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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 AssetsCurrent Ratio = ------------------------
Current Liabilities
QuickRatio
Quick Assets
Quick Ratio = ----------------------
Current Liabilities
Quick Assets = Current Assets - Inventories
Net Working Capital Ratio
Net Working Capital
Net Working Capital Ratio = --------------------------
Total Assets
Net Working Capital = Current Assets - Current Liabilities
Profitability Analysis Ratios
Return on Assets (ROA)
Net Income
Return on Assets (ROA) = ----------------------------------
Average Total Assets
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Average Total Assets = (Beginning Total Assets + Ending Total Assets) / 2
Return on Equity (ROE)
Net Income
Return on Equity (ROE) = --------------------------------------------
Average Stockholders' Equity
Average Stockholders' Equity= (Beginning Stockholders' Equity + Ending Stockholders' Equity) / 2
Return on Common Equity (ROCE)
Net Income
Return on Common Equity = --------------------------------------------
Average Common Stockholders' Equity
Average Common Stockholders' Equity
= (Beginning Common Stockholders' Equity + Ending Common Stockholders' Equity) / 2
Profit Margin
Net Income
Profit Margin = -----------------
Sales
Earnings Per Share (EPS)
Net Income
Earnings Per Share = ---------------------------------------------
Number of Common Shares Outstanding
Activity Analysis Ratios
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Assets Turnover Ratio
Sales
Assets Turnover Ratio = ----------------------------
Average Total Assets
Average Total Assets = (Beginning Total Assets + Ending Total Assets) / 2
Accounts Receivable Turnover Ratio
Sales
Accounts Receivable Turnover Ratio = -----------------------------------
Average Accounts Receivable
Average Accounts Receivable
= (Beginning Accounts Receivable + Ending Accounts Receivable) / 2
Inventory Turnover Ratio
Cost of Goods Sold
Inventory Turnover Ratio = ---------------------------
Average Inventories
Average Inventories = (Beginning Inventories + Ending Inventories) / 2
Capital Structure Analysis Ratios
Debt to Equity Ratio
Total Liabilities
Debt to Equity Ratio = ----------------------------------
Total Stockholders' Equity
Interest Coverage Ratio
Income Before Interest and Income Tax Expenses
Interest Coverage Ratio = -------------------------------------------------------
Interest Expense
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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
Price Earnings Ratio = ------------------------------------------------------
Earnings Per Share
Market to Book Ratio
Market Price of Common Stock Per Share
Market to Book Ratio = -------------------------------------------------------
Book Value of Equity Per Common Share
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
Dividend Yield = ------------------------------------------------
Market Price of Common Stock Per Share
Book Value of Equity Per Common Share= Book Value of Equity for Common Stock / Number of Common Shares
Dividend Payout Ratio
Cash Dividends
Dividend Payout Ratio = --------------------
Net Income
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Net Income Net Income Sales
ROA = ------------------------ = -------------- X ---------------
Average Total Assets Sales Average Tota
Profit Margin = Net Income / SalesAssets Turnover Ratio = Sales / Averages Total Assets
1) Capital budgeting techniques.
Internal Rate Of Return And Mutually ExclusiveProjects
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. Thecash 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.
OA = Profit Margin X Assets Turnover Ratio
ROA = Profit Margin X Assets Turnover Ratio
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1. The cash outflow of the projects may differ. i.e. a project may need capital outlay not only at the time ofinvestment 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, wewill 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 subtractingnet investment from the discounted net cash flows. The result is called the Net PresentValue(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. Ifthey pick all projects that add to the value of the company they would choose all projects withpositive net present values, even if that value is just $1. On the other hand, if they have limitedresources, 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 followingnet cash flows be if the company's cost of capital is 5%? NCF's for year one is $25,000, for yeartwo is $36,000 and for year three is $5000.
