What does Finance study regarding monetary resources?
How individuals, businesses, and organizations raise, allocate, and use scarce monetary resources over time.
What distinguishes risk from uncertainty?
Risk involves uncertain outcomes that can be assessed, unlike uncertainty.
What does uncertainty describe in outcomes?
Outcomes that are not reliably predictable.
How does diversification reduce exposure?
By avoiding concentration in a single investment.
What rule summarizes the principle of diversification?
Never put all your eggs in one basket.
What are the key steps in financial decision making?
Assessing expected returns, evaluating investment opportunities, analyzing risk, and allocating assets.
What are the key benefits an equity holder receives?
Potential dividends and share-price appreciation.
What rights does an equity holder have that a debt holder does not?
Voting and control rights.
Who is paid first in liquidation, equity or debt holders?
Debt holders are paid before equity holders.
How does ownership differ between private and public companies?
Private companies have concentrated ownership among identified owners.
How does a public company offer ownership shares?
Through a stock-market listing to a broader investing public.
What is the opportunity cost of capital?
The return forgone on the best alternative investment with equivalent risk and term.
What must an expected return be compared with?
An appropriate benchmark like a time trend, competitors, or an alternative with the same risk.
What distinguishes required return from realized return?
Required return is an estimate used for today's decision, not the future realized return.
What should higher risk lead investors to require?
Higher return as compensation.
Does taking more risk guarantee a higher realized return?
No, it does not guarantee higher realized return.
What does historical evidence show about risk and return?
There is a statistical correlation between high risk and high return.
Does past performance guarantee future investment results?
No, past performance does not guarantee future results.
What does correlation between two variables fail to establish?
It fails to establish causation.
Name one important driver of value creation in companies.
Attracting and satisfying clients.
Do shareholders directly own a company’s assets?
No, shareholders own part of the company’s equity.
According to Berk and DeMarzo, what does the equity cost of capital represent?
The return required by shareholders to compensate for company risk.
What does financial analysis evaluate in a company?
Whether the company is financially healthy to retain stakeholder trust and attract investors.
Which three stakeholder perspectives drive financial analysis?
Equity-oriented, debt-capital-oriented, and compensation-oriented stakeholders.
What do equity-oriented stakeholders seek in financial analysis?
Valuation and returns.
Why must financial analysis combine multiple indicators?
Because there is no single indicator of good financial health.
What are the main steps in a financial analysis process?
Assess sector and accounting policies, analyze growth, profitability, risk, then communicate conclusions and recommendations.
What must a company do to survive in the long run?
Create shareholder value, meet stakeholder commitments, generate wealth, invest, finance investments, earn sufficient return, and manage illiquidity risk.
What does a balance sheet represent for a firm?
A snapshot of a firm’s financial position at a given point in time.
What equation must a balance sheet satisfy?
Total Assets = Liabilities + Shareholders' Equity.
Name two types of assets listed on a balance sheet.
Long-lived assets and inventories.
Why can the balance-sheet date affect financial interpretation?
Seasonal businesses show different inventories and cash balances at different times.
What does an income statement report?
Revenues and expenses over a period of time to measure accounting wealth creation.
How do operating expenses differ from investments in fixed assets?
Operating expenses reduce wealth immediately; fixed assets are capital expenditures not directly destroyed.
Why does net income usually differ from cash earned?
Accrual accounting records revenues and costs when sales occur, not when cash moves.
Why does net income usually differ from cash earned by a firm?
Because of non-cash items, accruals, and unrecorded cash uses.
When does accrual accounting recognize revenue?
When a sale is made, not when cash is received.
What does the cash flow statement assess and show?
It assesses cash generation ability and shows cash allocation in operations, investing, and financing.
What are the three components of the cash flow statement?
Cash flows from operations, investments, and financing.
What does depreciation represent in accounting?
The wearing out and value loss of fixed assets over time.
What is the formula for calculating working capital needs?
What do working capital needs represent in a business?
The short-term cash required to operate the business reflecting the time lag between cash outflows and inflows.
How much did JIT's working capital needs increase from Year 1 to Year 2?
They increased from €2.6 million to €3.3 million.
How much financing was required for JIT's working capital increase?
€700,000 was required to finance the increase.
What cash flow effect does a reduction in working capital needs have?
It generates a positive cash flow if the firm's functioning is not altered.
On what factors do working capital needs depend?
Sales, operating cycle length and nature, supplier credit terms, average collection period, and inventory turnover.
What is the formula for net financial debt?
Net financial debt equals financial debt minus cash and short-term investments.
How is capital employed calculated?
Capital employed equals fixed assets plus working capital and also equals shareholders’ equity plus net financial debt.
What was JIT’s capital employed in Year 2?
€124.0 million.
What was JIT’s capital employed in Year 1?
€83.5 million.
Why is analyzing financial debt important?
It helps assess default risk, management autonomy, financial distress and reputation, and the cost of capital.
What does book value of equity reflect compared to market value?
Book value reflects historical asset costs, market value reflects future expectations.
What is the formula for market capitalization?
Market capitalization equals market price per share times shares outstanding.
How is JIT's market capitalization calculated with 3.6 million shares at €14 each?
3.6 million shares times €14 equals €50.4 million market capitalization.
What was JIT's book value of equity in the example?
JIT's book value of equity was €32 million.
How is the market-to-book ratio calculated?
It equals market value of equity divided by book value of equity.
What does a market-to-book ratio of 1.5 indicate about investor willingness?
Investors pay one and a half times the book value of shares.
Why does positive net income not guarantee good future performance?
Non-cash items, accruals, extraordinary and non-recurring items can distort earnings quality.
What does EBITDA measure in a business?
Wealth generated by the core business.
Which factors do not alter EBITDA?
Investment policy, depreciation methods, financial debt, taxes, and non-recurring items.
What does positive free cash flow indicate about a company's cash generation?
Operating cash generation covers operating and investment needs.
What can a company do with positive free cash flow?
Pay dividends or reduce debt.
What must a company do if free cash flow is negative?
Raise additional financial resources.
Why was JIT’s free cash flow negative €38.5 million?
Because cash from operating activities was €1.3 million and capital expenditures were €39.8 million.
What does Free Cash Flow greater than zero indicate about a firm?
The firm’s cash covers operating and investment needs and can pay dividends or reduce debt.
What must a company do if Free Cash Flow is less than zero?
Raise additional financial resources to cover capital requirements.
What is the formula for Free Cash Flow in the JIT example?
million euros.
What do free cash flows reflect about a company?
The financial strength or “muscles” of the company.
What does a margin measure relative to?
Profit relative to net revenue.
What does a return measure relative to?
Profit relative to invested capital.
How is the margin ratio calculated?
Profit divided by net revenue.
What do margin ratios indicate about a firm?
The firm’s ability to generate profit after expenses.
Why are margin ratios useful for comparison?
They help compare operating performance across firms and over time.
What was JIT’s Year 2 gross margin?
52.0%.
What was JIT’s Year 2 net margin?
1.1%.
How should margins be compared?
With an appropriate benchmark through time-trend, competitor, or target comparison.
Test your knowledge with 60 questions on Free Cash Flow and Time Value.
1. What does finance primarily study when monetary resources are scarce and decisions unfold over time?
2. Which situation best illustrates risk rather than uncertainty?
Review the complete course in the study sheet for Free Cash Flow and Time Value.
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