BEC 2
Common stock dividend payout ratio
% = dividends paid/net income available to common shareholders = dividend per share/EPS
Total return to shareholders
(Change in price + Dividend1)/Original price
Methods to speed up collections
- Credit policy (screen customers and cash discount offered) - EFT - Lockbox system - Concentration banking - Factoring - Collection agencies, who chase down broke asses who won't pay us back
1 basis point is equal to
0.01%
Why is Equity more expensive than Debt?
1) Dividend payments are not tax deductible 2) Preferred shareholders' claim to assets is after creditors, which increases their risk and demanded rate of return
Certain financial statement items that are valued using accounting estimates
1. A/R --> AfDA 2. Inventory --> Market or NRV 3. Fixed assets --> Depreciation 4. Contingent liabilities --> Estimated amount of probable future loss
Two types of current assets
1. Permanent 2. Temporary (fluctuating)
Order of claims to assets in the event of bankruptcy
1. Secured creditors 2. Unsecured senior creditors 3. Unsecured general creditors and debentures 4. Subordinated debentures 5. Preferred stock 6. Common stock
Factors influencing the level of cash to hold
1. Volume and timing of collection 2. Volume and timing of disbursements 3. Degree to which idle cash is invested in marketable securities
Materials requirement planning (MRP)
A computer-based operations management system that uses sales forecasts to make sure that needed parts and materials are available at the right time and place. It is a system for calculating the materials and components needed to manufacture a product. It consists of three primary steps: taking inventory of the materials and components on hand, identifying which additional ones are needed and then scheduling their production or purchase.
Economic order quantity (EOQ) inventory model
A model that determine the optimal amount of inventory to order to minimize total inventory costs by equating ordering costs to carrying costs
Internal rate of return (IRR) Definition
A project's rate of return; rate of return that makes NPV equal ZERO (Initial investment = PV of after-tax inflows)
Which one of the following provides a spontaneous source of financing for a firm? A. Accounts payable. B. Preferred stock. C. Accounts receivable. D. Debentures.
A. Accounts payable. Called spontaneous because it originates automatically from purchasing transactions.
Considering the SCOR Model of supply chain operations, which of the following key management processes does implementing changes in engineering fall into? A. Make. B. Plan C. Deliver. D. Source
A. Make.
What does an Investment Decision tell us and what interest rate do we use?
After-tax cash operating inflows from the asset, discounted using WACC.
Cash flows from operation of the asset
Annual cash inflows/savings, net of tax Depreciation tax shield (Depreciation x T)
Should CyberAge use trade credit and continue paying at the end of the credit period, rather than pay within the discount period? A. No, if the cost of alternative short-term financing is more. B. Yes, if the cost of alternative short-term financing is more C. Yes, if the firm's weighted average cost of capital is equal to its weighted average trade credit. D. No, if the cost of alternative long-term financing is more.
B. Yes, if the cost of alternative short-term financing is more It is very expensive for a company to miss out on a quick discount. They incur a cost by not taking the discount, which means they pay a high APR to borrow money for a short period of time. However, if they need cash for other uses and need a source of short-term financing, and other sources are more expensive, it is okay to miss out on the discount and pay on the last day of the pay period.
Income bonds
Bonds that only pay interest payments when there is earnings8. Mortga
Zero coupon bonds
Bonds that pay no annual interest but are sold at a deep discount
American-style options
Can be exercised anytime after they are purchased up to their expiration
European-style options
Can only be exercised only at the expiration date
What is a risk inherent in capital budgeting?
Capital budgeting is based on predictions of an uncertain future
The main reason a firm would strive to reduce the number of days sales in receivables is to increase
Cash
Options
Contracts that entitle the owner (holder) to purchase (call option) or sell (put option) a stock or other asset at a given price within a stated period of time
Working capital
Current assets (cash and cash equivalents, accounts receivable, marketable securities, inventory)
Balsam Company's issued nonparticipating, 8%, cumulative preferred stock. Which of the following characteristics is not true of this preferred stock? A Dividend payments are not tax deductible by Balsam B Fixed dividend amount C Higher claim than common stock in the event of liquidation D Voting rights
D Voting rights Preferred stockholders typically don't have voting right
Reasons for issuing convertible bonds include A. Convertible bonds have lower interest rates than bonds that are not convertible. B. Less EPS dilution and control taken away C. Enticing investors by giving them the best of both worlds (bonds + stock) D. All of the above
D. All of the above
What are P/S debt-like and equity-like features?
Debt: Fixed dividend payments are offered or required, similar to coupons Equity: 1) Timing of dividend payments is at the discretion of the board and 2) dividend payments are not tax-deductible
Materials Requirement Planning (MRP)
Determining inventory requirements for demand-dependent inventory types such as work-in-process and raw materials when a given number of finished goods units is demanded
Does debt or equity have higher issuance costs?
Equity does.
Safety stock (cushion)
Extra inventory (cushion) that a company holds to protect itself against uncertainties in either demand or replenishment time and to ensure manufacturer/customer demands are met.
Negative arbitrage
For companies that issue bonds, when the cost of interest payment to bondholders exceeds the interest income earned from investing/holding bond proceeds
How are depreciation and interest expense handled in the NPV method?
Ignore depreciation expense, but consider depreciation tax shield. Ignore interest expense.
What costs are used to determine the value of intangibles under the cost method.
Include: DM, DL, MO, production costs, development costs, legal fees, opportunity costs Do not include: Administrative costs, sunk costs
Effect of using accelerated depreciation method when determining depreciation tax shield
Increases the present value of the depreciation tax shield
The goal is achieve the (lowest/highest) WACC.
LOWEST. Optimal capital structure minimizes the cost of all capital and thus maximizes entity's total value. The entity's value is presumed to be all future cash flows, discounted by the cost of capital used to finance it.
Methods to value intangible assets
MIC 1. market 2. Income approach 3. Cost approach
Discounted payback period is often (more/less) than the undiscounted payback period.
MORE. Because the after-tax cash flows are discounted, they are worth less in present value, which means it'll take longer to recover the investment.
Is the historical cost and net book value of the old asset considered?
No, it is a sunk cost and is irrelevant.
Is depreciation considered for payback method?
Only to the extent of depreciation tax shield as part of annual cash inflows
Ordering costs are driven by
Order frequency, not quantity per order. The costs remain fixed no matter how many units are in each order/production run.
Profitability index
PV of future cash inflows/Initial net investment Measures PV of $ of inflows per $ invested
Cash flows associated with leasing the asset with operating lease
PV of lease payments, after tax, discounted at after-tax cost of debt
Average inventory equals
Q/2 + Safety stock Where Q is the lot size/# of units in every order
How vendors vs customers should react to quick payment discounts on accounts payable?
Quick discounts are very EXPENSIVE for vendors, as it is a very expensive way to get cash faster. On the flip side, there is a very high cost associated with not taking advantage of a discount offered by a vendor, as it is an expensive way to borrow money for a short period of time.
Discounted payback period is usually used when companies that experience
Rapid technological changes that want to recoup their investment quickly
Line of credit
Revolving, short-term loan with a bank that is up a specific dollar maximum amount for a defined term and is renewable upon the maturity date. Line of credit drawn represent a loan from the bank. x
Cash equivalents
Short-term (<90 days), highly liquid investments that can be readily converted to a specific amount of cash and which are relatively insensitive to interest rate changes.
Valuation methods for Tangible assets (PPE) CALM1
Stay CALM 1. Cost (NBV) method 2. Appraisal method 3. Liquidation value 4. Market value method
European vs. American Options
The Black Scholes model is used for European options. Thus, it only considers the underlying security at one point in time. The Binomial model is used for American options, which can be exercised at any time up to the expiration date Thus, it considers the underlying security over a period of time. Because of this added flexibility of being able to exercise anytime before expiration, the valuation of options under this model is usually higher than with Black Scholes.
Income approach
The asset is valued as the present value of future cash flows over the estimated useful life of the intangible asset, discounted using discount rates reflecting the level of risk
Carrying (holding) costs include
The costs of warehousing and storing inventory. 1. Storage/warehousing costs 2. Insurance 3. Spoilage or obsolescence 4. Opportunity costs due to investment in inventory
Float
The difference between book cash and bank cash, representing the net effect of checks in the process of clearing
Temporary (fluctuating) current assets
The level of current assets resulting from seasonal fluctuations or unanticipated shocks
Cost (NBV) Method
The value of the asset is equal to the net book value, or the original cost paid to acquire the asset less depreciation to reduce the asset to reflect current utility
When would CyberAge borrow from a bank in order to take advantage of the discount period offered by a vendor?
They would do this if the cost of borrowing from the bank was LESS than the effective APR of forgoing the discount. They would save money by borrowing from bank at lower rate and paying the payable early to get the discount. This also allows them to defer payment of payables, since they did not have to use their own cash to pay the payable and can instead use this cash for something else.
Treasury bonds
United States government bond with maturity of 30 years
Debentures
Unsecured bonds backed only by the full faith and credit worthiness of the bond issuer
Appraisal method
Value of the asset is determined by a professional appraiser, assuming the company can find an appraiser with knowledge and experience working with the specific asset in question
Mortgage bonds
bonds secured with real estate as collateral
Which of the following is characteristic of primary capital markets? a. Exchanges of existing debt and equity securities b. Exchanges of future commodity contracts c. Exchanges of future commodity contracts and new issues of debt and equity securities d. New issues of debt and equity securities
d. New issues of debt and equity securities
Amalgamated Corporation is a public company that is not issuing new stock currently. Bill Charge wants to invest in Amalgamated. In which market would Bill Charge purchase Amalgamated's stock? a. Debt market b. Real estate market c. Mortgage market d. Secondary market
d. Secondary market
To maximize shareholder wealth, which of the following measures is most appropriate for management focus? a. Earnings per share b. Profits c. Stock value d. Total return per share
d. Total return per share
Banker's Acceptance
debt instrument drawn on a bank by a corporation and backed by an accepting bank 's unconditional promise to repay at maturity
NPV Rule
if the NPV is present value of all the cash inflows is greater than the present value of all the cash outflows, the project should be accepted
NPV is considered superior to IRR because
it is flexible enough to handle inconsistent rates of return for each year of the project.
