Financial Management, Internal Controls

Question 1

Define Change Identification and Change Management.

Answer 1

Change ID: The process of monitoring for change that includes ongoing and separate evaluations intended to identify and address changes in the effectiveness of internal controls.

Change Mgmt: When changes occur, verification of control effectiveness despite identified changes in controls and/or risks.

Question 2

Define Opportunity Cost

Answer 2

The discounted dollar value of benefits lost from an alternative as a result of choosing another alternative.

Question 3

What is the weighted average cost of capital?

Answer 3

It is the min rate of return that a firm must pay in order to attract and retain capital. Includes cost of debt, preferred stock, and common stock.

Calculated as the required rate of return on each source of capital weighted by the proportion of total capital provided by each source, and the resulting weighted cost to get the total weighted average.
Capital Element, Amt. as % of total * cost of capital = WC
where there is tax referenced, the cost of debt must be computed net of tax: rate * (cost of cap(1-tax rate))

Question 4

Define product cost.

Answer 4

The cost assigned to goods that were either purchased or manufactured for resale.

Question 5

When working with cash flows’ present and future values, what rates provide the higher present and future $ values?

Answer 5

With PV, the higher the interest rate, the lower the PV of the future amount. That is because more of the future sum is accounted for in interest.
With FV, the higher the interest rate, the greater the FV of a present amount because future value is computed as principal + compounded interest.

Question 6

What is the relationship between PV and single amounts and PV of annuities?

Answer 6

A PV of an annuity will always be higher than a PV of a single amount. With any annuity, a longer period will provide a higher PV.

Question 7

What is the effective interest rate?

Answer 7

The annual rate implicit in the relationship between net proceeds from a loan and the dollar cost of the loan.
IE, cost of borrowing divided by funds available for use.

Question 8

What is the annual rate of interest applicable when not taking credit terms 2/10, n/30?

Answer 8

When terms like 2/10, n/30 are used, the discount term is 30-10=20. How many 20 day periods are in a year? 18*20=360. And .02 leaves .98 of 1.00
Interest/Principal * time fraction of year
SO - .02/.98 * 360/20
.0204 * 18 = .3672 => 36.72%

Question 9

What is the nominal interest rate? What is the real interest rate?

Answer 9

Nominal: the rate of interest received before inflation
Real: the rate of interest after considering effects of inflation on the value of funds received.
–> Nominal rate-inflation rate

Question 10

What is the Capital Asset Pricing Model? What is the formula?

Answer 10

An economic model that determines the relative risk and expected return and uses that measure to value assets. Incorporates the time value of $ as the risk free rate and risk is incorporated as Beta.
CAPM = RFR + Beta * (Expected mkt return-RFR)
NOTE that Beta is NOT a % – watch decimals

Question 11

Define Beta. What would a plot of Beta look like?

Answer 11

Beta is a measure of volatility for the asset being valued.

A graph would show the relationship between the return of the asset and the return for the entire class of the asset, reflected as a benchmark return.

Question 12

How are items measured in a common-size balance sheet? In a common-size income statement?

Answer 12

BS - each item is measured as a % of total assets (L+OE)
IS - each item is measured as % of total revenue.

Common-size FS’s are useful for comparing between entities and over time for the same entity.

Question 13

What is the price-earnings ratio?

Answer 13

The P/E ratio is computed as market price of stock divided by EPS.

Question 14

What are the major approaches to assigning value to an entire going business?

Answer 14

Market approach - similar to comp sales used in RE

Income approach - calculates the NPV of benefit stream generated by entity. (Discount or Capitalization rate used is the yield needed to attract investors, given the risk.)

Asset approach - values biz by adding values of individual assets to comprise value

Question 15

What is the basic approach to capitalize earnings in order to value a business?

Answer 15

Annual earnings/required rate of return

Question 16

What are the 6 factors to determine option value?

Answer 16

1. Current stock price relative to option price
2. Time to expiration of option
3. Risk free rate of return
4. Measure of risk of optioned asset
5. Exercise price of option
6. Dividend payments on optioned security

Question 17

What is the Black Scholes Model, and how is it different from other option pricing tools?

Answer 17

It is a technique for valuing options on securities. The Black Scholes Model varies from other models in that it uses probabilities and discounts in addition to the initial 6 factors.

Question 18

What are the different forecasting methods available?

Answer 18

Qualitative (Subjective):
Exec. opinion - group of executives collectively use judgment and opinion to develop a forecast
Mkt research - surveys of cust to determine preference, etc.
Delphi - Consensus developed by a group of experts using a multi-stage process

Quantitative (Objective):
Time series - use patterns in past data to predict future value based on underlying patterns in past data
Causal - assume variable being forecasted is related to other variables and make projections based on those associations

Question 19

What are the different Time Series models?

Answer 19

..Naive - uses immediate prior period to forecast next
..Simple mean - uses average of past values
..Simple moving average - IE, 12 mos / 12 to forecast 1 period
..Weighted moving average - an average of a specific number of most recent values with diff weights
..Exponential smoothing - weighted average procedure with weights declining as data ages
..Trend adjusted exp smoothing - makes adjustments to past date when strong patterns are inherent in the data
..Seasonal indexes - adjust data to accom seasonal patterns
..Linear trend line - least squares method to fit a straight line to past data and extends trend to establish forecast

Question 20

What is the risk-free rate?

Answer 20

The rate of return required of lenders to compensate the investor for deferring use of the funds.

Question 21

What is the payback period and how is it calculated?

Answer 21

This method determines how many years are required to recover initial project investment costs.
Payback = investment cost / annual $ savings