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BEC > Financial Management > Flashcards

Financial Management Flashcards

1
Q

What is the primary focus of working capital management?

A

Managing inventory & receivables (current assets & liabilities)

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2
Q

How is Net Working Capital calculated?

A

NWC : Current Assets - Current Liabilities

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3
Q

What are the characteristics of effective Working Capital Management?

A

Shorten the cash conversion cycle

Don’t negatively impact operations

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4
Q

What is the Inventory Conversion Period?

A

Average time needed to convert materials into finished goods and sell them

Average Inventory : (BI + E) / 2

Inventory Conversion Period : Average Inventory / Sales Per Day

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5
Q

What is the Receivables Collection Period?

A

Average time needed to collect A/R

RCP : Average Receivables / Credit Sales Per Day

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6
Q

What is the Payables Deferral Period?

A

Average time between materials and labor purchase and their A/P payment

Average Payables : (BP + EP) / 2

Payables Deferral Period : Average Payables / (COGS/365)

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7
Q

What is the Cash Conversion Cycle?

A

Amount of time it takes to receive a cash inflow (Customers) after making a cash outflow (Vendors)

Inventory Conversion Period
+ Receivables Collection Period
- Payables Deferral Period
: Cash Conversion Cycle

(Inventory Really (-Pays) Cash)

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8
Q

What traits should Cash and Short-Term Investments have?

A

Liquid

Safe

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9
Q

For what are Letters of Credit used?

A

Used for importing goods.

Issued by importer’s bank.

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10
Q

What is the advantage of using Trade Credit?

A

No interest cost if paid timely.

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11
Q

What is a Lockbox System? What are the advantages?

A

Customer Payments are sent to a bank-managed PO box.

Employees don’t have access to cash.
Deposits are more timely.
Interest income from deposits should pay for the Lockbox fees (if they don’t- lockbox is not beneficial)

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12
Q

What is float?

A

Time it takes to mail a payment and have it clear your bank account

Maximize float on cash payments

Minimize float on cash receipts

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13
Q

What are Zero Balance Accounts?

A

Regional bank sends enough cash to cover daily checks

Advantages:
Checks take longer to clear -more float
Low amounts of cash tied up for compensating (minimum) balances

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14
Q

What is the difference between Treasury Bills- Notes and Bonds?

A

Treasury Bills: Short term (less than one year) Think: $1 Bill

Treasury Notes: Medium term (less than 10 years- more than 1)

Treasury Bonds: Long term (greater than 10 years) Think: government is in long-term bondage to you; they owe you money

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15
Q

What is commercial paper?

A

Similar to T-Bill- but issued by corporations instead of Government

Greater than 9 Months Maturity
Short Term negotiable instruments

Unsecured

Issued by large firms

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16
Q

What are the advantages and disadvantages of Commercial Paper?

A

Advantages: Financing at less than Prime. No compensating balances required.

Disadvantages: Unpredictability of markets. Credit crisis emerges and large insurance/investment companies aren’t lending.

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17
Q

What is Economic Order Quantity?

A

quantity of inventory that should be ordered at one time in order to minimize the associated costs of carrying and ordering inventory, such as purchase-order processing, transportation, and insurance. (inventory costs)

EOQ : Square Root of (2DO/C)

D : Unit Demand (Annual)
O : Order Cost
C : Cost of Inventory

Assumptions of economic order quantity analysis include the following:

Periodic demand for the good is known.
Total carrying costs vary with quantity ordered.
Costs of placing an order are unaffected by quantity ordered.
Purchase costs per unit are not affected by quantity discounts.

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18
Q

What is Carrying Cost?

A

The cost of keeping inventory.

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19
Q

What is Order Cost?

A

Cost of executing an order and starting product production.

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20
Q

What is inventory reorder point?

A

How low inventory should get before it should be re-ordered.

IOP : Average Daily Demand x Average Lead Time

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21
Q

What is a Just In Time (JIT) system?

A

Orders inventory so that you get it just in time for when it’s needed

JIT is valuable when Order Cost is low and Cost of Carrying Inventory is high

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22
Q

What is Factoring of receivables?

A

Receivables are sold to a financing company where they pay less than the value of the receivables due to a discount related to risk of non-collection

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23
Q

What is a Trade Discount?

