COMM 370 MIDTERM QUESTIONS WITH VERIFIED ANSWERS
TOPIC 1: Financial Analysis - Answers - TOPIC 1: Financial Analysis
What are the categories of ratios? - Answers - Leverage: Measure extent of debt in
Capital structure relative to equity
Liquidity: How many liquid assets can readily be turned into cash
Profitability: How profitable a firm is
Efficiency Ratios: How we use our assets
Market Value ratios: How metric compare against current market price
What is the operating cycle? - Answers - The operating cycle is the time from when
inventory arrives to when cash is received from customers
OC=Inventory Period + Accounts Receivable Period
Draw it out
What is the cash cycle? - Answers - The cash cycle is the time from when a firm pays
back its supplied for inventory to when it receives cash for selling the product to its
customers
CC=Operating Cycle-Accounts Payable Period
CC=IP+ARP-APP
Cash cycle determines need for short term financing
How is change in cash calculated? - Answers - Change in:
ADD changes in:
LTD
Stock
Current Liabilities
Operating Cash Flow (Net income+Depreciation)
DEDUCT changes in:
Current Assets
Gross PPE (Net PPE+Depreciation)
Dividends
What are sources and uses of cash? - Answers - sources:
issuance of LTD
Issuance of equity
increases in CL
decreases in CA
,decreases in fixed assets
Operating cash flow
Uses:
buyback LTD
retire equity
decrease in CL
increase in CA
increase in fixed assets
dividends
What is a financial implication of an increase in cash cycle? - Answers - With a
lengthening cash cycle the firm's short
-term financial needs are increasing over
time, and the firm needs to plan how these funds can be obtained.
What is a reason for receivable period increasing? - Answers - The
receivables
period may be longer simply because the firm is offering better terms
of credit to its customers (for example, giving them two months to pay instead of one).
Or
it could be that the firm itself is
less efficient in the collection
of receivables, perhaps
because with a larger volume of sales the firm's staff cannot fo
llow its customers easily.
The more interesting case is when the firm's credit policy and its efficiency in collecting
its receivables remain unchanged. In this case, it is po
ssible that customers are unable to
repay on time because they are facing financial difficulties
.
What is a reason for inventory period increasing? - Answers - A longer inventory period
may be associated with a reduction in demand. When demand
falls, firms accumulate inventory until they realize they need to cut production.
What is a reason for payable increasing? - Answers - The payables period can be
longer if the firm obtains better terms of credit in its
purchases from suppliers. But more generally, firms in need of money but constrained in
the amount they can borrow from banks usually try to free up some cash by stretching
their
payables beyond their contractual agreements with the suppliers: delaying payment to
suppliers is the same as borrowing from them. Alternatively, firms that usually paid cash
for their purchases but now lack enough cash (possibly
because banks refuse
to lend) may
, decide to take trade credit from suppliers, thus extending the
payables period. A
longer
payables period may indicate that the firm is facing economic adversity and is no longer
able
to borrow from banks, and thus is forced to rely on the mor
e expensive trade credit
offered by suppliers.
Suppose you have a firm with a debt/assets ratio of 50%, how do you know if this is too
high or low? - Answers - The amount of debt that is reasonable depends a lot on the
type of business. The key is
to compare a firm's debt ratio to that of other similar firms in the industry. If the firm has
the highest leverage in the industry, it means it has abnormally high financial risk, and
one
should wonder why: is it a symptom
of financial trouble or has the firm perhaps
borrowed
aggressive
ly to expand its operations?
How do you know If a firm with an ROA of 15% is well managed? - Answers - Again,
compare a firm's ROA to that of other firms in the industry. For example, you
can calculate ROA -
Av
erage
(ROA other firms in the industry), the industry
-adjusted
ROA. Then firms with higher industry
-adjusted ROA are likely to be better managed.
What can you infer from a company that pays no dividends? - Answers - One possibility
is that the firm has no free cash flow. If after firms make all necessary
investments there is some cash left that is not needed, they should pay it out to
shareholders.
So if they don't do it, it means there is no free cash. Usually, firms that are unable to pay
dividends are thought to be financially constrained.
What can you infer from a firms whose sales/assets are decreasing over time? -
Answers - If the productivity of labor is decreasing, it could be due to technological
reasons. But
more commonly, one would think that sales are falling but the number of workers is not.
