FINA351-Managerial Finance, Study Guide for Test 1, Chapters 1-7

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Nov 10, 2013 (3 years and 1 month ago)

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FINA351
-
Managerial Finance
, Study Guide for Test 1, Chapters 1
-
7


NOTE: Make sure to bring a pencil to the test since the answers sheets require
a

pencil

to
be used
. You may
bring a 3” by 5” index card (or piece of paper that size) with both sides
crammed with as much information as
possible (such as formulas, definitions, etc.) Time
-
value
-
of
-
money tables will be supplied, as well as the ratio
formulas (i.e. Table 3.5 in your text).


Chapter 1

1.

Know the four basic areas of finance.

2.

Managerial or cor
porate finance deals with which three broad areas? How would you define these
areas?

3.

What is the goal of a corporation? Is it possible to achieve this goal in the long
-
run and ignore corporate
responsibility to employees, communities, environment or cust
omers? What was Johnson & Johnson’s
view on this? Should a Christian view the goal of a corporation differently

from your textbook goal
?
Why should the goal of corporation not be focused on maximizing current profits? Does the goal of
maximizing the c
urrent stock price reflect only short
-
term results or does it also reflect long
-
term
expectations?

4.

Will corporations usually act in a totally responsible manner without any government intervention?
What was the impetus for
the Sarbane
s

Oxley Act of 2002 (
Sarbox or SOX)
?

5.

What is the agency problem? What are
the
five

ways for

stockholders to encourage

their hired managers

to do a good job

for them
? What are
the
ways for management to fight back

against stockholders who
want to replace them
?

(See teacher n
otes.)

6.

Review the info on financial markets. How do the primary and secondary markets differ? What do the
following stand for: NASDAQ, NYSE?
How do these two markets differ?
Which is the largest market
in terms on dollars? In terms of listings? Which market is also known as the Big Board?

How can you
generally tell if a ticker is traded on the NASDAQ or the NYSE?

7.

Review the
notes on
market indices, particularly the DJIA and

the S&P500. What is the DJIA made up
of and how is it calculated? What are its weaknesses?

Is a bear or bull an optimist?



Chapter 2

1.

What does a balance sheet tell us? What are its other names? In what order are assets listed? Liabilities?
What is

liquidity?

2.

Review the assignment on Microsoft. How is the book value (or net worth) of a company determined?
How is the market value determined? What are two reasons
why

they are not the same?
(
Note that the
total market value of a company is called
its market capitalization

or market cap
.
)

How do you calculate
and interpret the market
-
to
-
book ratio?
Is a ratio less than one good

or bad
?

3.

What does an income statement tell us? What are its other names? Why should a person never look
only at the bot
tom
-
line? How does an income statement on the accrual basis differ from one on the cash
basis? What is earnings management

and d
oes it always result in higher earnings?

4.

What are the three sections of a cash flow statement and what activities appear under

each category? Be
able to read and interpret a statement of cash flows, as we did in class. For example, what is going on in
a company if operating and investing activities used cash
(negative)
but financing activities provided
cash

(positive)
? What wo
uld a normal and healthy cash flow look like?

5.

Be able to find the tax liability and the average & marginal tax rates for a corporation if given the tax
rates and the taxable income. Which rate (marginal or average) is more important for tax planning?
Why

is a marginal and average tax rate of 35% assumed for large corporations?

6.

Are individual federal tax rates in the U.S. progressive

or regressive
? (See instructor notes.)
For the
latest year with data, w
hat percent of federal income taxes are paid by tho
se with the highest 10% of
taxable income? Bottom 50% of taxable income? Ha
ve the rich been getting more or less rich over

the
last few decades?

7.

Why might corporations prefer to finance with debt (bonds) rather than equity (stock)? [See instructor
notes

for Ch. 2]

8.

Why do corporations get a tax break on dividend income they receive from stocks invested in other
corporations?

[Answer: Otherwise there
w
ould be triple taxation on the same money as it is passed
from one corporation to another

and eventually

to the ultimate stockholder
.]

9.

Why might corporate investors heavily invest in preferred stock?

[Answer:
Because preferred stock
usually pays lots of dividends and
most
inter
-
corporate dividend income is
tax
-
exempt
.]

10.

Say you own some stock.
Are dividends received by individuals
(not corporations)
fully taxable?
[Answer: Yes, they are reported right smack on the front of your Form 1040.]
How does this cause
double taxation?
[Answer: the corporation pays tax on its profits and then distribu
tes the profits in the
form of dividends to shareholders who pay tax on the dividends.]

11.

If capital gains were taxed at a lower rate than dividends, would a tax
-
conscious investor prefer to
receive dividends now or would s/he rather let the company keep the

money and reinvest internally,
hopefully to produce a higher stock price?

[Answer: tax
-
conscious investor
s

would rather receive
capital gains
later
than dividends
now. They

would prefer that the corporation reinvest its money and
rais
e

the stock price
rather than pay dividends.

This way the tax is deferred to a later date, compounding
tax free in the meantime. Also the tax rate will be lower on the capital gains when the stock is
eventually sold.
]


Chapter 3

1.

Be able to prepare
simple
common
-
size and
base
-
year financial statements. On a common
-
size income
statement, what equals 100%
: total revenues/sales or net income
?
In base
-
year analysis,
if the base year
is set to 100%, how are future year’s percentages calculated?

2.

Be able t
o work
/interpret

the financial ratios that
were on the assignment for

Target and Wal
-
Mart.
You will not be responsible for ratios that were not on the assignment. Note that a copy of Table 3.5
(ratio formulas)
will be distributed with the test.

3.

