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29 Cards in this Set

  • Front
  • Back

5 Steps Needed to Reach a Decision:

1. _____________
2. _____________ (_______ like reduced costs or ________ like increased quality)
3. ________________
4. ________________
5. ________________

________ - deemed this if they ____ as a result of _________. These costs can be ______ or ____.

______ - costs that are identified with a cost object.
______ - include direct material and direct labor.
________ - arising from periodic budgeting to spend in areas not related to manufacturing.

_______ - additional costs incurred to produce an additional amount of the unit.
________ - costs not incurred from choosing an action.
________ - allocated portion of fixed OHD (not relevant)
1. Determine the strategic Issues
2. Specify Criteria and ID alternate courses of action (Sort term quantifiable criteria; Non-quantifiable criteria)
3. Perform Analysis of Relevant/Strategic Costs
4. Choose an Alternative
5. Evaluate Performance to Provide Feedback

relevant cost; change; choosing a different alternative; fixed or variable;

Direct Costs;
Prime Costs;
Discretionary Costs;

Incremental Costs;
Avoidable Costs; (unavoidable is not relevant)
Absorption Costs;

Expected Value:
The expected value of perfect information is the difference between the expected payoff under _____ and the expected monetary value of the best alternative under _______.

Shortcomings of Expected Value:
1. Based on _______, when business decisions based on _______
2. Represents _______, not actual.
certainty; uncertainty;

repetitive trials; one trial;
average outcome;

Cash Flows & Capital Budgeting:
A. ________ - when a co receives cash, pays cash or makes cash commitment;
B. ________ - represents transactions indirectly associated w project or non-cash activity that provides cash benefits / obligations (eg. _____)

Stages of Cash Flows:
1. Inception of project:
a. Direct Effects: acquisition
b. Indirect effects: ________ (ie increase in _____ or ______ to operate project; Implementing JIT to decrease CA) AND ________ of the replaced asset.

EXAMPLE: what are components on net cash outflow?

2. Operations: CFs generated from asset & the ________.

3. Disposal of asset: Other than proceeds from sale consider:
-_________ (employees not needed)
-_______ (severance pay)
Direct Effect;

Indirect Effect; depreciation;

changes in working capital; payroll; inventory; anticipated salvage value.

Invoice + Shipping + Installation +/- Changes in WC - Proceeds from sale of old asset (net of tax) = NET CASH OUTFLOW

depreciation tax shield;

- Changes in WC
- Certain direct expenses due to disposal
- If asset sold, indirect effects on taxes

After tax cash flows: WC is NOT taxed. Plus Operating CFs can be quite different from NI for a year

There are different tax implications of an asset abandonment, sale, or trade-in as a result of a new asset acquisition.


Asset Sale?

Asset Trade-in?
Abandonment: Old assets net SALVAGE value reduces the New assets initial investment. The remaining book value is deductible as a tax loss, which reduces tax liability. This reduction is considered a reduction in the new asset's initial investment.

Asset Sale: The Cash Proceeds reduce the new investment's value. Also, the tax effects from a gain or loss increase or decrease the initial expenditure.

Asset Trade-in: No gain/loss recognized on trade-ins. Old assets BV becomes a part of New Asset's depreciable base, thus more depreciation in later years.

DCF methods: 3 Factors:
1. Initial Investment (additional WC - example?)
2. Future Cash inflows/outflows
3. Rate of return / hurdle rate:
Different approaches:
a. Use _____
b. Use __________
c. Recommend that the discount rate be related to ________.

1. Calculate after tax CFs
2. Calc. depreciation tax shield
3. Discount the CFs
4. Subtract t=0 cash outflow.
5. NPV
Example: in most projects, if need more inventory, the increase in WC is a cash outflow in the CY, and when need less inventory after project is over, cash inflow in the last period (discounted).

WACC method;
target for new projects;
specific risk of new project;
Payback period= ________ / _________

1. __________
2. __________
1. __________
2. __________
3. __________

Alternate approach: _____ payback method. Assumes what?

Discounted payback method / Breakeven time method (BET)

Advantages / Limitations?
Net initial investment / Average expected CFs

1. Easy to understand
2. Emphasis on Liquidity

1. TV of M ignored
2. Total profitability is ignored
3. Reinvestment of CF is not considered.

"Bail-out"; assumes the salvage value is part of the cash flow;

Same as normal payback, except TV of M.

IRR = Hurdle rate when ____

IRR also known as time adjusted RoR. How to calculate:

Limitations of IRR method

If companies have unlimited capital = invest in all positive NPV projects. If not, rank all investments using PI & NPV.

