BEC - B2: Financial Management Flashcards
How do we calculate the cost of a company’s preferred stock?
Dividend paid* / net proceeds**
(similar to effective rate of interest - with finance charge / net proceeds being the calculation)
- Dividend paid = par value * dividend %
- *Net Proceeds = selling price - flotation costs (costs to sell)
What are the three elements needed to estimate the cost of equity capital (formula) when determining a firm’s weighted average cost of capital?
- Current dividends per share (D)
- Expected growth rate in dividends (g)
- Current market price per share (P)
Formula is:
R (cost of capital: “return”) = (D1 / P0) + g
Under the discounted cash flow method, what is the cost of retained earnings calculation?
K (cost of retained earnings) = (D1/P0) + G
The overall cost of capital is the:
- Minimum rate a firm must earn on high-risk projects
- Maximum rate of return on assets
- Rate of return on assets that covers the costs associated with the funds employed
- Cost of the firm’s equity capital at which the market value of the firm will remain unchanged
- Rate of return on assets that covers the costs associated with the funds employed.
- Firms must earn at least a return rate on investments equal to their cost of capiatl, or the investments are losing money
How is the cost of debt most commonly measured?
Interest rate - tax savings
How do we calculate Market Capitalization?
Common shares outstanding * fair market value per share
The annual depreciation expense on an asset reduces income taxes by an amount equal to:
Firm’s marginal tax rate * depreciation amount
How do we calculate the price a firm will pay to buy shares of a company in two years, given a
- dividend growth rate of 5%
- discount rate (required return) of 10%
- current year dividend of $20
First, calculate what dividends will be in 2 years + 1
=20 * (1.05 * 1.05) * (1.05)
(you are buying the company in 2 years, so you are concerned about dividend payout in 2 years + 1)
Second, apply growth rate model to your calc:
=D (t + 1) / (R - G)
=23.15 / (10% - 5%)
How do we calculate quick ratio?
Quick Assets / Current Liabilities
Excludes inventory and prepaids from the current assets.
How do we calculate inventory turnover ratio?
COGS / Average Inventory
How do we calculate Accounts Receivable Turnover?
Net Credit Sales / Average Accounts Receivable
Which of the following are examples of carrying costs? Which are not?
- Handling costs
- Obsolescence
- Disruption of production schedules
- Quantity discounts lost
- Opportunity cost on inventory investment
- Spoilage
- Inspections
- Insurance
- Shipping
Yes, carrying costs:
- Obsolescence
- Opportunity cost on inventory investment
- Spoilage
- Insurance
No, not carrying costs:
- Handling costs
- Disruption of production schedules
- Quantity discounts lost
- Inspections
- Shipping
Which of the following provide a spontaneous source of financing for a firm?
- Preferred stock
- A/P
- A/R
- Debentures
A/P is spontaneous. The others take time to factor or issue in order to receive financing.
What’s the difference between a JIT (just-in time) inventory system and other traditional approaches?
- JIT “pulls through” inventory with customers orders driving the need for inventory. Push systems, on the other hand, begin with forecasting customer demand
- JIT inherently involves maintaining a lower level of inventory, and, in turn, request inventory from suppliers as needed. JIT is used when the focus is on reducing the carrying costs of maintaining inventory, while it also reduces the risk of inventory obsolescence.
Which SCOR model of supply chain ops process does “managing accounts receivable and collections from customers” fall into?
“Deliver”: encompasses all the activities of getting the “finished product into the hands of the ultimate consumers to meet their planned demand.” Managing accounts receivable and collections from customers falls into the “deliver” process
Which inventory management approach orders at the point where “carrying costs are nearly equal to restocking costs”, in order to minimize total inventory cost?
EOQ method of inventory control.
When a firm who manufactures its own inventory uses EOQ, ordering costs consist primarily of… ?
Production set up.
Not storage and handling.
How do we calculate the cost of a credit policy (in other words… the “annual interest cost”)?
