BEC 3

Question 1

Payback period

Answer 1

Net initial investment/ Increase in annual net after-tax cash flow

Question 2

Calculate IRR

Answer 2

First calculate:

Net incremental investment (investment required)/ Net annual cash flows = Factor of the IRR

Second: Located the factor derived above to identify the rate of return it represents.

Question 3

Profitability index

also referred as “excess present value index”

Answer 3

The profitability index is a varitation of the net present value capital budgeting model.

Profitability index= Present value of net future cash inflows/ Present value of net initial investment

Question 4

IRR computed as

Answer 4

Investment / Cash flows = PV factor

Question 5

Operating leverage

Answer 5

Defined as the degree to which a firm uses fixed operating costs, as opposed to variable operating costs.

Question 6

Financial leverage

Answer 6

Defined as the degree to which a firm uses debt to finance the firm, not purely operating fixed costs. The firm can choose to issue debt or equity.

Question 7

Weighted-average cost of capital

Answer 7

The weighted average cost of capital is frequently used as the hurdle rate within capital budgeting techniques.

Investments that provide a return that exceeds the weighted-average cost of capital should continuously add to the value of the firm.

Question 8

Capital Asset Pricing Model (CAPM)

Answer 8

C= R+ b(M-R)

C=Cost of capital
R=Risk-free rate
b=Beta
M=Market rate of return

Question 9

Cost of equity capital (K)

Answer 9

K = D/P + G

D=Future Dividend (or D X 1 + G)
P=Price (Current market price)
G=Growth

Question 10

Three elements needed to estimate cost of equity capital are:

Answer 10

1) Current dividends per share (D)
2) Expected growth rate in dividends (G) and
3) Current market price per share of common stock (P)

Question 11

Return on Investment (ROI)

Answer 11

ROI=Income/ Average Investment

Question 12

Residual Income (RI)

Answer 12

RI= Income - (Investment X Hurdle rate)

Question 13

Investment turnover ratio

Answer 13

Investment turnover= Sales/ Invested capital

aka Asset turnover = Sales/ Total assets

Question 14

Asset turnover ratio

Answer 14

Asset turnover= Sales/ Assets

Question 15

Times interest earned ratio

Answer 15

Times interest earned ratio = Earnings before interest and taxes (EBIT)/ Total interest expense

Question 16

Return on equity (ROE)

Answer 16

ROE= Net income/sales X Sales/Assets X Assets/Equity

aka ROE= Net income/ Total equity

Question 17

Optimal level of inventory

Answer 17

Optimal level of inventory is affected by:

1) time required to receive inventory
2) cost per unit of inventory, which will have a direct impact on inventory carrying costs
3) cost of placing an order impacts order frequency, which affects order size and optimal inventory levels.

Question 18

Inventory turnover

Answer 18

COGS/ Average Inventory

Question 19

Cost of credit discount

Answer 19

=360/(total pay period - discount period) X Discount %/ (100%-Discount%)

Question 20

Material requirements planning (MRP)

Answer 20

Is an inventory management technique that projects and plans inventory levels in order to control the usage of raw materials in the production process. MRP applies to WIP and raw materials.

Question 21

Economic Order Quantity (EOQ)

Answer 21

EOQ= }2SO/C

EOQ= Order size
S= Annual Sales quantity in units
O=Cost per purchase Order
C=Annual cost of Carrying one unit in stock for one year.

Question 22

Present value

Answer 22

PV= FV/ (1+r)^n; FV=1

What is the factor for the PV of $1 to be received two years in the future at an int rate of 6%?
PV=1/(1+.06)^2=0.890

Then, calculate the present value of an annuity

Step 1: Calculate PV factor for 1
As last step = 0.890

Step 2: 1- discount factor/ rate of return

=1-0.890/.06=1.8333

Question 23

NRV and IRR

Answer 23

The required rate of return must be less than the project’s internal rate of return (IRR). The IRR is the rate earned by an investment that equates to a net present value (NPV) of zero. By definition, a project with a positive NPV will have an IRR greater than the required rate of return used to compute that NPV.

Question 24

Relevant Terms

Answer 24

Incremental costs: represent the change in cost associated with different alternatives and are considered synonymous with relevant

Differential costs: represent the change in cost associated with two separate courses of action and are considered synonymous with relevant

Avoidable costs: represent the costs that can be averted by selecting different courses of action and are considered synonymous with relevant

Question 25

IRR

Answer 25

IRR is the rate that provides a zero net present value

Question 26

Investment turnover

Answer 26

Investment turnover= Sales/ Average investment

Question 27

Days’ sales

Answer 27

Days’ sales outstanding= Average net receivables/ (Net credit sales/365)

same as:
Days’ sales outstanding= Ending AR/ Average daily sales

or

365/ AR turnover

Question 28

Materials requirement planning (MRP)

Answer 28

MRP is an inventory management technique that projects and plans inventory levels in order to control the usage of raw materials in the production process. MRP primarily applies to WIP and raw materials.

Question 29

Negotiable CD’s

Answer 29

• Generally carry interest rates slightly lower than banker’s acceptances (which are drafts drawn on deposits at a bank) or commercial paper (which is unsecured debt issued by credit worthy customers)
• have a formal secondary market
• product of the banking industry, regulated by the Federal reserve
• usually sold in denominations of a min of $100K