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BEC > Financial Mngmt, Cap Budget > Flashcards

Financial Mngmt, Cap Budget Flashcards

1
Q

Cost of debt is currently 8% based on 40% debt ratio. Stock issuance would require 10% return. What is cost of capital?

A

Debt ratio is .40 x .08 = .03
Equity is .60 x .10 = .06
CoC = 9.2%

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2
Q

What are the 3 theories on the reason for differences in yields?

A

Liquidity preference, market segmentation, and expectations

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3
Q

Cash Conversion Cycle

A

Number of days from when you pay for inputs to when collect cash from the sales. try to shorten to minimize financing (net operating cycle)
= ICP + RCP - PDP [2-4]

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4
Q

Inventory Conversion Period

A

Days to convert inventory to sales

ICP=Avg Inv/CGS per day [1-3]

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5
Q

AR Collection Period

A

Days to collect AR

RCP=Avg AR/Avg credit sales per day [3-4]

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6
Q

AP Deferral Period

A

Days from buying inventory and paying for it
PDP=Avg payables/purchases per day (or CGS/365)
[1-2]

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7
Q

The number system for cash conversion cycle..

A

1- Receive inputs from suppliers
2- Pay suppliers
3- Sell finished product on credit
4- Collect receivables

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8
Q

AR Turnover

A

Net credit sales/Avg AR

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9
Q

Days sales in Avg AR

A

360/AR Turnover

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10
Q

Reorder point calculation

A 
Avg daily demand (usage in units per day)
x Avg lead time
= reorder point w/out safety stock
\+ safety stock
= reorder point w/ safety stock
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11
Q

Economic order quantity (EOQ)

A

= square root of (2xAxP)/S
A= Annual usage of inventory (demand)
P= Cost of placing an order (order cost)
S= Cost of storing unit for one period (carrying cost per unit for 1 year)
* The order size that minimizes order and carrying costs

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12
Q

JIT characteristics

A

Order as needed to minimize non-value added costs

  • when costs of storing are high (non value)
  • lead times are low
  • needs for safety stock are low, good relationships
  • costs per purchase order are low
  • “pull” system
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13
Q

Backflush Approach

A

Delayed, or Endpoint costing:

  • Don’t record production charge until FG or sales
  • Standard costs used to allocate man costs to FG
  • Usually used with JIT
  • Simple accounting, have standard cost for each product, would have same results using sequential tracking
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14
Q

Inventory Turnover

A

CGS/Avg Inventory

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15
Q

Days supply in Inventory

A

360/Inventory Turnover

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16
Q

FV factor =

A

1/PV

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17
Q

What are the 4 capital budgeting techniques

A
  1. Payback period
  2. Internal rate of return
  3. Accounting rate of return
  4. Net present value
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18
Q

Payback period

A

Initial investment/After tax net CF’s = # of years

  • No discounted unless question says so
    • Salvage value is collected at the end of the asset life, it is used in calculation only if payback period extends that long or beyond
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19
Q

Internal Rate of Return

A

PV factor = Investment/annual cash flows

* Rate at which NPV=0, if IRR

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20
Q

Accounting rate of return

A

ARR= Accounting income (include dep and taxes)/Avg Investment (Carrying amount minus depreciation)

  • Ignores time value of money
    • If you’re given CF, need to add back depreciation and non-cash items to get N/I
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21
Q

Net Present Value

A

= PV of future CF’s - Required investment

* Discount the PV of both inflows and out and then subtract them

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22
Q

Excess PV index (profitability index)

A

PV of annual after tax CF/Initial cash invested in project

* Use to rate and order projects

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23
Q

Depreciation Tax shield calculation

A

Tax rate x depreciation

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24
Q

Annual Financing Cost (AFC)

A

*Cost of not taking the discount

= (Discount %/ 100 - discount)x(365 / total pay period, or net - discount period, or first num)

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25
Q

Compensating Balances actual interest rate

A
  • Increases the effective interest rate paid on the net part of the loan
    = Interest paid / Net funds available (principal-compensating balance)
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26
Q

Current Yield

A

Fixed interest rate / Current selling price of the bond

* Not take into account that principal repayment will not be selling price but face value

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27
Q

YTM (effective rate)

A

Rate at which PV of CF will equal current selling price of bond
YTMcurrent yield = discount

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28
Q

Advantages of debt financing

A
  • Interest is tax deductible
  • Fixed obligation
  • No control given up
  • Less costly than equity
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29
Q

Disadvantages of debt financing

A
  • Predetermined payments independently of performance

- High debt levels increase risk business will fail

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30
Q

Operating Leverage (DOL)

A

= % change in EBIT / % change in sales volume

  • small change in sales causes a relatively large change in EBIT
    or. .. CM/EBIT
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31
Q

