BEC 3 Flashcards
What is capital budgeting?
Process for evaluating and selecting long term investment projects.
What is the advantage of NPV?
It is flexible but limited by not providing the true rate of return on the investment.
What is profitability Index?
Present value of FCF/ Present value of initial investment
What is objective of IRR?
It focuses on the discount rate at which the present value of the cash inflows equals the present value of cash outflows.
What are limitations of IRR?
Unreasonable reinvestment assumptions
Inflexible cashflow assumptions
What is operating leverage?
Degree to which a company used fixed operating costs rather than variable operating costs. Capital intensive are generally high operating leverage.
What is financial leverage?
Degree to which a company uses debt rather than equity to finance the company.
What is benefit of debt?
Debt carries lowest cost of capital and is tax deductible
The higher the tax rate, the more incentive exists to use debt financing
What are three methods of computing Cost of Retained Earnings?
Capital asset pricing model
DCF
Bond yield plus risk premium
What is Dupont ROE?
Net Profit/ Sales x Sales/ Average Assets x Average Assets/ Equity
What is advantage of residual income method issues?
Realistic target rates
Focus on target return and amount
What is disadvantage of residual income method issues?
Reduced comparability
Target requires judegement
What are disadvantages of high levels of cash?
The negative arbitrage effect
Attractiveness as takeover target
Investor dissatisfaction with allocation of assets
What are methods of speed collections?
Customer screening
Prompt billing
Payment discounts
What is APR of quick payment discount?
360/Pay period - Discount Period x Discount/100 - Discount%