B3: Financial Management

Question 1

The discount rate is determine in advance for which of the following capital budgeting techniques?

Answer 1

Net present value

The discount or hurdle rate is determined in advance for computations of net present value. Project cash flows are discounted based upon a predetermined rate and compared to the investment in the project to arrive at a positive or negative net present value. Advance determination of management’s required return is integral to the development and evaluation of net present value.

Question 2

In equipment-replacement decisions, which one of the following does not affect the decision-making process?

Answer 2

Original fair market value of the old equipment

The original FMV of the old equipment is a sunk cost that does not affect equipment-replacement decisions.

Question 3

Which of the following is an advantage of NPV modeling?

Answer 3

It accounts for compounding of returns

The NPV method assumes that positive cash flows are reinvested at the hurdle rate thereby considering compounding.

Question 4

For the next 2 years, a lease is estimated to have an operating net cash inflow of $7,500 per annum, before adjusting for $5,000 per annum tax basis lease amortization, and a 40% tax rate. The present value of an ordinary annuity of $1 per year at 10% for 2 years is $1.74. What is the lease’s after-tax present value using a 10% discount factor?

Answer 4

PV of cash inflows: $7,500 x 1.74 = $13,050
PV of cash outflows: ($7,500 - $5,000) x 40% x 1.74 =
$2,500 x 40% x 1.74 = - 1,740

$13,050 - 1,740 = $11,310 After-tax PV

Question 5

A project’s net present value, ignoring income tax considerations, is normally affected by the:

Answer 5

Proceeds from the sale of the asset to be replaced

Question 6

Para Co. is reviewing the following data relating to an energy saving investment proposal:

Cost: $50,000
Residual value at the end of 5 years: $10,000
PV of annuity of 1 at 12% for 5 years: 3.60
PV of 1 due in 5 years at 12%: 0.57

What would be the annual savings needed to make the investment realize a 12% yield?

Answer 6

PV cash savings/inflows = PV net cash outflows

Annual savings x 3.60 = $50,000 - (10,000 x 0.57)

Annual savings x 3.60 = $50,000 - 5,700

Annual savings x 3.60 = $44,300

Annual savings = $44,300 / 3.60

Annual savings = $12,306

Question 7

PV of $1

Answer 7

PV = FV / (1+r)^n

Example: 2 years, rate of 6%

PV = 1 / (1 + .06)^2

PV = 0.890

Question 8

PV of Annuity

Answer 8

Step 1: Calculate PV factor for $1
PV = FV / (1 + r)^n

Step 2:
(1 - PV of $1) / r

Example: 2 years, rate of 6%

Step 1:
PV = 1 / (1.06)^2
PV = 0.890

Step 2:
PV of annuity = (1 - 0.890) / .06
.16 / .06 = 2.673

Question 9

A company recently issued 9% preferred stock. The preferred stock sold for $40 a share with a par of $20. The cost of issuing the stock was $5 a share. What is the company’s cost of preferred stock?

Answer 9

Dividend paid ($20 par x 9%) = $1.80
Net proceeds ($40 SP - $5 flotation) = $35

$1.80 / 35 = 5.1%

Question 10

Cost of Retained Earnings (CAPM)

Answer 10

Risk-free rate + [Beta x (Market return - Risk-free rate)]

Question 11

Discounted Cash Flows (DCF)

Answer 11

Future Dividend (D1) / Current Market Price (P0) + growth rate (g)

Question 12

“Pretax” Bond Yield Plus Risk Premium (BYRP)

Answer 12

Pretax cost of long-term debt (YTM or coupon) + Market risk premium

Question 13

Return on Equity (ROE)

Answer 13

NI / E

Question 14

Return on Investment (ROI)

Answer 14

Income / Investment Capital (D + E)

~OR~

Profit Margin x Investment turnover

Question 15

Profit Margin

Answer 15

NI / Sales

Question 16

Investment turnover

Answer 16

Sales / Invested Capital (D + E)

Question 17

Return on Assets (ROA)

Answer 17

NI / Avg. total Assets

~OR~

NI / Avg. PP&E + Avg. WC

~OR~

Profit Margin x Asset Turnover

Question 18

Asset Turnover

Answer 18

Sales / Avg. total Assets

Question 19

Financial Leverage

Answer 19

Avg. total assets / Equity

Question 20

DuPont Analysis (3 stage)

Answer 20

Net profit margin (NI / Sales)
x
Asset turnover (Sales / Avg. Assets)
x
Financial leverage (Avg. Assets / Equity)

Question 21

Extended DuPont Model (5 stage)

Answer 21

Tax burden (NI / Pretax Income)
x
Interest burden (Pretax Income / EBIT)
x
Operating Income Margin (EBIT / Sales)
x
Asset TO (Sales / Avg. total assets)
x
Financial Leverage (Avg. total assets / Equity)

Question 22

Residual Income

Answer 22

Net Income(I/S) - Required return (NBV Equity x Hurdle)

Question 23

Economic Value Added

Answer 23

Step 1: Required return in dollars
Investment (D + E) x cost of capital (WACC)

Step 2:
Net operating profit after taxes (NOPAT) - Required return in dollars

Question 24

Net operating profit after taxes (NOPAT)

Answer 24

EBIT x (1 - t)

Question 25

Current Ratio

Answer 25

Current Assets (CA) / Current Liabilities (CL)

Question 26

Quick Ratio

Answer 26

Cash + Marketable Securities (MS) + Receivables / Current Liabilities (CL)

Question 27

Payment Discounts

Answer 27

360 / (Pay period - Discount period) x Discount / (100 - Discount %)

Question 28

Cash conversion cycle

Answer 28

Inventory conversion period (365 / inventory turnover)
+
Receivables collection period (365 / A/R turnover)
-
Payables deferral period (365 / A/P turnover)

Question 29

Economic Order Quantity (EOQ)

Answer 29

SQRT ( 2 x Annual Sales x Order costs / Carrying cost per unit)

Question 30

The following information regarding inventory policy was assembled by the JRJ Corporation. The company uses a 50-week year in all calculations.

Sales 10,000 units per year
Order quantity 2,000
Safety stock 1,300
Lead-time 4 weeks

What is the reorder point?

Answer 30

10,000 units per year / 50 weeks = 200 units per week

4 weeks x 200 units per week = 800 sold during lead-time

1,300 safety stock + 800 units during lead-time = 2,100 units required for reorder point