Degree Financial Leverage (DFL)

A

% change in EPS / % change in EBIT
(small change in EBIT causes a relatively large change in common shareholders’ return, or..
EBIT / (EBIT-interest)

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32
Q

Cost of Debt

A

After tax cost of interest payments measured by YTM

  1. YTM x (1 - effective tax rate)
  2. (Interest exp x (1-tax rate)) / Avg market
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33
Q

CAPM

A

Capital asset pricing model: risk v. expected return

= Risk Free interest rate + [(expected-risk free rate)xbeta]

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34
Q

6 ways to measure cost of equity

A 
CAPM
Arbitrage
Bond Yield Plus
Dividend Yield Plus
Cost of New Common Stock
Weighted Avg Cost of Capital
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35
Q

Dividend Yield Plus growth

A

= (Next expected dividend/current stock price)+expected growth in earnings

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36
Q

Cost of New Common Stock

A

= Next expected dividend / (current stock price - flotation costs) + expected growth in earnings
* Must cover costs of issuing securities

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37
Q

WACC

A

Weighted Avg Cost of Capital

  • Lower required rates of return mean lower WAAC
  • Low debt to equity ratios means lower WAAC and rely more on debt
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38
Q

Residual Income

A

= Operating profit - Interest on investment (invested capital x required rate of return)

39
Q

Economic Value Added

A

= Net Operating profit after taxes (NOPAT) - cost of financing (Capital invested x WAAC)

40
Q

Return on Assets

A

= Net income / Avg total assets

41
Q

Return on Equity

A

= Net income / Avg common stockholders’ equity(total sock equity - preferred stock liquidation value)

42
Q

Debt to Equity

A

Total debt / Total equity

43
Q

SD measures…

Coefficient measures…

A

Volatility

Risk

44
Q

Unsystematic risk is…

systematic risk is..

A

Avoidable

Unavoidable

45
Q

Beta measures..

A

How volatile the investment is relative to the overall market (how quickly stock changes when market sways) - systematic risk

46
Q

Coefficients of variation in Hedges against risk..

A

-1

The closer to 0, the less of a relationship there is. +1 means they act the same. -1 means they act in opposite manner

47
Q

Calc Compensating balances using only interest rates given

A

Interest rate=Interest paid/(Principal-Comp bal)
= .11 / (1 - .10)
where 11% is proposed rate and 10% is comp rate

48
Q

Which capital budgeting methods is depreciation expense ignored?

A

When income taxes are ignored, depreciation expense is excluded from calculations of NPV, IRR, and payback methods
When income taxes are ignored, depreciation is INCLUDED when calculating the accounting rate of return

49
Q

The discount rate (hurdle rate of return) must be determined in advance for the…

A

NPV method

50
Q

What is an internal rate of return?

A

A time-adjusted rate of return from an investment

51
Q 
Sales = 750,000
Asset turnover = 1.5 times
Return on sales = 8%
Imputed rate = 12%
What is the residual income for year 1?
A

Residual is Profit reduced by required return on assets
Profit = 750,000 x 8%= 60,000
Assets= 750,000/ 1.5= 500,000 x 12%= 60,000
Therefore, NO residual income

52
Q

Price Earnings Ratio

A

Common stock price per share/EPS

53
Q

Which of the following factors would not be relevant when determining the risk premium on a specific security?

A

EPS - while dependent on profitability, the denominator is dependent on number of shares, so 2 with similar earnings and risk but with diff shares could have vastly diff EPS

54
Q

Where are gains/losses reported for CF hedges?

A

The effective portion is recorded in OCI and ineffective portion in income

55
Q

ROI

A

Net income / Avg assets or Avg invested capital

**Measures profitability in relation to avg capital invested. Could be profitable but decrease company’s overall ROI

56
Q

Total Asset Turnover

A

Sales / Avg total assets

57
Q

Credit Default Swaps protect…

A

The buyer against bond defaults (not interest rate changes)

58
Q

Invest 100,000 in prop, sell for 120,000 in one year. 10% rate. What is NPV?

A

120,000 / 1.10 = 109,091 - 100,000 = 9,091

59
Q

Explain depreciation tax shield

A

Incremental earnings on project have related incremental tax liability. Depreciation reduces incremental earnings and thus tax liability. Shield part of the inflow from taxation ONLY WHEN taxes are a factor in the problem

60
Q

Explain the concept behind economic order quantity

A

The purchase order size that minimizes the total of inventory order cost and inventory carrying costs

61
Q

Factoring receivables generally improves..

A

AR turnover ratio

62
Q

Profitability index =

A

PV of cash inflows / initial cost of a project

**Used to compare projects with positive NPV that differ in size

63
Q

Credit risk is..

