Financial Management

Question 1

Weighted Average Cost of Capital (WACC)

Answer 1

(W * Cost of common equity) + (W * Cost of preferred stock equity) + (W * After tax cost of debt)

Question 2

Weighted Average Cost of Debt

Answer 2

Effective Annual Interest Payments / Debt Outstanding

Question 3

Cost of preferred stock

Answer 3

Preferred stock dividends / (Net proceeds of preferred stock - Flotation cost)

Question 4

Cost of Retained Earnings (CAPM)

Answer 4

Rf + B * (Mr - Rf)
Mr - Rf = Market risk premium
B * (Mr - Rf) = Risk premium

Question 5

Cost of Retained Earnings using discounted cash flow

Answer 5

(Div at end of one year / Current market price) + constant growth rate of dividend

Question 6

If CAPM, DCF and BYRP yield consistent results,

Answer 6

the average of the three percentages can be used as CAPM/cost of retained earnings

Question 7

Total Debt Ratio

Answer 7

Total Liabilities / Total Assets

Lower the ratio, greater solvency and presumed ability to pay debts (Assets cover more of the liabilities)

Question 8

Times Interest Earned Ratio

Answer 8

EBIT / Interest Expense

Higher the better, shows how many times interest expense is covered, measure of long term solvency

Question 9

Inventory Turnover

Answer 9

COGS / Average inventory
Number of times a year inventory is sold
Measure of effective inventory management

Question 10

Days in Inventory

Answer 10

Ending Inventory / (COGS / 365)

Question 11

AR Turnover

Answer 11

Sales (Net) / Average AR (Net)
Number of times a year AR is collected
Measure of effective credit policy

Question 12

Days sales in AR

Answer 12

Ending AR / (Sales (Net) / 365)

Question 13

AP Turnover

Answer 13

COGS / Average AP
Number of times a year company pays its suppliers
Measures effectiveness of company’s attempt to delay payment to creditors

Question 14

Days of payables outstanding

Answer 14

Ending AP / (COGS / 365)

Question 15

Working Capital Turnover

Answer 15

Sales / Average Working Capital

Higher better; means WC is being converted to sales

Question 16

Reorder Point

Answer 16

Safety Stock + (Lead time * Sales in lead time)

Question 17

Economic Order Quantity

Answer 17

Sq rt of (2Sales in unitsOrder cost) / Carrying cost per unit

Question 18

APR of Quick Payment Discount

Answer 18

( 360 / (Pay period -Discount Period) ) * (Discount Rate / (100% + Discount Rate)

Question 19

Value of stock in perpetuity

Answer 19

Dividend / Required rate of return

Question 20

Value of equity using dividend growth model

Answer 20

Dividend after one year * (1+g)
divided by
Required return - g

Question 21

Discounted cash flow

Answer 21

1. Calculate after tax cash flows
2. Add depreciation benefit
3. Multiply sum by PV annuity factor
4. Subtract initial cash outflow (investment)

Question 22

Net Present Value

Answer 22

1. Estimate cash flows (depreciation shield (depreciation * tax rate), ignore interest rate)
2. Discount the cash flows using factor
3. Compare inflows and outflows

Question 23

NPV Decisions

Answer 23

Positive = make investment
Negative = do not make investment

Question 24

Which is more superior: NPV or IRR?

Answer 24

NPV because it is flexible enough to handle inconsistent rates of return for each project

Question 25

Profitability Index

Answer 25

Present value of cash flows / PV of initial investment

Question 26

What does IRR calculate?

Answer 26

The PV factor (%) that yields an NPV = 0

Question 27

IRR Decisions

Answer 27

When IRR > Hurdle Rate, accept

When IRR < Hurdle Rate, reject

Question 28

Payback Period (Solving for partial year)

Answer 28

1. Keep cumulative cash inflow
2. Divide remaining amount for recovery over the respective year’s total cash inflow
3. Add to whole number years solved

Question 29

Discount Payback Period

Answer 29

Same as payback period, but applies PV factor of $1 for EACH year in question at respective discount rate