SU5: Working Capital

Question 1

Net Working Capital

Answer 1

Current Assets - Current Liabilities

Question 2

Permanent Working Capital

Answer 2

Minimum level of current assets maintained by the firm, usually financed with long term debt.

Question 3

Current Ratio

Answer 3

Current Assets / Current Liabilities

Question 4

Quick Ratio or Acid Test Ratio

Answer 4

Quick Assets / Current Liabilities

Question 5

Economic Order Quantity

Answer 5

sq root of (2bT/i)
b = fixed cost per transaction
T = total demand for cash
i=intrest rate on marketable securities

Question 6

Annual Benefit of receiving cash earlier

Answer 6

Daily Cash Receipts x Days of Reduced Float x Opportunity Cost of Funds

Question 7

The three motives for holding cash are

Answer 7

Transactional Motive, precautionary motive and the speculative motive

Question 8

T-Bills

Answer 8

1 year or less, no coupon rate, sold at a discount

Question 9

T-Notes

Answer 9

Maturities of 1-10 years, interest paid every 6 months

Question 10

T-Bonds

Answer 10

Maturities of 10 years or longer. Interest payment every 6 months.

Question 11

Repos

Answer 11

Repurchase agreement - a means for dealers in government securities to finance their portfolios.

Question 12

Commercial Paper

Answer 12

Unsecured, short-term ntoes issued by large companies that are very good credit risks

Question 13

CD’s

Answer 13

Certificate of Deposits - less risky than commercial paper and bankers acceptances

Question 14

Eurodollars

Answer 14

time deposits of US dollars in banks located abroad

Question 15

Bankers Acceptance

Answer 15

less risky than commercial paper

Question 16

CAPM Model

Answer 16

ROR = Rf + B*(Rm-Rf)

Question 17

Long hedges are purchased to protect against price <> and short hedges are sold to protect against price <>

Answer 17

Long hedges are purchased to protect against price increases, and short hedges are sold to protect against price declines

Question 18

Economic Order Quantity

Answer 18

= square root of ( 2ad/k)
a= fixed cost per PO (ordering costs)
D=periodic demand in units
k=carrying cost per unit

Question 19

List the assumptions of the EOQ model

Answer 19

Demand is uniform.
Carrying costs are constant.
The same quantity is ordered at each reorder point.
Purchasing costs are unaffected by the quantity ordered.
Sales are perfectly predictable.
Lead time is known with certainty.
Deliveries are consistent.
Adequate inventory is maintained to avoid stockouts.

Question 20

Cost of carrying safety stock

Answer 20

=expected stockout cost + carrying cost

Question 21

Reorder formula

Answer 21

average daily demand x lead time in days + safety stock

Question 22

List the four types of inventory costs

Answer 22

Purchase Costs, order or setup costs, carrying costs and stockout costs

Question 23

Equation for effective interest rate on loan with compensating balance

Answer 23

Stated rate divided by (1-stated rate-compensating balance %)

Question 24

Current Market Value Eq

Answer 24

Next divident divided by (Required Rate of Return - Dividend Growth Rate)

Question 25

In the context of the capital asset pricing model (CAPM), the beta coefficient of a stock that has the same systematic risk as the market as a whole is equal to

Answer 25

1

Question 26

List the three main items that contribute to a firms beta value

Answer 26

Debt to equity ratio, Industry characteristics and operating leverage

Question 27

List the three major motives for holding cash according to Keynes.

Answer 27

i) the transactions-motive, i.e. the need of cash for the current transaction of personal and business exchanges; (ii) the precautionary-motive, i.e. the desire for security as to the future cash equivalent of a certain proportion of total resources; and (iii) the speculative-motive, i.e. the object of securing profit from knowing better than the market what the future will bring forth

Question 28

Covariance of two stock portfolio eq

Answer 28

correlation coefficient x standard dev of stock A x standard dev of stock B

Question 29

Risk premium

Answer 29

the risk premium is the difference between the return on market portfolio and the risk free return

Question 30

An optimal portfolio of investments is

Answer 30

Tangential to the investors highest indifference curve

Question 31

Describe capital rationing

Answer 31

Capital rationing exists when a firm sets a limit on the amount of funds to be invested during a given period. In such situations, a firm cannot afford to undertake all profitable projects. Another way of stating this is that the firm cannot invest the entire amount needed to fund the theoretically optimal capital budget, so only those projects that will return the greatest net present value for the limited capital available in the internal capital market can be undertaken.

Question 32

Method for calculating Beta

Answer 32

divide the covariance of the return on the market and the return on the security by the variance of the return on the market

Question 33

Describe factors that would impact the beta value that is chosen for use in evaluating a project

Answer 33

the inudustry and it’s risk characteristics
experience the division has with similar projects
ability of the division to realize estimated returns on projects in the past
strength of the management team in the division
level of competition expected
geographical location of the project
the degree to which the project involves new technology

Question 34

Coefficient of variation (as related to returns on a project)

Answer 34

= the standard deviation of a project divided by the expected return

Question 35

The returns on two stocks can be correlated in values except those that are

Answer 35

Skewed.

The correlation voefficient measures the degree to which to variables are rleated. This can be positive, negative or 0.

Question 36

The returns on two stocks can be correlated in values except those that are

Answer 36

Beta Coefficient

Question 37

For a firm engaged in risk management, value-at-risk is defined as the

Answer 37

Maximum loss within a certain time period at a given level of confidence

Question 38

Things to consider when looking at lease vs buy

Answer 38

Bank covenants, expected rate of obselescence (cancellation clause)
Potential use of asset after useful life

Question 39

What rate to use in lease vs buy?

Answer 39

Risk free rate.

Question 40

List the three motives to hold cash

Answer 40

Medium of exchange (transactions), provide a reserve for contingencies (precautionary) and to take advantage of unexpected opportunity (speculative)