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QB Flashcards

1
Q

IRR definition and decision rule

A

Cost of capital at which NPV = 0

Accept if IRR % > cost of capital (usually)

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2
Q

IRR formula

A

a + (NPVa ÷ (NPVa - NPVb)) × (b - a)

a = lower discount rate
b = higher discount rate
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3
Q

1 advantage and 2 disadvantages of IRR

A

Advantage:
- % return easy to understand

Disadvantages:

  • Doesn’t calculate absolute change in wealth so may be wrong when ranking projects
  • Non-conventional cash flows can create more than one IRR
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4
Q

NPV discount formula

A

(1 + r) ^-n

r = cost of capital
n = years
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5
Q

Dividend discussion

A
  • Prefer divs now rather than CG later (certainty)
  • MM:
    > Share value future earnings/level of risk
    > Divs paid don’t affect wealth if reinvested
    > Create home-made divs
    > Taxes/transaction costs/issues costs have effect
  • Signalling
  • Clientele effect (habitat)
  • Agency (sub-optimal decision)
  • Agency costs
  • Tax (IT vs CGT)
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6
Q

Cost of material - not in stock so have to buy

A

Purchase cost

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7
Q

Cost of material - in stock, in regular use

A

Current replacement cost

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8
Q

Cost of material - in stock, no other use

A

Current resale value

Scrap value lost

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9
Q

Cost of material - in stock, scarce, if used cannot replace

A

Opportunity cost

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10
Q

Cost of labour and variable overheads - spare capacity

A

Nil labour cost plus variable overhead only

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11
Q

Cost of labour and variable overheads - full capacity, workforce available for hire

A

Current rate of pay plus extra variable overhead incurred

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12
Q

Cost of labour and variable overheads - full capacity, no workforce available

A

Opportunity cost

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13
Q

Projects when no capital rationing

A

All with a positive NPV

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14
Q

Projects when limited in first year and independent + divisible

A

Rank by NPV ÷ investment

Can do a portion of a project

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15
Q

Projects when limited in second year and independent + divisible

A 
Never = -ve NPV / consumes funds in rationing year
Always = +ve NPV / generates funds in rationing year

Rank projects by NPV ÷ investment in rationing year
Check whether -ve NPV outweighed by capital released

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16
Q

Projects when limited in first year and independent + INdivisible

A

Figure out combination options

Choose combination with highest NPV

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17
Q

7 finance lease characteristics

A
  • Transfers substantially all the risks/rewards of ownership to lessee
  • 1 lease for whole/major part of useful life
  • Ownership may pass at the end of the lease
  • May be bargain price in secondary lease period
  • Lessor does not usually deal directly in type of asset
  • Cannot be cancelled without penalty (rest of cost)
  • Substance is purchase of asset by lessee finance by loan from lessor
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18
Q

6 operating lease characteristics

A
  • Lease period less than useful life
  • Lessor depends on subsequent leasing to generate profit
  • Lessor carries on trade in type of asset
  • Lessor responsible for repairs and maintenance
  • Can sometimes be cancelled at short notice
  • Substance is short-term rental of asset by lessee
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19
Q

5 attractions of lease over purchase (CC FTC)

A
  • Cash flow predictable/spread
  • Cost of capital lower
  • Flexibility
  • Tax
  • Capital rationing
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20
Q

4 drawbacks replacement analysis

A
  • Ignores price changes
  • Assumes replacement is identical
  • Beneficial timing of cash flows not considered
  • Effects of taxation ignored
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21
Q

Risk and uncertainty definition

A

Risk = possible outcomes and probabilities known

Uncertainty = possible outcomes known but probabilities unknown

22
Q

Real options definition

A

Strategic implications attaching to undertaking a project

Not normally included in the traditional NPV calculation

23
Q

5 types of real option (FAT GF)

A
  • Follow-on (R+D)
  • Abandonment (alternative uses)
  • Timing (wait and see)
  • Growth (delay/complete only part of a project)
  • Flexibility (future proofing)
24
Q

CAPM cost of equity formula (given in exam)

A

ke = rf + βj (rm - rf)

ke = cost of equity
rf = risk-free rate
βj = beta of security j
rm = expected return on the market portfolio
25
Q

WACC formula

A

(MVe × ke) + (MVd × kd)
__________________
MVe + MVd

MVe = MV of issued shares
MVd = MV of debt
26
Q

Net of tax cost of debt formula

A

Pre-tax cost of debt × (1 - 0.17)

