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BEC > Financial Management > Flashcards

Financial Management Flashcards

2
Q

How is Net Working Capital calculated?

A

Net Working Capital = Current Assets - Current Liabilities

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3
Q

What is the primary focus of working capital management?

A

Managing inventory & receivables (current assets & liabilities)

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4
Q

What are the characteristics of effective Working Capital Management?

A

Shorten the cash conversion cycle

Don’t negatively impact operations

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5
Q

What is the Inventory Conversion Period?

A

Average time needed to convert materials into finished goods and sell them

Inventory Conversion Period = Average Inventory / Sales Per Day

  • Average Inventory = (BI + E) / 2
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6
Q

What is the Receivables Collection Period?

A

Average time needed to collect A/R

RCP = Average Receivables / Credit Sales Per Day

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7
Q

What is the Payables Deferral Period?

A

Average time between materials and labor purchase and their A/P payment

Average Payables = (BP + EP) / 2

Payables Deferral Period = Average Payables / (COGS/365)

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8
Q

What is the Cash Conversion Cycle?

A

Amount of time it takes to receive a cash inflow (Customers) after making a cash outflow (Vendors)

Inventory Conversion Period
+ Receivables Collection Period
– Payables Deferral Period
= Cash Conversion Cycle

(Inventory Really (-Pays) Cash)

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9
Q

What traits should Cash and Short-Term Investments have?

A

Liquid

Safe

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10
Q

For what are Letters of Credit used?

A

Used for importing goods.

Issued by importer’s bank.

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11
Q

What is a Lockbox System? What are the advantages?

A

Customer Payments are sent to a bank-managed PO box.

  1. Employees don’t have access to cash.
  2. Deposits are more timely.
  3. Interest income from deposits should pay for the Lockbox fees (if they don’t- lockbox is not beneficial)
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12
Q

What is the advantage of using Trade Credit?

A

No interest cost if paid timely.

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13
Q

What are Zero Balance Accounts?

A

Regional bank sends enough cash to cover daily checks

Advantages:

  1. Checks take longer to clear -more float
  2. Low amounts of cash tied up for compensating (minimum) balances
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14
Q

What is float?

A

Time it takes to mail a payment and have it clear your bank account

Maximize float on cash payments

Minimize float on cash receipts

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15
Q

What is the difference between Treasury Bills- Notes and Bonds?

A

Treasury Bills: Short term (less than one year) Think: $1 Bill

Treasury Notes: Medium term (less than 10 years- more than 1)

Treasury Bonds: Long term (greater than 10 years) Think: government is in long-term bondage to you; they owe you money

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16
Q

What is commercial paper?

A

Similar to T-Bill- but issued by corporations instead of Government

Greater than 9 Months Maturity

Unsecured

Issued by large firms

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17
Q

What are the advantages and disadvantages of Commercial Paper?

A

Advantages: Financing at less than Prime. No compensating balances required.

Disadvantages: Unpredictability of markets. Credit crisis emerges and large insurance/investment companies aren’t lending.

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18
Q

What is Economic Order Quantity?

A

The order quantity that minimizes inventory costs.

EOQ = Square Root of (2DO/C)

D = Unit Demand (Annual)
O = Order Cost
C = Cost of Inventory
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19
Q

What is Carrying Cost?

A

The cost of keeping inventory.

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20
Q

What is Order Cost?

A

Cost of executing an order and starting product production.

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21
Q

What is a Just In Time (JIT) system?

A

Orders inventory so that you get it just in time for when it’s needed

JIT is valuable when Order Cost is low and Cost of Carrying Inventory is high

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22
Q

What is inventory reorder point?

A

How low inventory should get before it should be re-ordered.

IOP = Average Daily Demand x Average Lead Time

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23
Q

What is Factoring of receivables?

A

Receivables are sold to a financing company where they pay less than the value of the receivables due to a discount related to risk of non-collection

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24
Q

What is a Trade Discount?

A

Buyer saves if paid early

Example: 1/10 Net 30

1% Discount if paid within 10 days

If not- bill is still due in 30 days

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25
Q

What is the cost of forgoing a discount?

A

(Discount % x 365) / ((100% - Discount) x (Pay Period - Discount Period))

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26
Q

What is the Prime Rate?

A

A benchmark used for lending only to the best customers

Most customers will be charged Prime + 3%- for example

If the lending institution and the customer are not in the same country- the LIBOR rate is often used

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27
Q

What is the Nominal (Face- Coupon- Stated) Rate?

