Formulae and Calculations in Finance

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Questions and Answers

What is the total amount of current assets reported in the financial statements?

  • $1.9m
  • $22.0m
  • $10.0m
  • $4.6m (correct)

What is the annual interest expense on the long-term bank loan?

  • $800,000 (correct)
  • $1,500,000
  • $1,200,000
  • $1,000,000

What is the total equity of APX Co according to the statement of financial position?

  • $5.0m
  • $12.5m (correct)
  • $10.0m
  • $7.5m

If APX Co maintains its current dividend payout ratio, how much will be paid in dividends next year if anticipated operating profit is $1,200,000?

<p>$600,000 (B)</p> Signup and view all the answers

How long is the inventory turnover period forecast for APX Co?

<p>110 days (A)</p> Signup and view all the answers

What is the effective current ratio of APX Co, considering current assets and current liabilities?

<p>1.5 (C)</p> Signup and view all the answers

How many days does APX Co have for trade receivables collection in the next year?

<p>65 days (C)</p> Signup and view all the answers

What will be the forecasted interest on the overdraft for the next year?

<p>$140,000 (A)</p> Signup and view all the answers

What is the annual financial effect if management reduces the collection period to 60 days by offering an early settlement discount of 1% that all customers adopt?

<p>$85,479 benefit (D)</p> Signup and view all the answers

Which of the following services is NOT typically provided by a debt factor?

<p>Invoices management (D)</p> Signup and view all the answers

Which method is LEAST likely to be utilized in managing foreign accounts receivable?

<p>Commercial paper (A)</p> Signup and view all the answers

What is the total cost of L Co's factoring package, given a non-recourse cost of 1.5% of sales and an admin fee of $6,000 per annum, with sales of $1.5 million?

<p>$39,000 (D)</p> Signup and view all the answers

Which of the following is NOT a drawback associated with the Economic Order Quantity (EOQ) model?

<p>Assumes uncertainty in demand (C)</p> Signup and view all the answers

Which of the following is NOT a potential hidden cost of increasing credit taken from suppliers?

<p>Increased operational efficiency (A)</p> Signup and view all the answers

Which of the following would be LEAST likely to arise from the introduction of a just-in-time inventory ordering system?

<p>Greater inventory discrepancies (A)</p> Signup and view all the answers

What financial impact results from a uniform 1% early settlement discount offered to all customers?

<p>Net gain due to quicker cash flow (C)</p> Signup and view all the answers

What is the formula to calculate the Current Ratio?

<p>Current assets : Current liabilities (A)</p> Signup and view all the answers

In the context of the Interest Coverage Ratio, how is it calculated?

<p>PBIT / Interest (A)</p> Signup and view all the answers

What does the Profitability Index measure?

<p>Net present value of cash flows divided by capital investment (A)</p> Signup and view all the answers

How is the weighted average cost of capital (WACC) calculated?

<p>Value of equity / Total value * Cost of equity + Value of debt / Total value * Cost of debt (A)</p> Signup and view all the answers

What does the formula for Accounts Receivable Days measure?

<p>Accounts receivable / Credit sales * 365 days (B)</p> Signup and view all the answers

What is the formula for calculating the Dividend Yield?

<p>Dividend per share / Market price per share (A)</p> Signup and view all the answers

How do you calculate the Equivalent Annual Cost (EAC)?

<p>Present Value of cash flows / Annuity factor for the number of years (A)</p> Signup and view all the answers

In the Capital Asset Pricing Model (CAPM), what does E(ri) represent?

<p>Expected return on an investment (A)</p> Signup and view all the answers

Which formula correctly represents the calculation for Economic Order Quantity (EOQ)?

<p>SQRT((2 * C0 * D) / Ch) (A)</p> Signup and view all the answers

What is the main purpose of the Miller-Orr Model?

<p>To manage cash flows effectively (D)</p> Signup and view all the answers

How is the Cost of Equity calculated?

<p>Ke = (D0 * (1 + g)) / P0 (C)</p> Signup and view all the answers

Which of the following is NOT a liquidity ratio?