Distinguishing feature of mortgage bonds
neutral third-party trustee acts on behalf of the bondholders to foreclose on mortgaged assets in the event of default
Subordinated debentures
Unsecured bonds having a claim on assets only after the senior debt has been paid in full in the event of liquidation
Value of call option formula
Value of call option = Price of underlying stock - PV of exercise price Since we only exercise options if market price of the stock exceeds the exercise price, - The higher the exercise price - The lower the PV of the options price The more likely we are to exercise it and thus, it has more value to us.
Market approach 1. Why does this method present challenges? 2. What if there is a range of values given?
Value of intangible is based on an actual arms length transaction in similar markets. *This is a preferred method of valuation. However, the unique nature of individual intangible assets and relative trading infrequency present challenges. 2. If there is a range of values, use the MEDIAN value.
Binomial (Cox-Ross-Rubinstein) Model
Variation of Black-Scholes model which allows for valuation of stock options
Effect of inputs on the value of options
WE WANT A HIGHER OPTION VALUE. An increase in almost all inputs, except for exercise price, result in an increase in options price. 1. Price of underlying stock 2. Options exercise price 3. Risk-free interest rate 4. Current time until maturity 5. Measure of risk for the underlying stock
Determining the optimal mix of current assets and current liabilities requires
Weighing the benefits of current assets and current liabilities against the risk of technical insolvency or loss of liquidity (current liabilities > current assets)
When would a call option be exercised?
When market price > strike/exercise price, since we could purchase the stock for cheaper with the option.
Over the counter market
a network of dealers who buy and sell the stocks of corporations that are not listed on a securities exchange
Short-term notes issued by Federal National Mortgage Association (Fannie Mae) are called a. Agency securities b. Bankers' acceptances c. Municipal bonds d. Repurchase agreements
a. Agency securities
Of the following, the marketable security with the least risk is a. Commercial paper of a AAA-rated company b. Common stock of an AAA-rated company c. Gold d. Stock options of a AAA-rated company
a. Commercial paper of a AAA-rated company Stock and options are more risky.
Mott Company has a $100 ten-year, 6% certificate of deposit that receives interest annually. Present and future value factors are as follows: Present value of 1 at 6% for 10 periods - 0.614 Future value of 1 at 6% for 10 periods - 1.791 PV of ord annuity of 1 at 6% for 10 periods - 7.360 FV of ord annuity of 1 @ 6% for 10 periods - 13.181 How much will Mott Co. receive in ten years? a. $61 b. $179 c. $736 d. $1,381
b. $179
Net present value, like most capital budgeting techniques, focuses on a. Cash flow B. Net income b. After-tax cash flow
b. After-tax cash flow
The economic order quantity model may be used for cash management to determine appropriate a. Ratio of current assets to current liabilities b. Mix of cash and marketable securities c. Long-term capitalization d. Credit and collection policies
b. Mix of cash and marketable securities According to the EOQ model, optimum level of cash should be determined by balancing the carrying cost of holding cash (the opportunity cost of interest foregone on marketable securities) against the fixed cost of transferring marketable securities to cash or vice-versa so as to minimize total costs.
Which of the following cash management techniques focuses on cash disbursements? a. Lockbox system b. Zero-balance account c. Preauthorized checks d. Depository transfer checks
b. Zero-balance account A. A lockbox system focuses on cash collections. C. Preauthorized checks are checks written on behalf of customers to pay an amount they owe. There is no further action by the customer. D. Depository transfer checks are made out directly by a local bank to a particular firm or person, typically used by a company to transfer funds from one of its outlying depository locations to its concentration account.
Which of the following ratios is most appropriate for evaluating the effectiveness of working capital management? a. Debt-to-equity ratio b. Return on assets c. Inventory turnover ratio d. Return on Stockholders' Equity
c. Inventory turnover ratio. This ratio is a productivity measure, which measures the efficiency and effectiveness of operations. Working capital deals with current assets, which includes inventory. Debt to equity is a debt ratio that determines level of leverage, while Return ratios measure profitability.
Each of the following is a potential problem for a company that has implemented just-in-time inventory management, except A. Low-quality inventory could cause shortages. B. Actual lead time for material orders could be longer than expected. c. Seasonal fluctuations in inventory requirements could cause inventory shortages. D. Loss of quantity discounts could be more than the cost of handling and purchasing larger lots of inventory.
c. Seasonal fluctuations in inventory requirements could cause inventory shortages. as long as the manufacturer and supplier are coordinated, which they should be, it is no issue to quickly adjust for seasonal fluctuations. A. is false because firms rely on suppliers for quality assurance and if they cannot provide high quality products quickly, JIT cannot function properly. B. is a problem. D. is designed to reduce inventory and lower carrying costs. However if the benefit of quantity discounts from buying a lot of inventory exceeds savings from carrying costs, its better to purchase big lots.
What is short selling? a. Selling securities financed by money from a loan that is still outstanding b. Selling securities based on inside information c. Selling securities that are not owned by the seller d. Speculating that securities will have a dramatic price increase c. Selling securities that are not owned by the seller
c. Selling securities that are not owned by the seller
Which of the following is the least likely reason for an entity to hold cash and marketable securities? a. Maintain sufficient cash to meet transaction requirements b. Maintain a reserve for unexpected events c. Fulfill compensating balance requirements d. Earn maximum returns on assets
d. Earn maximum returns on assets. Cash is held for transaction, speculative, and precautionary reasons, in addition to being held for compensating balances. Amounts tied up in cash are low-yielding and reduce ROA.
What could a corporation do to decrease the market value per share of common stock? a. Bond retirement as scheduled b. Treasury stock purchase c. Reverse stock split d. Stock dividend
d. Stock dividend All stock dividends do is increase the number of shares outstanding and decrease the share price. Total equity and shareholder's ownership percentage do not change.
A limitation of using the discounted payback method to evaluate a project is that it ignores which of the following? • A. A project's cost of capital. B. Duration of funds being tied up. • С. Cash flows after the payback period. • D. A project's breakeven point.
С. Cash flows after the payback period. A. Cost of capital is considered since we discount the cash flows using this rate. B. and D are exactly what we are trying to measure.
Residual theory of dividends assumptions
(1) the corporation can reinvest earnings at a higher rate of return than investors can find through another investment with comparable risk (2) investors prefer to have the corporation re-invest the earnings, rather than pay dividends (e.g., start up/tech company) (3) The rate of return that investors require is not affected by dividend policy, but rather by other forces - e.g. risk of investment, market rate, etc.
Osteen Industries has experienced a significant drop in its cash reserves. The company is attempting to secure a line of credit from its bank as a precaution. Osteen's most effective argument on its own behalf would be: • A. Deterioration in cash reserves is tied directly to slower collections of receivables; however, the current ratio is unchanged, indicating liabilities are paid as they come due. • B. Declining cash balances result from aggressive liquidation of accounts payable to capitalize on discounts, as evidenced by an increase in the current ratio. • C. Sudden deterioration in cash results from requirements to pre-pay annual insurance premiums; however, the trend will reverse over the course of the year. • D. Deterioration in cash reserves results from increased investments in inventory, which will be turned over soon.
(B. Declining cash balances result from aggressive liquidation of accounts payable to capitalize on discounts, as evidenced by an increase in the current ratio.) A good cash management technique is taking advantage of discounts. Not taking them is very expensive. Current liabilities would decrease, and current assets (cash) would decrease by less, meaning WC and CR would increase. Tying up cash in inventory and prepaid insurance will not help the cash position.
General rule for accounts payable management
- Delay cash disbursement as much as possible and pay on the last day of payment period, to take advantage of interest-free grace period - TAKE THE EARLY PAYMENT DISCOUNT IF OFFERED.
If NPV is positive, then we can infer:
- Rate of return of the project (IRR) is greater than discount rate used - PI > 1
If NPV is negative, then we can infer:
- Rate of return of the project (IRR) is less than the hurdle rate - PI < 1
Cash flows from last year of the project
1. Annual cash inflows/savings, net of tax & Depreciation tax shield (Depreciation x T) 2. Terminal year cash flows Recovery (repurchase) of working capital Sale: Proceeds from sale of asset, net fo tax, and Tax savings (expense) from loss (gain) on disposal Abandonment/Scraped with zero tax basis: Any salvage value, net of tax, Tax savings from remaining book value
Assumptions of EOQ
1. Annual demand is known and constant 2. Stockout costs and safety stock are not considered 3. The only relevant costs are carrying cost per unit and cost per order, which are known and constant
Limitations of IRR
1. Assumes cash flows are reinvested at the IRR, which is unrealistic. 2. Inflexible cash flow assumptions: Timing and/or amount of cash flows must be constant. IRR is misleading when there are several alternating periods of net cash inflows and outflows or the amounts of the cash flows differ significantly. 3. Evaluates only rates, doesn't consider the dollar amount
Characteristics of NPV method
1. Calculates dollar profitability of the project, rather than rate of return 2. Assumes cash flows are reinvested at the discount/hurdle rate used in the analysis. 3. Considered the single best technique of capital budgeting 4. Considers TVM by discounting all cash flows by a hurdle rate established by management.
