Study Guide Chapter 1-2

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Study GuideChapter 1-2

• Agricultural Economics 330
• Instructor David J. Leatham

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Question 1

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

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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

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Question 3

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

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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.

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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.)

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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.

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(No Transcript)
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E(X)100 Var(X)312.5 Standard Deviation
17.68
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Investment B dominates A -- Choose Investment B
Risk (S.D.)
.
A
25.0
.
17.68
B
100
Expected Profit
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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.

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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

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Question 8

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

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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.

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Question 9

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

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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.

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Question 10

• Keys to InvestmentAn investment with a high
  return has a low, medium, high risk. Circle
  a word in the brackets.

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Answer 10

• Keys to InvestmentAn investment with a high
  return has a high risk. Circle a word in the
  brackets.

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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 Nature Profit Probability
• Pessimistic 0 .35
• Most Likely 100 .5
• Optimistic 200 .15

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