BEC 2 - Financial Management

Question 1

Three common methods of computing the cost of retained earnings

Answer 1

1) Capital asset pricing model (CAPM)
2) Discounted cash flow (DCF)
3) Bond yield plus risk premium (BYRP)

Question 2

What is the beta coefficient

Answer 2

A numerical representation of the volatility (risk) of the stock relative to the volatility of the overall market.

B=1 as risky as market
B>1 riskier
B<1 less risky

Question 3

CAPM cost of retained earnings formula

Answer 3

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

Question 4

DCF cost of retained earnings formula

Answer 4

D1 / P0 + g

P0 = Current market value of price of the outstanding common stock
g = The constant rate of growth in dividends
*D1 = D0 x (1+g)
**D0 is the dividend at the end of the current year, D1 is at the end of next year

Question 5

BYRP cost of retained earnings formula

Answer 5

Pretax cost of long-term debt + Market risk premium

Question 6

Growth Rate

Answer 6

ROA x Retention rate / 1 - (ROA x Retention rate)
or
ROE x Retention rate

Question 7

Payout rate –> Retention rate

Answer 7

Payout rate = DPS / EPS

Retention rate = 1 - Payout

Question 8

Return on Sales rate

Answer 8

Income before interest income, interest expense, tax expense, and taxes / Sales (net)

Question 9

Return on investment (ROI)

Answer 9

Net income / Average invested capital

*Invested capital = A - operating liabilities

Question 10

Return on assets (ROA)

Answer 10

Net income / Average total assets

Question 11

Return on equity (ROE)

Answer 11

Net income / Average total equity

Question 12

Value of a levered firm (firm with debt)

Answer 12

= Value of an unlevered firm + Present value of the interest tax savings

*PV of ITS = Corporate tax rate x (interest rate on debt x amount of debt) / interest rate on debt

Question 13

Time interest earned ratio

Answer 13

Earnings before interest expense and taxes (EBIT) / Interest expense

*As ratio goes down, risk goes up

Question 14

Net working capital

Answer 14

Difference between CA and CL

Question 15

Reorder point

Answer 15

= Safety stock + (Lead time x Sales during lead time)

*Be consistent with lead time (days/weeks/months)

Question 16

Economic order quantity (EOQ) formula

Answer 16

E = square root of (2SO/C)

E: Order size
S: Annual ales (in units)
O: Cost per Purchase Order
C: Annual Carrying cost per unit

*Be consistent in annual vs monthly measure

Question 17

4 key management processes related to Supply Chain Operations Reference (SCOR)

Answer 17

1) plan
2) source
3) make
4) deliver

Question 18

Annual cost of not taking advantage of a discount (APR of quick payment discount formula)

Answer 18

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

Question 19

Dividend Discount Model

Answer 19

Write it down

Question 20

Investors are likely to view a high P/E ratio as an indication that

Answer 20

Company is relatively overvalued OR there is higher growth potential

Question 21

Profitability Index

Answer 21

Present value of cash flows / Cost (present value) of initial investment

Question 22

Cost of preferred stock

Answer 22

Preferred stock dividends / Net proceeds of stock

• Net proceeds = selling price less an issuance costs
• *Not tax deductible so taxes do not play a role in this calculation

Question 23

Effective Annual Percentage Rate

Answer 23

[1 + (i/p)]^p - 1

i = stated rate
p = compounding periods per year

Question 24

Effective Interest Rate

Answer 24

Interest paid per period / Net proceeds of loan