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BEC 44

Financial Mgmt

TermDefinition
Inventory conversion period average inventory/COGS per day
Receivables conversion period average receivables/ credit sales per day
Payables deferral period average payable/ purchase per day OR averages payables/ COGS/365 Cash conversion cycle
Float the time that elapses related to mailing, processing, and clearing checks; effective cash management involves extending the float for disbursements and shortening the float for cash receipts
Economic order quantity (EOQ) minimizes the sum of ordering (decrease with order size) and carrying (increase with order size) costs. EOQ = square root of 2(cost of placing one order) (annual demand in units)/cost of carrying one unit of inventory for one year.
Reorder point order at a point in time to avoid stockouts, but not so early that an excessive safety stock is maintained
Credit policy 1) credit period 2) discounts 3) credit criteria 4) collection policy
Day’s sales outstanding receivables/sales per day
Cost of not taking a discount on payables discount percentage/ 100- discount percentage x 365 days/total pay period- discount period
Mortgage bond secured with the pledge of specific property
Collateral trust bond secured by financial assets of the firm
Debenture not secured by the pledge of a specific property; can only be issued by firms with the highest credit rating due to default risk; usu. have a higher yield than secured debt
Subordinated debenture claims are subordinated to other general creditors in the event of bankruptcy of the firm
Income bond interest payments that are contingent on the firm’s earnings; often associated with firms undergoing restructuring
Serial payments/bonds paid off in installments over the life of the issue
Sinking fund provisions firm makes payments into a fund which is used to retire bonds by purchase
Conversion bonds may be convertible into common stock
Redeemable bondholder may have the right to redeem the bonds for cash under certain circumstances
Call feature allows the firm to force the bondholders to redeem the bonds before maturity
Coupon rate stated rate; rate at which interest payments are calculated
Current yield stated rate/current price of the bond
Yield to maturity the interest rate that will equate the future interest payments and the maturity payment to the current market price
Zero coupon bonds bond do not pay interest and sell at deep discount from the dace or maturity value
Floating rate bonds interest rate on bonds floats with market rate ==> bond’s market price does not fluctuate widely; reverse floaters- pay a higher rate of interest when other interest rates fall & lower rate when other rates rise- riskier than normal bonds
Registered bonds registered in the name of the bondholder
Junk bonds very high risk premium
Foreign bonds denominated in the currency of the nation in which they are sold
Eurobonds international bonds denominated in US dollars.
Advantages of debt financing 1) interest is tax deductible 2) obligation is generally fixed ( interest and principal) 3) inflation- debt is paid back with dollars that are worth less than the ones borrowed 4) SH do not give up control 5) less costly than equity
Disadvantages of debt financing 1)interest and principal must be paid regardless of economic position 2)payments are fixed despite performance 3)covenants and restrictions 4)increases the risk of equity holders
Capital leases 1) transfers ownership to the lessee 2) bargain purchase option at the end of the lease 3) lease term is 75 percent or more of the estimated life of leased property 4)pv of the minimum lease payments is >90 percent of the fmv of the lease
Stock warrants issued with bonds to increase their marketability; an option to buy common stock at a fixed price for some period of time
Advantages of issuing common stock 1) firm has no firm obligation/financial flexibility 2) reduces risk to borrowers ==> lower cost of capital 3) future profit potential for investors
Disadvantages of issuing common stock 1) issuance cost higher than debt 2) ownership and control is given up 3)dividends are not tax deductible 4) SH demand a higher rate of return 5) too much CS may increase the firms cost of capital
Preferred stock entitled to receive a stipulated dividend and must receive the dividend before payment od dividends to common stockholders; priority over CS holders
Features of preferred stock 1) cumulative dividends- if dividends not declared => in arrears & must be paid before CS holders 2)redeemability 3)conversion 4) call feature 5)participation- share with CS holders in dividends above the stated amount 6) can have a floating dividend rate
Operating leverage measures the degree to which a firm builds fixed costs into tis operations; the greater a firm’s fixed costs, the greater its business risk
Degree of Operating Leverage (DOL) percentage change in operating income/percentage change in unit volume
Financial leverage measures the extent ot which a firm uses debt financing
Degree of financial leverage ( DFL) percent change in EPS/percent change in EBIT
Cost of capital weighted average cost of debt and equity financing components
Cost of debt interest rate x (1-marginal tax rate)
Cost of preferred equity preferred dividend/issue price of the stock
Cost of common equity higher than that of debt and preferred equity
Capital Asset Pricing Model ( CAPM) cost of common equity = rfr +(err –rfr)Beta; uses only one variable to capture systematic risk
Arbitrage Pricing model uses a series of systematic risk factors to calculate the market rate of return
Bond yield plus approach adding a risk premium of 3 to 5 percent to the interest rate on the firm’s long term debt
Dividend yield plus growth rate approach cost of common equity = Next expected dividend/current stock price- floatation cost per share + expected growth rate
Factors affecting capital structure strategies 1) business risk2) tax position 3) financial flexibility 4) management’s conservatism or aggressiveness
Weighted average cost of capital ( WACC) weighting the cost of capital for each type of financing by percentage of total capital
Horizontal merger combining with a firm in the same line of business
Vertical merger combining with another firm in the same supply chain
Congeneric merger merging firms are somewhat related
Conglomerate merger merging firms are completely unrelated
Created by: tsp7c