Marketable securities are held for two purposes
1. Cash substitutes: If we need cash, quickly sell it to get cash 2. Temporary investment: Held during low volume periods and are sold to get cash in peak periods to finance seasonal/cyclical needs
Organization usually offer trade discounts when
1. Competition, competitors are offering similar terms 2. Cash is needed quickly
5 Inputs into Black Scholes that affect the value of options
1. Current price of underlying stock 2. Option exercise price 3. Risk-free rate 4. Current time until maturity 5. Measure of risk of the underlying stock
Limitations of Black Scholes
1. Due to the assumptions, results produced by the BSM may differ from actual prices. 2. Model tends to underestimate extreme price movements. 3. Assumes instant, cost-less transactions, which is unrealistic 4. Model is not applicable to pricing American-style options.
Strengths of payback method
1. Easy to use and understand, so it is often used in practice. 2. Emphasizes liquidity and return of the principal.
Factors to consider when preparing accounting estimates
1. Historical information 2. Market information 3. Expected usage 4. Estimates from experts
Limitations of payback method
1. Ignores time value of money 2. Ignores any cash flows after the initial investment is recovered 3. Ignores total project profitability 4. Reinvestment of cash flows is not considered.
Concepts related to the determination of optimal level of inventory
1. Inventory turnover 2. Safety stock 3. Reorder point 3. Economic order quantity (EOQ) 4. Materials requirement planning 5. Lead time 6. Costs per unit of inventory, which includes carrying costs 7. Costs of placing orders
What 2 decisions are needed in a lease vs. buy decision?
1. Investment decision 2. Financing decision
Methods to Delay Cash Disbursements
1. Line of credit/Borrowing from bank to pay off the trade accounts with borrowed funds an allowing the company a longer period to pay back that loan to the bank. 2. Drafts/checks which increase float period, rather than using EFT.
Assumptions of the model
1. Perfectly efficient stock market 2. The underlying security will mode up ro down at certain points in time, called nodes, during the life of the option.
For accounting estimates, management should
1. Regularly review support for material accounting estimates 2. Approve each estimate when reviewed
Determination of safety stock depends on
1. Reliability/variability of sales forecast 2. Level of customer dissatisfaction resulting from back orders. 3. Stockout costs 4. Lead time 5. Seasonal demands for inventory
The discount rate used in NPV analysis can be adjusted for:
1. Risk. The higher the risk, the higher the rate should be. 2. Inflation. The higher the inflation, the higher the rate should be. By choosing a higher discount/hurdle rate, they discount FCF by more and devalue the NPV of the project. This gives it a bigger chance of yielding an NPV below zero.
Assumptions of Black-Scholes Model
1. Stock prices behave randomly. 2. The risk free rate and volatility of stock prices are constant over the options life. 3. There are no taxes or transaction costs. 4. The stock pays no dividend, but the model can be adopted to dividend-paying stock. 5. The options must be European-style, which are exercisable only at maturity.
What type of options can the Binomial model be used for?
1. Stocks that pay dividends without modifying the model like is needed with Black Scholes 2. American style options
When is the cost approach used?
1. There are no similar assets 2. There are no transactions involving similar assets 3. No reasonable estimates of future income
4 reasons for holding cash
1. Transaction demand Payments and collections in ordinary course of business 2. Speculative demand: Held to take advantage of temporary opportunities, such as a bargain purchase 3. Precautionary demand: Safety cushion to meet unexpected needs 4. Compensating balance
The Frame Supply Company has just acquired a large account and needs to increase its working capital by $100,000. The controller of the company has identified a source of funds which is given below: Pay a factor to buy the companys receivables, which average $125,000 per month and have an average collection period of 30 days. The factor will advance up to 80 percent of the face value of receivables at 10 percent and charge a fee of 2 percent on all receivables purchased. The controller estimates that the firm would save $24,000 in collection expenses over the year. Assume the fee and interest are not deductible in advance. Using a 360-day year in all of your calculations, the cost of factoring is:
16%. The amount loaned is the advance, which is 80% of the face value $125,000 = 100,000. Interest on this amount is 10% per year, which is 10,000 per year. The monthly fee is 2% of face value, which is equal to $2,500 each month or $30,000 per year. This cost is offset by the $24,000 in savings every year, leaving a new interest cost of 16,000. The average proceeds received over the year is $100,000. The APR is 16,000 net cost/100,000 average proceeds = 16%
Amicable Wireless, Inc. offers credit terms of 2/10, net 30 for its customers. Sixty percent of Amicable's customers take the 2% discount and pay on day 10. The remainder of Amicable's customers pay on day 30. How many days' sales are in Amicable's accounts receivable?
18. Because the information to use the formula is not available, the total days sales in AR is found using the weighted average of collection days. 60% take 10 days = 6 days 40% takes 30 days = 12 days Added up, this equals 18 days.
APR for Quick discount formula
360/Pay period - Discount period x Discount %/100%- Discount % This is the rate borrowers pay if they do not take the discount, and the rate vendors pay to get cash quickly is customer takes the discount.
Which of the following assumptions applies to the basic theory underlying the capital asset pricing model? A A single risk-free rate exists B The variability of returns is unrelated to stock prices C. The required return for a particular stock cannot be measured D. The total variability can be divided into three separate components.
A A single risk-free rate exists CAPM determines the cost of retained earnings/equity capital. It uses a single risk free rate and adds a risk premium to find the cost of equity. (B) is incorrect because the variability of returns/cost of capital is affected by beta. In CAPM, beta is multiplied by a market risk premium. Beta considers the volatility of an individual stock price compared to the whole market.
What of the following is the primary concern of a treasurer managing cash and short-term investments? A Liquidity B Maximizing return on working capital C Minimizing taxes D Minimizing transaction fees
A Liquidity We want to be liquid enough to meet short term obligations. However, if we are too liquid, we have too much cash tied up in current assets and could be making higher returns elsewhere. Maximizing return on working capital is a facet of working capital management, which aims to balance profitability and liquidity.
The overall cost of capital is the A Rate of return required to cover the cost of resources employed. B. Cost of the firm's equity capital at which the market value of the firm will remain unchanged. C. Maximum rate of return a company can expect to receive on a capital investment. D. Minimum rate a firm must earn on high-risk projects
A Rate of return required to cover the cost of resources employed. Overall cost of capital is the "hurdle rate," which is the minimum return a company must achieve in order to make an investment financial feasible. Like a breakeven point, where the cost of financing the resources employed equals the return generated from those resources invested. The weighted average cost of capital (WACC) can be used as a measure of the overall cost of capital, because it factors the company's proportion of its cost of debt and its cost of equity. The overall cost of capital is the rate of return a company requires in order to exceed the cost of employing that capital in the form of equity and debt.
Zero balance banking
A bunch a smaller, "child" accounts that maintain a zero balance and are accompanied by a master or parent account. When the business needs to disburse amounts, the exact amount moves from a connected "parent" account into the ZBA. If any funds are left in the account at the end of the day, they are swept back into the main account where the money can earn interest, often at a more favorable rate, rather than remaining idle.
Just in time (JIT) inventory systems
A strategy that requires suppliers to make and ship the materials that a factory or retailer needs quickly enough that the goods and materials arrive at the workstation, factory floor, or retail store just as they are required.
What is the result of applying the binomial model?
A tree diagram showing the possible values of the options at different points in time, or node.
Black-Scholes model
A widely used model for the valuation of call options.
Clauson Inc. grants credit terms of 1/15, net 30 and projects gross sales for next year of $2,000,000. The credit manager estimates that 40 percent of their customers pay on the discount date, 40 percent on the net due date, and 20 percent pay 15 days after the net due date. Assuming uniform sales and a 360-day year, what is the projected days sales in accounts receivable (rounded to the nearest whole day)? A. 27 days B. 24 days C. 30 days D. 20 days
A. 27 days 40% take 15 days = 6 days 40% take 30 days = 12 days 20% take 45 days = 9 days Total = 27 days
Which of the following is not a characteristic of materials resource planning (MRP)? A. Approaches the point where total carrying costs equate total restocking costs B. Determining inventory requirements for demand-dependent inventory types such as work-in-process and raw materials when a given number of finished goods units is demanded C. Entails creating precise schedules of which items will be needed and what times they will be needed D. Method of determining inventory requirements when a given number of units is needed, used to create schedules of what items are needed and what time they are needed E. Projects and plans inventory levels in order to control the usage of raw materials in the production process.
A. Approaches the point where total carrying costs equate total restocking costs. This describes EOQ.
An advantage of the net present value method over the internal rate of return model in discounted cash flow analysis is that the net present value method: A. Can be used when there is no constant rate of return required for each year of the project. B. Uses discounted cash flows whereas the internal rate of return model does not. C. Computes a desired rate of return for capital projects. D. Uses a discount rate that equates the discounted cash inflows with the outflows.
A. Can be used when there is no constant rate of return required for each year of the project. B. IRR uses discounted cash flows. C. and D describe IRR.
The level of safety stock in inventory management depends on all of the following, except the: A. Cost to reorder stock B. Level of customer dissatisfaction for back orders C. Level of uncertainty of the sales forecast D. Level of uncertainty in lead-time for stock shipments.
A. Cost to reorder stock
The optimal level of inventory would be affected by all of the following, except the: A. Current level of inventory. B. Cost of placing an order for merchandise. C. Lead time to receive merchandise ordered D. Cost per unit of inventory.
A. Current level of inventory.
Capital budgeting decisions include all but which of the following? A. Financing short-term working capital needs. B. Making investments that produce returns over a long period of time. C. Financing large expenditures. D. Selecting among long-term investment alternatives.
A. Financing short-term working capital needs.
Which of the following statements is true regarding the payback method? A. It does not consider the time value of money. B. It is a measure of how profitable one investment project is compared to another. C. The salvage value of old equipment is ignored in the event of equipment replacement. D. It is the time required to recover the investment and earn a profit.