In bad times that are only temporary, you ofte
n see this because firms tend to retain some
skilled workers. But over long periods of time, firms should lay off workers. If they can't-
perhaps
TOPIC 1: Financial Analysis - Answers - TOPIC 1: Financial Analysis
What are the categories of ratios? - Answers - Leverage: Measure extent of debt in
Capital structure relative to equity
Liquidity: How many liquid assets can readily be turned into cash
Profitability: How profitable a firm is
Efficiency Ratios: How we use our assets
Market Value ratios: How metric compare against current market price
What is the operating cycle? - Answers - The operating cycle is the time from when
inventory arrives to when cash is received from customers
OC=Inventory Period + Accounts Receivable Period
Draw it out
What is the cash cycle? - Answers - The cash cycle is the time from when a firm pays
back its supplied for inventory to when it receives cash for selling the product to its
customers
CC=Operating Cycle-Accounts Payable Period
CC=IP+ARP-APP
Cash cycle determines need for short term financing
How is change in cash calculated? - Answers - Change in:
ADD changes in:
LTD
Stock
Current Liabilities
Operating Cash Flow (Net income+Depreciation)
DEDUCT changes in:
Current Assets
Gross PPE (Net PPE+Depreciation)
Dividends
What are sources and uses of cash? - Answers - sources:
issuance of LTD
Issuance of equity
increases in CL
decreases in CA
,decreases in fixed assets
Operating cash flow
Uses:
buyback LTD
retire equity
decrease in CL
increase in CA
increase in fixed assets
dividends
What is a financial implication of an increase in cash cycle? - Answers - With a
lengthening cash cycle the firm's short
-term financial needs are increasing over
time, and the firm needs to plan how these funds can be obtained.
What is a reason for receivable period increasing? - Answers - The
receivables
period may be longer simply because the firm is offering better terms
of credit to its customers (for example, giving them two months to pay instead of one).
Or
it could be that the firm itself is
less efficient in the collection
of receivables, perhaps
because with a larger volume of sales the firm's staff cannot fo
llow its customers easily.
The more interesting case is when the firm's credit policy and its efficiency in collecting
its receivables remain unchanged. In this case, it is po
ssible that customers are unable to
repay on time because they are facing financial difficulties
.
What is a reason for inventory period increasing? - Answers - A longer inventory period
may be associated with a reduction in demand. When demand
falls, firms accumulate inventory until they realize they need to cut production.
What is a reason for payable increasing? - Answers - The payables period can be
longer if the firm obtains better terms of credit in its
purchases from suppliers. But more generally, firms in need of money but constrained in
the amount they can borrow from banks usually try to free up some cash by stretching
their
payables beyond their contractual agreements with the suppliers: delaying payment to
suppliers is the same as borrowing from them. Alternatively, firms that usually paid cash
for their purchases but now lack enough cash (possibly
because banks refuse
to lend) may
, decide to take trade credit from suppliers, thus extending the
payables period. A
longer
payables period may indicate that the firm is facing economic adversity and is no longer
able
to borrow from banks, and thus is forced to rely on the mor
e expensive trade credit
offered by suppliers.
Suppose you have a firm with a debt/assets ratio of 50%, how do you know if this is too
high or low? - Answers - The amount of debt that is reasonable depends a lot on the
type of business. The key is
to compare a firm's debt ratio to that of other similar firms in the industry. If the firm has
the highest leverage in the industry, it means it has abnormally high financial risk, and
one
should wonder why: is it a symptom
of financial trouble or has the firm perhaps
borrowed
aggressive
ly to expand its operations?
How do you know If a firm with an ROA of 15% is well managed? - Answers - Again,
compare a firm's ROA to that of other firms in the industry. For example, you
can calculate ROA -
Av
erage
(ROA other firms in the industry), the industry
-adjusted
ROA. Then firms with higher industry
-adjusted ROA are likely to be better managed.
What can you infer from a company that pays no dividends? - Answers - One possibility
is that the firm has no free cash flow. If after firms make all necessary
investments there is some cash left that is not needed, they should pay it out to
shareholders.
So if they don't do it, it means there is no free cash. Usually, firms that are unable to pay
dividends are thought to be financially constrained.
What can you infer from a firms whose sales/assets are decreasing over time? -
Answers - If the productivity of labor is decreasing, it could be due to technological
reasons. But
more commonly, one would think that sales are falling but the number of workers is not.
In bad times that are only temporary, you ofte
n see this because firms tend to retain some
skilled workers. But over long periods of time, firms should lay off workers. If they can't-
perhaps