A

Interest rate stated on the face of a bond.

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28
Q

How is Current Yield calculated?

A

CY = Interest Payment / Bond Price

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29
Q

What is the Effective (YTM- Market) Rate?

A

PV of Principle + Interest = Bond Price

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30
Q

What is a Zero Coupon Bond?

A

No interest payments made

Bond sold at a discount

Interest reflected when Bond matures

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31
Q

What are the characteristics of a Junk Bond?

A

High interest rate

High default risk

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32
Q

What are debenture bonds?

A

Bonds unsecured by collateral

33
Q

What are subordinated debentures?

A

Debenture Bonds that will be repaid if any assets are left after liquidation of a company

34
Q

What are Redeemable Bonds?

A

Provision in Bond contract allows demand of Bond payment under certain circumstances

35
Q

What is a Callable Bond?

A

Borrower can pay off debt early

36
Q

What is a Convertible Bond?

A

Lender can demand payment via company stock instead of money

37
Q

What is a Sinking Fund?

A

Borrower deposits regular sums into an account that will eventually pay off the debt

38
Q

What is the disadvantage of Common Stock in comparison to bonds?

A

Common Stock is more expensive to issue than debt.

Why? Investors demand a greater ROI than debtors (bondholders)

39
Q

What is the advantage of Preferred Stock?

A

Hold dividend priority over common stock

40
Q

What is Weighted Average Cost of Capital?

A

A company uses this to determine the true cost of their capital

Example:
Debt costs 5%; 40% of Cap.
Equity costs 12%; 60% of Cap.
(5% x 40%) + (12% x 60%)
WACC = 9.2%
41
Q

What is CAPM?

A

A stock’s expected performance is based on its beta (risk) compared to that of the stock market.

More risk = more expected return.

42
Q

How is Cost of Debt calculated?

A

(Interest Expense - Tax Benefit) / Carrying Value of Debt

43
Q

What is a Horizontal merger?

A

A horizontal merger is when a firm combines with another in the same line of business

44
Q

What is a Vertical merger?

A

A vertical merger is when a firm combines with another firm in the same supply chain

(i.e. a combination of a manufacturer with one of its suppliers)

45
Q

What is a Congeneric merger?

A

A congeneric merger occurs when the merging firms are somewhat related but not enough to make it a vertical or horizontal merger

46
Q

What is a Conglomerate merger?

A

A conglomerate merger is when the firms are completely unrelated

These types of mergers provide the greatest degree of diversification

47
Q

What is a zero-balance account?

A

A zero-balance account is used for cash disbursement; which is a cash management technique that involves maintaining a regional bank account to which just enough funds are transferred daily to pay the check presented

A zero-balance account is a type of account which helps you pay as late as possible

48
Q

What is a lockbox system used for?

A

A lockbox system is used for cash receipt collections

A lockbox system is also an internal control because you don’t have to worry about employees obtaining custody of the cash receipts (customer payments); thus, decreases the risk of misappropriation of assets & risk of check kiting

A lockbox system allows you to collect payment early

49
Q

What is concentration banking?

A

Concentration banking is a way to reduce float in your collection so you are able to collect payments earlier

50
Q

What characteristics does Electronic Funds Transfer (EFT) systems have?

A

Electronic Funds Transfer (EFT) systems actually take the float out of both the receipts & disbursement processes. EFT is a very good internal control because you do not have to worry about checks getting lost in the mail or misappropriation of assets

When you make a payment via EFT, the person that you’re paying (the payee) receives the money nearly immediately.

In terms of payment, the payor (person or entity making the payment) loses the float since EFTs does not take a lot of time to clear like check payment

51
Q

What are the 2 goals of inventory management?

A

To goals of inventory management are:

  1. To ensure adequate inventories to sustain operations
  2. To minimize inventory costs - including carrying costs, ordering & receiving costs and cost of running out of stock (stock out costs)
52
Q

What is safety stock?

A

Safety stock may be used to guard against stock outs; they are maintained by increasing the lead time (the time that elapses from order placement until after accrual); thus, safety stocks decreases stock out costs, but increases carrying costs

53
Q

How does Level production compare with Seasonal production?

Comparison in production patterns for a firm

A

Level production results in the most efficient use of labor & facilities throughout the year; however, it also results in inventory buildups during slow sale periods

in contrast…..

