3. Financial Mgmt Flashcards
Working Capital
CA - CL
Current Ratio
CA / CL
Quick (acid test) ratio
($ + mktable securities + A/R) / CL
[not inventory]
Cash Conversion Cycle
1 Receive materials on credit 2 Pay suppliers 3 Sell finished product on credit 4 Collect Receivable Sec 2-4
Cash Conversion Cycle calculations
[2-4] Cash conv cycle (pay $ to profits) EQUALS (want as LOW as possible) [1-3] Inv conv period (receive to sell) [3-4] A/R Collections [1-2] LESS: A/P deferral
Inventory Conversion Period ($ conv cycle)
Sec 1-3 (positive)
Receive goods to selling goods
Calc: Avg inv / COGS per day
Receivable Collections Period ($ conv cycle)
Sec 3-4 (positive)
From setting up receivable to it being paid
Calc: Avg Rec / Credit sales per day
Accounts Payable Deferral Period ($ conv cycle)
Sec 1-2 (negative)
Time it takes to pay for purchases
Want to have as high as possible
Calc: Avg Payables / Purchases per day
2 / 10 net 30
[2 / 98] x [360 / 20]
2 x 18 = 36% int
When dealing with cash mgmt, the time from when goods are paid for and A/R is collected is:
- A/R collection period
- Inventory conversion period
- A/P deferral period
- Cash conversion cycle
-Cash conversion cycle
Sec 2-4
If Inventory conversion period is 60 days, A/R collection period is 25 days, A/P deferral period is 29 days, how long is the cash conversion cycle?
56 Days
60 + 25 - 29 = 56
Which is not included in the Cash conversion cycle?
- Inventory conversion period
- A/R collection period
- Payables deferral period
- Cash discount period
Cash discount period
This is included as part of Average collection period but not as a separate entity
Lock-box system
Customers send payments directly to bank to speed up deposits and increase internal control over cash (reduces check processing float)
Concentration Banking
Customers pay local branches instead of main office so the busin gets funds more quickly reducing float
2 / 10 net 30 breakdown
2% discount if you pay within 10 days
30 days to pay otherwise
What do do with A/R?
Pledging: pledge as collateral for loan
Assignment: payer pays 3rd party, not you, for $ upfront
Factor: w/ recourse: contingent liab, have risk of loss if consumer doesn’t pay
w/o recourse: outright sale, get less $, but no risk of loss
A/R Turnover
Net credit sales / Avg AR
Avg A/R
(Beg + End A/R) / 2
days sales in avg A/R
360 / A/R turnover
Inventory should be at (cost)
Lower of cost or market
Economic Order Quantity
Decides appropriate quantity to order per order: SQRT[(2 x A x P) / S] A=annual usage of inv [annual demand] P=cost of placing order S=cost of storing a single unit for a yr
Reorder Point
# w/o safety stock = Avg Daily Demand x Avg Lead time (order to rec time) Just add safety stock to end amount if you want total
Just in time (JIT)
- Order as needed for production
- To lower nonvalue-added costs
- should have low lead times, so many small orders that are received quickly
Backflush approach
- Lower tracking of goods (no WIP/FG, immediately expense as COGS)
- Expect little to no ending inventory
Inventory Turnover
COGS / Avg inv
of days supply in avg inv
360 / Inv Turnover
Which effect would a lockbox system have on receivables management?
- Minimize collection float
- Maximize collection float
- Minimize disbursement float
- Maximize disbursement float
-Minimize collection float
Reduces float = makes collection faster
Which is used in computing reorder point for inventory? (pick 2) I. Cost II. Usage per day III. Lead time
II. Usage per day AND III. Lead time
(Avg daily demand x lead time) = Reorder point w/o safety stock
To determine inventory reorder point calculations normally include:
- Ordering cost
- Carrying cost
- Avg daily use
- Economic order quantity
Avg daily use
Sell 45,000 units in a year, safety stock desired is 1,250 units, avg cost per order $24, cost of carrying a unit is $6. What is the economic order quantity?
