - Answer A physical trading floor and a computer network where stocks are bought and sold. It is the largest stock exchange in the world. Nominal Rate - Answer The rate at which invested money grows for a certain period of time. Nondiversifiable Risk - Answer Risk that is inherent in the economy as a whole and cannot be diversified away; also called market risk or systematic risk. Operating Income Return On Investment (OIROI) - Answer An activity ratio found by operating income divided by total assets. Operating Margin - Answer A profitability ratio found by EBIT profit divided by sales. Opportunity Cost - Answer The loss of potential gain from other alternatives when one alternative is chosen. Ordinary Annuity - Answer A series of equal payments made at the end of consecutive periods over a fixed length of time. Par Bond - Answer A bond whose price is exactly equal to its par value. Par Value - Answer The sum of money that a corporation promises to pay at the expiration of a bond; also called face value. Payout Ratio - Answer The percent of net income distributed to the shareholders. Pension Fund - Answer A financial institution that specializes in managing and administering retirement funds. Perpetuity - Answer A constant stream of identical cash flows that continues forever. Personal Bankers - Answer A commercial bank position with the responsibility to find and attract new clients. Preferred Stock - Answer A hybrid security that has no fixed maturity, has fixed payments, and does not confer voting rights on bondholders.Premium Bond - Answer A bond whose price is above its par value. Present Value - Answer The worth of cash flows in terms of the dollar amount in the relative past. Price Risk - Answer The potential for the decline in the price of a financial security or an asset relative to the market. Price-to-earnings Ratio (P/E Ratio) - Answer A market ratio found by price per share divided by earnings per share. Primary Market - Answer The financial market where securities (stocks and/or bonds) are first sold. Private Equity - Answer A financial institution that invests in an entity that is not publicly listed or traded using money received from institutional investors and wealthy individuals. Privately Held Companies - Answer Firms that have not issued shares to the public where the ownership rights are privately held. Pro Forma Statements - Answer A financial statement that projects an estimate for future periods "as if" sales grew as predicted. Profit Forecasting - Answer The projection of future earnings after all projected costs are subtracted from projected sales. Profitability Index (PI) - Answer The ratio of payoff to investment for a proposed project. Profitability Ratios - Answer A category of ratios that are commonly used to directly judge how well management is doing as they strive to maximize owner wealth. Publicly Traded Firms - Answer Firms that have issued shares to the public. Real Rate - Answer An interest rate that is adjusted to remove the effects of inflation. Required Rate of Return - Answer The minimum return or compensation an investor requires in order to invest; see interest rate. Research and Development - Answer The business function responsible for improving and developing services and products. Retention Ratio - Answer The percent of net income retained in the firm; also called the plowback ratio. Return On Equity (ROE) - Answer A profitability ratio found by net income divided by owners' equity.Revenues - Answer The top line of the income statement. The total amount of money a business brings in (before subtracting any costs). Risk Avoidance - Answer A way to manage risk by not performing an activity that may carry risk. Risk Premium - Answer The compensation for the amount of risk taken on by investors. Risk Reduction - Answer A series of techniques that help reduce the amount of risk a person is exposed to by taking a particular action. Risk Separation - Answer A risk management technique that involves dispersing assets geographically instead of concentrating them in one location. Risk Transfer - Answer A risk management technique that involves reducing the amount of risk you are exposed to by transferring that risk to another entity. Risk - Answer The possibility that the realized or actual return will differ from the expected return. Risk-free Rate - Answer The rate of return on an investment with no risk. Sales - Answer The top line of the income statement. The total amount of money a business brings in (before subtracting out any costs). Seasonal Firms - Answer Firms whose performance varies according to the season. Secondary Market - Answer The financial market where securities are traded after the initial issuance. Shareholders - Answer A person who owns shares of a company's stock. Simple Interest - Answer The interest earned only on the principal. Specialist - Answer A market maker on the NYSE that holds an inventory of securities and acts as a liquidity provider to those that wish to buy and sel Spontaneous Accounts - Answer Accounts that vary naturally with sales. Stakeholder - Answer Anyone who may be affected by actions taken or a decision made. Standard Deviation - Answer A measure of dispersion of possible outcomes about the mean. Steady State Growth - Answer The level of growth where four key financial ratios— profitability, asset utilization, leverage, and payout—are constant and where the firm does not need to issue any new equity to fund the growth.Stock - Answer A share of ownership in a company. Sunk Costs - Answer A cost that has already been incurred and cannot be recovered. Sustainable Growth Rate (SGR) - Answer The growth rate