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Be Superior in Accounting / Finance

Wednesday, 18 May 2011


MBA (Finance) Important Viva Questions & Answers of AIOU, Pakistan
Ratio Analysis

Liquidity Analysis Ratios Current Ratio

Current Ratio =

Current Assets -----------------------Current Liabilities

Quick Ratio Quick Assets ---------------------Current Liabilities

Quick Ratio =

Quick Assets = Current Assets - Inventories

Net Working Capital Ratio Net Working Capital -------------------------Total Assets

Net Working Capital Ratio =

Net Working Capital = Current Assets - Current Liabilities

Profitability Analysis Ratios Return on Assets (ROA) Net Income ---------------------------------Average Total Assets

Return on Assets (ROA) =

Average Total Assets = (Beginning Total Assets + Ending Total Assets) / 2

Return on Equity (ROE) Net Income -------------------------------------------Average Stockholders' Equity

Return on Equity (ROE) =

Average Stockholders' Equity = (Beginning Stockholders' Equity + Ending Stockholders' Equity) / 2

Return on Common Equity (ROCE) Net Income -------------------------------------------Average Common Stockholders' Equity

Return on Common Equity =

Average Common Stockholders' Equity = (Beginning Common Stockholders' Equity + Ending Common Stockholders' Equity) / 2

Profit Margin Net Income ----------------Sales

Profit Margin =

Earnings Per Share (EPS) Net Income --------------------------------------------Number of Common Shares Outstanding

Earnings Per Share =

Activity Analysis Ratios

Assets Turnover Ratio Sales ---------------------------Average Total Assets

Assets Turnover Ratio =

Average Total Assets = (Beginning Total Assets + Ending Total Assets) / 2

Accounts Receivable Turnover Ratio Sales ----------------------------------Average Accounts Receivable

Accounts Receivable Turnover Ratio =

Average Accounts Receivable = (Beginning Accounts Receivable + Ending Accounts Receivable) / 2

Inventory Turnover Ratio Cost of Goods Sold --------------------------Average Inventories

Inventory Turnover Ratio =

Average Inventories = (Beginning Inventories + Ending Inventories) / 2

Capital Structure Analysis Ratios Debt to Equity Ratio Total Liabilities ---------------------------------Total Stockholders' Equity

Debt to Equity Ratio =

Interest Coverage Ratio Income Before Interest and Income Tax Expenses ------------------------------------------------------Interest Expense

Interest Coverage Ratio =

Income Before Interest and Income Tax Expenses = Income Before Income Taxes + Interest Expense

Capital Market Analysis Ratios Price Earnings (PE) Ratio Market Price of Common Stock Per Share -----------------------------------------------------Earnings Per Share

Price Earnings Ratio =

Market to Book Ratio Market Price of Common Stock Per Share ------------------------------------------------------Book Value of Equity Per Common Share

Market to Book Ratio =

Book Value of Equity Per Common Share = Book Value of Equity for Common Stock / Number of Common Shares

Dividend Yield Annual Dividends Per Common Share -----------------------------------------------Market Price of Common Stock Per Share

Dividend Yield =

Book Value of Equity Per Common Share = Book Value of Equity for Common Stock / Number of Common Shares

Dividend Payout Ratio Cash Dividends -------------------Net Income

Dividend Payout Ratio =

ROA = Profit Margin X Assets Turnover Ratio ROA = Profit Margin X Assets Turnover Ratio

ROA =

Net Income ------------------------ = Average Total Assets

Net Income -------------- X Sales

Sales -----------------------Average Total Assets

Profit Margin = Net Income / Sales Assets Turnover Ratio = Sales / Averages Total Assets

1) Capital budgeting techniques.

Internal Rate Of Return And Mutually Exclusive Projects


Internal Rate Of Return And Mutually Exclusive Projects. Whats the Concern? While considering the mutually exclusive projects, IRR technique can be misleading. Investment projects are said to be mutually exclusive if only one project could be accepted and others would have to be rejected. NPV and IRR methods for project evaluation leads to conflicting results under following conditions: 1. The pattern of cash inflows plays an important role in project evaluation while using IRR method. i.e. The cash flows of one project may increase over time, while those of others may decrease and vice versa. The major drawback with the IRR method is that for mutually exclusive projects, it can give contradictory investment decision when compared with NPV.