A. It does not consider the time value of money. B. Payback method does not consider profitability. C. Salvage value is specifically considered as part of payback computations because it contributes to the incoming cash flow when the OLD asset is sold. Salvage value of the new asset to be received in the future is not considered. D. Payback method measures the time to breakeven and does not consider profitability.
Which of the following is a strength of the payback method? A. It is easy to understand. B. It distinguishes the sources of cash inflows. C. It considers the time value of money. D. It considers cash flows from all years of the project.
A. It is easy to understand. B. This is not true. C. Payback method doesn't consider time value of money. D. Doesn't consider cash flows from years after the initial investment is recovered.
A project's net present value, ignoring income tax considerations, is normally affected by the: A. Proceeds from the sale of the asset to be replaced. B. Amount of annual depreciation on fixed assets used directly on the project. C. Carrying amount of the asset to be replaced by the project. D. Amount of annual depreciation on the asset to be replaced.
A. Proceeds from the sale of the asset to be replaced.
In capital budgeting, which of the following items is included in the payback model calculation? A. The total amount of the initial outlay for the project. B. The present value of the estimated salvage value of the project. C. The present value of the future cash flows of the project. D. The amount of depreciation over the life of the project.
A. The total amount of the initial outlay for the project. Payback period = Initial investment/After-tax annual cash inflow B. Payback method ignores time value of money. Also, it does not consider the salvage value. C. Payback method ignores time value of money. D. Depreciation is only considered to the extent of a depreciation tax shield.
What does beta measure in the capital asset pricing model? A. The volatility of a stock relative to the market. B The volatility of a stock relative to its competitors. C. Unsystematic risk. D. The additional return required over the risk-free rate.
A. The volatility of a stock relative to the market. In CAPM, beta is multiplied by the market risk premium. Market risk premium is the additional return demanded for market/undiversifiable/systematic risk. Thus, beta adjusts systematic risk rather than unsystematic risk.
The cost of holding cash: A. is the opportunity cost of the lost investment income. B. is zero because it is the most liquid asset a firm can hold. C. decreases as cash holdings increase. D. increases as market rates decline.
A. is the opportunity cost of the lost investment income. B is false because cash earns no return and there is a cost associated with holding idle cash. This cost is the opportunity cost equal to investment income earned from investing the cash.
When the risks of the individual components of a project's cash flows are different, an acceptable procedure to evaluate these cash flows is to: A.Discount each cash flow using a discount rate that reflects the degree of risk. B.Utilize the accounting rate of return. C. Compute the net present value of each cash flow using the firm's cost of capital. D. Compare the internal rate of return from each cash flow to its risk.
A.Discount each cash flow using a discount rate that reflects the degree of risk.
Short term lease
Accounting policy election to treat lease like Lease with a term of 12 months or less that does not have a long-term purchase option; the lessee records such lease payments as expenses.
Trade credit
Accounts payable; spontaneous financing granted by sellers when they deliver goods and services to customers without requiring immediate payment
Inception of the project cash flows
Acquisition cost of the asset Decrease (increase) in working capital Sale of old asset: Proceeds from sale of asset, net fo tax, and Tax savings (expense) from loss (gain) on disposal Abandonment/Scraped with zero basis: Any salvage value, net of tax, Tax savings from remaining book value that is deductible as a loss
Cash inflows considered in the payback method
After-tax annual operational cash inflows from new project OR annual cash savings from new asset Depreciation tax shield After-tax proceeds from selling the old asset
In evaluating the cost of components of capital structure, what cash flows are used?
After-tax cash flows. This is relevant for the cost of debt because interest is tax deductible. Dividends are not tax deductible.
Overtrading is insufficient working capital to support the level of business activities. This can also be described as under-capitalisation and is characterised by a high and rising proportion of short-term finance to long-term finance. What type of working capital policy is this characteristic of?
Aggressive. Aggressive WC policies strive to keep current assets low to reduce carrying costs and increase efficiency and profitability, and finances assets with short term debt. This may result in higher profitability, but there is a risk of having too low of current assets and liquidity issues.
Discounted payback method
Also called the breakeven time method (BET), it uses the PV of after-tax cash inflows to determine when the initial investment will be recovered.
Accounting Rate of Return (ARR)
Annual net income produced by an investment/cost of that investment * Does not consider TVM * Based on GAAP income instead of cash flows
Options are classified as __________ on the holder's balance sheet
Assets
Active dividend policy
Assumes that dividends are relevant to investor decisions, hence dividends are not set mechanically
Market Value Method (RC or NRV)
Assuming that similar assets are available in the marketplace in order to find a comparable value, value of the asset can be found under two iterations: 1. Replacement cost = Cost to replace the value asset plus any costs to get it ready for use 2. NRV = Selling price - Selling expenses
Payback period formula
Assuming uniform cash flows, Years = Initial investment/After-tax annual cash inflows
Companies that use accounting estimates should expect
Auditors to closely scrutinize the assumptions and support underlying the estimates. Auditors expect accounting estimates to be reasonable and look closely at info that contradicts the assumptions made by management when preparing the estimates.
Karma Company finances each asset with financial instruments with maturities with lengths similar to an asset's life. What is this policy called? A Financial leverage B Hedging approach C Operating leverage D Return maximization
B Hedging approach Return maximization would result in using the lowest cost sources of financing, which is only short term debt.
A working capital technique, which delays the outflow of cash, is: A. A lock-box system. B. A draft. C. Compensating balances. D. Factoring.
B. A draft.
What is an internal rate of return? A. An accounting rate of return. B. A time-adjusted rate of return from an investment. C. A payback period expected from an investment. D. A net present value.
B. A time-adjusted rate of return from an investment. IRR is sometimes called the time adjusted rate of return because it utilizes present value concepts.
Net present value as used in investment decision-making is stated in terms of which of the following options? A. Net income. B. Cash flow. C. Earnings before interest and taxes. D. Earnings before interest, taxes, and depreciation.
B. Cash flow. Choice "B" is correct. Net present value, like most capital budgeting techniques, focuses on cash flow. Cash flow is a pure measure of financial performance that isolates relevant information for decision making. The amount of cash the firm takes in and pays out for an investment affects the amount of cash the firm has available for operations and other activities. Net income, EBIT, EBITDA distorts financial results useful for capital budgeting decisions with non-cash items, such as depreciation as well as with sunk costs
Which of the following events would decrease the internal rate of return of a proposed asset purchase? A. Shorten the payback period. B. Decrease tax credits on the asset. C. Decrease related working capital requirements. D. Use accelerated, instead of straight-line depreciation.
B. Decrease tax credits on the asset. IRR PVF-OA = Initial investment/After-tax annual cash inflows The higher the PVF is, the lower the rate of return. Shortening the payback period, decreasing related working capital requirements, and using accelerated depreciation would increase cash inflows, which
Which of the following characteristics is a primary benefit of a just-in-time inventory system for raw materials? A. Decreases deliveries required to maintain production. B. Eliminates non-value-added operations. C. Increases standard dlivery quantity D. Increases total number of suppliers to ensure competitive bidding
B. Eliminates non-value-added operations. A. is false, as more deliveries are necessary. C. is false as more deliveries of less items are necessary. D. JIT requires loyal and close relationship with suppliers, which means usually less suppliers.
Which of the following effects would a lockbox most likely provide for receivables management? A. Minimized disbursement float. B. Minimized collection float. C. Maximized disbursement float. D. Maximized collection float.
B. Minimized collection float.
Management at MDK Corp. is deciding whether to replace a delivery van. A new delivery van costing $40,000 can be purchased to replace the existing delivery van, which cost the company $30,000 and has accumulated depreciation of $20,000. An employee of MDK has offered $12,000 for the old delivery van. Ignoring income taxes, which of the following correctly states relevant costs when making the decision whether to replace the delivery vehicle? A. Purchase price of new van, disposal price of old van, and gain on sale of old van. B. Purchase price of new van, disposal price of old van. C. Purchase price of new van, purchase price of old van, accumulated depreciation of old van, gain on sale of old van, disposal price of old van. D. Purchase price of new van, purchase price of old van, and gain on sale of old van.
B. Purchase price of new van, disposal price of old van. If we considered taxes, then we would consider the depreciation tax shield of the new asset. We would also consider the tax effect of gain or loss on disposal of the old asset.
The internal rate of return is the: A. Required rate of return. B. Rate of interest that equates the present value of cash outflows and the present value of cash inflows. C. Risk-adjusted rate of return. D. Weighted average rate of return generated by internal funds.
B. Rate of interest that equates the present value of cash outflows and the present value of cash inflows. IRR is the rate that results in an NPV of 0. The required rate of return is what is compared to the IRR to see if we should take the project.
The net present value method of capital budgeting assumes that cash flows are reinvested at: A. The rate of return of the project. B. The discount rate used in the analysis. C. The risk-free rate. D. The cost of debt.
B. The discount rate used in the analysis.
Which of the following limitations is common to the calculations of payback period, discounted cash flow, internal rate of return, and net present value? A. They require knowledge of a company's cost of capital. B. They rely on the forecasting of future data. C. They do not consider the time value of money. D. They require multiple trial and error calculations.
B. They rely on the forecasting of future data.
The cost of having a compensating, transaction, speculative, or compensating cash balance is
Because cash earns a 0% return, there is an opportunity cost of the investment income that could be earned elsewhere (Balance x APR % of alternative investment)
Valuation of contingent liabilities
Best estimate of probable future losses
Convertible bonds
Bonds that can be converted into common stock at the bondholder's option at a specified price, usually when the stock price rises. Corporations may issue convertible bonds when the equity market is unattractive; effectively they postpone the stock issue until the stock price is high but still get immediate financing. A conversion feature typically attracts investors at a lower rate than nonconvertible bonds, but they have the added benefit of being able to convert to shares. When the stock prices rise, holders will convert their bonds and the issuer no longer has to meet regular interest payments.
