Exam 1 Study Guide Chapter 1 o Know the definitions and examples of capital budgeting capital structure and working capital investments Capital budgeting the process of planning and managing a firm s long term Ex Apple expanding product line Starbucks opening a new store Capital structure the specific mixture of long term debt and equity the firm uses to finance its operations Ex The capital structure of XYZ Inc is 40 long term debt bonds 10 preferred stock and 50 common stock Working capital a firm s short term assets and liabilities Concerns ability to continue operations and avoid costly interruptions Ex how much cash and inventory should be kept on hand o Know the definition of sole proprietorship partnership and corporation Sole proprietorship business owned by single individual Partnership business formed by two or more individuals of entities Corporation business created by distinct legal entity composed of one or more individuals or entities Ex ford Google o Know the advantages and disadvantages of a sole proprietorship a partnership and a corporation Sole proprietorship Advantages Partnership Corporation Disadvantages easy to start little regulation single owner keeps all profit taxed once as personal income owners personal wealth unlimited liability hard to transfer ownership interest limited to life of owner equity capital limited to Advantages Disadvantages easy to start partners share gains and losses income taxed once as personal income limited partners partnership dissolves when one partner dies or decides to sell amount of equity raised limited to combined wealth of partners difficult to transfer ownership unlimited liability only applies to general partners not Advantages limited liability unlimited life owner and manager separation transfer of ownership is easy amount of equity that can be raised is much higher taxation income taxed at corporate rate and cash distributions taxed at personal rate separation of ownership and management double Disadvantages o Know the primary goal of financial management To maximize the current value per share of the existing stock o Know the definition and an example of an agency problem Agency problem conflict of interest between principal and agent Chapter 2 Principal hires agent to represent his her interests Ex conflict between management and stockholders the purchase of a private jet for manager o Know the difference between primary and secondary markets Primary market original sale of securities by corporations and governments Secondary market securities bought and sold after the original sale o Know the difference between dealer and auction markets Two types of secondary markets Dealer market dealers buy and sell for themselves OTC mkt Auction market matches buyers and sellers o Know how these items interact in terms of the balance sheet identity Assets Liabilities Shareholders Equity Balance sheet financial statement showing a firms accounting value on a particular date Asset any resource owned by a firm that generates value for the firm Current asset you expect to convert to cash in 1 year or less Fixed asset you expect to convert to cash in over 1 year Property equipment Liabilities debts and obligations Current expect to be paid off in 1 year or less Long term expect to be paid off in over 1 year Stockholder s equity total firm value that belongs to the shareholders o Know the difference between market and book values Book value amount originally paid at purchase Provided by balance sheet Market value price at which assets liabilities and equity can be bought or sold today More relevant to financial managers Components that effect market value reputation of the firm o Know the definition of liquidity and its two dimensions management experience Liquidity speed and ease with which an asset can be converted to cash Two dimensions 1 Ease of conversion 2 Loss of value Acts as financial slack and helps to protect the firm against downturns in the industry market Liquid assets usually earn a lower return o Know how to calculate average tax rates using a marginal tax rate table o Given an income statement and balance sheet know how to calculate the following Cash Flow From Assets OCF NCS Change in NWC Operating Cash Flow o OCF EBIT earning before interest and taxes Depreciation Taxes o Income stmnt measures whether a firm s cash inflows from business operations are sufficient to cover day to day cash outflows Net Capital Spending o NCS Ending NFA Beginning NFA Depreciation o Measures how much money is spent on fixed assets vs how much money is generated via the sale of fixed assets Change in Net Working Capital o Change in NWC Ending NWC Beginning NWC o Measures how much money is spent on current assets vs how much money is generated via the sale of current assets Cash Flow to Creditors Interest paid Net New Borrowing NNB ending long term debt beginning long term debt NNB not on equation sheet Measures how much money is distributed to creditors to repay old borrowing When cash flow to creditors is positive it represents cash leaving the firm and going to creditors When it is negative it represents cash inflow from the creditors Cash Flow to Stockholders Dividends paid Net New Equity Raised Net new equity raised refers to ending common stock beginning common stock NNER not on equation sheet Measures how much money is distributed to stockholders o Know whether cash flow to creditors or stockholders represents a cash inflow vs cash outflow When cash flow to stockholders is positive it represents cash leaving the firm and going to stockholders When it is negative it represents cash inflow from the stockholders Chapter 5 variables o Know how to compute PV FV N and I Y when you are given three of the four Plug given values into calculator PMT 0 Compute CPT for unknown value o Know how to compute simple interest compound interest and total interest o Know the Rule of 72 Rule stating that in order to find the number of years required to double your money at a given interest rate you divide the compound return into 72 The result is the approximate number of years that it will take for your investment to double For example if you want to know how long it will take to double your money at 12 interest divide 12 into 72 and you get six years Chapter 6 o Know how to compute PV FV PMT N and I Y of multiple cash flows under annual monthly weekly and daily compounding Know how to calculate a missing cash flow when given the PV and remaining
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