MGMT2023 END OF LECTURE SHORT QUIZZES
CHAPTER 01 – INTRODUCTION TO COPORATE FINANCE
1. What are the three types of financial management decisions and what questions are they
designed to answer?



Capital budgeting : What long-term investments or projects should the business
take on?
Capital structure: How should we pay for our assets? Should we use debt or
equity?
Working capital management: How do we manage the day-to-day finances of the
firm?
2. What are the three major forms of business organization?



Sole Proprietorship
Partnership (General, Limited)
Corporation (C-Corp, S-Corp, Limited Liability Company)
3. What is the goal of financial management?

Maximize profit?
Minimize costs?
Maximize market share?
Maximize the current value of the company's stock?

The goal of financial management is to maximize shareholder wealth. For
public companies this is the stock price, and for private companies this is the
market value of the owners' equity.
4. What are agency problems and why do they exist within a corporation?

Agency problem
Conflict of interest between principal and agent
Management goals and agency costs

An agency problem is a conflict of interest inherent in any relationship where one
party is expected to act in another's best interests. In corporate finance, an agency
problem usually refers to a conflict of interest between a company's management
and the company's stockholders.
5. What is the difference between a primary market and a secondary market?

Dealer vs. auction markets
Listed vs. over-the-counter securities
NYSE
NASDAQ

A primary market helps in the issue of new securities those which are offered for
the first time and the secondary market is for second hand sale of securities listed
on the stock exchange.

The primary market is where securities are created, while the secondary market
is where those securities are traded by investors.
CHAPTER 02 - FINANCIAL STATEMENTS AND CASH FLOWS
1. What is the difference between book value and market value? Which should we use for
decision-making purposes?

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 sold.
Market value is usually more important for decision-making because it is more up
to date.

Book value measures historical cost (ie. actual purchase cost) less depreciation
to-date.
Market value is the current recoverable or actual sales value if this asset were to
be sold or liquidated in the open market.
For decision making purposes, for a more accurate assessment of the current
values of assets, the market value should be preferred.
However, if your decision making is just for internal purposes and not for
acquisition of a business or assessing the real market value of the business for M
& A purposes, then book value should suffice.

Book value is the total value of a business' assets found on its balance sheet, and
represents the value of all assets if liquidated, where as market value is the worth
of a company based on the total value of its outstanding shares in the market, or
its market capitalization.
Market value tends to be greater than a company's book value, since market value
captures non-tangibles as well as future growth prospects.
They are both useful, as investors use them in combination to get a better
understanding of how stocks have performed.

Market Value is the price at which assets, liabilities and equity could actually be
bought or sold; the Book Value is what is put on the balance sheet...Market value
is usally more important as it is more up to date
2. What is the difference between accounting income and cash flow? Which do we need to
use when making decisions?

Accounting income is purely revenue - expenses = income.
Cash flow is when cash is actually changing hands, either coming in or leaving.
We need to use cash flow since it is more current.
3. What is the difference between average and marginal tax rates? Which should we use
when making financial decisions?

Average tax rates are the tax bills/taxable income.
Marginal Tax rates are the percentage paid on the next dollar earned
Marginal tax rates are used for financial decisions.

Average tax rates measure tax burden, while marginal tax rates measure the
impact of taxes on incentives to earn, save, invest, or spend.

The average tax rate is the total amount of tax divided by total income while
marginal tax rates measure the degree to which taxes affect household (or
business) economic incentives such as whether to work more, save more, accept
more risk in investment portfolios, or change what they buy.
4. How do we determine a firm’s cash flows? What are the equations and where do we find
the information?

Cash flow comes from operating, investing and financing activities
The sum of these three flows will determine the statement of cash flows

Figure out the cash flow from operating, investing and financing activities; the
sum of these three flows will determine the statement of cash flows

CFFA = CFC + CFS
CFFA = OCF - NCS - Changes in NWC

These numbers are found on the balance sheet and income statement, not the
statement of cash flows.
CHAPTER 03 - WORKING WITH FINANCIAL STATEMENTS
1. What is the Statement of Cash Flows and how do you determine sources and uses of
cash?

The statement of cash flows summarizes the firm's sources and uses of cash
during a financial-reporting period. It breaks the firm's cash flows into those
from operating, investment, and financing activities. It shows the net change
during the period in the firm's cash and marketable securities.

