Podcast
Questions and Answers
How does an increase in financial leverage typically affect Return on Common Equity (ROCE), assuming positive net income?
How does an increase in financial leverage typically affect Return on Common Equity (ROCE), assuming positive net income?
Which of the following is generally considered the final step in the financial forecasting process?
Which of the following is generally considered the final step in the financial forecasting process?
What primary role do working capital adjustments and other non-cash components of income adjustments play in the statement of cash flows?
What primary role do working capital adjustments and other non-cash components of income adjustments play in the statement of cash flows?
A company's ROCE is heavily influenced by what factors?
A company's ROCE is heavily influenced by what factors?
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What is the impact of accounting for non-recurring gains and losses in financial statement projections?
What is the impact of accounting for non-recurring gains and losses in financial statement projections?
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A company exhibits decreasing profits, declining operating cash flows, low investment cash flows, and negative financing cash flows. Which stage of the product life cycle is the company most likely in?
A company exhibits decreasing profits, declining operating cash flows, low investment cash flows, and negative financing cash flows. Which stage of the product life cycle is the company most likely in?
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Which transaction will increase the current ratio when it is already above 1.0?
Which transaction will increase the current ratio when it is already above 1.0?
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How are dilutive securities treated in basic earnings per share (EPS) calculations when computing diluted earnings per share?
How are dilutive securities treated in basic earnings per share (EPS) calculations when computing diluted earnings per share?
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Which change, assuming all other factors remain constant, would lead to an increase in the Return on Assets (ROA)?
Which change, assuming all other factors remain constant, would lead to an increase in the Return on Assets (ROA)?
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Which statement accurately compares Return on Assets (ROA) and Residual Income (RI) as profitability measures?
Which statement accurately compares Return on Assets (ROA) and Residual Income (RI) as profitability measures?
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How does an increase in the tax rate typically affect a company's Return on Assets (ROA), assuming all other factors remain constant?
How does an increase in the tax rate typically affect a company's Return on Assets (ROA), assuming all other factors remain constant?
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A company is analyzing a potential investment opportunity. Which scenario would suggest that the company's Return on Common Equity (ROCE) will significantly exceed its Return on Assets (ROA)?
A company is analyzing a potential investment opportunity. Which scenario would suggest that the company's Return on Common Equity (ROCE) will significantly exceed its Return on Assets (ROA)?
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A company decides to lease a significant portion of its operating equipment rather than purchase it. What is the likely initial impact on the company's asset turnover ratio and why?
A company decides to lease a significant portion of its operating equipment rather than purchase it. What is the likely initial impact on the company's asset turnover ratio and why?
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Which factor is most directly influenced by a company's internal decisions and relationships rather than broad market conditions?
Which factor is most directly influenced by a company's internal decisions and relationships rather than broad market conditions?
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The extent to which market prices reflect accounting information most critically depends on:
The extent to which market prices reflect accounting information most critically depends on:
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Which statement best describes the economic attributes of a rapidly growing company?
Which statement best describes the economic attributes of a rapidly growing company?
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During the introductory stage of its life cycle, a firm is most likely to experience cash inflows primarily from which type of activity?
During the introductory stage of its life cycle, a firm is most likely to experience cash inflows primarily from which type of activity?
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What is the most logical initial step an investigator should undertake when conducting financial statement analysis?
What is the most logical initial step an investigator should undertake when conducting financial statement analysis?
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Which transaction would typically NOT require an adjustment when reconciling net income to cash flows from operations?
Which transaction would typically NOT require an adjustment when reconciling net income to cash flows from operations?
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How do share repurchases affect a company's balance sheet?
How do share repurchases affect a company's balance sheet?
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How is depreciation treated when calculating free cash flow to the firm?
How is depreciation treated when calculating free cash flow to the firm?
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Which of the following represents an example of an income-increasing accrual?
Which of the following represents an example of an income-increasing accrual?
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Under which accounting treatment would the market-to-book (MB) ratio and value-to-book (VB) ratio be most likely presumed equal?
Under which accounting treatment would the market-to-book (MB) ratio and value-to-book (VB) ratio be most likely presumed equal?
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A firm has current earnings of $235. The earnings are expected to grow (g) by 4% annually. The cost of equity capital ($R(E)$) is 13%. What is the value of the firm (rounded to the nearest dollar)?
A firm has current earnings of $235. The earnings are expected to grow (g) by 4% annually. The cost of equity capital ($R(E)$) is 13%. What is the value of the firm (rounded to the nearest dollar)?