that allows a firm to maintain its present financial ratios without issuing new equity. Syndicate - Answer A group of intermediaries that is used to oversee the issuance of stocks and/or bonds. Systematic Risk - Answer Risk that is inherent in the economy as a whole and cannot be diversified away; also called market risk or nondiversifiable risk. Tax Strategies - Answer Methods used to minimize the amount of taxes a business pays. Teller - Answer An entry-level commercial bank position with the reponsibility to interact with customers at the bank's front desk or drive-through window. Time Value of Money (TVM) - Answer The idea that money that is available at the present time is worth more than the same amount in the future. Times Interest Earned (TIE) - Answer A financing ratio found by EBIT divided by interest expenses. Total Asset Turnover (TAT) - Answer An activity ratio found by sales divided by total assets. Treasury Bill - Answer A bill issued by the U.S. government as a financial security with no interest and a maturity of less than one year; abbreviated T-bill. Treasury Note - Answer A note issued by the U.S. government as a financial security with a fixed interest rate and a short maturity between 1 and 10 years; abbreviated T-note. Treasury Securities - Answer A debt instrument (bond) that is issued by the United States government in order to raise capital. Trend Analysis - Answer Comparing a firm's ratios across time. Trusts - Answer An arrangement that allows a third party to hold assets on behalf of a beneficiary or beneficiaries. U.S Securities and Exchange Commission (SEC) - Answer An independent federal government agency that (1) protects investors, (2) maintains fair, orderly, and efficient markets, and (3) facilitates capital formation. U.S Treasuries - Answer Bonds, bills, and notes issued by the U.S. government; considered to be the highest-quality securities available.Utility - Answer The total satisfaction received from consuming goods and services. Venture Capitalists (VCs) - Answer Professional managers of investment capital that typically invest in very young new ventures. Wills - Answer A legal expression of an individual's wishes concerning the disposition of his or her property after death Yield to Maturity (YTM) - Answer The rate of return that investors receive on a bond if they purchase a bond today at the market price and hold it until it matures; the required rate of return given the maturity and risk of the bond. Why can compounding interest be a good tool but also a significant detriment? - Answer Compounding interest can be a good tool because it allows a lender to gain interest on interest, but it is a detriment because it causes a borrower to pay interest on interest. Which action will increase the return on equity of a firm? - Answer Increasing the asset usage efficiency of the firm Which type of expense is a magazine subscription? - Answer Variable expense What can you do to reduce next year's DFN? - Answer Lower the amount of dividends that are paid out to shareholders next year Which method is most commonly used for determining a company's DFN? - Answer Percent of sales Why are financial models helpful in financial forecasting? - Answer Models allow users to see the complex relationships between sales and other aspects of the business. How does an analyst use the hurdle rate? - Answer It is used to compare with the IRR to determine whether a project should be accepted. Which term refers to the metrics and calculations that use tools such as net present value (NPV), internal rate of return (IRR), and profitability index (PI) to evaluate investments? - Answer Capital budgeting criteria What would profitability index (PI) be useful for? - Answer Determining whether a firm should invest in projects with different initial outlays The lowest rate of return is required by which type of investor or lender? - Answer Bank What is the effect of debt financing on a firm's income? - Answer Debt interest payments reduce taxable income.An investor is reviewing the bonds of four different companies: Company A issues AA-rated bonds. Company B issues A-rated bonds. Company C issues BB-rated bonds. Company D issues C-rated bonds. Which company is likely to provide the lowest rate of return to the investor? - Answer Company A How is the cost of capital used in the decision-making process for a capital investment project? - Answer It is used as the discount rate of cash flows. What should a potential bondholder (lender) do to prevent a company (borrower) from taking on risky projects? - Answer Set strict covenants that the company cannot uphold if it chooses a risky project What is the main question that both individuals and companies must consider when making financial decisions to reach a goal? - Answer Will the benefits of the action outweigh the costs? How can investing help a person reach personal financial goals? - Answer It provides access to potential revenue or increases in value to help meet goals faster. Which type of economic indicator changes after the economy changes and helps identify trends in the long term? - Answer Lagging indicator How does an investment institution, such as a mutual fund, facilitate the circulation of money in the economy? - Answer By providing individuals and firms access to financial markets to buy or sell financial securities Which type of economic indicator is used by governments and policymakers to implement or alter policies in an effort to avoid or minimize the effects of an economic downturn? - Answer Leading indicator Which condition indicates that an investment will add value to a company? -The positive cash inflows of the