SP2 Flashcards
What is WACC?
This formula helps in determining the average rate of return that a company is expected to pay on its securities to its shareholders and debt holders. It is a critical indicator to evaluate investment opportunities and the financial viability of projects by accounting for the cost of financing.
What is the formula for calculating the Weighted Average Cost of Capital (WACC)?
WACC=(EV×Re)+( DV×Rd×(1−Tc))
Where:
E is the market value of the equity.
D is the market value of the debt.
V is the total value of capital (equity + debt).
Re is the cost of equity.
Rd is the cost of debt.
Tc is the corporate tax rate.
What are three non-financial factors to consider when deciding whether to expand production capacity or outsource production?
Control Over Production Quality: Outsourcing production transfers control to a third party, which can pose risks to maintaining product quality standards. If the contract manufacturer cannot meet the required quality levels or faces operational issues, the company’s reputation for quality may be compromised.
Scalability: Outsourcing can offer flexibility and scalability without significant initial investment. Contract manufacturers might provide the ability to increase production more readily in response to market demand compared to expanding existing facilities, which might require additional capital outlays.
Supply Chain and Political Risks: Relying on an international supply chain introduces risks such as political instability, tariffs, or trade barriers that can affect delivery timelines and costs. These factors can lead to delays and increased operational complexity.
What are three possible issues to consider before deciding to adopt a more technological approach to production?
Impact on Product Quality and Reputation: Shifting from handcrafted to automated production could risk a decline in product quality, which may negatively affect the company’s reputation for excellence. This potential change in quality could lead to decreased customer satisfaction, fewer sales, and reduced profitability.
Workforce Implications: Automating production processes might reduce the need for labor, potentially leading to layoffs or redundancies. Such changes can affect employee morale and may lead to industrial action, especially if changes are not managed sensitively and in consultation with affected employees and their representatives.
Training and Transition Costs: Transitioning to automated systems requires significant investment not only in the technology itself but also in training employees to operate new machinery effectively. This transition involves costs and time, and the effectiveness of the training will directly impact the success of the technological adoption.
What are two potential disadvantages of reordering small quantities of parts frequently in a manufacturing process?
Inability to Meet Large Orders Promptly: Frequently reordering small quantities of parts may prevent a company from fulfilling large customer orders quickly, especially if lead times for parts are long. This could result in customers turning to competitors who can meet their demands more promptly, potentially leading to lost sales, profits, and decreased market share.
Missed Bulk Discount Opportunities and Increased Operational Costs: Ordering small quantities regularly may cause a company to miss out on bulk purchase discounts available for larger orders. Additionally, the administrative costs and time associated with frequent reordering can accumulate, reducing overall operational efficiency. These factors combined can negatively impact the company’s financial position and divert resources from other potentially beneficial uses within the business.
What are four examples of ordering costs in inventory management?
- Costs of Preparing and Issuing a Purchase Order: These are administrative costs related to the creation and processing of purchase orders to suppliers.
- Costs of Receiving Goods: Expenses associated with handling and checking goods as they arrive, ensuring they meet the order specifications.
- Costs of Quality Control on Inspection: Costs involved in inspecting and ensuring the received goods meet the required quality standards.
- Costs of Chasing Overdue Orders and Payment of Invoices: Administrative costs related to following up on delayed orders and processing payments for completed orders.
What are three examples of holding costs in inventory management?
- Costs of Storage: This includes expenses such as rent for the storage facility, insurance to protect the inventory, and security measures to safeguard the goods.
- Costs of Obsolescence: Costs arising from inventory losing value over time due to becoming outdated (obsolescence), needing rework, or being subject to spoilage, especially relevant in industries with rapid technological changes or perishable items.
- Opportunity Costs of Capital: Represents the potential earnings that are foregone from investing the capital tied up in inventory elsewhere. This includes the cost of the capital used to purchase inventory that could have been used for other potentially profitable investments.
What is Economic Order Quantity (EOQ)?
Economic Order Quantity (EOQ) is a formula used in inventory management to determine the optimal order size that minimizes the total cost of inventory. This includes ordering costs (costs associated with placing and receiving orders) and holding costs (costs related to storing unsold goods). The EOQ aims to find the most cost-effective quantity to order, balancing these costs to reduce the total inventory cost.
EOQ helps businesses reduce the costs associated with overstocking and understocking by identifying the most economical quantity to order at one time, enhancing inventory turnover efficiency.
What is the formula for EOQ?
EOQ = sqrt(2DS/H)
D is the annual demand for the product.
