B3: Financial Management Flashcards
The discount rate is determine in advance for which of the following capital budgeting techniques?
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.
In equipment-replacement decisions, which one of the following does not affect the decision-making process?
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.
Which of the following is an advantage of NPV modeling?
It accounts for compounding of returns
The NPV method assumes that positive cash flows are reinvested at the hurdle rate thereby considering compounding.
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?
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
A project’s net present value, ignoring income tax considerations, is normally affected by the:
Proceeds from the sale of the asset to be replaced
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?
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
PV of $1
PV = FV / (1+r)^n
Example: 2 years, rate of 6%
PV = 1 / (1 + .06)^2
PV = 0.890
PV of Annuity
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
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?
Dividend paid ($20 par x 9%) = $1.80 Net proceeds ($40 SP - $5 flotation) = $35
$1.80 / 35 = 5.1%
Cost of Retained Earnings (CAPM)
Risk-free rate + [Beta x (Market return - Risk-free rate)]
Discounted Cash Flows (DCF)
Future Dividend (D1) / Current Market Price (P0) + growth rate (g)
“Pretax” Bond Yield Plus Risk Premium (BYRP)
Pretax cost of long-term debt (YTM or coupon) + Market risk premium
Return on Equity (ROE)
NI / E
Return on Investment (ROI)
Income / Investment Capital (D + E)
~OR~
Profit Margin x Investment turnover
Profit Margin
NI / Sales
Investment turnover
Sales / Invested Capital (D + E)
Return on Assets (ROA)
NI / Avg. total Assets
~OR~
NI / Avg. PP&E + Avg. WC
~OR~
Profit Margin x Asset Turnover
Asset Turnover
Sales / Avg. total Assets
Financial Leverage
Avg. total assets / Equity
DuPont Analysis (3 stage)
Net profit margin (NI / Sales) x Asset turnover (Sales / Avg. Assets) x Financial leverage (Avg. Assets / Equity)
Extended DuPont Model (5 stage)
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)
Residual Income
Net Income(I/S) - Required return (NBV Equity x Hurdle)
Economic Value Added
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
Net operating profit after taxes (NOPAT)
EBIT x (1 - t)