project are greater than the negative cash outflows of the project. -The future value of the benefits of the investment outweigh the future value of the costs of the investment. -The present value of the benefits of the investment outweigh the present value of the costs of the investment. -The opportunity costs of the project outweigh the present value of current operations of the company. - Answer The present value of the benefits of the investment outweigh the present value of the costs of the investment. What would an analyst predict for a potential investment with an NPV of zero? - Answer The project would earn exactly the rate of return required by the firm. Why is it important to consider the cost of capital in an ideal evaluation method of capital investment? - Answer Because cash flows for a project may be uncertain What must be determined in order to compare the values of two projects with differently timed cash flows that does not need to be determined for projects with similarly timed cash flows? - Answer Opportunity costHow do you factor sunk costs into capital investment analysis? - Answer For the purposes of analysis, sunk costs are irrelevant. Why is NPV the most reliable method for evaluating investments? - Answer It considers the time value of money, it tells you the dollar value that the investment will add to the firm, and it takes risk into account. You are considering a project that has a profitability index of 1. What does this mean? - Answer The project has the internal rate of return equal to the cost of capital Why is it appropriate to calculate the value of a preferred stock in the same way that you would find the present value of a perpetuity? - Answer For a preferred stock, a fixed amount is paid forever to compensate the investors. How does management choose between two projects that are seemingly the same? - Answer Management can analyze the different inherent risks that change the cost of capital to the firm. Why is it important to have an accurate, carefully calculated required rate of return as part of the NPV? - Answer An inaccurate required rate estimate could cause a firm to reject good projects or accept bad projects. The YTM of a bond went from 8% to 7%. What can be predicted about the price of the bond? - Answer It will increase. There is an inverse relationship between YTM and the price of a bond. What type of financial institution is an insurance company? - Answer Contractual Personal income is which type of economic indicator? - Answer Coincident What is the second step in finding a solution to an ethical dilemma? - Answer First, identify and define the problem. Then, consider alternative courses of action. How can agency problems can be reduced through corporate control? - Answer Executive compensation Which type of financial institution is a mutual fund? - Answer Investment institution Which type of economic indicator is the consumer price index? - Answer Lagging indicator A company's officers and board of directors are selling their stocks in the firm at higher prices due to false accounting reports that made the stock seem more valuable than it truly was. Which ethical issue is occurring in this situation? - Answer Agency problem due to conflicting interests What is the name for a forecast of short-term events that helps a company understand if it has sufficient cash? - Answer Cash budgetIn which situation would a firm need to borrow cash? - Answer When the beginning cash balance plus the net cash is less than the minimum cash balance required for the month What type of accounts are cash, accounts receivable, and inventory accounts? - Answer Spontaneous accounts What does it mean when a firm's calculated discretionary financing needed (DFN) is negative? - Answer The firm will have enough financing to fund projected sales. What are the three things one must determine before making a personal budget? - Answer Income, expenses, and savings What three things should an individual or company be doing so that their budget is effective and so that they are on track to meet their financial goals? - Answer Track cash flows, monitor cash flows, and revise the budget What are long-term financial forecasts used for? - Answer Making investment and financing decisions Which type of account does not vary with sales and is left to management's discretion? - Answer Non-spontaneous accounts, or discretionary accounts do not vary automatically with sales but are left to the discretion of management. What are the six principles of budgeting? - Answer Keep records; understand the key areas of savings, expenses, and income; eliminate consumer debt; know yourself; develop savings, income, and expense strategies; and use a method that meets your needs and objectives. What makes the expected return subjective and different from other types of returns? - Answer The expected return is based on expectational data and the probability of different scenarios occurring.The expected return is calculated from hypothesized or "best-guess" estimates of future prices or returns in different scenarios. What is default risk? - Answer A firm-specific risk that comes from the probability of a loss resulting from a borrower's failure to repay a contractual obligation Why is the required rate of return also known as the hurdle rate? - Answer It is the minimum rate that a firm must surpass to accept a project. What does the risk-free rate indicate? - Answer Inflation and opportunity cost What kind of problem is this: A manager purchases a company car and allocates it as a company expense. - Answer Agency problem. It is a luxury that does not improve shareholder value and costs the company