Sources and use of cash - Cash flow is the statement prepared by the corporations
that shows the incoming and outgoing of the money

Generally,Cash flow statement reflects the cash inflows and cash flows over a
period and the basis of accounting shall be cash basis rather than the accrual basis
by which income statement is prepared
2. How do you standardize balance sheets and income statements and why is
standardization useful?

Common-size balance sheet - all accounts = percent of total assets (%TA)
Common-size income statements - all line items = percent of sales or revenues
(%SLS)
Standardization is useful in comparing financial information year-to-year and
comparing companies of different sizes, particularly within the same industry.

Standardization is useful because it will provide uniformity and much more public
disclosure norms and transparency and the fixation of responsibility on the
management as well

Balance Sheets: compute all accounts as a percent of total assets.
Income Statements: compute all line items as a percent of sales.
Standardized statements make it easier to compare financial information,
particularly as the company grows; it also is useful for comparing companies of
different sizes
3. What are the major categories of ratios and how do you compute specific ratios within
each category?

Liquidity Ratios or Short-term Solvency
Financial Leverage Ratios or Long-term Solvency ratios are intended to address
the firm's long-run ability to meet its obligations, or, more generally, its financial
leverage. These ratios are sometimes called financial leverage ratios or just
leverage ratios.
asset managment or turnover ratios
* profitability ratios
* market value ratios
4. What are some of the problems associated with financial statement analysis?

Financial Statement analysis entails evaluating the company's financial reports to
gather all relevant information for decision making.
Through the use of ratio, vertical or horizontal analysis, financial statement
analysis help know the risks, performance and potential of the company

#1 Stale Financials - Financial statements only show you what the company
looks like for a short period of time. If the company is deteriorating or growing
quickly, it’s hard to see those changes.
If you look at what happened to many stocks that went bankrupt or on the brink,
the rate of their deterioration is severe. Waiting for 3 month financials for a public
investor can be brutal and a huge nasty surprise.
On the flipside, there’s a company like Amazon where they have recently
disclosed their Amazon Web Services (AWS) business. Growth is gangbusters.
Trying to calculate the value based on old financials is tough. Read Jeff Bezos’
letter.
#2 Financial Cookbook - Some companies will fake their numbers. The
temptation is too great.
Enron, Worldcom, Diamond Foods and Satyam are a few examples. You can
protect yourself by learning forensic accounting methods. It helps, but not 100%
perfect.
#3 Difficulty and Time Consuming - Unless it’s your job, most people don’t do
it.
That’s why tools like Old School Value were created. To do the heavy lifting for
you. If you look at the post on forensic accounting, there are advanced methods
and models that you can use to verify early warning signs and red flags.

Comparability between periods. The company preparing the financial
statements may have changed the accounts in which it stores financial
information, so that results may differ from period to period. For example, an
expense may appear in the cost of goods sold in one period, and in administrative
expenses in another period.
Comparability between companies. An analyst frequently compares the
financial ratios of different companies in order to see how they match up against
each other. However, each company may aggregate financial information
differently, so that the results of their ratios are not really comparable. This can
lead an analyst to draw incorrect conclusions about the results of a company in
comparison to its competitors.
Operational information. Financial analysis only reviews a company's financial
information, not its operational information, so you cannot see a variety of key
indicators of future performance, such as the size of the order backlog, or changes
in warranty claims. Thus, financial analysis only presents part of the total picture.

Based on Market Patterns: One disadvantage of using financial statements for
decision making is that the data and figures are based on the market at that given
time. Depending on the market, it may change quickly, so executives should not
assume that the numbers from a previous financial statement will remain the same
or increase. Just because a company has sold 5 million copies of a product during
one year does not guarantee it will sell the same amount or more. It may sell
much less if a competitor releases a similar product.
At-One-Time Analysis: Another disadvantage is that a single financial statement
only shows how a company is doing at one single time. The financial statement
does not show whether the company is doing better or worse than the year before,
for example. If executives decide to use financial statements for making decisions
about the future, they should use several financial statements from previous
months and years to ensure they get an overall picture of how much the company
is doing. The financial statement becomes a continuous analysis, which is more
useful than using a single statement.

- There is no underlying theory , so there is no way to know which ratios are
most relevant
- Benchmarking is difficult for diversified firms
- Globalization and international competition makes comparison more difficult
because of differences in accounting regulations
- Firms have different fiscal years
- Extraordinary, or one-time, events
CHAPTER 04 - LONG-TERM FINANCIAL PLANNING AND GROWTH
1. What is the purpose of long-range planning?

