BEC 3: Finanical Management Flashcards
What are the three general stages of cash flows?
- Inception of the project
- Operations
- Disposal of the project
Step 1: Invoice + Shipping + Installation (O)
+ Increase in working capital (O)
less: Cash proceeds on sale of old (net of tax) (I)
= Net initial outflow
Net proceeds on sale of old (net of tax):
Proceeds on sale (I)
less: tax paid on gain (GT) (O)
+ tax saved on loss (LT) (I)
Step 2:
a. Pretax cash info. * (1-T) (I)
b. Depreciation * tax (I)
Step 3:
a. Asset sold/tax effects (net inflow)
b. Direct exps. incurred for disposal ( less outflow)
c. Asset scrapped/donated (+inflow)
d. Working capital - dec. work. cap. (+inflow)
= Terminal yr. net inflow
Discounted cash flow is the basis for net present value methods. What is the formula for NPV?
- Calculate after tax cash flows = Annual net cash flow * (1 - tax rate)
- Add dep. benefit = Dep. * tax rate
- Multiply result by appropriate PV of an annuity
- Subtract initial cash outflow
Result: NPV
What is the profitability Index formula?
PV of net future cash inflow/PV of net initial investment
What is the pay back period formula?
Net initial investment/Increase in annual net after-tax cash flow
What is operating leverage and the degree of operating leverage formula?
The degree to which a firm uses fixed operating costs as opposed to variable operating costs; high leverage = high fixed operating costs and low variable operating costs; higher the degree, the greater the potential profit, but the greater the risk.
DOL = % change in EBIT/% change in sales
What is financial leverage and the degree of financial leverage formula?
The degree to which a firm’s use of debt to finance the firm magnifies the effects of a given % change in EBIT on the % change in its EPS; the higher the degree = higher degree of fixed financing costs
DFL = % change in EPS/% change in EBIT
What is combined (total) leverage and the degree of combined leverage formula?
Use of fixed operating costs and fixed financing costs to magnify returns; the higher the degree = greater portion of sales goes to bottom line.
DCL = % change in EPS/% change in sales = DOL * DFL
What is the WACC formula, the weighted-average interest rate, and the cost of debt?
WACC = (cost of equity * % equity in capital structure) + (weighted avg. cost of debt * % debt in capital structure)
WAIR = Effective annual interest payable/debt cash available
Cost of debt = (after-tax) = int. rate * (1 - tax rate)
What is Kdt?
Pre-tax cost of debt - cost of debt before considering tax shielding effects of the debt.
What is Kdx?
Cost of LT debt/after-tax cost of debt - After-tax cost of debt by raising LT funds through borrowing
= Kdt * (1 - tax rate)
What is Kps?
Cost of preferred stock - tax considerations irrelevant b/c dividend not tax deductible
= DPS/NPS
NPS: inflow - net proceeds of preferred stock; gross proceeds - flotation costs
DPS: outflow - preferred stock cash dividend; finance charge to company for raising capital with preferred stock.
What is Kre and the three common methods for computing it?
Cost of R/E - cost of equity capital obtained through R/E is equal to the rate of return required by a firm’s common stockholders.
a. Capital Asset Pricing Model (CAPM)
b. Discounted Cash Flow (DCF)
c. Bond Yield plus Risk Premium (BYRPP
What is the cost of R/E formula - CAPM?
Kre = risk-free rate + risk premium
Kre = krf + the stock’s beta coefficient (bi) * market risk premium (PMR)
Kre = krf + [bi * (km - kfr)] (km = mkt rate)
Note: krf - “US” Treasury Securities
What is the cost of R/E formula - DCF?
Kre = (D1/P0) + g P0 = current market value or price of the out. c/s D1 = dividend per share expected at the end of yr. 1 g = constant rate of growth in dividends D1 = D0(1+g)
What is the cost of R/E formula - BYRP?
Kre = Kdt + PMR
Kre = pretax cost of LT debt + mkt. risk premium
* Kdt = pretax YTM (firm’s own bond yield)
What is ROI and its formula?
Provides for the assessment of a company's % return relative to its capital investment risk - the higher the better. = Income/Invested Capital OR profit margin * Investment Turnover PM = Income/Sales IT = Sales/Invested Capital
What is ROA?
Return on Assets = NI/Avg. Total Assets
What is residual income and its formula?
Measures the excess of actual income earned by an investment over the required (target or hurdle) return rate required by the company.
=NI (from I/S) - Required Return
*Required Return = NBV * Hurdle Rate
What is EVA and its formula?
Economic value added - measures the excess of income after taxes earned by an investment over the return rate defined by the company’s cost of capital.
= 1. Investment * cost of capital = required return
2. Income after taxes - required return = EVA
What are the debt-to-total capital, debt-to-asset, and debt-to-equity ratios?
- Total debt/total capital (debt & equity)
- > related to LT debt paying ability
- > the lower, the better the ability - Total debt/total assets
- > LT debt paying ability
- > The lower, better creditor protection - Total debt/total S/E
- > Indicates degree of leverage used
- > The lower, the lower the risk involved
What is net working capital, an aggressive working capital management, and a conservative working capital management?
- CA - CL
- Current ratio down, working capital down
More CA financed with CL - Current ratio up, working capital up
More CA financed by non-CL
What is the current ratio and the quick (acid test) ratio?
Measures # of times CAs exceed CLs and measures ST solvency - a firm’s ability to generate cash to meet its ST obligations - higher, the better - liquidity at a point in time.
= CA/CL
More rigorous test - higher, the better
= Cash + marketable securities + receivables/CL
=Cash - inv. - prepaids/CL
What is the formula for calculating the annual cost (APR) of a quick payment discount?
[360/(pay period - disc. period)] * [Disc./(100-disc. %)]
What is the cash conversion cycle and how you get to it?
“Net Operating Cycle” - Length of time from the date of cash expenditure for production to the date of cash collected from customers (cash-to-cash)
= Inv. Conversion Period + Rec. Collection Period - Pay. Deferral period
a. Inv. turnover = COGS/Avg. Inv.
Inv. Conversion Period = 365/Inv. Turnover
b. A/R turnover = Sales/Avg. A/R
Rec. Collection period = DSO = 365/A/R Turnover
c. A/p turnover = COGS/Avg. A/P
A/P def. period = 365/A/P turnover