money. How can agency costs be mitigated? - Answer Aligning managers' interests with shareholders' interests. This is most commonly done by compensating management with shares of ownership in the company.What is the third step in finding a solution to an ethical dilemma? - Answer First, you should identify and define the problem. Second, consider alternative courses of action. Third, consider all stakeholders involved. What are the effects of attempting to maximize shareholder value for a business in an unethical way? - Answer It often leads to decreased shareholder value for the business. Which financial institution ensures that a nation's economy remains healthy by controlling the amount of money circulating in the economy? - Answer Central banks control the supply of money in the economy How do insurance companies pay policyholders when a claim is made? - Answer They use returns from stocks and bonds. Insurance companies invest the money that they earn from premiums into stocks and bonds, and then the returns are used to fill claims. A large corporation is looking to merge with another large corporation. Which financial institution can help them do this? - Answer Investment banks facilitate complex financial deals, like mergers. Why does the time value of money play an important role in financial decisionmaking? - Answer Because the benefits of investments received at different times are comparable only when you consider the time value of money What is one way that a firm can improve its return on equity? - Answer Successfully cutting production costs to boost net margin Which actions, taken together, will certainly increase a firm's ROE? -Decreasing equity financing and decreasing return on assets -Increasing net margin and decreasing debt financing -Increasing total asset turnover and decreasing debt financing -Decreasing equity financing and increasing net margin - Answer Decreasing equity financing and increasing net margin. Decreasing equity financing increases the leverage multiplier, therefore increasing ROE, and increasing net margin also increases ROE. What is the main reason why it is important to track and record cash flows? - Answer Tracking your cash flows allows you to recognize where and how your money is spent so you can monitor your cash flows and revise your budget as needed. This is the first step in the budgeting process, and it is necessary in order to have an accurate budget going forward. Which processes help you identify and fix problems in your budget? - Answer Monitoring your budget allows you to identify problems, and then gradual revision and implementation of new processes allow you to fix those problems. What role does financial forecasting play in the future success and growth of a firm? - Answer Financial forecasting supplements historical data with proposed investments or changes to allow for more accurate foresight.Which question is answered by financial forecasting? - Answer How much financing will the firm need in the future? When can the discretionary financing needed (DFN) be determined? - Answer After pro-forma financial statements are forecasted using the percent of sales method. Once all the financial statements are projected according to a given set of assumptions, you can determine the financing required to fund the predicted growth in sales. Which action decreases the discretionary financing needed (DFN)? - Answer Increasing the plowback ratio increases projected owners' equity and thus decreases DFN. How does the PI aid in interpretation of the NPV? - Answer It gives an idea of the return generated by a project. The PI scales different-sized projects so that their returns are comparable. Why is the timing of cash flows an important characteristic of capital investment? - Answer Timing of cash flows is related to the opportunity cost associated with those cash flows. Simple Interest equation - Answer Annual Interest=Principal×Interest Rate Simple Interest for t years equation - Answer Total Interest=Annual Interest×t(Annual Interest=Principal×Interest Rate) Components of Required Rate of Return - Answer Opportunity cost Risk Inflation Interest Rate or Required Rate of Return equation - Answer Rate=Risk-Free Rate+Risk Premium Growth Rate of Purchasing Power equation - Answer Growth Rate in Purchasing Power=(1 + Nominal Rate / 1 + Inflation) − 1 Real Rate equation - Answer Real Rate=Nominal Rate−Inflation(The real rate is the same as the growth rate in purchasing power, even though the formula seems different.) Future Value equation - Answer Future Value=Present Value×(1+i)(i is the discount rate, or the interest rate you are earning)Future Value=Present Value×(1+i)n(n is the number of compounding periods) Present Value equation - Answer Present Value=Future Value/ (1+i)^n(i is the discount rate,n is the number of compounding periods) DuPont Framework equation - Answer ROE=ROA×Leverage Multiplier orROE=Net Profit Margin×Total Asset Turnover×Leverage MultiplierorROE=Profitability×Activity×Financing orROE= (Net Income/Sales) × (Sales/Total Assets) × (Total Assets/Owners' Equity) Which area of finance involves deciding which assets to invest in to create wealth in the future? - Answer Investments What does the Dupont Analysis do? - Answer The DuPont framework helps analyze where changes in return on equity come from. What is Return on Equity? - Answer Return on equity is a composition of the profitability, efficiency, and capital structure of a firm. What are the steps to creating a cash budget? - Answer Determine cash receipts Estimate cash disbursements Create the cash budget DFN equation - Answer DFN=Projected Total Assets−Projected Total