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BEC 3
1. 2. 3. Questions: Answers If PVFCF>Todays cost then: accept, value added Cost of new project equals: invoice + shipping +installation + change in working capital - cash proceeds from old (net of tax) working capital equals: current assets - current liabilities Relevant tax flows are those that we can keep: after paying taxes After tax cash inflows equal: pretax cash inflow x (1- tax rate) + depreciation x tax rate = annual OCF book value of old asset is a: sunk cost (ignored) The best method for valuation of assets and liabilities are: discounted cash flow Same cash inflow every year is also called an: ordinary annuity 4 steps for net present value method: annual net cash flow x (1-tax rate), depreciation x tax rate, multiply times appropriate pv of annuity, subtract initial cash outflow Main limitation of DCF: Simple constant growth (single interest rate) Payback period calc =: net initial investment/increase in annual net after tax cash flow another way to do payback period calc is: initial outflow/annual annuity objective of net present value method: invest in a capital asset that will yield returns in excess of designated hurdle rate Net Present Value method ignores: method of funding The Hurdle or target rate is the: minimum rate or return that is set by management to evaluate investments In NPV is positve or 0: make investment If NPV is negative: do not make invesment With NPV rates may be adjusted to account for: risk and inflation NPV can take into account: different rates for different years NPV method is beneficial because: its flexible and used when there is no constant rate of return The NPV rate is limited by: not being able to provide the true rate of return If a company has unlimited capital, investment alternatives with a positive NPV: should be purchased If limited capital, managers should: allocate capital to a combination of projects with maximum net present value Profitability index calculation equals: PV of net future cash inflows / PV of net initial investment Future revenues and costs are deemed to be relevant if: they change as a result of selecting a different alternative 3 types of relevant costs: direct, prime, discretiaonary

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28. Other terms for relevant costs are: incremental cost, avoidable cost 29. costs that are not relevant: sunk,historical, absorption, rent, deprec. 30. expected value is used to: determine best course of action when there is uncertainty 31. ST financing is classified as: current and will mature within one year 32. ST debt rates: lower 33. LT debt rates: higher 34. ST debt advantage: increased liquidity, increased profitability 35. LT debt advantage: decreased interest rate risk, decreased credit risk 36. ST debt disadvantage: increased interest rate risk, increase credit risk 37. LT debt disadvantage: decreased liquidity, decreased profitability 38. ST debt strategy: use with higher levels of temp working capital 39. LT debt strategy: use with higher levels of permanent working capital 40. Letter of credit: helping secure loan from another party 41. Line of credit: loan

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42. Degree of Operating Leverage equation (DOL): Percentage change in EBIT/Percentage change in sales 43. A high degree in operating leverage implies a small change in sales: will have a larger impact on profits 44. High DOL has greater profitability but: greater risk 45. Degree of Financial Leaverage (DFL) is: Percentage change in EPS/Percentage change in EBIT 46. A high degree in financial leverage implies a small change in sales: will have a larger impact on profits 47. Degree of Combined Leverage calc is: percentage change in EPS/Percentage change in sales 48. Operating leverage decisions are often based on: the result of industry characteristics 49. DCL =: DOL * DFL 50. Mgmt invests in projects where ROIC is: greater than WACC 51. The maximized value of a firm is the lowest: mixture of debt and equity securities that produce the lowest WACC 52. Cost of debt for WACC purposes is based on: an after tax basis 53. WACC is better if it is: lower 54. WACC =: cost of equity*percentage equity + after tax cost of debt*percentage debt 55. the historic WACC may not be appropriate when: the project carriest different amount of risks 56. Cost of Debt=: (I+(PV-Nd)/n)/((Nd+PV)/2) 57. After tax cost of debt =: pre tax cost of debt (kdt) * (1-tax rate) 58. debt carries: the lowest cost of capital and is tax deductible 59. the higher the tax rate the more incentive to: use debt financing 60. for cost of retained earnings, a firm should: have same amount that stockholders could have earned on alternative investments of equivilent risk 61. The key assumption of CAPM is: the cost of retained earnings is equal to the risk-free rate plus a risk premium 62. CAPM =: Risk Free + Beta(Market Rate-Risk Free Rate) 63. Cost of long term debt has: a fixed return and tax benefit 64. cost of preferred stock has: a fixed return and no tax benefit 65. cost of retained earnings has: no fixed return, growth relates to corporate and industry performance, no tax benefit 66. ROI=: Income/Investment Capital (Avg assets,Ave PPE + Avg WC) 67. ROI also equals=: profit margin * investment turnover 68. 2 limitations to ROI: disincentive to invest, short term focus 69. Residual income =: net income - required return 70. Required return for Residual income =: net book value (equity) x hurdle rate (capm) 71. 2 Benefits of Residual Income method: realistic targets, focus on target return and amount 72. 2 waeknesses of residual income: reduced comparability, target rates require judgement

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73. Return on Total assets =: NI/Avg Assets 74. Debt to total capital ratio=: total debt/total capital (debt + equity) 75. Aggressive working capital management: increase current liabilities to non current liabilities 76. Conservative working capital management: increase ratio of current assets to non current assets 77. Quick ratio (acid test) =: cash + marketable securities + receivables / current liabilities 78. Less working capital increases the risk by exposing company: to less likelihood of possible failure to meet current obligations 79. a precationary motive is: a move to make enough cash to maintain a safety cusion so that unexpected needs may be met 80. APR of quick payment discount =: (360/pay period discount period) * (discount/100-discount%) 81. Retail lock box systems are used for: low dollar, high volume transactions 82. Wholesale lock bock systems are used for: high dollar, low volume transactions 83. You want a (negative,postive) float balance: positive

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84. Cash conversion cycle =: inventory conversion period + receivables collection period - payables deferral period 85. You want cash conversion cycle to be: Lower 86. Inventory conversion period =: average inventory / average cost (COGS) of sales per day 87. Receivables collection period (days sales outstanding) =: Average Receivables/ Average Sales (Sales) per day 88. Payabales deferral period =: average payables/ average purchases (COGS) per day 89. Steps for calculating net cost for factoring: AR cost per year + interest expense per year - expense saved = net cost 90. APR for factoring: Net cost/average amount advanced 91. The lower the carrying costs the: more inventory companies are willing to carry 92. Reorder Point for safety stock =: Safety stock + (lead time * units sold) = reorder point 93. Increased inventory turnover: reduces inventory 94. cost savings for inventory turnover =: decreased inventory * APR 95. Economic Order Quantity takes into account: storage, obsolescence, materials, insurance, interest 96. EOQ equation is: E= sqrt(2SO/C) 97. EOQ equation takes into account: ESOC - S(annual sales) O(cost per order) C (carrying cost per unit) 98. Zero growth stock assumptions: must specify dividend, stock price will never grow, must specify required return 99. Constant growth equation: Pt=(Dt+1)/(R-G)

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