Seasonal production involves increasing production during periods of peak demand & reducing production during slow sale period. Seasonal production often have additional operating costs for such things as overtime wage & maintenance of machines

54
Q

What is Inventory Management & Materials requirement planning (MRP)

A

Inventory management & material requirement planning (MRP) is a computerized system that manufactures finished goods based on demand forecasts.

A key weakness of MRP is that it is a “push through” system

55
Q

What is Just-in-Time (JIT) Purchasing?

A

JIT purchasing is a demand pull inventory system which may be applied to purchasing so that raw materials arrive just as it is needed for production

56
Q

What are Permanent current assets?

A

Permanent current assets are the amount of current assets that are required to operate the business (even in slowest period of the year).

These types of assets are more appropriately financed with long-term financing (i.e. issuing stock or bonds)

57
Q

What are Temporary current assets?

A

Temporary current assets are current assets that are accumulated during periods of higher production & sales (i.e. inventory & A/R)

These types of assets may be appropriately financed with short-term financing

58
Q

What are negative debt covenants?

A

Negative covenants specify actions that the borrower cannot take such as restrictions on:

  1. Sale of certain assets
  2. Incurrence of additional debt
  3. Payment of dividends
  4. Compensation of management
59
Q

What are positive debt covenants?

A

Positive covenants specify what the borrower must do and includes the following:

  1. Provide audited financial statements annually
  2. Maintain certain minimum financial ratios
  3. Maintain life insurance on key employees
60
Q

What is Yield-to-maturity (YTM)?

A

Yield-to-maturity is the interest rate that will equate future interest payments and the maturity payment into the current market price

61
Q

What are the advantages to Debt financing?

A

Advantages of debt financing are:

  1. Interest is tax-deductible
  2. Obligation is generally fixed in terms of interest & principal payments
  3. In periods of inflation, debt is paid back with dollars that are worth less than ones borrowed
  4. The owners (common shareholders) do not give up control of the firm
  5. Debtors do not participate in excess earnings of the firm
  6. Debt is less costly than equity; therefore, the use of debt (up to some limit) will lower the firm’s cost of capital
62
Q

What are the disadvantages to Debt financing?

A

Disadvantages of debt financing include:

  1. Interest & principal obligations must be paid regardless of the economic position of the firm
  2. Interest payments are fixed in amount regardless of how poorly the firm performs
  3. Debt agreements contain covenants that place restrictions on the flexibility of the firm
  4. Excessive debt increases risk to equity holders; therefore, depresses share prices
63
Q

What are the advantages of using lease financing to acquire assets (vs. purchasing it)?

A

Using leasing as a financing strategy has advantages over purchasing the asset and financing through other means:

  1. Firm may be able to lease an asset when it doesn’t have the funds or credit capacity to purchase it
  2. Provisions of lease agreement may be less stringent than a bond indenture
  3. Maybe no down payment required
  4. Creditor claims to certain types of leases, such as real estate, are restricted in bankruptcy
  5. Cost of a lease to lease an asset may be reduced if the lease is structured in a way where the Lessor retains the tax benefits
  6. Operating leases do not require recognition of a liability on the financial statement of the lessee (type of off-balance sheet financing)

A big disadvantage of using leasing as a financing strategy is the dollar cost of leasing an asset is often higher than the cost of purchasing it

64
Q

What are the advantages of issuing common stock?

A

Advantages of issuing common stock are:

  1. Firm has no firm obligations, which increase financial flexibility
  2. Increased equity reduces the risk to borrowers; thus, will reduce the firm’s cost of borrowing
  3. Common stock is more attractive to may investors because of the future profit potential
65
Q

What are the disadvantages of issuing common stock?

A

Disadvantages of issuing common stock are:

  1. Issuance costs are greater for equity
  2. Ownership & control is given up with respect to issuing common stock
  3. Dividends are not tax-deductible, whereas interest is (double-taxation results from issuing common stock)
  4. Shareholders demand a higher rate of return than lenders
  5. Issuance of too much common stock may increase the firm’s cost of capital
66
Q

What are the characteristics of Temporary equity?

A

Preferred stock that is redeemable for cash or other kinds of assets is considered to be temporary equity if:

  1. Its redeemable at a fixed price or at a certain date
  2. Redeemable at the option of the holder
  3. Event occurs for which the issuer cannot control

Temporary equity is a mezzanine item, which mean it is presented between debt & equity on the balance sheet

Note: Mandatorily redeemable preferred stock is considered to be a liability

67
Q

What are the advantages of issuing Preferred stock?

