CH09-FP&A

Question 1

only way to compare the economic value of cash flows from different investment alternatives that have different timing of cash flow streams such as stocks versus bonds?

Answer 1

Present Value

Question 2

Formula for:
A construction firm has a contract in which it is paid $10,000 today, January 1, and then requires a payment of $5,000 at the end of the year and $15,000 at the end of the second year. Assuming that all funds can be invested to earn a return of 6%, how much will the contract be worth at the end of the second year?

Answer 2

Finding the FV of the inflows b/c getting paid for contract over 2 years.

=10k (1.06)^2 + 5k(1.06)^1 + 15k

Question 3

T/F: Return on Assests (ROA) needs to be higher than WACC to satisfy investor expectations

Answer 3

True

Question 4

In capital budgeting, a company might use ___ as its discount rate?

Answer 4

WACC

Question 5

Best way to estimate a firm’s cost of debt for use in WACC

Answer 5

after-tax yield to maturity on the firm’s most recent bond issuance

Question 6

Formula for EVA =

Answer 6

EBIT (1 - Tax Rate) - (WACC)(Long-Term Debt + Equity)

Question 7

Explain IRR three ways

Answer 7

IRR is the discount rate where NPV=0
so
PV cash inflows - Cost = 0

Where PV of cash inflows = PV of cash outflows

Question 8

What does if mean when IRR > WACC?

Answer 8

When IRR>WACC increases firm’s value

Question 9

WACC calc on page 255

Answer 9

[Debt%YTM on new debt before tax(1-t)] + (Equity%*Required rate of return on equity)

Where:

wD = Weighting of debt financing: D / (D+E)

rD = Yield to maturity on newly issued debt on a before-tax basis

T = Firm’s marginal income tax rate

wE = Weighting of equity financing: E / (D+E)

rE = Required rate of return on equity

Question 10

Degree of TOTAL Leverage (DTL) =

Answer 10

%Change in Net Income / %Change in Sales

Question 11

Degree of OPERATING Leverage (DOL) =

Answer 11

%Change in EBIT / %Change in Sales

Question 12

Degree of FINANCIAL Leverage (DFL) =

Answer 12

%Change in Net Income / %Change in EBIT

Question 13

Cash Conversion Efficiency =

Answer 13

Cash Flow from Operations / Revenues

Question 14

Return on Assets =

Answer 14

Net Income / Total Assets

Question 15

What is the formula used to determine a firm’s ability to meet its interest payments?

Answer 15

Times Interest Earned (TIE) = EBIT/Interest Exp

Question 16

Debt to Tangible Net Worth =

Answer 16

Total Debt / (Total Equity - Intangible Assets)

Question 17

What is the best way to estimate a firm’s cost of debt for use in WACC calc?

Answer 17

use the YTM (yield to maturity) on the firm’s most recent bond issuance

Question 18

T/F: The capital asset pricing model can estimate the required rate of return on retained earnings

Answer 18

True

Question 19

Typical project acceptance criteria might include:

NPV > ?
Profitability index > ?
IRR > ?

Answer 19

NPV > 0
Profitability index > 1
IRR > WACC

Question 20

The capital asset pricing model (CAPM) may be used to estimate the market’s required rate of return on a firm’s equity. This is the cost that applies to equity funds that are obtained through retained earnings. The cost of issuing new, additional common stock will be a bit higher because the company will receive less per share than shares sold due to issuance expenses.

Answer 20

TRUE