Floating rate bonds
Bonds with "floating" coupons that adjust with changes in short-term interest rates to produce a constant market value for that instrument with no need for premiums or discounts. Bonds that are most likely to maintain a constant rate.
Why is long term debt more expensive than short term debt?
Borrower is presumed to be more liquid for short-term debt. A higher interest rate is charged for longer term debt because the likelihood that interest rates change increases as the term of the loan increases.
What is the par value of common stock? A The value of the stock that must be entered as equity in the issuer's financial statements B The value of the stock that must be entered as paid-in-capital in the issuer's financial statements C A shareholder's liability ceiling if the issuer goes bankrupt D Estimated market value of the stock when it was issued
C A shareholder's liability ceiling if the issuer goes bankrupt As long as the par value (e.g., $0.01) is paid to the corporation, shareholders obtain limited liability protection. Thus, the maximum they owe in the event of bankruptcy is $0.01. This is as opposed to a partnership where owners are totally liable.
Which of the following is least appropriate for use as a cash substitute? A Banker's acceptances B Commercial paper C Convertible bonds D Marketable securities
C Convertible bonds Bankers acceptances, commercial paper, and marketable securities are all highly liquid and low risk, which makes them good substitutes for cash.
In the event of a company liquidation, which of the following classes would rank the same as a general or a trade creditor? A Subordinated debenture holders B Common shareholders C Debenture holders D Preferred shareholders
C Debenture holders
A company with $4.8 million in credit sales per year plans to relax its credit standards, projecting that this will increase credit sales by $720,000. The company's average collection period for new customers is expected to 75 days; and the payment behavior of the existing customers is not expected to change. Variable costs are 80 percent of sales. The firm's opportunity cost is 20 percent before taxes. Assuming a 360-day year, what is the company's benefit (loss) on the planned change in credit terms? A. B. c. D. $28,800 $126,000 $120,000 $144,000
C. $120,000
Newman Products has received proposals from several banks to establish a lockbox system to speed up receipts. Newman receives an average of 700 checks per day averaging $1 ,800 each, and its of short-term funds is 7 percent per year. Assuming that all proposals will produce equivalent processing results and using a 360-day year, which one of the following proposals is optimal for Newman? A. A flat fee of $125,000 per year. B. A fee of $0.35 per check plus 0.01 percent of the amount C. A compensating balance of $1 , 750,000. D. A fee of 0.03 percent of the amount
C. A compensating balance of $1 , 750,000. The cost of holding a compensating balance, or any cash balance, is the opportunity cost of lost investment income. In this case, we could earn a return of 3%, or $122,500, if we invested it. Thus, the cost of this option is $122,500. Compared to the other options, this opportunity cost is the lowest.
A working capital technique that increases the payable float and, therefore, delays the outflow of cash is: A. Concentration banking B. A lock-box system. C. A draft. D. The use of a local post office box.
C. A draft. A. Concentration banking automatically channels funds into a single useable account, which makes funds available more quickly since we don't have to transfer funds between banks. B. Bank collects checks from customers into one box, which means funds are available quickly. D. A local post office gets mail faster than getting it delivered to a home address.
Which of the following statements that relate to capital budgeting is true? A. The depreciation method used for financial accounting reporting and not the depreciation method used for tax purposes should be used in capital budgeting decisions. B. The impact of taxes on capital budgeting will not make a difference in the decision to purchase new equipment. C. Accelerated methods of depreciation provide tax shields that are advantageous from a present-value point of view. D. If the depreciable life of a project is shorter than the expected useful life of the project, then the anticipated cash flows should be evaluated over the depreciable life.
C. Accelerated methods of depreciation provide tax shields that are advantageous from a present-value point of view. A) is false because you would consider TAX BASIS depreciation to determine tax shield. B) is false because taxes create an indirect effect on cash flows. D) All anticipated cash flows should be evaluated over the life of the project.
The sales manager at Ryan Company feels confident that if the credit policy at Ryan's was changed, sales would increase and, consequently, the company would utilize excess capacity. Currently, payment terms are net 30. The proposal payment terms for Proposal A and Proposal B are net 45 and net 90, respectively. The bad debt percentage is the same for both alternatives. An analysis to compare these two proposals for the change in credit policy would include all of the following factors, except the: A. Impact on the current customer base of extending terms to only certain customers. B. Bank loan covenants on days sales outstanding. C. Current bad debt experience. D. Cost of funds for Ryan.
C. Current bad debt experience, because it is the same for either option (D) Cost of funds would be considered. The two alternatives and current credit policy have different payment periods. The longer the pay period, the more time amounts are sitting in accounts receivable and increasing working capital. The cost to fund this could have been spent on other investments. Thus, the cost to fund the extra pay period is greater for Proposal B, so this is a legit concern.
Which one of the following is most relevant to a manufacturing equipment replacement decision? A. A lump-sum write-off amount from the disposal of the old equipment. B. Gain or loss on the disposal of the old equipment. C. Disposal price of the old equipment. D. Original cost of the old equipment.
C. Disposal price of the old equipment. This represents a cash inflow. A lump sum write off of the remaining tax basis if abandoned and or gain or loss on disposal is only considered for tax benefits, which is an indirect cash flow. This is relevant, but direct cash inflows are more important. The original cost of the old equipment is always irrelevant since it is a sunk cost.
A firm can best delay disbursements through the use of. A. A centralized disbursement function. B. Factoring C. Drafts. D. Trade discounts.
C. Drafts. Paying by a draft or check causes float.
The rankings of two mutually exclusive investments determined using the internal rate of return (IRR) method and the net present value (NP) method may be different in which of the following situations? A. If the required rate of return equals the IRR of each project. B. If the expected lives of the two projects are equal and the amounts of the required investments are equal. C. If the two proiects have unequal lives and the size of the investment for each project is different. D. If the required rate of return is higher than the IRR of each project.
C. If the two projects have unequal lives and the size of the investment for each project is different. A. If this were true, then the NPV would equal zero and the decision would be indifferent for both methods. B. If this were the case, both methods would provide the same conclusion. D. If ROR>IRR, then NPV would be negative, and
The controller of Theme Parks Inc. is involved with initially approving accounting estimates for critical balance sheet accounts. On a time permitted basis, the controller's group will then review a sample of accounting estimates each fiscal year for accuracy based on supporting documentation. The procedure in place for accounting estimates at the company would be best described as which of the following? A. Inadequate because the controller is only involved in the initial approval of accounting estimates. B. Adequate. C. Inadequate due to a lack of approval on estimate reviews and no regular review periods. D. Inadequate as there is no established regular review period
C. Inadequate due to a lack of approval on estimate reviews and no regular review periods. The controller only initially approves the estimates. Management should 1. Review each accounting estimate on a regular basis 2. Approve each estimate when reviewed
A valuation estimation technique that can be adapted to start up companies and other situations where earnings are very low is: A. Price Earnings (PIE) ratio. B. Constant Growth (D/(r-g)). C. Price Sales ratio. D. Price Earnings Growth (PEG) ratio.
C. Price Sales ratio.
Which one of the following statements about trade credit is correct? Trade credit is: A. A source of long-term financing to the seller. B. Usually an inexpensive source of external financing. C. Subject to risk of buyer default D. Not an important source of financing for small firms.
C. Subject to risk of buyer default A. is false as trade credit is a spontaneous, short term form of financing. B. is false because if the company fails to pay within the stipulated time, they may end up paying additional charges for late payment which will be very expensive compared to the short period they "borrowed" money for. D. is false because accounts payable is the largest source of short-term credit for small firms.
When estimating cash flow for use in capital budgeting, depreciation is: A. Utilized to estimate the salvage value of an investment. B. Excluded for all purposes in the computation. C. Utilized in determining the tax costs or benefit. D. Included as a cash or other cost.
C. Utilized in determining the tax costs or benefit. Depreciation is used in capital budgeting for determining tax costs or benefits of a decision. After-tax cash flows consider the tax impact of depreciation deductions.
Commercial paper is usually only issued by
Companies with very high credit ratings
Concentration banking
Concentration banking automatically channels funds from every source of the business into a single usable account, thus quickly identifying available funds each day, and moving them to accounts that have funding requirements that day, and investing the remainder in short-term, interest-bearing instruments until needed.
Over-capitalisation is an excessive level of working capital, leading to inefficiency. What type of working capital policy is this characteristic of?
Conservative. Conservative WC policies strive to keep high levels of working capital to reduce risk and liquidity issues, but tying up funds in working capital makes little return and is indicative of low efficiency of turning assets into cash.
The rate of return demanded by common shareholders is equal to
Cost of retained earnings. The cost of retained earnings is the cost of funds reinvested to fund operations and generate profit. A firm and therefore its shareholders should earn a return from these investments of at least the cost used to fund it. Furthermore, this return should be at least as much as shareholders could earn on alternative investments of equivalent risks.
Stockout costs
Cost of running out of inventory 1. Loss of income 2. Cost of restoring goodwill with customers 3. Cost of expedited shipping to meet demands)
Best measure of liquidity
Current ratio
A small retail business most likely would finance merchandise inventory with A A chattel mortgage B Commercial paper C Factored accounts receivable D A line of credit
D A line of credit A small business is usually restricted to owner financing, bank loans, and lines of credit. A line of credit typically is a contract for a bank to lend up to a specified amount during a specified period. Lines of credit are smaller and shorter in length than loans with specified terms.
