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Study Guide Chapter 1-2

Study Guide Chapter 1-2. Agricultural Economics 330 Instructor: David J. Leatham. Question 1. List three types of budgets that can be used in financial management. Enterprise Cash Flow Capital. Question 2.

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Study Guide Chapter 1-2

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  1. Study GuideChapter 1-2 Agricultural Economics 330 Instructor: David J. Leatham

  2. Question 1 • List three types of budgets that can be used in financial management. • Enterprise • Cash Flow • Capital

  3. Question 2 • The Farm Credit Banks, Commercial Banks and Individuals are major lenders to agricultural firms. Which of these three has the greatest market share of agricultural loans? • Commercial Banks

  4. Question 3 • List the three major financial statements. • Balance Sheet • Income Statement • Cash Flow Statement

  5. Question 4 • Explain why maximizing single period profit is not always appropriate when making financial decisions. • Because the planning horizon for most financial decisions extend beyond one period (e.g., land and machinery provide service over multiple years (or production cycles) and this must be considered. Also, the outcome of financial decisions are dependent on future events, thus time and risk must be considered.

  6. Question 5 • What is a risk premium? • Compensation for taking risk (difference between expected returns from a risky investment and the returns from a risk free investment.)

  7. Question 6 • Assume that you are risk averse. Choose between investment A and investment B assuming that both are acceptable investments, you only have money to buy one investment, and they both cost the same. You have already determined that investment A has an expected return of $100 with a standard deviation of $25. You have also determined that investment B has the following probability distribution. Choose between them. Show your work, including a graph showing risk (measured as the standard deviation) and expected profit.

  8. E(X)=100 Var(X)=312.5 Standard Deviation = = 17.68

  9. Investment B dominates A -- Choose Investment B Risk (S.D.) . A 25.0 . 17.68 B 100 Expected Profit

  10. Question 7 • 1. Suppose a firm makes a profit before interest and taxes. What does the owner do with this profit? Make a list of who (which entities) have a claim on this money or how the money can be used. • A. • B. • C. • D. • E.

  11. Answer 7 • Suppose a firm makes a profit before interest and taxes. What does the owner do with this profit? Make a list of who (which entities) have a claim on this money or how the money can be used. • A. Uncle Sam (Taxes) • B. Lender (Interest & Principal Payments) • C. Lessor (Lease Payments) • D. Family Withdrawals (living expenses) • E. Retained Earnings

  12. Question 8 • Define Pro Forma Statements. Discuss how they can be used in business plan.

  13. Answer 8 • Define Pro forma Statements. Discuss how they can be used in business plan. • A financial Statement or presentation of data that represents financial performance based on projections of events and conditions. Examples are pro forma balance sheet and a pro forma income statement. • Pro forma statements can be used in business plans to show the impact of business decisions and plans on the projected financial performance and position of the firm.

  14. Question 9 • Discuss why a risk averse individual is willing to take risks.

  15. Answer 9 • Discuss why a risk averse individual is willing to take some risks. • A risk averse individual does not like taking risk and must be compensated for taking risk. Thus, a risk individual is willing to take risk as long as the compensation for taking risk is high enough.

  16. Question 10 • Keys to Investment—An investment with a high return has a [ low, medium, high ] risk. Circle a word in the brackets.

  17. Answer 10 • Keys to Investment—An investment with a high return has a [ high ] risk. Circle a word in the brackets.

  18. Question 11 • Suppose you have the opportunity to purchase an investment with the following probability distribution. Calculate the investments expected profit, and the variance, standard deviation and coefficient of variation of profit. • State of NatureProfitProbability • Pessimistic $0 .35 • Most Likely $100 .5 • Optimistic $ 200 .15

  19. Answer 11 Continued next Page

  20. Answer 11 (Continued) E(X)=80 Var(X)=4,600 Standard Deviation = = 67.8 Coefficient of Variation = 67.8/80 = 0.85

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