FIRE 311 Exam-1 Study Guide

Chapter 1
1) Three main forms of business organization: Differences
Proprietorship
Advantages:
o Ease of formation
o Subject to few government regulations
o No corporate income taxes
Disadvantages:
o Unlimited personal liability
o Limited life
o Transferring ownership is difficult
o Difficult to raise capital
Partnership
Like proprietorship just with two or more members
Corporation
Advantages:
o Unlimited life
o Easy transfer or ownership
o Limited liability
o Ease of raising capital
Disadvantages:
o Cost of set up and report filing
o Double taxation
2) Advantages and disadvantages of each form of organization
Look above
3) Primary Goals of management and application.
Primary goal: Stockholder wealth maximization maximizing the stock price
Other goals: managerial incentives and social responsibility
4) Majority of business by numbers vs. business volume
5) Agency Problem: managers vs. owners
An agency relationship exists whenever a principal hires an agent to act on his or her
behalf.
An agency problem results when the agent makes decisions that are not in the best
interest of principals
6) Mechanism how to get managers to act in SHs best interest
o Managerial compensation (incentives)
o Shareholder intervention
o Threat of takeover
7) Management social responsibility

8) By-laws(Electing officers) and Corporate charters(Activities)

9) Why go global?
Five reasons firms go international:
o To seek new markets
o To seek raw materials
o To seek new technology
o To seek production efficiency
o To avoid political and regulatory hurdles
10) Business Ethics
Business Ethics: A companys attitude and conduct toward its employees, customers,
community, and stockholders

Chapter 2
1) Names and Functions of 4 main Financial Statements: Balance Sheet, Income Statement,
Stmt of Cash Flows and Stmt of Retained Earnings
Balance Sheet:
o Represents a picture taken on a specific date that shows a firms assets
(investments) and how those assets are financed (debt or equity)
Income Statement:
o Presents the results of business operations during a specified period of time
o Summarizes the revenues generated and the expenses incurred
Statement of Cash flows:
o Designed to show how the firms operations have affected its cash position
o Examines investment decisions (uses of cash)
o Examines financing decisions (sources of cash)
Statement of Retained Earnings:
o Changes in the common equity accounts between balance sheet dates
2) Liquidity ratios- is the firm able to meet its current obligations
Current ratio vs. Quick ratio
o Current ratio: current assets/ current liabilities
o Quick ratio: current assets-inventories/ current liabilities
3) Asset management ratios- is the firm effectively using its assets
Inventory Turnover Ratio
o COGS/inventory
Days Sales Outstanding (DSO)
Receivable s
Receivable s
DSO

Daily Sales Annual Sales

360
o

Fixed Asset Turnover Ratio

o Sales/ Net fixed assets
Total Assets Turnover Ratio
o Sales/Total assets
4) Debt management ratios- does the firm have the right mix of debt and equity
Debt Ratio
o Total liabilities/total assets
Times- Interest-Earned Ratio (TIE)
o EBIT/interest charges
Fixed Charge Coverage Ratio
EBIT Lease payments
FCC
Interest Lease Sinking fund payment

1 Tax rate
charges payments
o

5) Profitability ratios- how do the combined effects of liquidity, asset and debt management
affect profits
Net Profit Margin
o Net Profit/Sales
Return on Total Assets (ROA)
o Net income/Total assets
Return on Common Equity (ROE)
o Net income/ common equity
6) Market ratios- what do investors think about the firms future financial prospects
Price/Earnings Ratio
o Price per share/ Earnings per share
Market/Book Ratio
o Market price per share/ Book value per share
7) Importance of TIE ratio for Creditors
TIE measures the extent to which a firms operating earnings- before interest and
taxes (EBIT) also called net operating income (NOI)- can decline before these
earnings are no longer sufficient to cover annual interest costs. Failure to meet this
obligation can bring legal action by the firms creditors, possibly resulting in
bankruptcy. Note that the EBIT, rather than net income, is used in the numerator
because interest is paid with pre-tax dollars.
8) Cash outflow vs. cash inflow

9) Non-cash expenses: Depreciation

a. With non-cash depreciation: If they take out depreciation and there is an expense
for it then EBT, Taxes and net income will be lower. If there is NO depreciation
then EBT, taxes and net income will bee higher. But remember this isnt a cash
flow, this is an expense that gets taken off before EBT.
10) Annual report contains: Financial STMTs and letter from CEO about past performance
and future outlook
11) Source of capital and use of capital: BS
The essence of finance is to make money by raising capital such as bonds and stock
12) How to use and interpret Financial Ratios in book (with exception of fixed charge ratio)
Ratios are accounting numbers that are converted to show relationship between firms
and their financials.
13) Trend analysis versus comparative analysis
Trend analysis: An evaluation of changes (trends) in a firms financial position over a
period of time, perhaps years. Trend analysis gives information whether the firms
financial position is more likely to improve or deteriorate in the future. A simple
approach to trend analysis is to construct graphs containing both the firms ratios and
the industry averages for the past five years.
Comparative analysis: An analysis based on a comparison of a firms ratios with those
of other firms in the same industry at the same point in time. This tells us how well
the firm is currently performing.
14) Concept of Dupont Analysis: ROA and ROE

ROA = Net Profit Margin X Total Assets Turnover

15) How to calculate: PM, TATO, EM
Look up in textbook/ google
16) ROE of 100% equity firm
Look above and research on google.
Chapter 3
1) Transferring funds from savers to borrowers: Direct way vs. Indirect ways
2) Primary vs. Secondary Markets transaction
a) Relationship
b) Services provided by Secondary Markets
c) Role of the Secondary Market
3) Capital markets and Money Markets: Long-term Securities vs. Short-term Securities
4) Money market instruments vs. Capital market instruments
5) Derivative market and its instruments
6) Investment Banking versus Financial Intermediaries

a) Services provided by Investment Bankers: Advice, marketing/distributions of

securities, underwriting, best effort, Dutch auction
b) Types of financial intermediaries
7) Efficient Market: Economic efficiency
8) Informational efficiency: Weak form, Semi-strong form and Strong form of EMH
9) Role of financial intermediaries
10) Benefits of financial intermediaries
11) American Depository Receipt: Foreign company trading in US stock market
Exam 1
One 8 x 11 sheet and calculator allowed in exam.