=
number of days in the year (360) / (total pay period - discount rate)
- times *
discount % / (100% - discount %)
How do we calculate the Cash Conversion Cycle for a company?
DIO + DSO - DPO
DIO = (365) / Inv Turnover DSO = (365) / AR Turnover DPO = (365) / AP Turnover
Inv Turnover = COGS / avg int
AR Turnover = Net Credit Sales / avg AR
AP Turnover = COGS / avg AP
If…a company has $96,000 in additional Average A/R for the year,
and. .. required rate of return is 10%
and. .. Variable Cost Ratio is 60%
What is the pretax cost of carrying the additional investment in receivables?
96,000 average AR increase
60% of 96,000 = additional investment in AR (in terms of required VC’s to hold it)
10% of additional investment (required return is 10%) = pretax cost of carrying the AR.
What is the formula for a zero-growth model?
P = D / R
Price = Dividend / Rate of Return
What is the formula for P/E ratio?
PE Ratio = Current Market Price / Annual Earnings Per Share
PE ratio can either be calculated as a forward P/E (earnings expected in one year is used), or a trailing P/E (most recent earnings are used)
What is the formula for PEG ratio?
PEG = (P@0 / EPS@0) / (Growth % * 100)
What is the formula for a constant-growth dividend discount model?
P = D(t+1) / (Rate of Return% - Growth%)
What is one assumption that is inconsistent with the Black-Scholes option pricing model?
The options can be exercised at any time before maturity. This is not true because the Black-Scholes model requires European-style options, which can be exercised only at maturity.
Which of the following is the least acceptable method for determining accounting estimates of fixed assets?
- Historical information
- Market Information
- Expected Usage
- Industry Consensus
-Industry Consensus.
What are the inputs to the Black-Scholes model?
Current price of the underlying stock, option exercise price, risk-free interest rate, time until expiration, measure of risk tied to the underlying stock
A company issues a $1000 face value bond, paying an annual coupon rate of 6.5%, maturing in 4 years. Market interest rate is 6.0%. What is the bond’s price?
Annual interest payment (4 years of this): $1000 * 6.5% coupon rate = $65
Principal repayment at end of Y4: $1000
Discount rate: 6% each year (6% to the 4th for year 4)
A rock label wants to value the cost of one of its artists copyrights. It chooses to use the replacement cost approach (a valid approach). What costs are NOT allowed to be included within the calculation of the copyright’s value?
-Only the general administration allocated costs are excluded.
- All other costs to develop/create an album’s copyright are included in the value, INCLUDING:
- opportunity costs
- legal fees
- overhead
- production, development, etc.
How do we calculate the depreciation tax shield?
Reduction in taxes paid (therefore, real cash saved) as a result of having depreciation as a deductible expense.
Depreciation amount * tax rate = depreciation tax shield
How do we calculate the profitability index of a project?
Present value of net future cash inflows / Present value of net initial investment = Profitability index
What is a disadvantage of the NPV method of capital expenditure evaluation?
It does not provide the true rate of return on investment. It simply indicates whether or not an investment will earn the “hurdle rate” used for the purposes of the NPV calculation.
What is the accounting rate of return used for?
Capital budgeting techniques
NPV is stated in which of the following?
- Net income
- Cash flow
Cash flow. Like most capital budgeting techniques.
What’s a major advantage of the NPV method over the internal rate of return model?
NPV method can be used when there is no constant rate of return required for each year of the project.
You can use different hurdle rates for each year of the project effectively…
What’s a major drawback of the payback method?
Does not consider the time value of money (unless you use the discounted payback method of course)
The internal rate of return (IRR) is the:
- Rate of interest where the NPV = 0.
- Hurdle rate
- Rate of interest where the NPV = 0.
- The hudle rate is a “desired or minimum rate of return”… set by management, in order to evaluate investments
What is an internal rate of return?
-A time- adjusted rate of return from an investment.
How do we calculate the IRR?
Net incremental investment (investment required) / Net annual cash flows = Factor of the IRR
Once you have the factor, you can identify the appropriate rate of return.