A

The risk that the counter-party to a contract will fail to honor its obligations

64
Q

Disadvantages to internal rate of return

A

CF’s are assumed to be reinvested at the rate earned by the project and IRR is more difficult to use

65
Q

Cost of debt

A

Interest expense x (1-tax rate)

/ Avg market value of debt (bonds)

66
Q

Dividend Yield

A

Dividend yield= dividend per share/selling price

67
Q

Why would a firm generally choose to finance temporary assets with short-term debt?

A

Matching the maturities of assets and the related liabilities reduces risk.

68
Q

Cost of Preferred Stock

A

Preferred dividends/Avg market of p/s

69
Q

Cost of common stock

A

(Dividends on common/Avg market of common)

+ Expected growth rate in dividends

70
Q

When income tax are ignored, depreciation is excluded from calc for the…

A

NPV
IRR
Payback

71
Q

Expected c/s dividend

A

EPS x c/s payout rate

72
Q

How to decrease market vale per share of c/s?

A

Stock dividend

73
Q

Calc to figure out price of a stock

A

P/E ratio x EPS (Net income/shares out)

74
Q

Best method for comparing capital projects if capital rationing used…

A

Profitability index best for independent initial ranking

75
Q

Materials Requirements Planning

A

MRP is forecast based planning and inventory control to ensure materials are available when needed

76
Q

Operating profit equals

A

EBIT or..

Net income + interest + taxes

77
Q

What is the typical reason for a corporation to use warrants?

A

make a corporation’s securities attractive to a wider range of investors, increasing the supply and decreasing the cost of capital.

78
Q

What is the effect of a stock dividend?

A

Decreases future earnings per share (A stock dividend increases the quantity of outstanding stock. Future EPS will be less than it would otherwise be, as earnings are spread over more shares. A stock dividend effectively moves equity from retained earnings to paid-in-capital)

79
Q

A company purchases inventory on terms of net 30 days and resells to its customers on terms of net 15 days. The inventory conversion period averages 60 days. What is the company’s cash conversion cycle?

A

It is the sum of the inventory conversion cycle (60 days) plus the receivables collection period (15 days) less the payables deferral period (30 days) = 45 days

80
Q

Cost of Retained Earnings

A

Cost of c/s [dividends/price + growth] x (1-stockholders marg tax rate)

81
Q

Debt ratio

A

Total debt / Total assets

** Measures a company’s leverage

82
Q

Operating assets =

A

Sales / Capital turnover ratio

83
Q

Times interest earned

A

EBIT/Interest expense

84
Q

Life Cycle of products, industry, entity

A
  1. Infancy - little direct competition, higher promotional expenses, high resources to start in new market (experimentation phase)
  2. Growth - sales increase, attract direct competitors, may need to reinvest profits dramatically
  3. Maturity - rates of increase slow down, more competition, fund next generation or pay out
  4. Decline- sales decreases as replacement products evolve
85
Q

When there are products competing for a scarce resource, for short run profit maximization..

A

the company should produce and sell the product that has the greater contribution margin per unit

86
Q

Incremental profit

A

= Incremental sales - incremental costs

87
Q

Safety Stock

A

Extra inventory on hand to avoid a stock-out in case lead time demand was higher than average
Max demand during lead time less expected demand during lead time

88
Q

After tax Payback example: 1,000 investment, 250 CF, 200 depreciation /yr, 25% tax rate

A

Depreciation tax shield= 200 x 25%= 50
CF with taxes = 250 x 75% = 187.50
Payback= 1,000/237.50 = 4.21 years

89
Q

How will financing long term assets with short term debt affect the entity?

A

Adversely: when rates go up they need to refinance ST debt at new higher rate to keep long term assets funded.

  • Also, the return on the asset may decrease when rates increase
  • Match maturities of ST assets with ST debt -extra costs paid on new ST debt will be compensated by extra returns earned on new ST asset bc higher rates apply to both borrowing and investing
90
Q

Advantages and Disadvantages of NPV

A

Ad: CF over life used, including residual sales; TVM is used; CF reinvested at cost of cap
Dis: Doesn’t est rate of return, merely tests against hurdle rate; more difficult to use; difficult to apply to strategic investments with unidentifiable CF’s

91
Q

Financial and Business Risk

A

Financial- additional risk owners bear due to decision to carry debt
Business- riskiness of operations without any debt (the risk inherent in operations)

92
Q

Floating Rate Bonds

A

Has a variable interest rate. The interest rate is reset to equal the current market interest rate. Therefore, the market value of the bond itself will remain constant since that set price will always yield the current market rate.

93
Q

Expected return on stock (given price info)

A

Dividends + expected increase in price (or cap gains)

/ current market price

BEC (7 decks)

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