YrNet
Cash Flows x PVIF@5%DiscountedCash Flows
1 $25,000 .952 $23,800
2 $36,000 .907 $32,652
3 $5,000 .864 $4,320
Total Discounted Cash Flows Discounted at 5%
Less: Net Investment
Net Present Value
$60,772
$40,000
$20,772
The internal rate of return (IRR) on a project is the rate of return where the cash inflows (net cashflows) equals the cash outflows (net investment.) The easiest way to find IRR is to use a financialcalculator 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 investmentshown as a negative number.The column of data appears:
A B
1 -10000
2 5000
3 4000
Once you have entered the column of numbers as detailed,position the cursor in an adjacent, empty cell and insert afunction by selecting Function... from the Insert menu onthe menu bar at the top of the screen.In the Paste Function dialog box you will notice twocolumns, Function category and Function name. SelectFinancial as the category and IRR as the name and clickOK. Once doing this, you will notice a IRR dialog box
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4 3000
5 2000
6 1000
7
appearing which asks you for Values. Values is thereference to cells that contain numbers for which you wantto calculate IRR; in this case cells A1 through A6. Entercells A1 through A6 as A1:A6 and click OK. You will noticethe IRR is returned as 20%.
In our example, we calculate the IRR to two decimal places. So to do this, select the cell containingthe IRR and click Format on the menu bar at the top of the screen. Then click Cells... and theCategory Percentage should be highlighted. On the right you will notice a box allowing you tochange the Decimal places. In this box, enter 2 and click OK. The IRR is now 20.27%.
Capital Budgeting
What Does Capital BudgetingMean?
The process in which a business determines whether projects such as building a new plant orinvesting in a long-term venture are worth pursuing. Oftentimes, a prospective project's lifetimecash 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 themost 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.
Financialposition/PerformanceThe level ofperformance of a business over a specified period of time, expressedin terms ofoverallprofits and losses during that time. Evaluatingthe financial performance of a business allows decision-makerstojudge the results of business strategies and activities in objectivemonetaryterms.
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
arbitrageopportunity of buying a product or service in one country and
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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 ofU.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 competitivemarkets for the goods and services in
both countries.
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.
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 heavywithdrawals.
Libor & kibor
Libor
London Inter-Bank Offer Rate. The interest rate that the bankscharge
each other for loans (usually in Eurodollars). This rate is applicable to
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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 liquidityrequirements 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 investorsdemandadditional
expected return(called the risk premium) ifasked 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.
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Effectiveness of credit control lies in proceduresemployed for judging
a prospect'screditworthiness, rather than in procedures used in extracting the
owed money. Also called credit management.
Market data
Data reflecting current trading information to include pricing andvolume and other additional information related to the trade. Marketdata helps traders and investors learn as much as possible about dailytrades. In finance, market data is associated with investmentinstruments.
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 incomesources
and expenditures.
Risk & return
A concept whereby an investor must realize the impossibility ofachieving a return on their investment without facing the certainamount of risk involved the process.
E Banking/Home Banking
Facility to securely accessfunds, accountinformation, and other banking
services through a PC over a wide area network or internet. Also called electronic
banking.
Private & public limited
Private Ltd. Company
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MBA Questions Answers
11/17
A type of company that offerslimited liability to its shareholders but
that places certain restrictionson its ownership. These restrictions are spelled
out in the companys articles of association or bylaws and are meant to prevent
any hostile takeover attempt.
The major ownership restriction are: (1) shareholders
cannot sell or transfer their shares without offering them first to the other
shareholders for purchase, (2) shareholders cannot offer their shares
or debentures to the generalpublic 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. Publiclimited 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 rateinclude (1) interest rates, (2) inflation rate, (3) trade balance, (4)
political stability, (5) internal harmony, (6) highdegree oftransparency in
the conduct of leaders and administrators, (7) general state ofeconomy, and
(8) quality ofgovernance.
Internal audit
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MBA Questions Answers
12/17
Frequent or ongoing audit conducted by a firm'sown (as opposed
to independent) accountants to (1) monitor operatingresults, (2)
verify financialrecords, (3) evaluate internal controls, (4) assist with
increasing efficiency and effectiveness ofoperations and, (5) to detect fraud.
Internal audit can identify controlproblems, and aims at correcting lapses before
they are discovered during an external audit. Although the internal auditors arethe 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, without too
many compromises in system integrity, security, and control.
2. Management: Intentional reduction in the size of a workforce at
all staffinglevels, to survive a down turn, improveefficiencies, or become a
more attractivecandidate 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 cost-
cutting, reduction ofworkforce, or reorganizing upper-level management.