Which of the following involves an imputed cost? A Depreciation B Interest portion of a capital lease C Interest paid on a bank loan D Interest on internally generated cash used to purchase fixed assets
D Interest on internally generated cash used to purchase fixed assets An imputed cost is not recognized by GAAP, but is estimated in order to model economic reality for decision making purposes. All cash has an opportunity cost, which is the interest income that could be earned by investing cash instead of buying a fixed asset.
As a consequence of finding a more dependable supplier, Dee Co. reduced its safety stock of raw materials by 80%. What is the effect of this safety stock reduction on Dee's economic order quantity? A 80% decrease B 64% decrease C 20% increase D No effect
D No effect EOQ does not consider safety stock. Safety stock is important determining WHEN to place order, but does not affect how much to order.
Which of the following is most often used as a cash substitute? A Bankers' acceptances B Certificates of deposit C Municipal bonds D Treasury bills
D Treasury bills. CDs and Treasury bills are cash equivalents. However treasury bills carry essentially zero default risk and thus are most likely to be used as a cash substitute. Municipal bonds are investments and banker acceptances are instruments drawn by a bank to guarantee payment.
Kore Industries is analyzing a capital investment proposal for new equipment to produce a product over the next eight years. The analyst is attempting to determine the appropriate "end-of-life" cash flows for the analysis. At the end of eight years, the equipment must be removed from the plant and will have a net book value of zero, a tax basis of $75,000, a cost to remove of $40,000, and scrap salvage value of $10,000. Kore's effective tax rate is 40 percent. What is the appropriate "end-of-life" cash flow related to these items that should be used in the analysis? A. $(18,000) B. $(30,000) C. $27,000 D. $12,000
D. $12,000 After tax scrap salvage value proceeds, less cost to remove = (10,000 - 40,000) x (1-40%) = -18,000 Tax savings from deducting entire tax basis = 75,000 x 40% = 30,000 After tax cash inflows = 12,000 Remaining tax basis that is deductible as a loss when asset is scrapped
One short-term financing technique that effectively guarantees payment to creditors and is available to entities trying to access trade credit is: • A. Debentures. • B. Subordinated debentures. • C. A line of credit. • D. A letter of credit.
D. A LETTER of credit.
Which is not an advantage of concentration banking? A. Improved controls over inflows and outflows B. Reduced idle balances C. Improved effectiveness for investments D. Accounts at different banks to support several different business locations.
D. Accounts at different banks to support several different business locations. A. is true, as having all cash inflows and outflows in one place makes it each to analyze transactions and activity B. Having multiple bank accounts is harder to keep track of which would result in idle balances. Having a single repository allows for greater control, which means we can reduce idle balances. C. Because we have more control and oversight of all funds available to us, we can quickly identify what funds are available to invest
The use of an accelerated method instead of the straight-line of depreciation in computing the net present value of a project has the effect of: A. Increasing the cash outflows at the initial point of the project. B. Lowering the net present value of the project. C. Raising the hurdle rate necessary to justify the project. D. Increasing the present value of the depreciation tax shield.
D. Increasing the present value of the depreciation tax shield.
When evaluating capital budgeting analysis techniques, the payback period emphasizes: A. Profitability. B. Net income. C. The accounting period. D. Liquidity.
D. Liquidity. Payback period focuses exclusively on how quickly we can make back the cash flows (liquidity), rather than how profitable the project is.
Which of the following is NOT true about zero balance banking? A. Increased visibility and awareness of cash disbursements, which reduces fraud. B. Centralized cash with flexibility through smaller accounts where all transactions pass through C. Moving idle funds into interest-bearing accounts D. Maintaining all bank accounts at one bank
D. Maintaining all bank accounts at one bank. This describes concentration banking.
Which of the following inventory management techniques focuses on a set of procedures to determine inventory levels for demand-dependent inventory types such as work-in-process and raw materials? A. Cycle counting. B. Safety stock reorder point. C. Economic order quantity D. Materials requirements planning.
D. Materials requirements planning. MRP projects and plans inventory levels in order to control the usage of raw materials in the production process. Primarily applies to WIP and Raw materials. A. Cycle counting is a method of checks and balances by which companies confirm physical inventory counts match their inventory records
Which of the following methods should be used if capital rationing needs to be considered when comparing capital projects? A. Return on investment. B. Net present value. C. Internal rate of return. D. Profitability index.
D. Profitability index.
Three suppliers offer Ruby Co. different credit terms. The cost of forgoing the discount for each supplier is as follows: Brandy 36%, Caryl 18%, and Platt 14%. Based on a 360-day year, which of the following options would be most attractive for Ruby Co.? A. Purchase from Caryl Co. pay in 10 days, and borrow from the bank. B. Purchase from Platt Co., pay in 60 days, and do not borrow from the bank. C. Purchase from Bandy Co., pay in 30 days, and do not borrow from the bank. D. Purchase from Bandy Co., pay in 15 days, and borrow from the bank.
D. Purchase from Bandy Co., pay in 15 days, and borrow from the bank. They would incur the highest cost by not taking Brandy's discount. Because the cost of borrowing from the bank is lower than the APR of the lost discount, they should borrow from this bank and pay the payable within the discount period. Bandy's offer would effectively cost the company 36.55% to not take advantage of the discount. At a borrowing rate of 10%, the company should take advantage of the discount rather than wait to pay until the last day.
Which of the following statements about investment decision models is true? A. The net present value model says to accept investment opportunities when their rates of return exceed the company's incremental borrowing rate. B. The internal rate of return rule is to accept the investment if the opportunity cost of capital is greater than the internal rate of return. C. The discounted payback rate takes into account cash flows for all periods. D. The payback rule ignores all cash flows after the end of the payback period.
D. The payback rule ignores all cash flows after the end of the payback period. A. NPV rule is to accept all projects with a positive NPV. Although a positive NPV would infer than the IRR is greater than hurdle rate, it doesn't calculate a rate nor assumes a hurdle rate equal to the IBR. B. The IRR rule is to accept projects with an IRR > hurdle rate established by management. C. The discounted payback model considers only the PV of cash flows during the payback period. Any cash flows after the initial investment is recouped are ignored.
Foster Inc. is cnnsidering implementing a lock-box collection system at a of $80,000 per year. Annual sales are $90 million, and the lock-box system will reduce time by 3 days. If Foster can invest funds at 8 percent, should it use the lock-box system? Assume a 360-day year. A. No, producing a loss of $60,000 per year. B. Yes, producing savings of $60,000 per year. C. No, producing a loss of $20,000 per year. D. No, producing a loss of $140,000 per year.
Daily sales = $90 mil/360 = $250k. Cash received faster = $250k per day x 3 days = $750,000 Benefit of investment income from Cash received faster = $750k x 3% per year = 60,000 Cost = 80,000 Net benefit (loss) = (20,000)
Concentration banking
Designating a single bank as central depository. Greater availability of funds due to centralized bank balance, rather than having to transfer amounts between balances, which increases speed at which we can use funds. - Quickly identifying available funds each day, and moving them to accounts that have funding requirements that day - Investing the remainder in short-term, interest-bearing instruments until needed.
Disadvantage of NPV Method
Doesn't provide a rate of return of the project, it instead indicates if the project will earn the hurdle rate used in the calculation
EOQ formula
EOQ = sqrt(2SO/C) EOQ = Order size S = Sales per period in units O = Cost per order C = Carrying cost per period per unit
Interest expense for finance lease vs. operating lease
Finance lease: Interest expense is based on the lease liability. As lease liability falls over time, interest expense will fall as well. In the earlier years, expense will be higher than for an operating lease. Operating lease: Lease expense is the same every period.
Pro and con of offering discounts and customers taking them
Get cash very quickly, but it is very expensive to do so.
Kanban Inventory Control
Give visual signals that a component required in production must be replenished to prevent the oversupply or interruption of the entire manufacturing process as a result of a lack of a component
Lockbox system
Having checks sent directly to mailbox that bank has access to, which allows the bank to deposit it immediately into their bank account. Expedites cash flows, as it reduces collection float. This is as opposed to traditional method of receiving checks, which is receiving them at your business, then sending it to the bank, which then deposits it. Lockbox takes us out of it and directly routes check to the bank.
Junk bonds
High-risk, high-yield bonds. Very high default risk and are considered "non-investment grade"*
Conservative Working Capital financing Policy
Higher Working capital (more current assets and less current liabilities) Financing: Prefer long term debt. - Temporary current assets with STD, and permanent current assets with long term financing -All assets with long-term debt (very conservative) Effects: - Higher level of current assets means MORE LIQUID and less risk of not being able to meet short term obligations (higher CR and QR) - Higher level of assets means LESS EFFICIENT at turning assets into cash (high OC and CCC, low asset turnover) which reduces cash flow and profitability. - Funds tied up in working capital tend to earn little, or no, return, such as cash or marketable securities. - More funds tied up in working capital, like inventory, and more funds put into investments with higher returns, such as stock. - Long term debt is cheaper.
Holders of subordinated debentures demand a (higher/lower) rate of return
Higher because they assume more risk by ranking behind all other creditors.
Preferred stock
Hybrid equity security that has features of both debt and equity
Relationship between carrying costs and ordering costs
INVERSE. There is a trade-off between carrying costs and ordering costs. If order quantity is small, there will be smaller carrying costs due to lower average inventory levels but ordering costs will be higher because inventory will have to be ordered more frequently. if order quantity is large, there will be higher carrying costs due to higher average inventory levels but ordering costs will be lower because inventory will be ordered less frequently.
