Familar? Flashcards
What is beta of the investment?
Beta indicates how much and in what direction a rational investor expects an investment to move given a 1% change in the market
What is the challenge with recognizing and measuring opportunity costs?
The challenge with opportunity costs is that there is not a recorded transaction in the accounting records to indicate and put a dollar value on the cost
What is interest rate risk?
Interest rate risk is the risk that market interest rates will vary and impact the value of interest-bearing securities, such as bonds
Can sunk costs take place in the future
If future costs are committe and cannot be avoided by making the decision at hand, these future costs are considered “sunk” and are not relevant to the decision
What is the C-V-P formula to solve for sales volume?
(Sales Price x Volume) - (Variable Cost per unit x Volume)- Total Fixed Costs = Profit
What is the cpaital asset pricing model? CAPM
CAPM describes the relationship between risk and expected return. It is used to determine how much return investors require for an investment given its systematic risk (beta)
Ke= Rf + B (Rm- Rf)
Triple bottom line?
Business sustainabilty is oftern defined as managing the organization’s performance in terms of a triple bottom line. Sustainability is a process by which companies manage their financial, social, and environmental risk, obligations, and opportunities. People, profit, planet
What does the phrase “tone at the top” mean?
A clear signal and consistent example of ethical practice by the organization’s executive team. If the tone at the top of the organization is inconsistent with the mission statement on ethics, we can expect problems with professional ethics throughout the org
Describe morality and virtue
Morality is a set of rules and principles that answered the question: What should I do?
Virtue is defined by our attititudes and character traits. A virtue based approach to ethics answers the question, What kind of person should I be? A person who has developed virutes through learning and practice will be naturally inclined to act in ways that are consistent with moral principles
How do business ethics at the firm level differ from business ethics at the indidivudal level?
At the firm level, business ethics are expressed mission, standards, culture of behavior that sets the ethical tone of the organization and provides direction to individual managers in their work and decision making
At the individual level, business ethics are a set of principles and personal commitments that guides the professional in the scope of his or her job when a conflict of values is presented
What are two ways accounting and finance professionals can improve their ability to be ethical?
Recognizing and anticipating WHEN ethics will be challenged in a particular situation
Recognizing and describing exactly HOW ethics are being challenged in a particular situation
How can discount rates be used to represent inherent risk on one capital investment versus another in capital budgeting?
Use higher discount rate or the investment with a higher inherent rate
What is the basic payback formula with constant cash flow?
Investment/Cashflow
What does Payback method tell us?
Payback method measures the amount of time it takes for the original net cash investment to be recovered
When NPV method and IRR method disagree on how to prioritize different investments, which method generally provides the most consistently correct comparison and why?
The most consistently correct comparison method is NPV. This is because the IRR method struggled with high IRR levels when cash flows vary significantly from period to period
Explain how to calculate the IRR of a potential investment
- Find the discount rate that discounts all future cash flows to be equal to the net cash investment
- The discount rate that balances the discounted future inflows with present investment outflow is the IRR (Internal Rate of Return)
What does a positive NPV indicate about IRR?
A positive NPV indicates that the IRR is higher than the discount rate used to compute NPV
Explain how to calculate the NPV of a potential investment
- Discount all future cash flows to “Year 0” using an effective discount rate and the appropriate number of time periods
- Compare the present value of al future cash flows to the net cash investment
- IF the present value of future cash flows is more than the net cash investment, the capital investment NPV is greater than zero (positive)
What is the connection between time and interest rates when considering amounts of money?
Using an interest rate makes one amount of money equal to a different amount of money at a different point in time
What is the difference between the direct and indirect approach in calculating operating cash flows?
An indirect approach is to add back all non-cash expenses to after-tax operating profit.
Indirect approach= After -tax profit + Non-Cash expense
A direct approach to add the cash value of the tax shield to the after cash flows from operations
Direct approach: After-tax cash + tax shield
What are examples of financial analysis tools?
NPV, IRR, Payback, ROI
Risk due to uncertainty in the capital investment can be managed by increasing flexibility on certain characteristics in the investment. What are those characteristics?
- The ability to accelerate or delay future payments involved in the capital investment
- The ability to expand or educe the size of the investment in the future
- The ability to extend or early exit the timeline of the investment commitment
Describe three reasons or purposes for making significant investments in a business that stretch across long time horizons
- Operational purposes: Focus on either reducing operating costs or increasing revenue
- Strategic purposes: Often concentrated on strengthening the organization’s competitive position in its market place
- Regulatory purposes: While not done to enhance profit, allow the organization to continue to operate in its industry or market`
Define capital investments
- The core assets and resources for the organizations
- Both tangible and intangible investments
- Worth significant sums of money for the org
- Have a long future horizon
What is the inherent problem with estimating the likelihood of an outcome?
The estimation process can be subject to bias due to subjectivity involved in judging the likelihood of an outcome
When a competitive oligopoly market emerges during the maturity stage of the product life cycle, what can a company do to compete?
- Cut prices aggressively, but this usually initiates an undesirable price war
- Differentiate its services by offering more product features
- Market more in order to strengthen the brand name
What is price elasticity of demand?
Price elasticity of demand describes how much movement in demand the org can expect from movement in price. If demand is elastic, then the increasing price will decrease overall revenue. If demand is inelastic, then increasing the price will increase overall revenue.
