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Principles of Finance

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Principles of FinanceReview Questions

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Table of contents
  1. Preface
  2. 1 Introduction to Finance
    1. Why It Matters
    2. 1.1 What Is Finance?
    3. 1.2 The Role of Finance in an Organization
    4. 1.3 Importance of Data and Technology
    5. 1.4 Careers in Finance
    6. 1.5 Markets and Participants
    7. 1.6 Microeconomic and Macroeconomic Matters
    8. 1.7 Financial Instruments
    9. 1.8 Concepts of Time and Value
    10. Summary
    11. Key Terms
    12. Multiple Choice
    13. Review Questions
    14. Video Activity
  3. 2 Corporate Structure and Governance
    1. Why It Matters
    2. 2.1 Business Structures
    3. 2.2 Relationship between Shareholders and Company Management
    4. 2.3 Role of the Board of Directors
    5. 2.4 Agency Issues: Shareholders and Corporate Boards
    6. 2.5 Interacting with Investors, Intermediaries, and Other Market Participants
    7. 2.6 Companies in Domestic and Global Markets
    8. Summary
    9. Key Terms
    10. CFA Institute
    11. Multiple Choice
    12. Review Questions
    13. Video Activity
  4. 3 Economic Foundations: Money and Rates
    1. Why It Matters
    2. 3.1 Microeconomics
    3. 3.2 Macroeconomics
    4. 3.3 Business Cycles and Economic Activity
    5. 3.4 Interest Rates
    6. 3.5 Foreign Exchange Rates
    7. 3.6 Sources and Characteristics of Economic Data
    8. Summary
    9. Key Terms
    10. CFA Institute
    11. Multiple Choice
    12. Review Questions
    13. Problems
    14. Video Activity
  5. 4 Accrual Accounting Process
    1. Why It Matters
    2. 4.1 Cash versus Accrual Accounting
    3. 4.2 Economic Basis for Accrual Accounting
    4. 4.3 How Does a Company Recognize a Sale and an Expense?
    5. 4.4 When Should a Company Capitalize or Expense an Item?
    6. 4.5 What Is “Profit” versus “Loss” for the Company?
    7. Summary
    8. Key Terms
    9. Multiple Choice
    10. Review Questions
    11. Problems
    12. Video Activity
  6. 5 Financial Statements
    1. Why It Matters
    2. 5.1 The Income Statement
    3. 5.2 The Balance Sheet
    4. 5.3 The Relationship between the Balance Sheet and the Income Statement
    5. 5.4 The Statement of Owner’s Equity
    6. 5.5 The Statement of Cash Flows
    7. 5.6 Operating Cash Flow and Free Cash Flow to the Firm (FCFF)
    8. 5.7 Common-Size Statements
    9. 5.8 Reporting Financial Activity
    10. Summary
    11. Key Terms
    12. CFA Institute
    13. Multiple Choice
    14. Review Questions
    15. Problems
    16. Video Activity
  7. 6 Measures of Financial Health
    1. Why It Matters
    2. 6.1 Ratios: Condensing Information into Smaller Pieces
    3. 6.2 Operating Efficiency Ratios
    4. 6.3 Liquidity Ratios
    5. 6.4 Solvency Ratios
    6. 6.5 Market Value Ratios
    7. 6.6 Profitability Ratios and the DuPont Method
    8. Summary
    9. Key Terms
    10. CFA Institute
    11. Multiple Choice
    12. Review Questions
    13. Problems
    14. Video Activity
  8. 7 Time Value of Money I: Single Payment Value
    1. Why It Matters
    2. 7.1 Now versus Later Concepts
    3. 7.2 Time Value of Money (TVM) Basics
    4. 7.3 Methods for Solving Time Value of Money Problems
    5. 7.4 Applications of TVM in Finance
    6. Summary
    7. Key Terms
    8. CFA Institute
    9. Multiple Choice
    10. Review Questions
    11. Problems
    12. Video Activity
  9. 8 Time Value of Money II: Equal Multiple Payments
    1. Why It Matters
    2. 8.1 Perpetuities
    3. 8.2 Annuities
    4. 8.3 Loan Amortization
    5. 8.4 Stated versus Effective Rates
    6. 8.5 Equal Payments with a Financial Calculator and Excel
    7. Summary
    8. Key Terms
    9. CFA Institute
    10. Multiple Choice
    11. Problems
    12. Video Activity
  10. 9 Time Value of Money III: Unequal Multiple Payment Values
    1. Why It Matters
    2. 9.1 Timing of Cash Flows
    3. 9.2 Unequal Payments Using a Financial Calculator or Microsoft Excel
    4. Summary
    5. Key Terms
    6. CFA Institute
    7. Multiple Choice
    8. Review Questions
    9. Problems
    10. Video Activity
  11. 10 Bonds and Bond Valuation
    1. Why It Matters
    2. 10.1 Characteristics of Bonds
    3. 10.2 Bond Valuation
    4. 10.3 Using the Yield Curve
    5. 10.4 Risks of Interest Rates and Default
    6. 10.5 Using Spreadsheets to Solve Bond Problems
    7. Summary
    8. Key Terms
    9. CFA Institute
    10. Multiple Choice
    11. Review Questions
    12. Problems
    13. Video Activity
  12. 11 Stocks and Stock Valuation
    1. Why It Matters
    2. 11.1 Multiple Approaches to Stock Valuation
    3. 11.2 Dividend Discount Models (DDMs)
