Questions and Answers of Contemporary Financial Management

Thompson Electronics, Inc., is presently 100 percent equity financed and has assets of $100 million. Thompson’s present net income is $9 million, and the company’s marginal and average tax rates
Express the return on stockholders’ equity ratio as a function of the net profit margin, total asset turnover, and equity multiplier ratios. k-63
Calculate the following market-based ratios: k-63a. Price-to-earnings ratiob. Market price-to-book value ratio
Calculate the following profitability ratios: k-63a. Gross profit marginb. Net profit marginc. Return on investmentd. Return on stockholders’ equity
Calculate the following financial leverage management ratios: k-63a. Debt ratiob. Debt-to-equity ratioc. Times interest earned ratiod. Fixed-charge coverage ratio
Calculate the following asset management ratios: k-63a. Average collection periodb. Inventory turnoverc. Fixed-asset turnoverd. Total asset turnover
Calculate the following liquidity ratios: k-63a. Current ratiob. Quick ratio
What is the relationship between EVA and MVA? k-63
The Farmers State Bank recently has been earning an “above average” (compared to the overall banking industry) return on total assets of 1.50 percent. The bank’s return on common equity is only
Many large corporations, such as General Motors, have written off large amounts of their nonperforming (or poorly performing) assets as they have shrunk their operations. What is the impact of these
Why would you anticipate a lower P/E ratio for a typical natural gas utility than for a computer technology firm, such as Apple? k-63
Discuss the general factors that influence the quality of a company’s reported earnings and its balance sheet. k-63
What is the relationship between a firm’s P/E multiple and that firm’s risk and growth potential? k-63
How can inflation affect the comparability of financial ratios between firms? k-63
What specific effects can the use of alternative accounting procedures have on the validity of comparative financial analyses? k-63
What are the three most important determinants of a firm’s return on stockholders’ equity? k-63
What problems may be indicated by an inventory turnover ratio that is substantially above or below the industry average? k-63
What problems may be indicated by an average collection period that is substantially above or below the industry average? k-63
What is the major limitation of the current ratio as a measure of a firm’s liquidity?How may this limitation be overcome? k-63
What are the primary limitations of ratio analysis as a technique of financial statement analysis? k-63
Financial statements of multinational firms are influenced by fluctuating foreign exchange rates. k-63
Economic Value Added is a yearly measure of the operating performance of a firm, considering investor return requirements. k-63
The Market Value Added concept is the market’s assessment of the accumulated value created from a firm’s past and projected investment projects. k-63
The quality of a firm’s balance sheet is enhanced as the ratio of the market value of the firm’s assets to the book value of those assets increases and as the amount of hidden liabilities that
To gain further insight into the relative financial position of a firm, the analyst must compare the financial ratios with industry averages. The more diversified the firm, the more difficult it will
The relationship of the return on investment (ROI) to “margin” and “turnover” can be used to determine whether one or both are deficient in contributing to the profitability of a firm. k-63
Trend analysis introduces the element of time into financial ratio analysis. It gives the analyst a more dynamic view of a company’s situation than does a pure comparative financial ratio analysis
Common-size financial statements, which express financial items in percentages, are helpful in detecting and monitoring financial trends. k-63
The limitations of financial statements and financial ratio analysis? k-63
How to calculate and interpret financial ratios? k-63
The major financial statements? k-63
When evaluating a firm’s performance based on its balance sheet, income statement, and a series of financial ratios, a good financial analyst must be aware of the accounting techniques used by the
Trend analysis evaluates a firm’s performance over time, whereas comparative analysis evaluates a firm’s performance relative to other firms. k-63
Common-size financial statements express financial items as percentages (rather than dollar amounts) and are useful in evaluating financial performance. k-63
Financial ratios, which use data from a firm’s balance sheet, income statement, statement of cash flows, and certain market data, are often used when evaluating the financial performance of a
The evaluation of financial performance involves a series of techniques that can be used to help identify the strengths and weaknesses of a firm. k-63
Shareholder wealth is defined as the present value of the expected future returns to the owners of the firm. It is measured by the market value of the shareholders’ common stock holdings. Lo25
The primary normative goal of the firm is to maximize shareholder wealth. Lo25
Achievement of the shareholder wealth maximization goal is often constrained by social responsibility concerns and problems arising out of agency relationships. Lo25
The market value of a firm’s stock is determined by the magnitude, timing, and risk of the cash flows the firm is expected to generate. Managers can take a variety of actions to influence the
Ethical standards of performance are an increasingly important dimension of the decision-making process of managers. Lo25
The most important forms of business organization are the: Lo25a. Sole proprietorshipb. Partnership—both limited and generalc. Corporation
Corporations have the advantages of limited liability for owners, potentially perpetual life, and the ability to raise large amounts of capital. Even though they account for only 20 percent of
The finance function is usually headed by a vice president or chief financial officer.a. Financial management responsibilities are often divided between the controller and treasurer.b. The controller
The primary goal of the firm? Lo25
The determinants of the value of a firm? Lo25
The meaning and implication of agency problems in a corporation? Lo25
The importance of ethics in running a business organization? Lo25
The major types of business organizations and their distinguishing features? Lo25
The role and function of the financial manager? Lo25
The relationship between finance and other business disciplines? Lo25
Expenditures to structure the organization in such a way as to minimize the incentives for management to take actions contrary to shareholder interests. Lo25