In the above example A and B are mutually exclusive projects. Both projects require an initial outlay of $ 1,000,000.00 but the pattern of cash inflows is different. Cash inflows for Project A are increasing over the period of time while for Project B these are declining. IRR decision rule leads to select Project A as Project A IRR>Project B IRR. But decision on the basis of NPV evaluation implies that project B is more viable. Thus on the basis of mere IRR the company may select less profitable project.

1.

The cash outflow of the projects may differ. i.e. a project may need capital outlay not only at the time of investment but after regular intervals during its expected life. Consider the following example:

Project A requires an initial outlay at the beginning of the project while Project B needs cash outflow in year 2 and year 4 also. Decision based on IRR method leads to select project B but NPV of project B is less than of Project A. again under such circumstances IRR method plays a deceive role. Summarizing the above discussion the timings and pattern of cash flows can produce conflicting results in the NPV and IRR methods of project evaluation.

There are a number of capital budgeting techniques available to an analyst. For our purposes, we will only review net present value and internal rate of return. Net Present Value The Net Present Value technique involves discounting net cash flows for a project, then subtracting net investment from the discounted net cash flows. The result is called the Net Present Value(NPV). If the net present value is positive, adopting the project would add to the value of the company. Whether the company chooses to do that will depend on their selection strategies. If they pick all projects that add to the value of the company they would choose all projects with positive net present values, even if that value is just $1. On the other hand, if they have limited resources, they will rank the projects and pick those with the highest NPV's. The discount rate used most frequently is the company's cost of capital. For Example: What would the net present value for a project with a net investment of $40,000 and the following net cash flows be if the company's cost of capital is 5%? NCF's for year one is $25,000, for year two is $36,000 and for year three is $5000. Yr 1 2 3 Net Cash Flows $25,000 $36,000 $5,000 x PVIF@5% .952 .907 .864 Discounted Cash Flows $23,800 $32,652 $4,320 $60,772 $40,000 $20,772

Total Discounted Cash Flows Discounted at 5% Less: Net Investment Net Present Value

The internal rate of return (IRR) on a project is the rate of return where the cash inflows (net cash flows) equals the cash outflows (net investment.) The easiest way to find IRR is to use a financial calculator or spreadsheet program. An example of a project with a net investment of $10,000, net cash flows of $5,000, $4,000, $3,000, $2,000, $1,000 for years 1-5 returns an IRR of 20.27%. To determine this using Microsoft Excel, enter the numbers in a column with the net investment shown as a negative number. The column of data appears: Once you have entered the column of numbers as detailed, position the cursor in an adjacent, empty cell and insert a A B function by selecting Function... from the Insert menu on the menu bar at the top of the screen. 1 -10000 In the Paste Function dialog box you will notice two 2 5000 columns, Function category and Function name. Select Financial as the category and IRR as the name and click 3 4000 OK. Once doing this, you will notice a IRR dialog box

4 5 6 7

3000 2000 1000

appearing which asks you for Values. Values is the reference to cells that contain numbers for which you want to calculate IRR; in this case cells A1 through A6. Enter cells A1 through A6 as A1:A6 and click OK. You will notice the IRR is returned as 20%.

In our example, we calculate the IRR to two decimal places. So to do this, select the cell containing the IRR and click Format on the menu bar at the top of the screen. Then click Cells... and the Category Percentage should be highlighted. On the right you will notice a box allowing you to change the Decimal places. In this box, enter 2 and click OK. The IRR is now 20.27%.