Liabilities−Projected Owner's Equity Plowback Ratio equation - Answer Plowback Ratio=1−Payout Ratio Payout Ratio equation - Answer Payout Ratio=Dividends/Net Income Projected Retained Earnings equation - Answer Projected RE = Old RE+(Projected Sales×Net Margin×Plowback Ratio) Projected Total Assets equation - Answer Projected Total Assets=Projected Cash+Projected AR+Projected Inventory+Projected Net Fixed Assets What are the steps to creating a personal budget? - Answer Understand your goals Track your savings, income, and expenses Develop a cash budget (plan)Implement your plan Compare the cash budget to your actual spending and make necessary changes Sustainable Growth Rate equation - Answer SGR=ROE×(1−b)(b is the dividend payout ratio (dividends divided by net income)) orSGR=Net Margin×Total Asset Turnover×Leverage Multiplier×(1−b Sales Capacity equation - Answer Sales Capacity=Actual Sales/% of capacity What are the components of sustainable growth rate? - Answer The components of SGR are profitability, asset use efficiency, capital structure, and dividend policy. If a firm is expecting sales growth of 15%, is it possible to increase fixed assets by 15%? - Answer No. The percent of sales method to project fixed assets is unrealistic because lumpy assets must be purchased as a whole. What are the disadvantages of NPV? - Answer NPV: Requires calculation of appropriate cost of capitalIs not useful to compare projects of varying sizesWhat are the advantages of IRR? - Answer IRR: is easy to interpret,considers time value of money, anddoes not require use of required rate of return. What are the disadvantages of IRR? - Answer IRR: is not a good indicator of the amount of value created,ignores mutually exclusive projects,assumes reinvestment at the IRR rate,cannot be used to compare projects with different durations, andrequires conventional cash flows. What are the advantages of PI? - Answer PI:Considers the time value of moneyTakes into account the risk of future cash flows through the cost of capitalIncludes all future cash flowsIndicates whether an investment will create value for the company What are the disadvantages of PI? - Answer PI:requires calculation of cost of capital andis not useful for mutually exclusive projects. What are the two distinct parts of bond cash flows? - Answer A stream of semiannual interest payments (an annuity) A final principal repayment (a lump sum) Perpetuity Model equation - Answer Vps=D/kps(Vps is the value or price of the preferred stock, D is the annual fixed dividend, and kps is the discount rate or required rate of return) What is Par Value? - Answer Also known as the face value of the bond, the par value is the sum of money that the corporation promises to pay at the bond's expiration. In most cases, it is also the amount that the bondholder gives to the corporation when the bond is initially issued. For corporate bonds in North America, the par value is almost always $1,000. Gordon Growth Model equation - Answer Vcs=D1/(kcs−g)(Vcs is the value or price of the common stock today, D1 is the dividend to be paid next year, kcs is the discount rate or required rate of return, and g is the constant growth rate.) Required Rate of Return equation - Answer Required Rate of Return=Risk-Free Rate +Risk Premium Capital Asset Pricing Model (CAPM) equation - Answer Ri=Rf+βi(Rm−Rf)(Ri is the return on the security i, Rf is the risk-free rate, Rm is the return on the market and βi is the security's beta. Also, Rm - Rf is defined as the market risk premium. You can often use the U.S. Treasury rate as a proxy for the risk-free rate and a market index such as S&P 500 as a proxy for the market return.) What is the capital asset pricing model used for? - Answer CAPM provides you with a way to price risk. In essence, if you wanted to know the required rate of return on Google's stock, you could plug the inputs into the CAPM and get a very good idea of the company's required rate of return. What is the Gordon Growth Model used for? - Answer It is derived from the dividend discount model and is used to find the intrinsic value of common stock.What is the perpetuity model used for? - Answer It is used to value preferred stock. What are TMV functions used for? - Answer Time value of money functions are used to calculate the current value, or price, of a bond and a bond's yield to maturity. What are NPV, IRR, and PI used for? - Answer NPV, IRR, and PI can be used to evaluate whether capital investment is worth pursuing based on certain criteria. Why is the concept of incremental cash flows important? - Answer When you perform capital budgeting analysis, you want to understand the overall impact of the project on the company.The idea of incremental cash flows will prevent others from allocating cash flows (especially expenses) to your project. How is cost of capital used in the capital budgeting process? - Answer The cost of capital accounts for the risk of a project, because investors demand a certain required rate of return on their investment given the level of risk they have to take. What equation should you usually for capital investment calculations? - Answer In most cases, you should use NPV as the primary method and use the other methods to supplement when making capital investment decisions What equation should you usually use for capital investment calculations if there are mutually exclusive projects? - Answer If there are capital constraints when choosing multiple projects, use the PI to rank the projects and then decide which projects to do based on the PI ranking. What are the five major types of ratios? - Answer There are five major types of financial ratios: