CPA Exam Flashcards
Present Value
The higher the interest or discount rate, the lower the PV of a future amount
The higher the interest or discount rate, more interest is counted and there is less PV
e.g would you want $1000 today or $1,100 5 years from now?
Future Value
The higher the interest rate, the greater the FV of a present amount
e.g compound interest for an IRA
Incremental Cost
Costs that are different between 2 more alternatives i.e the difference between the 2
Is the original price a sunk cost?
Yes, the original price and depreciation are not important when considering relevant costs
What is a sunk cost?
Cost incurred in the past, cannot be changed by current decisions, and is irrelevant to making current and future replacement decisions
Why does a company want a lower WACC?
It is the cost to a firm for long-term financing and also serves as the minimum a company must earn on its investments. The lower the WACC, the lower the required revenue to earn a profit and the easier it is to increase shareholder value
What is opportunity cost?
It is the discounted dollar value of benefits lost from an alternative opportunity as a result of choosing another opportunity. It does not involve an actual transaction or cash outlay
i.e By choosing option A, you give up option B
Why would you not use an entity wide cost of capital to evaluate new investments?
A high-risk division may end up under investing while a low-risk division may over invest. Risk needs to be assessed at each division rather than the entire company.
What are product costs?
Cost assigned to goods that were either purchased or manufactured for resale. AKA inventoriable costs
weighted cost of capital formula
percent of total x cost of capital
What is the opportunity cost for idle space that has no alternative?
Zero
Calculating an annuity stream
Must have the same amount for each year to multiply by the annuity rate
Compounding of interest
The more frequent the compounding, the higher the effective interest rate will be regardless of the length of the loan
Yield Curve
upward sloping curve in which short term rates are less than intermediate term rates, which are less than long term rates
Annual percentage rate
interest = principal x interest rate x time period of loan
calculate real interest rate
real interest rate = stated (nominal) - inflation
Effective cost of a loan
determined as the annual dollar cost of the loan divided by the net useable proceeds of the loan
Risk free rate of interest
rate of return with zero risk
Inflation premium
compensation for expected inflation by increasing nominal interest rates
Default risk premium
additional amount a borrower must pay to compensate a lender for taking risk
Liquidity premium
difference between two securities that have the same qualities except for liquidity
Maturity risk premium
amount of extra return you’ll see on your investment by purchasing a bond with a longer maturity date
What is the market risk rate for a one year treasury bill?
T-bills are risk free with zero inflation expected but if there is inflation premium, then add to risk free rate
Nominal interest rate
Real risk free + inflation premium + default risk premium + maturity premium + liquidity premium +/- special premiums/discounts
Relative seniority
Relative seniority is a factor relevant in determining the risk premium on a security. A security with seniority has some form of priority claim over other securities and, therefore, is relatively more likely to be satisfied than securities with lesser seniority. The greater the relative seniority, the lower the risk premium.
Earnings per share
Income-interest expense/shares outstanding
Explain why a 1 yr maturity yield increased higher than 10 year maturity yield
Investors are expecting reduced inflation in the future as reflected in the lower long-term returns. That’s why the short term rates have risen compared to the long term rates
U.S GAAP observable inputs
Level 1 and 2. Level 3 unobservable
U.S GAAP Level 1 input
highest level, unadjusted quoted prices in active markets for A&L
U.S. GAAP Level 2 input
middle level, observable either directly or indirectly, othr than quoted prices (active (similar) or inactive (similar or identical))
U.S. GAAP level 3 input
lowest level, unobservable inputs, reflect entity assumptions about market participants
Valuation approaches
market (sales comparison): uses prices and other info (best evidence of fair value)
income: convert future amounts to present
cost: amount required to acquire or construct a substitute
characteristic in valuing a specific item
condition, location and level of activity in the relevant market
What is Beta?
Beta measures the volatility of a stock relative to the market. In general, beta measures volatility of an asset against the asset class of the asset being valued.
What does an investment’s beta measure?
it shows how the value of an investment changes with changes in the entire class of similar investments. Systematic risk is the uncertain inherent in the entire market; it cannot be avoided through diversification.
Required rate calculation
risk free rate + beta (expected rate - risk free rate)
Beta volatility
the lower the beta the lower volatility and vice versa
Plotting beta would show…
asset return and benchmark return
CAPM limitations and assumptions
all investors have equal access to info asset risk is measured by its variances from the asset class benchmark no external costs no restrictions on borrowing or lending there is a market for all asset classes uses historical data
P/E Ratio
Market price/EPS
Common-size income statement
each item is a measure of total revenue
Noncontrolling interest discount
applied to determine the value of partial ownership of a business
Least likely for a going concern
An entity would not seek to determine the value of an entity as a going concern in connection with a property tax determination. Valuation for property tax purposes would be concerned only with the value of the separate taxable assets of the entity, not with the value of the entity as a going concern.
Basis risk
Basis risk is the risk that relates to the possibility that a derivative might not be effective at hedging a particular. Basis risk is a measure of the ineffectiveness of a hedge.
Should the macroeconomic and industry status be considered when valuing a company?
Yes
Which are more difficult to value, public or non public entities?
nonpublic, b/c …
Payback period approach
Determines the number of year needed to recover intial cash investment. This is the easiest method to apply
Profitability Index Approach
The profitability index approach to capital project evaluation is primarily concerned with the relative economic ranking of projects by taking into account the cost of a project as well as with its net present value.
What does Discounted Payback Period ignore?
The discounted payback period approach to assessing a capital project determines the number of years (or other periods) needed to recover the initial cash investment in the project and compares the resulting time with a preestablished maximum payback period. Because the discounted payback period approach determines only the length of time required to recover the initial investment, it does not consider the results after the payback period; it ignores cash flows received after the payback period.
Average accounting rate of return
The (average) accounting rate of return is determined by dividing the average annual after-tax net income by the average cost of the investment.
Capital structure
all long term debt and equity
Financial structure
all debt and equity
short term debt
not included in capital structure of an entity
pledging accounts receivable
using AR as collateral
Factoring accounts receivable
AR is sold at a discount for cash to a factor
Revolving credit agreement
A revolving credit agreement is a formal legal commitment, usually by a bank, to extend credit up to some maximum amount to a borrower over a stated period.
Letter of credit
A letter of credit is a conditional commitment to pay a third party in accordance with specified terms.
Field warehouse agreement
a form of inventory secured loan in which the inventory is placed under the control of an independent third party
Floating lien agreement
Under a floating lien agreement the borrower gives the lender a lien against its inventory, but retains control of the inventory and can continuously sell and replace the inventory.
cost of debt
actual interest rate - tax savings
Float
Float is the length of time between the writing of a check (or other draft instrument) and the actual transfer of the funds.
Receipt float
Receipt float is the time between the writing of a check (or other instrument) by a customer and when those funds become available to the party to which the check was made.
Disbursement float
Disbursement float is the time between the writing of a check by a firm writes and removal of the funds from the firm’s account.
Zero balance account
A zero-balance account is a cash management technique that permits control over cash outflows by using a checking account that has a zero ($0) real balance because payments made from the account exactly equal deposits to the account.
Reorder point formula
safety stock + delivery time stock
