Capital Intensive Industry, PPE Inc "Fixed" Salary- TC indep on sales "Variable" Commission- TC dep on sales FORMULA! Degree of Operating Leverage (DOL)= _% change EBIT_ % change Sales

Decided by Management, Capital Struct Fixed- Debt- IE indep on profit Variable- Equity- Div dep on profit FORMULA! Degree of Financial Leverage (DFL)= _% change EPS_ % change EBIT

FORMULA! kdx = kdt (1-T) Pre-tax cost of debt = kdt After-tax cost of debt = kdx cheapest b/c int exp tax ded assume least risk

FORMULA! kps = Dps/Nps = outflow/inflow PS Cash Div = Dps Net Proceeds PS = Nps kps \> kdx b/c div not tax dec & assume more risk

3 Methods! Capital Asset Pricing Model (CAPM) Discounted Cash FLow (DCF) Bond Yield plus Risk Premium (BYRP) \ \ Use average of methods to compare kre \> kpr b/c CS assume most risk

B3- Financial Management Flashcards by Anna Latrobe

Capital Budgeting Projects:

3 Stages of Cash Flow

Step 1: Initial Outlay

Step 2: Operations

Step 3: TYCF

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Capital Budgeting Projects:

3 Stages of Cash Flow:

Step 1: Initial Outlay

Invoice + Ship + Install

+ NWC Inc

- Cash Proceeds sale of old (net of tax)

= Net Initial Outflow

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Capital Budgeting Projects:

3 Stages of Cash Flow:

Step 2: Operations

Net cash inflow after tax

+ Deprection * Tax

= Annual OCF

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Capital Budgeting Projects:

3 Stages of Cash Flow

Step 3: TYCF

Net proceeds from sale (net of tax)

Disposal Expense (severance pay)

+ tax savings on donated asset

+ NWC Dec

=TY Net inflow

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Net Present Value (NPV)

Annual After tax cash flow

+ Dep * tax

= Total Cash flow annually

* PV annuity factor (use only if =FCF)

= DFCF

_- Initial Outlay _

= NPV (Accept if +)

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NPV vs. IRR

NPV method of capital investment valuation is considered to be SUPERIOR to IRR because it is flexible enough to handle uneven CF or inconsistent rates of return.

NPV rate of return- can use WACC, Target rate, or dependent on risk of project

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Profitability Index =

Profitability index = PVFCF/initial outlay

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Payback period method

(Discounted or undiscounted)

Payback period = initial outlay/ annual =CF

or initial outlay - unequal CF until reach 0

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Operational and Financial Leverage

Leverage is the use of Fixed Costs

Risk Inc, but Potential Return Inc.

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Operating Leverage

Capital Intensive Industry, PPE Inc
“Fixed” Salary- TC indep on sales
“Variable” Commission- TC dep on sales
FORMULA!
Degree of Operating Leverage (DOL)=
% change EBIT
% change Sales

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Financial Leverage

Decided by Management, Capital Struct
Fixed- Debt- IE indep on profit
Variable- Equity- Div dep on profit

FORMULA!
Degree of Financial Leverage (DFL)=
% change EPS
% change EBIT

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Combined (Total) Leverage

FORMULA!

Degree of Combined Leverage (DCL)=

% change EPS
% change Sales

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Weighted Average Cost of Capital (WACC)

WACC = (cost of equity * % share of equity) +

(cost of debt * % share of debt)

** Want the lowest mixture of debt and equity to produce lowest WACC, easier to grow the business

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Yield to Market (YTM)

Weighted Average Interest Rate

YTM =

effective annual interest payment (outflow)

debt cash available (net inflow)

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Cost of Capital Components

Cost of LTD = kdx (cheapest)
Cost of PS = kps
Cost of RE/CS = kre (most expensive)

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Cost of LTD = kdx

FORMULA!

kdx = kdt (1-T)

Pre-tax cost of debt = kdt
After-tax cost of debt = kdx

cheapest b/c

int exp tax ded
assume least risk

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Cost of PS = kps

FORMULA!

kps = Dps/Nps = outflow/inflow

PS Cash Div = Dps
Net Proceeds PS = Nps
kps > kdx
b/c div not tax dec & assume more risk

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Cost of RE/CS = kre

3 Methods!

Capital Asset Pricing Model (CAPM)
Discounted Cash FLow (DCF)
Bond Yield plus Risk Premium (BYRP)
** Use average of methods to compare

kre > kpr
b/c CS assume most risk

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Capital Asset Pricing Model (CAPM)