What conc
lusions were drawn in
y
our comparison of Target and Wal
-
Mart? Which company was the
biggest? Which company appears to have higher quality products/service and charge
s

higher prices?
How can you tell? Which company appear
s
to be more efficient through
economies of scale (higher
sales volume
, more sales per sq. foot, etc.
)? Which company ha
s

less percent of sales spent on
operating expenses?

W
hich company ha
s

more efficient

inventory management? How can you tell?


Chapters 4 & 5

The best way to review
these chapters is to rework the homework
, since t
he test will have a couple of
problems very similar to the homework. Review subjects such as: simple vs. compound interest, present and
future values of single
-
sums, present and future values of annuities,

present and future values of cash flows of
different amounts, difference between ordinary annuities and annuity dues (you won’t have to calculate
annuit
y

due
s
), effect of compounding more often (quarterly, daily, perpetually, etc.), EAR, APY, Rule of 72,
and amortization tables. If you have a financial calculator, you will be allowed to use it on the test. For those
without calculators, tables will be provided.


Chapter 6

1.

Review the various features of a typical bond, including the terminology discussed
in your text and in
the notes. For example, what is the difference between an indenture and a debenture? Are most
corporate bonds debentures? Are most bonds term or serial bonds, and which would more likely
require a sinking fund?

Are coupon/bearer or
registered bonds more common today? Would an
investment grade bond have a higher or lower interest rate than a junk bond? Why?

2.

Be able to determine the price of a bond by calculating the present value of the annuity (interest
payments) and the single
-
sum

($1,000 maturity value). Be able to explain why premiums and
discounts arise
when

interest rates
change
. For example, if a $1,000 face value bond
i
s paying
interest of $100 annually (10% coupon), but its YTM (or market rate)
is

12%, would the bond be
pr
iced at a premium or a discount? Why?

3.

Review the
five
bond pricing theorems illustrated in
the notes and
the homework. What relationship
(direct or inverse) does a bond price have with market interest rates? What happens in general to the
price of a pre
mium bond as it approaches maturity? A discount bond? Why? Which are more
sensitive to changes in interest rates: long
-
term or short
-
term bonds? Low
-
coupon or high
-
coupon
bonds? What is interest rate risk?

If a short
-
term bond investor thought inte
re
st rates were headed
up, how could the investor minimize interest
-
rate risk: by lengthening or shortening the average
maturity of the portfolio? By raising or lowering the average coupon rate of the portfolio?

4.

When we refer to the national debt, what exa
ctly are we talking about?
How much does the U.S.
Fed
eral government currently owe

(approximately)
?

5.

Differentiate between a T
-
Bill, T
-
Note,
and
T
-
Bond. Do Treasury securities have default
(or
credit)
risk

(at least theoretically)
? Do Treasury securities

have liquidity risk?

6.

What are municipal bonds? Are interest payments on municipal bonds subject to federal tax?

7.

What are zero
-
coupon bonds and how do they work? Are T
-
Bills
essentially zero
-
coupon bonds?

8.

Be able to read and interpret corporate and gover
nment bond quotes. A quote on a corporate bond of
99.25 means a price of how many dollars? What are the bid price, asked price, and spread?
Which
would usually be higher: the bid or asked price?

Why?

9.

Understand how inflation affects the required rate
of return
on a fixed
-
income investment
. In other
words, be able to

calculation real returns according the Fisher Effect (exact method) and the more
simple approximate method. Why is focusing on the real return, rather than the nominal return, so
critical

in investing? What does it mean to have a negative real return?
How would you define
inflation

and what causes it? How is
inflation

measured (
i.e. what is the
name of
the
index)? Is it
possible for the nominal return to be smaller than the real return
? Has this ever happened in the US
?

10.

What is
meant by
the

term structure of interest rates?


For what reasons are

long
-
term rates usually
higher than short
-
term rates

on fixed
-
rate investments
? What is the normal shape of a yield curve?
What does an in
verted yield curve usually signify? What is its current shape? Be familiar with the
following types of risk
s
: inflation risk, interest
-
rate risk, default

(or credit)

risk,
and l
iquidity risk.
W
hich
of these
risk
s

would cause a

T
-
Bond
to
usually have
a
higher rate than a T
-
Bill? Why would
corporate bonds usually have higher rates than T
-
Bonds

with the same maturity?


Chapter 7

1.

Why is valuing stock more difficult than valuing bonds? In other words, why are the future cash
flows more uncertain for stocks

than for bonds?

2.

Be able to value a share of common stock using the Dividend Growth Model (assuming constant
growth) as was done in the homework.

3.

What are the two components of required return on stock? How are they determined? Which one is
more importan
t in a bull market? In a bear market?

4.

Why is it said that corporate democracy follows the golden rule? Which of the two voting procedures
(cumulative or straight) favors minority voters? What is a proxy? Why do some firms have more
than one class of st
ock? What rights does a
common stock owner

have?

5.

What preference does preferred stock
owners
have?
What do they give up to get this preference?

6.

Review the discussion in your text on stock markets: dealers vs. brokers, NYSE members, NYSE
organization/op
eration, Nasdaq market, ECNs, etc. Be able to answer similar questions to those on
your homework over this material.

7.

Know how to read and interpret a stock quote.


Come prepared to move quickly on the test as there’ll be no time for socializing. The bett
er you know it, the
faster you can answer it. Expect a mixture of T/F and M
/C

questions
, probably about a dozen T/F and maybe
20
-
25

M/C questions
. Good luck!

But remember that Thomas Jefferson said “I'm a great believer in luck
;

and I find that the hard
er I work, the more I have of it.” See you at the grand celebration.