Capital Budgeting
What Does Capital Budgeting Mean? The process in which a business determines whether projects such as building a new plant or investing in a long-term venture are worth pursuing. Oftentimes, a prospective project's lifetime cash inflows and outflows are assessed in order to determine whether the returns generated meet a sufficient target benchmark. Also known as "investment appraisal". Investopedia explains Capital Budgeting

Ideally, businesses should pursue all projects and opportunities that enhance shareholder value. However, because the amount of capital available at any given time for new projects is limited, management needs to use capital budgeting techniques to determine which projects will yield the most return over an applicable period of time. Popular methods of capital budgeting include net present value (NPV), internal rate of return (IRR), discounted cash flow (DCF) and payback period.

Financial position/Performance
The level of performance of a business over a specified period of time, expressed in terms of overall profits and losses during that time. Evaluating the financial performance of a business allows decision-makers to judge the results of business strategies and activities in objective monetary terms.

PPP (purchasing power parity)


The theory that, in the long run, identical products and services in different countries should cost the same in different countries. This is based on the belief that exchange rates will adjust to eliminate the arbitrage opportunity of buying a product or service in one country and

selling it in another. For example, consider a laptop computer that costs 1,500 Euros in Germany and an exchange rate of 2 Euros to 1 U.S. Dollar. If the same laptop cost 1,000 dollars in the United States, U.S. consumers would buy the laptop in Germany. If done on a large scale, the influx of U.S. dollars would drive up the price of the Euro, until it equalized at 1.5 Euros to 1 U.S. Dollar - the same ratio of the price of the laptop in Germany to the price of the laptop in the U.S. The theory only applies to tradable goods, not to immobile goods or local services. The theory also discounts several real world factors, such as transportation costs, tariffs and transaction costs. It also assumes there are competitive markets for the goods and services in both Zero base budgeting Budgeting method for a corporation or government in which all expenditures must be justified each year, not just amounts in excess of the previous year. countries.

Lender of loss resort


A function of a central bank, such as the Federal Reserve, in which it lends money to a bank which is facing unusually heavy withdrawals.

Libor & kibor


Libor London Inter-Bank Offer Rate. The interest rate that the banks charge each other for loans (usually in Eurodollars). This rate is applicable to

the short-term international inter bank market, and applies to very large loans borrowed for anywhere from one day to five years. This market allows banks with liquidity requirements toborrow quickly from other banks with surpluses, enabling banks to avoid holding excessively large amounts of their asset base as liquid assets. The LIBOR is officially fixed once a day by a small group of large London banks, but the rate changes throughout the day.

Kibor (Karachi Inter-bank offer rate)


It is Karachi Inter Bank Offer Rate (KIBOR), given by specialized institution on daily, weekly, monthly and on 1, 2 and 3 yearly basis to all the commercial banks of Pakistan so that they charge interest to their customers on that basis. This rate is inflation adjusted rate and then banks by adding 2 or 3% in KIBOR rate charge their customers for their profit.

Capital Asset pricing Model (CAPM)


CAPM. An economic model for valuing stocks by relating risk and expected return. Based on the idea that investors demand additional expected return(called the risk premium) if asked to accept additional risk.

Credit management/Credit Control


Activity aimed at serving the dual purpose of (1) increasing sales revenue by extending credit to customers who are deemed a good credit risk, and (2) minimizing risk of loss from bad debts by restricting or denying credit to customers who are not a good credit risk.

Effectiveness

of

credit

control

lies

in procedures employed

for

judging

a prospect's creditworthiness, rather than in procedures used in extracting the owed money. Also called credit management.

Market data
Data reflecting current trading information to include pricing and volume and other additional information related to the trade. Market data helps traders and investors learn as much as possible about daily trades. In finance, market data is associated with investment instruments.

Matching principal
The principle inbusiness accounting that states that revenues generated during an accounting period should be matched to expenses from that period, in order to capture the cause-and-effect relationship between them. Adherence to this principle produces accounting records that capture meaningful connections between income sources and expenditures.

Risk & return


A concept whereby an investor must realize the impossibility of achieving a return on their investment without facing the certain amount of risk involved the process. E Banking/Home Banking
Facility to securely access funds, account information, and other banking services through a PC over a wide area network or internet. Also called electronic banking.

