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introduction to financial accounting
Questions and Answers of
Introduction To Financial Accounting
What is traded off in the trade-off theory of capital structure?
What is the relation between a company’s operating risk and its optimal capital structure?
What is meant by the pecking order theory of capital structure?
What are the implications of the Modigliani-Miller theory of capital structure when the assumption of no corporate taxes is not valid?
Consider three financing alternatives:Alternative A: Finance solely with equity Alternative B: Finance using 50% debt, 50% equity Alternative C: Finance solely with debta. Which of the three
List the potential costs associated with financial distress.
List the potential direct and indirect costs associated with bankruptcy.
Regarding financial slack:a. What is it?b. How is slack created?c. Why do companies wish to have financial slack?
What is the difference between core and no-core risk?
How does the theory of portfolio risk relate to enterprise risk management?
What is meant by sustainability risk?
What are the three choices available to management for dealing with risk?
What distinguishes an unfunded from a funded retained risk?
What is the function of an insurance-linked note for risk management?
What methods can a company use to transfer risk?
How does a core risk differ from a non core risk?
How can derivatives be used in risk management?
What is a cat bond and how can it be used to manage risk?
The following “Company Overview” of AIG Risk Finance was described on the Internet (investing.businessweek.com/research/stocks/private/snapshot.asp?privcapId=11673577):AIG Risk Finance designs
What is the relationship between compounding and discounting of a lump-sum?
Complete the following: “The larger the interest rate, the _________(larger/smaller) the future value of a value today.”
Holding everything else the same, what is the effect of using a higher discount rate to discount a future value to the present?
If you invest the same amount in each of three accounts today, which account produces the highest future value if the annual percentage rate is the same? Account A: annual compounding, Account B:
What distinguishes an ordinary annuity from an annuity due?
What distinguishes an ordinary annuity from a deferred annuity?
If a cash flow is the same amount each period, ad infinitum, how do we value the present value of this series of cash flows?
Which is most appropriate to use in describing the annual growth of the value of an investment: the arithmetic average growth rate or the geometric average growth rate? Why?
How can we break down the valuation of a deferred annuity into manageable parts for computation purposes?
Which has the highest present value if the payments and number of payments are identical, an ordinary annuity or an annuity due?
If you are offered two investments, one that pays 5% simple interest per year and one that pays 5% compound interest per year, which would you choose? Why?
Consider a borrowing arrangement in which the annual percentage rate(APR) is 8%.a. Under what conditions does the effective annual rate of interest(EAR) differ from the APR of 8%?b. As the frequency
Suppose you deposit $1,000 in an account with an APR of 4%, with compounding quarterly.a. After 10 years, what is the balance in the account if you make no withdrawals?b. After 10 years, how much
Suppose you are promised $10,000 five years from today. If the appropriate discount rate is 6%, what is this $10,000 worth to you today?
Suppose you buy a car today and finance $10,000 of its cost at an APR of 3%, with payments made monthly.a. If you finance the car for 24 months, what is the amount of your monthly car payment?b. If
What is the relation between a company’s current ratio and its quick ratio?
What is the relation between the cash conversion cycle and a company’s need for liquidity?
Can a company’s cash conversion cycle ever be negative? Explain.
What is the relation between a company’s inventory turnover and the number of days’ inventory?
If a company has a return on assets of 10% and a net profit margin of 5%, what is the company’s total asset turnover?
If a company has a debt-to-assets ratio of 35%, what is the company’s debt-to-equity ratio?
If a company’s use of debt financing increases, as compared to equity financing, what would you expect to find in terms of a change in return on equity if the company’s return on assets remains
If a company has no debt in its balance sheet, what is the relation between the return on assets and the return on equity?
When would you want to use the basic earning power to compare companies instead of the return on assets?
If a company has a return on assets of 10% and has a debt-to-assets ratio of 50%, what is the company’s return on equity?
Suppose you calculate the following ratios for two companies, A and B.What can you say about the relative investment in inventory? Company A Company B Current ratio Quick ratio 2.0 2.0 1.0 1.5
Suppose you are comparing two companies that are in the same line of business. Company C has an operating cycle of 40 days, and CompanyD has an operating cycle of 60 days. Company C has a current
Suppose you calculate a return on fixed assets of 20% for 2008 and 15% for 2009 for a company. Explain how you would use the DuPont system to further investigate this change in the return on fixed
In examining the trend of returns on assets over a 20-year period for a company, you find that the returns have been declining gradually over this period. What information would you look at to
Data for the Lubbock Corporation is provided as follows:Calculate the following ratios for the Lubbock Corporation:a. Current ratiob. Quick ratioc. Inventory turnover ratiod. Total asset turnover
Consider two companies, each with a return on assets of 10%. Company X has a return on equity of 15%, and Company Y has a return on equity of 20%. Which company uses more financial leverage? Explain.
Construct the common size balance sheet for Grisham Company for 2009: Balance Sheet (in millions) Cash $50 Current liabilities $30 Accounts receivable 30 Long-term debt 90 Inventory 80 Equity 240
Why is depreciation added back to net income to arrive at cash flow?
