BEC - Financial Management

Question 1

Current Ratio Formula

Answer 1

Current Assets + Current Liabilities

Question 2

ABC Co increased allowance for uncollectable accounts, this will cause:

Answer 2

Increasing the allowance will reduce current assets, but not affect current liabilities. This will reduce current ratio.

Question 3

Capital Asset Pricing Model (CAPM)

Using CAPM, Current Cost of Common Equity Problem:
Risk-Free Rate: 7% Market Rate: 15% Beta Value: 1.25

Answer 3

The risk of price change due to unique circumstances of a specific security, as opposed to the overall market that can be virtually eliminated from a portfolio through diversification

7% + (1.25(15% - 7%) = 17%
Risk Free Rate + (Beta Value *(Market Rate - Risk-Free Rate)) = Cost of common equity

Question 4

Working Capital

Answer 4

Current Assets - Current Liabilities

Aggressive Policy: Reduce Current Assets in relation to Current Liabilities, high profitability potential

Question 5

1. ) Current Amount of Current Liabilities
2. ) Projected Current Ratio
3. ) New Current Liabilities
4. ) Reduction of CL needed

Answer 5

1.) Total Current Assets - Working Capital
2 & 3.) Total Current Assets / New Current Liabilities
4.) Current Amount of CL - New CL

Question 6

Zero Balance Account - Cash Disbursement Control

Answer 6

Imprest Fund. A checking account that carries a zero balance. Payroll Example.

When a large # of checks will be written a once, the net amount of the checks is deposited in the account. As the checks are cleared the balance will equal the outstanding checks, and when all are cleared, the balance in the account is Zero.

Question 7

Return on Investment (ROI)

Answer 7

Dividing Capital into net income. There are 2 elements of this.

1. ) Profit Margin = Operating Income / Sales
2. ) Invested Capital Turnover = Sales / Average invested capital

Question 8

Debt-To-Equity Ratio

Financial Leverage

Answer 8

Measures the relationships between total debt to total equity. Debt / Equity

Refers to the extent to which debt and preferred stock are used in capital structure. More leverage means greater risk which means higher cost of capital.

Question 9

Quick Ratio (Acid-Test Ratio)

Answer 9

A test for liquidity that includes only the most liquid of current assets in it calculation anf excludes inventory.

The ability to discharge currently maturing obligations based on the most liquid (quick) assets, higher the ration, better for store creditors.

Quick Assets / CL (OR) (Cash + MES + AR) / CL

Question 10

Reorder Point

Answer 10

Inventory level at which an order is placed.

It is average demand during the lead-time period plus any safety stock

Question 11

Economic Order Quantity (EOQ)

Answer 11

Quantity of Inventory that should be ordered at one time in order to minimize the associated costs of carrying and ordering inventory.

Question 12

Cost of Retained Earnings (Gordon Model) –> Cost of Funds

KRM = (Estimated dividend paid next yr / Current market price of the stock) + Estimated annual growth rate in dividends, in %

Answer 12

GM ignores flotation costs and underpricing. Must earn a return for the owners of the retained earnings.

krm = (D1 / PO) + G

KRM = Cost, in %, of using existing equity in the form of RE
D1 = Estimated dividend that will be paid back next year
PO = Current market price of the stock
g = Estimated annual growth rate in dividends in %

Question 13

Accounts Receivable Turnover

Answer 13

Measures the efficiency of credit and collection policies with respect to trade accounts

Net Credit Sales / Average AR
Average AR = (Beginning Balance + Ending Balance) / 2

Question 14

Dividend Payout Ratio

Answer 14

Dividend per common share / Earnings per share

Question 15

Cost of Debt is most frequently measured as:

Answer 15

Actual Interest Rate - Tax Savings

Use the after-tax cost of interest

Question 16

Cost of Preferred Stock

Answer 16

Dividend % of Par Value per share / (Per Share - Issuance Costs)

Question 17

Operating Leverage

Answer 17

Impact on operating income resulting from a change in sales. The higher the fixed costs in relation to variable costs, the greater the impact on operating income from a change in sales.

