BEC Chapter 3B
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Degree of Operating Leverage
(DOL)

Degree of Financial Leverage
(DFL)

Degree of Combined (Total) Leverage
(DCL)

Weighted Average Cost of Capital (WACC)  Formula
WACC = (Cost of Equity * % of Equity in Capital Structure) + (Cost of Debt * % of Debt in Capital Structure)

Weighted Averaged Interest Rate
= Effective Annual Interest Payments/Debt Cash Available

Symbol: Cost of Debt (PreTax)
 Kdt
 = Effective Interest Rate

Symbol: After Tax Cost of Debt
Kdx

Formula: After Tax Cost of Debt

Symbol: Cost of Preferred Stock
Kps

Symbol: Net Proceeds of Preferred Stock
Nps

Symbol: Preferred Stock Cash Dividend
Dps

Formula: Cost of Preferred Stock

Symbol: Cost of Retained Earnings

Symbol: Market Risk Premium



Formula: The Market Risk Premium


Formula: The Risk Premium

Solve for Cost of Retained Earnings using CAPM

Symbol: Current Market Value of Outstanding Common Stock

Symbol: The Dividend per share Expected at the End of the Year

Symbol: Constant Rate of Growth in Dividends
g

Solve for Cost of Retained Earnings using the DCF Model

Solve for Cost of Retained Earnings using BYRP Method

Formula: Profit Margin
Profit Margin = Income/Sales

Formula: Investment Turnover
Aka: Asset Turnover
Investment Turnover = Sales/Invested Capital

Solve for Return on Investment (ROI):
2 Formulas
1) ROI = Income/Investment Capital
2) ROI = Profit Margin * Investment Turnover

Formula: Required Return
2 Formulas
1) Required Return = NBV * Hurdle Rate
2) Required Return = Investment * Cost of Capital

Formula: Net Book Value
NBV = Historical Cost  Accumulated Depreciation

Formula: Solve for Residual Income
RI = Net Income  Required Return
RI = NI  (Hurdle Rate * (Historical Cost  Accumulated Depreciation))

Solve for Economic Value Added
2 Steps
1) Investment * Cost of Capital = Required Return
2) Income after tax  Required Return = EVA

Formula: Debt to Capital Ratio
Total Debt / Total Capital

Formula: Debt to Asset Ratio
Total Debt / Total Assets

Formula: Debt to Equity Ratio
Total Debt / Total Equity

Formula: Current Ratio
Current assets / Current Liabilities

Formula: Net Working Capital
Current AssetsÂ  Current Liabilities

Formula: Quick (Acid Test) Ratio
(Cash + Receivables + Investments)/Current Liabilities

APR of Quick Payment Discount
example: 1\10 net 30

Formula: Economic Order Quantity
(EOQ)
 E = Order Size
 S = Annual Sales (in Units)
 OÂ = Cost per Purchase Order
 C = Carrying Cost per Unit

Purpose of EOQ
EOQ of inventory control anticipates orders at the point where carrying costs are nearest to restocking costs
The objective is to minimize total inventory costs

Formula: Inventory Turnover
= COGS/Average Inventory

Formula: Inventory Conversion Period

Formula: Accounts Receivable Turnover

Formula: Receivable Collection Period
(Days  Sales  Outstanding)

Definition: The overall cost of capital is the:
Rate of return on assets that covers the costs associated with the funds employed

When does Financial Leverage Increase
DFL increases when the debttoequity ratio increases
Using a high % of debt (bonds) for future investments would increase financial leverage

The imputed interest rate used in the residual income approach for performance measurement and evaluation is the
Historical Weighted Average Cost of Capital for the Company

Formula: Cash Conversion Cycle
Inventory Conversion Period + Receivables Collection Period  Payables Deferral Period

Accounts Payable Turnover

Formula: Accounts Payable Deferral Period

Formula: Market rate of interest

Definition: Materials Requirement Planning
MRP is an inventory management technique that projects and plans inventory levels in order to control the usage of raw materials in the production process
Applies primarily to WIP and Raw Materials