Financial Management Flashcards
Define marginal tax rate
The marginal tax rate is the percentage of tax paid on the last dollar of taxable income. It is the highest percentage paid.
How does a treasury stock transaction affect financial leverage?
Debt to equity rate can increase a a result of decrease in stockholders equity.
Since Treasury stock decrease SE, this increases financial leverage as SE is reduced.
After-tax cost of debt calculation?
Where is this used in WACC?
(1 − Tax rate) × (Before-tax cost of debt).
The after tax cost is multiplied by debt weight for WACC calculation.
How is available principal calculated given compensating balance? How is effective cost of loan calculated?
Available principal is the amount remaining after deducting compensating balance.
Effective cost of loan in interest incurred ÷ principal payment.
WACC =
How is debt weight calculated?
WACC = (Debt weight × After-tax cost of long-term debt)
=+ (Preferred stock × Preferred stock cost)
=+ (Retained earnings weight × Cost of retained earnings)
Debt weight = Expected weight of financing * After tax cost of long term debt
Cost of common equity formula
(Dividend ÷ Price) + Growth percentage
Financial leverage ratio =
Financial leverage index =
Total assets ÷ Common equity
ROE ÷ ROA
Amount greater than 1 indicates company has benefited from positive effects of leverage.
Who does bond issuance and dividends payment effect WACC?
Bonds issuance lowers WACC because interest portion is deductible. This tax shield lowers the effective after tax cost of debt.
Dividends are paid with after tax income and they are not deductible.
How is beta measured and beta greater than 1 implies?
Beta is the measure of systematic (market) risk. A beta greater than 1 implies that the stock is more risky than the market portfolio.
The term “structure of interest rates” pertains to?
pertains to the relationship between interest rates on short- and long-term financial instruments
Difference between business risk and financial risk?
Business risk is measured in the context of major uncertainties in the economy such as firm’s degree of operating leverage, sales price variability, and impact of inflation on input prices. Financial risk relates to the level of firm’s financial leverage.
How is after-tax cost of equity calculated?
Cost = [(Dividend × (1 + Growth)) ÷ Price per share] + Growth rate
There is no tax on equity, so no tax effect is calculated.
How is short term credit secured?
What does secured loans include?
Short-term credit is secured by current assets such as inventory or accounts receivable.
Secured loans include short-term credit, the pledging of receivables, factoring receivables, and inventory financing.
What does unsecured loan include?
Are they backed by any collateral?
Unsecured loans include a line of credit, revolving credit agreement, commercial paper, or a letter of credit. Unsecured loans are not backed by any collateral and are used primarily to resolve short-term cash flow issues.
How is preferred sock cost calculated?
The preferred stock’s cost is calculated as the per-share dividend on preferred stock divided by the market price of preferred stock. Preferred stock’s cost = Per-share dividend on preferred stock
÷ Price of preferred stock
