Webster UniversityBUSN 5200Midterm ExaminationI. Short Essay –

1. Explain SOX.
2. List and explain the 4 financial statements.
3. List and explain the 3 forms of business organization.
4. What is agency relationship.
5. Why is ethical behavior so important in Finance.
6. Explain the 3 activities of a Cash Flow statement.
7. What is the Rule of 72.
8. What is opportunity cost.
9. Why is maximization of shareholder wealth the goal of financial management and not profit maximization.
10. Explain the overall purpose of a financial statement analysis?

II. Identify on what Financial Statement these accounts are found in:

a. Common stock
b. Accounts payable
c. Depreciation expense
d. Accumulated depreciation
e. Sales
f. Gain on sale of land
g. Dividend payable
h. Long-term debt

III. Explain the measurement purpose of the following ratios

1. Profitability ratios
2. Asset Utilization ratios
3. Liquidity ratios
4. Debt Utilization ratios

IV. Time Value of Money

.1. Suppose a company expects to receive $10,000 after 5 years. Calculate the present value of this sum if the current market interest rate is 12% and the interest is compounded annually.

.2. Mrs Smith is planning his estate and wants to leave his son some money. He can choose between an annuity of $60,000 paid annually at the end of each year for 25 years or a $1,000,000 lump sum. The annuity would have a 4% annual interest rate. She wants to know (only) what the present value of the annuity for his son would be.

.3. What is the future value of $1,000 a year for five years at a 6 percent rate of interest?

.4. You contribute $30,000 per year to your 401k plan, for 20 years, 10%. What is FV annuity?

V. Extra Credit

What is a recent profit margin of WalMart, Inc? Provide date and what does it mean?

Short Essay –

1. 
   The advent of the Sarbanes-Oxley Act (SOX) in 2002 by the United States Congress was a direct response to the worrisome wave of accounting scandals such as Enron and WorldCom and aimed to safeguard the interests of investors by bolstering the transparency and dependability of corporate financial reporting. The legislation ushered in new benchmarks and prerequisites for public corporations, auditors, and their governance. The act put in place stringent measures to tighten internal controls, enhance financial disclosures, and reinforce the autonomy of auditors. In addition, the creation of the Public Company Accounting Oversight Board (PCAOB) was a significant component of the act’s provisions and furnished a supervisory role over the auditing profession and the enforcement of compliance with the act’s edicts.
2. 
   The four financial statements are:

a) The Income Statement, also known as the Profit and Loss Statement, serves as a comprehensive report detailing a company’s financial performance over a specified time frame. It presents an overview of the company’s revenues, expenses, gains, and losses, and subsequently calculates the net income or net loss by deducting expenses and losses from revenues and gains.
b) The Balance Sheet is a crucial financial statement that provides a snapshot of a company’s financial position at a specific point in time. It assesses the company’s assets, liabilities, and shareholders’ equity. Assets represent what the company owns, liabilities indicate its debts or obligations, and shareholders’ equity is the residual interest in the assets after deducting liabilities.
c) The Cash Flow Statement is a financial report that outlines a company’s cash inflows and outflows within a defined timeframe. This statement is divided into three key sections: operating activities, investing activities, and financing activities. By analyzing the Cash Flow Statement, stakeholders can gain valuable insights into how cash is generated and allocated by the organization, thus providing a comprehensive overview of the company’s cash flow performance.
d) The Statement of Shareholders’ Equity is a financial statement that tracks changes in shareholders’ equity during a specific period. This statement includes pertinent information such as share issuance or repurchase, dividend payments, and retained earnings, which can provide a deeper understanding of the company’s ownership structure. By examining the Statement of Shareholders’ Equity, stakeholders can assess the factors that have impacted the company’s equity and determine the company’s financial health.

