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Questions and Answers
What is capital expenditure expected to produce?
What is capital expenditure expected to produce?
- Immediate cash flows unrelated to long-term projections
- Benefits over a period of time greater than 1 year (correct)
- Immediate benefits within 6 months
- Benefits that are exclusive to the first year
What do managers compare actual costs and benefits against?
What do managers compare actual costs and benefits against?
- Other firms' financial projections
- General economic trends
- Historical data from previous projects
- Projections used to justify the investment (correct)
What characterizes independent projects?
What characterizes independent projects?
- They rely on the same cash flow
- Their cash flows are unrelated to one another (correct)
- They are mutually exclusive of one another
- They require simultaneous approval from finance personnel
What happens to mutually exclusive projects?
What happens to mutually exclusive projects?
What is indicated if a project has a payback period greater than the maximum acceptable payback period?
What is indicated if a project has a payback period greater than the maximum acceptable payback period?
Which step involves proposals being reviewed by finance personnel?
Which step involves proposals being reviewed by finance personnel?
During the follow-up phase, what actions might managers take based on actual outcomes?
During the follow-up phase, what actions might managers take based on actual outcomes?
What is the primary focus of the review and analysis step?
What is the primary focus of the review and analysis step?
What are Authorized Shares?
What are Authorized Shares?
What does the Accept–Reject Approach in capital budgeting primarily evaluate?
What does the Accept–Reject Approach in capital budgeting primarily evaluate?
What indicates that a project should be accepted when using the Net Present Value (NPV) method?
What indicates that a project should be accepted when using the Net Present Value (NPV) method?
What are Supervoting Shares primarily used for?
What are Supervoting Shares primarily used for?
What does Treasury Stock represent?
What does Treasury Stock represent?
When capital is rationed, what does it mean for a firm?
When capital is rationed, what does it mean for a firm?
Which of the following best describes Preemptive Rights?
Which of the following best describes Preemptive Rights?
How is the Profitability Index calculated?
How is the Profitability Index calculated?
What is the primary purpose of a Proxy Statement?
What is the primary purpose of a Proxy Statement?
Which type of stock ownership is characterized by being owned by unrelated investors?
Which type of stock ownership is characterized by being owned by unrelated investors?
What does a Payback Period indicate?
What does a Payback Period indicate?
What does the term 'Dilution of Ownership' imply?
What does the term 'Dilution of Ownership' imply?
What is the primary use of the Internal Rate of Return (IRR) in capital budgeting?
What is the primary use of the Internal Rate of Return (IRR) in capital budgeting?
What would lead to rejecting a project based on the Payback Period criterion?
What would lead to rejecting a project based on the Payback Period criterion?
Which of these accurately describes Outstanding Shares?
Which of these accurately describes Outstanding Shares?
When using the Ranking Approach in capital budgeting, what is primarily evaluated?
When using the Ranking Approach in capital budgeting, what is primarily evaluated?
What are American Depositary Shares (ADSs)?
What are American Depositary Shares (ADSs)?
What characteristic distinguishes preferred stock from common stock?
What characteristic distinguishes preferred stock from common stock?
How often do most corporations that pay dividends typically distribute them?
How often do most corporations that pay dividends typically distribute them?
In which situation do preferred stockholders hold precedence over common stockholders?
In which situation do preferred stockholders hold precedence over common stockholders?
In a common-size income statement, how are items represented?
In a common-size income statement, how are items represented?
What is dilution of earnings?
What is dilution of earnings?
Why is preferred stock considered quasi-debt?
Why is preferred stock considered quasi-debt?
What is the purpose of issuing nonvoting common shares?
What is the purpose of issuing nonvoting common shares?
What does an income statement provide?
What does an income statement provide?
What is the purpose of cross-sectional analysis?
What is the purpose of cross-sectional analysis?
What ratio measures the percentage of each sales dollar remaining after costs are deducted?
What ratio measures the percentage of each sales dollar remaining after costs are deducted?
What do American Depositary Receipts (ADRs) allow U.S. investors to do?
What do American Depositary Receipts (ADRs) allow U.S. investors to do?
What is the primary focus of market ratios?
What is the primary focus of market ratios?
Which type of analysis combines both cross-sectional and time-series analyses?
Which type of analysis combines both cross-sectional and time-series analyses?
Dividends per share represent what financial metric?
Dividends per share represent what financial metric?
What does the degree of indebtedness ratio measure?
What does the degree of indebtedness ratio measure?
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Study Notes
Income Statement
- Summarizes a firm's operating results over a specific period.
- Includes cash flows from operating, investing, and financing activities.
- Highlights dividends paid per share, indicating cash distributed to shareholders.
Types of Ratio Comparisons
- Cross-Sectional Analysis: Compares financial ratios of different firms at a single point in time; aids in benchmarking against industry averages.
- Time-Series Analysis: Evaluates a firm’s financial performance over time.
- Combined Analysis: Merges both cross-sectional and time-series analyses for comprehensive evaluation.
Capital Expenditure vs. Operating Expenditure
- Capital Expenditure: Funds spent on long-term projects expected to yield benefits over one year.
- Operating Expenditure: Short-term spending providing immediate benefits, typically within one year.
Capital Budgeting Process
- Proposal Generation: Managers propose new investments which undergo rigorous review, especially costly ones.
- Review and Analysis: Financial managers analyze investment proposals' viability.
- Implementation: After approval, projects are financed and executed, often in phases.
- Follow-Up: Managers monitor outcomes and adjust based on actual vs. projected performance.
Project Types
- Independent Projects: Cash flows are not affected by other projects; accepting one does not impact the rest.
- Mutually Exclusive Projects: Acceptance of one eliminates consideration of others serving similar functions.
Decision Criteria
- Payback period criteria: Accept if it is less than the maximum acceptable period.
- Net Present Value (NPV): Accept if NPV > 0;rejectifNPV<0; reject if NPV < 0;rejectifNPV<0.
- Internal Rate of Return (IRR): Accept if IRR > cost of capital; reject if IRR < cost of capital.
Stock Valuation
- Common Stock Ownership: Varied ownership structures - privately owned, publicly owned, closely owned, and widely owned.
- Shares Classifications:
- Authorized Shares: Maximum allowed to be issued based on corporate charter.
- Outstanding Shares: Shares held by investors, including those bought back as treasury stock.
- Treasury Stock: Shares repurchased by the firm.
Common Stock Attributes
- Voting Rights: Common stock typically grants one vote per share; proxy statements facilitate voting via representatives.
- Preemptive Rights: Allow existing shareholders to maintain ownership percentage during new share issues.
- Dilution: Occurs due to new shares issued, affecting both ownership and earnings per share.
Dividends
- Payment is at the board's discretion; most firms distribute quarterly.
- Cash Dividends: Commonly paid as fixed periodic amounts, resembling interest on debt.
Preferred Stock
- Considered quasi-debt due to fixed dividend promises but lacks a maturity date.
- Preferred shareholders have priority over common stockholders in asset liquidation during bankruptcy.
International Stock Issues
- American Depositary Shares (ADSs): Represent foreign company stocks held by U.S. banks.
- American Depositary Receipts (ADRs): Allow U.S. investors to trade shares of non-U.S. companies, facilitating international investment.
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