liquidity, activity, leverage, profitability, and market. What do liquidity ratios measure? - Answer Liquidity ratios measure a firm's ability to meet short-term obligations. What do activity ratios measure? - Answer Activity ratios measure how well a company uses its assets to generate sales or cash. What do leverage ratios measure? - Answer Leverage ratios consider how a firm is financed and how financially risky a firm is. What do profitability ratios measure? - Answer Profitability ratios are used to directly judge how well management is maximizing shareholder wealth. Quick Ratio equation - Answer Quick Ratio=Current Assets − (Inventory/Current Liabilities) Current Ratio equation - Answer Current Ratio=Current Assets/Current Liabilities AR Turnover equation - Answer AR Turnover=Credit Sales/Accounts Receivable Average Collection Period equation - Answer Average Collection Period=365/AR Turnover(AR Turnover=Credit Sales/Accounts Receivable)Inventory Turnover equation - Answer Inventory Turnover=COGS/Inventory Total Asset Turnover equation - Answer Total Asset Turnover=Sales/Total Assets Operating Margin equation - Answer Operating Margin=EBIT/Sales Fixed Asset Turnover equation - Answer Fixed Asset Turnover=Sales/Fixed Assets Operating Income Return on Investment equation - Answer OIROI=Operating Income/Total Assets Debt Ratio equation - Answer Debt Ratio=Total Liabilities/Total Assets Times Interest Earned equation - Answer TIE=EBIT/Interest Expense What type of ratio are debt ratio, debt-to-equity ratio, and times interest earned? - Answer Debt ratio, debt-to-equity ratio, and times interest earned are leverage ratios. What type of ratio are return on assets, return on equity, gross margin, operating margin, and net profit margin? - Answer Return on assets, return on equity, gross margin, operating margin, and net profit margin are profitability ratios. Return on Assets equation - Answer ROA=Net Income/Total Assets Return on Equity equation - Answer ROE=Net Income/Owners' Equity Gross Margin equation - Answer Gross Margin=Gross Profit/Sales Net Margin equation - Answer Net Margin=Net Income/Sales Market-to-Book Ratio equation - Answer Market-to-Book Ratio=Market Value of Equity/Book Value of Equity Price-to-Earnings equation - Answer Price-to-Earnings=Price per Share/Earnings per Share What kind of ratio are market-to-book ratio and the price-to-earnings ratio? - Answer Market-to-book ratio and the price-to-earnings ratio are market ratios. What are activity ratios used for? - Answer Activity ratios such as inventory turnover, accounts receivable (AR) turnover, and average collection period (ACP) are used to check short-term operating asset management efficiency, while total asset turnover (TAT), fixed asset turnover (FAT), and operating income return on investment (OIROI) assess how well a firm is using its assets to generate sales. What does the debt ratio tell us? - Answer The debt ratio tells us the capital structure of a firm, while times interest earned (TIE) is used to assess a firm's ability to pay interest and long-term obligations.What are market ratios used for? - Answer Both the market-to-book (M/B) and priceto-earnings (P/E) ratios are used to assess whether a stock or a firm is correctly valued. How are the quick ratio and current ratio different? - Answer Current and quick ratios are different because of potential illiquidity of inventory, and they are compared with liquidity ratios to assess how well a firm can meet short-term obligations. Why are ratios useful? - Answer Standardization Flexibility Focus Evaluation (Ratios themselves are not useful, but through comparisons such as trend analysis, cross-sectional analysis, and progress measurement, they become meaningful.) What are the pitfalls to keep in mind when doing ratio analysis? - Answer timing issues and accounting issues What are the main sources of inflation? - Answer increased demand for goods and services, rising costs, and adaptive expectations What are the components of the required rate of return? - Answer Opportunity cost Risk Inflation What is the difference between the real rate and the nominal rate? - Answer Inflation. The nominal rate represents the actual change in the return, the inflation rate represents the rate at which prices are increasing, and the real rate is the resulting return you will receive in terms of what you can actually purchase with the money. The interest rate that you typically see (the nominal rate) reflects the amount of money you will have in the future but does not measure potential increase in buying power. Real interest rate = nominal interest rate - inflation What are the main tasks of a finance manager? - Answer making investment decisions, making financing decisions, and managing working capital What are leading indicators? - Answer Leading indicators change before the economy changes and include yield curve and stock market return. What are lagging indicators? - Answer Lagging indicators change after the economy changes and include unemployment rate and CPI. What are coincident indicators? - Answer Coincident indicators are collected and analyzed as economic shifts happen and include GDP and personal income. What do financial institutions do? - Answer Financial institutions circulate money by providing financial services such as accepting deposits, offering loans, and managing investmentsWhat is the purpose of financial markets? - Answer In general, the purpose of financial markets is to determine prices of financial securities and provide liquidity for investors. What are the major types of financial securities? - Answer Three major types of financial securities are Treasuries, corporate