S is the ordering cost per order.
H is the holding cost per unit, per year.
What are (6) key features of a Just-In-Time (JIT) production system?
Production Cells: JIT systems often utilize production cells where equipment is organized to facilitate efficient manufacturing, minimizing movement and handling.
Reduction in Setup Times: JIT emphasizes reducing setup times to increase production efficiency and minimize downtime between production runs.
Emphasis on Total Quality Management (TQM): TQM is critical in JIT to reduce defects and ensure that every part of the production process contributes to overall quality, minimizing waste and rework.
Flexible Workforce: Workers in JIT systems are trained to perform multiple tasks, allowing for greater flexibility and efficiency in responding to production demands.
JIT Purchasing: This involves timing the purchase of materials so that they arrive just as they are needed, reducing inventory costs.
Modified Performance Measures and Costing Systems: JIT often requires changes to performance metrics and costing methodologies to support and reflect the efficiencies of JIT operations.
What are two benefits that a company might experience by implementing a Just-In-Time (JIT) production system?
Improved Working Capital and Space Utilization: Implementing JIT can significantly reduce the amount of capital tied up in inventory, as materials are purchased and received only as needed. This frees up financial resources for other business development activities. Additionally, space previously used for storing inventory can be repurposed for more productive uses, such as expanding production areas or renting out space for additional income.
Enhanced Operational Efficiency and Customer Satisfaction: JIT systems can lead to shorter production cycles and faster response times to market demands, resulting in quicker delivery to customers. This can enhance customer satisfaction by providing products when they are needed, potentially increasing repeat business and improving overall profitability. Moreover, integrating Total Quality Management (TQM) with JIT helps reduce defects and improve product quality, further enhancing customer satisfaction and reducing returns.
What are external failure costs in the context of cost-of-quality reporting?
External failure costs occur when a product fails to meet quality standards after it has been delivered to the customer.
These costs arise from the need to address defects discovered by customers, which may include repairs, replacements, handling complaints, and any legal actions taken by the customer as a result of the defective product.
These costs not only involve direct financial outlays to rectify the issue but can also impact the company’s reputation and customer satisfaction negatively.
What are two examples of external failure costs that any company might incur?
Cost of Customer Complaints: Managing customer complaints involves significant company resources. This process includes documenting the complaint, addressing the issue, fixing the product, and ensuring it is returned to the customer. The administrative and operational tasks associated with these processes consume both time and money.
Cost of Extended Warranties: Providing extended warranties as a customer goodwill gesture can lead to additional costs. Companies might face repeated product returns under these warranties, requiring further repairs or replacements and ongoing customer service, increasing the financial burden.
What factors should be considered when setting a dividend policy for a company in its first year as a public company and designing its ongoing payout policy?
Cash Flow vs. Investment Needs: Use a residual model to balance net profit against investment requirements and target leverage ratios. This helps set dividends that minimize the need for external equity financing, which is often costly.
Financing Structure: Evaluate the balance between debt and equity financing. As dividends decrease retained earnings, ensure there’s enough retained profit to fund necessary investments without excessive borrowing.
Shareholder Expectations: Recognize that shareholders generally prefer stable dividends and view cuts negatively. Setting a conservative initial dividend can avoid future reductions, thereby preserving shareholder confidence.
Dividend Signaling: Consider the implications of dividend announcements on market perceptions. Paying dividends may signal to the market that fewer profitable investments are available, which could impact growth perceptions.
Profit Stability and Growth Prospects: Plan dividends in line with expected future profit stability. As profits stabilize and the company moves past initial heavy investments, dividends can be adjusted upward to reflect stronger, more stable cash flows.
What are the key considerations for assessing corporate governance in the context of a company transitioning from private to public status?
Division of Roles: Ensure a clear division of responsibilities between the leadership of the board and executive management to avoid conflicts of interest. This includes appointing an independent, non-executive chairperson, distinct from the CEO.
Board Composition: Transition to a board structure with a balance between executive and non-executive directors, where at least half are independent to enhance unbiased decision-making and oversight.
Establishment of Committees: Form mandatory committees such as Audit, Remuneration, and Nomination committees to handle specific governance aspects efficiently and transparently.
Shareholder Relations: Improve communication strategies with shareholders to ensure a mutual understanding of the company’s objectives, adhering to public company standards for transparency and engagement.
Executive Remuneration: Implement formal processes for setting executive pay, typically overseen by a Remuneration Committee, to prevent self-serving practices and align executive compensation with shareholder interests and company performance.
