1B - Prospective Analysis, Including the Use of Data

Question 1

What are the approaches in capital investment planning?

Answer 1

1. Net Present Value
2. Internal Rate of Returns. Discount rate that makes the NPV of an invstmt zero
3. Payback Period
4. Discounted PB Period
5. Profitability index: Accept the invest if PI > 1
6. Accounting Rate of Return. Accounting profit/Initial investment
7. Real Options.

Question 2

Real Option Approach (ROA)

Answer 2

Helps managers in dealing with uncertainties. (ROA) is a sophisticated approach used in capital investment planning to evaluate and manage the value of flexibility and strategic decision-making under uncertainty.

Question 3

Costs in diagram. Interpretation

Answer 3

In a diagram, the line of total budgeted cost represent the total budgeted fixed cost and total budgeted variable cost. If budgeted variable cost stars from 0, then no fixed cost is assumed.

Question 4

Interest rate for individuals

Answer 4

Interest rate for individuals are determined primarily by Creditworthdiness. A more creditworthy individuals is likely to receive a lower interest rate than a less creditworthy individual.

Question 5

Transferring risk

Answer 5

Transferring the risk of interest rate changes from the institution to the member is a form of Financial risk management. Example, an institution starts offering fixed rate, and then decided to offer variable-rate.

Question 6

Cashflow hedging. Treatment

Answer 6

In a hedge against the exposure to the variable cash flow the entity would recognize the effective portion of the derivative`s gain or loss initially as a component fo OCI, and subsequently reclasify it into earnings when the forecasted transaction affects earnings.

Question 7

Discounted Cashflow for MACRS Depr.

Answer 7

Discounted cash flow for MACRS Depreciation is calculated Multiplying the asset value (no substracting the SV) by the rate of depreciation, then by the income tax rate if any and finally by the PV factor for the period asked.
Discounte Chash flow = Cost of new asset x MACRS rate x Income tax x PV factor.
Income tax rate is used assuming the amount of tax is what we saved.

Question 8

Accounting Rate of Return

Answer 8

To calculate the accounting rate of return: Substract the depreciation from the annual expected cost saving, and divide by the Investment(Asset value). If the problem ask for averall ARR we would need to divide the investment by 2.
ARR = (20000-10000)/100000
Averall ARR = (20000-10000)/(100000/2)

Question 9

Market beliefs related to efficient market

Answer 9

Market beliefs related to efficient market:
1, Waek form efficiency: past prices would not be used of use in predicting future perfomance
2. Semi-strong efficient: All publicly available information is incorporated in market prices.
3. Strong-form efficient: All available information is incorporated in current market prices.

Question 10

When diseconomies of scales start?

Answer 10

Diseconomies of scale begin where the average total cost starts goin up.

Question 11

Coef. of Variation calculation

Answer 11

In case coeficient of variation is asked: R2= 1 - (unexpected variation / total variation). The value range is from 0 to 1

Question 12

Payback Period uses

Answer 12

The payback period serves as a fair approximation of the annuity factor value from the table of present values of an annuity. Payback = Investment / Annual saving
If payback is equal to 5,00 in 10 periods, then te internal rate of retunr can be obtained as a percentage rate from an annuity table for the 10 periods nearest the annuity factor of 5,00

Question 13

Merger and adquisition strategy

Answer 13

Merger and adquisition strategy can provide vertical integration that is expected to result in lower costs along the value chain of activities:
* lower risk by diversifying into addtitional industies
* enter new markets
* provide possible opportunities for quick profitability
* provide opportunities to take advantage of economies of scope
*potentially lower costs along the value chain of activities
* broaden the strength of resources and capabilities.

Question 14

Capital budgeting decision

Answer 14

Capital budgeting decision are based upon predictions that are uncertain. Financial planning decisions are based on pedictions of operations, capital requirements, and financing needs.

Question 15

Short-term vs Long-term credit risk

Answer 15

Short-term credit can generally obtained quicker than long-term credit; however, short-term credit hold more risk due to the need to renew more often.

Question 16

Gordon Growth Model, cost of new CS

Answer 16

To calculate the cost of new common stock; Use the Gordon Growth Model, and remember that is the next dividend that is used. Ks = [Dividend(1+%Growth)/(Price(1-%cost)] + % of Growth

Question 17

Type of profits

Answer 17

• Accounting Profit: Revenue menus explicit costs
• Economic Profit: Acounting profit menus implicit costs
• Normal Profit: The point where the economic profit is equal to zero

Question 18

Expected Rate of Return

Answer 18

The CAPM computes the ERofR, CAPM = Rf + B(Rm-Rf)

Question 19

Economic exposure

Answer 19

Economic exposure represents any impact of exchange rate fluctuation on a firm’s future cash flow.