The purpose of long-range planning is to avoid random, non-specific growth
and focus the organization's skills toward those areas where it excels, such as
making high-quality consumer goods.

The aim is to permanently resolve issues and reach and maintain success over a
continued period.

Examining interactions - helps management see the interactions between
decisions
Exploring options - gives management a systematic framework for exploring its
opportunities
Avoiding surprises - helps management identify possible outcomes and plan
accordingly
Ensuring feasibility and internal consistency - helps management determine if
goals can be accomplished and if the various stated (and unstated) goals of the
firm are consistent with one another.
Communication with investors and lenders

Trying to develop a plan for investments in new assets, the degree of financial
leverage, how much cash to be paid to shareholders, and liquidity requirements.
2. What are the major decision areas involved in developing a plan?

Planning horizon - divide decisions into short-run decisions (usually next 12
months) and long-run decisions (usually 2 – 5 years).
Level of aggregation - combine capital budgeting decisions into one big project.
Inputs in the form of alternative sets of assumptions about important variables
usually to create a worst case, normal case and best case scenario.
Make realistic assumptions about important variables.
Run several scenarios where you vary the assumptions by reasonable amounts.
Determine at least a worst case, normal case and best case scenario.

Sales Forecast
Pro forma Statements,
Asset Requirements,
Financial Requirements,
Plug Variables
3. What is the percentage of sales approach?

Percentage of sales approach is a financial planning method in which accounts are
projected depending on a firm’s predicted sales level. Some items tend to vary
directly with sales, while others do not.
Costs may vary directly with sales. If this is the case, then the profit margin is
constant.
Dividends are a management decision and generally do not vary directly with
sales – this affects the retained earnings that go on the balance sheet.
Initially assume that all assets, including fixed, vary directly with sales.
Accounts payable will also normally vary directly with sales.
Notes payable, long-term debt and equity generally do not vary with sales because
they depend on management decisions about capital structure.
The change in the retained earnings portion of equity will come from the dividend
decision.

Some items vary directly with sales, others do not.

The percent of sales approach is a financial forecasting model in which all of a
business's accounts — financial line items like costs of goods sold, inventory, and
cash — are calculated as a percentage of sales. Those percentages are then applied
to future sales estimates to project each line item's future value.
4. How do you adjust the model when operating at less than full capacity?
When operating at less than full capacity, you adjust the model by finding full capacity
sales in order to see how much sales could increase by before you would need new fixed
assets. If you are at less than full capacity, you do not need new fixed assets.
5. What is the internal growth rate?

The internal growth rate tells us how much the firm can grow assets using
retained earnings as the only source of financing.
IGR = (ROA x R) / (1 - ROA x R)

Internal Growth Rate (or IGR) is the maximum growth rate that the company
is confident of achieving without having to obtain funding from outside. This
is the growth rate at which the company assumes it would continue to grow the
business and run the operations.

An internal growth rate (IGR) is the highest level of growth achievable for a
business without obtaining outside financing. A firm's maximum internal
growth rate is the level of business operations that can continue to fund and grow
the company without issuing new equity or debt.
6. What is the sustainable growth rate?

The sustainable growth rate tells us how much the firm can grow by using
internally generated funds and issuing debt to maintain a constant debt ratio.
SGR = (ROE x R) / (1 - ROE x R)

The sustainable growth rate (SGR) is the maximum rate of growth that a
company or social enterprise can sustain without having to finance growth
with additional equity or debt. The SGR involves maximizing sales and revenue
growth without increasing financial leverage.

The sustainable growth rate is the maximum increase in sales that a business can
achieve without having to support it with additional debt or equity financing.
7. What are the major determinants of growth?

Profit margin – operating efficiency
Total asset turnover – asset use efficiency
Financial policy – choice of optimal debt/equity ratio
Dividend policy – choice of how much to pay to shareholders versus reinvesting
in the firm
CHAPTER 05 - TIME VALUE OF MONEY
1. What is the difference between simple interest and compound interest?

Simple interest is based on the principal amount of a loan or deposit. In contrast,
compound interest is based on the principal amount and the interest that
accumulates on it in every period.

Simple interest is paid on the principal only; compound interest is paid on both
principal and interest.

