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BEC > BEC 3 > Flashcards

BEC 3 Flashcards

1
Q

Define sunk costs.

A

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

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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

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3
Q

The forumla for computing a depreciation tax shield is:

A

Tax rate x depreciation deduction

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4
Q

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

A
  1. Cash flows at the inception of the project
  2. Operating cash flows
  3. Cash flows from the disposal of the project
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5
Q

What 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
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6
Q

Define net present value (NPV)

A

Difference between the present value of the cash inflows and outflows from a project

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7
Q

How are investment decisions made using the NPV method?

A

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

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8
Q

What is the profitability index?

A

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

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9
Q

Define internal rate of return (IRR)

A

Discount rate at which the present value of the cash inflows equals the present value of the cash outflows from an investment/project

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10
Q

How are investment decisions made using IRR?

A

When IRR exceeds the hurdle rate

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11
Q

What is the payback method formula?

A

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

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12
Q

Define operating leverage

A

Degree to which a firm uses fixed operating costs, as opposed to variable operating costs

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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

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14
Q

Define financial leverage

A

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

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15
Q

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

A

DLF = Percentage change in EPS / Percentage change in EBIT

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16
Q

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

A

DCL = Percentage change in EPS / Percentage change in sales

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17
Q

Define weighted average cost of capital (WACC).

A

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 = kft + (risk premium/[bi x (km - krf)]/PMR)

krf = Risk-free rate
bi = Beta coefficient of the stock
PMR = Market risk premium
km = Market rate

21
Q

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

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 = Market rate

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

Terminology used in the cost of capital and is part of the WACC formula:
- wdx = (weighted for) long-term debt
- wps = (weight for) preferred stock
- wcs = (weight for) common stock equity
- kwc = weighted average cost of capital

“k” stands 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 return on investment (ROI)

A

Used to assess the percentage return relative to capital investment risk.

ROI can be calculated as:
Income / invested capital

or

  • Product of profit margin (income/sales)
  • Investment turnover (sales/assets)
25
Q

List the two alternative 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

Measures the excess of actual income earned by an investment over the hurdle rate

28
Q

What is the formula for residual income?

A

Residual income = Net income - Required Return

Where the required return is equal to:
Net book value x Hurdle Rate

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

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
- 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 required amount of return and income after taxes
Required return = Investment x Cost of Capital

Step 2: Compare income to the required return
Economic value added = Income after taxes - Required return

31
Q

What is the formula for working capital?

A

Working capital = Current assets - Current liabilities

32
Q

What are three common motivations for holding cash?

A
  1. Transaction Motive: having enough cash to meet payments arising from the ordinary course of business
  2. Speculative Motive: having enough cash to take advantage of temporary opportunities
  3. Precautionary Motive: 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 conversion period + Receivables collection period - Payables deferral period

37
Q

How is the inventory conversion period calculated?

A

Inventory turnover = COGS / Avg inventory

Inventory conversion period = 365 / Inventory turnover

38
Q

How is the receivables collection period calculated?

A

AR turnover = Sales / Avg AR

Receivables collection period = 365 / AR Turnover

39
Q

How is the payables deferral period calculated?

A

AP Turnover = COGS / Avg AP

Payables deferral period = 365 / AP turnover

40
Q

What is the equation for economic order quantity EOQ)?

A

EOQ = Squareroot (2SO/C)

S = (S)ales in Units
O = Cost per Purchase (O)rder
C = (C)arrying Cost per Unit

BEC (29 decks)

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