bonds, and stocks. What are the three roles of prices according to Milton Friedman? - Answer Prices convey information, affect incentives, and affect the distribution of income What is the difference between the primary market and the secondary market? - Answer Companies use the primary market to sell their financial securities to raise capital, while the secondary market is where securities are traded after the initial issuance. What is the difference between the money market and the capital market? - Answer The money market is for short-term borrowing and lending while a capital market is for long-term borrowing and lending. Which area of finance deals with sources of funding and the capital structure of corporations and seeks to increase the value of a firm to its owners? - Answer Business finance What is the primary difference between finance and accounting? - Answer Finance focuses on the future, while accounting is generally backward-looking. Finance is the management and allocation of capital with the objectives of investing, forecasting, budgeting, saving, lending, and borrowing. Which subspecialty of finance primarily involves deciding which assets will create more wealth and earn positive returns? - Answer Investments. Investments is the area of finance that seeks to create wealth in the future by deciding where to allocate money. What is the primary goal of the financial manager of a firm? - Answer To maximize owner wealth. The financial manager should make decisions based on the primary goal of maximizing owner wealth.. What should be the main question a firm asks when considering any investment decision? - Answer Do the benefits of this investment outweigh the costs? For any investment, you should expect to receive a benefit worth at least as much as the initial cost. What is the primary aim of personal finance goals? - Answer To maximize satisfaction from products purchased and services obtained. The objective of personal financial goals is to maximize one's utility.. Which task does a financial manager perform when choosing to obtain a loan to purchase a piece of equipment for a new project? - Answer Making financing decisions. The manager is deciding where to get the funds to support a new project, which means the manager is making a financing decision.Which financial career focuses on investing capital into firms whose shares are not currently sold on any public stock exchange? - Answer Private equity. Private equity deals with investments in firms that are privately held and whose ownership is not yet bought or sold on any public stock exchange.. Which task does a financial manager perform when assessing the costs and benefits of potential projects? - Answer Making investment decisions. Understanding how benefits weigh up against costs is the first priority before moving forward with financing and managerial decisions. What tool can you use to understand your overall personal cash flows? - Answer Budgeting. Budgeting helps you to understand your income and expenses and to analyze your cash flows. What is a reasonable alternative to keeping an emergency stash of cash? - Answer Investing in a savings account. Investing in a readily withdrawable account that still earns some interest is a value-preserving alternative. You want to buy a house, so you obtain a mortgage for which you can afford the monthly payments. What process have you engaged in as part of your financial decision-making? - Answer Financing. Part of the personal finance process is figuring out how to finance your goals in a way that is within your means.. What are the purposes of financial markets? - Answer To provide liquidity and determine prices. The purposes of financial markets are to provide liquidity and to determine prices. In which financial market are securities such as stocks and bonds are traded after their initial issuance? - Answer Secondary market. Financial securities are first sold in the primary financial market and then traded among investors in the secondary financial market.. What kind of market primarily allows institutions to borrow and lend in the short term? - Answer Money market. Assets in money markets are typically highly liquid and intended for use within a year or less.. A local start-up company just hit its five-year anniversary and is planning an initial public offering sometime this year. In order to issue public stock, which market will the company use? - Answer Primary market. When a company issues stock for the first time to raise capital, shares must initially be sold through a primary market.. What is the primary role of financial institutions? - Answer To conduct financial transactions such as investments, loans, and deposits. Financial institutions conduct transactions to circulate money.. What is a depository institution? - Answer An institution that accepts and pays interest on deposits of money, as well as extends loans. This is the definition of a depository institution. Examples include banks and credit unions.The Federal Reserve sometimes adjusts the interest rate at which commercial banks can borrow from it. What is the purpose of adjusting the interest rate? - Answer To regulate inflation and unemployment. Regulating inflation and unemployment is the main objective of the Federal Reserve and central banks, and it is accomplished by adjusting the interest rate.. What would an inverted yield curve signal? - Answer It may indicate an economic downturn. An inverted yield curve reflects the expectation that the economy will have low or negative growth in the future. In what way are coincident indicators useful? - Answer They are analyzed during economic shifts