BEC 2: Financial Management

Question 1

what are the 3 elements needed to estimate the cost of equity capital?

Answer 1

1. current dividends per share (D)
2. expected growth rate (g)
3. current market price per share of common stock (P)

Question 2

what is the formula for cost of retained earnings aka capital asset pricing model (CAPM)?

Answer 2

risk-free rate + (beta x market risk premium)

Question 3

what is the formula for market risk premium?

Answer 3

market return - risk free rate

Question 4

what is the formula for cost of debt?

Answer 4

interest expense/total debt x (1-tax rate)

Question 5

the cost of debt is mostly measured as:

Answer 5

actual interest rates minus tax savings

Question 6

what is the formula for cost of preferred stock?

Answer 6

perferred stock dividends / net proceeds of preferred stock

*annualize it

Question 7

what would cause a current ratio to increase?

Answer 7

paying on accounts payable is one reason - cash would decrease and the payment would reduce current liability. (use actual numbers to understand)

Question 8

inventory turnover formula:

Answer 8

cogs / average inventory

Question 9

what is the cost of credit formula aka APR of quick payment discount?

Answer 9

(360 / pay period - discounted period) x (discount % / 100% - discount %)

Question 10

what are the reasons a company would use just-in-time inventory?

Answer 10

1. reduce the lag time between inventory arrival and use
2. reduce carrying costs of inventory

Question 11

once you’ve figured out the APR, and the problem states that “the entity can borrow money at a specific rate”, what do you do with the specific rate to get the right answer?

Answer 11

subtract that rate from the cost of credit aka APR to get the right answer.

example: the apr is 36.7% and borrowed money specific rate is 5%, subtract this and get 31.7%

Question 12

what are the components of economic order quantity’s (EOQ) formula?

Answer 12

E = order size
S = sales
O = cost per purchase order
C = carrying cost per unit

Question 13

why would you use the economic order quantity model?

Answer 13

to minimize total ordering and carrying costs because its the number of units added to inventory with each order to minimize the total cost of inventory

Question 14

if the storage cost rises, what would happen to the order size associated with the economic order quantity model?

Answer 14

it would decrease the amount ordered because the cost of inventory would be more with the increase in storage costs

Question 15

what are the 3 primary motives for holding cash?

Answer 15

1. transaction demand - hold cash to meet payments from ordinary course of business
2. precautionary demand - cash on hand to maintain safety cushion to meet unexpected needs
3. speculative demand - cash needed to take advantage of temporary opportunities

Question 16

what method is used for capital rationing when comparing capital projects?

Answer 16

profitability index

Question 17

what is the profitability index?

Answer 17

the ratio of present value of net future cash inflows to the present value of the net initial investment

note:
- list projects in descending order
- limited capital resources are applied in the order of the index until the resources are exhausted

Question 18

what is an advantage of the net present value method over the internal rate of return model in discounted cash flow analysis?

Answer 18

net present value can be used when there is no constant rate of return required for each year of the project

Question 19

what is net present value?

Answer 19

the difference between present value of cash inflows and present value of cash outflows at a given period of time

Question 20

what type of factor is used for future lump sum cash flows?

Answer 20

present value factor of $1 - to the lump sum to value in today’s dollars

Question 21

what type of factor is used for recurring annual cash flows?

Answer 21

present value of an annuity for $1 - consistent recurring cash flows for the same amount over a series of years

Question 22

what type of factor is used for annual cash flows for different amounts?

Answer 22

present value factor for $1 to each year then add up the PV adjusted cash flows - for projected cash flow amounts for different periods

Question 23

what are all the rates used in net present value analysis?

Answer 23

• cost of capital
• hurdle rate
• discount rate
• required rate of return

Question 24

the technique that determines the present value factor such that the present value of the after-tax cash flows equals the initial investment on the project (produces a NPV of zero)

Answer 24

internal rate of return

Question 25

what is a limitation of the profitability index?

Answer 25

it requires detailed long-term forecasts of the project’s cash flows

Question 26

if the NPV of a proposed investment is negative, the discount rate used must be _________ than the project’s internal rate of return.

Answer 26

greater