CAPM

kre = krf + bi(km-krf)

kre= cost of retained earnings
krf= risk free rate
bi= beta coefficient
km= market rate
PMR = km-krf

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Discounted Cash Flow (DCF)

DCF

kre = (D₁/P₀) + g

kre= cost of retained earnings
D₁= div per share in 1 year = D₀ * (1+g)
P₀= current market value/price
g= growth rate

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Bond Yield plus Risk Premium (BYRP)

BYRP

kre = kdt + PMR

kre= cot of retained earnings
kdt= pre-tax cost of LTD
PMR= market risk premium = km-krf

Return on Investment (ROI)

ROI = _Income _

Investment Capital (Avg Assets, Avg PPE + Avg WC)

ROI = Profit Margin * Investment Turnover

Profit Margin = Income/Sales

Investment Turnover = Sales/Investment Capital

Return on Assets (ROA)

ROA =

Net Income

Avg Total Assets

Residual Income (RI)

RI = NI - Required Return ($)

Required Return ($) = NBV * Hurdle Rate

Economic Value Added (EVA)

EVA = NI - Required Return ($) Required Return ($) = Inv \* _WACC_

3 Measures of Financial Leverage (Risk)

Debt to Capital Ratio Debt to Asset Ratio Debt to Equity Ratio

Debt to Capital Ratio

_= Total Debt_ Total Capital (Debt + Equity)

Debt to Asset Ratio

_= Total Debt_ Total Assets

Debt to Equity Ratio

_= Total Debt_ Total SEq

Net Working Capital (NWC)

= CA - CL

Current Ratio

= CA/CL

Quick Ratio

_= Cash + MS + Rec_ CL

Motives for holding cash vs. Disadvantages for high cash levels

ADV. transaction motive- pay for operations speculative motive- potential opportunities precautionary motive- concern of treasurer: liquidity/safety DISADV. ROA Dec. Negative Arbitrage- int % paid \> int % rec

Methods to Inc Cash Balance

1. Customer Screening and Credit Policy 2. Prompt Billing 3. Payment discounts (2/10,n30), APR 4. Expedite Deposits (EFT, Lockbox) 5. Concentration Banking (one bank) 6. Factoring A/R (selling)

OC of not taking payment discount

APR = _360_ \* _Discount_ Pay Pd - Disc Pd 100-Disc %

Methods to Delay Disbursements

Defer Payments (take full adv of grace pd) Drafts/Checks Line of Credit Zero Balance Accounts

Other Cash Management Techniques

Managing Float (bank bal \> book bal) Overdraft Protection (benefit \> cost) Compensating/Minimum Balances (protects bank)

Cash Conversion Cycle

Avg days to generate cash = Int Conv Pd + Rec Coll Pd - Pay Def Pd \*Usually when Rec Coll Pd Dec, Inv Conv Pd Inc

Inventory Conversion Period

= # of days to sell = 356 / Inventory Turnover Inventory Turnover = COGS/Avg Inv

Receivables Collection Period

= # of days to collect = 356 / AR Turnover AR Turnover = Sales/Avg AR

Payables Deferral Period

= # of days to pay = 356 / AP Turnover AP Turnover = COGS/Avg AP

Factors influencing inventory levels

\*\* depend on accuracy of sales forecasts Lack of inv, then lost sales too much inv, then carrying costs

Optimal Levels of Inventory

* Inventory Turnover * Safety Stock * Reorder Point * Economic Order Quantity (EOQ) * Materials Requirement Planning

Reorder Point =

Safety Stock + (lead time \* sales during lead time)

Economic Order Quantity (EOQ)

When I say "two" you say "SOC" = sqrt (2SO/C) * S= annual sales * O= order cost * C= carrying cost per unit

Other Inventory management issues

* just in time inventory (JIT) * Kanban inventory- visual reorder signals * computerized inventory- walmart * Materials reuirement planning (MRP)- ext of computerized

Common Marketable Securities

(Highly liquid, low risk, low return) 1. US T-Bills (CAPM "krf") 2. CDs 3. Bankers Acceptance 4. Commercial Paper- Notes/drafts 5. Equity securities of public companies 6. Eurodollars 7. Hedge Transactions

Overall cost of capital

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

Benefits of debt financing over equity financing

When high marginal tax rates and few noninterest tax benefits

What happens when a seller extends credit to a purchaser for a period of time longer than the PURCHASER's operating cycle?

The seller is, in effect, financing more than just the purchaser's inventory needs

How do you calculate the total investment for expansion?

Original investment + expansion of CA _- expansion of CL_ = total investment for expansion