FIN111 Lecture Notes - Lecture 1: Corporate Finance, Sole Proprietorship, Capital Budgeting

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5 May 2018

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Week One

Fin111

Introductory Principles Of Finance - Financial Manager & Company!

Role of the Financial Manager!

-A ﬁrm generates cash ﬂows by selling the goods and services produced by it’s

productive assets and human capital —> the ﬁrm can pay the remaining cash

(proﬁt), called residual cash ﬂows, to the owners as a cash dividend or reinvest

the cash in the business!

-Cash ﬂows…!

•Cash ﬂow diagram in presentation discussed:!

-Anything left over from payments is proﬁt which can be used to pay

shareholders (owners) or be put back into the company as an investment!

-It is important to decide the order in which you make your payments (debts)!

•Firm is unproﬁtable when it fails to generate suﬃcient cash ﬂows!

•Firms that are unproﬁtable over time will be forced into bankruptcy by their

creditors —> not paying suppliers can allow them to ﬁle bankruptcy against the

company!

•In bankruptcy the company will either be reorganised or the company’s assets

will be liquidated!

-Three fundamental decisions in ﬁnancial management…!

•The capital budgeting decision: Which productive assets should the company

purchase?!

•The ﬁnancing (NOT FINANCIAL! FINANCING) decision: How to raise funds?

Debt or equity or mix?!

•Working capital management decision: How to manage current assets and

current liabilities?!

-How ﬁnancial manager’s decisions aﬀect the balance sheet…!

•

Legal Forms of Business Organisation!

-Sole trader…!

•Is the simplest type of business to start and the least regulated!

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Week One

•All company income is taxed as personal income!

•A sole trader has unlimited liability for all business debts and other obligations

of the company!

-Partnership…!

•Has the same basic advantages and disadvantages as a sole trader!

•When a transfer of ownership takes place the partnership is terminated and a

new partnership is formed!

•The problem of unlimited liability can be avoided in a limited relationship!

-Company…!

•In a legal sense it is a ‘person’ distinct from its owners —> can sue a company

like you can sue a person!

•The owners of a company are its shareholders!

•A major advantage of the company form a business is that shareholders have

limited liability !

•The owners of companies are subject to double taxation ﬁrst at the corporate

level and then at the personal level when dividends are paid to them!

•Public companies can sell their debt or equity in the public securities markets!

•Private companies are held typically by a small number of investors!

Managing the Financial Function!

-Chief Executive Oﬃcer CEO!

•Ultimate management responsibility and decision making power in the ﬁrm!

•Repots directly to the board of directors which is accountable to the company’s

owners —> hired by the board of directors!

•Company organisation chart explained…!

-Refer to the order of the chart!

-Chief ﬁnancial oﬃcer CFO!

•Reports directly to the CEO and manages all aspects of the company’s

ﬁnancials!

•CFO’s key ﬁnancial repots…!

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Document Summary

Introductory principles of finance - financial manager & company. Cash ows : cash ow diagram in presentation discussed: Anything left over from payments is pro t which can be used to pay shareholders (owners) or be put back into the company as an investment. Three fundamental decisions in nancial management : the capital budgeting decision: which productive assets should the company purchase, the nancing (not financial! How nancial manager"s decisions a ect the balance sheet . Sole trader : is the simplest type of business to start and the least regulated. %1: all company income is taxed as personal income, a sole trader has unlimited liability for all business debts and other obligations. Refer to the order of the chart. Chief nancial o cer cfo: reports directly to the ceo and manages all aspects of the company"s. The controller prepares nancial statements, oversees the rms cost accounting systems, prepares taxes and works closely with the rms external auditors.

Related Questions

1.The management of current assets and current liabilities in the short run can lead to several challenges for the financial manager. What are some of the more common challenges or problems encountered by the firm in this regard, and what are the possible solutions? Explain your answers.

2. Solve the following problem. Normaâs Cat Food of Shell Knob ships cat food throughout the country. Norma has determined that through the establishment of local collection centers around the country, she can speed up the collection of payments by two and one-half days. Furthermore, the cash management department of her bank has indicated to her that she can defer her payments on her accounts by one-half day without affecting suppliers. The bank has a remote disbursement center in Iowa.

If the company has $5 million per day in collections and $3 million per day in disbursements, how many dollars will the cash management system free up? Justify your answers.

If the company can earn 8 percent per annum on freed-up funds, how much will the income be? Justify your answers.

If the annual cost of the new system is $800,000, should it be implemented? Explain why or why not.

