B2 - Financial management

Question 1

the benefits of debt financing over equity financing are likely to be highest

Answer 1

if the marginal tax rate is high and there are few non interest tax benefits

Question 2

WACC

Answer 2

1,000,000/3,000,000 8% = 2.67%
2,000,000/3,000,0009%=6%
2.6+6=8.6%

Question 3

The net cost of debt financing is

Answer 3

.14*.70= 9.8% == Effective Interest Rate Net of TAx

Question 4

WACC is frequently used as a hurdle rate within capital budgeting techniques

Answer 4

investments that provide a return that exceed the wacc should continuously add to the value of the firm

Question 5

an increase in the corporate tax rate might cause a firm to

Answer 5

increase the debt in its financial structure because interest is tax deductible, while dividends are not deductible.

Question 6

Discounted cash flow model – K = D/P + G =

Answer 6

Dividend 3/30 +10%= 20%

Question 7

Expected Rate of Returns Using Capital Asset Pricing Model(CAMP)

Answer 7

C= r + B (m-r)

Question 8

Equity Market expected = 12%
US treasury Bond current = 5%
Beta Coefficient =.60
Tax rate = 40%

Answer 8

C = r+B (m-r)
C = .05 + .60 (.12-.05)  =.092

Question 9

The most frequently used measure for cost of debt

Answer 9

actual interest rate minus tax savings

Question 10

The optimal capitalization for an organization can be determine by the lowest Total WACC

Answer 10

Capitalization at wacc serves to maximize shareholder equity

Question 11

capital investments whose rate of return exceed the rate of return associated with the firms beta factor will increase the value of the firm

Answer 11

increase value of firm

Question 12

The overall cost of capital

Answer 12

is the rate of return on assets that cover the cost associated with the funds employed

Question 13

The cost of capital considers

Answer 13

the cost of all funds, whether they are short term, long term, new or old

Question 14

Because debt is a cheaper form of financing than equity

Answer 14

Bonds will have the cheapest form of financing

Question 15

Three elements to estimate cost of equity capital are

Answer 15

Current Dividends per Share D
Expected growth Rate in Dividends G
Current Market Price Common Stock P

Question 16

the cost of prefer stock is computed in a manner consistent with the computation of effective rate of interest

Answer 16

dividend paid  ($20 PV * Dividend 9%) = 1.8
net proceeds (40- 5) = 35
1.8/35=5.14

Question 17

CAMP = cost of retained earnings

Answer 17

C = R + B (M-R) = CAMP is a method used to calculate the required rate of return on retained earnings (Equity)

Question 18

EPS -earnings per share is calculated

Answer 18

Net Income and dividing it by the number of common shares of stock outstanding

Question 19

The market rate of interest on a one year us treasury bill is comprised of

Answer 19

Risk free rate of return and inflation premium.

Question 20

the beta coefficient represents

Answer 20

the measure of a particular stock percentage change compared to the percentage change in the market over the same period.

Question 21

The optimal capital structure

Answer 21

is the financial structure that would theoretically maximize shareholder wealth by maximizing the net worth of the company

Question 22

Commercial Paper Market

Answer 22

• Avoids the expense of maintaining a compensating balance
• Provides a broad distribution for borrowing
• accrues a benefit to the borrower, because its name becomes more widely known

Question 23

The effective interest rate in the form of discounted note

Answer 23

$100,000 for one year @ 9% = 100,000*.09 = 9,000

100,000-9,000= 91,000; therefore interest charged divided by cash proceeds = 9,000/91,000=9.89

Question 24

the principle that deficiencies should be reported in ongoing separate evaluations and deficiencies should be reported

Answer 24

Monitoring

Question 25

the net cost of debt is computed as the effective interest rate net of tax

Answer 25

Do not use the coupon rate

Question 26

discounted cash flow model

Answer 26

k = D/P+G or Dividend/Stock Price + Growth

Question 27

the overall cost of capital is the

Answer 27

Rate of return on assets that covers the costs associated with the funds employed

Question 28

The financial manager should establish a hurdle rates for capital investments

Answer 28

At or above the WACC to ensure that the company receives returns equal to its costs of long - term capitalization

Question 29

the three elements needed to estimate the cost of equity are

Answer 29

Current Dividends per share
Expected growth rate in dividends
Current Market Price per share of common stock
R=D / (P+G)

Question 30

the cost of preferred stock is computed, similarly to the computation of the effective interest rate

Answer 30

Dividend paid ($20 PV * 9%) / Net proceeds 40-5)

Question 31

Operating Leverage is defined as the degree

Answer 31

to which a firm uses fixed operating cost as opposed to variable costs

Question 32

Times Interest Earned Ratio

Answer 32

EBIT(Earnings Before Interest and Taxes)/Interest Expense
Income after tax = 5.4 Mil
Interest Expense = 1 Mil
Tax Rate = 40%
5.4/.60 = 9 Mil = Income after tax
Pretax income+ int expense = 9+1= 10/1 = 10

Question 33

Debt-to-Equity Ratio

Answer 33

Total Debt / Total shareholder ‘s equity

Question 34

Financial leverage is the degree to which a company uses debt rather than equity to finance the company

Answer 34

financial leverage increase when the debt to equity ratio increases - Using a higher % of debt (bonds) for future investments would increase financial leverage

Question 35

to calculate financial leverage EBIT must first be calculated

Answer 35

EBIT / EBIT - I - (P/(1-T))

Question 36

if a company does not have preferred stock

Answer 36

the degree of total leverage would decrease in proportion to a decrease in financial leverage

Question 37

operating leverage is the

Answer 37

degree to which a company uses fixed costs rather than variable costs. The computation for operating leverage is the ratio of fixed cost/variable cost

Question 38

Day’s sales in AR may be calculated as

Answer 38

Ending AR / Avg daily sales

Question 39

Working capital policy is deemed to be more conservative

Answer 39

as an increasing portion of an organization assets, permanent current assets, and temporary current assets are funded by long term financing

Question 40

Net Working Capital

Answer 40

is defined as the difference b/t CA & CL

Question 41

CA Increased by 120 CL Decreased by 50 , then Net Working Capital increase by 170

Answer 41

CA = 500  + 120 CA = 620
CL = 300 - 50 = CL = 250
NWC = 200  = NWC = 370  = increase by 170

Question 42

Avg Inventory

Answer 42

Cost of Sale / Inventory Turnover

Inventory Turnover = COGS / AVG INVENTORY

Question 43

The working capital financing policy that finances permanent assets with ST debt

Answer 43

Subjects the firm to the greatest Risk of being unable to meet the firms maturing obligations

Question 44

Working capital

Answer 44

working capital increases only if CA are increased or CL are decreased. Exchanging AP(CL) for a Two year Note (LTL) would decrease CL and increase WC

Question 45

Quick (acid-test) ratio

Answer 45

Cash + Marketable securities + receivables / CL = the formula is Quick assets / CL –> Quick Assets exclude inventory and pre-paids from the CA

Question 46

To evaluate ST liquidity management

Answer 46

management uses quick ratio