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Which statement accurately describes a characteristic of a firm with high operating leverage?
Which statement accurately describes a characteristic of a firm with high operating leverage?
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A decrease in which of the following would increase cash flow?
A decrease in which of the following would increase cash flow?
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Company A and Company B both operate in the same industry, but Company A uses straight-line depreciation and Company B uses accelerated depreciation. Which of the following is true?
Company A and Company B both operate in the same industry, but Company A uses straight-line depreciation and Company B uses accelerated depreciation. Which of the following is true?
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A company prematurely recognizes revenue, what effect does this have on the financial statements?
A company prematurely recognizes revenue, what effect does this have on the financial statements?
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A company fails to record a contingent liability. What is the most likely effect on the company's financial statements?
A company fails to record a contingent liability. What is the most likely effect on the company's financial statements?
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A firm sells machinery at a loss. How is this loss typically reflected in the statement of cash flows?
A firm sells machinery at a loss. How is this loss typically reflected in the statement of cash flows?
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What is the likely effect on a company's Return on Equity (ROE) if it issues new shares of stock, assuming net income remains constant?
What is the likely effect on a company's Return on Equity (ROE) if it issues new shares of stock, assuming net income remains constant?
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A company experiences a sudden increase in demand for its product, leading to higher prices and significant profit from existing inventory. Which financial statement primarily reflects this gain?
A company experiences a sudden increase in demand for its product, leading to higher prices and significant profit from existing inventory. Which financial statement primarily reflects this gain?
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What impact does a decrease in accounts receivable typically have on a company's cash flow?
What impact does a decrease in accounts receivable typically have on a company's cash flow?
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A company's initial stock price is $35, based on a previous quarter's book value per share. After two months, the stock price increases to $48 due to news of a potential acquisition. How should an analyst most likely interpret this increase?
A company's initial stock price is $35, based on a previous quarter's book value per share. After two months, the stock price increases to $48 due to news of a potential acquisition. How should an analyst most likely interpret this increase?
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If a firm prematurely recognizes revue, what will be the impact on the financial statements?
If a firm prematurely recognizes revue, what will be the impact on the financial statements?
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Which of the following best describes the impact of capitalizing rather than expensing an expenditure?
Which of the following best describes the impact of capitalizing rather than expensing an expenditure?
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A company's stock price increases significantly following an acquisition announcement. What does this indicate?
A company's stock price increases significantly following an acquisition announcement. What does this indicate?
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Which type of earnings management involves making non-cash adjustments to financial statements within the bounds of GAAP to influence reported earnings?
Which type of earnings management involves making non-cash adjustments to financial statements within the bounds of GAAP to influence reported earnings?
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How is earnings before interest, taxes, depreciation, and amortization (EBITDA) similar to cash flow from operations?
How is earnings before interest, taxes, depreciation, and amortization (EBITDA) similar to cash flow from operations?
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How can a company lower its cost of capital?
How can a company lower its cost of capital?
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What effect does capitalizing an expense have on a company's financial statements?
What effect does capitalizing an expense have on a company's financial statements?
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A company uses $50,000 from its retained earnings to repurchase stock. What impact does this transaction have on the company's balance sheet?
A company uses $50,000 from its retained earnings to repurchase stock. What impact does this transaction have on the company's balance sheet?
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A law firm applies for a loan to expand business operations. Before the loan is approved, the lender conducts a detailed analysis of the firm's liquidity and solvency. Why are liquidity and solvency important for the lender to assess?
A law firm applies for a loan to expand business operations. Before the loan is approved, the lender conducts a detailed analysis of the firm's liquidity and solvency. Why are liquidity and solvency important for the lender to assess?
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A company increases its operating leverage. How does this affect its return on assets (ROA)?
A company increases its operating leverage. How does this affect its return on assets (ROA)?
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A company's cost of equity capital is 12%. The company's existing assets and operations generate a 12% return on common equity. The company is considering raising additional equity capital to invest in a new product that will generate a return of 9%. How does this investment affect the company's residual income?
A company's cost of equity capital is 12%. The company's existing assets and operations generate a 12% return on common equity. The company is considering raising additional equity capital to invest in a new product that will generate a return of 9%. How does this investment affect the company's residual income?
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How does increasing leverage affect a company's return on equity (ROE)?
How does increasing leverage affect a company's return on equity (ROE)?
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Which financial statement is most useful in assessing a company's liquidity?
Which financial statement is most useful in assessing a company's liquidity?
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Which cash flow category reflects the purchase or sale of long-term assets such as property, plant, and equipment?
