Study Unit 9 Flashcards
Cost of Not taking a discount
(Discount % / 100%-Discount %) * (days in year / Total pmt pd- discount pd)
Term loan vs line of credit
term- definite time to repay
line of credit- revolving, no time
Effective interest rate
ratio of amnt company must pay to amnt company can use
Effective interest rate = Interest expense/usable funds
usable funds are the net proceeds (i.e. principle-charges)
Discount loan
interest and finance charges are paid at the beginning of loan term
Total borrowings= amnt needed/ (1.0-stated rate)
effective rate rate is higher than nominal rate
ER=net interest expense (annualized) / usable funds
net interest expense = total borrowings
ER=stated rate/ (1-stated rate)
loans with compensating balance
reduce risk as banks require borrowers to maintain compensating balance
Total borrowing= amnt needed/(1-compensating bal %)
ER=stated rate/(1-comp bal %)
Capital budgeting
planning and controlling investments for LT projects
LT aspect causes most challenges for accountants
affect multiple accounting pds and constrain org’s financial planning for LT; decisions tend to be relatively inflexible
Capital budgeting applications include
buying eqt building facilities acq a business developing a product or product line expansion into new mkts replacing of eqt
Relevant cash flows
cost of new eqt
annual after tax cash savings or inflows
proceeds from eqt disposal (salvage value)
depreciation tax shield (reduces TI and outflow for tax expense)
Accounting RoR
assessing potential capital projects, ignores time value of $
RoR= Annual increase in GAAP NI/Req investment
= (Annual cash inflow-depreciation)/initial investment
s/h and analyst like Ror b/c Gaap #s available
Affects Accounting RoR
choosing the expenditures to capitalize vs expense
NPV
diff bet the PV of the net cash savings/inflows expected over the life of project and required dollar investment
- diff > 0; do the project
- diff
Adjust for inflation
compensate for loss of purchasing power, hurdle rates adjust upward
Adjust for risk
risky project assigned higher hurdle rates to ensure those whose potential returns are commensurate w/ risk are acceptable
Single company wide hurdle isn’t good when
large, complex firms have risk wrt capital costs,
-mgrs of high risk division to over invest in new projects and those of low risk divisions will be underinvested
IRR
d/c rate when investment’s NPV = 0
rate = PV of expected cash inflows w/ PV of expected cash outflows
IRR>Hurdle rate: accept project = positive NPV
IRR
Cash flow patterns
DM choose bet higher inflows in early years that fall off and one w/steady throughout life
higher hurdle rate, more quickly project must pay off
low hurdle rate prefer slow and steady paychec
NPV vs IRR
reinvestment rate is critical
NPV assumes CF from investment can be reinvest @ desired RoR
both give info on whether to undertake or not when projects are independent
IRR assumes CF reinvested @ IRR
-NPV gives better grasp of problem in decision b/c reinvestment assumed to be in the desired RoR
Payback pd
# of years req for net cash savings or inflow to equal the orig investment (time necessary to pay for itself) -co's set max length of time w/in which project must pay to be considered acceptable
PP=initial investment/ (annual after tax cash savings/inflows)
if CF not constant, must do cumulative calculation
Weakness of payback pd
disregards time value of $
(weighing all cash inflows equally ignores that funds have a time cost)
disregards cash inflows after payback cutoff date
Discounted payback
overcomes drawbacks of basic payback mthd
D/c using pv factor to find D/c cash savings; subtract DCS from initial investment; the final # for Remaining investment is divided by the last DCS for the final pd
that number should be added to the last pd (yr) with the remaining initial investment
