Financial Management

Question 1

Short-term financing advantages and disadvantages

Answer 1

Higher liquidity & profitability, disadvantage is you don’t know what next years interest rate is, could just go up

Question 2

Degree of operating leverage formula

Answer 2

% change in EBIT/ % change in sales

Question 3

Financial leverage

Answer 3

Using more debt than equity. Assuming more risk, but your ROE is much higher

Question 4

Degree of financial leverage

Answer 4

% change in earnings (EPS or earning before tax) / % change in EBIT = DFL

Question 5

Degree of total leverage

Answer 5

DOL (operating leverage ) * DFL (financial leverage)

Question 6

CAPM

Answer 6

Risk free rate + (beta * Market risk premium)

MRP = market rate - risk free rate

Question 7

Market risk premium

Answer 7

Market rate - RF rate

Question 8

cost of stock formula

Answer 8

(Par value * rate) / net proceeds
Can either do on a per share basis, or a sum (if sum, do par value * # shares * rate)

Remember: net proceeds, take out floating costs!

Question 9

Constant growth dividend discount model formula

Answer 9

Intrinsic stock price = [dividend * (1+g) ] / [rate - growth]

Question 10

Compensating balance agreement

Answer 10

Fee reduction (bank waive fees if you maintain X amount of money)

Question 11

EOQ formula

Answer 11

EOQ = square rout of two sock

EOQ = SQR ROOT ( [2 * SO]/C )

S = annual sales
O = order cost
C = carry cost

Question 12

EOQ relationship with sales, order cost , carry cost

Answer 12

Positive correlation with sales and order cost; i.e. you will order MORE quantity if you have a HIGHER sales or HIGHER order cost

negative correlation with carry cost; i.e you will order LESS if you have a HIGHER carry cost

Question 13

Residual income

Answer 13

RI = net income - required return

Required return = NBV of equity x hurdle rate (CAPM/interest rate)