Interpretation of IRR
IRR > Hurdle rate established by management: Accept IRR = Hurdle rate: Indifferent IRR < Hurdle rate: Reject
IRR Formula
IRR Factor = Initial investment/After-tax annual inflows IRR factor x Annual after tax inflows (rent) = Initial investment
Participating feature of P/S
In addition to their fixed dividends, preferred shares may participate pro-rata in declared dividends along with common shareholders to the extent there is excess undistributed dividends after satisfying both P/S and C/S requirements at the P/S rate.
Effect of increase/decrease in ordering costs on inventory and carrying costs
Increase in ordering costs would lead to the company placing less orders of higher quantities, increasing average inventory and carrying costs. Decrease in ordering costs would lead to the company placing more orders of lower quantities, decreasing average inventory and carrying costs.
The discount rate to be used for qualitatively desirable or non-optional investments is
Incremental borrowing rate, which is the after-tax cost of borrowing
Examples of working capital being tied up
Inventory = Instead of buying a lot of inventory that will just be sitting there we can invest it. Accounts receivable = Instead of them paying you back immediately and investing that money, you are essentially giving them a interest free loan where you get money later
Reorder point definition and formula
Inventory level at which a company should order or manufacture additional inventory to meet demand and avert stockout costs. Reorder point = Safety stock + (Lead time x sales during lead time)
What does a Financing Decision tell us and what interest rate do we use?
Is borrowing to buy/finance lease or an operating lease cheaper? Discount future cash outflows at the AFTER-TAX COST OF DEBT.
Callable bonds
Issuer has the ability to call or refinance the bonds if interest rates become favorable (e.g., interest rates falls so they can reissue bonds at a lower interest cost)
Cost approach (RC and reproduction)
Iterations of the cost approach include: 1. Replacement cost = Expenses required to create a similar asset 2. Reproduction cost = Expenses required to reproduce the same asset
LT financing includes
LT debt and equity
Interest rate risk for long term debt: Borrowers vs. lenders
Lenders have INCREASED interest rate risk. The risk of interest rates changing increases as the length of the loan term increases. There is a possibility that interest rates increase, but the long term debt had a fixed rate, which leaves lenders worse off. Thus, lenders have to charge higher for assuming this risk. Borrowers have DECREASED interest rate risk as they are locked into a fixed rate of interest, and they pay a premium to do so.
Bank draft
Like a cheque but it is written on a banks own account rather than a customers account. The money has already been taken from their account.
Working capital management definition
Managing current assets so the company can meet its short-term (current) obligations, which is LIQUIDITY
The lower the carrying costs, the ______ inventory a company is willing to carry.
More
Maturity date of commercial paper
Must be 270 days or less, is usually 30 days. If it is greater than 270 days, a registration statement must be filed with the SEC.
What are mutually exclusive projects and what would a company use in this situation?
Mutually exclusive means they have a limited amount of capital to invest (capital rationing) In this scenario, they can use profitability index (PI) to rank the projects.
When dealing with mutually exclusive projects, NPV and IRR may result in different ranking. Which ranking is more reliable?
NPV. NPV is regarded as the most reliable capital budgeting measure.
Is salvage value for sale of the asset to be purchased considered for payback method?
No. Payback method doesn't consider cash flows after the initial investment is recovered. Assuming the investment is recovered before the end of the asset's useful life and the asset is sold, then the salvage value cash inflow would be ignored. However, if we are selling old equipment to help us a buy a new asset, we would consider this after-tax inflow.
Restocking costs typically represent the costs of
Ordering and setup costs; Labor associated with placing orders and setting up equipment for a production run 1. Entering the purchase order 2. Processing the receipt of the inventory 3. Inspecting the inventory to ensure the goods received are acceptable 4. Processing the vendor invoice and subsequent payment 5. Production set-up, tooling, cleaning, equipment set-up
Positive vs negative float
Positive float = GOOD, Checks we write that are in the process of clearing and haven't left our account yet Negative float = BAD, checks we have deposited but haven't been added to our account yet
Profitability varies (directly/inversely) with liquidity.
Profitability varies inversely with liquidity. The more liquid, the more current assets, the
Cash flows associated with borrowing and asset and buying it/finance lease
Purchase of the asset/PV of lease payments Depreciation tax shield Salvage scrap proceeds, net of tax *Do not consider interest expense.
Rights of shareholders compared to bondholders. How does this change the rate of return they demand?
Rights of shareholders to the firm's assets in the event of bankruptcy are less than both secured and unsecured bondholders. Because shareholders have higher chance of not receiving anything upon liquidation, they have more risk and thus demand a higher rate of return.
Treasury Bills (T-Bills)
Short-term debt obligations the U.S. government sells to raise money
Marketable securities
Short-term, low-risk investments that can be easily sold and converted to cash. Either held as cash substitute or as temporary investment. - Treasury bills - Banker's acceptance - Commercial paper - CDs
Commercial paper
Short-term, unsecured debt instrument issued by corporations used to finance current assets or meet short-term obligations
Compensating balance
Specified minimum cash balances to offset cost of services in lieu of bank charges, such as check processing or lockbox collection, or as collateral for a loan
Beta
Standard CAPM measure of systematic risk (market, nondiversifiable). Measures a stock's volatility compared to the volatility of the entire market (e.g., systematic risk).
A company invested in a new machine that will generate revenues of $35,000 annually for seven years. The company will have annual operating expenses of $7,000 on the new machine. Depreciation expense, included in the operating expenses, is $4,000 per year. The expected payback period for the new machine is 5.2 years. What amount did the company pay for the new machine?
The annual cash inflows are 35 revenues - 3 expenses, not including non-cash depreciation.
Capital budgeting
The process a firm uses to evaluate large, long-term investment proposals
Liquidation value method
The value of the asset is equal to the amount a company would receive upon sale if the asset had to be sold today, assuming there is an active market for the asset. Because there is a need to sell it immediately, the value under this method may be at a discount.
Bond indenture
The written agreement between the corporation and the lender detailing the terms of the debt issue; A set of covenants that typically restricts the amount of debt than a bond issuer may carry and the dividends it may pay
Letter of credit
Third party guarantee, generally by a bank, of financial obligations incurred. Can be used when issuing otherwise unsecured debt to enhance credit or may be required by vendors to ensure payment. For example, a vendor may require a letter of credit before extending trade credit to a company trying to purchase inventory.
Payback period method focuses on what two aspects of a potential investment?
This is a paranoid approach, we are only determining how fast we can make back our investment. 1. Liquidity of a project: How fast we can make the CASH back? 2. Risk of a project: The longer it takes to make back our investment, the riskier the project.
Lead time
Time between an order being place and receiving the order or time it takes to manufacture a product
What is the trade-off in cash and cash equivalent management?
Too little cash = Risk increases Too much cash = It's just sitting around, potentially in short-term investments that are low-risk, low return. Thus, return on assets decreases.
What is the primary advantage of serial bonds for a purchaser? A All bonds in an issue mature at the same time. B Purchasers may select the maturity that matches their financial goals. C The bonds are retired by lottery based on serial numbers. D The coupon rate is adjusted based on the maturity date.
B Purchasers may select the maturity that matches their financial goals. With serial bonds, investors can select a maturity appropriate for their purposes. For term bonds, portions of a bond issue be retired at random, which might be inconvenient for investors who planned on holding the bonds for longer.
What is characteristic of debentures? A Require interest payments only when earnings are sufficient B Secured by the full faith and credit of the issuer C Secured by a lien on specified collateral D A set of covenants that typically restricts the amount of debt than a bond issuer may carry and the dividends it may pay
B Secured by the full faith and credit of the issuer A. Income bonds C. Secured bonds D. Bond indenture
Capital investments require balancing risk and return. Managers have a responsibility to ensu that the investments that they make in their own firms increase shareholder value. Managers have met that responsibility if the return on the capital investment A. Is less than the prime rate of return. B. Exceeds the rate of return associated with the firm's beta factor C. Is greater than the prime rate of return. D. Is less than the rate of return associated with the firm's beta factor.
B. Exceeds the rate of return associated with the firm's beta factor The rate of return should exceed the cost of capital. The cost of equity can be found using the CAPM, which find the cost of equity capital using beta.
The optimal capitalization for an organization usually can be determined by the A Maximum degree of financial leverage (DFL) B Maximum degree of total leverage (DTL) C Lowest total weighted-average cost of capital (WACC) D Intersection of the marginal cost of capital and the marginal efficiency of investment
C Lowest total weighted-average cost of capital (WACC) An optimal capital structure maximizes the price of the stock by balancing risks and returns. A structure with a low total WACC tends to reduce risk and, hence, the required rate of return.
Why is equity capital generally more expensive than debt financing? A Shareholders require a higher degree of confidence and expect payments before creditors. B Interest on bonds is a legal obligation. C Shareholders expect to be paid more for exposure to higher risk. D Investors have a greater demand for equity investments than for debt investments.
C Shareholders expect to be paid more for exposure to higher risk.
What is the primary disadvantage of convertible bonds for an issuer? A Convertible bonds have higher interest rates than bonds that are not convertible. B Dilution of financial leverage. C Holders of nonconvertible bonds typically accept less restrictive covenants in bond indentures. D Investors may choose not to convert the bonds.
D Investors may choose not to convert the bonds. If the stock performs poorly, there is no conversion and an issuer must continue to pay regular interest payments they would not have had to pay if they originally issued equity. (A) is not true. Convertible bonds have LOWER interest rates than non-convertible bonds which is an advantage for issuers. (B) is not true. Issuing bond is debt, which means financial leverage increases. (C) is true, but this is an advantage.
Which of the following objectives is consistent with an optimal capital structure? A Maximum earnings per share B Minimum cost of debt C Minimum risk D Minimum weighted average cost of capital
D Minimum weighted average cost of capital Debt generally is cheaper than equity, until high debt levels increase risk levels, driving up the weighted average cost of capital. Maximum earnings per share (EPS) is not always optimal; steps to increase EPS may cause total market value to drop. Minimal risk is not always optimal; investors are willing to incur risk for the opportunity to achieve high returns.
