Finc Mgmt B3 - Financial Decisions Flashcards
In a cash flow problem with a LOC and interest payments, remember:
- interest is paid in the month after use of the LOC
- any cash after netting cash in and cash out should first be applied to the LOC and then it can be ending cash
- ending cash is where you begin the next month
- make sure to calc interest on all LOC amounts for previous months
- interest payment is a cash outflow and if there is no money left at month end you must borrow on the LOC
The cost of debt most frequently is measured as
actual interest rate - tax savings
A financial lease has
a duration that corresponds to the useful life of the asset and payments that amortize the cost of the asset while providing the lessor an interest return
Cost of Preferred Stock =
(annual dividend per share x par value ) / (stock sales $ - issuance costs)
When interest rates decline, bond prices
increase
Advantages of short term credit:
- funds can be obtained quickly
- financing with this credit usually results in lower interest costs
- there are some spontaneous sources of funds (i.e. trade credit)
- some of this debt is interest free (ex. wages payable)
Disadvantages of short term credit:
- interest rates vary quickly
- this type of debt is more risky
Advantages of long term credit:
- interest rates tend to be more stable
Disadvantages of long term credit:
retirement will probably contain a prepayment penalty
Short term vs long term credit:
- short term can generally be obtained more quickly
- generally short term is more flexible
- short term is generally less costly as shown by the yield curve
- prepayment penalties are generally associated with long term but are not the basic reason for higher cost with ong term
- short term holds more risk due to the need to renew more often
The type of bond most likely to maintain a constant market value is a
floating rate bond
Advantages of long term debt:
- fixed interest rates for the life of the loan protect the firm from changing interest rates
- interest expense is tax deductible
- lower risk, thus the yield required by long term debt providers is lower
- control of the firm is not shared by long term debt holders
Advantages of common stock:
- a period of low profit or loss, common dividends do not have to be paid
- there is no maturity for common stock since it represents permanent ownership
- common stock increases the equity position of the corporation and can provide a basis for increasing debt
Both debt and equity security holders have an ownership interest in the corporation. Fact or Fiction?
Fiction
Both debt and equity securities have an obligation to pay income. Fact or Fiction?
Fiction
Debt is
a form of financing that increases the liabilities of the firm
Equity securities are
an ownership interest
Buyers of bonds must pay the seller the interest accrued from the last interest payment date to the date of issue in advance. =
face value + (face value x rate x % of year)
Short term interest rates are generally
lower than long term rates
*less risk involved in the shorter term
When a corporation is earning excess profits,
participating preferred stock acts more like equity than cumulative preferred stock
*because the stock does not receive a fixed % like debt. when excess profits are earned, the participating receive additional dividends
Cost of common equity under Dividend Growth Model =
(Dividend / Price) + Growth %
- no taxes
Cash proceeds from factoring AR =
Face amount - % reserve x face - % comm x face = Net amount available x Interest % x # days out of 360 = Interest $ Net amount - Interest $ = Cash proceeds
Preferred stock and long term bonds are similar from the standpoint of the issuing firm because
interest and dividend payments are fixed
WACC =
(% debt x int % x (1-tax %))
+ (% c/s x int %)
+ (% p/s x int %)
Line of credit is
an agreement between a small firm and a bank that permits the firm to borrow varying amounts of funds as needed over a specified time period
Letter of credit is
an international financing tool that guarantees payment to an international supplier upon safe arrival of goods by issuing a loan to the purchaser
Bond interest payment =
Stated rate of interest x Par value
The primary objective of variable interest rate loans is to
reduce the impact of rate changes on both parties
Everything else being equal, a noncallable bond will be priced in comparison to a callable bond so that the noncallable bond will provide
a lower yield
Variable rate loans can be used to reduce the risk associated with changes in interest rates during the term of the loan. the greatest level of risk relates to
long term loans
XYZ Lawn Care provides a variety of lawn care supplies and services. Sales and series vary greatly by season and are affected by changes in weather conditions. The financing method that would likely result in meeting XYZ’s cash needs at the lowest cost is
line of credit
Larson Corp issued $20 million of long term debt in the current year. The major advantage to Larson with the debt issuance is
the relatively low after tax cost due to the interest deduction
A secured bond issue is one that
provides bondholders with a pledge against certain assets
The covenant that obliges the borrower to repay the bonds if a large quantity of common stock is held by a single investor and the bond rating is downgraded is
a poison put clause
The covenant that requires a corporation to maintain, at all times, some minimum level of working capital is
an affirmative covenant
Variable rate loans reduce the potential interest rate risk of
both borrowers and lenders
Letters of credit are often to facilitate international trade. The basic purpose of the letter of credit is to reduce risk to the
exporter
Effective interest rate of loan with compensating balance =
Annual Interest Expense / (Full loan amount - Compensating Balance)
A company can finance an equipment purchase via lease financing or loan financing. A factor that would not be considered when comparing the two methods is
the capacity of the equipment
The Aida company plans to issue bonds with a maturity of $1,000,000 and a stated rate of interest of 10%. If the effective rate of interest aka YTM is 9% then the bond is
issued at a premium
A spontaneous source of financing for a firm is
A/P
Sales-type lease is
- a type of capital lease
- Fair Value is different than the carrying amount
- involves real estate
- transfer of ownership occurs at end of the term
NPV as used in investment decision making is stated in terms of
CFs
The original cost of equipment is ________ and _______ be considered in a replacement decision
sunk cost; should not
A project should be accepted if the PV of CF from the project is
greater than the initial investment
The decision making model that equates the initial investment with the PV of future CF is
IRR
The method to use if capital rationing needs to be considered when comparing capital projects is called
profitability index
Relevant costs are
expected future costs that are important or pertinent to the decision under consideration and will be affected by the decision
Relevant costs include the
- initial investment required
- future net cash inflow or net savings in cash outflow
- disposal cost or salvage value of old equipment and the new equipment
Relevant costs do not include
sunk costs, depreciation, gain/loss on sale
Technical analysis involves
analyzing past market data of price and volume movements to attempt to determine future price movements of individual securities
Weak Form of the efficient market hypothesis suggests
that information about past prices would not be of use in predicting future performance and therefore technical analysis would not be a viable technique to use
Fundamental analysis uses
factors specific to a firm in an attempt to find undervalue securities (i.e. F/S, ratios, projected earning growth, and dividend yield)
Efficient market beliefs (3)
weak form
semi-strong form
strong form
Weak form efficient market suggests
information about past prices would not be of use in predicting future performance