Which cash flow category reflects the purchase or sale of long-term assets such as property, plant, and equipment?
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What is the impact of rising interest rates on bond prices?
What is the impact of rising interest rates on bond prices?
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A company experiences a loss on the sale of equipment. How is this loss typically reported on the income statement?
A company experiences a loss on the sale of equipment. How is this loss typically reported on the income statement?
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What is the impact of depreciation on a company's financial statements?
What is the impact of depreciation on a company's financial statements?
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When evaluating potential investments with varying required rates of return, how should a company decide which investment to undertake?
When evaluating potential investments with varying required rates of return, how should a company decide which investment to undertake?
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How can a company improve its asset turnover ratio?
How can a company improve its asset turnover ratio?
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Which financial ratio is most directly indicative of a company's ability to meet its immediate financial liabilities?
Which financial ratio is most directly indicative of a company's ability to meet its immediate financial liabilities?
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What is the immediate impact on the retained earnings account when a company distributes cash dividends to its shareholders?
What is the immediate impact on the retained earnings account when a company distributes cash dividends to its shareholders?
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A company with a high dividend payout ratio is considering a new project with a positive net present value (NPV) but requires significant upfront investment. How might the dividend policy affect the company's decision?
A company with a high dividend payout ratio is considering a new project with a positive net present value (NPV) but requires significant upfront investment. How might the dividend policy affect the company's decision?
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What is the most prudent measure for a company to take when it has generated high operating cash flows but operates in a mature industry with limited growth opportunities?
What is the most prudent measure for a company to take when it has generated high operating cash flows but operates in a mature industry with limited growth opportunities?
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A company reports a significant increase in net income on its income statement but only a slight increase in cash from operations on its statement of cash flows. Which scenario could explain this discrepancy?
A company reports a significant increase in net income on its income statement but only a slight increase in cash from operations on its statement of cash flows. Which scenario could explain this discrepancy?
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A company's market-to-book (MB) ratio is significantly below 1.0. What conclusion can an analyst most reasonably draw?
A company's market-to-book (MB) ratio is significantly below 1.0. What conclusion can an analyst most reasonably draw?
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A company reports positive net income but negative residual income. What does this imply about the company's performance?
A company reports positive net income but negative residual income. What does this imply about the company's performance?
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How could management use the flexibility afforded in applying accounting standards regarding depreciation to manage earnings, and what is a likely motivation for doing so?
How could management use the flexibility afforded in applying accounting standards regarding depreciation to manage earnings, and what is a likely motivation for doing so?
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A company's CFO is contemplating two options: increasing the dividend payout ratio or repurchasing shares. From a financial reporting perspective, what is the key difference between these two uses of cash?
A company's CFO is contemplating two options: increasing the dividend payout ratio or repurchasing shares. From a financial reporting perspective, what is the key difference between these two uses of cash?
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When evaluating a potential investment, an analyst notices significant differences between a company’s net income and its operating cash flow. What is the most appropriate course of action?
When evaluating a potential investment, an analyst notices significant differences between a company’s net income and its operating cash flow. What is the most appropriate course of action?
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Which of the following best describes a 'Special Purpose Entity' (SPE)?
Which of the following best describes a 'Special Purpose Entity' (SPE)?
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What is the primary difference between 'Real Earnings Management' and general 'Earnings Management'?
What is the primary difference between 'Real Earnings Management' and general 'Earnings Management'?
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Which of the following is the most accurate definition of 'Accruals' in financial accounting?
Which of the following is the most accurate definition of 'Accruals' in financial accounting?
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In the context of financial statement analysis, what does a 'Common-size balance sheet' primarily show?
In the context of financial statement analysis, what does a 'Common-size balance sheet' primarily show?
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A company reports a significant gain from the sale of a subsidiary that was part of a strategic restructuring. How should this gain be classified?
A company reports a significant gain from the sale of a subsidiary that was part of a strategic restructuring. How should this gain be classified?
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Which valuation method is most exposed to market volatility and why?
Which valuation method is most exposed to market volatility and why?
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Consider a scenario where a company significantly impaired an asset due to a sudden change in market conditions. What effect would this impairment most directly have on the company's financials?
Consider a scenario where a company significantly impaired an asset due to a sudden change in market conditions. What effect would this impairment most directly have on the company's financials?
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A highly specialized manufacturing company that has created a new industry-disrupting device is acquired for a price significantly above its net asset value. Under accounting principles, what is the most likely primary driver for the difference between acquisition price and net asset value, and how is it treated on the acquirer's balance sheet?