    4. 11.3 Discounted Cash Flow (DCF) Model
    5. 11.4 Preferred Stock
    6. 11.5 Efficient Markets
    7. Summary
    8. Key Terms
    9. CFA Institute
    10. Multiple Choice
    11. Review Questions
    12. Problems
    13. Video Activity
  13. 12 Historical Performance of US Markets
    1. Why It Matters
    2. 12.1 Overview of US Financial Markets
    3. 12.2 Historical Picture of Inflation
    4. 12.3 Historical Picture of Returns to Bonds
    5. 12.4 Historical Picture of Returns to Stocks
    6. Summary
    7. Key Terms
    8. Multiple Choice
    9. Review Questions
    10. Video Activity
  14. 13 Statistical Analysis in Finance
    1. Why It Matters
    2. 13.1 Measures of Center
    3. 13.2 Measures of Spread
    4. 13.3 Measures of Position
    5. 13.4 Statistical Distributions
    6. 13.5 Probability Distributions
    7. 13.6 Data Visualization and Graphical Displays
    8. 13.7 The R Statistical Analysis Tool
    9. Summary
    10. Key Terms
    11. CFA Institute
    12. Multiple Choice
    13. Review Questions
    14. Problems
    15. Video Activity
  15. 14 Regression Analysis in Finance
    1. Why It Matters
    2. 14.1 Correlation Analysis
    3. 14.2 Linear Regression Analysis
    4. 14.3 Best-Fit Linear Model
    5. 14.4 Regression Applications in Finance
    6. 14.5 Predictions and Prediction Intervals
    7. 14.6 Use of R Statistical Analysis Tool for Regression Analysis
    8. Summary
    9. Key Terms
    10. Multiple Choice
    11. Review Questions
    12. Problems
    13. Video Activity
  16. 15 How to Think about Investing
    1. Why It Matters
    2. 15.1 Risk and Return to an Individual Asset
    3. 15.2 Risk and Return to Multiple Assets
    4. 15.3 The Capital Asset Pricing Model (CAPM)
    5. 15.4 Applications in Performance Measurement
    6. 15.5 Using Excel to Make Investment Decisions
    7. Summary
    8. Key Terms
    9. CFA Institute
    10. Multiple Choice
    11. Review Questions
    12. Problems
    13. Video Activity
  17. 16 How Companies Think about Investing
    1. Why It Matters
    2. 16.1 Payback Period Method
    3. 16.2 Net Present Value (NPV) Method
    4. 16.3 Internal Rate of Return (IRR) Method
    5. 16.4 Alternative Methods
    6. 16.5 Choosing between Projects
    7. 16.6 Using Excel to Make Company Investment Decisions
    8. Summary
    9. Key Terms
    10. CFA Institute
    11. Multiple Choice
    12. Review Questions
    13. Problems
    14. Video Activity
  18. 17 How Firms Raise Capital
    1. Why It Matters
    2. 17.1 The Concept of Capital Structure
    3. 17.2 The Costs of Debt and Equity Capital
    4. 17.3 Calculating the Weighted Average Cost of Capital
    5. 17.4 Capital Structure Choices
    6. 17.5 Optimal Capital Structure
    7. 17.6 Alternative Sources of Funds
    8. Summary
    9. Key Terms
    10. CFA Institute
    11. Multiple Choice
    12. Review Questions
    13. Problems
    14. Video Activity
  19. 18 Financial Forecasting
    1. Why It Matters
    2. 18.1 The Importance of Forecasting
    3. 18.2 Forecasting Sales
    4. 18.3 Pro Forma Financials
    5. 18.4 Generating the Complete Forecast
    6. 18.5 Forecasting Cash Flow and Assessing the Value of Growth
    7. 18.6 Using Excel to Create the Long-Term Forecast
    8. Summary
    9. Key Terms
    10. Multiple Choice
    11. Review Questions
    12. Problems
    13. Video Activity
  20. 19 The Importance of Trade Credit and Working Capital in Planning
    1. Why It Matters
    2. 19.1 What Is Working Capital?
    3. 19.2 What Is Trade Credit?
    4. 19.3 Cash Management
    5. 19.4 Receivables Management
    6. 19.5 Inventory Management
    7. 19.6 Using Excel to Create the Short-Term Plan
    8. Summary
    9. Key Terms
    10. Multiple Choice
    11. Review Questions
    12. Video Activity
  21. 20 Risk Management and the Financial Manager
    1. Why It Matters
    2. 20.1 The Importance of Risk Management
    3. 20.2 Commodity Price Risk
    4. 20.3 Exchange Rates and Risk
    5. 20.4 Interest Rate Risk
    6. Summary
    7. Key Terms
    8. CFA Institute
    9. Multiple Choice
    10. Review Questions
    11. Problems
    12. Video Activity
  22. Index
1.
Intelligent Cookies Inc. (ICI) sold $30,000,000 of product in a year that had a cost of goods sold of $10,000,000. The average inventory carried by ICI was $500,000. On average, it takes 35 days for ICI’s customers, such as grocery stores and restaurants, to pay on their accounts. ICI buys ingredients, including flour, spices, and eggs, from its vendors on credit, and ICI takes about 40 days to pay its suppliers. How many days is ICI’s cash conversion cycle?
2.
Shown below are account balances for Electra Engines Inc., a manufacturer. The accounts are shown in a random order. What is the amount of net working capital?

