B2 Flashcards
Capital Asset Pricing Model Formula
Risk Free Rate + (Beta * (Market Return - Risk Free Rate))
Stated Interest Rate
rate of interest charged before adjustments for compounding or market factors
Simple Interest Rate
amount of interest paid on the original principal without including compounding
Compound Interest
amount of interest earnings or expense that is based on the original principal plus unpaid interest earnings or expense
Net Proceeds Formula
Total Loan Amount - Fees and Charges - Compensating Balance
Effective Interest Rate Formula
Net Proceeds
Calculate Effective Interest Rate
Actual Interest = ( P x Rate x Time)
Net Interest Cost = Actual Interest - Interest Earned
Effective Interest Rate= Net Interest Cost/ Loan Proceeds - Additional Balance
Calculate Effective Interest Rate in form of a discounted note
Cash Proceeds = Loan Principal - Interest discounted in advance
Effective Interest Rate = Interest Charged/ Cash Proceeds Of discounted note
Calculate Effective annualized percentage cost of financing
(Face Value - Original Issue Discount ) = x
X + Transaction costs = Y
(Y/ Original Issue Discount) x number of years = Answer
Interest Paid Formula
loan amount * ( annum interest amount ) - interest earned
Weighted Average Cost of Capital (WACC)
The average cost of debt and equity financing associated with the firms existing assets and operations.
After Tax Cost of Debt Formula
Pre tax Cost of Debt x ( 1- Tax Rate)
Cost of Preferred Stock Formula
Preferred Stock Cash Dividends / Net Proceeds of Preferred Stock
Cost of Retained Earnings using CAPM formula
Risk Premium
Risk Free Rate +———————————————————
[Beta Coefficient x (Market Rate - Risk Free Rate)]
—————————————-
Market Risk Premium
Retained Earnings using Discounted Cash Flow
(Dividend per share at year end/ Current Market Value) + Constant growth rate of dividends
Retained Earnings under bond yield plus risk premium
Pretax cost of debt + Market Risk Premium
1) Operating Lease
1) Operating lessee will record (ROU) asset and a lease liability on balance sheet. ROU will be amortized and lease liability paid down over life of lease.
Finance Lease
Will record a ROU and Lease liability on balance sheet. Each lease will consist of interest (IS) and principal pay (BS) down.
1) Debenture
2) Subordinated Debenture
1) Debenture: unsecured obligation of the issuing company
2) Subordinated Debenture: bond issue that is unsecured and ranks behind senior creditors in a bankruptcy scenario
Examples of Delay Disbursement
1) Defer Payments
2) Drafts
3) Letter of Credit
4) Zero Balance Accounts
Annual Percentage rate for quick payment discounts
360 Discount %
——————————————-x —————————-
Pay Period - Discount Period 100% - Discount %
Formula for Reorder Point Inventory
Reorder Point = Safety Stock + (Lead Time x Sales During Lead Time)
Economic Order Quantity (EOQ) Formula
2 x Sales in Units x Cost per Purchase Order
\ ——————————————————————-
Carrying Cost per Unit
Motivation to hold Cash
1) Transaction Motive
2) Speculative Motive
3) Precautionary Motive
Advantages and Disadvantages of Short Term Financing
1) Advantages: Increased liquidity, Increased profitability, Decreased financing costs
2) Disadvantages: Increased interest rate risk, Decreased capital availability
Advantages and Disadvantages of Long Term Financing
1) Advantages: Decreased interest rate risk, increased capital availability
2) Disadvantages: decreased liquidity, decreased profitability, increased financing costs
Present Value Formula
(1 + Interest Rate) ^ Number of Years
Present Value of annuity
Dividend Discount Model
(Required Return - Growth Rate)
Valuing Intangible Assets (Patents, Trademarks, Intellectual Property)
1) Market Approach: similar market
2) Income Approach: expected cash flow over useful life
3) Cost Approach: based on replacement cost
Net Present Value (NPV)
Difference between the present value of the cash inflows and outflows from a project (If positive then invest)
Internal Rate of Return (IRR)
The discount rate which the present value of the cash inflows equals the present value of the cash outflows from project. (IRR should exceed the hurdle rate)
Payback Method Formula
Increase in annual net after tax cash flow
The bond will sell at a premium when the
stated coupon rate on the bond is greater than the market interest rate on the bond at a given date
Commercial paper generally does not have an
active secondary market, it usually sold to the money markets by high creditworthy companies
Commercial paper avoids the expense of
maintaining compensating balance with commercial bank, Provide a broad distribution for borrowing, borrowers name becomes more widely known
Cost of Capital aka hurdle rate is the minimum return
a company must achieve in order to make an investment financially feasible, which can be calculated using WAAC.
