B2 Flashcards
How do you calculate weighted cost of capital?
- add up the investment amounts
- divide each one by the total to get the % (proportion)
- multiply each % by the market rate of return and cost of equity respectively
- add up the final percentages
note: make sure that the debt calculation (market rate of return) is NET OF TAX!!
What would cause a firm to increase the debt in its financials structure?
an increase in the corporate tax rate
reason: interest expense is tax deductible (while dividends are not)
What is a major difference between futures and forward hedges?
Futures - for a specific transaction
Forward - for large groups of transactions
What is the difference between a letter of credit and a line of credit?
Letter of credit: 3rd party guarantee of obligations to ensure payment to creditors; short-term
Line of credit: borrowing from a financial institution to ensure the entity meets cash flow requirements; short-term; does not specifically guarantee payments on trade credit
What would the ordering costs of inventory mostly consist of (for a manufacturing business)?
production set-up costs
What are some examples of inventory carrying costs?
-storage
-insurance
-obsolescence
-spoilage
note: inspection costs are associated with ordering costs
What is the difference between safety stock reorder point and materials requirements planning?
materials requirements planning - projects and plans inventory levels in order to control the usage of raw materials in the production process; used for raw materials and WIP
safety stock - applied to both manufacturing and finished goods inventory to ensure that supply requirements are met
What is the formula for calculating WACC?
- debt: % of debt x interest rate x (1-tax rate)
- preferred equity: % of preferred equity x interest rate
- common equity: % of common equity x interest rate
formula: 1 + 2 + 3 = WACC
What is the PEG ratio?
(price / earnings) / (growth % x 100)
T/F: One of a company’s highest objectives is to minimize the WACC.
true; a decrease in the WACC increases the value of the company
What is operating leverage compared to financial leverage?
operating leverage: causing fixed expenses to be higher than variable costs (which is good for increasing profits, but you may incur higher losses b/c you still have to cover fixed expenses if sales decline)
financial leverage: higher percentage of debt than equity (the idea is that you will have higher operating income once sales cover fixed interest payments which would be returns to equity holders)
What is the goal of compensating balance arrangements?
to have a minimum balance in that cash account for reduced fees (NOT to increase the availability of cash)
What is the goal of zero balance accounts?
to increase the availability of cash (cash will be invested for the maximum period before disbursement)
What is the formula for required rate of return?
- real rate of return + inflation premium = nominal rate of return
- interest rate risk + liquidity risk + default risk = risk premium
- 1 + 2 = required rate of return
EBIT margin:
EBIT / Sales
