Finance & Accounting

Frameworks
Finance and accounting concepts for use in
case interviews
Capital Asset Pricing Model (CAPM)
The first step in arriving at an appropriate discount rate for a given investment is determining
the investment's riskiness. The market risk of an investment is measured by its "beta" (ß),
which measures riskiness when compared to the market as a whole.
An investment with a beta of 1 has the same riskiness as the market (so when the market
moves down 10 percent, the value of the investment will on average fall 10 percent as well).
An investment with beta of 2 will be twice as risky as the market (so when the market falls 10
percent, the value of the investment will on average fall 20 percent).
Once the consultant has determined the beta of a proposed investment, he can use the Capital
Asset Pricing Model (CAPM) to calculate the appropriate discount rate (r):
r = rf+ b(rm– rf)
Where r is the discount rate, rfis the risk-free rate of return, rmis the market
rate of return and b is the beta of the investment
Weight Average Cost of Capital (WACC)
The interest rate you use will be the WACC Weighted Average Cost of Capital (I)
WACC is composed of the cost of debt and cost of equity.
WACC = (Debt *(Cost of Debt)/(Debt + Equity)) + (Equity *(Cost of Equity)/(Debt +
Equity))
Once the consultant has determined the beta of a proposed investment, he can use the Capital
Asset Pricing Model (CAPM) to calculate the appropriate discount rate (r):
r = rf+ b(rm– rf)
Where r is the discount rate, rfis the risk-free rate of return, rmis the market
rate of return and b is the beta of the investment
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Net Present Value (NPV)
The NPV is a project's net contribution to wealth. Net present value is the present value (PV)
of all incremental future cash flow streams minus the initial incremental investment. The
present value is calculated by discounting future cash flows by an appropriate rate (r), usually
called the opportunity cost of capital, or hurdle rate. Ct represents the cash flow at time t. (Ct
can be negative, as in the initial investment, Co.) The NPV is calculated as follows:
NPV = C0 + Cl/(l+r) + C2/(l+r)2 + C3/(l+r)3 +... + Ct/(l+r)t
If the net present value of the project is greater than zero, the firm should invest in the project.
If the net present value is less than zero, the firm should not invest in the project.
Cost Driver Analysis
This analytical tool can help you understand what makes a particular kind of cost go up or
down. These areas will be covered in Managerial Accounting, but here is an overview:
Cost Drivers
Materials Commodity Prices
Product Formula
Scrap Level
Direct Labor Labor Policies
Wage Rates
Throughput Rate
Indirect Labor Size Of Staff
Wage Rates
Plant Output
Overhead Capacity Utilization
Allocation Methods
Staff Size
Office Expenses
Accounting Basics—Income Statement
Net Income
- Cost of Good Sold (COGS)
Labor
Materials
Overhead/Delivery
Gross Margin
- Depreciation
- Sales, General & Administration (SG&A)
Operating Profit
- Interest Expense
Earnings Before Taxes (EBT)
- Taxes
Net Income
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Accounting Basics—Balance Sheet
Assets
Cash
Accounts Receivables
Inventories
Investments
Property, Plant & Equipment
Intangibles
Total Assets
Liabilities
Accounts Payable
Short Term Debt
Long Term Debt
Other Liabilities & Reserves
Shareholders' Equity
Common Stock
Retained Earnings
Total Liabilities & Shareholders' Equity