A highly specialized manufacturing company that has created a new industry-disrupting device is acquired for a price significantly above its net asset value. Under accounting principles, what is the most likely primary driver for the difference between acquisition price and net asset value, and how is it treated on the acquirer's balance sheet?
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Which of the following ratios is best used to evaluate a company's operational cash flow relative to its short-term liabilities?
Which of the following ratios is best used to evaluate a company's operational cash flow relative to its short-term liabilities?
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What does a Price-to-Sales (P/S) ratio greater than 1 suggest about a company?
What does a Price-to-Sales (P/S) ratio greater than 1 suggest about a company?
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How is the 'g' term (growth rate) used in the Continuing Value (CV) formula calculated?
How is the 'g' term (growth rate) used in the Continuing Value (CV) formula calculated?
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A company forecasts a significant increase in net income, but its cash flow from operations remains relatively stable. Which of the following could explain this discrepancy?
A company forecasts a significant increase in net income, but its cash flow from operations remains relatively stable. Which of the following could explain this discrepancy?
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If a company's Free Cash Flow to Equity (FCFE) is consistently negative, what might this indicate?
If a company's Free Cash Flow to Equity (FCFE) is consistently negative, what might this indicate?
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Which scenario would lead to a higher inventory turnover ratio, assuming cost of goods sold remains constant?
Which scenario would lead to a higher inventory turnover ratio, assuming cost of goods sold remains constant?
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Company A and Company B have identical financial metrics except that Company A's ROCE is consistently higher than its cost of equity, while Company B's ROCE is consistently lower. What does this suggest?
Company A and Company B have identical financial metrics except that Company A's ROCE is consistently higher than its cost of equity, while Company B's ROCE is consistently lower. What does this suggest?
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What is the impact of including dilutive securities in the calculation of diluted EPS?
What is the impact of including dilutive securities in the calculation of diluted EPS?
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Which of the following adjustments would increase the quick ratio?
Which of the following adjustments would increase the quick ratio?
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A company with a high P/E ratio acquires a company with a low P/E ratio. Assuming the market values the earnings of the combined entity similarly to the acquiring company, what is the most likely short-term impact on the acquiring company's stock price immediately following the announcement?
A company with a high P/E ratio acquires a company with a low P/E ratio. Assuming the market values the earnings of the combined entity similarly to the acquiring company, what is the most likely short-term impact on the acquiring company's stock price immediately following the announcement?
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Which business strategy involves a company expanding by acquiring or merging with a competitor in the same industry and production stage?
Which business strategy involves a company expanding by acquiring or merging with a competitor in the same industry and production stage?
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What accounting method records revenues and expenses when they are earned or incurred, regardless of when cash changes hands?
What accounting method records revenues and expenses when they are earned or incurred, regardless of when cash changes hands?
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Which valuation method relies heavily on projecting future cash flows and discounting them back to their present value?
Which valuation method relies heavily on projecting future cash flows and discounting them back to their present value?
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How is Gross Margin Percentage Index (GMI) calculated?
How is Gross Margin Percentage Index (GMI) calculated?
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According to Porter's Five Forces Model, which of the following represents horizontal competition?
According to Porter's Five Forces Model, which of the following represents horizontal competition?
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Which financial ratio category assesses a company's ability to meet its short-term obligations using its current assets?
Which financial ratio category assesses a company's ability to meet its short-term obligations using its current assets?
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What is the formula for calculating Net Income?
What is the formula for calculating Net Income?
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How is Enterprise Value (EV) typically calculated?
How is Enterprise Value (EV) typically calculated?
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What does a Gross Margin Percentage Index (GMI) of less than 1 indicate?
What does a Gross Margin Percentage Index (GMI) of less than 1 indicate?
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During which phase of a business product's life cycle does a company typically experience a rapid increase in sales coupled with increased debt financing?
During which phase of a business product's life cycle does a company typically experience a rapid increase in sales coupled with increased debt financing?
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A company's current assets are $1,500,000 and its current liabilities are $900,000. What is its Net Working Capital?
A company's current assets are $1,500,000 and its current liabilities are $900,000. What is its Net Working Capital?
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A company with a market capitalization of $5 billion would be classified as what type of company?
A company with a market capitalization of $5 billion would be classified as what type of company?
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Which of the following adjustments is typically made when using the indirect method to calculate cash flow from operating activities?
Which of the following adjustments is typically made when using the indirect method to calculate cash flow from operating activities?
