BUS 3 Financial Modeling & Analysis (1)

Question 1

Internal Rate of Return computed as followed

Answer 1

*Investment / Cash Flows = Present Value Factor

• Higher present value factor, the lower the computed IRR
• Increase to Investment or decrease to cash flows serve to increase present value factor

Question 2

Economic Value Added

Answer 2

• Different than residual income:
  
  • WACC must be used to calculate EVA
  • Income and Invest numbers used to calculate EVA generally adjusted to produce more accurate analysis

Question 3

Required Return vs EVA

Economic Order Quantity

Answer 3

RR: NBV x Hurdle Rate
EVA: 1. Investment x Cost of Capital
2. Income after taxes - Required Return = EVA

EOQ: Minimize variable inventory costs
=Square Root (2 x Sales Unit x Cost per Purchase Order / Carrying Cost per Unit)

Question 4

Discounted Payback Rate
NPV
IRR
Payback Period

Answer 4

DPR = Considers time value money, ignores cash flows after initial investment
NPV = Absolute return and not a rate
IRR = Accept investment in the event that the IRR is greater than hurdle rate
Payback Period = ignores cash flows after initial investment has been recovered

Question 5

Residual Income Approach

Answer 5

Historical weighted average cost of capital is used as the target or hurdle rate

Question 6

• Preferred stock formula
• Cost of Retained Earnings (DCF)
• Cost of Retained Earnings (Bond Yield Risk Premium)

Answer 6

• Kps = Pref stock div / Net proceeds of pre stock
• Kre = (Div per share / market value outstand stock) + market Rate
• Kre = Pre tax cost of debt / Market risk premium

Question 7

• Cost of retained earnigs Required Rate of Return using the CAPM
• Discounted Cash Flow

Answer 7

*Required Rate of Return = Risk free + Beta(Market rate- Risk free)
*=(Div Next Period/Stock Price) + % Growth
(Do not factor in tax)