BEC MCQ 3.3 Flashcards
Capital budgeting decisions
doesn’t include short term financing needs they are more of operational
The annual depreciation expense on an asset reduces income taxes
The firms marginal tax rate times the depreciation amount
Manufacturing equipment replacement decision
Disposal price of the old equipment
Items included in discounted cash flow analysis
Future operating cash saving
current asset disposal price
tax effects of future asset depreciation
future asset disposal price
not included in discounted cash flow analysis
future asset depreciation expense
A project should be accepted
if the NPV is greater or equal to zero
Rates used in Net present value analysis
The discount rate, hurdle rate and cost of capital. These are the synonymous terms for an arbitrary rate set by management
Rates which will Decrease NPV
Increase in discount rate will reduce NPV.
Increase in NPV
Increase the estimated salvage value
Extend the project life and associated cash inflow
Decrease the estimated effective income tax rate
If the NPV of a proposed investment is negative the discount rate used must be greater than the project IRR.
The IRR is the discount rate that results in a NPV of zero
The disadvantage of NPV is that it does not provide the true rate on investment. The NPV indicates whether the investment will earn the hurdle rate used in the NPV calculation.
Sensitive analysis
is a what if technique that’s asks how a given organization will change if the original estimates used in capital budgeting are changed
IRR
is the rate of return that produces a npv of zero. IRR valuation do not require cash flows that are constant. IRR an be determined even the profitability index is less than one. IRR is defined as the technique that determines the present value factor after the tax flows equals the initial investment of the project. Alternatively IRR is the discount rate that produces a npv of zero . NPV will greater than zero when IRR is higher than the hurdle rate
Pay back method
is the length of time required to recover the initial cash outlay of a project. It emphasis liquidity
A firm with a higher degree of operating leverage
implies that firms profit are more sensitive to changes in sales volume
higher variable costs implies a lower degree of operating leverage
A firm using significant amount of debt has higher degree of financial leverage
when the cost of funds from the sale of Common stock is asked
annual dividend/sale price of common shares -floatation cost-underpricing
Strategies for creating an optimal capital structure is
Maximizing earning per share
Minimizing cost of debt
minimizing cot of equity
maximizing cash flow
If a company becomes more conservative in its working policy
it would tend to have an increase of ratio of current assets to current units of output
Turnaround document
Is a computer output that can be later used as a source document
Converting accounts receivable to cash
Collection agencies: Used to collect overdue A/R
Selling AR or factoring AR
Cash discount
Electronic fund transfers
Commercial paper
does not have an active secondary market. Commercial papers are sold by money markets by highly credit worthy companies. The maturity is less than 270 days. The interest on commercial paper is below prime rate but above Treasury bill rate.
There are restrictions as to the type of corporation that can enter into a commercial market for short term financing since to use of the open market is restricted to a small number of most credit worthy large corporations
ADvantage
it avoids the expense of maintaining a compensating balance
provides a broad distribution for borrowing
accrues a benefit to the borrower because its name is more widely known
Negotiable certificate of deposit
Negotiable CD have former secondary market
are regulated by Federal Reserve System
Are sold in denominations of 100000.
It carry lower interest than banker acceptance and commercial paper
The primary motivation for holding cash
Transactions demand
Speculative demand
Precautionary demand
If we are asked to Determine additional investment in Accounts receivable
Step 1: Determine average accounts receivable and the additional accounts receivable as follows:
it is new credit policy minus old credit policy it will give additional A/R
Determine the additional investment in additional accounts receivable
It is the receivable balance minus variable cost
then calculate the returned on investment
that is the amount
IF a seller extends credit to a purchaser more than his operating cycle
it means in effect financing more than inventory needs
Comparing a change in credit policy
Cost of funds
Bank may require that a day sales O/S cannot exceed certain number of days.
Customers may feel they should be given extended terms. If this is true additional working capital may be even greater
what does not affect safety stock
re-order level The facts that affect safety stock are uncertain sales forecasts dissatisfaction of customers uncertain lead times
Re-order point is
safety stock+ stock units used during lead time
inventory carrying costs
uinspections are part of ordering costs not carrying cots. Disruption of productions schdules,quantity discount lost, handling cost Inventory cost or carrying cost include insurance opportunity cost on inventory investment obsolescence and spoilage Cost of capital invested in industry
expected stock out cost + carrying costs
safety stock costs
Ordering costs primarily consist of
production set up
Average inventory
Re-order quantity/2 Average inventory excluding safety stock + Avg safety stock= avg. Inventory including safety stock.
Operating leverage
Fixed costs/Variable costs
Historical weighted average cost of capital
It is often used as target or hurdle rate not the optimal rate
residual income
first step=Average invested capital=sales/capital turnover
second step=operating income-(imputed rate x average invested capital)
Return on assets
Income/Ave.Assets or income /sales or sales /avg.assets
ROI
Net Income/ Invested Capital
Cost of fund from retained earnings
Dividend /stock price
Free cash flow`
Net operating profits after taxes+ Depreciation + Amortization -Capital expenditures-net increase in WC
Interest on investment
Invested capital x required rate of return
Economic value added
Net operating profit after taxes-cost of financing
Cost of financing
Total assets-current liabilities x WACC
Economic rate of return on C.S
Dividends+change in price/ Beginning price
ROI based on assets
Net Income/ Total assets or Average invested capital
Du point ROI analysis=Return on salesx asset turnover
Return on sales= Net Income/sales
Asset turnover= Sales/total assets
Market capitalization
Common Stock price per share x common stock O/S
Market Ratio
Common stock price per share/Book value per share
Market capitalization/ Common Stockholders Equity
Cost of funds from sale of C.S
Annual dividend/ Sale price of common share -flotation costs-underpricing
Coefficient of variation
Standard Deviation/Rate of return