3. The three forms of business organization are as follows:
   a) Sole Proprietorship: A sole proprietorship is a business owned and operated by a single individual. The owner assumes unlimited liability for the business’s debts and obligations, and the business’s profits and losses are reported on the owner’s personal tax return. This form of organization is relatively easy to establish and provides the owner with complete control over the business.
   b) Partnership: A partnership is a legal entity established by two or more individuals who jointly own and manage the business. This business structure is governed by a partnership agreement which outlines the rights, duties, and profit-sharing arrangements among partners. There are two primary forms of partnerships: general partnerships and limited partnerships. In a general partnership, all partners are exposed to unlimited liability, while limited partnerships have general partners with unlimited liability and limited partners with restricted liability. The partnership structure offers a flexible and collaborative arrangement for business owners seeking to pool their resources, skills, and expertise. c) Corporation: A corporation is a legal entity separate from its owners (shareholders). It is created by filing articles of incorporation with the relevant government authority. Corporations have limited liability, meaning shareholders are generally not personally liable for the company’s debts and obligations. They can raise capital by issuing shares of stock and have a perpetual existence. Corporations are governed by a board of directors, who oversee the management and strategic decisions of the company.
4. An agency relationship occurs when one party (the principal) delegates authority to another party (the agent) to act on their behalf. In finance, an agency relationship commonly arises between shareholders (principals) and company management (agents). Shareholders, as owners of the company, appoint managers to make decisions and run the business on their behalf.
   The agency relationship can give rise to conflicts of interest because shareholders and managers may have different objectives. Shareholders typically aim to maximize their wealth by increasing their investment’s value, while managers may prioritize their own interests or pursue alternative goals. This divergence of interests can result in agency costs, such as managerial shirking, excessive executive compensation, or decisions that prioritize short-term gains over long-term value.
   To mitigate these agency problems, mechanisms like executive compensation plans, independent boards of directors, shareholder voting rights, and external audits are implemented to align the interests of shareholders and managers. These mechanisms aim to ensure that managers act in the best interests of shareholders and fulfill their fiduciary duty.
5. Ethical behavior is of utmost importance in finance for several reasons:
   a) Trust and Reputation: Ethical behavior fosters trust and credibility among stakeholders. Financial markets rely on trust, and unethical behavior can damage a company’s reputation, leading to a loss of investor confidence, reduced access to capital, and higher borrowing costs.
   b) Investor Protection: Ethical behavior ensures that investors receive accurate and reliable financial information to make informed investment decisions. Manipulating financial statements or engaging in fraudulent activities deceives investors and undermines the integrity of the market.
   c) Long-Term Sustainability: Ethical behavior promotes sustainable business practices. Companies that prioritize ethical conduct tend to have better long-term performance, as they focus on building enduring relationships with customers, suppliers, and employees.
   d) Legal Compliance: Ethical behavior ensures compliance with laws and regulations. Violations can result in legal consequences, financial penalties, and damage to a company’s reputation. Overall, ethical behavior in finance cultivates a culture of transparency, fairness, and accountability, contributing to the stability and integrity of financial markets.
6. The three activities of the Cash Flow statement are as follows:
   a) The Operating Activities section of a company’s financial statement provides insights into the cash flows generated from its primary operations, which encompass revenue generation, inventory management, and day-to-day expenses. Components of this section include cash receipts from sales, payments to suppliers, salaries, interest received, and interest paid. This section plays a critical role in evaluating a company’s cash-generating ability from its core business operations.
   b) The Investing Activities section of a company’s financial statement presents cash flows related to investments in long-term assets and other investments. This section includes cash inflows from the sale of property, plant, and equipment, as well as cash outflows for the purchase of such assets. Additionally, it encompasses cash flows from buying or selling investments such as stocks, bonds, and other securities. This section aids in assessing a company’s capital expenditure decisions and investment activities.
   c) Financing Activities: The Financing Activities section of the Cash Flow statement presents a comprehensive overview of the cash flows that arise from changes in a company’s capital structure and financing arrangements. This section encompasses cash inflows gained from the issuance of stocks or bonds and cash outflows incurred from dividend payments, share repurchases, or debt repayments. It serves as a valuable analytical tool for evaluating a company’s capital-raising strategies and financial structure management. The Cash Flow statement also offers valuable insights into a company’s cash position, its capacity to generate future cash flows, and how it allocates cash across various activities.
7. The Rule of 72 presents a fundamental mathematical tool utilized in the estimation of the time required for an investment or debt to augment twofold in value, given a predetermined annual interest rate. The formula is derived through dividing 72 by the interest rate, resulting in the following calculation: Time to Double = 72 / Interest Rate. It is noteworthy that the Rule of 72 provides only a rough approximation, as it assumes the presence of compound interest. This formula is commonly employed as a speedy method of calculation and serves as a useful tool for comprehending the influence of compounding on investments or debts over an extended period. As an illustration, an investment featuring an annual interest rate of 8%, when subjected to the Rule of 72, would require roughly 9 years to double in value (72 / 8 = 9).
   8.
   The notion of opportunity cost pertains to the conceivable benefit or worth that is relinquished when opting for one alternative over another. It embodies the value of the second-best option that is forfeited when reaching a decision. Within the realm of finance, opportunity cost is a fundamental concept in evaluating investment decisions. When assigning resources or capital, selecting a particular investment opportunity translates to relinquishing the potential returns and advantages that could have been obtained from an alternative investment. The opportunity cost of an investment denotes the return or advantage that could have been garnered from the most favorable alternative investment that was not selected. A comprehensive comprehension of opportunity cost facilitates investors in appraising the trade-offs involved in distinct investment options and enables them to make well-informed decisions that optimize their returns or desired outcomes.
8. The goal of financial management is often expressed as the maximization of shareholder wealth, rather than profit maximization. While profit maximization focuses solely on generating the highest possible profit, shareholder wealth maximization takes into account the timing and risk associated with the cash flows generated by the business.