A

Buyer saves if paid early

Example: 1/10 Net 30

1% Discount if paid within 10 days

If not- bill is still due in 30 days

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24
Q

What is the cost of forgoing a discount?

A

(Discount % x 365) / ((100% - Discount) x (Pay Period - Discount Period))

25
Q

What is the Prime Rate?

A

A benchmark used for lending only to the best customers

Most customers will be charged Prime + 3%- for example

If the lending institution and the customer are not in the same country- the LIBOR rate is often used

26
Q

What is the Nominal (Face- Coupon- Stated) Rate?

A

Interest rate stated on the face of a bond.

27
Q

How is Current Yield calculated?

A

CY : Interest Payment / Bond Price

28
Q

What is the Effective (YTM- Market) Rate?

A

PV of Principle + Interest : Bond Price

29
Q

What is a Zero Coupon Bond?

A

No interest payments made

Bond sold at a discount

Interest reflected when Bond matures

30
Q

What are the characteristics of a Junk Bond?

A

High interest rate

High default risk

31
Q

What are debenture bonds?

A

Bonds unsecured by collateral

32
Q

What are subordinated debentures?

A

Debenture Bonds that will be repaid if any assets are left after liquidation of a company

33
Q

What are Redeemable Bonds?

A

Provision in Bond contract allows demand of Bond payment under certain circumstances

34
Q

What is a Callable Bond?

A

Borrower can pay off debt early

35
Q

What is a Convertible Bond?

A

Lender can demand payment via company stock instead of money

36
Q

What is a Sinking Fund?

A

Borrower deposits regular sums into an account that will eventually pay off the debt

37
Q

What is the disadvantage of Common Stock in comparison to bonds?

A

Common Stock is more expensive to issue than debt.

Why? Investors demand a greater ROI than debtors (bondholders)

38
Q

What is the advantage of Preferred Stock?

A

Hold dividend priority over common stock

39
Q

What is Weighted Average Cost of Capital?

A

A company uses this to determine the true cost of their capital. a firm’s optimal capital structure would be the minimum weighted average cost of capital.

Example:
Debt costs 5%; 40% of Cap.
Equity costs 12%; 60% of Cap.
(5% x 40%) + (12% x 60%)
WACC : 9.2%
40
Q

What is CAPM?

A

A stock’s expected performance is based on its beta (risk) compared to that of the stock market.

More risk : more expected return.

41
Q

How is Cost of Debt calculated?

A

(Interest Expense - Tax Benefit) / Carrying Value of Debt

42
Q

U.S. Treasury securities

A

U.S. Treasury securities are considered to be the financial instrument with the least default risk, followed by securities of federal government agencies. Default risk is simply the possibility that interest or principal payments will not be made.

43
Q

In capital budgeting, the profitability index

A

computed as the present value of future net cash inflows divided by the discounted initial investment. The result is an index number rather than a dollar amount.

Useful in evaluating different-sized projects when capital budgeting funds are limited.

44
Q

Payback

A

The payback capital budgeting technique indicates how soon a project will recover its cost. The sooner the cost is recovered, the less risky the project—returns are less knowable the further in the future they are.

The payback method does not adjust for the time value of money.

The formula is Initial investment ÷ Annual cash flow.

This method ignores profitability

45
Q

IRR

A

Internal rate of return (IRR) is the method used to determine the rate of return that causes the present value of the net cash flows to equal the initial investment. It is a way of evaluating an investment as the present value of the net future cash flows from the investment, expressed as:

Investment = PV (i,t)
…where i (the rate at which the cash flows are discounted) is unknown.

An acceptable or beneficial proposal is one for which the IRR is equal to or greater than the firm’s predetermined minimum acceptable rate of return on the investment.

it is a time-adjusted rate of return related to the project being considered

46
Q

Creditors of a corporation should monitor a corporation’s

A

The debt to equity ratio is computed by dividing total debt by total stockholders’ equity. A higher ratio indicates existence of significant debt which could entail higher interest expense and creditor risk in a liquidation situation.

Times interest earned indicates the “cushion” related to a firm’s ability to pay interest on debt. It is computed by dividing income before interest and taxes by interest expense.

