BEC Deck 5-Financial Mangement Cont'

Question 1

Six different techniques for evaluating capital budgeting opportunities-

Answer 1

1) Payback period approach
2) Discounted payback period approach
3) Accounting Rate of Return approach
4) Net Present Value approach
5) Internal Rate of Return approach
6) Profitability Index approach

Question 2

Accounting Rate of Return (Simple Rate of Return)-

Answer 2

Assesses a project by measuring the expected annual incremental accounting income from the project as a percent of the initial (or average) investment. Expressed as a formula would be:
ARR=(Avg Annual Incremental Revenues-Avg Annual Incremental Expenses)/ Initial (or Avg) Investment

Question 3

Net Present Value Approach-

Answer 3

Assesses projects by comparing the present value of the expected cash flows (revenues or savings) of the project with the initial cash investment in the project.

Question 4

The Internal Rate of Return (adjusted rate of return)-

Answer 4

Evaluates a project by determining the discount rate that equates the present value of the project’s future cash inflows with the present value of the project’s cash outflows. The rate so determined is the rate of return earned by the project.

Question 5

Current & Non Current Liabilities and Owners’ Equity=Financial Structure
Non Current Liabilities & Owners’ Equity=Capital Structure

Answer 5

Thus financial structure is a more inclusive concept & measure than capital structure. While all elements of financial structure are sources of an entity’s financing, only the elements of capital structure provide long-term financing.

Question 6

Inventory Secured Loans-A firm pledges all or part of its inventory as collateral for a short-term loan. Types of inventory secured loan-

Answer 6

1) Floating Lien Agreement-The borrower gives a lien against all of its inventory to the lender, but retains control of its inventory, which it continuously sells & replaces.
2) Chattel Mortgage Agreement-The borrower gives a lien against a specifically identified inventory & retains control of the inventory, but cannot sell it with the lenders approval.

Question 7

Types Inventory Secured Loans continued-

Answer 7

3) Field Warehouse Agreement-The inventory used as collateral remains at the firm’s warehouse, placed under the control of an independent 3rd party and held as security.
4) Terminal Warehouse Agreement-The inventory used as collateral is moved to a public warehouse where it is held as security.

Question 8

Bonds-

Answer 8

Long-term promissory notes wherein the borrower, in return for buyers’/lenders’ funds, promises to pay the bondholders a fixed amount of interest each year and to repay the face value of the note at maturity.

Question 9

Debenture Bonds-

Answer 9

Unsecured; no specific asset is designated as collateral. These bonds are considered to have more risk and ,therefore, must provide a greater return than secured bonds.

Question 10

Secured Bonds-

Answer 10

Have specific assets (e.g. machinery & equipment) designated as collateral for the bonds.

Question 11

Mortgage Bonds-

Answer 11

Secured by a lien on real property (e.g. land & building)

Question 12

Current Yield-

Answer 12

Is the ratio of annual interest payments to the current market price of the bond.
CY=Annual Coupon Interest/Current Market Price

Question 13

Yield to Maturity (Expected Rate of Return)-

Answer 13

The rate of return required by investors as implied by the current market price of the bonds is the yield to maturity.

Question 14

Preferred Stock Value(PSV)-

Answer 14

PSV=Annual Dividend/Required Rate of Return

Question 15

Preferred Stock Expected Rate of Return(PSER)-

Answer 15

PSER=Annual Dividend/Market Price

Question 16

Current Value of Common Stock(CSV)-

Answer 16

CSV=Dividend in 1st Year/Required Rate of Return-Growth Rate)

Question 17

Common Stock Expected Return(CSER)-

Answer 17

CSER=(Dividend in 1st Year/Market Price)+Growth Rate

Question 18

Working Capital(Net Working Capital)-

Answer 18

The difference between a firm’s current assets and its current liabilities. Expressed in formula it is:
Working Capital=Current Assets-Current Liabilities

Question 19

Economic Order Quanity-Determining the order size that will minimize total inventory cost is solved using this model which has these formulas:

Answer 19

Total Inventory Costs=Total Order Cost+Total Carrying Costs
Total Order Costs=# of orders X per order cost or
T/Q X O
Total Carrying Costs=Avg Inv X Per Unit Carrying Costs or Q/2 X C
Total Inv Costs=(T/Q) X O + (Q/2) X C
EOQ=Square Root of 2 TO/C

Question 20

Reorder Point=

Answer 20

Delivery time stock + Safety stock

Question 21

Ration Analysis-

Answer 21

The development of quantitative relationships between various elements of a firm’s financial and other information.

Question 22

Debt to Equity Ration-

Answer 22

Total Debt (Liabilities)/Owner’s Equity

Question 23

The name given to Ratios frequently indicates the quantitative function to be performed.

Answer 23

The terms “to” and “on” indicate dividing of the first item described by the second item described.

Question 24

Liquidity-

Answer 24

Measures the ability of the firm to pay its obligations as they become due.

Question 25

Working Capital-

Answer 25

Measures the extent to which current assets exceed current liabilities and, thus, are uncommitted in the short term. It is expressed as:
Working Capital=Current Assets-Current Liability

Question 26

Working Capital Ratio-

Answer 26

Measures the quantitative relationship between current assets & current liabilities in terms of the “number of times” current assets can cover current liabilities. It is computed as:
Working Capital Ratio=Current Assets/Current Liabilities

Question 27

Acid Test Ratio (Quick Ratio)-

Answer 27

Measures the quantitative relationship between highly liquid assets & current liabilities in terms of the “number of times” that cash & assets that can be converted quickly to cash cover current liabilities. It is computed as:
(Cash + (Net) Receivables + Marketable Securities)/ Current Liabilities.

Question 28

Defensive Internal Ratio-

Answer 28

Measures the quantitative relationship between highly liquid assets and the average daily use of cash in terms of the number of days that cash & assets that can be quickly converted to cash can support operating costs. It is computed as: (Cash + (Net) Receivable + Marketable Securities) / Average Daily Cash Expenditures

Question 29

Average Collection Period-

Answer 29

Measures the # of days on average it takes an entity to collect its accounts receivable; the avg # of days required to convert accounts receivable to cash. It is computed as: (Days in Year x Avg Accts Receivable) / Credit Sale of Period

Question 30

Times Interest Earned-

Answer 30

Measures the ability of current earnings to cover interest payments for a period. It is measured as:
(Net Income + Interest Expense + Income Tax Expense) / Interest Expense

Question 31

Times preferred dividends earned ratio-

Answer 31

Measures the ability of current earnings to cover preferred dividends for a period. It is computed as:
Net Income / Annual Preferred Dividend Obligation