Profit maximization alone may not be sufficient to ensure the long-term success and sustainability of a company. It does not consider the impact of risk, the timing of cash flows, or the shareholders’ required return on investment. By focusing on shareholder wealth maximization, financial management aims to create sustainable value for shareholders over the long term, balancing profitability, growth, and risk considerations.

10. The overall purpose of financial statement analysis is to evaluate the financial health and performance of a company. It involves systematically examining and interpreting a company’s financial statements to gain insights into its liquidity, solvency, profitability, and efficiency.
    Financial statement analysis assists various stakeholders, including investors, creditors, management, and regulators, in making informed decisions. It can be used to assess a company’s past performance, evaluate its current financial position, and make predictions about its future prospects. The key objectives of financial statement analysis include:
    a) Evaluating Profitability: Analyzing financial statements helps assess a company’s profitability by examining its revenue, expenses, and net income. Profitability ratios such as gross profit margin, operating margin, and return on equity are calculated to understand how efficiently the company generates profits.
    b) The process of evaluating a company’s ability to fulfill its short-term obligations (liquidity) and long-term debt obligations (solvency) entails a comprehensive review of its financial statements. Liquidity ratios, such as the current ratio and quick ratio, are employed to assess the company’s short-term liquidity, while solvency ratios, such as the debt-to-equity ratio, are utilized to evaluate its long-term financial stability.
    c) The assessment of a company’s efficiency in managing its assets, liabilities, and equity is a crucial aspect of financial statement analysis. Efficiency ratios, such as inventory turnover, receivables turnover, and asset turnover, are employed to gain insights into how effectively a company utilizes its resources.
    d) The identification of trends and patterns by comparing financial statements over multiple periods is a valuable tool for evaluating a company’s historical performance, identifying areas of improvement or concern, and making forecasts for the future.
    Overall, financial statement analysis provides a comprehensive understanding of a company’s financial performance and helps stakeholders make informed decisions about investments, lending, and strategic planning.
    II. Identify on what Financial Statement these accounts are found in:
    a. Common stock: Common stock is found in the Statement of Shareholders’ Equity.
    b. Accounts payable: Accounts payable is found in the Balance Sheet under current liabilities.
    c. Depreciation expense: Depreciation expense is found in the Income Statement as an operating expense.
    d. Accumulated depreciation: Accumulated depreciation is found in the Balance Sheet under the property, plant, and equipment section, as a contra-asset account.
    e. Sales: Sales are found in the Income Statement as part of the revenue section.
    f. Gain on sale of land: Gain on sale of land is found in the Income Statement as a non-operating or other income item.
    g. Dividend payable: Dividend payable is found in the Balance Sheet under current liabilities.
    h. Long-term debt: Long-term debt is found in the Balance Sheet under non-current liabilities.