The overall cost of capital is
rate of return required to cover the cost of resources employed
The optimal capitalization for an organization usually can be determined by
lowest total weighted average cost of capital (WACC)
When the mean return is greater than the standard deviation that means
there is a greater reward/ risk ratio.
Debt is a cheaper source of financing
than equity, bonds will be the cheapest form of financing. In addition issuing bonds receives a tax deduction for interest paid which further reduces cost
In the CAPM (Capital Asset Pricing Model) formula the
beta coefficient measures the volatility or risk inherent investment by % change in stock price
Manager have met the responsibility if
the return on capital investment exceeds the rate of return associated with the firms beta factor
CAPM model is calculated by taking the
Risk free rate + {Risk premium aka Beta * (Market Rate return - Risk Free Rate)}
Calculate Market rate of interest on a one year US treasury bill
Risk free rate of interest + Inflation Premium
When determining the risk premium
length of maturity, relative liquidity, and relative security is relevant
An example of operating leverage is a
firm cost structure includes a higher degree of operating fixed costs than variable costs by electing to pay salaries instead of commission.
Net working capital is the difference
between current assets and current liabilities
Determine the appropriate level of working capital requires
offsetting the benefit of current assets and current liabilities against liabilities rising at a faster rate than assets
As a company becomes more conservative in its working capital
it increases in the ratio of current assets to units of output
Refinancing a short term note payable with a two year note payable would
increase the working capital of the firm
The working capital financing policy that finances permanent
current assets with short term debt subjects the firm to the greatest risk of being unable to meet maturity
Loan X require 4 equal payments which includes both interest and principal and Loan Y require one lump sum payment at the end of year four. Interest is an expense while principal is a liability,
there for Loan X will be higher in Year 1 due to the principal owed in Year 2 which means a lower working capital, Loan Y does not reflect principal until last payment.
The current ratio is measure current assets by current liabilities which will increase if you receive
payment on accounts payable but the ratio will stay unchanged if cash is received from a receivable bc that cash already was included in assets just moved to a different category
Refinancing of accounts payable with a two year note payable would
increase capital of a firm
When a long term debt instead of short term debt is used to finance inventory purchases
current ratio and total debt ratio both increase
Quick ratio includes
marketable securities but excludes inventory and prepaids
Increase inventory Turnover lowers
cash conversion cycle
Net realizable value method, recognize the price
at which the inventory could be sold less any costs associated with shipping inventory
Examples of inventory carrying costs are
insurance, opportunity cost on inventory investment, obsolescence and spoilage
Safety stock the minimum level on
inventory that a firm keeps on hand, which depends on sales forecast, customer dissatisfaction for back orders, lead time for stock shipments
The optimal level of inventory would be affected by
cost per unit of inventory, cost of placing an order for merchandise, lead time to receive merchandise ordered.
When the Economic order quantity (EOQ) model is used for a
firm which manufactures inventory ordering costs consist of production set up
The economic order quantity formula (EOQ) assumes
the periodic demand is known
Economic Order Quantity is when
Inventory Management approaches orders at the point where carrying costs equate nearest to restocking costs in order to minimize total inventory
SCOR model says when
key management processes does assess the ability of suppliers to supply resources falls under “Plan”
Supply Chain Operations Reference (SCOR) says a company would include
determining demand requirements, assessing capacity concerns and capabilities, making make/ buy decisions in its planning
Potential Problems for a company with just in time inventory are
actual lead time for materials order could be longer than expected, loss of quantity discounts more than the cost of handling and purchasing larger lots of inventory, low quantity inventory. Seasonal fluctuations should not be a problem bc manufactures and suppliers should expect it and coordinate
Primary benefit of just in time inventory system for raw materials is
eliminates non value added operations
Materials requirements planning has a set of procedures to
determine inventory levels for demand dependent inventory types such as work in process and raw materials
Supply Chain Operations Reference (SCOR) says key management processes does
managing accounts receivable and collections from customers falls into Deliver
Supply Chain Operations Reference (SCOR) says
key management processes does collecting and processing vendor payments falls into Source
Accounts Payable provides a
spontaneous source of financing for a firm
Trade credit is subject
to risk of buyer default
A firm best delay disbursements through
the use of Drafts
Trade credit should still be used if
cost of alternative short term financing is more
If a seller extends credit to a purchaser for a longer period of time than operating cycle it in effect
financing more than just the purchaser’s inventory needs
If a seller extends the payback period on a customer it affects
cost of funds, impact on current customer base of extending terms for certain customers, bank loan covenants on days sales outstanding. No affect on current bad debt.
