Corporate Finance

Question 0

Capital budgeting process

Answer 0

1. Generate inv ideas
2. Analyze project ideas
3. Create firm-wide capital budget
4. Monitor discussions and conduct a post-audit

Question 1

5 principles of capital budgeting

Answer 1

1. Decisions are based on cash flows
2. Cash flows are based on opportunity costs
3. Timing of CF matters
4. CF are analyzes on after-tax basis
5. Financing costs are reflected in project’s required rate of return

Question 2

Categories of capital projects

Answer 2

1. Replacement costs
2. Expansion projects
3. New product or market dev
4. Mandatory projects for regulation
5. Other, like R+D

Question 3

COGS

Answer 3

Beg inventory + purchases - end inventory

Question 4

Operating cycle

Answer 4

Days if inventory + days of receivables

Question 5

Break even quantity of sales

Answer 5

=(fixed op costs + fixed fin costs)
/
(Price- var cost per unit)

Question 6

EPS after buy back

Answer 6

= (total earnings - after tax cost of funds) / shares outstanding after buy back

Question 8

Degree of total leverage

Answer 8

= DOL • DFL
= % ch net income / % ch sales
= % ch EPS / % ch sales

Question 9

Degree of financial leverage

Answer 9

= % ch EPS / % ch EBIT
= %ch net income / % ch operating income
= EBIT / (EBIT - interest)

Question 10

Degree of operating leverage

Answer 10

= % ch EBIT / % ch sales

Question 11

cash dividends and share repurchases have what kind of effect on shareholder wealth?

Answer 11

none

Question 12

value of a levered company

Answer 12

= unlevered value + (debt * tax rate)

Question 13

CAPM

Answer 13

required rate of return on equity (ke) =

RFR + Beta [ expected return on market - RFR ]

RFR + Beta [market risk premium]

Question 14

Dividend Discount Model

Answer 14

ke = g + D1/Po

Question 15

Bond Yield plus Risk Premium Equity Cost Model

Answer 15

ke = bond yield + equity risk premium

Question 16

Preferred Stock cost of capital

Answer 16

kp = D/P

Question 17

Debt cost of capital

Answer 17

kd = pre-tax costs

kd ( 1 - t ) = post tax cost

Question 18

Marginal Cost of Capital

Answer 18

• schedule shows WACC for different amounts of capital

- upward-sloping

Question 19

flotation costs

Answer 19

adjust flotation costs as an initial cash outflow s.t.

NPV = PV of cash inflows - cost of project - flotation cost

Question 20

effect of leverage on net income and ROE

Answer 20

greater financial leverage decreases net income
expected ROE increases if ROA > debt cost
variability of ROE increases (increased risk)

Question 21

money market yield MMY

Answer 21

= HPY x 360 / days

= [(face val - price) / price] * 360/days

Question 22

bond equivalent yield BEY

Answer 22

= HPY x 365/days

Question 23

Cost of trade credit

Answer 23

= {[1 + (%disc /[1-%disc])] ^ (365/days past discount)} - 1

Question 24

profitability index

Answer 24

= PV of future cash flows / initial outlay for project

Question 25

sustainable growth rate

Answer 25

= (retention rate) * (ROE)

= (1 - payout ratio) * ROE

Question 26

market risk premium

Answer 26

= expected return on the market - risk free rate

Question 27

nominal risk free rate

Answer 27

= [(1 + real risk free rate) * (1 + expected inflation rate)] - 1

approx ~ real risk free rate + expected inflation rate

Question 28

reasons for holding money

Answer 28

1. transaction demand
2. precautionary demand
3. speculative demand

Question 29

breakpoint for component cost of capital

Answer 29

= amt of capital when component’s cost of capital changes / weight of component in capital structure