A high degree of operating leverage indicates a firm’s profits will be more sensitive to change in sales.

Question 18

Dividend Yield

Answer 18

Dividends per C/S / Market Price per C/S

Increase in market price of company’s common stock will immediately effect this

Question 19

Rule Of Thumb’s

Answer 19

Can’t be used as THE method to determine value, but can be used as a reasonableness check on a value that is determined through another method.

Provide support for a valuation estimate at using another method with similar results

Question 20

NPV is normally affected by:

Answer 20

Proceeds from the sale of the asset to be replaced.

NPV normally used methods of calculation:

• Computing the discounted (present) value of all FUTURE cash inflows and outflows of the proposed project
• Subtracting the PV of outflows from inflows to arrive at the NPV

Question 21

Net Annual Savings Problem/Formula

Answer 21

Discount Allowed = (Discount amount * Amount)
Bank Loan Cost = [Amount x (100% x Discount amount)] x Short Term Loan % x (Pay period # days - Terms Days) / 1 Year
Savings = Discount Allowed - Bank Loan Cost

Question 22

How can short term debt be acquired?

Answer 22

Secured Bank Loans
Unsecured Bank Loans
Commercial Paper

Question 23

How much preferred stock cost should be used in calculating the company’s cost of capital?

Answer 23

Preferred Stock’s Cost = Per-Share Dividend on preferred stock / Price of preferred stock

4.5% = Preferred Stock
$8 = Par Value
Preferred stock is trading at $9.50

= (4.5% x $8) / $9.50 = 3.79%

Question 24

Operating Leverage

Answer 24

The impact on operating income resulting from a change in sales. A high degree of operating leverage indicates a firm’s profits will be more sensitive to changes in sales.

Question 25

Debt Covenants

Answer 25

Long Term Debt frequently has various restrictive covenants that can dramatically limit choices available to management.

If a company violates its debts covenants, concessions are negotiated between the bank and customer in order to bring the debtor out of default or violation of the covenants.

Question 26

DuPont Equation

Answer 26

Return on Equity (ROE) = (Net Income / Net Sales) x (Net Sales / Avg. Assets) x (Avg. Assets / Avg Stockholders Equity)

which is actually: Profit Margin x Total Asset Turnover x Equity Multiplier

IF EM = 1.9, Total asset turnover = 1.2, FA TO = 1.1 and profit margin is 8%, THEN

.008 x 1.2 x 1.9 = .1824 or (18.24%)

Question 27

Inventory Decision Models

Answer 27

Work with opposing costs.

Carrying costs increase as the size of the order increases.
Setup or Ordering costs decrease as the size of the production run or order increases.

Question 28

Window Dressing

Answer 28

The intentional alteration of elements of the financial statements to improve performance measures and account balances.

Question 29

Margin of Safety

Answer 29

A calculation that indicates how much sales can drop before a loss will occur. (Excess sales / breakeven sales point)

Question 30

Risk Analysis

Answer 30

Evaluate the probability of the achievement of future returns from the proposed investment.

Question 31

Debit Capital

Equity Capital

Answer 31

DC: Derive from the issuance of interest-bearing obligations such as bonds and long-term notes.

EC: Originates from investments by shareholders (stock) and through retained earnings

Question 32

Under the capital asset pricing model (CAPM) method, what is E (Rm) − Rf known as?

Answer 32

Equity Risk Premium

This is used to determine the required rate of return for a stock. It is the expected return that investing in the stock market can provide over the risk-free rate.

Question 33

Inventory Turnover

Days Sales in Inventory

Receivables Turnover

Days Sales in Receivables

Answer 33

IT = Cost of Sales / Avg Inv
DSII = 365 Days / Inv Turnover
RT = Net Credit Sales / Avg Trade Receivables
DSIR = 365 Days / Rec. TO

Question 34

Degree of Financial Leverage Equation

Answer 34

Return on Equity / Adjusted Return on Assets =

Net Income + (Interest expense x (1 - Tax Rate)) / Net Income

Question 35

Market Capitalization

Answer 35

Total # of Shares Outstanding * Stocks Market Price