A

Advantages of issuing preferred stock are:

  1. Firm has no obligation to pay dividends until they are declared, which increases financial flexibility
  2. Increased equity reduces the risk to borrowers, which reduces the firm’s cost of borrowing
  3. Common stockholders do not give up control of the firm because preferred stockholders have no voting rights
  4. Preferred stockholders do not generally participate in superior earnings of the firm
68
Q

What are the disadvantages of issuing Preferred stock?

A

Disadvantages of issuing preferred stock are:

  1. Issuance cost are greater than for debt
  2. Dividends are not tax-deductible, whereas interest is (double-taxation)
  3. Dividends in arrears accumulated over a number of years may create financial problems for the firm
69
Q

What are the advantages of Going public?

Issuing common stock & registering shares of stock with the SEC

A

Advantages of “going public” are:

  1. An IPO provides firm with access to a larger pool of equity
  2. Publicly traded stock may be used for acquisitions of other firms. If a private company decides to acquire another company, it generally must do so with cash
  3. Firm can offer stock options and other stock-based compensation to attract & retain qualified manager
  4. Going public provides the owners of the private company liquidity for their investment; meaning they could easily sell their ownership portion by selling their shares
70
Q

What are the disadvantages of Going public?

Issuing common stock & registering shares of stock with the SEC

A

Disadvantages of “going public” are:

  1. Going public requires a significant amount of management effort & cost
  2. There is a significant cost of being a publicly traded company due to compliance with security laws, SEC, stock exchange regulatory, SOX - becoming a SEC registrant, and the Dodd-Frank Act
  3. Being a publicly traded company forces management to focus on stock price maximization, which may or may not be the best long-term interest of the firm
  4. Management must provide a great deal of information about the firm to investors (10K, 10Q, 8k’s, etc.). Also, a firm’s competitors has access to this information as well
71
Q

What is Operating leverage?

A

Operating leverage measures the degree to which a firm builds fixed costs into its operations

Note: There is a trade-off between PP&E & labor, meaning that you do things in an automated fashion or with labor. The higher your operating leverage, the more you have invested in PP&E (means you have high fixed costs)

In good times when you have large sales volume, you get economies of scale associated with high operating leverage. However, if you have low operating leverage, you will have to do all the production with additional labor

Higher DOL in good times = Increased opportunity for higher profits = Lower variable costs/unit

Higher DOL in bad times = stuck with higher fixed cost associated with PP&E held for higher operating leverage

72
Q

What is Financial leverage?

A

Financial leverage measures the extent to which the firm uses debt financing

Higher financial leverage in good times = More well-off common stockholders are because once the firm pays its creditors (fixed interest expense); the excess goes to the common stockholders

73
Q

What is the Arbitrage pricing model?

A

The Arbitrage pricing model uses a series of systematic risk (market risk that can’t be diversified away) factors to develop a value that reflects the multiple dimensions of systematic risk

74
Q

What factors affect a firms capital structure strategy?

A

The following factors affect a firm capital structure strategy:

  1. Business risk - the greater the inherent risk of the business, the lower the optimal debt-to-equity ratio. Some businesses are just inherently more risky than other. For example, the business of making cars is more risky than operating a movie theatre partly because the purchase of a car will largely depend on the level of interest rates, since most people finance this type of purchase. A movie theatre is less expensive since people usually pay cash when they go
  2. Tax position - a major advantage of debt is the tax deductibility of interest payments. If the firm has a low marginal tax rate, debt become less advantageous as a form of financing
  3. Financial flexibility - is the ability of the firm to raise capital on reasonable terms under adverse conditions. Less debt should be assumed by firms with less financial flexibility
  4. Management conservatism or aggressiveness - is a firm’s target capital structure will be affected by the risk tolerance of management. More aggressive management may take on more debt
75
Q

What kind of assertion can an investor make when a company declares a dividend?

A

The relevance of dividends are in their information content

Dividends signal to investors that management believes that the firm had a good year

INCREASE in dividends = Increase in share price
DECREASE in dividends = decrease in share price

As a result, management is hesitant to decrease dividends

76
Q

What kind of assertion can an investor make when a company repurchases its own shares (Treasury stock acquisition)?

A

Share repurchases (treasury stock acquisition) have information content:

  1. Sends positive signal to investors that management believes the stock is undervalued
  2. Reduces the # of shares outstanding; thus INCREASES EPS
  3. Provides a temporary floor for the stock

BEC (9 decks)

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