Expenditures to monitor management’s actions, such as paying for audits of managerial performance and internal audits of the firm’s expenditures. Lo25
Bonding expenditures to protect the owners from managerial dishonesty. Lo25
The opportunity cost of lost profits arising from complex organizational structures that prevent management from making timely responses to opportunities. Lo25
The primary normative goal of financial management decision making is the maximization of shareholder wealth as measured by the price of the firm’s stock. Lo25
Agency relationships, such as the relationship between stockholders and managers and the relationship between owners and lenders, give rise to certain agency problems and costs that can have an
The amount, timing, and risk of the cash flows generated by a firm are, in large part, determined by key financial management decisions, including investment decisions, dividend decisions, financing
The three primary forms of business organization are the sole proprietorship, the partnership, and the corporation. Corporations have certain advantages over the other two forms of business
A corporation is defined as a “legal person” composed of one or more actual individuals or legal entities. The owners of a corporation are called stockholders or shareholders. The stockholders
Corporations issue debt securities to investors who lend money to the corporation and equity securities to investors who become owners. Lo25
The optimal form of organization for a business enterprise is influenced by such factors as cost, complexity, owner liability, business continuity, need for raising capital, the owners’ desire to
The finance function is usually headed by a vice president or chief financial officer. The financial management responsibilities are often divided between the controller and the treasurer. The
Financial management is closely related to other areas of business decision making, particularly accounting and economics. Lo25
The finance profession offers a number of exciting career opportunities both within the corporate finance function and in the financial services sector. Lo25
Define shareholder wealth. Explain how it is measured. Lo25
Which type of corporation is more likely to be a shareholder wealth maximizer—one with wide ownership and no owners directly involved in the firm’s management or one that is closely held? Lo25
Is the shareholder wealth maximization goal a short- or long-term goal? Explain your answer. Lo25
Explain why management may tend to pursue goals other than shareholder wealth maximization. Lo25
Explain what is meant by agency relationships and agency costs. Lo25
Give some examples of agency costs incurred by shareholders in the agency relationship between the shareholders (owners) and management of a firm. Lo25
What is the source of potential agency conflicts between owners and bondholders?Who is the agent and who is the principal in this relationship? Lo25
Explain the differences in the responsibilities of the treasurer and the controller in a large corporation. Lo25
Explain the relationship between financial management and (a) microeconomics and (b) macroeconomics. Lo25
Why is earnings per share not a consistently good measure of a firm’s performance? Lo25
What are the major factors that determine the value of a firm’s stock? Lo25
In 2009, General Motors Corporation declared bankruptcy. How can you reconcile a bankruptcy declaration with a management pledged to maximize shareholder wealth? Lo25
How can the adherence to high standards of ethical business practice contribute to the goal of shareholder wealth maximization? Lo25
Compare the potential for agency problems in sole proprietorships, partnerships, and corporations. In light of your analysis, why is the corporate form of organization so popular? Lo25
In the U.S. financial system, funds flow from net savers (such as households) to net investors(such as businesses) through financial middlemen and financial intermediaries.a. Financial middlemen
Financial markets are classified as money or capital markets and primary or secondary markets.a. Short-term securities with maturities of one year or less are traded in money markets.Long-term
Companies engaged in international financial transactions face such problems as political and exchange rate risk in addition to those risks encountered in domestic transactions. V=96
The exchange rate is the rate at which a currency can be converted into another currency.a. The spot rate is the present exchange rate for immediate delivery.b. The forward rate is the present
The Eurocurrency market is an important alternative to domestic sources of financing for multinational firms. LIBOR, the London InterBank Offer Rate, is the basic interest rate against which
In efficient capital markets, security prices represent an unbiased estimate of the true economic value of the cash flows expected to be generated for the benefit of that security holder. V=96
Holding period returns measure the actual or expected return from holding a security, including price changes and distributions, such as dividends or interest. V=96
The role and significant aspects of financial markets? V=96
The structure and operation of U.S. securities markets? V=96
Currency markets and their importance to companies and the global economy? V=96
The meaning of market efficiency? V=96
The calculation of holding period returns? V=96
An overview of the financial crisis of 2007–2010? V=96
An overview of the U.S. corporate income tax structure? V=96
Legal restrictions limit the amount of foreign investment by some institutional investors. Some countries limit the amount of foreign ownership of domestic industries in an attempt to prevent a loss
High transactions costs may also make the free flow of capital across country borders difficult.These high costs include the cost of gathering information, trading costs, fees for managing
Taxation policies between nations sometimes discourage the flow of capital across borders. V=96
International investments are subject to greater political risks than are domestic investments.These risks range from expropriation to limits on the repatriation of profits and assets. V=96
Foreign exchange risks, that is, the risks of unfavorable movements in the value of foreign currencies, also act as a deterrent to the flow of capital across national borders.? V=96
The main purpose of an economy’s financial system is to facilitate the transfer of funds from surplus spending units to deficit spending units. Financial middlemen, such as investment bankers,
Financial assets consist of money, debt securities, and equity securities. V=96

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