Introduction to Finance

Question 1

Characteristics of a sole trader and partnership

Answer 1

+ Easy and Cheap to set up

• Unlimited personal liability
• Firm and owner have the same legal identity.

Question 2

Two types of partners in a partnership

Answer 2

A General Partner runs the firm on a day to day basis.

A Limited Partner is not involved in managerial decisions, but has limited liability, thus financial liability is limited to a fixed sum and can only lose their initial investment.

Question 3

Limited Liability Companies

Answer 3

A business structure that protects its owners from the companies debts and legal issues.

Question 4

Characteristics of a corporation

Answer 4

• Separate legal identity to owners, thus limited liability.
• Ownership represented by share of stock e.g. shareholders / equity
• Easy to transfer ownership by selling stocks.
  -Double taxation (Profit and Dividends)

Question 5

The 3 Responsibilities of a Financial Manager

Answer 5

1. Investment Decisions e.g. acquiring assets
2. Financial Decisions e.g. How to fund investments
3. Cash / Working Capital Management on a day to day basis

Question 6

Difference between the Primary & the Secondary Market

Answer 6

The Primary is where stocks are issued.
The Secondary is where stocks are traded.

Question 7

Relationship between Board of Directors and CEO’s.

Answer 7

Board of Directors have ownership and decision-making authority.
CEO runs the business after being delegated tasks by the BoD.

Question 8

Book Value of Equity / Stockholder equity

Answer 8

Remaining assets for shareholders after all debt is paid.

Stockholder equity = Total Assets - Total Liabilities

Question 9

Net Working Capital

Answer 9

Current assets - Current Liabilities

Question 10

Market Value of Equity (Market capitalisation)

Answer 10

Share price * Number of shares Issued

Question 11

Market to Book Ratio

Answer 11

Market value of Equity / Book Value of Equity

Low M/B ratio = Value stock (stable growth)
High M/B ratio = Growth stock (fast growth)

Question 12

Enterprise Value

Answer 12

Used to calculate the value of a company, and measures potential takeover.

Market value of Equity + Debt - Cash

Ratio below 10 is attractive.

Question 13

How do Receivables and Payables apply to cash flow ?

Answer 13

Receivables deduct cash as money is yet to be paid.
Payables add cash as borrowed money is available.

Question 14

How does Depreciation and Amortisation apply to income statements and cash flow?

Answer 14

Reduces profit in income statements. but…
Adds to cash flow as it is a non-cash item.

Question 15

Gross Profit Margin (Profitability Ratios)

Answer 15

Gross Profit / Sales x 100

Question 16

Operating Profit Margin (Profitability Ratios)

Answer 16

Operating Profit / Sales x 100

Question 17

EBIT Margin (Profitability Ratios)

Answer 17

EBIT / Sales x 100

Question 18

Net Profit Margin (Profitability Ratios)

Answer 18

Net Profit / Sales x 100

Question 19

Current ratio (Liquidity Ratios)

Answer 19

Current Assets / Current Liabilities

Question 20

Cash ratio (Liquidity Ratios)

Answer 20

Cash / Current Liabilities

Question 21

Quick Ratio (Liquidity Ratios)

Answer 21

(Cash + Short Term investments + Recievables)
/ Current Liabilities

Question 22

Price to Earnings (P/E) ratio

Answer 22

Share price / Earnings per share

Question 23

Enterprise Value to EBIT

Answer 23

Market value of Equity + Debt - Cash / EBIT

Question 24

Enterprise Value to Sales

Answer 24

Market value of Equity + Debt - Cash / Sales

Question 25

Enterprise Value to EBITDA

Answer 25

Market value of Equity + Debt - Cash / EBITDA

Question 26

Arbitrage

Answer 26

Exploiting price differences in different markets to maximise profits.

Question 27

Law of One Price

Answer 27

States that the same good should be sold at the same price in different locations.

Question 28

No arbitrage price of security

Answer 28

Price of security = PV of all cash flows paid by security.

Question 29

Perpetuity present value formula

Answer 29

PV = C * (perpetuity cash flow) / r (interest w/out 1)

Question 30

Growing perpetuity present value formula.

Answer 30

PV = C / r - g (rate of growth)

Question 31

Annuity present value formula

Answer 31

PV = C / r ( 1 - (1 / 1 + r ^n))

Question 32

Growing annuity present value formula

Answer 32

C / r - g * (1 - (1 + g / 1 + r) ^n)

Question 33

Difference between Effective Annual Interest and Annual Percentage Rate

Answer 33

EAR is annual interest with compounding. APR is annual interest without compounding.

Question 34

Discount rate period conversion formula

Answer 34

( 1 + r ) ^n - 1

Question 35

How to convert APR to an EAR

Answer 35

1 + EAR = (1 + (APR / K )) ^k

Question 36

How to calculate NPV

Answer 36

NPV = PV (benefits) - PV costs)

Question 37

Internal rate of return formula

Answer 37

(Future Value / Present Value) ^ 1/ periods - 1

Question 38

Coupons Payment formula

Answer 38

CPN = Coupon rate % * Face Value / Coupon payments per year

Question 39

Yield to Maturity of a zero coupon bond formula

Answer 39

(Face Value / Price of the bond) ^ 1 / n - 1

Question 40

Valuing Stocks for a one-year investor

Answer 40

Div1 + P1 / 1 +rE (cost of capital equity)

Question 41

Valuing stocks for a multi-year investor

Answer 41

(Div1 / 1 + rE) + (Div2 / (1 + rE)^2) + (DivN + Pn / (1 + rE)^N)

Question 42

Total Return (rE) Formula

Answer 42

rE = Dividend Yield + Capital Gain Rate rE = Div1 / P0 + P1 - P0 / P0