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8. Your company issued bonds at a premium. Which of the following statements is NOT true?
A. The contra account, premium on bonds payable, is amortized each year by shifting part of its balance to interest expense.
B. On the date of issuance, the stated interest rate was greater than the market interest rate.
C. As the current date approaches the maturity date, the carrying value of the bond approaches the face value of the bond.
D. The account used to record the premium has a normal debit balance.

9. Which of the following would help a company improve its quick ratio without necessarily lowering the liability risk to a creditor?
A. Borrowing money on a long-term note just before the end of the accounting period.
B. Shifting resources from long-term assets to short-term assets such as supplies and inventory.
C. Shifting obligations from long-term liabilities to short-term liabilities.
D. Acquiring inventory by issuing a long-term note.

10. Which of the following is not used to calculate the times interest earned ratio?
A. Net income.
B. Income tax expense.
C. Interest earned on investments.
D. Interest expense.

11. Which of the following statements regarding treasury stock is true?
A. When a company reissues treasury stock for more than it originally paid for the stock, it does not report a gain.
B. When a company purchases treasury stock or pays a dividend, it increases total stockholders' equity.
C. Treasury stock is reported as an asset on the balance sheet.
D. Treasury stock is reported as issued and outstanding stock.

16. Typically, all other things equal, a profitable company that pays little or no dividends:
A. is a bad investment.
B. will reinvest profits which can lead to greater growth potential.
C. will experience relatively stable stock prices over time.
D. will appeal to investors who desire distributions of profit.

17. If a corporation declares and distributes a 10% stock dividend on its common shares, the account debited is:
A. Dividends Payable.
B. Common Stock.
C. Share Capital.
D. Retained Earnings.

20. Limited Liability Companies (LLCs) are like general partnerships in that:
A. income tax is not paid by the company itself.
B. the business has a separate legal identity.
C. liability is limited.
D. amounts paid to the owners are recorded as salaries expense.

21. Which of the following statements regarding financing activities is NOT true?
A. Cash dividends paid to a company's stockholders are reported as cash outflows from financing activities.
B. When a company issues stock for cash, it reports a cash inflow from financing activities.
C. When a company repurchases stock with cash, it reports a cash outflow for financing activities.
D. When a company repays a loan, it reports a cash outflow from investing activities.

22. Which of the following statements regarding quality of income ratio is NOT true?
A. A quality of income ratio will increase if a company's working capital management allows current assets such as inventory to increase out of control.
B. Variations in the ratio can be seasonal and are the result of sales fluctuations rather than reasons for alarm.
C. The quality of income ratio measures the portion of income that was generated in cash.
D. The quality of income ratio is useful when compared to industry competitors or to prior periods.

23. Which of the following types of information is not provided by the statement of cash flows?
A. Company management of current assets and liabilities.
B. Expenditures on long-term assets.
C. Current profitability as measured by specific revenues and expenses.
D. Reliance on external financing.

24. Cash and cash equivalents include:
A. assets that have stable long-term value.
B. assets that are short-term, highly liquid, and are purchased within three months of maturity.
C. assets that consistently grow in value over the long run.
D. assets that are expected to be used up within a year.

