Financial Management Flashcards
What are the effects of over/under investing in net Working Capital?
Over investing=lower return than earned on capital investment
Under investing=unable to meet current obligations
What is the formula for excess Present Value Index?
Present value if future net cash inflows
_______________________
Initial investment
*
100
___________________________
?
What figured is used as the denominator when creating a Common-Size Balance Sheet?
Total assets
How is residual income RI calculated?
Imputed charges
___________________
Or
Required return
_________________
In Machine Replacement, what factors are considered?
Old machine salvage value
Life if the new machine
Maintenance cost of new machine
What factor might lead to an increase in a company’s Debt Level?
Increases tax rate
What is another name for the Profitability Ratio and what is the formula?
Cost benefit analysis
Net present value of an investment’s cash flow
_________________________
Investment’s initial cost
(Used in capital budgeting and ranks projects by dollars returned vs dollars invested; the higher the ratio, the more attractive the investment)
What decision making model equates the initial investment with the present value of future cash flows?
IRR
(Disadvantage of IRR is that it has limitation when evaluating mutually exclusive investments)
(IRR is not preset but estimated)
(IRR is a time adjusted rate of return from an investment)
(IRR assumes cash flows are reinvested at the rate earned by the investment)
Which approach to valuing a business is best when the entity is losing money and being sold in distress?
Asset approach
Which technique gives the best answer when evaluating investment projects that are mutually exclusive?
NPV
NPV assumes cash flows are reinvested at the minimum rate of return
What is the Cash Conversion Cycle and the formula?
The time between cash paid to suppliers and cash collected from employers.
Receivables conversion cycle (AR/(sales/365)) \+ Inventory conversion cycle (Inventory/(cogs/365)) - Payables conversion cycle (AP/(cogs/365)) \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
What is a primary difference between Common and Preferred Stock?
Voting rights, preferred stock usually doesn’t have them.
(Preferred stock is still equity)
(Preferred stock is not required to issue a dividend)
(Preferred stock has higher priority over common stock in bankruptcy)
What is a Corporate Treasurer’s primary concern when managing cash and short-term investments?
Liquidity and safety to provide funds when needed
What is the Payback Period formula?
Initial cost of investment
_______________________
Annual net cash inflows
(The length of time needed for net cash flows to recover the initial cash investment in a project; depreciation expense in not included in cash outflows)
(The strength of this method is the ease of use. The weakness is that it use discounted amounts and only factor fund recovery)
What is the formula for Assets?
Liability
+
Shareholder’s equity
______________________
Why are Serial Bonds attractive?
Investors choose the maturity that suits their financial needs
What is the formula for the Annual Cost of Carrying Inventory?
Average inventory level (Order quantity/2) * Unit cost * cost of capital \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ ?
(An assumption of EOQ is that periodic demand is known)
How is the Effective Cost calculated?
Annual dollar cost
_______________________
Net useable proceeds
What Capital Budgeting technique assumes that cash flows are reinvested at the rate earned by the investment?
IRR and NPV
IRR and NPV are the two methods that consider the time value of money
What is the Profitability Index formula and how is it used?
NPV
_____
Cost
The expected return for each dollar invested
(The higher the result the more desirable the project)
(Should be used when comparing projects during capital rationing)
(Limitation: forecasting cash flows)
How do Capital and Operating Leases differ?
The lessor finances the transaction through the leased asset under capital leasing
(Capitalization of a lease increases debt)
What Risk is inherent in every firm?
Business risk
What does a graph that plots Beta depict?
The relationship between asset return and benchmark return
What amount affects a projects NPV (excluding taxes).
Salvage value
Proceeds from the sale of an asset to be replaced
What Cash Management technique focuses on disbursements?
Zero-Balance Accounts
What Rate of Return is required from investors for deferring current consumption when investing?
Risk-free rate
What is the Hedging principle of finance (also called the principle if self-liquidating debt)?
Financing short term assets with short term liabilities
Adding seasonal inventory by increasing accounts payable
What is Exponential Smoothing?
A technique to reduce random fluctuations in time series data with declining weights assigned to data as it gets older
What type of Investment is best during periods of high inflation?
Precious metals
What is the affect of a firm purchasing Treasury Stock with surplus cash?
Increases a firm’s financial leverage
What is a Field Warehouse Agreement?
An arrangement where the inventory remains with the borrower but is placed under the control of a third party
(In a terminal warehouse agreement inventory is moved to a public warehouse controlled by a third party)
What factors affect Risk Premium?
Length of maturity
Relative liquidity
Relative seniority
How is return on assets ROA/ equity ROE/ or investments ROI calculated?
Net income/Net Operating Profit
______________________
Average Total Assets/Equity/Investments
(Begin+Ending/2)
Or
Capital turnover (Sales/investment) * Return on sales (Net income/sales) \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
What is the cost of capital difference between Retained Earnings and external common Equity?
Retained earnings cost should be less because floatations costs aren’t needed
What rate is equivalent to a one year U.S. Treasury bill?
Risk-free rate of interest
+
Inflation premium
___________________
Does business Forecasting use qualitative and/or quantitative techniques?
Both
What are the after tax Cash Flow factors?
Revenue, taxes, and depreciation benefit
What is the WACC?
Percent of debt * rate \+ Percent of equity * rate \+ Percent of mixed vehicle * rate \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ ?
(Optimal capital structure= minimum WACC)
What is the objective of AR management?
Maximize profits
AR policies are concerned with recognition and collection
How is the Cost of Debt calculated?
Tax advantage
___________________________
What is the relationship between Capital Structure and Financial Structure?
Financial structure includes capital structure
(Financial structure includes all liabilities and equity used to finance assets=right hand side of balance sheet=total assets)
(Capital structure only includes long term liabilities and shareholder equity)
What is the difference between a Simple Moving Average and a Weighted Moving Average times series models for forecasting?
The simple moving average uses unadjusted raw prior period values. Under the weighted moving average, values are adjusted by assigning different weights to some or all values
What factors are considered in valuing a Stock Option?
Time until expiration date
Risk-free rate of return
Exercise price
(Industry classification of the stock is not relevant)
How is CAPM calculated?
(Market rate-Risk-free rate) * Beta \_\_\_\_\_ ? \+ Risk-free rate \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
How is Total Equity calculated?
Capital stock
+
Retained earnings
___________________
How is Total Liability calculated?
Total equity
____________
How is Times Interest Earned calculated?
Income before income taxes and interest expense
_______________________
Interest expense
What is a Bond backed by fixed assets?
Mortgage bond
What reason would a company agree to a Debt Covenant limiting the percentage of it’s long-term debt?
To reduce the interest rate on the bonds being sold
How do NPV and IRR differ?
NPV assumes reinvestment at the cost of capital while IRR assumes reinvestment at the IRR
Is the WACC determined by short-term and/or long-term financing?
Long-term financing. WACC consists of common stock, preferred stock, and long term debt
(WACC is the minimum a firm must earn on its investments. A lower WACC means the lower revenue needed to make a profit and the easier to increase shareholder’s wealth, it’s the optimum capital structure)
How is ROA calculated?
Net income
_____________________
Average total assets
Or
Asset turnover * Profit margin on sales \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ (Convert answer to percent)
What does the DuPont return on assets consist of?
The return on assets formula separated into two components:
Net profit margin ratio (Net income/net sales) * Average total asset turnover ratio (Net sales/ average total assets) \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
What does investment Beta measure?
The investment’s systematic risk
What kind of Risk is company specific risk?
Unsystematic risk
Why is depreciation relevant in NPV?
Depreciation increases cash flow by reducing income taxes