Question 20

Best-cost provider

Answer 20

Best-cost provider attempts to provide a product with superior quality, features, durability, service, etc. At the lowest cost. In other words, they are trying t give the buyer more value for their money

Question 21

Costs relevant in short-term decision making.

Answer 21

Only incremental costs, whether fixed or varaible, are relevant in decision making. Incremental costs represent the difference in the total cost between two alternatives.

Question 22

Factoring of AR

Answer 22

When there is a withheld amount, this should be substracted from the gross amount to calculate the amount subject to interes, and then apply all interest and fee costs.

Question 23

What does Payback emphasize?

Answer 23

Payback is computed as net investment divided by average expected annual cash inflow, so payback period emphasizes liquidity

Question 24

Assumptin in the income approach

Answer 24

The limits are essential when using the income approach. There are four basic approach:
1. The prediction of the future benefit stream is used to establish value
2. The number of periods in the projection
3. The terminal value at the end of the projection
4. The discount/capitalization rate.

Question 25

Cross rate calculation

Answer 25

If 1 euro = 1,48 usd and 1 pound = 2,06USD. To calculate cross rate of euro per pound we use EURO rate to denominator and pund rate to denominator and viceversa, cross rate of pound per euro; Pound rate/ euro Rate.

Question 26

ERM assist board in fulfilling their risk overside role, wich include all of the following:

Answer 26

* Participating in investor and stakeholder relations * Approving management incentives and remuneration * Reviewing, challenging with management on various topics.

Question 27

Business Risk

Answer 27

Include sensitivity to the business cycle, competition, and stability of local and foreign economies. An increase in fixed costs is an operating costs, not a business risk.

Question 28

Law of diminishing returns

Answer 28

States that as a firm adds additional units of a variable resource to a fixed resource, output will first increase at an increasing rate, then will increase at a decreasing rate, and at some point may become negative. Resources are fixed, not variable.

Question 29

The market approach to determining the fair value

Answer 29

The market approach to determining the fair value of a small company is based upon the theory that companies within the industry that have similar performance records and structure will have similar value.

Question 30

Transaction exposure

Answer 30

Is define as the degree to which the value of a firms future cash transactions can be affected by exchange rate fluctuation. Forecast of net cash flow Projection of consolidated net position Use of historical data can measure dthe degree of currency variability. The actual level of cash flows is known is not a caracteristic.

Question 31

Performance component of ERM

Answer 31

The performance component identifies and assesses risks that may impact the achievement of strategy and business objetives.

Question 32

Strategic vs Operational Planning

Answer 32

Strategic Planning It is performed only at the highest level of management and focuses on long-range goals Operational planning Results in budget data to be used in planning day-to-day operations

Question 33

Identure, the legal document contains:

Answer 33

Call provision Sinking fund Restrictive covenant The bond rating does not appear in the identure.

Question 34

Intracompany Service Price Transfer

Answer 34

In a intracompany service transfer, from cost center to profit center, STANDART VARIABLE COST is likely to be more conducive to evaluating whether both divisions have met their responsabilities. Thats becouse variable costs include direct costs that can generally be controlled by the division to which they are allocated.

Question 35

Sensitivity Analysis

Answer 35

It is any process that measures the impact of a change in a sinble variable or combination of varialbes on profits or on some other decision variable. That is, it is a technique to analyze the alternatives before the decision is mnade by measuring how changes in the critical assumptions will influence the results.

Question 36

Stakeholders in business information systems

Answer 36

Anyone in the organization whi has a role in creating or using documents and data stored on the computers or network

Question 37

Tecniques for measurement of inflation

Answer 37

* Consumer price index * Gross domestic product deflactor Wholesale price index

Question 38

Control Cycle approach

Answer 38

Key elements of the control cycle approach to risk management include the following: Modeling the expected results using a set of initial assumptions Doing a profit test to determine if the product provides a contribution margin Measuring the actual results Determining, both in quantitative and qualitative terms, an understandable explanation of the differences between expected and actual results Determining what actions need to be taken with respect to the product, including possible adjustments to reserves Using the findings to strengthen the model and update the assumptions as needed with feedback from the process

Question 39

Integrating Mecanism

Answer 39

Integrating mechanisms connect the information, tasks, and resources with the work groups in the organization. The major integrating mechanisms include: general management systems, increasing coordination potential, and reducing the need for coordination.

