REVISED STUDY GUIDE FOR FNAN522 Exam I Preparation.

REVISED STUDY GUIDE FOR FNAN522 Exam I Preparation. 1 FINANCE 522 EXAM I PREPARATION 1. What are the two requirements for a firm to be successful discussed in the 5-minute lesson for success? 1. All successful companies identify, create and deliver products or services that are highly valued by their customers. These products or services are so highly valued by the companies or customers that they choose to purchase them from the successful company rather than from its competitors. This happens only if the company has a competitive advantage, that is, it provides more value than its competitors, either in the form of:  lower prices with acceptable quality (McDonald’s, C’C’s Pizza, Kia),  convenience or location (C Store near interstate highway, Amazon),  delivery speed or method (Halliburton, Mary K, Amazon), or  Superior products (Ruth Chris, Vertu cell phone $310,000, Mercedes). LESSON I. Produce at a low cost or provide a better product/service or have a most attractive location/delivery means 2. All successful companies sell their products/services at prices that are high enough to cover all operating costs (debt) and to compensate owners and creditors for their exposure to risk. In other words, it’s not enough just to win market share and to show a profit. The profit must be high enough to adequately compensate investors and creditors. LESSON II. Cover all costs including operating and debt and equity financing 2. List the three key attributes common to successful companies? 1) Successful companies have skilled people: -Executives-long term vision, smart, experience, know business, etc -Middle management-loyal, intelligent, understand goals and mission, want to succeed -Labor force-talented, dedicated, believe they contribute and they are part of the company 2) Successful companies have strong relationships with groups outside of the company. -Suppliers/purveyors-Suppliers know what their customers’ needs -Customers-Company knows who their customers are and know their desires and expectations 3) Successful firms have sufficient capital to execute plans and support their operations. -Internal Funds- Retained Earnings (Balance Sheet and contribution from Income Statement) -External Funds-Bank Loans, Issue Bonds, Issue Stock 3. Write and describe the stock price function-model. Stock Price (variables under the control of management) is a function of expected cash flows, timing of cash flows, risk of cash flows, dividend policy, and capital structure SP = f (ECF, TCF, RCF, DP, CS) VARIABLES UNDER THE CONTROL OF MANAGEMENT, Where:  ECF is Expected Cash Flow  TCF is Timing of Cash Flow (Time Value of Money)  RCF is Risk of Cash Flow  DP is Dividend Policy CS is Capital Structure 2 4. Define: Agency theory – Management is the shareholders' (principals) agents. They are employed to represent the owners' interest. Management's direct actions may not be observable to the owners in large corporations. There may be conflicts between the owners and the agents. Liquidity ratios – short-term solvency ratios. - These ratios measure if the firm can pay its bills? given the current resources are they sufficient to meet firm’s current liabilities? 1. Current Ratio Current Assets Current Liabilities This ratio indicates the extent to which the claims of short-term creditors are covered by assets that are expected to be converted to cash in a period roughly corresponding to the maturity of the liabilities. 2. Quick ratio (or acid-test ratio) Current Assets-Inventory Current Liabilities A measure of the firm’s ability to pay off short-term obligations without relying on the sale of its inventories. Most stringent measure of liquidity. Inventory is the least liquid thing. Anything under 1 means you’ll have to turn inventory to cash. WHO IS INTERESTED IN THE LIQUIDITY RATIOS? Trade creditors & commercial banks Activity ratios – asset management ratios - These ratios measure the speed at which certain accounts re converted to cash or sales; velocity measures 1. Inventory turnover CGS Sales Inventory OR Inventory When compared to industry averages, it provides an indication of whether a company has excessive or perhaps inadequate finished goods inventory. Lower value is poor inventory management. 2. Fixed assets turnover Sales Fixed Assets A measure of the sales productivity and utilization of plant and equipment (EARNING ASSETS). 3. Total assets turnover Sales Total Assets A measure of the utilization of all the firm’s assets; a ratio below the industry average indicates the company is not generating a sufficient volume of business, given the size of its asset investment. Lower value means too many fixed assets or not enough sales 4. Average collection period Accounts Receivable OR Accounts Receivable Total Sales / 365 Average daily sales Indicates the average length of time the firm must wait before it receives payment. Poor value means either poor collection or poor credit policy Depreciation – the allocation of the cost of a fixed asset over some prescribed time period; most firms use accelerated depreciation method Retained earnings – Non-distributed Profits (INTERNAL FINANCING); the cumulative total of all earnings, net of dividends, that have been retained and reinvested in the firm since its inception; The Statement