Examples of methods of converting accounts receivable to cash
Cash discounts, collection agencies, and electronic funds transfers
A change in credit policy has caused an increase in
sales, increase in discounts taken, decrease in the amount of bad debt, decrease in accounts receivable means the average collection period decreased
If a business sells a product and they receive 55% of it by check and 45% by credit card after they receive the invoice all of it goes to
accounts receivable bc they aren’t paying it until they receive an invoice not immediate payment
Concentration banking is when
company establishes a single bank as its central depository
Lockbox System accelerated
accounts receivable because its systems of mailboxes in many locations where customers send payments. Company checks mailboxes and immediately deposits checks
A lockbox most likely provides for receivable management
a minimized collection float because its expedites cash inflows
The primary reason for a company to agree to debt covenant
limiting the percentage of its LT debt is to reduce the coupon rate on the bonds being sold
Stock price will grow at the same rate as the dividend if the company uses
a constant growth dividend discount model to forecast the value of share of common stock
Price sales ratio is a valuation of estimation technique that can be adapted
to start up companies and other situations where earnings are very low
Capital Budgeting is accelerated method of
depreciation provide tax shields that are advantageous from a present value point of view
Estimating Cash Flow for use in capital budgeting, depreciation is utilized in
determining the tax costs or benefit
Increase in manufacturing flexibility, improved product delivery and service, reduction in new product development cost are factors in making capital budgeting decisions
development cost are factors in making capital budgeting decisions
When buying a new van and selling the old van the relevant costs are
Purchase Price of new van, disposal price of old van
Capital Budgeting is based on predictions of an
uncertain future, financing large expenditures, making investments that produce returns over long period of time, selecting among long term investment alternatives
Opportunity Cost is the potential benefit lost by selecting a different course of action.
by selecting a different course of action.
When buying a new machine the orginal price of the old machine is a
sunk cost that will not change, sunk costs are not relevant in deciding to buy new machines
MACRS method of capital budgeting is equal to
straight line depreciation (only timing differs)
Evaluating a capital budget project the use of the net present value is generally affected by
initial cost of the project, amount of added working capital needed for operations, amount of the projects associated depreciation tax allowance
Calculations of payback period
discounted cash flow, internal rate of return and net present value rely on the forecasting of future data
A projects net present value ignoring income tax considerations
is normally affected by proceeds from sale of the asset replaced
Net Present Value analysis uses
cost of capital, hurdle rate, and discount rate
Using accelerated method instead of straight-line
increases the present value of the depreciation tax shield
When the risks of the individual components of a projects cash flows are different an acceptable
procedure to evaluate cash flows is to discount each cash flow using a discount rate that reflects the degree of risk
An advantage of net present value over internal rate of return is
NPV can be used when there is no constant rate of return required for each year of the project
Limitations of the profitability Index is it
requires detailed long term forecasts of the projects cash flows
Profitability Index should be used if capital rationing needs to be considered
when comparing capital projects
When net present value is positive (greater than zero) the project should
be accepted, considering only present value is wrong because it ignores cash outflows, considering only IRR is wrong because it could be less than minimum desired rate
Internal Rate of Return (IRR) rate of interest where the
net present value is equal to zero
Factor of the IRR Formula=
Net Incremental Investment (Investment Required)
_______________________
Net annual cash flows
Internal Rate of Return equates the present value of a projects expected
cash inflows to the present value of the projects expected cash outflows
Internal Rate of Return decision making models equates
the initial investment with the present value of the future cash inflows
A time adjusted rate of return from an investment is
the internal rate of return
Present Value Factor =
Investment
____________
Cash Flows
Internal Rate of Return (IRR) is equal
to the discount rate
IRR and NPV method may be different if the two projects have unequal lives
and the size of the investment for each project is different
Internal Rate return method is less reliable than the net present value technique when
there are several alternating periods of net cash inflows and net cash outflows
Evaluating capital budgeting analysis techniques
the payback period emphasizes liquidity
In capital budgeting the total amount of the initial outlay for the project
is included in the payback model calculation
The payback rule ignores all cash flows after
the end of the payback period
A limitation of using the discounted payback method
to evaluate a projects is that it ignore cash flows after the payback period
Trade Credit provides
the largest source of short term credit for small firms
A practitioner considers when determining the sufficiency of the procedures is
In a agreed upon procedures engagement the sufficiency of the procedure is determined based on THE NEEDS AND UNDERSTANDING OF THE INTENDED USERS
In a review of interim financial information, the auditor report should
a statement that the auditor is not aware of any material modifications that should be made to the interim financial information (no assurance, reviews give negative assurance)
Company best ensure the reliability of its financial data
System automatically verifies the math and consistency of financial data. Automated data validation controls provide real time assurance of data reliability. The system checks mathematical accuracy, consistency, and completeness of data, ensuring reliability.