A simple interest is interest strictly on the money you deposited while a
compound interest is interest on the money you deposited + the interest
accumulated thus far

With Simple Interest, the interest is only ever calculated on the original starting
amount, called the Principal. The amount of interest therefore stays the same from
one year to the next.
With compound Interest, the interest earned is ADDED to the original amount
which is then bigger than at the beginning.
The interest is calculated on that larger amount and once again is ADDED to the
total amount. The amount of interest therefore keeps changing because the value
on which it is calculated keeps changing.

In simple interest transactions the interest is earned ONLY on the principal no
matter how long the period;
Interest = Principle * Rate * Time.
In compound interest transactions, interest is earned on both the principal AND
any accrued interest;
Amount = Principal * (1 + annual rate)n where n is the number of years in the
transaction.

Simple Interest is purely the number of periods times the amount invested times
the rate
Compound Interest includes the interest on top of interest in successive periods
2. Suppose you have $500 to invest and you believe that you can earn 8% per year over the
next 15 years.
a. How much would you have at the end of 15 years using compound interest?

Amount invested = $500
Interest rate = 8%
Period = 15 years
Future value = Amount invested * (1 + Interest rate)^Period
Future value = $500 * 1.08^15
Future value = $500 * 3.172169
Future value = $1,586.08

Time Period, n = 15,
Interest Rate per year = 8%,
-500 PV,
0 PMT, CPT
FV = 1586.08
FV = 500(1.08)^15 = (.08, 15, 0, -500)
b. How much would you have using simple interest?

Amount invested = $500
Interest rate = 8%
Period = 15 years
Future value = Amount invested * (1 + Interest rate * Period)
Future value = $500 * (1 + 0.08 * 15)
Future value = $500 * 2.20
Future value = $1,100.00

500 + 15(500)(.08) = 1,100
3. What is the relationship between present value and future value?

They can be used to find each other, if the number of periods and rate are given.
The present value gives you the value of your money now and the future value
gives you the value of your money in a given amount of time in the future.

Present Value is the value of an investment at the beginning of the investment
period
Future Value is the value of an at investment at the end of the investment period.

Present value takes the future value and applies a discount rate or the interest rate
that could be earned if invested.
Future value tells you what an investment is worth in the future while the present
value tells you how much you'd need in today's dollars to earn a specific amount
in the future
4. Suppose you need $15,000 in 3 years. If you can earn 6% annually, how much do you
need to invest today?

You need $15,000 in 3 years. You can earn 6% annually, how much do you need
to invest today?
3 N 6 I/Y 15000 FV 0 PMT CPT
PV = -12594.29
PV=15000/(1.06)^3
=PV(.06,3,0,15000)

5. If you could invest the money at 8%, would you have to invest more or less than at 6%?
How much?
 15,000FV; 3N; 6I/YR; PV = 12,594.29
15,000FV; 3N; 8I/YR; PV = 11,907.48
Difference = 686.81

3 N 8 I/Y 15000 FV 0 PMT
CPT PV = -11907.48
PV=15000/(1.08)^3
=PV(.08,3,0,15000)
Difference = $686.81
6. What are some situations in which you might want to know the implied interest rate?
When there are more than one opportunities to invest, we might want to compute for their
risks and Future Values. higher interest and low risk is more preferable.
7. You are offered the following investments:
You can invest $500 today and receive $600 in 5 years. The investment is considered low
risk.
You can invest the $500 in a bank account paying 4%.
a. What is the implied interest rate for the first choice and which investment should you
choose?
5N
-500 PV
0 PMT
600 FV
CPT I/Y 3.714%
r=(600/500)^(1/5)-1= 3.714%
RATE (5,0,-500,600)
The bank account pays a higher rate.
8. When might you want to compute the number of periods?

If you want to know how much time a certain investment will take place given the
amount you have now at a given rate and how much your investment will be at a
later time to get you the desired product/service/whatever it is you are investing
for

If we know the present value (PV), the future value (FV), and the interest rate per
period of compounding (i), the future value factors allow us to calculate the
unknown number of time periods of compound interest (n).
9. Suppose you want to buy some new furniture for your family room. You currently have
$500 and the furniture you want costs $600. If you can earn 6%, how long will you have
to wait if you don’t add any additional money?

-500PV; 600FV; 6I/YR; N = 3.13 years

6 I/Y
-500
PV 0
PMT
600 FV
CPT N = 3.13 years
t = ln(600/500) / ln(1.06) = 3.13 years
= NPER (.06, 0, -500, 600)