Finance Test 1 02 19 2014 When a firm is considering the size timing and risk of cash flows they are in the process of Working Capital Management relates to the management of cash while Capital Budgeting and Capital Structure refer to the management of cash The goal of a financial manager is to If a firm does not have publicly traded shares does the goal above still apply A firm with bankruptcy concerns should consider using to finance their investments is cheaper than What is the primary reason for the answer above An investor should only exercise their options if they are A company that does a lot of international business could utilize what type of derivative to minimize their risk True or False When purchasing a put option the investor is betting that the market price of the underlying security will go down Explain why an option is called a derivative Explain why depreciation is added back when calculation Free Cash Flow When Calculation Capital Expenditures why can t a company just take the difference in what they started the year with in Net Fixed Assets and what they finished the year with Marrangelli Inc sells 1 500 000 of merchandise on credit Which one of the four components of Free Cash Flow will reflect this cash outflow Will this increase or decrease the Free Cash Flow If a company purchases a new office building for 900 000 which one of the four components of Free Cash Flow will reflect this cash outflow As the time increases the present value As the rate increases the future value As the time increases the future value As the rate increases the present value The goal of financial management is to maximize the current value of the Chapter 1 company s stock Value CASH Capital Budgeting Capital Structure What long term investments should the firm take on Based on size timing and risk How will the firm finance these long term investments How much how to get it debt vs equity Working Capital Management Managing short term cash inflows and outflows There are 2 primary means that a firm has to pay for their investments or projects These two sources are Debt and Equity Debt exchanging money for a contract Equity Exchanging money for ownership Types of securities debt borrowing long term debt Debt securities are contractual obligations to repay corporate A corporation can sell bonds or take out a loan Both are considered Federal and state governments can also issue bonds There are also several forms of short term debt Can be both short term and long term Types of securities equity Equity securities are shares of common and preferred stock Equity is a non contractual claim to the residuals cash flows of the firm Equity can only be sold by corporations All equity is considered long term Debt vs Equity Interest on debt is tax reductible Debt is cheaper Debt is not ownership interest in the firm Equity does not have to be paid back Equity will not force the company into bankruptcy if payments cannot be made Public vs Private Debt and equity can either be issued on a public or private basis Public open to everyone for purchase Private only available to select investors for purchase Short term vs Long term Short term lasts less than one year Long term lasts more than one year The various forms that debt and equity can take as sources of financing is called Financial Instruments 3 Categories of Financial Instruments Debt Instruments Equity Instruments Derivatives Types of Financial Instruments Debt Current liabilities short term debt will come due in less than one year Long term debt debt that will not come due for more than one Liabilities and debts are often associated with cash burdens referred year to as debt service Financial Instruments There are lots of means of obtaining short term debt The type used will depend on the liquidity of other factors Liquidity and Financial Assets Examples of long term debt The ease of conversion to cash without significant loss of value Term loans typical term loan Private Placements are also used as a means of obtaining long term debt by corporations but are not as common as the first Several banks bid against each other for the loan should result in lower rate much more time consuming Bonds major source of public debt for corporations They are long term contractual agreements with varying lengths of maturity Why is equity considered long term Because it doesn t expire Which one is better Debt or Equity It depends Two primary means of private equity Venture money for a new business Non Venture need money because of financial stress The higher the risk the higher the potential reward Derivative a financial asset whose value is based on or derived from the value of other aspects Used to hedge insure against a variety of risks Options a contract entitling the owner the right to buy or sell an asset at some predetermined price within a present time frame Derivatives Options Call option a contract entitling the owner the right to buy or call in an asset stock at some predetermined price within a preset time frame Put Option a contract entitling the owner the right to sell or put out an asset stock at some predetermined price within a preset time frame Value of call or put option is based on or derived from the underlying stock price In the money situation Out of the money situation Strike price for call option strike price below current market price For call option strike price is higher than the market price Buy price in a call option and the sell price in a put option Market Price whichever you are doing buying selling with the strike price you are doing the opposite in the market Derivatives Convertibles Convertible Security bonds that have a feature allowing them to be exchanged for or converted to common stock o No additional capital is raised o Debt is converted to equity o Strengthens balance sheet Convertible feature adds value to the bond Convertibles are derivatives because the value of the convertible feature is derived from the underlying stock Chapter 2 point of time The balance sheet is a snapshot of the firm s assets and liabilities at a given Assets on the balance sheet are listed in order of liquidity Current Assets will be converted to cash within one year Accounts receivable Inventory Prepaid expenses Fixed Assets have a life of longer than one year PP E property plant and equipment The book value of a firm is also called net assets and is simply the assets minus the liabilities debt of the firm 1 Total assets total debt from