Final
· Cash Budget – Definition and what does it include?
· Percent of sales model and how to calculate it. MATH.
· Sales Forecast – Definition.
· Projected financial statements – Definition.
· Pro-Forma financial statements – Definition. Watch the video “What is a Pro-forma” on
this also.
· What are some examples of when a pro-forma statement is used?
· What are the deficiencies of pro-forma financial statements?
· Dividend payout ratio – Definition and how to calculate it. MATH
· Retention (Plowback) ratio – Definition and how to calculate it. MATH
· Leverage – Definition.
· Fixed assets.
· External Funds Needed – Definition and how to calculate it. MATH
· Internally and externally generated funds – Definitions.
· What is financial planning and why is it important?
· What planning documents are included in a financial plan, and what do they tell you about
a company?
· Strategic Plan – Definition and what does it include?
· Investment Plan – Definition and what does it include?
· Financing Plan – Definition and what does it include?
· Capital structure – Definition.
Exam 3
Net present value capital budgeting technique for maximizing shareholder wealth can tell whether
positive cash flows of a project exceed the initial investment or cost of the project in present value
terms, and find future cash flows. Determine initial investment and calculate future cash flow valuation
into present value, the current value of all future cash flows generated by the project, including initial
capital investment
Payback period time required to recover the initial cost of investment, # of years it would take to get
back the initial investment made for the project. Compare projects, least amount of years is preferred,
disregards time value of money
Capital budgeting (aka cost/benefit analysis): a systematic process of determining which fixed asset to
purchase, large sums of money, and long-term consequences, different that capital management
because of longevity
Why are capital budgeting decisions the most important investment decisions made by a firm's
management? Creates accountability and measurability
Key reasons for making capital expenditures:
1. Expansion: need additional assets
2. Replacement: buy new or repair
3. Renewal: modernize an existing asset, make it more efficient
4. Compliance: government/safety/environmental reasons
Sources of information in making capital budgeting decisions
Most of the information is internally generated, often beginning with the sales force, the production
team gets involved, then accountants, all information is reviewed by financial managers
Classifications of investment projects:
1. Independent: rejecting or accepting project will not directly affect the decision-making of other
projects
2. mutually exclusive: two or more projects cannot exist at the same time, one or another
3. Contingent: dependent on one another, one project affects another project that is closely
associated and needs others to function properly
Cost of capital: cost to borrow long terms funds, minimum acceptable return for a new asset, required
return
Capital rationing process of placing a limit on the extent of new projects or investments that a company
decides to undertake
Valuation of real assets and the practical difficulties in valuing real assert
Valuing real assets requires the same steps as valuing financial assets, Estimate future cash flows,
Estimate the cost of capital/required-rate-of return, Calculate the present value of future cash flows,
Practical difficulties in valuing real assets, Cash flow estimates must be prepared in-house and are not as
readily available as those for financial assets with legal contracts, Estimating required-rates-of-return for
real assets is more difficult than estimating required return for financial assets because no market data is
available
Five-step approach for calculating the net present value
1. Estimate project cost: Identify and add the present value of expenses related to the project, There are
projects whose entire cost occurs at the start of the project, but many projects have costs occurring
beyond the first year, The cash flow in year zero (NCF0) on the timeline is negative, indicating and
outflow
2. Estimate project net cash flows: Both cash inflows and outflows are likely in each year of the project;
estimate the net cash flow for each year, Include the salvage value of the project in its terminal year
3. Determine project risk and estimate cost of capital: The cost of capital is the discount rate used to
determine the present value of expected net cash flow, The riskier a project, the higher its cost of capital
4. Compute the project's NPV: Determine the difference between the present values of the expected net
cash flows from the project and the expected cost of the project
5. Make a decision: Accept the project if it has a positive NPV, Reject the project if it has a negative NPV
Explain the benefits of post-audit and periodic review of capital projects Capital budgeting, review the
status of all ongoing capital projects and perform post-audits on completed capital projects, the review
should contain business plan (cash flow projections, cost assumptions, and performance of people
responsible for implementing the capital project, the post-audit examination may reveal why a project
was successful or failed to achieve its financial goals
Why do many financial managers use multiple capital budgeting tools? Better alignment between
practitioners and the academic community
The opportunity cost of capital
Fixed assets
Depreciation
Intangible assets
Amortization
Salvage value
Quiz 3
Stock: partial ownership in a corporation
Bond: loan from you to a company or the government
Dividend: portion of the profit that is distributed to shareholders of the company
Interest: borrowing cost incurred by the company
Capital Gain: economic concept, profit earned on the sale of an asset that has increased in value over
the holding period
Common Stockholders, rights: voting power, ownership, right to transfer ownership, dividends, the
right to inspect corporate documents, and the right to sue for wrongful acts
Common stock can be classified as
1. Authorized (refers to the specific number of shares a company has authorized to issue or sell)
2. Issued (has been authorized and distributed to investors)