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A company has EBIT of $500,000, interest expense of $50,000, and a tax rate of 30%. Calculate the company's Net Income.
A company has EBIT of $500,000, interest expense of $50,000, and a tax rate of 30%. Calculate the company's Net Income.
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Company A and Company B have identical financial statements except for the fact that Company A uses Preferred Dividends while Company B does not. Assume Preferred Dividends are relatively large and Return on Assets (ROA) is chosen as the profitability ratio. Which of the following is true?
Company A and Company B have identical financial statements except for the fact that Company A uses Preferred Dividends while Company B does not. Assume Preferred Dividends are relatively large and Return on Assets (ROA) is chosen as the profitability ratio. Which of the following is true?
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Flashcards
Decline Stage
Decline Stage
A phase in the product life cycle characterized by decreasing profits and cash flows.
Current Ratio Increase
Current Ratio Increase
Paying down accounts payable can increase the current ratio if it is above 1.0.
Dilutive Securities
Dilutive Securities
Financial instruments that can dilute earnings per share, affecting EPS calculations.
Strike Price Effect
Strike Price Effect
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Return on Assets (ROA) Increase
Return on Assets (ROA) Increase
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Profitability Measures
Profitability Measures
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Return on Common Equity (ROCE) vs. ROA
Return on Common Equity (ROCE) vs. ROA
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Residual Income (RI) Relationship
Residual Income (RI) Relationship
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Dependence on suppliers
Dependence on suppliers
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Market prices and accounting
Market prices and accounting
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Growing companies need capital
Growing companies need capital
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Cash inflows in introduction stage
Cash inflows in introduction stage
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Steps in financial statement analysis
Steps in financial statement analysis
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Equipment purchase with note payable
Equipment purchase with note payable
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Depreciation in free cash flows
Depreciation in free cash flows
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Income-increasing accrual
Income-increasing accrual
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Fair value accounting
Fair value accounting
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Value of the firm formula
Value of the firm formula
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Operating leverage
Operating leverage
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Financial leverage risk
Financial leverage risk
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Accrual accounting
Accrual accounting
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Stock buybacks
Stock buybacks
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ROCE and Risk
ROCE and Risk
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Asset Management Impact on ROCE
Asset Management Impact on ROCE
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Cash Flow Projection
Cash Flow Projection
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Impact of Non-Cash Adjustments
Impact of Non-Cash Adjustments
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Capital Structure Leverage
Capital Structure Leverage
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Market-Based Multiples
Market-Based Multiples
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Loss on Sale of Asset
Loss on Sale of Asset
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Return on Equity (ROE)
Return on Equity (ROE)
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Income Statement
Income Statement
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Accounts Receivable Impact
Accounts Receivable Impact
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Intrinsic Value vs. Market Value
Intrinsic Value vs. Market Value
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Financial Efficiency
Financial Efficiency
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Impact of Equity Increase on ROE
Impact of Equity Increase on ROE
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Overvalued Stock
Overvalued Stock
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Undervalued Stock
Undervalued Stock
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Accrual-Based Earnings Management
Accrual-Based Earnings Management
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EBITDA
EBITDA
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Capitalizing an Expense
Capitalizing an Expense
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Cost of Capital
Cost of Capital
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Residual Income
Residual Income
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Interest Rates Effect on Bonds
Interest Rates Effect on Bonds
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Liquidity
Liquidity
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Solvency
Solvency
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Return on Assets (ROA)
Return on Assets (ROA)
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Leverage Impact on ROE
Leverage Impact on ROE
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Investing Activities
Investing Activities
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Depreciation Effect
Depreciation Effect
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Investment Decision Criteria
Investment Decision Criteria
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Asset Turnover
Asset Turnover
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Current Ratio
Current Ratio
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Dividends Impact on Retained Earnings
Dividends Impact on Retained Earnings
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High Dividend Payout Ratio
High Dividend Payout Ratio
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Excess Cash Flow Use
Excess Cash Flow Use
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Balance Sheet vs Cash Flows
Balance Sheet vs Cash Flows
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High Market-to-Book Ratio