Why do we adjust net income for changes in working capital accounts?
If a company has cash flow from operations of $3 million, depreciation and amortization of $2 million, and its working capital accounts did not change from the previous period, what its net income
How does the statement of cash flows relate to the balance sheet?
How does the statement of cash flows relate to the income statement?
Is it possible for a company to have a net loss for a period, yet still have a positive cash flow?
What distinguishes the free cash flow of a firm from its cash flow from operations?
What is the relation between EBITDA and cash flow from operations?
How can a negative free cash flow be considered good news?
How can a positive free cash flow be considered bad news?
Consider the Austin Company, which has a free cash flow to equity of$100 million, and free cash flow to the firm of $125 million. If the Austin Company had interest after tax of $10 million, what is
Suppose the cash flow from operations of the Knoxville Company is$200 million and the company had capital expenditures of $50 million during this period. If Knoxville has no debt in its capital
Suppose Provo, Inc., had net income of $30 million for the most recent fiscal period. If its depreciation and amortization for the period is$3 million and its cash flow from operations is $35
Using the data in this chapter for the Exemplar Company for fiscal year 20X2 and the cash flow from operations as the measure of cash flow(cash flow definition 3), calculate the:a. Cash flow to
If a project does not affect a company’s revenues, but reduces its costs, how can this affect the value of the company?
What is a depreciation tax shield, and how does this affect a capital budgeting decision?
If a company is making an investment decision to use a facility that is currently idle, how does the cost of this facility enter into the decision?
If a capital project has a positive net present value, does it pay back in terms of discounted cash flows? Explain.
If a company sells an asset for less than its original cost, but more than its book value, how is that gain classified and taxed?
If a company chooses to use straight-line depreciation instead of MACRS depreciation for an asset, how does this decision affect the profitability of the project?
If a company is deciding between two projects, and can only select one of the two projects, what evaluation techniques should this company use in the analysis of these projects?
Suppose, when evaluating two mutually exclusive projects, the company makes the value-maximizing decision to select the one with the lower internal rate of return. What does this tell you regarding
When selecting capital projects and there is a limit to the capital budget, which evaluation techniques are appropriate to use?
The net present value method and the internal rate of return method may produce different decisions when selecting among mutually exclusive projects. What is the source of this conflict?
Classify each of the following projects for a toy manufacturer into one of the three categories: replacement, new product or market, or mandated, by checking the appropriate box: Replacement Opening
A shoe manufacturer is considering introducing a new line of boots.When evaluating the incremental revenues from this new line, what should be considered?
The Pittsburgh Steel Company is considering two different wire soldering machines. Machine 1 has an initial cost of $100,000, costs $20,000 to set up, and is expected to be sold for $20,000 after 10
The president of Fly-by-Night Airlines has asked you to evaluate the proposed acquisition of a new jet. The jet’s price is $40 million, and it is classified in the 10-year MACRS class. The purchase
Suppose you calculate a project’s net present value to be $10 million.What does this mean?
Suppose you calculate a project’s profitability index to be 1.3. What does this mean?
Suppose you calculate a project’s net present value to be $30 million. If the required outlay for this project is $100 million, what is the project’s profitability index?
You are evaluating an investment project with the following cash flows:Calculate the following:a. Payback periodb. Discounted payback period, assuming a 10% cost of capitalc. Discounted payback
Suppose you are evaluating two mutually exclusive projects, Thing 1 and Thing 2, with the following cash flows:a. If the cost of capital on both projects is 5%, which project, if any, would you
What is the difference between a cash and carry trade and a reverse cash and carry trade?
If there is no arbitrage opportunity, what is the expected profit from a cash and carry in futures?
What is the difference between forwards and futures?
If a call option’s exercise price is $100 and the underlying is currently$90, is this option in, at, or out of the money?
If the payoff of a call option at a specified price is $5, what is the payoff for the call writer at that price?
What is the relation between the time to expiration and the value of a:a. call option?b. put option?
What is the relation between the volatility of the price of the underlying and the value of a:a. call option?b. put option?
If you believe that a stock’s price will fall over the next few months, what option transaction are you most likely to use?
If you believe that a stock’s price will fall over the next few months, what option transactions are you most likely to use?
What is the transaction that involves one party agreeing to pay a fixed interest rate, based on a notional amount, and the other party agreeing to pay interest that is pegged to some reference rate?
The following appears in the 2000 10-K of International Business Machines:The company employs a number of strategies to manage these risks, including the use of derivative financial
A manufacturer of furniture is concerned that the price of lumber will increase over the next three months. Explain how the manufacturer can protect against a rise in the price of lumber using lumber
The chief financial officer of the corporation you work for recently told you that he had a strong preference to use forward contracts rather than futures contracts to hedge: “You can get contracts
What is the difference between a put option and a call option?
What distinguishes an American option from a European option?
“There’s no real difference between options and futures. Both are tools for controlling risk, and both are derivative products. It’s just that with options you have to pay an option price,
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