Mid Term Exam 1 Study Guide & Cheat Sheet
Part 1: 10 Multiple Choice Questions (20%) *Theory Main Points in Chapters 1-4; 10 questions
Chapter 1 Main Points
∙ Finance the branch of economics concerned with resource allocation, resource management, acquisition, investment and managing wealth.
∙ Makes firms better off through sound financial decisions.
- Financial Management are the activities that create or preserve the economic value of assets o Main objective of Financial Manager: The goal of Financial Management is to Maximize the market value of the firm or Current Stock Price.
∙ By making the right capital Budgeting (allocating scarce resources) and financing decisions (raising funds optimally to finance projects) and by making working capital decisions. ∙ Why You Would Want to Maximize Value of the Firm Before Profit
To maximize profit, for example one can simply cut maintenance which would decrease costs and increase profits but this will potentially add greater costs in the future. It would make more sense to maximize the firm’s current stock price (which reflects value of the firm). Think short term vs Long term. Don't forget about the age old question of How do you solve chemical equations?
1. Capital Budgeting: Evaluates long term projects on a standalone basis, Accept or Reject basis.
∙ Capital Budgeting Tools: 1.) Pay Back Period 2.) Net Present Value (NPV) = Present value of cash flow minus the costs. Positive NPV contributes to the value of the company. 3.) Internal Rate of Return: Should always be greater than the cost of the project Don't forget about the age old question of Who had an important role in the development of the radio?
2. Capital Structure: the means by which a company finances its business activities. ∙ Where do we raise money to fund activities?
3. Working Capital Management: the process of managing day to day operating needs of the company through its current assets and current liabilities.
∙ Assets = Labilities + Owner’s Equity
∙ Balance Sheet: Snapshot of firm’s assets and liabilities at a given time.
- Net Working Capital = Current Assets – Current Liabilities
- Total Assets = Current Assets + Fixed Assets
∙ Market value vs Book Value: Balance sheet shows book value; market value is the price at which the firm can be sold. Market value is more important than book value.
∙ Net Income = Revenues – expenses. – Is not Cash Flow. Net Income is he accounting profit from operations.
∙ EBIT = Revenues – Operating Expenses We also discuss several other topics like What is rough riders?
∙ Net Income is different from Cash Flow because of accrual accounting, noncash expense items, Preference to classify interest expense. (Details)
∙ Operating Cash Flow is a good metric of a company’s health because cash flow is harder to manipulate under GAAP than net income, it shows if a company can generate cash flow on the long term and shows liquid assets.
∙ Operating Cash Flow is the estimated cash flow generated from the basic operations of business or EBIT + Depreciation – taxes.
o It’s a better metric for a company’s financial health because cash flow isn’t easily manipulated under GAAP in comparison to net income, A good metric to show that a firm is generating cash, Cash is liquid.
o Cash Flow from Assets = Cash Flow to Creditors + Cash Flow to Owners
o Cash Flow from assets= OCF – NCS – Change in NWC
o OCF= EBIT + Depreciation – Taxes *Standard Method*
o OCF = NI + Depreciation + Interest *Bottom up Approach*
o OCF = (Sales – Costs) (1Tax) + Depreciation *Tax Shield Approach* We also discuss several other topics like Which of the following agencies uses the multiple use philosophy?
If you want to learn more check out What is the 4th largest continent by landmass and the longest continent from north to south?
o NCS + Ending Net Fixed Assets – Beginning Net Fixed Assets + Depreciation o Change in NWC = Ending NWC – Beginning NWC
Key for Formulas
o OCF = Operating Cash Flow NWC = Net Working Capital (Current assets – Cur. Liabilities) o NCS = Net Capital Spending EBIT =
∙ Present Value – earlier money on a time line (PV)
∙ Future Value – later money on a time line If you want to learn more check out What is the role of modern project management?
∙ Interest rate – exchange rate between earlier money and later money
∙ FV = PV(1+R)^n
∙ Future Value Interest factor = (1+r)^n
∙ PV = FV x [1/(1=r)]^n
∙ r = [FV/PV] ^ 1/n – 1
∙ n = [ln(FV/PV)/ln(1+r)]
∙ Future Value of an Annuity Stream = PMT * (1+r)^n – 1
- PMT is periodic cash flow, n is the number of periods and r is the rate of interest.
∙ FV = PV(1+r)^n
- to find the total after say for example, 10 years, add up all the values for each year. Start from 0 for n.
∙ PV annuity due = PV ordinary annuity x (1+r)
FV annuity due = FV ordinary annuity x (1+r)
PV annuity due > PV ordinary annuity
FV annuity due > FV ordinary annuity
∙ PV = PMT
PV PMT =
(1 ) 1
> Of Annuities
Part 2: Open Ended Problems (Calculations Required)
∙ Average Tax vs Marginal Tax Rate *Tax Table Included* (15%) - Marginal – the percentage paid on the next dollar earned - Average – the tax bill / taxable income
- Marginal tax rate is what we should use in our analysis.
∙ Construct Income Statement (Net Income) & Construct Operating Cash Flows (20%)
∙ Net Income = Revenues – Operating Expenses -Depreciation = EBIT Less Interest Expenses = Taxable Income
Less taxes= Net Income after taxes
∙ Financial Ratios – Chapter 14 (20%)
- Financial ratios are relationships between different accounts from financial statements. Usually the income statement and the balance sheet.
o Current ratio = current assets
Quick ratio = (current assets – inventories)
Cash ratio = cash/ current liabilities
o Debt ratio = liabilities/ total assets
Times interest earned = EBIT/ Interest Expense
Cash Coverage ratio = (EBIT + depreciation)
o Basic Ratio/ Du Point
- Return on equity = net income * sales * total assets = net income Sales T.A. Total Equity total equity
∙ TVM Problems; FVCS, PVLS, R, n – (25%)
- Formulas are above in Chapter 4 summary. Do practice problems.