The account balances for Electra Engines, Inc. shows the following line items: Property, Plant, and Equipment - $500,000; Accounts Payable - $6,000; Intangible Assets - $5,000; Cash - $10,000; Marketable Securities (maturing in 6 months of less) - $30,000; Retained Earnings - $25,000; Interest Payable - $2,000; Notes Payable (due in 24 months) - $10,000; Accounts Receivable - $20,000; Notes Payable (due in 6 months) - $20,000; Common Stock - $45,000; Dividends Payable - $3,000; and Inventory - $50,000. A line at the top of the sheet says Net Working Capital dollar sign and has a blank to write the answer in.

3.
Shown below are account balances for Electra Engines Inc., a manufacturer. The accounts are shown in a random order. What is the current ratio and the quick ratio?

The account balances for Electra Engines, Inc. shows the following line items: Property, Plant, and Equipment - $500,000; Accounts Payable - $9,000; Intangible Assets - $5,000; Cash - $12,000; Marketable Securities (maturing in 6 months of less) - $25,000; Retained Earnings - $25,000; Interest Payable - $2,500; Notes Payable (due in 24 months) - $10,000; Accounts Receivable - $25,000; Notes Payable (due in 6 months) - $20,000; Common Stock - $45,000; Dividends Payable - $3,000; and Inventory - $55,000.

4.
Imagine that these are the cash collection cycles for some well-run companies:

A table shows the types of companies and their cash conversion cycles. The Grocery chain has a conversion cycle of 6.20. The building/construction company has a conversion cycle of 162.69. The restaurant chain has a conversion cycle of 4.06. The department store has a cash conversion cycle of 63.60.