- Calculate demand percentage change and price percentage change
- Calculate price elasticity of demand
Demand % Change/ Price % Change
If > 1 = Elastic
If < 1 = Inelastic
If =1 then unitary elastic
What causes supply or demand curves to shift?
Events that cause supply to change or shift to the right: improvements to tech, reduction of production costs, growth in producers, decreases in price of substitute products. Opposite events shift supply to the left.
Events that cause demand to change or shift to the right: upsurges in preferences for the product, price increases for product substitutes, price decreases for complementary goods or services. As income increases, demand for luxury goods will shift to the right, but demand for inferior goods will shift to the left.
What causes an oversupply or shortage?
If the price is too high, then there will be an oversupply of the product or service in the market place because suppliers will provide more than consumers demand.
If the price is too low, then there will be a shortage (or undersupply) of the product or service in the marketplace because consumers will demand more than suppliers will provide.
What happens to supply and demand as the price of a good or service increases?
All else remaining equal, as the price of a good or service increases, the quantity of the supply will increase. Conversely, as the price of a good or service increases, the quantity of demand will decrease.
When an organization has a resource constraint, what is a two-step process to determine which products or services to prioritize?
- Compute contribution margin per unit of output for each product or service using the constraint
- Multiply contribution margin per unit of output by the number of outputs generated based on each unit of resource input
What accounting template can be used to evaluate the relevant revenues and costs of a division, product line, customer group, or another for-profit business unit?
Revenues - variable costs = Cm - direct fixed costs = business unit profit
How do you determine whether to process a product further?
Compute the change in cost (marginal) and compare it to the change in revenue (marginal) If the marginal revenue exceeds the marginal cost, then process further to the next sales point
What is a two-step process to analyze relevant costs?
- Identify the cot affected by the decision as the relevant cost
- Determine the amount by which relevant cost affects the decision, in other words, how much additional (incremental) cost is created by the relevant cost. This is known as marginal cost.
How is an opportunity cost typically measured?
By the revenue less the variable costs less direct fixed costs represented by the next best opportunity given up to make the current decision
Why is it important to recognize when capacity is a factor in the current decision for an org?
When the org is running out of capacity, it has more opportunities than it has the capacity to pursue and needs to make choices about how to best optimize the capacity. It is those situations with limited capacity where opportunity costs occur.
Describe the concept of cost and value when considering opportunity costs
Value given up in the next best opportunity is a cost of the current decision whereas costs that would have been paid in the next best opportunity are a value of the current decision
What are sunk costs?
Sunk costs are unchanged by the decision about to be made and are never relevant
What are irrelevant costs?
Irrelevant costs (unavoidable costs) are costs not affected by the decision about to be made
What are relevant costs?
(Avoidable costs) are defined as the costs affected by the decision about to be made
How is sensitivity analysis performed with the C-V-P formula?
While holding the other inputs constant, adjust one of the four CVP inputs (price, volume, variable cost rate, total fixed costs) to observe the possible range of uncertainty for that input. Then determine if the impact on profit is unacceptable.
What is the computation for margin of safety percentage?
Margin of Safety / Current Sales (In units or dollars)
Or
Margin of Safety/ Breakeven sales
What is the computation for margin of safety for sales in revenue dollars?
Current sales revenue - break even sales revenue
What is the computation for margin of safety for sales in units?
Current sales units - breakeven sales units
What is basic computation for margin of safety?
Current sales - breakeven sales
What kinds of opportunities and threats in the business environment crease uncertainty for an org?
Many business issues that increase uncertainty for an org, including issues involving competitors, suppliers, customers, government, environment, society, and tech
When computing C-V-P analysis on the volume of units, what are three steps of the basket method?
- Make a basket with the sale mix in units
- Solve the cvp for the basket
- Open the basket and multiply the sales mix
What is the basic approach when computing the C-V-P analysis on the volume of sales dollars?
- Determine the sales mix ratios based on revenue dollars
- Use total variable cost ratio to solve cvp formula for total revenue dollars
- Break out the total revenue dollars to the products using the sales mix ratios
What is a sales mix?
The sales of each product or service relative to total sales in the org
What is the conversion formula to change after-tax profits to pre-tax profits for use in C-V-P analysis?
After Tax Profit / (1- Tax Rate)= Pre-Tax Profit
Are the factors in the C-V-P formula in pre- or after-tax dollars?
Pre-tax dollars. It is critical that the profit target is converted from after-tax profit to pre-tax dollars before using the C-V-P formula.
What is the formula for targeted profit?
It is the same basic C-V-P formula but set equal to the targeted profit.
Revenue- Variable Cost - Fixed Cost = Proft
What factors can we solve for and manage in achieving targeted profit?
Volume, price, variable cost, variable cost ratio, revenue, total fixed costs
Why is it important to understand the Relevant Range when working with C-V-P and Contribution margin?
If the operation being managed is expected to extend beyond the time horizon Relevant Range or extend outside of the relevant range of activity, then the C-V-P formula and analysis need to be carefully re-evaluated to adjust for changes in total fixed costs or changes in variable costs per unit. In addition, sales prices may also shift outside of the Relevant Range.
What is the Relevant Range?
The Relevant Range refers to a time horizon or range of activity within which fixed costs are expected to remain constant in total and variable costs are expected to remain constant per unit.
How can the Contribution Margin Rate and the Contribution Margin Ratio be used to the Breakeven Point?
Total Fixed Costs/ CM Rate= Breakeven Volume of Units
Total Fixed Costs/ CM Ration= Breakeven Revenue Dollars
