Question Bank – Advanced Corporate Finance

1. Explain the meaning of surplus units and deficit units.

Surplus units are those units who receive more money than they spend. They can
be termed as investors. They provide their net savings to the financial markets while
deficit units are those units who spend more money than they received. They are
also termed as borrowers. They access funds from the financial markets.
2. Distinguish between primary and secondary markets.
Primary markets are those markets where fresh issuance of shares is done to raise
capital directly. IPO is an example of such market whereas secondary markets are
those market where trading of issued securities takes place, i.e., listing. Listing of IPO
and open trading is a secondary market.
3. What is the difference between debt instruments and equity?
Debt instruments (the issuer agrees Equity (issuer pay the investor an
to pay the investor interest, plus amount based on earnings, if any,
repay the amount borrowed), fixed after the obligation)
income instruments. Ex: common stock
Ex: Bonds, Loans, Notes (similar to
bonds but typically
have an earlier maturity date)

4. What is the difference between depository and non-depository institutions?

Depository institutions focus on collecting demand deposits from their
customers. Common types include credit unions, retail banks, and thrift banks. On
the other hand, non-depository institutions do not accept demand deposits. They
typically act as intermediaries, obtaining funds and then passing them off somewhere
else. Some common types include brokerage firms and insurance companies.
Depository Non-depository
Commercial banks, Savings Finance companies, Mutual funds,
institutions, Credit unions Securities companies, Insurance
companies, Pension funds
 5. Explain the term liability and differentiate between limited and unlimited
liability.
Liability in finance: Liabilities are the financial obligations a company owes to other
entities.
Unlimited liability: Unlimited Limited liability is a legal structure of
liability refers to the full legal organizations that limits the extent of
responsibility an economic loss to assets invested in
that business owners and partners the organization and that keeps the
assume for all business debts. This personal assets of investors and owners
liability is not capped, and obligations off-limits. (Investopedia)
can be paid through the seizure and
sale of owners’ personal assets.
(Investopedia

6. What are the similarities and difference between an Ltd. and a Plc.?
Similaritires Differences
• Both have limited
liability.
• Tax benefits. Parameters
• Raising finance - banks of LTD PLC
will be more willing to Comparison
lend becuase the status of
the company in Private owner Government
Supervision
increased. (one or many) mostly
• Business continuity.
Transfer of Not easily Easily
• Protecting the business share transferred transferred
name.
Government
Shareholders Private people and general
public

Aims their own Aims for public’s

Profit
profit profit

7. Highlight the difference between internal and external sources of financing.

INTERNAL FINANCING EXTERNAL FINANCING

Finance is generated within the The finance is sourced from outside
business. Internal sources are used of the business. External sources are
when the requirement of funding is used when the requirement of
limited. Cost of capital is low. funding is huge. Most of the time,
Ex: Retained earnings, reserves, collateral is required
profits, assets of the company; (especially when the amount is huge)
Ex: Equity financing, debt
financing, etc.
 8. What are the benefits and drawbacks of debt financing compared to those of
equity financing?
Benefits of debt financing Drawbacks of debt financing
Control: Taking out a loan is Qualification: The company and the
temporary. The relationship ends when owner must have acceptable credit
the debt is repaid. The lender does not ratings to qualify.
have any say in how the owner runs his Fixed payments: Principal and
business. interest payments must be made on
Taxes: Loan interest is tax deductible, specified dates without fail. Businesses
whereas dividends paid to shareholders that have unpredictable cash flows
are not. might have difficulties making loan
Predictability: Principal and interest payments. Declines in sales can create
payments are stated in advance, so it is serious problems in meeting loan
easier to work these into the company's payment dates.
cash flow. Loans can be short, medium Cash flow: Taking on too much debt
or long term makes the business more likely to have
problems meeting loan payments if cash
flow declines. Investors will also see the
company as a higher risk and be
reluctant to make additional equity
investments.
Collateral: Lenders will typically
demand that certain assets of the
company be held as collateral, and the
owner is often required to guarantee the
loan personally.