High Market-to-Book Ratio
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Residual Income Definition
Residual Income Definition
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Impact of Depreciation
Impact of Depreciation
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Reinvestment Opportunities
Reinvestment Opportunities
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Cash Flow Statement Adjustments
Cash Flow Statement Adjustments
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Transitory Income
Transitory Income
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Special Purpose Entity (SPE)
Special Purpose Entity (SPE)
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Accruals
Accruals
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Depreciation
Depreciation
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Goodwill
Goodwill
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Book Value
Book Value
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Common-size Income Statements
Common-size Income Statements
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Fair Value (Mark-To-Market)
Fair Value (Mark-To-Market)
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Return on Common Equity (ROCE)
Return on Common Equity (ROCE)
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Earnings per Share (EPS)
Earnings per Share (EPS)
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Price-Earnings Ratio (P/E)
Price-Earnings Ratio (P/E)
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Quick Ratio (Acid Test)
Quick Ratio (Acid Test)
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Operating Cash Flow to Current Liabilities Ratio (OFC Ratio)
Operating Cash Flow to Current Liabilities Ratio (OFC Ratio)
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Free Cash Flow to Equity (FCFE)
Free Cash Flow to Equity (FCFE)
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Present Value (PV)
Present Value (PV)
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Days in Inventory
Days in Inventory
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Horizontal Integration Strategy
Horizontal Integration Strategy
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Industry Diversification Strategy
Industry Diversification Strategy
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Product Differentiation Strategy
Product Differentiation Strategy
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Low-Cost Leadership Strategy
Low-Cost Leadership Strategy
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Indirect Method (Cash Flow)
Indirect Method (Cash Flow)
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Direct Method (Cash Flow)
Direct Method (Cash Flow)
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Market Value of Assets
Market Value of Assets
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Discounted Cash Flow (DCF)
Discounted Cash Flow (DCF)
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Net Working Capital
Net Working Capital
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Gross Margin Percentage Index (GMI)
Gross Margin Percentage Index (GMI)
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Porter's Five Forces Model
Porter's Five Forces Model
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Enterprise Value (EV)
Enterprise Value (EV)
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Dividends
Dividends
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Study Notes
Product Life Cycle
- Companies in the decline stage typically experience decreasing profits and declining cash flows (operations, investment, and financing).
- Business products have four phases: Introduction, Growth (rapid sales & debt financing), Maturity (slowing sales), Decline (loss of sales/profits).
Current Ratio Improvement
- Paying down accounts payable reduces current liabilities, increasing the current ratio if it's already above 1.0.
Dilutive Securities and EPS
- Stock options with a strike price above the market price do not lead to EPS dilution.
Return on Assets (ROA)
- An increase in non-controlling interest earnings (not property, plant, and equipment, advertising expenses, or tax rates) increases profitability, thereby boosting ROA.
- ROA = Net Income / Total Assets
Profitability Measures
- ROCE (Return on Common Equity) surpasses ROA when ROA exceeds the cost of capital from creditors and preferred shareholders. ROCE accounts for financing costs.
- ROCE = (Net income - Preferred Dividends) / Average Common Equity
Business Risk Factors
- Dependence on one or a few suppliers is a controllable risk factor.
- Porter's Five Forces Model analyzes industry competitive strength & profitability. Factors include competition, new entrants, supplier power, customer power, and substitute threats. Buyer and supplier power are vertical competition, while industry competition, new entrants, and substitutes are horizontal competition.
Market Price & Accounting Information
- Market prices accurately reflecting accounting information depends on investors using accounting data to forecast future earnings. Market value may not accurately reflect intrinsic value until significant events (like acquisitions) are finalized.
Company Economic Attributes
- Companies with rapid growth require significant external financing (from issuing stocks or bonds).
Cash Inflows in Introductory Stage
- Cash inflows mainly come from financing activities, as the firm raises capital for initial operations.
Financial Statement Analysis Steps
- The initial step in financial statement analysis is understanding the industry and competitive environment.
Adjusting Net Income to Cash Flows
- Purchased equipment with a note payable does not directly affect cash flow or net income; therefore, no adjustment is needed.
Share Repurchases
- Share repurchases decrease the number of outstanding shares and equity, impacting equity.
Free Cash Flow & Depreciation
- Depreciation expense is added back to net income when calculating free cash flow because it's a non-cash expenditure.
Accruals and Income
- Recording work completion for which payment was previously received increases income via accrual accounting.
Market Value vs. Book Value
- Fair value accounting (trading securities) ensures assets are recorded at market value, aligning market-to-book and value-to-book ratios. Market value may not accurately reflect intrinsic value.
Firm Valuation
- Firm value calculation involves dividing current earnings by the difference between the cost of equity and the growth rate.
Leverage
- Higher operating leverage indicates a higher proportion of fixed costs in a company's cost structure. Higher leverage can increase ROE if the return on assets exceeds the cost of debt.