to provide information about the current state of the economy. Coincident indicators help analysts see the big picture of economic trends. Which type of financial institution provides individuals and firms access to financial markets? - Answer Investment institutions. Investment institutions provide both individuals and firms access to financial markets. Which financial institution includes entities that receive money from institutional investors and wealthy individuals to buy troubled companies to improve them and earn returns by selling them or going public? - Answer Private equity. This is the role of a buyout private equity firm. Yield curve is which type of economic indicator? - Answer Leading. Leading indicators change before the economy changes.. About a year ago, the short-term Treasury bill had 1.54% interest and the long-term Treasury note had 2.54% interest. This week, the 1-year Treasury bill has an interest rate of 3.13%, while the 10-year Treasury note has an interest rate of 2.28%. What does this information indicate about the future economy? - Answer It may indicate an economic downturn. Since the long-term Treasury interest rate is lower than the short-term rate, it has an inverted yield curve, which may indicate an economic downturn. Which term reflects a person's beliefs about right and wrong, good and bad, or just and unjust? - Answer Moral. Moral reflects one's beliefs about right and wrong, good and bad, or just and unjust. What characterizes an ethical action? - Answer An ethical action is based on accepted standards of conduct. Why would bondholders set bond contracts that are very strict to deter the company from taking on risky projects? - Answer Bondholders are primarily interested in making sure they will be paid back. If a company takes on a riskier project, there is a higher probability of the project being unsuccessful, which means that the bondholders may put themselves at a higher risk of not receiving their loan back. Which kind of projects are bondholders interested in? - Answer Safe projects with a higher chance of providing sufficient compensation. Bondholders provide money fora company for a certain period of time and want companies to pay them back for their investment. What is the term for the percentage of the principal that a lender charges a borrower for the use of assets? - Answer Interest rate How is the interest rate expressed? - Answer As a percentage. Interest is the percentage of the principal that a lender receives or that a borrower pays to use the money. What is the main purpose of charging interest? - Answer It allows borrowers to pay to use the assets of another entity to accomplish their own goals. Because the funds do not belong to borrowers, they must pay to use them. This payment is the interest rate. What is a component of the required rate of return? - Answer Opportunity cost. The required rate of return is composed of opportunity cost, risk, and inflation. Why would a long-term investment require a higher rate of return? - Answer There is greater risk involved and a higher opportunity cost. There is greater risk because you cannot ensure the return of your investment for a longer period of time, and there is a higher opportunity cost because you cannot use that money for other things for a longer period of time. Why is built-in inflation linked to adaptive expectations? - Answer Workers want higher wages to keep their standard of living as prices increase, which pushes the prices even higher. When the prices of goods and services go up, employees expect and even demand higher wages to maintain their living standard, which will lead to further increases in prices. Why does an increased demand for goods and services cause inflation? - Answer An increase in demand often causes an insufficient supply in the market, which causes prices to go up until the demand is once again equal to the supply. An increase in demand results in an increase in prices, which is the definition of inflation. What happens to prices in a market in which there is inflation? - Answer Prices rise. Prices rise because of increase in demand, increase in cost of goods, and adaptive expectations What is the compensation for risk given to investors called? - Answer Risk premium. Risk premium is the compensation that investors take for the risk they have to bear. Which type of interest rate is the rate at which invested money grows for a certain period time? - Answer Nominal rate. The nominal rate is the rate at which invested money grows for a certain period of time and is the interest rate most often used in your daily life.Which component of an interest rate is an indicator of inflation and opportunity cost? - Answer Risk-free rate. The risk-free rate describes the rate of return on an investment with no risk, so it just measures inflation and opportunity cost. What is the name for a series of equal payments made at the end of consecutive periods over a fixed length of time? - Answer Ordinary annuity Which statement correctly contextualizes what a return is? - Answer A return is the gain or loss on an investment over some period of time. What is an expected return? - Answer A hypothesized estimate of future returns under different scenarios based on expectational data The word risk is used in many different contexts. How is risk defined in finance? - Answer The possibility that the realized or actual return will differ from the expected return What makes market risk different from firm-specific risk? - Answer Market risk cannot be diversified away, and firm-specific risk can. Which statement accurately describes firm-specific risk? - Answer Firm-specific risk is the