D076 128 Finance Skills for Managers

A company calculated variances of a budget and actual cash flows that indicate the firm's strengths and weaknesses in cash flows and its budgeting process. Which major use of cash budgeting is this an example of? - Performance evaluation A company currently has a ratio of 1.5 but hopes to improve the ratio to 2 to align more with the industry benchmark. To achieve this goal, costs were cut in production through an investment in efficient equipment, and the company achieved a higher profit margin. If this continues, you are certain that the firm will achieve its goal in two years. What is this an example of? - Progress measurement (You are comparing the company's ratio to the goal and checking how the company is progressing toward the goal.) A company is considering five projects that are not mutually exclusive. However, the company does not have enough money to do all of them. In order to prioritize projects that fit within the company's budget, which capital budgeting method should be used? - Profitability index (PI) (The PI should be used first to compare the projects and then to rank them to maximize the value of the firm.) A company is developing a financial forecast for the next year. The company plans to implement a new factory that will increase production and resulting sales by 20%. Since the company's assets are increasing significantly what else must increase? - Financing A company is trying to decide which of four projects to invest in. Project 1 has an IRR of 14% and an NPV of $54,000. Project 2 has an IRR of 11% and an NPV of $67,000. Project 3 has an IRR of 9% and an NPV of $60,000. Project 4 has an IRR of 13% and an NPV of $47,000. - Project 2 (The project with the highest NPV will bring the most value to the company.) A company is trying to finance a project with a mortgage loan from a bank. The company's assessment of the project indicates that the company may experience several years of loss until the project becomes profitable. This means that the company might lose its ability to pay back the loan and the interest on the mortgage. What action might the bank take to protect its interest? - Set a strict covenant that the company cannot easily achieve. (By setting a strict covenant, there is a risk that the company may not meet its obligation, which would deter the company from taking on risky projects.) A company that produces soap, shampoo, lotion, and other personal care products has recently taken a hit due to a competitor's new product line. The company decides to reduce wages for its labor force to save money while the company focuses on building up its reputation again, but the company's labor force goes on strike to protest the pay cuts. What type of risk does the strike represent? - Idiosyncratic risk (Idiosyncratic risk is the same as firm-specific risk. Since the strike will most likely affect only this firm, it is a firm-specific risk.) A financial manager at a company is trying to determine whether to issue new stocks or new bonds to cover the costs of a project the company is doing the next year. Which main task in business finance is this situation an example of? - Making financing decisions A firm had sales of $100,000 this month. However, the firm received only $90,000 in cash from sales. Why would the firm receive $10,000 less cash than its monthly sales? - Because the firm did not make all sales on cash A firm is currently operating at 75% capacity with current sales of $34 million. Will the firm need to acquire additional fixed assets if its sales are predicted to increase by $6 million next year? - No because the increase in sales will not exceed the firm's sales capacity. A pharmaceutical company recently spent $2 million developing a new drug. The company then conducts capital budgeting analysis to determine if it should produce the newly developed drug. The net present value (NPV) of the project is $1.5 million. Why should this company produce the drug? - Because the NPV is greater than zero A potential project to expand the size of an apartment complex will cost $100,000. Its calculated net present value is $5,000. Given this information, which statement is correct? - The project should be accepted because it has a positive NPV. (Because the NPV is positive, the project should be accepted.) A sign company is planning to have an initial public offering (IPO). In which type of market will its stock first be sold to the public? - Primary market About a year ago, the short-term Treasury bill had 1.54% interest and the long-term Treasury note had 2.54% interest. This week, the 1-year Treasury bill has an interest rate of 3.13%, while the 10-year Treasury note has an interest rate of 2.28%. What does this information indicate about the future economy? - It may indicate an economic downturn. (Since the long-term Treasury interest rate is lower than the short-term rate, it has an inverted yield curve, which may indicate an economic downturn.) After W&H Inc. has developed a cash budget, what should the company do in the following months? - It should monitor its actual cash flows and then revise the cash budget if needed. (Monitoring and revising the cash budget will allow W&H Inc. to identify and fix any problems that may arise.) An employee was recently hired as a financial analyst and asked to create a cash budget for the employee's division for the next year. Which component should the employee exclude from the budget? - Purchase of equipment that will be bought in three years An energy company discovers that a new bill has been proposed to change the amount of fuel that can be exported outside the country. If passed this could have a serious negative effect on the company's revenues. Some of the company's competitors are obtaining insurance policies to compensate for this risk but since the energy company believes the likelihood of this bill passing is low it chooses to do nothing—ultimately taking responsibility for this particular risk instead of trying to transfer the risk through an insurance policy. Which risk management technique is this choice an example of? - Risk retention An investment analyst is concerned about a construction company's ability to sell its inventory to meet current obligations because much of the inventory (commercial buildings) it builds and sells takes longer than a year to construct. Which ratio should this analyst use to consider the effect of the firm's inventory on the firm's ability to meet current obligations? - Quick ratio