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FIRE 311 Exam-1 Study Guide

Chapter 1

 

1)

Three main forms of business organization: Differences

Proprietorship

 
 

Advantages:

 
 

o

Ease of formation

o

Subject to few government regulations

o

No corporate income taxes

 

Disadvantages:

 

o

Unlimited personal liability

o

Limited life

o

Transferring ownership is difficult

o

Difficult to raise capital

Partnership

 

Like proprietorship just with two or more members Corporation

Advantages:

 

o

Unlimited life

o

Easy transfer or ownership

o

Limited liability

o

Ease of raising capital

Disadvantages:

 

o

Cost of set up and report filing

o

Double taxation

2)

Advantages and disadvantages of each form of organization

Look above

3)

Primary Goals of management and application.

Primary goal: Stockholder wealth maximization – maximizing the stock price

Other goals: managerial incentives and social responsibility

4)

Majority of business by numbers vs. business volume

5)

Agency Problem: managers vs. owners

An agency relationship exists whenever a principal hires an agent to act on his or her

behalf. An agency problem results when the agent makes decisions that are not in the best interest of principals

6)

Mechanism how to get managers to act in SHs’ best interest

 

o

Managerial compensation (incentives)

o

Shareholder intervention

o

Threat of takeover

7)

Management social responsibility

8)

By-laws(Electing officers) and Corporate charters(Activities)

9)

Why go global?

Five reasons firms go “international”:

o

To seek new markets

o

To seek raw materials

o

To seek new technology

o

To seek production efficiency

o

To avoid political and regulatory hurdles

10) Business Ethics

Business Ethics: A company’s attitude and conduct toward its employees, customers,

community, and stockholders

Chapter 2

1)

Names and Functions of 4 main Financial Statements: Balance Sheet, Income Statement,

Stmt of Cash Flows and Stmt of Retained Earnings

 

Balance Sheet:

 
 

o Represents a picture taken on a specific date that shows a firm’s assets

 

(investments) and how those assets are financed (debt or equity)

 

 Income Statement:

 
 

o

Presents the results of business operations during a specified period of time

o

Summarizes the revenues generated and the expenses incurred

 

 Statement of Cash flows:

 
 

o

Designed to show how the firm’s operations have affected its cash position

o

Examines investment decisions (uses of cash)

o

Examines financing decisions (sources of cash)

 

 Statement of Retained Earnings:

 
 

o Changes in the common equity accounts between balance sheet dates

2)

Liquidity ratios- is the firm able to meet its current obligations

Current ratio vs. Quick ratio

 
 

o

Current ratio: current assets/ current liabilities

o

Quick ratio: current assets-inventories/ current liabilities

3)

Asset management ratios- is the firm effectively using its assets

Inventory Turnover Ratio

 
 

o COGS/inventory

 
 

Days Sales Outstanding (DSO)

 
 

DSO

Receivables

Receivables

 

Daily Sales

Annual Sales

 
 

 

  • 360  

o

4)

Fixed Asset Turnover Ratio

o Sales/ Net fixed assets

Total Assets Turnover Ratio

o Sales/Total assets

Debt management ratios- does the firm have the right mix of debt and equity

Debt Ratio

o Total liabilities/total assets

Times- Interest-Earned Ratio (TIE)

o EBIT/interest charges

Fixed Charge Coverage Ratio

FCC

EBIT

Lease payments

Interest

 

charges

    
   

Lease

payments

    
   

Sinking fund payment

 

1

Tax rate

 

o

5)

6)

7)

Profitability ratios- how do the combined effects of liquidity, asset and debt management

affect profits

Net Profit Margin

o Net Profit/Sales

Return on Total Assets (ROA)

o Net income/Total assets

Return on Common Equity (ROE)

o Net income/ common equity

Market ratios- what do investors think about the firm’s future financial prospects

Price/Earnings Ratio

o Price per share/ Earnings per share

Market/Book Ratio

o Market price per share/ Book value per share

Importance of TIE ratio for Creditors

TIE measures the extent to which a firm’s operating earnings- before interest and

taxes (EBIT) also called net operating income (NOI)- can decline before these

earnings are no longer sufficient to cover annual interest costs. Failure to meet this

obligation can bring legal action by the firm’s creditors, possibly resulting in

bankruptcy. Note that the EBIT, rather than net income, is used in the numerator

because interest is paid with pre-tax dollars.

8)

Cash outflow vs. cash inflow

9)

Non-cash expenses: Depreciation

  • a. With non-cash depreciation: If they take out depreciation and there is an expense for it then EBT, Taxes and net income will be lower. If there is NO depreciation then EBT, taxes and net income will bee higher. But remember this isn’t a cash flow, this is an expense that gets taken off before EBT.

10) Annual report contains: Financial STMTs and letter from CEO about past performance

and future outlook

11) Source of capital and use of capital: BS

The essence of finance is to make money by raising capital such as bonds and stock

12) How to use and interpret Financial Ratios in book (with exception of fixed charge ratio)

Ratios are accounting numbers that are converted to show relationship between firms

and their financials.

13) Trend analysis versus comparative analysis

Trend analysis: An evaluation of changes (trends) in a firm’s financial position over a

period of time, perhaps years. Trend analysis gives information whether the firm’s

financial position is more likely to improve or deteriorate in the future. A simple

approach to trend analysis is to construct graphs containing both the firm’s ratios and

the industry averages for the past five years.

Comparative analysis: An analysis based on a comparison of a firm’s ratios with those

of other firms in the same industry at the same point in time. This tells us how well

the firm is currently performing.

14) Concept of Dupont Analysis: ROA and ROE

9) Non-cash expenses: Depreciation a. With non-cash depreciation: If they take out depreciation and there is

ROA = Net Profit Margin X Total Assets Turnover

15) How to calculate: PM, TATO, EM

Look up in textbook/ google

16) ROE of 100% equity firm

Look above and research on google.

Chapter 3

1)

Transferring funds from savers to borrowers: Direct way vs. Indirect ways

2)

Primary vs. Secondary Markets transaction

  • a) Relationship

  • b) Services provided by Secondary Markets

  • c) Role of the Secondary Market

3) Capital markets and Money Markets: Long-term Securities vs. Short-term Securities

4) Money market instruments vs. Capital market instruments

5) Derivative market and its instruments

6) Investment Banking versus Financial Intermediaries

  • a) Services provided by Investment Bankers: Advice, marketing/distributions of securities, underwriting, best effort, Dutch auction

  • b) Types of financial intermediaries

7)

Efficient Market: Economic efficiency

8)

Informational efficiency: Weak form, Semi-strong form and Strong form of EMH

9)

Role of financial intermediaries

10) Benefits of financial intermediaries

11) American Depository Receipt: Foreign company trading in US stock market

Exam 1

One 8 ½ x 11 sheet and calculator allowed in exam.