Therefore, creditors are affected by and should monitor both of these measures.

47
Q

preventive control activity

A 
separation of duties,
use of passwords,
required authorizations,
required approvals,
alarm systems,
use of locks,
security guards and cameras, and
education, training, and monitoring of employees.
48
Q

Detective control activities

A 
audits,
required vacations,
background investigations,
rotation of duties,
variance analysis,
reconciliations, and
physical inventories.
49
Q

highest present value

A

Increases in cash inflows (decreases in cash outflows) will result in higher present values, all else being equal.

The earlier the cash inflows (the later the cash outflows) the higher the present value, all else being equal.

Increases in cash flows can be the result of increased revenues, increases in other cash inflows, or decreases in cash outflows. ex: $100 decrease in taxes each year for four years) results in increased net cash inflows for each of four years, thus resulting in the highest present value.

50
Q

hedge

A

A hedge is a strategy to insulate a firm from exposure to foreign exchange, commodity price, or interest rate fluctuation. A hedge reduces the risk of gains or losses by purchasing or selling futures contracts.

Under the hedging approach, the length of financing term is matched to the life or duration of assets financed. Long-term assets are financed with long-term debt and short-term assets (such as current assets) are financed with short-term debt.

51
Q

inventory reorder point

A

is the inventory level at which an order is placed. The reorder point is average demand during the lead-time period plus any safety stock

The ordering cost and carrying cost are used to compute the best quantity to order

52
Q

average gross receivable balance

A

Average daily sales × Average collection period
OR
average gross receivable divided by average daily sales gives you the average collection period.

53
Q

Short-term credit

A

Short-term credit can generally be obtained quicker than long-term credit.

Generally short-term credit is more flexible than long-term credit.

Short-term credit is generally less costly than long-term credit as shown by the yield curve.

Prepayment penalties are generally associated with long-term credit, but these penalties are not the basic reasons for a higher cost for long-term credit.

Short-term credit holds more risk than long-term credit due to the need to renew more often.

54
Q

Floating-rate bonds

A

eliminate interest rate risk since the interest rate paid for a given payment period is based upon the prevailing rates in the current bond market; therefore, if interest rates rise, the interest payment will also increase. Since the market value of bonds is based upon the present value of future cash flows, the market value of floating-rate bonds will remain relatively constant.

55
Q

Accounting rate of return is

A

a nondiscounted method of computing the rate of return of an investment. It is based on accrual accounting and has the measurement of profitability as the goal. The limitation of this method, however, is that it ignores the time value of money.

Accounting rate of return = (Net cash inflow - Depreciation) ÷ Investment or net income ÷ investment.

There is some controversy about the denominator—the most commonly used amount is the initial cost of the investment, but some advocate the use of an average investment.

56
Q

As the cost of capital increases and all other factors remaining constant

A

As the cost of capital increases, the present value factors decrease, meaning that it becomes harder and harder to obtain a positive net present value. Hence, fewer projects will probably meet the company’s investment criteria.

57
Q

Efficient market hypothesis relates to the degree to which past or current information is incorporated in and/or influences the current market prices of securities

A

three forms: weak-form efficiency suggests that information about past prices would not be of use in predicting future performance;
semi-strong efficient markets suggest that all publicly available information is incorporated in market prices; and
strong-form efficient markets suggest that all available information is incorporated in current market prices.

58
Q

Net present value modeling

A

Advantages of using the net present value method for decision making include the following:

The time value of money is considered (compounding of returns).
Given a perfect market, correct decision advice will be obtained.
A correct ranking will be obtained for mutually exclusive projects given similar lives and investments.
An absolute value is obtained.
Disadvantages of using the net present value method for decision making include the following:

The discount rate is difficult to determine.
Assumptions related to cash flows have to be made that may or may not be correct.

59
Q

fair value
and
fair market value

A
  • Fair market value implies a willing buyer and seller, whereas the buyer and seller under fair value are not necessarily willing.
  • Fair market value defines the seller as hypothetical, whereas there is a specific seller when using fair value.
  • Fair market value takes advantage of an unrestricted market, whereas fair value uses the principal or most advantageous market.

BEC (9 decks)

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