COMM 370 Midterm Exam Questions
With Accurate Answers
TOPIC 1: Financial Analysis - ANSWER TOPIC 1: Financial Analysis
What are the categories of ratios? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER
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? - ANSWER 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? -
ANSWER 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
because labor unions are very strong (e.g., in the US auto industry), then
productivity of labor goes down, a
nd ultimately hurts profits.
What can you infer from observing a firm whose book leverage is roughly
constant over time but the fraction of total debt that is short term is increasing? -
ANSWER A larger fraction of short
-term debt could be a firm's choice if long-
term borrowing
is
too expensive relative to short
-term borrowing, or if long
-term interest rates are expected
to fall in the near future. Or it could be that lenders refuse to lend long term to
the firm
because
it is too risky, and thus the firm is forced to borrow using short
-term instruments.
This last possibility is a classical symptom of financial trouble
, as lenders see it too risky
to lend to a firm that most likely will not be able to repay the loan.
What can you infer from observing a firm with a large cash
-to-assets ratio? - ANSWER Carrying cash is costly, because you forgo the
interest you could make. Firms holding
abnormally high cash often do this because they are financially constrained, that
is, they
cannot easily raise outside capital with debt or equity issues. Thus, they kee
p high cash to
be able to fund new investment opportunities that may arise. Other firms have
lots of cash
With Accurate Answers
TOPIC 1: Financial Analysis - ANSWER TOPIC 1: Financial Analysis
What are the categories of ratios? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER 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? - ANSWER
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? - ANSWER 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? -
ANSWER 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
because labor unions are very strong (e.g., in the US auto industry), then
productivity of labor goes down, a
nd ultimately hurts profits.
What can you infer from observing a firm whose book leverage is roughly
constant over time but the fraction of total debt that is short term is increasing? -
ANSWER A larger fraction of short
-term debt could be a firm's choice if long-
term borrowing
is
too expensive relative to short
-term borrowing, or if long
-term interest rates are expected
to fall in the near future. Or it could be that lenders refuse to lend long term to
the firm
because
it is too risky, and thus the firm is forced to borrow using short
-term instruments.
This last possibility is a classical symptom of financial trouble
, as lenders see it too risky
to lend to a firm that most likely will not be able to repay the loan.
What can you infer from observing a firm with a large cash
-to-assets ratio? - ANSWER Carrying cash is costly, because you forgo the
interest you could make. Firms holding
abnormally high cash often do this because they are financially constrained, that
is, they
cannot easily raise outside capital with debt or equity issues. Thus, they kee
p high cash to
be able to fund new investment opportunities that may arise. Other firms have
lots of cash