Private & public limited Private Ltd. Company

type

of company that offers limited

liability to

its

shareholders but

that places certain restrictions on its ownership. These restrictions are spelled out in the companys articles of association or bylaws and are meant to prevent any hostile The major ownership restriction are: shareholders for purchase, (2) shareholders (1) first to offer cannot takeover attempt. shareholders the their other shares

cannot sell or transfer their shares without offering them

or debentures to the general public over a stock exchange, (3) the number of shareholders cannot exceed a fixed figure (commonly 50).

Public Limited Company


A company whose securities are traded on a stock exchange and can

be bought and sold by anyone. Public companies are strictly regulated, and are required by law to publish their complete and true financial position so thatinvestors can determine the true worth of its stock(shares). Also called publicly held company. Public limited company and its abbreviation Plc are commonly used in the UK in the way that corporation and Inc. is used in the United States.

Exchange rate
Price for which the currency of a country can be exchanged for another country's currency. Factors that influence exchange rate include (1) interest rates, (2) inflation rate, (3) trade balance, (4) political stability, (5) internal harmony, (6) high degree of transparency in the conduct of leaders and administrators, (7) general state of economy, and (8) quality of governance.

Internal audit

Frequent or ongoing audit conducted by a firm's own (as opposed to independent) accountants to (1) monitor operating results, (2) verify financial records, (3) evaluate internal controls, (4) assist with increasing efficiency and effectiveness of operations and, (5) to detect fraud. Internal audit can identify control problems, and aims at correcting lapses before they are discovered during an external audit. Although the internal auditors are the firm's employees, they normally do not audit themselves or their own departments, but entrust it usually to independent auditors.

Downsizing & right sizing


Downsizing
1. Computing: Adapting mainframe computer based software to a desktop or personal computer (PC) based architecture, the size of a without too many compromises in system integrity, security, and control. 2. Management: Intentional reduction in workforce at all staffing levels, to survive a down turn, improve efficiencies, or become a more attractive candidate for acquisition or merger. Used often as a euphemism for indiscriminately firing the employees. See also rationalization.

Rightsizing The process of a corporation reorganizing or restructuring their business by costcutting, reduction of workforce, or reorganizing upper-level management. The goal is to get the company molded properly to achieve the maximum profit. The term rightsizing is often used by companies instead of downsizing because it sounds less drastic. "The company felt that rightsizing was necessary after four quarters of losses."

Economic Cycle
Recurring, fairly predictable, general pattern of periodic fluctuations (as measured by gross national product) in national economies. Left to themselves, all market economies repeatedly (typically every five years) move through four stages of (1) expansion, (2) peak, (3)recession, and (4) recovery. Despite numerous attempts to explain causes of economic cycles, no theory is universally accepted or applicable. Also called business cycle or trade cycle.

FOH (Factory over Head)


The costs associated in the manufacturing process, like a

federal contract to produce a new research drug.

Lifo & fifo LIFO


Last In First Out. A method of valuing inventory in which the items acquired last are treated as the ones sold first. FIFO
First In First Out. A method of valuing the cost that uses the cost of the oldest items in inventory first. of goods sold

Sole Proprietorship
A business structure in which an individual and his/her company are considered a single entity for tax and liability purposes. A sole proprietorship is a company which is not registered with the state as a limited liability company or corporation. The owner does not pay income tax separately for the company, but he/she reports business income or losses on his/her individual income tax return. The owner is inseparable from the sole proprietorship, so he/she is liable for any business debts .also called proprietorship.

Retained earnings
Profits generated the business or by kept as a company a reserve for that specific are are not either distributed reinvested as to in

stockholders (shareholders)

as dividends but

objectives (such

to pay

off a debt or purchase a capital asset). A balance sheet figure shown under the heading retained earnings is the sum of all profits retained since the company's inception. Retained earnings are reduced by losses, and are also called accumulated earnings, accumulated profit, accumulated income, accumulated surplus, earned surplus, undistributed earnings, or undivided profits. See also retention ratio.

Accrued income, deferred income & unearned income Accrued Income


Amount earned in the current accounting period, but which will be received in a subsequent period.