9. What is the difference between the future value and the present value of
money?
Present value refers to today's value of money.
Future value: Amount to which an investment will grow after earning interest.
10. What is the difference between compound and simple interest?
If the bank calculated the interest only on your original investment, you would be
paid simple interest.
Compound interests=interests on interests
Simple Interest = PV * r * t Compound interest-𝑭𝑽 = 𝑷𝑽(𝟏 + 𝒓)t
In this case, the variable PV is your FV: the future value of money
principal amount, r is your annual interest PV: the present value of money
rate, and t is the term of the loan, expressed r: the interest rate or rate of return per
in years. period
t: number of periods (years) of investment
– also called time
 11. What is the difference between nominal cash-flow and real cash-flow?
Nominal cash flow refers to the actual dollar amount of money that a company
expects to take in and pay out, without any adjustment for inflation.
Real cash flow is adjusted for inflation in order to reflect the change in the value of
money over time.
12. Explain the term ‘historic cost convention’.
A historical cost is a measure of value used in accounting in which the value of an
asset on the balance sheet is recorded at its original cost when acquired by the
company.
13. What is the balance sheet formula and explain in what way the balance sheet
reveals information on the company’s wealth?
The balance sheet is one of the three fundamental financial statements and is key
to both financial modelling and accounting. The balance sheet displays the company’s
total assets and how the assets are financed, either through either debt or equity. It
can also be referred to as a statement of net worth or a statement of financial
position.

TOTAL ASSETS = LIABILITIES+ OWNER’S EQUITY

14. How can you classify assets?

Types of Assets Classification

Convertibility Physical Existence Usage

Current Fixed Tangible Intangible Operating Non-

assets Assets Assets Assets Assets operating
Assets
 Types of Assets Classification

Convertibility Physical Existence Usage

Current Fixed Tangible Intangible Operating Non-

assets- Assets- Assets- Assets- Assets- operating
Asset that Fixed assets Tangible Intangible Operating Assets-
will are long- assets are assets do not assets are Non-
normally be term assets physical; exist in those assets operating
turned into that a they include physical acquired for assets are
cash within company cash, form and use in the assets that
a year. has inventory, include conduct of are not
purchased vehicles, things like the ongoing considered
and is using equipment, accounts operations to be part of
for the buildings receivable, of a a company's
production and pre-paid business; core
of its goods investments. expenses, this means operations.
and services. and patents assets that
and are needed
goodwill. to generate
revenue.

15. Give the three most important items of the current assets.
• Cash and temporary investments
• Accounts and notes receivable
• Inventories

16. How are assets valued on the balance sheet?

• The value of an asset as stated on the balance sheet is its “carrying value” (book
value).
• The balance sheet carries assets at their cost to the enterprise (historical cost
principle)
• Assets that contribute to an enterprise’s operations over a useful life of many
accounting periods, such as buildings and equipment, require adjustment to
historical cost.
• In order to match properly the revenue generated in each accounting period with
the expenses incurred to generate that revenue, enterprises systematically allocate
the costs of these types of assets over an estimated useful life.

• In order to match properly the revenue generated in each accounting period with
the expenses incurred to generate that revenue, enterprises systematically allocate
the costs of these types of assets over an estimated useful life. => This allocation
of costs is “amortization”.
 17. What is the function of the income statement and what information does it
reveal about the company’s wealth?
An income statement reconciles an enterprise’s revenues, expenses, gains, and losses
for an accounting period, and states the total of those items.
Though the main purpose of an income statement is to convey details of profitability
and business activities of the company to the stakeholders, it also provides detailed
insights into the company’s internals for comparison across different businesses and
sectors.
An income statement provides valuable insights into various aspects of a business. It
includes a company’s operations, the efficiency of its management, the possible leaky
areas that may be eroding profits, and whether the company is performing in line
with industry peers.
18. Describe the difference between financial and non-financial reporting.
Financial reporting refers to standard practices to give stakeholders an accurate
depiction of a company’s finances, including their revenues, expenses, profits, capital,
and cash flow, as formal records that provide in-depth insights into financial
information
Non-financial reporting, put simply, is a form of transparency reporting where
businesses formally disclose certain information not related to their finances,
including information on human rights.
19. In what way do equity and liabilities differ from each other in terms of claims?
There are two important differences between liabilities and equity.
• First, liabilities are claims held by outsiders, whereas equity is the aggregate claim
of a business’s owners.
• Second, the amount of an enterprise’s liabilities is independent of the amount of
its assets, whereas the amount of equity depends on the amounts of assets and
liabilities both.