Profitability Index = ?
NPV = 0

1. Determine life of project.
2. Determine payback period.
3. Find Proper Present Value Table to Use (annuity if consistent CFs)
4. Locate PV interest factor: find length of time = n and then look for payback period that best matches PV interest factor to determine IRR.

1. Unreasonable reinvestment assumption (of project CFs at IRR)
2. Inflexible CF Assumption (timing / amount of CFs is misleading)
3. Evaluates alternatives only based on Interest Rates.

PV of all future cash inflows / PV of net initial investment.

Risk & Return:
1. Risk indifferent behavior: _____________. Atypical.
2. Risk adverse behavior:
_____________. Typical.
3. Risk seeking behavior:
_____________. Atypical.

Manager's preferences defined by their point of risk indifference. This point is defined in relation to the _______ (ie. the amount of return offered for a riskless security.) Therefore, CE < risk adverse individual's expected value of riskier investment. (= for risk indiff. and > for risk seeking).

Diversification - reduces risk.

Any investor can get rid of diversifiable risk, therefore must only be concerned with systematic risk.
Increase risk, no demands for increase in return.

Increase risk, demand increase in return.

Increase risk, allow decrease in return.

Certainty equivalent.

Diversifiable risk
Unsystematic risk

Non-diversifiable risk
Systematic Risk (market)
Types of risk:
1. Interest rate risk: fluctuations in interest rates - exposure to instrument ______ / _____
2. __________ - same as _________.
3. ________ - impacts borrowers ability to get favorable terms
4. _________ - impacts lenders ability to recover investment

________ - rate charged before any adjustments for _____ or ______

______ rate = interest paid on loan agreement / net proceeds

________ rate - ignores compounding, but takes into account effective yields

________ rate - same as above but with compounding;
holders; lenders

Market risk; non-diversifiable risk;

Credit risk;

Default risk;

Stated interest rate; market; compounding;


Annual percentage rate;

Effective annual percentage rate;
Operational & Financial Leverage

Operational - degree to which firm uses _______ vs. ________. (high OL is using alot of FC, low is using alot of VC).
Degree of Leverage (DOL):
_______ / ________

Financial Leverage: Equity v Debt
Degree of Financial Leverage (DFL):
________ / ________

________ / _________

fixed operating costs vs. variable operating costs.

% change in EBIT / % change in sales

% change in EPS / % change in EBIT

% change in EPS / % change in sales

The theoretical optimal ______ is the one that produces the _____ WACC


Cost of debt (weighted avg. interest rate) formula?

**Always calculate simple cost of debt as after tax.
capital structure; lowest;

Cost of Equity x % of equity + Cost of debt x % of debt

Weighted average interest rate = Effective Annual interest payments / Debt Cash Available
Cost of LT Debt (kdx)

kdx formula?
*due to interest tax shield

kdt formula?

-The lower the cost of capital / WACC, the higher the returns
-Debt carries lowest coc
-higher the tax rate - greater benefit of debt.

Cost of Preferred Stock (kps):

kdx = kdt (pre-tax) x (1-t)

kdt = (I + (PV-Nd) / n) / (Nd + PV) / 2

I = annual interest payments
PV = par value of bond
Nd = Net procceds from sale (less flotation costs)
n = number of years to bond maturity

kps = Dps / Nps

Dps = Preferred Stock Dividends
Nps = Net proceeds of Preferred Shares
kre (cost of retained earning / equity)

*after tax considerations are irrelevant (no tax shield)

3 common methods:

kre = _____ + ______
2. DCF
3. Bond Yield plus Risk Premium

kre = krf + B(km - krf)

km = market rate
krf = risk free rate
B = stock's Beta coefficient
Advantages / Disadvantages (LT vs ST)

ST financing strategies:
Rates tend to be _____ with ST.
Advantages (Disadvantages of LT):
1. _________ (presumes higher turnover of assets)
2. _________ (presumes high cash conversion)
3. _________ (for LT - this is increased because of lender's exposure to and borrower's elimination of ________)

Disadvantages (Advantages of LT)
1. _________ (don't 'lock in' rate)
2. _________ (refinancing might be denied)

Increased Liquidity;
Increased Profitability;
Decreased Financing Cost; interest rate risk;

Increased Interest Rate Risk;
Increased Credit Risk;
Financing Strategies:

1. Working Capital Financing: ex? maturity matching?

2. Letter of Credit - ex?

3. Line of Credit - ex?

4. Capital vs. Operating Leases.
Operating - no opportunity to assume ownership.
Capital - acquisition of asset either ______ or _______. (in substance = lessee uses ____ of the assets ______ or assumes lease payments whose principal components make up ____ of the assets fair value)

5. Debentures: _____ financing. Can mitigate risks by including a _________ which stops a company from pledging _____ to ________.