Deferred Income
1. General: Income received after the period in which it was earned, such as sales commission that is computed quarterly. 2. Accounting: Income received or recorded before it is earned, and shown in the income statement only when it can be matched with the period in which it is earned.

Unearned Income
1. Accounting: Income received before a good is sold or a service is provided. Unearned income is classified as a current liability on the balance sheet until it is recognized as earned income during the accounting cycle. 2. Taxation: Income derived such as from means other that derived as than the provision of personal efforts, dividends, interest,

or rent. Pensions and royalties, however, are not considered unearned income.

Discount rate, hurdle rate Discount Rate


1. Banking: Rate at which a bill of exchange or an accounts

receivable is paid (discounted) before its maturity date. 2. Commerce: Rate by which an invoice amount is reduced when a condition is complied with, such as payment on delivery or an order amount that exceeds a certain minimum figure. 3. Investment appraisal: Multiplier that converts anticipated returns from an investment project to their current market value (present value). It is always less than 1, and depends on the cost of capital (current compound

interest rate) and the time interval between the investment date and the date when returns start to flow. Formula: 1 (1 + r) ^n where 'r' is the required rate of return (interest rate) and 'n' is the number of years. Also called discount factor or present value factor. See also discounted cash flow. 4. Securities trading: Amount by which the market value of a bond, certificate of deposit, or share (stock) is below its par value.

Hurdle Rate
Minimum return on investment necessary to cover all costs associated with a project. If the expected rate of return is below the hurdle rate, the project is abandoned or is modified to increase the return. It must be equal to the incremental cost of capital and is also called break-even yield. Incremental cost of capital

The average cost incurred for each additional unit of debt or equity issued.

Initial Public Offering (IPO)


IPO. The first sale of stock by a company to the public. The most common reason for a company to initiate an IPO is in order to raise more capital. One of the most difficult parts of an IPO is to determine the properpriceto initially offer the new stock; too high and investors won'tbe interested, but too low and the company is sacrificing the amount of money that might have been made if they priced it higher. There is generally a significant amount of risk in an IPO, because the company going public is frequently small or relatively unknown, and hasn't had a chance to prove itself to the public; as such, they also have the capacity for significant payoffs.

Contribution margin
The sales price minus the variable cost.

Breakeven point
1. The price at which an option's cost is equal to the proceeds acquired by exercising the option. For a call option, it is the strike price plus the premium paid. For a put option, it is the strike price minus the premium paid. 2. The price at which a securities transaction produces neither a gain nor a loss. 3. The volume of sales at which a company's net sales just equals its costs.

Breakeven Analysis
A calculation of the approximate sales volume required to just cover costs, below which production would be unprofitable and above which it would be profitable. Break-even analysis focuses on the relationship between fixed cost, variable cost, and profit.

Depreciation
1. A noncash expense that reduces the value of an asset as a result of wear and tear, age, or obsolescence. Most assets lose their value over time (in other words, they depreciate), and must be replaced once the end of their useful life is reached. There are several accounting methods that are used in order to write off an asset's depreciation cost over the period of its useful life. Because it is a non-cash expense, depreciation lowers the company's reported earnings while increasing free cash flow. 2. A decline in the value of a given currency in comparison with other currencies. For instance, if the U.S. dollar depreciates against the Euro, buyers would have to pay more dollars in order to obtain the original amount of Euros before depreciation occurred.

Financial markets (money market, capital market, primary market, secondary market) Money market
Market for short-term debt securities, such as banker's acceptances, commercial paper, repos, negotiable certificates of deposit, and Treasury Bills with a maturity of one year or less and often 30 days or less. Money market securities are generally very safe investments which return a relatively low interest rate that is most appropriate for temporary cash storage or short-term time horizons. Bid and ask spreads are relatively small due to the large size and high liquidity of the market.

Capital Market
A market where debt or equity securities are traded.

Primary Market
The market for new securities issues. In the primary market the security is purchased directly from the issuer. This differs from the secondary market.

Secondary Market/After Market


A market in which an investor purchases a security from another investor rather than the issuer, subsequent to the original issuance in the primary market. also called after market.