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GT-OMSA-MGT-8803 > Financial Management Week 5 > Flashcards

Financial Management Week 5 Flashcards

1
Q

What does WACC stand for within financial management?

A

Weighted Average Cost of Capital

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2
Q

What is the formula for WACC ?

A

WACC = Cost of Debt * (1 - Tax Rate) * [Debt / (Debt + Equity)] + Cost of Equity * [Equity / (Debt + Equity)]

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3
Q

What factors influence the capital structure decision?

A
  • Taxes
  • Stability of cash flows and earnings
  • Financial and operating flexibility
  • Type of assets
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4
Q

What are the most important factors in the Cost of Debt?

A
  • Current interest rate on US treasury bonds with the same maturity
  • Default risk
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5
Q

What is the formula for the Cost of Debt?

A

Cost of Debt = Treasury Bond Rate + Default Premium

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6
Q

How are Bonds Rated within financial management?

A
  • A3, A2, A, B3
  • B2, B, C3, C2, C
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7
Q

What rated bonds are Junk or Speculative Bonds?

A

B2, B, C3, C2, C

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8
Q

What are the most important factors in the Cost of Equity?

A
  • Current interest rate on long-term U.S. Treasury bonds
  • Risk of equity
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9
Q

What is the formula for the Cost of Equity?

A

Cost of Equity = Treasury Bond Rate + Risk Premium

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10
Q

What does Beta stand for within financial management?

A

A measure of market risk for a company’s stock

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11
Q

What do Beta’s value tell you about a company’s stock?

A
  • Betas of one are at an average risk
  • Betas greater than one are more sensitive to macroeconomic risk
  • Betas less than one are less sensitive to macroeconomic risk
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12
Q

What is the formula for Total Portfolio Risk?

A

Total Portfolio Risk = Avg. Beta * Market Standard Deviation

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13
Q

What does CAPM stand for within financial management?

A

Capital Asset Pricing Model

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14
Q

What is the formula for CAPM?

A

Cost of Equity = USA Treasury Rate + Market Risk Premium * Beta

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15
Q

What is CAPM used within financial management?

A

It provides an estimate of the cost of equity based upon the stock’s beta

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16
Q

What does Market Risk Premium stand for within financial management?

A

The average difference in the rate of return on stocks and long-term USA Treasury bonds

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17
Q

What are the most popular firm evaluation methods within financial management?

A
  • Discounted Cash Flow (DCF)
  • Comparables
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18
Q

What does DCF stand for within financial management?

A

Discounted Cash Flow

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19
Q

What does EBIT stand for within financial management?

A

Earnings Before Interest and Taxes

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20
Q

What is the “CFₜ” in the formula CFₜ = EBITₜ * (1 - T) + DEPRₜ - CAPEXₜ - ΔNWCₜ?

A

Free Cash Flow at time t

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21
Q

What is the “EBITₜ” in the formula CFₜ = EBITₜ * (1 - T) + DEPRₜ - CAPEXₜ - ΔNWCₜ?

A

Earnings Before Interest and Taxes at time t

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22
Q

What is the “T” in the formula CFₜ = EBITₜ * (1 - T) + DEPRₜ - CAPEXₜ - ΔNWCₜ?

A

Corporate Tax Rate

23
Q

What is the “DEPRₜ” in the formula CFₜ = EBITₜ * (1 - T) + DEPRₜ - CAPEXₜ - ΔNWCₜ?

A

Depreciation at time t

24
Q

What is the “CAPEXₜ” in the formula CFₜ = EBITₜ * (1 - T) + DEPRₜ - CAPEXₜ - ΔNWCₜ?

A

Capital Expenditures at time t

25
Q

What is the “ΔNWCₜ” in the formula CFₜ = EBITₜ * (1 - T) + DEPRₜ - CAPEXₜ - ΔNWCₜ?

A

Increase in Net Working Capital at time t

26
Q

What does TV stand for within financial management?

A

Terminal Value

27
Q

What are some weaknesses in the DCF formula?

A
  • One point estimate
  • Beta estimation from companies
  • Terminal values play a crucial role
  • Changing capital structures or effective tax rates
  • DCF method assumes the capital structure and effective tax rates are both incorporated in the discount rate (WACC) and assumed to be constant
28
Q

What are some weaknesses in the Comparables Method?

A
  • Financial information often unavailable for private companies
  • Valuation may be misguided
29
Q

If you are valuating public market Comparables, what must you remember after getting you valuation?

A

Reduce your valuation by 20%-25% to discount for liquidity

30
Q

What are the strengths in using Comparables within financial management?

A
  • Quick to use
  • Simple to understand
  • Commonly used
  • Market based
31
Q

What are the weaknesses in using Comparables within financial management?

A
  • Private companies comparable difficult
  • If public company Comparables use liquidly discount
32
Q

What are the strengths in using DCF within financial management?

A
  • Theoretically Sound
33
Q

What are the weaknesses in using DCF within financial management?

A
  • Cash flows difficult to estimate
  • WACC assumes constant capital structure
  • Sensitive to terminal growth assumptions
34
Q

What does EVA stand for within financial management?

A

Economic Value Added

35
Q

What does MVA stand for within financial management?

A

Market Value Added

36
Q

What does Opportunity Cost of Capital stand for within financial management?

A

Opportunity Cost of Capital is the rate of return you can earn on securities in the capital markets with the same risk as your investment project

37
Q

What is the formula for Opportunity Cost of Capital?

A

Opportunity Cost = Rate of Return on Securities of Capital with the Same Risk

38
Q

What does TC stand for within financial management?

A

Total Capital

39
Q

What does Capital Charge stand for within financial management?

A

Capital Charge measures the opportunity cost of money for your investment project

40
Q

What is the formula for Capital Charge?

A

Capital Charge = r * TC

41
Q

What is the “r” in the formula Capital Charge = r * TC?

A

Rate of Return

42
Q

What does ROS stand for within financial management?

A

Return On Sales

43
Q

What is the formula for ROS?

A

ROS = NOPAT / Sales

44
Q

What does NOPAT stand for within financial management?

A

Net Operating Profit After Tax

45
Q

What is an alternative to using Total Capital within financial management?

A

Total Capital = Net Assets

46
Q

What does CT stand for within financial management?

A

Capital Turnover

47
Q

What is the formula for CT?

A

CT = Sales / TC

48
Q

What does ROTC stand for within financial management?

A

Return on Total Capital

49
Q

What is the formula for ROTC?

A

ROTC = NOPAT / TC

50
Q

What is the formula for MVA?

A

MVA = Market Value of Equity - Book Value of Equity

51
Q

What is the formula for Economic Profit?

A

Economic Profit = Accounting Profit - Capital Charge

52
Q

What are the main ways a company can improve it’s economic profits and increase it’s stock price?

A
  • Manage: Increase efficiency of existing operations and thus improve the spread between r* (Total Capital) and r (Cost of Capital).
  • Build: Invest in businesses and projects with positive spreads
  • Harvest: Withdraw capital from operations or activities where r* (Total Capital) is less than r (Cost of Capital).
53
Q

What metric do many companies use to determine performance-based compensation within financial management?

A

Economic Value Added (EVA)

54
Q

How do you measure a stock risk within financial management?

A

The stock’s Beta value

GT-OMSA-MGT-8803 (5 decks)

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