________ - pay interest only if reach certain income level;
1. Toy company needing seasonal financing - ie use more A/P. Maturity matching - the expectation that maturities of CAs (collections) will match those of CLs (disbursements)

2. Using Comm. paper to finance inventory and needing to assure suppliers of creditworthiness. Get bank to guarantee by issuing LOC.

3. Essentially a contingent loan from bank.

4. in legal form; in substance; 75% useful life; 90%

5. unsecured financing; negative pledge clause; assets; additional debt;

income bond;
Debt & Equity:

Tax Deductibility?
EPS Dilution?
Increased Risk?
ROI (*ideal for SBUs - Strategic Business Units) is
________ / ________
_______ x _________

Issues: If managers shrink assets, then increase ROI! Instead of using net book value can use:
a. Gross Book Value: ie the _______ method which adds back depreciation to account for this.
b. Replacement Cost
c. Liquidation Value
d. Treatment of ________ / ________ (take them out)

Limitations of ROI:
a. _______ - ("_________" - overemphasis on investment balances)
b. ________
Income / Avg Assets
Profit Margin (ROS - Income / Sales) x Asset Turnover (Sales / Assets)

Unproductive Assets / Intangibles

a. ST focus; "investment myopia"
b. Disincentive to invest;
Residual Income (*ideal for SBUs like ROI)




Net Book Value x Hurdle Rate = Required Return

Net Income - Required Return = Residual Income

1. Realistic Target Rates
2. Focus on Target Return & Amount (no dilution of rates)

1. Reduced comparability (larger unit to smaller unit)
2. Target Rates require judgement
Debt to Capital Ratio Formula?

Debt ratio (to assets) formula?

Debt to Equity Ratio Formula?

Net Working Capital?

Current Ratio?
(Aggressive Working Capital Management? Conservative?)

Quick Ratio?
*more conservative

There is an inherent limitation of the Current Ratio if ST liquidity is not an issue (a restaurant with healthy CF, but low CAs and high CLs)
Total Debt / Total Debt + Equity

Total Debt / Total Assets

Total Debt / Total Equity


(Increase ratio of CL to non-CL; Increase ratio of CA to non-CA)

Cash + Marketable Securities + Receivables / CL
Motives for holding cash:

1. _________ - having enough cash to meet _____ arising from ______
2. _________ - having enough cash to take advantage of temporary opportunities
3. _________ - maintain a safety cushion for hard times

Disadvantages of high cash levels:
1. The ________ effect (interest levels from investments less than interest obligations)
2. More likely a _________.
3. Investor _________ (no dividends)
1. Transaction motive; payments; ordinary business;
2. Speculative motive;
3. Precautionary motive;

1. interest arbitrage
2. takeover target
3. dissatisfaction
Methods of speeding up cash collections:

1. Customer screening
2. Prompt Billing
3. Discounts:
FORMULA for calculating APR?
4. Expedite Deposits - reduce time payment in hand but not at bank:
a. ________ - movement from one institution to another. (expedites and leaves documentation)
b. _________ - having bank receive payments from company directly. Two types:
i. _____ lockbox systems - low dollar, high volume (CC company)
ii. _______ lockbox systems - high dollar, low volume.
*** compare lockbox fees to additional interest income to determine effectiveness.
5. ________ - using a single bank as central depository.
6. _______ - turning over the collection to a third party _____ in exchange for a discounted ST discounted ____.
360 / (Pay period - Discount period) x (Discount / 100 - Discount)

4. a. EFT
b. Lockbox systems
i. Retail
ii. Wholesale.

5. Concentration banking
6. Factoring A/R; 'factor'; loan;
Methods to Delay Disbursements:
1. _______
2. Drafts (slower than a ____)
3. ________ - replace payable with another form of credit.
4. ________ - set up master account to fund negative balances (ie. instead of transferring a lump sum for payroll, company able to capitalize on time before employees cash checks.

_____ - difference in the balance of cash accounts and balance of bank's records. _______ (_____) occurs when company checks written but not recorded by bank. _______(_____) occurs when deposits have been recorded in the company's books but not recorded by bank.
** cos that handle receipts more efficiently than firms they write checks to achieve positive net float.

Overdraft protection - essentially a _____ activated when an overdraft occurs.