3. Outstanding (refers to any shares a company has issued but has not repurchased that is, it is
investor-owned)
4. Treasury (stock a corporation has issued and subsequently repurchased from the investors. By
buying back its own shares in the open market, the corporation reduces the number shares
outstanding treasury stock does not carry the rights of outstanding common stares)
Residual claim to assets: if a corporation is liquidated, the common stockholder (as owner) has residual
right to claim corporate assets after other security holders, and liquidating is generally
1. Administrative costs (courts, legal fees, etc)
2. Wages and salaries
3. Taxes (federal, state, municipal)
4. Secured creditors
5. Unsecured creditors
6. Preferred stockholders
7. Common stockholders
Market order: immediate execution at the best price available. Can be buy order or sell order
Day order: if the order hasn’t been filled by the end of the trading day, it is canceled. All price-specific
orders (stop and limit) are assumed to be Day Orders unless marked to the contrary
Good-till-canceled order (Open Order): order is kept open until executed or canceled. Regardless of
when an open order is placed, a designated marker clears it out of his book at the end of April of
October, and the order has to be reentered, typically only good for 90 days
Stock splits: forward splits and reverse splits, one $150 share gets changed to 3 shares of $50
Current yield (Dividend yield): distributions of a companies profits to its stockholders. Investors who buy
stock are entitled to dividends only when the companies board of directors cotes to make such
distributions
Dividend yield = annual dividend / current market value of the stock
Price-earnings ratio: PE ratio = price per share / earnings per share
Small-cap: fewer publicly-traded shares, not very liquid, mid-cap, large-cap: liquidity and research
Ibbotson chart
: Risk
market risk: volatility, day-to-day fluctuations in a stock’s price. The market risk applies mainly to stocks
and options. As a whole, stocks tend to perform well during a bull market and poorly during a bear
market,
decreased or no income; low priority at the dissolution
Credit (Default) risk: risk that a company or individual will be unable to pay the contractual interest or
principal on its debt obligations
Interest rate risk: risk that an investment’s value will change as a result of a change in interest rates,
affect the value of bonds more directly than stocks
Exam 2
Chapter 5:
- Time value of money
- Future value: formula (annual and semi-annual) & definition
- Principal
- Simple interest
- Compound interest
- Interest on interest
- Compounding
- Present value: definition, formula and calculations
- Discounting
- Discount rate
- The rule of 72: know the formula and components of formula
Chapter 8:
- Fixed-income securities
- Coupon payments
- Face value or par value
- Coupon rate
- Vanilla bonds: debentures
- Indenture
- Zero coupon bonds
- Convertible bonds
- Opportunity cost
- Par value bonds
Bonds:
Chapter 14
- Cash Conversion Cycle
- The firm invests cash to purchase the raw materials that would be used to produce the
goods that the firm manufactures, cycle ends when you take into account the time taken
by the firm to pay for its inventory
- NOT when the finished goods being sold to customers and the cash collected on
the sales
- Financial managers general goals : Maximize the value of the firm, shorten the cash
conversion cycle and improve the firm’s liquidity
Cash Conversion Cycle = DSO + DSI - DPO
- Days’ Payable Outstanding (components, calculation, and what it tells you)
- Shows how long a firm takes to pay off its suppliers for the cost of inventory
DPO = Average accounts payable / cost of goods sold * number of days
- Operating cycle
- Begins when the firm receives the raw materials it purchases and ends when the firm
collects cash payments on its credit sales
Operating cycle = DSO + DSI
- Days’ Sales Outstanding
- How long it takes on average for the firm to collect its outstanding accounts receivable
balance, the lower the better
- AKA a verage c ollection p eriod
DSO = accounts receivables / total credit sales * number of days
- Days’ Sales Inventory
- Shows how long the firm keeps its inventory before selling
DSI = inventory / cost of goods sold * number of days
- Networking capital
- Difference between current assets and current liabilities, a measure of liquidity and
represents the net short-term investment the firm keeps in business
- Working capital management involves making decisions regarding the use and sources of
current assets
- Accounts receivable
- Represent the amount owed by customers who have taken advantage of the firm’s trade
credit policy
- Accounts Receivable Aging
- Shows the breakdown of firms accounts receivable by their date of sale - how long the
account has not been paid in days
- Track delinquent accounts
- Accounts receivable financing and factoring
- Medium-sizeand small businesses
- Secure a bank loan by pledging the firms’ accounts receivable as security
- Way for business to finance itself with accounts receivables is to sell the receivables to a
factor at a discount
- Firm that sold the receivables without recourse has no further legal obligation to the
factor
- Accounts payable
- 35% of total current liabilities for all publicly traded manufacturing firms
- Pay early with a discount or in full when it is due
- Represents the amount owed to the firm’s vendors and suppliers on materials purchased
on credit
- Reasons to hold cash:
1. Facilitates transactions with suppliers, customers, and employees
2. Most banks require firms to hold minimum cash balances, or compensating balances , in
exchange for the services they provide
3. Banks often require firs to hold minimum cash balances a partial compensation for the
loans and other services the banks provide
- Terms of sale : document where the seller (firm) spells out the terms and conditions of the sale,
when cash is due and if discounts can be applied for early payment
- Trade credit: short-term financing typically made with a discount for early payment rather than
an explicit interest charge
- Commercial paper: A promissory note issued by large financially secure firms which have high
credit ratings, Not secure, not pledging any assets, but backed by a credit line from a commercial
bank
