Question

1. Why do we take inventory out of Quick Ratio?
2. What does the Cash Conversion Cycle calculate (CCC)? Should firms generally try to increase or decrease the CCC? Why?
3. What is ROE commonly used for? Why is it important to analyze the sources of ROE (Du Pont analysis)?
4. Know what the Gross, Operating, and Net Profit margins are and what they communicate to an analyst.
5. What do the receivable turnover and receivable days communicate? Would a manager generally want these to increase or decrease? Why?
6. What do inventory turnover and inventory days on hand communicate? Would a manager generally want these to increase or decrease? Why?
7. Know Porter’s Five Forces and be prepared to identify what these are for an industry and how they affect the profitability of an industry.
8. Know Porter’s Three Generic Corporate Strategies. Be prepared to identify which strategy a company chooses (I’ll provide information on a firm) and how that affects the competitiveness and profitability of the firm.
9. Know the Sources and Uses of Cash for the statement of cash flows.
10. To know if financial statements are correctly constructed, I suggested looking for three things:
    1. Does the Balance Sheet Balance?
    2. Do Retained Earnings Flow Appropriately?
    3. Does the Cash Reconcile from One Year to the Next?
11. Know what Accumulated Depreciation, Retained Earnings, and Accrued Expenses are and how to calculate them.
12. Know how revenues and expenses are determined when using accrual accounting.
13. Be prepared to look at a financial statement and determine if it was constructed correctly.
14. Why is it important to estimate the cost of retained earnings?
15. Be prepared to calculate the cost of equity, cost of debt, and WACC is for a firm.
16. Be prepared to calculate unlevered (asset) betas and levered (equity) betas and know how a change in tax rates and capital structure affect the required rate of return on equity.
17. What are the three reasons why firms avoid issuing new equity?
18. What makes a firm a good or bad candidate to take on debt?
19. What does the beta in the CAPM measure?
20. Be prepared to identify whether a risk is a market risk or a firm-specific risk.
21. Why do firms spinoff their business divisions?
22. What is Capital Budgeting?
23. What is the difference between independent and mutually exclusive projects?
24. What is the NPV a measure of?
25. Why, theoretically, should a project be accepted if the NPV = 0 and/or the IRR = WACC?
26. Why might IRR and NPV not give the same ranking for mutually exclusive projects?
27. Why do managers often prefer using IRR to NPV for making capital budgeting decisions?
28. What is the modified internal rate of return (MIRR) and why is it useful?
29. What does the Profitability Index tell us about a project?
30. What does the Payback Period tell us about a project? Why should firms consider the payback period when evaluating a project?
31. Be prepared to calculate the NPV, IRR, Profitability Index, and Payback Period for two mutually exclusive projects and provide an answer as to which, if either, to choose.
32. What are externalities?

Answer 1

1. The Inventory often is not readily convertible to cash and hence does not represent a true picture of liquidity. Hence, we remove the inventory from the current assets while calculating quick ratio.

2. Cash conversion cycle gives you the amount of time it takes for the company to convert inventory into cash and pay the suppliers. So, the CCC = DIO + DSO - DPO where DIO is average inventory days, DSO is the account receivable days and DPO is days payable outstanding.

A business show try to reduce the CCC

3. ROE is used to determine the net return the stockholder;s are expected to make on average if they invest in the company. Also referred to as the return on equity.

As per DU pont, the components of ROE are Profit margin, total asset turnover and equity multiplier. Its important to analyse these sources since they give insights into the profits the company makes, explains if the assets are being utilized fully and also if the leverage is very high.

4. Gross margin just consider the gross profits which are nothing but sales less the cost of goods sold, the operating margin considers the EBIT and the net margin considers the net income or the bottom line.

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