600 units
SQRT[2 x 45000 x 24) / 6]
SQRT[36000] = 600
Ordinary Annuity
Due in arrears. O = A vowels
Get at end of month, year, etc
Annuity due
“in advance”. D = B consonants
Due at beginning, ex rent (due on first)
Ordinary annuity to annuity due
Add $1 and 1 year (or reverse for opposite)
EX) Ordinary: 2yr, 6% = 1.833
Due: 3yr, 6% = 2.833
Payback Period
[Initial investment / after tax inflows] = # years
Time to recover investment
Pro: easy, shows $ flow, year limit
Con: no TVMoney, no profitability
Internal Rate of Return (IRR)
[Investment / annual $ flows] = PV Factor
Find % rate that corresponds to it
Sames as Payback period formula
The disc rate when NPV=0
Pro: easy, TVM; Con: no unique IRR, estimated
Accounting Rate of Return (ROI)
[Increase in Acct income ($ flow less depr) / Avg investment] = ROI
Appx rate of return, net of acct exps
Pro: uses acct income
Con: no TVM, no $ flows
Net present value (NPV)
PV of inflows - PV of outflows [aka investment]
+ is good, - is bad
Excess of net PV over/under hurdle rate
Pro: TVM, risk, profitability
Con: may not actually follow investments, difficult
3.09 end of lesson for PV calc examples
3.09 end of lesson for PV calc examples
Which is correct about the payback method as a capital budgeting technique?
- It considers time value of money
- It indicates if a project will be profitable
- It indicates the years needed to recoup an investment
- It is calculated by dividing annual inflows by the net investment
-It indicates the years needed to recoup an investment
Investment / cash flows
Annual financing costs (aka 2/10 net 30)
[Discount % / (100% - disc %)] x [360 / (total pay period - disc period)]
ex) 2/98 x 360/20 = 36.7%
Annual financing costs for 3/15 net 45
3/97 x 360/30 = 37.1%
Compensating Balance
Effective rate = [int paid / (principal - compensating bal)]
Company has a 1-year bank loan of $500k @ 8% interest, but requires a 20% compensating balance. What is the effective interest rate?
10%
(500k*8%) / (500k - 100k)
40k / 400k = 10%
Client is taking terms of: 3/10 net 30, on a purchase. What would not taking the discount cost them? (as a percent)
55.67%
3/97 x 360/20 = 55.67%
A Co. offers “2/10 net 30” to its customers. 60% take the discount and pay early, the remainder pay within 30 days. How many days’ sales are in their A/R account?
- 6
- 12
- 18
- 20
18 Basically avg time to collect receivables 60% x 10 = 6 40% x 30 = 12 6 +12 =18
Prime Rate, ex prime plus 2%
Variable rate that is an index for what the bank charges their best customers
LIBOR (int rate)
For US to abroad or “abroad to abroad” loans
Public vs Private Debt
Public debt - fixed int, resold in public mkts (bonds)
Private debt- var int, loans from banks
Bonds: stated vs effective rate
Stated effective = premium
Debenture bond
No security, no collateral
Term vs Serial bonds
Term (normal bond) pays lump sum owed at maturity
Serial fraction of face is paid in installments throughout life
Redeemable vs Callable Bonds
Redeemable- you can return them if company does something risky that was discussed in the contract (buyout of another firm)
Callable- company can take them back at any time
Stated interest rate synonyms
Stated, face, nominal, coupon
Current yield
Annual int paid / issue price of bond
ex) $1k bond, 12% int, issued for $900
(1k x 12%) -> 120 / 900 = 13.33%
Debt Financing
Pro: Tax deductible, fixed obligation, no loss of control
Con: must be paid, covenants, how debt makes company look, increases cost of borrowing (credit score)
Leases
Lessor: operating “true rental”, non-operating
Lessee: operating lease, capital lease (looks like a rental but end result is purchase)
What is the primary reason a company would agree to a debt covenant limiting the percent of their LT debt?
- To cause the company’s stock to rise
- To lower the bond rating
- To lower risk for current bondholders
- To reduce the interest rate on the bond being sold
-To reduce the interest rate on the bond being sold
MAIN REASON
You’re lowering the risk so: Less risk = less interest
The benefit of debt financing over equity financing is highest in:
- High marginal tax rate, few non-interest benefits
- Low marginal tax rate, few non-interest benefits
- High marginal tax rate, many non-interest benefits
- Low marginal tax rate, many non-interest benefits
-High marginal tax rate, few non-interest benefits
Debt is tax deductible, higher rate = bigger deduction. And if there are fewer other benefits, interest would be more beneficial
The capital structure of a firm includes bonds with: coupon rate of 12%, effective int 14%, corp tax 30%. What is the net cost of debt?
