Final - Part 1

Question 1

Capital Budgeting

Answer 1

the process of planning and managing a firm’s long-term investments

Question 2

What is the essence of capital budgeting

Answer 2

Evaluating the size, timing, and risk of future clash flows

Question 3

Capital structure

Answer 3

mixture of debt and equity maintained by a firm

Question 4

Working capital management

Answer 4

a firm’s short-term assets and liabilities

Question 5

sole proprietorship

Answer 5

business owned by one person

Question 6

Advantages of a sole proprietorship

Answer 6

1. simplest type of business to start
2. least regulated form of organization
3. owner keeps all the profits

Question 7

Disadvantages of a sole proprietorship

Answer 7

1. Owner has unlimited liability for business debt
2. all business income is taxed as person income
3. life of sole proprietorship is limited to owner’s life span
4. amount of equity that can be raised is limited to the amount of the proprietor’s personal wealth
5. ownership may be difficult to transfer

Question 8

Partnership

Answer 8

A business formed by two or more individuals or entities

Question 9

Partnership advantages

Answer 9

same as sole proprietor

Question 10

partnership disadvantage

Answer 10

same as a sole proprietorship which can be summed up to having an inability to raise cash for investment

Question 11

Corporation

Answer 11

A business created as a distinct legal entity composed of one or more individuals or entities

Question 12

Advantages of a corporation

Answer 12

1. ownership can be easily transferred
2. life of a corporation is unlimited
3. limited liability for stockholders

Question 13

Disadvantages of a corporation

Answer 13

1. double taxation (taxed twice at corporate and personal level)

Question 14

What is the goal of financial management

Answer 14

The goal of financial management is to maximize the current value per share of the existing stock

Question 15

Agency problem

Answer 15

the possibility of conflict of interest between stockholders and management of a firm

Question 16

Primary Market Transaction

Answer 16

the corporation is the seller, and the transaction raises money for the corporation

Question 17

Secondary market transaction

Answer 17

Involves one owner or creditor selling to another

Question 18

What are the two types of secondary markets

Answer 18

1. Dealer markets
2. Auction markets

Question 19

What is the balance sheet formula

Answer 19

Assets = Liabilities + Stockholders Equity

Question 20

Net Working Capital

Answer 20

Difference between a firm’s current assets and its current liabilities

Question 21

Liquidity

Answer 21

Refers to the speed and ease with which an asset can be converted to cash

Question 22

Cash flow

Answer 22

the difference between the number of dollars that came in and the number of dollars that went out

Question 23

Operating Cash flow

Answer 23

cash generated from a firm’s normal business activities

Question 24

capital spending

Answer 24

refers to the net spending on fixed assets

Question 25

change in net working capital

Answer 25

measured as the net change in current assets relative to current liabilities for the period being examined and represents the amount spent on networking capital

Question 26

Financial Ratios

Answer 26

relationships determined from a firm's financial information and used for comparison purposes

Question 27

Why evaluate financial statements?

Answer 27

1. internal uses include performance evaluation and planning purposes 2. Useful to external parties such as potential investors, competitors, and credit rating agencies

Question 28

Percentage of sales approach

Answer 28

a financial planning method in which accounts are varied depending on a firm's predicted sales levels

Question 29

Internal Growth Rate

Answer 29

Maximum growth rate a firm can achieve without external financing of any kind

Question 30

Sustainable growth rate

Answer 30

maximum growth rate a firm can achieve without any external equity financing while maintaining a constant dept-equity ratio

Question 31

What factors does a firm's sustain growth rate depend on?

Answer 31

1. profit margin 2. dividend policy 3. financial policy 4. total asset turnover

Question 32

Coupon

Answer 32

Stated interest payment made on a bond

Question 33

Face Value or par value

Answer 33

the principal amount of a bond that is repair at the end of the term

Question 34

coupon rate

Answer 34

annual coupon divided by the face value of the bond

Question 35

Maturity

Answer 35

specified date on which the principal amount of a bond is paid

Question 36

What happens to the value of the bond's remaining cash flow when interest rises?

Answer 36

The value of the bond's remaining cashflow declines and the bond is worthless

Question 37

What happens to a bond when interest rates fall?

Answer 37

The bond is worth more

Question 38

Par Value bond

Answer 38

Bond that sells exactly at face value

Question 39

This type of bond sells for less than face value

Answer 39

Discount bond

Question 40

Bond that sells for more than face value

Answer 40

Premium bond

Question 41

Call provision

Answer 41

an agreement giving the corporation the option to repurchase a bond at a specified price prior to maturity

Question 42

Deferred Call Provisions

Answer 42

prohibit the company from redeeming a bond prior to a certain date

Question 43

Protective covenant

Answer 43

limits certain actions that might be taken during the loan's term, usually to protect the lender's interest

Question 44

term structure of interest rates

Answer 44

the relationship between nominal interest rates on default-free, pure discount securities and time to maturity

Question 45

Inflation Premium

Answer 45

the portion of a nominal interest rate that represents compensation for expected future inflation

Question 46

interest rate risk premium

Answer 46

the compensation investors demand for bearing interest rate risk

Question 47

Default Risk Premium

Answer 47

the portion of nominal interest rate or bond yield that represents compensation for the possibility of default

Question 48

taxability premium

Answer 48

the portion of a nominal interest rate or bond yield that represents compensation for unfavorable tax status

Question 49

Liquidity Premium

Answer 49

the portion of nominal interest rate or bond yield that represents compensation for lack of liquidity