BEC - Financial Management Flashcards
Current Ratio Formula
Current Assets + Current Liabilities
ABC Co increased allowance for uncollectable accounts, this will cause:
Increasing the allowance will reduce current assets, but not affect current liabilities. This will reduce current ratio.
Capital Asset Pricing Model (CAPM)
Using CAPM, Current Cost of Common Equity Problem:
Risk-Free Rate: 7% Market Rate: 15% Beta Value: 1.25
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
Working Capital
Current Assets - Current Liabilities
Aggressive Policy: Reduce Current Assets in relation to Current Liabilities, high profitability potential
- ) Current Amount of Current Liabilities
- ) Projected Current Ratio
- ) New Current Liabilities
- ) Reduction of CL needed
1.) Total Current Assets - Working Capital
2 & 3.) Total Current Assets / New Current Liabilities
4.) Current Amount of CL - New CL
Zero Balance Account - Cash Disbursement Control
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.
Return on Investment (ROI)
Dividing Capital into net income. There are 2 elements of this.
- ) Profit Margin = Operating Income / Sales
- ) Invested Capital Turnover = Sales / Average invested capital
Debt-To-Equity Ratio
Financial Leverage
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.
Quick Ratio (Acid-Test Ratio)
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
Reorder Point
Inventory level at which an order is placed.
It is average demand during the lead-time period plus any safety stock
Economic Order Quantity (EOQ)
Quantity of Inventory that should be ordered at one time in order to minimize the associated costs of carrying and ordering inventory.
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 %
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 %
Accounts Receivable Turnover
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
Dividend Payout Ratio
Dividend per common share / Earnings per share
Cost of Debt is most frequently measured as:
Actual Interest Rate - Tax Savings
Use the after-tax cost of interest
Cost of Preferred Stock
Dividend % of Par Value per share / (Per Share - Issuance Costs)
Operating Leverage
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.
Dividend Yield
Dividends per C/S / Market Price per C/S
Increase in market price of company’s common stock will immediately effect this
Rule Of Thumb’s
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
NPV is normally affected by:
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
Net Annual Savings Problem/Formula
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
How can short term debt be acquired?
Secured Bank Loans
Unsecured Bank Loans
Commercial Paper
How much preferred stock cost should be used in calculating the company’s cost of capital?
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%
Operating Leverage
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.
Debt Covenants
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.
DuPont Equation
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%)
Inventory Decision Models
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.
Window Dressing
The intentional alteration of elements of the financial statements to improve performance measures and account balances.
Margin of Safety
A calculation that indicates how much sales can drop before a loss will occur. (Excess sales / breakeven sales point)
Risk Analysis
Evaluate the probability of the achievement of future returns from the proposed investment.
Debit Capital
Equity Capital
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
Under the capital asset pricing model (CAPM) method, what is E (Rm) − Rf known as?
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.
Inventory Turnover
Days Sales in Inventory
Receivables Turnover
Days Sales in Receivables
IT = Cost of Sales / Avg Inv DSII = 365 Days / Inv Turnover RT = Net Credit Sales / Avg Trade Receivables DSIR = 365 Days / Rec. TO
Degree of Financial Leverage Equation
Return on Equity / Adjusted Return on Assets =
Net Income + (Interest expense x (1 - Tax Rate)) / Net Income
Market Capitalization
Total # of Shares Outstanding * Stocks Market Price