Disaggregating Return on Common Equity
- ROCE increases with higher financial leverage (using more debt).
Financial Forecasting
- Cash flow projections are determined from income statement and balance sheet forecasts.
Working Capital Adjustments in Cash Flow
- Working capital adjustments reflect the difference in income recognition and cash flow realization. Decreasing accounts receivable increases cash flow.
Market-Based Multiples
- Market-based multiples help value companies, but failure to consider contingent liabilities can result in overstated net income.
Statement of Cash Flows - Loss on Asset Sale
- Losses on the sale of long-term assets (like machinery) are recorded in the investing section of the statement of cash flows. This reflects any difference between the sale price and the asset's book value.
Return on Equity (ROE) Dilution
- Issuing new shares increases equity, leading to a decrease in ROE if net income remains constant. ROE = Net income / Shareholders' equity.
Income Statement Impacts - Inventory Gains
- Gains from increased inventory demand and higher prices are reflected in the income statement.
Contingent Liabilities and Net Income
- Failure to record contingent liabilities leads to an overstatement of net income.
Accrual-Based Earnings Management
- Accrual-based earnings management adjusts accruals within GAAP to influence reported earnings, not cash flow. It's distinct from real earnings management and earnings manipulation.
EBITDA and Cash Flow from Operations
- EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and cash flow from operations both exclude depreciation expenses but differ in their treatment of other items (interest and taxes).
Optimal Capital Structure
- Optimizing the debt-to-equity mix and reducing risk lowers the company's cost of capital, leading to better financial outcomes.
Capitalizing Expenses
- Capitalizing an expense extends its recognition period, reducing immediate expenses and increasing assets, rather than immediately impacting retained earnings.
Stock Repurchases and Balance Sheet
- Repurchasing stock using retained earnings decreases shareholders' equity.
Loan Analysis and Liquidity/Solvency
- Lenders analyze a firm's liquidity and solvency to assess its ability to repay both short-term and long-term debts.
Operating Leverage and ROA
- Increased operating leverage (higher proportion of fixed costs) lowers ROA if sales don't correspondingly increase.
Investment Decisions and Residual Income
- An investment generating a return lower than the cost of equity will result in decreased residual income. Residual income is the income earned above the required return on equity.
Leverage and ROE
- Increased leverage (using more debt) can increase ROE if the return on assets exceeds the cost of debt. This amplifies returns to equity holders.
Statement of Cash Flows - Investing Activities
- Purchases or sales of long-term assets (property, plant, and equipment) are recorded in the investing activities section of the statement of cash flows.
Bond Prices and Interest Rates
- Rising interest rates typically decrease bond prices.
Loss on Equipment Sale & Statement of Cash Flows
- Losses on the sale of equipment are recorded in the investing activities section of the statement of cash flows.
High Dividend Payout Ratio and Growth
- A high dividend payout ratio may reduce future growth potential by lowering retained earnings available for reinvestment.
Excess Cash Flow Use
- Reinvesting in capital expenditures allows the company to expand operations, improving long-term profitability and growth prospects.
Balance Sheet and Cash Flow Statement Discrepancies
- Differences in the balance sheet and statement of cash flows occur because the balance sheet uses accrual-basis accounting while the statement of cash flows uses cash-basis accounting.
Market-to-Book Ratio and Stock Valuation
- A high market-to-book ratio suggests the company may be overvalued or have strong growth prospects. High MB ratios imply investors expect future earnings to exceed current net asset values.
Residual Income Definition
- Residual income is the income earned above the required return on equity.
Depreciation's Impact on Financial Statements
- Depreciation is a non-cash expense that reduces net income but does not directly affect cash flow.
Investment Decision-Making
- Investment decisions involve comparing the return on investment to the required rate of return for each project.
Asset Turnover
- Asset turnover measures how efficiently a company uses its assets to generate revenue. Increasing sales or reducing assets will improve this ratio..
Current Ratio
- The current ratio measures a company's ability to pay its short-term obligations by comparing current assets to current liabilities.
Dividend Payments and Retained Earnings
- When dividends are paid, retained earnings decrease as the company distributes part of its accumulated profits to shareholders.
Important Definitions
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Transitory Income: Income not expected as regular earnings.
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Peripheral Activity: Activities not central to earnings.
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Contingent Income: Income dependent on conditions/events.
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Special Purpose Entity (SPE): Legal entity for specific, temporary objectives (e.g., collateral, risk transfer).
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Accruals: Revenues/expenses recognized before cash flow.
