Study Unit 9

Question 1

Cost of Not taking a discount

Answer 1

(Discount % / 100%-Discount %) * (days in year / Total pmt pd- discount pd)

Question 2

Term loan vs line of credit

Answer 2

term- definite time to repay

line of credit- revolving, no time

Question 3

Effective interest rate

Answer 3

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)

Question 4

Discount loan

Answer 4

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)

Question 5

loans with compensating balance

Answer 5

reduce risk as banks require borrowers to maintain compensating balance
Total borrowing= amnt needed/(1-compensating bal %)
ER=stated rate/(1-comp bal %)

Question 6

Capital budgeting

Answer 6

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

Question 7

Capital budgeting applications include

Answer 7

buying eqt
building facilities
acq a business
developing a product or product line
expansion into new mkts
replacing of eqt

Question 8

Relevant cash flows

Answer 8

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)

Question 9

Accounting RoR

Answer 9

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

Question 10

Affects Accounting RoR

Answer 10

choosing the expenditures to capitalize vs expense

Question 11

NPV

Answer 11

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

Question 12

Adjust for inflation

Answer 12

compensate for loss of purchasing power, hurdle rates adjust upward

Question 13

Adjust for risk

Answer 13

risky project assigned higher hurdle rates to ensure those whose potential returns are commensurate w/ risk are acceptable

Question 14

Single company wide hurdle isn’t good when

Answer 14

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

Question 15

IRR

Answer 15

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

Question 16

Cash flow patterns

Answer 16

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

Question 17

NPV vs IRR

Answer 17

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

Question 18

Payback pd

Answer 18

# 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

Question 19

Weakness of payback pd

Answer 19

disregards time value of $
(weighing all cash inflows equally ignores that funds have a time cost)
disregards cash inflows after payback cutoff date

Question 20

Discounted payback

Answer 20

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