<p>Debt ratio (B)</p> Signup and view all the answers

What does $g$ represent in Gordon's Growth Approximation?

<p>Growth rate of dividends (B)</p> Signup and view all the answers

Flashcards

Economic Order Quantity (EOQ)

The optimal quantity of inventory to order to minimize total inventory costs.

Miller-Orr Model

A model used to determine the optimal cash holding level.

Return Point (Miller-Orr)

The cash level where the firm must bring in additional cash.

Capital Asset Pricing Model (CAPM)

A model used to calculate the expected return on an asset.

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Asset Beta (βa)

Measures systematic risk of an asset.

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Growth Model (Gordon)

Calculates share price based on future dividends.

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Gordon's Growth Approximation

Simplified method to calculate the estimated growth rate.

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Weighted Average Cost of Capital (WACC)

Average rate of return needed to satisfy both debt and equity investors.

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Fisher Formula

Calculates nominal interest rate from real interest rate and inflation.

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ROCE

Return on Capital Employed - measures the rate of return on the capital employed by a firm.

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Gearing

Measures the proportion of debt relative to equity.

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Interest Coverage Ratio

Measure of profitability in relation to fixed costs like interest.

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Current Ratio

Liquidity ratio measuring short-term assets in relation to short-term liabilities.

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Dividend Yield

Ratio of dividend per share to market price per share.

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Earnings Per Share (EPS)

Measure of profitability per outstanding share.

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Impact of reduced collection period with early settlement discount

Reducing the collection period to 60 days with a 1% early settlement discount can result in a $85,479 benefit and an $114,521 cost.

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Debt factoring services

Debt factoring services can include bad debt insurance, advancement of credit, receivables ledger management, and debt collection processes.

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Foreign accounts receivable management

Management of foreign accounts receivable may involve various instruments such as letters of credit, bills of exchange, invoice discounting—with commercial paper being less likely.

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Cost of factoring package

The cost of a factoring package, in this case, includes a cost of 1.5% of sales and a $6,000 annual administrative fee.

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Drawbacks of EOQ model

The EOQ (Economic Order Quantity) model might assume certain/ zero lead times, certainty in demand, a small number of suppliers, and ignore hidden costs like obsolescence risk.

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Hidden costs of increased supplier credit

Potential hidden costs of increasing credit from suppliers include damage to goodwill, loss of early settlement discounts, business disruption, and increased bad debt risk.

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Just-in-time inventory ordering impacts

Implementing a just-in-time inventory ordering system is not explicitly described so inferring impacts like reducing inventory, need for close collaboration with suppliers, and potential disruptions is appropriate.

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EOQ model's limitations

EOQ (Economic Order Quantity) assumptions might not reflect real-world conditions.

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APX Co. Current Assets

Current assets are assets that are expected to be converted into cash within a year. These include inventory, trade receivables, and cash.

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APX Co. Long-term bank loan interest rate.

8% per year.

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APX Co. Tax rate.

30% per year.

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Gross Profit Margin

Percentage of revenue remaining after deducting the cost of goods sold.

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Operating Profit Margin

Percentage of revenue remaining after deducting all operating expenses.

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Inventory Turnover Period

Number of days it takes to sell the average inventory on hand.

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Trade Receivables Period

Average number of days it takes to collect payment from customers.

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Trade Payables Period

Average number of days it takes to pay suppliers.

