Flashcards in BEC 3.32 Deck (34):

1

## Leverage

###
- uses fixed costs

- amplifies risk and potential return

2

## Operating leverage

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- Fixed (salary) = Total cost is "independent" of sales

- Variable(sales) = Total cost is "dependent" on sales

3

## DOL( Degree of operating leverage)

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DOL = % change in EBIT / % change in sales

EBIT = earnings before income tax

4

## Fixed Leverage

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Fixed (debt) = Interest expense is "independent" of profit

Variable (equity) = Dividends "dependent" of profit

5

## DFL( Degree of financial leverage)

### DFL = % change in EPS(earnings per share) / % change in EBIT

6

## Combined Total Leverage

### do not add them together instead multiply, DOL x DFL = Combined Total leverage

7

## WACC and optimal capital structure

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- the optimal capital structure is the one with the lowest WACC(weighted average cost of capital)

FCFF/WACC

WACC = cost of equity multiplied by the percentage equity in capital structure + Weighted average cost of debt* multiplied by the percentage debt in capital structure

* MAKE sure it is AFTER tax considerations

8

## Weighted-average cost of debt

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- pre-tax only step 1

- step 2 take YTM "market rate" x (1 -tr) = after tax cost(relevant)

weighted average interest rate ( or YTM "market rate" = effective annual interest payments / debt cash available

( outflow / net inflow)

9

## Cost of long-term debt

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-Debt is typically the cheapest form of capital(compared to equity), since the government makes interest payments tax deductible, and it is less risky for the lenders since they get paid back in bankruptcy before the stockholders

To get cost of long term debt take the debt x (1 - tr). i.e if your debt is $100,000 and the tax rate is 30% since the debt is tax deductible your cost of detb is only $70,000

10

## Cost of Preferred stock

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- is GREATER than the cost of debt, since dividends are not tax deductible and the stockholders assume more risk than lenders so it costs more

Outflow(dividends) / net inflow = Cost

11

## Cost of retained earnings(common equity)

### - Greater cost than debt and preferred stock, since common stockholders assume the greatest level of risk in the event of a bankruptcy

12

## Risk premium

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- if beta = to 1 the company is equally as risky as the stock market

- if beta is greater > than 1 the company is riskier than the stock market

- and if beta is less < than 1 the company is safer than the stock market

13

## Cost of retained earnings formula(CAPM)

###
rfr(risk free rate)

mr(market rate)

b = beta

= rfr +[ b x (mr - rfr)]

14

## Discounted cash flow formula(cost of retained earnings DCF)

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Div1 = forecasted dividend in future

= Div0(today's dividend) x ( 1 + g)

P = price of stock

g = growth

DCF=[Div1 / P] + g

15

## Bond Yield Plus Risk Premium(cost of retained earnings BYRP)

### BYRP = Pre-tax YTM + Risk premium

16

## ROI (return on investment)

###
ROI =Income / Investment capital( or "avg. assets) (or Avg PPE + Avg WC(working capital)

OR

ROI = profit margin* x Investment turnover**

Profit margin = Income / sales

Investment turnover** = Sales / invested capital

17

## ROA ( return on assets)

### ROA = Net income / total average assets

18

## Residual income EVA( economic value added)

###
Residual income is the income earned beyond what was desired

Residual income = Net income - required return in $*

*required return in $ = hurdle rate x net book value

19

## EVA( economic value added)

### - same exact formula as residual income, except the hurdle rate for required rate of return MUST be that companies WACC(weighted average cost of capital)

20

## Debt-to-capital ratio

###
- Measure of financial leverage, i.e risk

= Total debt / Total Capital(= Debt + Equity)

21

## Debt-to-Asset ratio

### = total debt / total assets

22

## Debt-to-equity ratio

### Total debt / total shareholders equity

23

## Working Capital

### Current Assets - Current Liabilities

24

## Quick Ratio

### Cash + Marketable securities + Receivables / Current Liabilities

25

## APR of quick payment discount

### = [360 / Pay period - discount period] x Discount / 100 - Discount %

26

## Lockbox systems

### Good if the additional interest income is > then the bank fees

27

## Zero balance account

### cash is only transferred into account in time to pay checks , that way can earn interest on the money until you are ready to pay

28

## Cash conversion cycle(avg number of days to create cash from core business)

###
= inventory conversion period + Receivables collection period - Payables deferral period

29

## Inventory conversion period

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inventory turnover = Cost of goods sold / average inventory

THEN

365 / inventory turnover

30

## Receivables collection period

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A/R turnover = Sales / avg A/R

Then

365 / A/R turnover

31

## Payables deferral period

###
A/P turnover = Cost of goods sold / Avg. A/P

Then

365 / A/P turnover

32

## Reorder point

### = Safety stock + (Lead time x Sales during lead time(a week or day))

33

## Economic order quantity

###
2SOC

E = Square Root of [ 2 x Sales x order cost / carrying cost per unit]

34