III. Explain the measurement purpose of the following ratios

1. Profitability ratios are a set of financial metrics that enable businesses to determine their ability to generate profit relative to their sales, assets, or equity. By assessing the overall profitability and efficiency of the company’s resource utilization, these ratios provide valuable insights into various aspects of the business, such as operational efficiency, pricing strategies, cost management, and overall profitability. The primary objective of measuring profitability ratios is to evaluate the company’s financial performance and determine its capacity to deliver returns to its shareholders. 2. Asset utilization ratios, also known as efficiency ratios, are essential tools that help companies assess how effectively they are utilizing their assets to generate income or sales. These ratios evaluate the efficiency of a company’s operations and its asset management practices, allowing businesses to identify areas of inefficiency or underutilization of resources. The primary purpose of measuring asset utilization ratios is to evaluate the company’s operational efficiency, productivity, and resource utilization, which ultimately contributes to enhancing the overall performance and profitability of the business.
2. Liquidity ratios are financial metrics that gauge a company’s ability to fulfill its short-term obligations and uphold financial stability. By evaluating the company’s ability to convert its assets into cash to satisfy immediate liabilities, these ratios help determine the company’s short-term solvency and its capacity to cover immediate financial obligations. The analysis of liquidity ratios is a critical aspect of assessing cash flow management, identifying potential liquidity risks, and gauging the ability to meet short-term debt obligations. 4. Debt utilization ratios, also referred to as leverage ratios, are indicators of the degree to which a company relies on debt financing in its capital structure. These ratios provide insights into the company’s debt levels, its ability to meet financial obligations, and the extent to which it can manage its debt load. Measuring debt utilization ratios is crucial in evaluating a company’s financial risk and determining its capacity to manage its debt effectively. By analyzing these ratios, valuable information can be obtained about the company’s overall financial health.
   IV. Time Value of Money
3. To determine the present value of $10,000 after 5 years with an annual interest rate of 12% compounded annually, we can utilize the formula for present value of a future sum:
   PV = FV / (1 + r)^n
   Here, PV represents the present value, FV denotes the future value, r represents the interest rate, and n signifies the number of periods.
   Plugging in the given values:
   PV = $10,000 / (1 + 0.12)^5
   PV = $10,000 / (1.12)^5
   PV ≈ $6,425.98
   Hence, the approximate present value of $10,000 to be received after 5 years, with an interest rate of 12% compounded annually, is roughly $6,425.98.
4. To calculate the present value of an annuity, we can use the formula for present value of an ordinary annuity:
   PV = PMT * [(1 – (1 + r)^(-n)) / r]
   In this formula, PV represents the present value, PMT represents the annuity payment, r represents the interest rate, and n represents the number of periods.
   Applying the provided values to the formula:

PV = $60,000 * [(1 – (1 + 0.04)^(-25)) / 0.04]
PV ≈ $834,794.38
Therefore, the approximate present value of the annuity for Mrs. Smith’s son, with annual payments of $60,000 for 25 years at a 4% annual interest rate, is around $834,794.38.

3. 
   To determine the future value of $1,000 per year for five years at a 6% rate of interest, we can use the formula for future value of an ordinary annuity:
   FV = PMT * [(1 + r)^n – 1] / r
   Here, FV represents the future value, PMT denotes the annuity payment, r represents the interest rate, and n signifies the number of periods.

Plugging in the given values into the formula:
FV = $1,000 * [(1 + 0.06)^5 – 1] / 0.06
FV ≈ $5,637.09
Hence, the approximate future value of $1,000 per year for five years at a 6% rate of interest is approximately $5,637.09.

4. 
   To calculate the future value of an annuity where $30,000 is contributed per year for 20 years at a 10% interest rate, we can use the formula for future value of an ordinary annuity:
   FV = PMT * [(1 + r)^n – 1] / r
   Here, FV represents the future value, PMT denotes the annuity payment, r represents the interest rate, and n signifies the number of periods.
   Applying the provided values to the formula:
   FV = $30,000 * [(1 + 0.10)^20 – 1] / 0.10
   FV ≈ $1,506,191.17
   Therefore, the approximate future value of the annuity with annual contributions of $30,000 for 20 years at a 10% interest rate is roughly $1,506,191.17.
   V. Extra Credit
   Over the past decade, Walmart has consistently maintained a strong financial standing, as evidenced by its impressive gross margin, operating margin, and net profit margin. The gross margin, or the difference between revenue and cost of goods sold, has increased steadily from 24.7% in 2012 to 26.6% in 2022. The operating margin, which measures the profitability of a company’s core business operations, has also seen an upward trend, reaching 5.5% in 2022 compared to 4.5% in 2012. The net profit margin, a crucial metric that reflects a company’s ability to generate profit after expenses, has remained consistently high for Walmart, standing at 1.82% as of April 30th, 2023. This is a testament to the company’s ability to operate efficiently and control costs while generating revenue. Walmart’s consistent financial performance over the years has made it a stalwart in the retail industry and a model for other companies to follow.