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Study Notes

Formulae and Calculations

  • Economic Order Quantity (EOQ): EOQ = √(2C0D / Ch), where C0 = ordering cost, D = demand, Ch = holding cost per unit per year. (Chapter 5)
  • Miller-Orr Model: Return point = Lower limit + (1/3 × spread). Spread = 3√(4 × transaction cost × variance of cash flows / interest rate). (Chapter 6)
  • Capital Asset Pricing Model (CAPM): E(ri) = Rf + βi(E(rm) – Rf), where E(ri) = expected return of asset i, Rf = risk-free rate, βi = beta of asset i, E(rm) = expected return of market portfolio. (Chapter 15)
  • Asset Beta Formula: βa = [(Ve/ (Ve + Vd(1-T))) × βe] + [(Vd(1-T)/ (Ve+ Vd(1-T))) × βd], where Ve = market value of equity, Vd = market value of debt, T = tax rate, βe = equity beta, βd = debt beta. (Chapter 16)
  • Growth Model: P0 = D0(1 + g) / (re - g), where P0 = current stock price, D0 = previous dividend, g = growth rate, re = required return on equity. (Chapter 17)
  • Gordon's Growth Approximation: g = b × re, where g = growth rate, b = retention ratio, re = required return on equity. (Chapter 17)
  • Weighted Average Cost of Capital (WACC): WACC = [(Ve / (Ve + Vd)) × ke] + [(Vd / (Ve + Vd)) × kd(1-T)], where Ve = market value of equity, Vd = market value of debt, ke = cost of equity, kd = cost of debt, T = tax rate.(Chapter 15)
  • Fisher formula: (1 + i) = (1 + r)(1 + h), where i = nominal interest rate, r = real interest rate, and h = inflation rate. (Chapter 19)
  • Purchasing Power Parity and Interest Rate Parity: S1 = S0 × (1 + hc) / (1 + hb), F0 = S0 × (1 + ic) / (1 + ib ), where S1 = future spot exchange rate, S0 = current spot exchange rate, F0 = future forward exchange rate, hc = foreign inflation rate, hb = domestic inflation rate, ic = foreign interest rate, ib = domestic interest rate. (Chapter 19)
  • Return on Capital Employed (ROCE): ROCE = Profit before interest and tax (PBIT) / Capital employed; or ROCE = Profit margin × asset turnover, where Profit margin = PBIT/Revenue, and Asset Turnover = Revenue / Capital employed.
  • Gearing: Gearing = Debt / Equity or Debt / (Debt+Equity) : can use book or market values. Also, Gearing = Prior charge capital / Equity capital (including reserves).
  • Interest coverage: Interest coverage = PBIT/Interest.
  • Liquidity ratios: Current ratio = Current assets / Current liabilities; Acid test ratio = (Current assets – Inventory) / Current liabilities
  • Shareholder investor ratios: Dividend yield = (Dividend per share / Market price per share) × 100 ; Earnings per share (EPS) = Profits distributable to ordinary shareholders / Number of ordinary shares issued; Price/Earnings (P/E) ratio = Market price per share / EPS.
  • Accounts Receivable Days: Accounts receivable days= (Receivables / Credit sales) × 365 days.
  • Inventory Days: (a) Finished goods =(Finished goods / Cost of sales) × 365 days; (b) Work-in-progress (WIP) = (Average WIP/Cost of sales) × 365 days; (c) Raw material = (Average raw material inventory/Annual raw material purchases) × 365 days
  • Accounts payable period: Accounts payable period = (Payables/Credit purchases or cost of sales) × 365 days
  • Internal Rate of Return (IRR): IRR = a + [(NPVa / (NPVa - NPVb)) × (b-a)], where a and b are discount rates, NPVa = net present value at discount rate a, NPVb = net present value at discount rate b. .
  • Equivalent annual cost: Equivalent annual cost = (PV of cost over one replacement cycle / Annuity factor for the number of years in the cycle).
  • Cost of equity: Cost of equity = D1 / P0 + g.
  • Cost of debt: Cost of debt = i(1 - T) / P0.
  • Cost of preference shares: Cost of preference shares = Preference Dividend / Market Value(ex div).
  • Profitability index: Profitability index = PV of cash flows (not including capital investment) / Capital investment

Exam Information (Specific Cases)

  • Collection Period Reduction (Exam Q): Reducing collection period to 60 days with early settlement discount of 1% would result in a $85,479 benefit.
  • Debt Factor Services: Debt factors can do bad debt insurance, advancement of credit, receivables ledger management, and debt collection process management.
  • Foreign Accounts Receivable Management: Letters of credit, bills of exchange, and invoice discounting is most common.

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