Weighted average cost of capital
average cost of all forms of financing used by a company
Used as internal hurdle rate for capital investment decisions
Optimal capital structure
Mix of financing instruments that produces lowest WACC
Weighted Average Cost of Capital (WACC)
Average cost of debt and equity financing associated w/ firm's existing assets/operations
Weight the cost of each type of capital by its proportion to firm's total capital structure
Cost of debt
Computed on after-tax basis b/c interest is tax deductible
Generally stated as interest rate
Weighted average interest rate (cost of debt)
effective annual interest payments / debt outstanding
Effective interest rate
***AFTER-TAX
Basis point
(Points x .0001) + RF rate
Cost of preferred stock
Preferred Stock Dividends / Net Proceeds of Preferred Stock
% dividends x PAR VALUE
Cost of retained earnings
Rate of return required by stockholders
1. Capital asset pricing model
2. Discounted cash flow
3. Bond yield plus risk premium
Capital asset pricing model
Risk free rate + [Beta (Market return - Risk free rate)]
Beta
Risk of stock/Risk of overall market
Discounted cash flow
(D1/P0) + g
Bond yield plus risk premium
Pretax cost of long term debt + Market risk premium
Pretax cost of long term debt + Market return - Risk free rate
Optimal cost of capital
ratio of debt to equity that produces the lowest WACC
Growth rate
(ROA x Retention)/[1 - (ROA x Retention)]
ROE x Retention
Profitability Ratios
1. Return on sales
2. Return on assets
3. Return on equity
4. Return on investment
Operating leverage
Using fixed operating costs
Need higher sales to compensate
Financial leverage
Use debt rather than equity
Need higher EBIT to cover
Solvency
1. Total debt ratio
2. Debt-to-equity
3. Equity multiplier
4. Times interest earned
Retention
Addition to RE/NI
Working capital
current assets - current liabilities
Market capitalization
Shares x FMV/share
Working Capital Management
Matching life of asset w/ length of financial instrument used to finance asset
Factors influencing inventory levels
1. Storage costs
2. Sales forecasts
3. Insurance costs
4. Opportunity cost of inventory investment
5. Obsolescence/spoilage
Factors influencing optimal levels of inventory
1. Usage rate of inventory
2. Cost per unit
3. Cost of placing orders
4. Time required to receive order
Safety stock
1. Sales forecasts
2. Customer dissatisfaction
3. Stockout costs
4. Lead time
5. Seasonal demand
Reorder point
Safety stock + (Lead time x sales during lead time)
Economic Order Quantity
Minimize total ordering costs & carrying costs
Just-in-time
Reduce lag time between inventory arrival & us
Kanban
Visual signals that component needs to be replenished
Supply Chain Management
when firm and entire supply chain are able to reasonably predict expected demand of consumers for a product & then plan accordingly
SCOR Model
1. Plan
2. Source
3. Make
4. Deliver
Plan
1. Determine demand requirements
2. Assess ability of suppliers to supply resources
3. Plan inventory levels
Source
1. Select vendors
2. Collect & process vendor payments
Make
1. Production process
2. Manufacture
3. Test
4. Package
Deliver
1. Managing orders
2. Forecasting
3. Pricing
4. Shipping
5. Labeling
APR of quick payment discount
(360/ (pay period-discount period) x (discount/(100-discount %)
Methods to Speed Collections
1. Customer screening
2. Credit policy
3. Prompt billing
4. Discounts
5. EFTs
6. Lockbox system
7. Concentration banking
Short-term financing
1. Increased profitability
2. Decreased financing costs
1. Increased Interest rate risk
2. Decreased capital availability
Long-term financing
1. Decreased interest rate risk
2. Increased capital availability
1. Decreased profitability
2. Increased financing cost
Constant (Gordon) Growth Dividend Discount Model (DDM)
Pt = Dt (1 +g)/(r - g)
P/E ratio
P0/EPS1
Peg Ratio
(P0/E1)/G
Price-to-sales
P0/S1
Price-to-cash flow
P0/CF1
P/B ratio
P0/B0
Black-Scholes
1. No dividends
2. European-style - only exercised at expiration/maturity date
Binomial
1. Dividends
2. American-style - exercised any time prior to expiration date
Capital budgeting
process for evaluating/selecting LT investment projects
Net present value
$ amount of return
Different Rates OK
DOESN'T PROVIDE TRUE RATE OF RETURN
Profitability index
ratio of PV of net future cash inflows to PV of net initial investment
Internal Rate of Return
PV that yields NPV=0
Payback Period
Time required for AFTER-TAX CASH INFLOWS to recover initial investment in a project