BEC MCQ 3.3 Flashcards Preview

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Flashcards in BEC MCQ 3.3 Deck (45):

Capital budgeting decisions

doesn't include short term financing needs they are more of operational


The annual depreciation expense on an asset reduces income taxes

The firms marginal tax rate times the depreciation amount


Manufacturing equipment replacement decision

Disposal price of the old equipment


Items included in discounted cash flow analysis

Future operating cash saving
current asset disposal price
tax effects of future asset depreciation
future asset disposal price


not included in discounted cash flow analysis

future asset depreciation expense


A project should be accepted

if the NPV is greater or equal to zero


Rates used in Net present value analysis

The discount rate, hurdle rate and cost of capital. These are the synonymous terms for an arbitrary rate set by management
Rates which will Decrease NPV
Increase in discount rate will reduce NPV.
Increase in NPV
Increase the estimated salvage value
Extend the project life and associated cash inflow
Decrease the estimated effective income tax rate
If the NPV of a proposed investment is negative the discount rate used must be greater than the project IRR.
The IRR is the discount rate that results in a NPV of zero
The disadvantage of NPV is that it does not provide the true rate on investment. The NPV indicates whether the investment will earn the hurdle rate used in the NPV calculation.


Sensitive analysis

is a what if technique that's asks how a given organization will change if the original estimates used in capital budgeting are changed



is the rate of return that produces a npv of zero. IRR valuation do not require cash flows that are constant. IRR an be determined even the profitability index is less than one. IRR is defined as the technique that determines the present value factor after the tax flows equals the initial investment of the project. Alternatively IRR is the discount rate that produces a npv of zero . NPV will greater than zero when IRR is higher than the hurdle rate


Pay back method

is the length of time required to recover the initial cash outlay of a project. It emphasis liquidity


A firm with a higher degree of operating leverage

implies that firms profit are more sensitive to changes in sales volume
higher variable costs implies a lower degree of operating leverage
A firm using significant amount of debt has higher degree of financial leverage


when the cost of funds from the sale of Common stock is asked

annual dividend/sale price of common shares -floatation cost-underpricing


Strategies for creating an optimal capital structure is

Maximizing earning per share
Minimizing cost of debt
minimizing cot of equity
maximizing cash flow


If a company becomes more conservative in its working policy

it would tend to have an increase of ratio of current assets to current units of output


Turnaround document

Is a computer output that can be later used as a source document


Converting accounts receivable to cash

Collection agencies: Used to collect overdue A/R
Selling AR or factoring AR
Cash discount
Electronic fund transfers


Commercial paper

does not have an active secondary market. Commercial papers are sold by money markets by highly credit worthy companies. The maturity is less than 270 days. The interest on commercial paper is below prime rate but above Treasury bill rate.
There are restrictions as to the type of corporation that can enter into a commercial market for short term financing since to use of the open market is restricted to a small number of most credit worthy large corporations
it avoids the expense of maintaining a compensating balance
provides a broad distribution for borrowing
accrues a benefit to the borrower because its name is more widely known


Negotiable certificate of deposit

Negotiable CD have former secondary market
are regulated by Federal Reserve System
Are sold in denominations of 100000.
It carry lower interest than banker acceptance and commercial paper


The primary motivation for holding cash

Transactions demand
Speculative demand
Precautionary demand


If we are asked to Determine additional investment in Accounts receivable

Step 1: Determine average accounts receivable and the additional accounts receivable as follows:
it is new credit policy minus old credit policy it will give additional A/R
Determine the additional investment in additional accounts receivable
It is the receivable balance minus variable cost
then calculate the returned on investment
that is the amount


IF a seller extends credit to a purchaser more than his operating cycle

it means in effect financing more than inventory needs


Comparing a change in credit policy

Cost of funds
Bank may require that a day sales O/S cannot exceed certain number of days.
Customers may feel they should be given extended terms. If this is true additional working capital may be even greater


what does not affect safety stock

re-order level
The facts that affect safety stock are
uncertain sales forecasts
dissatisfaction of customers
uncertain lead times


Re-order point is

safety stock+ stock units used during lead time


inventory carrying costs

uinspections are part of ordering costs not carrying cots. Disruption of productions schdules,quantity discount lost, handling cost
Inventory cost or carrying cost include
opportunity cost on inventory investment
obsolescence and spoilage
Cost of capital invested in industry


expected stock out cost + carrying costs

safety stock costs


Ordering costs primarily consist of

production set up


Average inventory

Re-order quantity/2 Average inventory excluding safety stock + Avg safety stock= avg. Inventory including safety stock.


Operating leverage

Fixed costs/Variable costs


Historical weighted average cost of capital

It is often used as target or hurdle rate not the optimal rate


residual income

first step=Average invested capital=sales/capital turnover
second step=operating income-(imputed rate x average invested capital)


Return on assets

Income/Ave.Assets or income /sales or sales /avg.assets



Net Income/ Invested Capital


Cost of fund from retained earnings

Dividend /stock price


Free cash flow`

Net operating profits after taxes+ Depreciation + Amortization -Capital expenditures-net increase in WC


Interest on investment

Invested capital x required rate of return


Economic value added

Net operating profit after taxes-cost of financing


Cost of financing

Total assets-current liabilities x WACC


Economic rate of return on C.S

Dividends+change in price/ Beginning price


ROI based on assets

Net Income/ Total assets or Average invested capital


Du point ROI analysis=Return on salesx asset turnover

Return on sales= Net Income/sales
Asset turnover= Sales/total assets


Market capitalization

Common Stock price per share x common stock O/S


Market Ratio

Common stock price per share/Book value per share
Market capitalization/ Common Stockholders Equity


Cost of funds from sale of C.S

Annual dividend/ Sale price of common share -flotation costs-underpricing


Coefficient of variation

Standard Deviation/Rate of return