Question 40

General Rueles for internal rate of return (IRR) of a proposed asset purchase

Answer 40

1. Increases in cash inflows (decreases in cash outflows) will result in a higher internal rate of return. 2. The earlier the cash inflows (the later the cash outflows) the higher the internal rate of return, all else being equal. Taxes in general will lower the IRR of a proposed asset purchase, as will decreases in the tax credits available when an asset is purchased.

Question 41

Relevant factors when determining Risk Premium

Answer 41

The size of the premium will vary depending on the level of risk in a particular portfolio (including liquidity and seniority) and will also change over time (i.e., length of maturity) as market risk fluctuates. Liquidity refers to the ease (or lack thereof) of converting the security into cash without affecting the security’s price. Seniority, in terms of a security, refers to the order of repayment in the event of bankruptcy or liquidation. As a rule, high-risk investments are compensated with a higher premium.

Question 42

The rule of Thumb

Answer 42

The use of a rule of thumb can show the valuator is knowledgeable about the subject company’s industry; support valuation arrived at using another method with similar results; and/or support valuation arrived at using another method with different results along with why arguments as to why the subject company is not average within the industry.

Question 43

What Knd of risk can be reduced by diversification?

Answer 43

Since different industries and countries experience different risks of labor strikes, diversification between industries and countries can reduce company risk.

Question 44

Payback Reciprocal

Answer 44

Payback reciprocal = 1/Payback period Can be used to approximate a project's internal rate of return if the cash flow pattern is relatively stable

Question 45

Option Risk

Answer 45

Option risk occurs when a firm gives the customer the right (but not the obligation) to change the stream from assets, liabilities, or off-balance sheet items. Allowing a customer to prepay a mortgage without a prepayment penalty gives the customer a call option

Question 46

Re-pricing Risk

Answer 46

Re-pricing risk occurs when a firm deliberately mismatches in an upsloping yield curve environment by holding assets with a longer duration than that of the liabilities used to fund them.

Question 47

Basic Risk

Answer 47

An example of basis risk would be found in the situation where a bank's interest margins are generally spontaneously enhanced in a period of rising interest rates as loan rates tend to adjust upward more rapidly than the rates on deposits. Basis risk arises from the imperfect correlation between the price movements of a hedged asset and the hedging instrument. This risk is particularly relevant in financial markets where derivatives such as futures, options, or swaps are used to hedge against price movements of underlying assets.

Question 48

Yield Curve Risk

Answer 48

Yield curve risk arises when the underlying shape of the yield curve changes (e.g., steepens, flattens, becomes inverted). These changes tend to accentuate any asset-liability mismatches the firm has.

Question 49

Factors that impact on a firm's Beta

Answer 49

The debt-to-equity ratio, industry characteristics, and operating leverage would all have potential impact on the riskiness (beta) of a stock. The payout ratio measures the percentage of earnings paid to shareholders as dividends. The payout ratio would have the least impact on a firm's beta value.

Question 50

Which situations is an income-based approach appropriate for valuation?

Answer 50

The use of an income-based approach for a valuation is appropriate when a reliable benefit stream projection such as cash flow or income is available; the projected future benefit stream is expected to differ significantly from the past; and a substantial amount of goodwill appears to exist.

Question 51

Poson Put Clause

Answer 51

A poison put clause is a covenant that obliges the borrower to repay the bonds if a large quantity of common stock is held by a single investor and the bond rating is downgraded. This type of bond covenant is used as a defensive strategy to prevent hostile takeovers.

Question 52

Actual incidence of an idirect tax

Answer 52

Sharing of the tax depends on the relative elasticities of the demand and supply curves. The greater burden is borne by the side that has a relatively inelastic curve.

Question 53

Cost of Financing. Factoring

Answer 53

AR monthly average: 100,000 Factor advance up to 80% at 10% annual Fee 2% on receivables purchased. Saving $18,000 annually on collection expenses. Calculation: 2% fee on entire factoring $100,000 = 2,000 10% interest for 30 days on amount factored 80.000x0.1/12 = 667 Total fee = 2,667 Menus monthly savings -1,500 (18,000/12) Monthly interes rate = 1,46% (1,167/80,000) Annual rate = 17,5% (1,46% x 12)

Question 54

Methods that are prescribed by the IRS for setting arm's-length prices

Answer 54

The comparable uncontrolled price, the resale price, and the cost-plus approach to set transfer prices are all methods allowed by the IRS in an attempt to control transfer pricing manipulation.