__________ - minimum balances by bank customer in lieu of bank fees.
1. Defer Payments
2. check
3. Line of Credit
4. Zero Balance Account

Float; Disbursement float (positive); Collections float (negative);


Compensating Balances;
Cash Conversion Cycle:

CCC = _________ + ________ - ________

Forumlas for all three?
CCC = Inventory Conversion Period + Receivables Collection Period - Payables Deferral Period

Inventory conversion period = Avg. Inventory / Avg. CoGS per day

Receivables collection period (Days sales outstanding) = Avg. Receivables / Avg. Sales per day

Payables Deferral period = Avg. Payables / Avg. CoGS
_______ - use of credit from suppliers to finance operations

1. ______ - defacto financing / "spontaneous credit". _______ - payables can be extended to guarantee sales / avoid 'rush'

2. _________ (Salary payable, etc).

3. _________ - formalized promissory notes

4. _________ - less formal that N/P, more formal than A/P (still originates with supplier). These are _______ on their own.

________ - formalized ST financing - promissory note. Usually only given to stable / credit-worthy companies; 2 ways to access this financing:
a. _________ - dealers purchase and then remarket to investors; medium sized companies / utilities
b. _________ - Larger companies that market to investors themselves;

** also use cashier's checks to prevent fraud / simplify bookkeeping
Trade credit

1. Accounts Payable / Open Account; Seasonal Dating;

2. Accrued Expenses

3. Notes Payable

4. Trade Acceptances; marketable securities;

Commercial Paper;
a. Dealer Markets;
b. Direct-Placement Markets;
Common Marketable securities (that you don't know about):

1. ____ - backed by US, sold in __, ___ and ___ day denominations; risk free
2. ________ - short term IOUs of large corps guaranteed by commercial banks
3. __________ - _____ deposited in banks outside the US (time deposits free from US regs)

Strategies for Mark. Securities:
1. Periods of Low Rates - if takes a substaintial time to liquidate, ______ preferable to ______
2. Periods of High Rates: opposite.

Calculation of Required RoR?
T-Bills; 30,60,90;

Banker's Acceptances;

Eurodollars; dollars;

cash; marketable securities

Real rate of return +
Inflation Premium =
Risk free rate
+ Interest Rate Risk (MRP)
+ Liquidity Risk (LP)
+ Default Risk (DRP) =
Required rate of return
Factoring Questions:

5 steps?

Average Collection Period Formula?

Number of days receivables outstanding?
1. Calculate Annual Fees
2. Calculate Annual Interest (with amount subject to interest)
3. Sum the 2 - Cost to Company
4. Compare with (subtract from) cost saved
5. Get Net cost and divide by average amount advanced.

A/R balance / Average Daily Sales

Ending A/R / Average Daily Sales
Inventory Levels:

-Inventory Management - requires accurate sales forecasts or else extra,
a. Storage Costs
b. Insurance Costs
c. Opportunity Costs of inventory investment
d. Lost inventory due to spoilage / obsolescence.

Optimal Levels of Inventory concepts:
1. Safety Stock - determined by a number of factors. examples?
Reorder Point is what?
2. ________ - loss of income from product unavailability (expedited shipping, loss of GW)
3. Inventory Turnover: Formula? Increase IT ratio decreases inventory totals. Decreased inventory x ____ = Cost Savings;
Uncertain Lead Times (time from placement of order to receipt of order); Reliability of sales forecasts; possible customer dissatisfaction from back orders; Seasonal demands;

Safety Stock + Lead Time;

Stockout Costs;

CoGS / Average Inventory; APR;
Inventory (cont'd)

Number of days of inventory in stock. Formula?

EOQ inventory model attempts to minimize ordering and carrying costs. EOQ does not consider ______ or costs for _______. Assumes carrying costs include the following:

EOQ Equation? **determines order size

360 (or 365) / Inventory Turnover Ratio

stockout costs; safety stock;

1. Storage;
2. Obsolescence
3. Materials
4. Insurance
5. Interest

E = sqrt( 2 x S x O / C)

E=Order size
S=Annual Sales (in units)
O=Cost per Purchase Order
C=Carrying Cost per Unit
Inventory (cont'd)

JIT - reduces lag time between _______ and _______.

______ Inventory Control - give _______ that a production component must be replenished. Prevents ______ and _____ of process.

Computerized Inventory Control: Inventory levels monitored instantaneously for improved control. (Every _____ recognized).

_________ (__) - Like above but with raw materials;
inventory arrival; inventory use;

Kanban; visual signals; oversupply; interruption;


Materials Resource Planning (MRP);