BEC 2: Financial Management Flashcards

1
Q

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

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

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

A

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

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3
Q

what is the formula for market risk premium?

A

market return - risk free rate

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4
Q

what is the formula for cost of debt?

A

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

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5
Q

the cost of debt is mostly measured as:

A

actual interest rates minus tax savings

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6
Q

what is the formula for cost of preferred stock?

A

perferred stock dividends / net proceeds of preferred stock

*annualize it

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7
Q

what would cause a current ratio to increase?

A

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

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8
Q

inventory turnover formula:

A

cogs / average inventory

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9
Q

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

A

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

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10
Q

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

A
  1. reduce the lag time between inventory arrival and use
  2. reduce carrying costs of inventory
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11
Q

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?

A

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%

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12
Q

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

A

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

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13
Q

why would you use the economic order quantity model?

A

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

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14
Q

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

A

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

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15
Q

what are the 3 primary motives for holding cash?

A
  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
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16
Q

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

A

profitability index

17
Q

what is the profitability index?

A

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

18
Q

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

A

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

19
Q

what is net present value?

A

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

20
Q

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

A

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

21
Q

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

A

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

22
Q

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

A

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

23
Q

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

A
  • cost of capital
  • hurdle rate
  • discount rate
  • required rate of return
24
Q

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)

A

internal rate of return

25
Q

what is a limitation of the profitability index?

A

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

26
Q

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

A

greater