9.8%
Use 14% to figure out what its costing me, true int exp (cuz of discount plus int)
14(1 - .3) = 9.8%
Equity Financing
Pro: Dividends not liab until declared, no obligation to pay, higher equity = lower risk, makes investors happy when company does well
Con: costly to put out, lose ownership/control, not tax deductible, shares profits
Preferred vs Common
Cumulative dividends, liquidation value, redeemablility/ callablility, doesn’t vote
Operating Leverage
How fixed costs affects performance with changes in revenue
DOL = (% change in EBIT) / (% change in sales volume)
High DOL = high fixed costs, but higher proportionary increase in profitability
Financial Leverage
How much a corp relies on debt financing, looks at interest cost
High debt = higher int = higher risk = HIGH COST
DFL = (% change in EPShare) / (% change in EBIT)
Cost of Debt
[Yield aka Effective rate] x (1 - tax rate)
Cost of Preferred Stock
[Dividend aka par x # shares] / [Net issue price] = %
Cost of Existing Common Stock: CAPM
CAPM, measures volatility of stock relative to avg stocks
CAPM = Risk free rate + [(expect mkt rate - risk free) x Beta]
Beta is avg=1, low risk= 1
Cost of Existing C/S: Dividend Yield plus growth
(Next expected divid / current stock price) + expected growth in earnings [%]
Cost of NEW C/S
(Next expected divid / current stock price - flotation costs) + expected growth in earnings [%]
Weighted Avg Cost of Capital (WACC)
Cost to issue equity/debt, want to keep low
(% of total capital x effective cost % [less tax rate for debt])
Do this formula for each piece and sum
B Co. needs funds without fixed charges, fixed maturity date, and an increase in the credit-worthiness of the company. Which should B Co use?
- Bonds
- Common Stock
- LT Debt
- ST Debt
-Common Stock
C/S is not fixed and helps credit-worthiness (lowers risk)
Which is correct about WACC?
- A co. should try to reduce WACC
- A co. with a high WACC is attractive
- An increase in WACC increases value
- WACC equals the borrowing rate
-A co. should try to reduce WACC
Lower WACC equals lower costs
30% tax rate with the following capital structure: 40% weight, bond, 10% cost 50% weight, C/S, 10% cost 10% weight, P/S, 20% cost WACC after tax?
9.8% 40 x 10 x .7 = .028 50 x 10 = .05 10 x 20 = .02 Sum = 9.8%
Sold 9% preferred stock, for $40 a share, with a par of $20, cost of issuing was $5. What is the cost of preferred stock?
5.1%
(9% x 20) / (40 - 5)
1.8 / 35 = 5.1%
Stock is selling for $85 per share, next expected dividend $4.25, expected growth of 7%, corp tax of 30%. What % represents the cost of common stock?
12%
(4.25 / 85) + 7%
5% + 7% = 12%
Asset and Liability Valuation
Actual Price- compare $ to identical assets recently sold
Similar price- comparable asset, base on sq foot etc but not everything is matched/the same
Valuation model- not comparable, base on future cash flows, use equations to see growth
Vertical vs Horizontal Merger
Vertical - same supply chain, supplier and customer
Horizontal - same line of business (competitor)
Conglomerate- 2 random businesses
Gross Margin
Gross profit / Net sales
DuPont ROI
ROI = Return on sales x Asset Turnover
RoS = NI / Sales
Asset Turnover = Sales / Avg assets
3.19 lots of ratios
3.19 has ratios
What would increase a quick ratio?
- Purchase inventory with a long term note
- Implement procedures to collect A/R faster
- Pay an existing A/P
- Sell obsolete inventory at a loss
Sell obsolete inventory at a loss
Inventory isn’t included in the quick ratio, but you receive cash so it improves it
Beg Inv: 17k, Purchases: 56k, End inv: 13k
What is inventory turnover?
4.0 COGS / Avg Inv 17 + 56 = 73 Goods avail for sale 73 - 13 = 60 COGS 60 / (17+13 /2) = 4.0
Cash 5k, A/R 10k, Inv 20k, A/P 15k, Short term note 5k, LT note 35k. What is the acid test ratio?
.75
Cash, AR, AP, ST note
(5 + 10) / (15 + 5) = 15 /20 = .75
Inventory Turnover
COGS / Avg Inv
COGS = Beg + Purch - End
