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Flashcards in B-3 2013 Deck (40)
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1
Q

Define sunk costs.

A

Sunk costs are those costs that have already been incurred, are unavoidable in the future, and will not vary with the course of action taken.

2
Q

What is the formula for after-tax cash flow?

A

(1.0 - tax rate) x Pre-tax Cash Flows = After-tax Cash Flow.

3
Q

The formula for computing a depreciation tax shield is:

A

Tax rate x Depreciation deduction = Tax savings from the depreciation tax shield

4
Q

What are the three general stages in which capital investment cahs flows are categorized?

A

Cash flows at the inception of the project; Operating cash flows; Cash flows from the disposal of the project.

5
Q

Wha approaches can management take to select the desired rate of return for a project?

A

Use a weighted-average cost of capital (WACC) method; Assign a target rate for new projects; Recommend that the discount rate be related to the risk of the project.

6
Q

Define net present value (NPV).

A

NPV is the difference between the present value of the cash inflows and outflows from a project.

7
Q

How are investments decisions made using the NPV method?

A

If NPV is positive, then the investment should be made. If NPV is negative, then the investment gould not be made.

8
Q

What is the profitability index?

A

The ratio of the present value of net future cash inflows to the present value of the net intiial investment. The higher the profitability index, the more desirable the project.

9
Q

Define internal rate of return (IRR).

A

The IRR is the discount rate at which the present value of the cash inlfows equals the present value of the cash outflows from an investment or project.

10
Q

How are investment decisions made using IRR?

A

An investment should be made when the IRR exceeds (greater than) the hurdle rate.

11
Q

What is the payback method formula?

A

Net initial investment / Increase in annual net after-tax cash flow = Payback period

12
Q

Define operating leverage.

A

Operating leverage is defined as the degree to which a firm uses fixed operating costs, as opposed to variable operating costs.

13
Q

What is the degree of operating leverage (DOL) formula?

A

DOL = Percentage Change in EBIT (Earnings Before Interest and Taxes) / Percentage Change in Sales

14
Q

Define financial leverage.

A

Financial leverage is defined as the degree to which a firm’s use of debt to finance the firm magnifies the effects of a given percentage change in EBIT on the percentage change in EPS.

15
Q

What is the degree of financial leverage (DFL) formula?

A

DFL = Percentage Change in EPS / Percentage Change in EBIT

16
Q

What is the degree of combined leverage (DCL) formula?

A

DCL = Percentage Change in EPS / Percentage Change in Sales

17
Q

Define weighted-average cost of capital (WACC).

A

The weighted-average cost of capital is the average cost of debt and equity financing associated with the firm’s existing assets and operations.

18
Q

What is the after-tax cost of debt formula (kdx)?

A

kdx = pre-tax cost of debt x (1 - tax rate)

19
Q

What is the cost of preferred stock formula (kps)?

A

kps = Dps / Nps. Dps = Preferred stock cash dividends; Nps = Net proceeds of preferred stock.

20
Q

What is the cost of retained earnings (kre) using the CAPM formula?

A

kre = krf + { risk premium / [bi x (km - krf)/PMR]}. Krf = Risk-free rate; bi = Beta coefficient of the stock; PMR = Market risk premium; km = Market rate. Kre = Risk-free rate + Risk premium; Kre = Krf + [bi x (km-krf)]; Kre = krf + (bi + PMR).

21
Q

What is the cost of retained earnings (kre) using discounted cash flow (DFC)?

A

Kre = (D1 / P0) + g D1 = Dividend per share expected at the end of one year; P0 = Current market value or price of outstanding common stock; g = Constant growth rate of dividends.

22
Q

What is the cost of retained earnings (kre) under bond yield plus risk premium (BYRP)?

A

kre = kdt + PMR; kdt = Pre-tax cost of debt; PMR = Market risk premium.

23
Q

Define the weighted-average cost of capital by formula.

A

This is the terminology used in the cost of capital and is part of the WACC formula: wdx = (weight for) long-term debt; wps = (weighted for) preferred stock; wcs = (weighted for) common stock equity; kwc = weighted-average cost of capital. “k” standa for the specific COST of each type of capital, and “w” stands for the WEIGHT of each. So WACC would be: kwc = (kdx x wdx) + (kps x wps) + (kre x wcs).

24
Q

Define rate on investment (ROI).

A

Return on investment is used to assess the percentage return relative to capital investment risk. ROI can be calculated as income divided by invested capital or as a product of profit margin (income / sales) and investment turnover (sales / assets).

25
Q

List the two alternate formulas of Return on Investment.

A

ROI = Income / Investment Capital; ROI = Profit Margin (or Return on Sale) x Investment Turnover (Sales / Assets).

26
Q

What are the limitations of ROI?

A

Short-term focus; Disincentive to invest.

27
Q

Define residual income.

A

The residual income method measures the excess of actual income earned by an investment over the hurdle rate.

28
Q

What is the formulas for residual income?

A

Residual Income = Net Income - Required Return. Where the Required Return is equal to: Net Book Value x Hurdle Rate = Required Return. If the amount of the income from the investment exceeds the computed required return, performance objectives have been met.

29
Q

Define economic value added (EVA). How does EVA differ from residual income?

A

EVA measures the excess of income after taxes earned by an investment over the rate of return defined by the company’s WACC. EVA differs from residual income in the following ways: WACC must be used to calculate EVA; The income and investment numbers used to calculate EVA are generally adjusted to produce a more accurate analysis of economic profit.

30
Q

Define the steps and formula for economic value added.

A

Step 1: Calculate the required amount of return and income after taxes: Investment x Cost of capital = Required Return. Step 2: Compare income to the required return: Income after taxes - Required return = Economic Value Added.

31
Q

What is the formula for working capital?

A

Current assets - Current liabilities = Working capital

32
Q

What are three common motivations for holding cash?

A
  1. Transaction Motive: A transaction motive for holding cash concerns having enough cash to meet payments arising from the ordinary course of business. 2. Speculative Motive: A speculative motive for holding cash concerns having enough cash to take advantage of temporary opportunities. 3. Precautionary Motive: A precautionary motive for holding cash concerns having enough cash to maintain a safety cushion so that unexpected needs may be met.
33
Q

What methods can be used to speed collections?

A

Customer screening; Prompt billing; Payment discounts; Expedite deposits; Concentration banking; Factoring accounts receivable.

34
Q

What methods can be used to delay disbursements?

A

Defer payments; Drafts; Line of credit; Zero balance accounts.

35
Q

What is the formula for computing the annual percentage rate for quick payment discounts?

A

[360 / (Pay period - Discount period)] x [Discount % / (100% - Discount %)]

36
Q

What is the cash conversion cycle formula?

A

Cash Conversion Cycle = Inventory Converion Period (low) + Receivables Collection Period (low) - Payables Deferral Period (defer)

37
Q

How is the inventory conversion period calculated?

A

Inventory turnover = Cost of goods sold / Average inventory. Inventory conversion period = 365 / Inventory Turnover.

38
Q

How is the receivables collection period calculated?

A

AR turnover = Sales / Average AR. Receivables collection period = 364 / AR Turnover.

39
Q

How is the payables deferral period calculated?

A

AP turnover = Cost of goods sold / Average AP. Payables deferral period = 365 / AP Turnover

40
Q

What is the equation for economic order quantity?

A

EOQ = Square Root (2SO / C). E = Order size; S = Sales in units; O = Cost per purchase order; C = Carrying cost per unit.