The goal of the firm is to ____ because _____. Answer maximize shareholders' wealth; it considers all risks invest funds in real estate; the return is longer maximize shareholders' profit; it is a short term outlook closely matching management goals Mike is paying $8,000 a year on his mortgage at 6% nominal annual interest. He has 15 more years to make payments. He wants to sell his house today. The lowest [minimum] price he can sell the house without losing any money on the house would be about ___. Answer $120,000 $ 50,000 $77,698 $ 186,208 A firm's net income before tax, EBT [NIBT] (on the income statement) is affected by _____. Answer taxes interest dividends Common Stock as listed on the Balance Sheet could include which of the following? Answer A) retained earnings B) additional paid in capital over par value C) preferred capital Both A) and B) If an asset is sold for ___ than its basis, the tax effect would be ____. Answer A) more; capital gain and depreciation recapture B) less; depreciation recapture C) more; capital loss Both A) and B) The main reason for a firm to have assets is to _______. Answer generate revenue match the liabilities and equity both of the above be able to borrow money and pay its debts none of the above The only risk you would NOT have in loaning money to the United States Government (Uncle Sugar) is _____ risk. Answer liquidity maturity default A(n) ____ shows _____. Answer balance sheet; sources and uses of funds income statement; net income as of a specific date cash flow statement; how well the firm is doing relative to its competition You can compare dollars _____ because ______. Answer computed using equations; any math is always correct at any point in time; time is never a factor if they are at nominal value; that is when decisions are made only at the same point in time; dollars can be invested to earn interest There ___ a tax benefit to the company with paying preferred dividends because _______. Answer is; investors can write them off is not; investors declare them as income is; the company can use the payments as an expense is not; the company cannot use the payments as an expense XYZ issued a 6% coupon, $1,000 par, 30 year to maturity bond. It is now 6 years to maturity. What is the price of the bond if the yield to maturity [market interest rate] is 10%? Answer $1,000 $659.46 $825.79 $705.33 The valuation process can be described as ______. Answer calculating the present value of an expected future cash flow using the investor's required rate of return as the discount rate calculating the future value of an expected future cash flow using the investor's required rate of return as the discount rate amortizing the value of the asset over its holding period The ______ is the minimum required rate of return a firm must earn on its investments. Answer net present value opportunity cost of capital or weighted average cost of capital. internal rate of return gross profit margin The value of an asset is the _____ dollar price someone is willing to pay for it. Answer usual maximum minimum Companies use ____ in capital budgeting project analysis because ________. Answer accounting profit; that is the total net income after tax cash flow; that is what the owners would receive from the project and reinvest accounting profit; that is what the owners would receive from the project and reinvest after tax cash flow; that is the result of prudent accounting When borrowing money, you want to know the ____ interest rate because ____. Answer nominal; it is the easiest to find. effective; it is the true cost of borrowing risk free; that is what the government pays Fed funds; that is what you would pay the bank Cash available to pay out to the investors after the firm pays for new investments or additions to working capital is _____. Answer a statement of cash flows operating after tax cash flow free cash flow net income An organization that raises money from investors and provides financing for individuals and businesses is a ___. Answer factor federal government regulatory unit state government taxing authority financial intermediary Negatives/cons of the Net Present Value (NPV) technique include: Answer least conservative reinvestment assumption multiple rates of return for non-conventional cash flows all of the above none of the above A fixed exchange rate means a country _____. Answer can only use gold coins as money is limited in the amount of paper money it can print can print money as the economy demands Your company is considering an investment with the following expected cash flows: Initial Investment = $407,596 Operating Cash Flows = $73,428 per year Terminal Cash Flow = $11,872. The company's WACC is 11% for similar risk projects. The proposed project would have an expected life of 9 years. Your boss asks you to do the analysis. You would tell your boss this proposed project ___ because ____. Answer is acceptable; NPV is about $3,620 is acceptable; NPV is zero should be rejected; NPV is about -$5,660 [negative $5,660]. should be rejected; NPV is zero All ratios are ___ and a reason to analyze ratios is ____. Answer good; to continue to look productive good and bad; because seemingly good ratios can be masking something bad bad; to try to rework the numbers to have them look good basically irrelevant; there really is no need to analyze financial statements When analyzing financial statements, ratio analysis gives ____ and provides insight into ____. Answer very little useful information; practically nothing good practice in logical thinking; what has occurred and the logic behind it financiers something to do during slow periods; how the financier spends his time accountants a reason to provide financial statements; why accountants do what they do while at work Given: Economic State[i]: Good Average Expected Return[i]: 10% 8% Probability[i]: 30% 70% What is the Standard Deviation? Answer 3% 8.4% 0.92% 5.6% Chapter 9: XYZ has a projected project to install a new press. The expected cash revenue is $175,000 per year. Expected yearly expenses are: Operatinf costs of $50,000; Rental of $17,000; Utilities of $20,500; and Depreciation of $10,000. The tax rate is 35%. What is the expected After-Tax Operating Cash Flow for the first year? Answer $65,500 $60,375 $77,500 $97,500 A stock just paid a dividend of $1.60 per year. The dividend is expected to grow at 3% per year indefinately. Equally risky stocks offer expected rates of return of 8%. What should be the stock price? Answer 53.33 $16.00 $32.96 None of the above. A plot of the CAPM is the _____. Answer wrong thing to do Security Market Line a function showing how to calculate TVM All of the above. Derivatives are used to ___. Answer divide one number by another find old ways to do things hedge risk none of the above With the end of the Gold Standard in the 1970's, what new risk did business face in the international market? Answer Comjpetition Exchange rate Worker compensation Property taxes One of the positive aspects [pros] of a Floating Exchange Rate System is ____. Answer money can be printed as needed to support financial/economic growth no/reduced inflation economic growth is reduced as a result of reduced liquidity [lower money supply] business planning is more difficult A(n) ____ contract obligates the seller to execute the contract and the contract is executed. Answer backwards forward future option What policies did countries institute after the Great War that help lead to the Great Depression? Answer A. Mandatory military service B. Trade restrictions C. High tariffs D. Isolationism Only B., C. and D. All of the above

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FIN111 Lecture Notes - Lecture 1: Corporate Finance, Sole Proprietorship, Capital Budgeting

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