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Cost of Goods Sold (COGS): Total cost of producing/selling a product/service.
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Financing: Obtaining funds for a purchase, with repayment over time.
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Investing: Putting money into assets/projects for profit.
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Equity: Value of company shares.
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Earnings management: Manipulating financial statements to mislead users.
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Real Earnings Management: Manipulating operations to increase earnings.
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Depreciation: Asset value reduction due to wear and tear.
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Amortization: Periodic reduction of loan/intangible asset value.
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Current Replacement Cost: Estimated cost to replace an asset/service currently.
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Fair Value (Mark-To-Market): Current market value of assets/liabilities.
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Adjusted Historical Cost: Asset value adjusted for wear, depreciation, or impairment.
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Goodwill: Premium paid for a business above its fair market value.
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Tax Basis: Asset value for tax purposes.
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Book Value: Business/asset value on the balance sheet.
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Common-size balance sheet: Balance sheet with all amounts as a percentage of total assets.
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Common-size income statements: Income statement with all items as a percentage of total revenues.
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Percentage change financial statements: Statements showing year-over-year growth rates.
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Gross Margin Percentage Index (GMI): Compares current gross margin to the previous year's.
- GMI > 1: Improved profitability relative to sales
- GMI = 1: No change in gross margin
- GMI < 1: Decreased profitability relative to sales.
- GMI < 0: Losses from core operations
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Net Working Capital: Difference between current assets and current liabilities
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Dividends: Payments to shareholders from profits.
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Preferred Dividends: Paid to preferred shareholders before common stock dividends.
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Small-Cap Company: Market cap $250M - $2B.
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Mid-Cap Company: Market cap $2B - $10B.
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Large-Cap Company: Market cap over $10B.
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Zero Market-Cap Company: Market cap is zero.
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Short-Term Liquidity Ratios: Assess a company's ability to pay short-term debts.
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Profitability Ratios: Measure company income generation relative to various metrics.
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Solvency Ratios: Assess a company's ability to pay debts and generate cash flow.
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Net Income: Profit after expenses, taxes etc.
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Earnings before Interest and Taxes (EBIT): Net income - operating expenses - Similar Formulas: Earnings before Interest, Taxes, and Amortization (EBITA) and Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA) - EBITA: Net Income + Interest + Taxes + Amortization - EBITDA: Operating Income + Depreciation + Amortization
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Enterprise Value (EV): Company's total value, including market cap, debt, and cash.
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EV = Market Capitalization + Total Debt - Cash and Cash Equivalents
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Market Capitalization = Market Price per Share x Number of Shares Outstanding
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Return on Assets (ROA). ROA = Net Income / Total Assets
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Return on Common Equity (ROCE).ROCE =(Net income - Preferred Dividends) / Average Common Equity.
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Earnings per share (EPS): Company's net income / Total number of outstanding shares.
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Diluted Earnings per share (EPS): EPS assuming conversion of all convertible securities
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Price-earnings ratio (P/E): Market price per share / company EPS.
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Price-to-Sales (P/S): Company's market capitalization / Total sales (revenue).
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P/S Valuation: Revenue x P/S multiple
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Current ratio: Current assets / Current liabilities.
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Quick Ratio (Acid Test): (Current assets – Inventory) / Current liabilities.
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Operating Cash Flow to Current Liabilities Ratio (OFC Ratio): Cash flow from operations / Current liabilities.
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Inventory Turnover Ratio: COGS/ Average inventory.
- Average Inventory: (Beginning Inventory + Ending Inventory)/2
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Days in Inventory: Days / Inventory Turnover Ratio
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Free Cash Flow to Equity (FCFE): Cash available to shareholders.
- FCFE = Net Income + Depreciation & Amortization (D&A) – Change in Net Working Capital – Capital Expenditures (Capex) + Net Borrowing
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Continuing Value (CV): Current value of future cash flows with a constant growth rate.
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CV = (FCFn x (1 + g))/(WACC - g) where:
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FCFn = Free Cash Flow (for the desired period)
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g = Growth rate
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WACC = Weighted Average Cost of Capital
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Present Value: Current value of future cash flows. PV = FV x (1 / ((1 + r)^n)) where: FV = Future value; r = Rate of return or discount rate; n = Number of periods
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Sum of the Present Value of Free Cash Flows: Total present value of projected free cash flows.
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Description
Test your knowledge on essential business finance concepts such as the product life cycle, current ratio improvement, and profitability measures. This quiz covers vital metrics like ROA and ROCE, as well as market price implications. Perfect for students and professionals alike!
