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Business CPA Review > BEC 3 > Flashcards

BEC 3 Flashcards

1
Q

Define sunk costs.

A

Sunk costs are those costs that have already been incurred, are unavoidable in the future, and will not vary with the course of action taken.

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2
Q

What is the formula for after-tax cash flow?

A

(1 - tax rate) x Pre-tax Cash Flows = After-tax Cash Flow

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3
Q

The formula for computing a depreciation tax shield is:

A

Tax rate x Depreciation deduction = Tax savings from the depreciation tax shield

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4
Q

What are the three general stages in which capital investment cash flows are categorized?

A
  • Cash flows at the inception of the project
  • Operating cash flows
  • Cash flows from the disposal of the project
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5
Q

What approaches can management take to select the desired rate of return for a project?

A
  • Use a weighted-average cost of capital (WACC) method
  • Assign a target rate for new projects
  • Recommend that the discount rate be related to the risk of the project.
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6
Q

Define net present value (NPV).

A

NPV is the difference between the present value of the cash inflows and outflows from a project.

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7
Q

How are investment decisions made using the NPV method?

A

If NPV is positive, then the investment should be made. If NPV is negative, then the investment should not be made.

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8
Q

What is the profitability index?

A

The ratio of the present value of net future cash inflows to the present value of the net initial investment. The higher the profitability index, the more desirable the project.

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9
Q

Define internal rate of return (IRR).

A

The IRR is the discount rate at which the present value of the cash inflows equals the present value of the cash outflows from an investment or project.

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10
Q

How are investment decisions made using IRR?

A

An investment should be made when the IRR exceeds the hurdle rate.

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11
Q

What is the payback method formula?

A

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

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12
Q

Define operating leverage.

A

Operating leverage is defined as the degree to which a firm uses fixed operating costs, as opposed to variable operating costs.

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13
Q

What is the degree of operating leverage formula?

A

DOL = % Change in EBIT / % Change in Sales

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14
Q

Define financial leverage.

A

Financial leverage is defined as the degree to which a firm’s use of debt to finance the firm magnifies the effects of a given percentage change in EBIT on the percentage change in EPS.

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15
Q

What is the degree of financial leverage formula?

A

DFL = % Change in EPS / % Change in EBIT

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16
Q

What is the degree of combined leverage formula?

A

DCL = % Change in EPS / % Change in Sales

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17
Q

Define weighted-average cost of capital (WACC).

A

The weighted-average cost of capital is the average cost of debt and equity financing associated with the firm’s existing assets and operations.

18
Q

What is the after-tax cost of debt formula (kdx)?

A

kdx = pre-tax cost of debt x (1 - tax rate)

19
Q

What is the cost of preferred stock formula (kps)?

A 
kps = Dps / Nps
Dps = Preferred stock cash dividends
Nps = Net proceeds of preferred stock
20
Q

What is the cost of retained earnings (kre) using the CAPM formula?

A

kre = Risk free rate + [beta x (market rate - risk free rate)]

21
Q

What is the cost of retained earnings (kre) using discounted cash flow (DCF)?

A 
kre = (D1 / P0) + g
D1 = Dividend per share expected at the end of one year
P0 = Current market value or price of outstanding common stock
g = Constant growth rate of dividends
22
Q

What is the cost of retained earnings (kre) under bond yield plus risk premium (BYRP)?

A 
kre = kdt + PMR
kdt = pre-tax cost of debt
PMR = market risk premium
23
Q

Define the weighted-average cost of capital by formula.

A

The is the terminology used in the cost of capital and is part of the WACC formula:
-wdx = (weight for) long-term debt
-wps = (weight for) preferred stock
-wcs = (weight for) common stock equity
-kwc = weighted-average cost of capital
“k” stands for the specific COST of each type of capital, and “w” stands for the WEIGHT of each. So, WACC would be:
kwc = (kdx x wdx) + (kps x wps) + (kre x wcs)

24
Q

Define return on investment (ROI).

A

Return on investment is used to assess the percentage return relative to capital investment risk. ROI can be calculated as income divided by invested capital or as a product of profit margin (income / sales) and investment turnover (sales / assets).

25
Q

List the two alternatives formulas of Return on Investment.

A 
ROI = Income / Invested Capital
ROI = Profit Margin (or Return on Sales) x Investment Turnover (Sales / Assets)
26
Q

What are the limitations of ROI?

A
  • Short-term focus

- Disincentive to invest

27
Q

Define residual income.

A

The residual income method measures the excess of actual income earned by an investment over the hurdle rate.

28
Q

What is the formula for residual income?

A

Residual income = Net income - Required return
Where the Required Return is equal to:
Net book value x Hurdle Rate

If the amount of the income from the investment exceeds the computed required return, performance objectives have been met.

29
Q

Define economic value added (EVA). How does EVA differ from residual income?

A

EVA measures the excess of income after taxes earned by an investment over the rate of return defined by the company’s WACC. EVA differs from residual income in the following ways:

  • WACC must be used to calculate EVA.
  • The income and investment numbers used to calculate EVA are generally adjusted to produce a more accurate analysis of economic profit.
30
Q

Define the steps and formula for economic value added.

A

Step 1: Calculate the required amount of return and income after taxes.
Investment x Cost of capital = Required Return
Step 2: Compare income to the required return.
Income after taxes - Required return = Economic Value Added

31
Q

What is the formula for working capital?

A

Current assets - Current liabilities = Working capital

32
Q

What are three common motivations for holding cash?

A
  1. Transaction Motive: A transaction motive for holding cash concerns having enough cash to meet payments arising from the ordinary course of business.
  2. Speculative Motive: A speculative motive for holding cash concerns having enough cash to take advantage of temporary opportunities.
  3. Precautionary Motive: A precautionary motive for holding cash concerns having enough cash to maintain a safety cushion so that unexpected needs may be met.
33
Q

What methods can be used to speed collections?

A
  • Customer screening
  • Prompt billing
  • Payment discounts
  • Expedite deposits
  • Concentration banking
  • Factoring accounts receivable
34
Q

What methods can be used to delay disbursements?

A
  • Defer payments
  • Drafts
  • Line of credit
  • Zero balance accounts
35
Q

What is the formula for computing the annual percentage rate for quick payment discounts?

A

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

36
Q

What is the cash conversion cycle formula?

A

Cash conversion cycle = Inventory conversion period + Receivables collection period + Payables deferral period

37
Q

How is the inventory conversion period calculated?

A

Inventory turnover = COGS / Average Inventory

Inventory conversion period = 365 / Inventory Turnover

38
Q

How is the receivables collection period calculated?

A

AR turnover = Sales / Average AR

Receivables collection period = 365 / AR Turnover

39
Q

How is the payables deferral period calculated?

A

AP turnover = COGS / Average AP

Payables deferral period = 365 / AP Turnover

40
Q

What is the equation for economic order quantity?

A

EOQ = Square root of: (2SO / C)

S = Sales in Units
O = Cost per Purchase Order
C = Carrying Cost per Unit

Business CPA Review (6 decks)

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