Question 55

Cost of retained earning

Answer 55

The cost of retained earnings, using the Gordon Model, ignores flotation costs and underpricing, since the firm does not need to issue new stock. However, it must earn a return for the owners of the retained earnings, that is, the existing shareholders, as follows: krm = (D1 / PO) + g

Question 56

The four categories of entity objectives in the enterprise risk management framework

Answer 56

1. strategic (high-level goals, aligned with and supporting the entity’s mission), 2. operations (effective and efficient use of its resources), 3. reporting (reliability of reporting), and 4. compliance (compliance with applicable laws and regulations).

Question 57

Premise of Value

Answer 57

An assumption regarding the most likely set of transactional circumstances that may be applicable to the subject of the valuation The premise of value refers to the fundamental assumption or scenario under which an asset's value is assessed. It dictates the conditions and circumstances that should be considered when determining the value of an asset.

Question 58

Three methods of breaking down mixed costs

Answer 58

The scattergraph method takes a graph of all observed cost-activity points and draws a regression line through the points based on visual inspection, creating the cost formula from the regression line. The high-low method requires that the cost involved be observed at both high and low levels of activity. The least squares method is similar to the scattergraph method, except the regression line is created through statistics rather than by visual inspection.

Question 59

Calculation of Discounted, net of cash amount from disposal of an asset

Answer 59

If the task ask for dicounte, net of tax amount that relates to disposal of existing asset, take into consideration de Proceeds from the sale, menos tax over gain on disposal discounted at its Present Value. Example: Selling Price: 180.000 Taxable Value of asset: 150.000 Gain on Disposal = 30,000 times tax rate (0,4) times PV Factor 0,8929 = 10,715 Discounted, net of tax amount = 169,285 (180,000-10,715)

Question 60

Discounted Payback Period

Answer 60

The discounted payback period is the length of time required for discounted cash flows to recover the cost of the investment.

Question 61

The binomial model of pricing options

Answer 61

The binomial model is a variation of the Black-Scholes model of pricing options, differing from Black-Scholes in that it incorporates the underlying security for a period, rather than a point in time. This is accomplished by allowing for the specification of nodes, or points in time, during the time span between the valuation date and the option's expiration date.

Question 62

Discounted Payback Calculation

Answer 62

The discounted payback method uses the present value of the projected cash flows in determining the payback period. Example: Investment = 43,000, cost of investment: 8% Present Value of Cash flow: Year 1 = 9,260 Year 2 = 12,855 Year 3 = 15,880 Year 4 = 19,845 The discounted CF from year 1 to year 3 cover the investmen of 43,000 and still remains 5,005, this is divided by the year 4 CF: Payback discounted = 3 years + Remaining 0,25 year (5,005/19,845)

Question 63

Profitability index

Answer 63

Is the present value of the cash flow after the initial investment divided by the amount of investment. This allows the comparison of projects with differing investment amounts. It represents the percentage that a project's net present value exceeds the cost of the project. Allows the comparisons of mutually exclusive projects.

Question 64

Normalization adjustment by the Valuator

Answer 64

The valuator may make adjustments for nonrecurring, nonoperating, comparability, and discretionary items. Valuators often remove discretionary items considered part of normal operations that may be excessive or below average compared to industry averages, such as below-average salaries paid to the owner of a small company.

Question 65

Intrinsec Value

Answer 65

The intrinsic method is the excess of the market price over the exercise price. Market price (100 x $10) $1,000 Exercise price (100 x $9) 900 Intrinsic value $ 100

Question 66

FASB ASC 718-10-25-2, “Recognition Principle for Share-Based Payment Transactions,” apply to:

Answer 66

All transactions in which an entity grants shares of its common stock, stock options, or other equity instruments to its employees, except for equity instruments held by an employee stock ownership plan (as per FASB ASC 718-10-15-7).

Question 67

Black-Scholes-Merton option-pricing model used to estimate the fair value of stock options granted to employees

Answer 67

The model's formula assumes that risk-free interest rates are constant over the option's term.

Question 68

Exponential smoothing

Answer 68

is a statistical method that is useful as a sales forecasting technique. This forecasting procedure is a special type of weighted moving average: it is reverse geometric progression in which the effect of past events (in this case sales) is discounted based on some multiple so that the effect which the past event has on current projections decreases as the time since the event increases.

Question 69

Linear programming

Answer 69

Linear programming is a model for the allocation of scarce resources.

Question 70

Queuing theory

Answer 70

Queuing theory relates to the balancing of the cost of waiting with the cost of service; for example, the cost of lost sales resulting from long lines at the cash register versus the cost of opening another cash register.

Question 71

Cost-volume-profit analysis

Answer 71

Cost-volume-profit analysis is a model used to aid decision making relating to product lines, pricing of products, marketing strategy, and utilization of production facilities.