What would be the primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt? A To cause the price of the company's stock to rise B To lower the company's bond rating C To reduce the risk for existing bondholders D To reduce the interest rate on the bonds being sold
D To reduce the interest rate on the bonds being sold For this new issue, they want to lower the interest rate they owe. By promising to limit the percentage of its long-term debt, the debtor assures debt holders that, even in a period of economic strain, there will be sufficient resources to make interest payments. This risk reduction makes the debt more attractive than similar instruments with the same terms except for the debt covenant, making its cost (interest rate) lower.
Which of the following is most often used as a cash substitute? A Bankers' acceptances B Certificates of deposit C Municipal bonds D Treasury bills
D Treasury bills. A Treasury bill is a highly liquid short-term U.S. government obligation that is considered practically risk-free; it frequently is held as a cash substitute.
Commercial paper's advantages include that it A Can be purchased without commission costs B Is readily available as a financing source to most businesses C Provides a line of credit at a preset fixed rate that can be used as needed D Typically is cheaper than a commercial bank loan
D Typically is cheaper than a commercial bank loan. Because commercial paper is issued by very credit worthy companies, they have lower interest rates. Investors have less risk, but they get less return. Issuers are able to charge less.
Capital included as a component of WACC include all of the following except A. Long term debt B. Interest bearing short-term debt C. Equity D. Current liabilities such as accounts payable
D. Current liabilities such as accounts payable Capital components include the sources of financing that bear a financing cost.
Why would a firm generally choose to finance temporary assets with short-term debt? A. Short-term interest rates have traditionally been more stable than long-term interest rates. B. Financing requirements remain constant. C. A firm that borrows heavily long term is more apt to be unable to repay the debt than a firm that borrows heavily short term. D. Matching the maturities of assets and liabilities reduces risk.
D. Matching the maturities of assets and liabilities reduces risk. Matching the maturities of current assets with liabilities as they come due is designed to ensure liquidity and reduce risk of cash shortages. Temporary current assets, such as seasonal inventories are financed with short term debt so the sales of that inventory will be used to repay the short term debt.
What is the effect of a stock dividend? A. Decreases future earnings per share B. Decreases the debt-to-equity ratio C. Increases the size of the entity D. Increases some shareholders' ownership percentages
Decreases future earnings per share. Although stock splits and stock dividends affect the way shares are allocated and the company share price, stock dividends do not affect stockholder equity.
Debt financing is preferred and cheaper when tax rates are
HIGHER, this allows even more interest to be deductible.
How does commercial paper compare to a regular bank loan?
Interest on commercial paper is typically paid by selling it an initial discount, which usually results in less interest being paid than a bank loan. This means the interest rate on commercial paper is below the prime rate, thus, it is a cheaper source of funds than a short-term bank loan.
The shorter the time to maturity, the (less/greater) change in the market value of a bond.
Less change. When there is a change in interest rates for a longer term to maturity, the new rate is multiplied more in the denominator, causing the price to change more. PV (Price of bond) = FCF/(1+r)^n
Capital structure definition
Long term debt and equity used to finance an entity's operations and growth
Aggressive working capital policy
Lower WC (Less current assets, more current liabilities) Financing: Prefer short term debt. - Temporary current assets AND permanent current assets with short-term debt - All assets (current + PPE) with short-term debt Effects: - Low level of current assets means low liquidity and higher risk of not being able to meet short term obligations (low CR and QR) - Low level of current assets means high efficiency of turning assets into cash (low CCC + OC, high asset turnover), which increases cash flows and profitability. - Less funds tied up in working capital, like inventory, and more funds put into investments with higher returns, such as stock. - Short term debt is cheaper, but it has more credit risk. In addition, if we cannot repay in time and have to refinance, there is a risk it will be at higher rates and interest will actually be higher.
Which pair of stocks, if the stocks are purchased in equal amounts, will create the portfolio with the least risk?
Stocks that are negatively correlated. A well-diversified portfolio with the least risk would have investments moving in opposite directions, i.e. the stocks in the portfolio would be negatively correlated such that when one stock fails, the other would give high returns thus minimizing the overall portfolio risk.
Permanent current assets
The level of current assets the company retains regardless of any seasonality in sales
Matching principle or hedging
The maturities of financing used to acquire assets should be the same as the asset's life Temporary current assets = Short term debt Permanent current assets and LT assets such as PPE = Long term debt
Capital structure
The mix of equity and debt financing a firm uses to finance operations and growth
Trade-off between levels of working capital
The tradeoff is between liquidity and profitability. High working capital = Lower risk as we are more liquid able to meet ST obligations, but lower return/profitability because working capital ties up funds that could be deployed elsewhere in the firm to earn a return and make operations more efficient Low working capital = Less liquidity so there is Higher risk of not being able to meet ST obligations as they come due, but higher return/profitability from greater availability of funds to invest and more efficient operations
When are the following used? a) Income bonds b) Junk bonds
a) Reorganization after bankruptcy b) Leveraged buyouts or acquisitions
Velocity Company estimates the following for next year, when com stock is expected to trade at a PE ratio of 7. Earnings before interest and taxes $45 million Interest expense $5 million Effective income tax rate 30% Preferred stock dividends $10 million Common shares outstanding 2 million Common stock payout ratio 25% What's the expected common stock div for next year? a. $2.25 b. $3.50 c. $8.75 d. $9.00
a. $2.25 Net income is $28 million. After paying preferred stock dividends, there is $18 million available to common shareholders. 25% will be paid out as dividends, which is 4.5 million. Across 2 million shares, this equals $2.25 dividend per share.
Overreach Company is implementing a more conservative working capital policy. Which of the following is Overreach likely to have? a. An increase in the quick ratio b. An increase in risk due to interest rate fluctuations c. An increase in the ratio of current assets to noncurrent assets d. An increase in the ratio of current liabilities to noncurrent liabilities
a. An increase in the quick ratio, caused by more liquid
Which is true about preferred shareholders? a. Preferred stock is a hybrid security that has features similar to debt and equity. b. Preferred shares may not participate in declared dividends along with common shareholders. c. Cumulative dividends may require that unpaid dividends in arrears must be paid prior to the payment of interest. d. Preferred shares are always given voting rights.
a. Preferred stock is a hybrid security that has features similar to debt and equity. b. False, preferred shares may participate pro-rata in declared dividends. c. False, cumulative dividends may require that unpaid dividends in arrears must be paid to P/S prior to payment of dividends to C/S/ d. false, P/S are usually not given voting rights.
Which of the following most likely is said to "make a market" in a particular security? a. A commercial bank b. A dealer in an over-the-counter market c. A mutual fund d. A pension fund
b. A dealer in an over-the-counter market
NET working capital is the difference between a. Capital assets and long-term liabilities b. Current assets and current liabilities c. Current assets, except for inventories, and current liabilities d. Fixed assets and long-term liabilities b. Current assets and current liabilities
b. Current assets and current liabilities
The benefits of debt financing over equity financing are likely to be highest in which of the following situations? a) High marginal tax rates and many noninterest tax benefits b. Low marginal tax rates and few noninterest tax benefits c. Low marginal tax rates and many noninterest tax benefits d. High marginal tax rates and few noninterest tax benefits
d. High marginal tax rates and few noninterest tax benefits If there are higher tax rates, interest payments cause more tax savings. If there are few noninterest rax benefits, why choose equity when you can have tax deductions from interest expense.
Cash and cash equivalent examples
- Coin and currency on hand (including petty cash) - Checking accounts - Savings accounts - Money market funds - Deposits held as compensating balances against borrowing arrangements with a lending institution that are not legally restricted - Negotiable paper (Bank checks, money orders, traveler's checks, bank drafts, and cashier's checks) - Commercial paper - Treasury bills - Certificates of deposit (having original maturities of 90 days or less)
Which of the following is an assumption of the residual theory of dividends? A The rate of return that investors require is not affected by dividend policy, but rather by other forces - e.g. risk of investment, market rate, etc. B Dividend payments should be a percentage of earnings and net income. C Dividend payments should be stable and paid annually. D Retained earnings take priority over dividends because shareholders want money on the balance sheet.
A The rate of return that investors require is not affected by dividend policy, but rather by other forces - e.g. risk of investment, market rate, etc. (B). This is the belief of the constant payout dividend policy. (C). This is the belief of the stable dividend model.
Term vs serial bonds
A term bond is a debt security that has a defined, single maturity date. A serial bond, on the other hand, does not have one maturity date, and instead has maturities staggered over a period of years where it receives a portion of face value.
Residual theory of dividends
A theory of dividend payout stating that a corporation will retain as much of its earnings as it will invest. Companies will 1. Determine target capital budget to raise, including debt and/or equity. 2. Supply the equity portion from retained earnings as much as possible, taking into account the net income added to retained earnings this year and P/S dividends paid. 3. Pay dividends to the extent that retained earnings exceed equity needed.
Weighted Average Cost of Capital (WACC)
A weighted average cost of all forms of financing associated with firm's existing assets and operations/funds employed. Often used as a "hurdle rate", meaning the firm will only accept investments higher than this rate. It can be used as a hurdle rate because a firm should earn from an investment at least enough to cover the costs of resources employed to fund that investment.
Goal of working capital management
Find the optimal mix of current liabilities and current assets to maximize shareholder value. To achieve a balance between risk and return in order to maximize shareholder value. Working capital management requires balancing profitability with liquidity. Holding too much current assets generally is not profitable because of the low rate of return, yet insufficient working capital could cause, for example, a failure to pay bills as they become due, resulting in involuntary bankruptcy.