The goal is to get the company molded properly to achieve the maximumprofit.
The term rightsizing is often used by companies instead ofdownsizing because it
sounds less drastic. "The company felt that rightsizing was necessary after four
quarters of losses."
Economic Cycle
Recurring, fairly predictable, generalpattern ofperiodic 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.
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MBA Questions Answers
13/17
FOH (Factory over Head)
The costsassociated in the manufacturingprocess, like a
federalcontract to produce a new researchdrug.
Lifo & fifo
LIFO
Last In First Out. A method of valuing inventory in which the itemsacquired last are treated as the ones sold first.
FIFO
First In First Out. A method of valuing the cost of goods soldthat uses the cost of the oldest items in inventory first.
Sole Proprietorship
A business structure in which an individual and his/her company areconsidered a singleentity for tax and liability purposes. A soleproprietorship is a company which is not registered with the state as alimited liability company or corporation. The owner does not payincome tax separately for the company, but he/she reportsbusiness
income or losses on his/her individual income tax return. The owner isinseparable from the sole proprietorship, so he/she is liable for anybusinessdebts .also called proprietorship.
Retained earnings
Profits generated by a company that are not distributed to
stockholders (shareholders) as dividends but are either reinvested in
the business or kept as a reserve for specific objectives (such as to pay
offa 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'sinception. 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.
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Accrued income, deferred income & unearned income
Accrued Income
Amountearned in the currentaccounting period, but which will be received in asubsequent 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 currentliabilityon the balance sheet until it is
recognized as earned income during the accounting cycle.
2. Taxation: Income derived from means other than the
provision ofpersonal efforts, such as that derived as 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 invoiceamount is reduced when a condition is
complied with, such as paymenton 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 (currentcompound
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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. Securitiestrading: Amount by which the market value of a bond, certificate
ofdeposit, or share (stock) is below its par value.
Hurdle Rate
Minimumreturn on investment necessary to cover all costsassociated witha project. If the expected rate of return is below the hurdle rate, the project isabandoned or is modified to increase the return. It must be equal to theincremental cost of capital and is also called break-even yield.
Incremental cost of capital
The average cost incurred for each additionalunit ofdebt or equityissued.
Initial Public Offering (IPO)
IPO. The first sale ofstock by a company to the public. The most commonreason for a company to initiate an IPO is in order to raise more capital. Oneof the most difficult parts of an IPO is to determine the properpriceto initiallyoffer the new stock; too high and investors won'tbe interested, but too low
and the company is sacrificing the amount ofmoney that might have beenmade if they priced it higher. There is generally a significant amount ofriskin an IPO, because the company going public is frequently small or relativelyunknown, and hasn't had a chance to prove itself to the public; as such, theyalso have the capacity for significant payoffs.
Contribution margin
The salesprice minus the variable cost.
Breakeven point
1. The price at which an option's cost is equal to the proceeds acquired byexercising the option. For a call option, it is the strike price plusthe premiumpaid. For a put option, it is the strike price minus the premium
paid.
2. The price at which a securitiestransactionproduces neither a gain nor a loss.
3. The volume ofsales at which a company'snet sales just equals its costs.
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Breakeven Analysis
A calculation of the approximatesales volumerequired to just covercosts,
below which production would be unprofitable and above which it would beprofitable. 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 ofwear and
tear, age, or obsolescence. Most assets lose their value over time (inother words, they depreciate), and must be replaced once the end of their useful
life is reached. There are several accounting methods that are usedin order to write offan 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 cashflow.
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 haveto pay more dollars in order to obtain the originalamount of Euros beforedepreciation occurred.
Financial markets (money market, capital market, primary market, secondary
market)
Money market
Market for short-term debtsecurities, such as banker's acceptances, commercialpaper, repos, negotiablecertificates ofdeposit, and Treasury Bills witha maturity of one year or less and often 30 days or less. Money market securitiesare generally very safe investments which return a relatively low interestrate that is most appropriate for temporary cash storage or short-term timehorizons. Bid and askspreads are relatively small due to the large size andhigh liquidity of the market.
Capital Market
A market where debt or equity securities are traded.
Primary Market
The market for new securitiesissues. In the primary market the security ispurchased directly from the issuer. This differs from the secondary market.
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