27
Q

MVe formula

A

Share capital ÷ share value × ex-div MV

28
Q

MVd formula (debentures)

A

Balance sheet × ex-interest ÷ nominal value

29
Q

MVd formula (bank loan)

A

Balance sheet figure

30
Q

Gordon growth (dividend valuation) model formula (given in exam)

A

Ke = D0*(1 + g)
_______ + g
P0

Ke = cost of equity
D0 = current dividend per ordinary shares
g = annual dividend growth rate
P0 - current ex-dividend price per ordinary share

31
Q

Growth earnings retention model formula

A

g = r × b

g = growth in future dividends
r = return on equity
b = proportion of profits retained
32
Q

Dividend formula

A

Share price × dividend yield

33
Q

Retentions rate formula

Proportion of profits retained (r)

A

1 - ((Dividend ÷ EPS) × 100) × 100

34
Q

Shareholder return formula

Return on equity (b)

A 
PAT = EPS ÷ number of shares in issue
Return = PAT ÷ (total equity - (number of shares in issue × (EPS - dividend)) * 100
35
Q

Gearing formula (given in exam)

A

βe = βa (1 + (D(1-T)÷E))

βe = beta of equity in geared firm
βa = ungeared (asset) beta
D = MV of debt
E = MV of equity
T = corporation tax rate

For degearing find βa

36
Q

APV cost of equity/beta

A

Ungeared

37
Q

2 consequences of higher WACC

A
  • Lower NPV

- Lower value of company

38
Q

Opening shareholder funds formula

A

End of year balance - retained profits

39
Q

If first NPV for IRR is negative

A

Use lower discount %

40
Q

Earnings formula

A

EPS × number of shares

41
Q

Cum div formula

A

Ex-div + dividend

42
Q

Preference shares cost of debt

A

(% ÷ nominal value) ÷ ex-div value

43
Q

MVd formula (pref shares)

A

Balance sheet ÷ share value × ex-div MV

44
Q

4 WACC underlying assumptions

A
  • Historical proportions of debt and equity will remain unchanged
  • Business risk remains unchanged
  • Finance raised is not project specific
  • Project is small in size relative to size of company
45
Q

Preference shares equity or debt

A

Debt

46
Q

3 key assumptions when using cost of equity in CAPM

A
  • Objective is to maximise wealth of shareholders
  • All shareholders hold market portfolio (fully diversified)
  • Shareholders are only participants in firm
47
Q

Advantages futures contracts as opposed to forward contracts when hedging foreign currency exposure

A
  • Transaction costs of future should be lower and they can be traded
  • Exact date of receipt or payment of foreign currency does not need to be known because futures contract does not have to be closed out until underlying transaction takes place
48
Q

Disadvantages futures contracts as opposed to forward contracts when hedging foreign currency exposure

A
  • Contracts cannot be tailored to exact requirements
  • Hedge inefficiencies cause by standard contract sizes and basis
  • Only a limited number of currencies are available with futures contracts
  • Procedure for converting between 2 currencies neither of which is $ is more complex with futures compared to forward contract
49
Q

Interest - forward rate agreement (borrower)

A

As a borrower ___ should buy a ___ and can thereby fix a borrowing rate of __

Interest rates have risen:

(1) Bank will pay = loan × (spot rate - FRA borrowing rate)% × x÷12months
(2) Loan payment = spot rate × loan × x÷12months
(3) Net payment = (2) - (1)
(4) Effective interest rate = FRA borrowing rate

50
Q

Interest - futures contract (borrower)

A

___ will need to sell ___ interest rate futures contracts

Interest rate risen:

(1) No. contracts = loan / standard contract size × x÷xmonths
(2) Sell at todays trading price
(3) Buy at future trading price
(4) Gain = (2) - (3)
(5) Futures outcome = (4) × standard contract size × x÷12months × (1)
(6) Loan payment = loan × spot rate × x÷12months
(7) Net payment = (6) - (5)
(8) Effective rate = spot rate - (4)

51
Q

7 risks of trading abroad

A
  • Government stability
  • Political and business ethics
  • Economic stability
  • Import restrictions
  • Remittance restrictions
  • Special taxes, regulations for foreign companies
  • Trading risk - physical, credit , liquidity

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