What types of conclusions can you reach when you see this kind of variability?

Imagine that those cash conversion cycles are based on this information:

A table shows the inventory turnover, accounts receivable turnover, and accounts payable turnover for different company types. A grocery chain has inventory turnover of 14.60, accounts receivable turnover of 91.00, and accounts payable turnover of 16.00.  A building/construction company has an inventory turnover of 2.00, accounts receivable turnover of 121.67, and accounts payable turnover of 16.00.  A restaurant chain has an inventory turnover of 150.00, accounts receivable turnover of 100.00, and accounts payable turnover of 36.00.  A department store has an inventory turnover of 2.78, accounts receivable turnover of 91.00, and accounts payable turnover of 3.00.

What would be your analysis of the cash conversion cycles based on the above information (inventory turnover, accounts receivable turnover, and accounts payable turnover)? Use the worksheet below to summarize your conclusions.

Worksheet

A table shows the types of companies and their cash conversion cycles. The Grocery chain has a cash conversion cycle of 6.20. The building/construction company has a cash conversion cycle of 162.69. The restaurant chain has a cash conversion cycle of 4.06. The department store has a cash conversion cycle of 63.60. There is a blank space to fill in the analysis of the cash conversion cycles based on the information given.

5.
What is the estimated annual percentage rate (APR) of not taking advantage of the early payment discount based on these terms: 4/15, n/45?
6.
If you were a credit manager reviewing a potential customer’s request for a $20,000 line of credit, what would you analyze? Generally, how would the 5Cs of Credit guide your analysis and help lead you to a prudent decision to accept or reject the request?
7.
Aspire Excellent Inc. is a book publisher. On March 1, Aspire sells $25,000 of books to Get Your Books Inc. (YBI), a large bookstore chain. The sale is made on account with terms net 60. Aspire’s customers usually take the full 60 days to pay their invoices. The books cost Aspire $10,000 to manufacture. Below, summarize the effect on the accounts on March 1 from the standpoint of the seller, Aspire Excellent Inc., and the buyer, YBI.

A table shows the line items accounts receivable, inventory, and sales for Aspire’s accounts.  A space is provided to indicate the change (amount and direction of change: positive or negative) in the account. The line items accounts payable and inventory are shown for YBI’s accounts. A space is provided to indicate the change (amount and direction of change: positive or negative) in the account.

8.
The financial manager of New England Blissful Dairies, a distributor of milk, cream, and ice cream products, has finished the 12-month operating budget. For the month of June, the following projections were made:

June 1 Cash Balance $90,000
Cash Receipts $300,000
Cash Disbursement $350,000

Taking into account an amount of cash that the firm likes to maintain as a target (minimum cash balance) of $75,000, prepare the cash budget for June using the format below. Assume that, if necessary, the company will draw upon a preestablished line of credit with their bank to be able to maintain the target cash balance.

A target cash balance sheet for New England Blissful Dairies shows beginning cash balance, cash collections, cash disbursements, net cash flow, preliminary ending cash balance, less: minimum cash balance, cash surplus or (deficiency), and ending cash balance for the month of June.

Will the company need short-term financing?

9.
The sales for Re-Works Inc., a company that fabricates iron fencing from recycled metals, are all on account. For the first three months of the year, Re-Works management expects the following sales:

A table shows Re-Works Inc’s sales for January ($120,000), February ($130,000) and March ($140,000).

Based on past collection patterns, management expects the following:

A table shows Re-Works Inc’s collection patterns in the month of February showing month of sale (10%), month after sale (50%), and the remainder- second month after sale (40%).

Also, based on past experience, management forecasts that 5 percent of accounts receivable will be uncollectible and will eventually be written off.

What are the expected cash receipts for March?

10.
With the same sales forecasts as in question 9, Re-Works Inc. management would like to implement some changes to credit policy and credit terms that they believe would change the collection pattern going forward and would lower the uncollectible accounts prediction to 3 percent.

What would be the expected cash receipts for March?

A table shows Re-Works Inc’s collection patterns in the month of February. The month of sale is 15%, month after sale is 55%, the remainder is 30%, and bad debt expense is 3%.

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