20. What are the two types of cash obligations?

Most of a typical enterprise’s liabilities are obligations to pay cash.
These cash obligations fall into two categories.
a. accrued expenses, which an enterprise incurs by purchasing goods and services for
which payment is not due immediately
b. outstanding debt, which an enterprise incurs by borrowing cash
 21. What does equity include?
• Equity includes:
The number of outstanding shares is an integral part of shareholders' equity. It
is the amount of company stock that has been sold to investors and not
repurchased by the company.
• Shareholders' equity also includes the amount of money paid for shares of stock
above the stated par value, known as additional paid-in capital (APIC).
• When a company retains income instead of paying it out as a dividend to
stockholders, a positive balance in the company’s retained earnings account is
created.
• The final item included in shareholders' equity is treasury stock, which is the
number of shares that have been repurchased from investors by the company.

22. What are the most common income statement items?

The most common income statement items include:
1) Revenue/Sales, Cost of Goods Sold (COGS), Gross Profit, SG&A Expenses, EBITDA
2) Depreciation and amortization, Operating Income, Interest Expense, Other
Expenses, Earnings Before Tax (EBT), Net Income
23. What information can you retrieve from the cash flow statement?
The cash flow statement is simply an analysis of the cash (including short-term,
highly liquid investments) received and paid out by the business during a period. It is
arranged in such a way that it will enable readers to derive helpful insights about the
sources and uses of cash over the period.
24. How can you classify financial ratios?
A financial ratio is a comparison between one bit of financial information and
another.
We can classify ratios according to the way they are constructed and the financial
characteristic they are describing.
We can also classify ratios according to the dimension of the company’s performance
or condition.
• Liquidity
• Profitability:
• Activity/Efficiency
• Financial leverage
• Return on investment

25. What is the role of working capital?

We often refer to current assets as working capital because they represent the
resources needed for the day-to-day operations of the company’s long-term capital
investments. The amount by which current assets exceed current liabilities is referred
to as the net working capital.
 26. What is the relation between a company’s current ratio and its quick ratio?
CURRENT RATIO = CURRENT ASSETS/CURRENT LIABILITIES
The current ratio is an indication of how many times the company can cover its
current liabilities, using its current assets.
QUICK RATIO = (CURRENT ASSETS – INVENTORY)/CURRENT LIABILITIES

27. List the margin ratios, what do they inform us about?

Gross profit margin, operating profit margin, net profit margin.
They provide information about how well a company is managing its expenses
Profit margin ratios compare components of income with sales. They give the
investor an idea of which factors make up a company’s income and are usually
expressed as a portion of each dollar of sales.

28. What information is provided by the activity ratios? Mention 3 ratios.

Activity ratios are used to evaluate the benefits produced by specific assets, such as
inventory or accounts receivable, or to evaluate the benefits produced by the totality
of the company’s assets.
Inventory turnover, accounts receivable turnover, total asset turnover

29. What do leverage ratios inform us about? Mention 2 of them.

We use financial leverage ratios to assess how much financial risk the company has
taken on.
There are two types of financial leverage ratios: component percentages and coverage
ratios.
30. Compare ROE and ROA with each other.
Return-on-investment ratios compare measures of benefits, such as earnings or net
income, with measures of investment. For example, if an investor wants to evaluate
how well the company uses its assets in its operations, he could calculate the return
on assets—sometimes called the basic earning power ratio—as the ratio of earnings
before interest and taxes (also known as operating earnings) to total assets
Investors may not be interested in the return the company gets from its total
investment (debt plus equity), but rather shareholders are interested in the return the
company can generate on their investment. The return on equity is the ratio of the net
income shareholders receive to their equity in the stock
31. How can you classify profitability ratios in the broad sense?