Assets = Liabilities + Stockholder’s Equity
Fixed Assets:
Tangible, EX: Property, Plants and Equipment;
Intangible: EX: copyrights goodwill.
Current Liability
Account Payable: trade/buy things from vender;
Notes Payable: financial debt shorter than one year, EX: loan less than one year, commercial paper;
EX. Retained Earnings, money from stock issued.Ease and quickness with which assets can be converted to cash.
own Liquid Assets, can sell immediately without losing its value, EX. Cash, Treasury Bill in low risk market.
The more liquid assets, with in certain amount of time, more ability to pay all bills.
Down side with too much liquid assets: lower return.
Notes: current assets is a proxi but not same
How much debt and Equity
Being Leverage = using more debt = More risky to be bankrupt = Increase rate of return
Debt to Equity ratio measures leverags:
Book value work with depreciation
Revenue - Expenses = Income
Revenue is recognized when earned.
transaction takes place → Account receivable created → revenue recognized
payed by customer ahead → Account Payable created → will pay back later but recognized.
Marginal: Next dollar rate
Average
Example: One earned $250,000 in taxable income:
| Rate | Bracket Size | Pay in Bracket | Left to Pay |
|---|---|---|---|
| - | - | - | 250,000 |
| 15% | 50,000 | 50,000 | 200,000 |
| 25% | 25000 | 25000 | 175,000 |
| 34% | 25000 | 25000 | 150,000 |
| 39% | 235,000 | 150,000 | - |
Total tax = 80,750, Marginal Tax Rate 39%, Average Tax Rate = 32.3%
Total Cash from Operating cash flow (OCF) measures cash generated from operations not counting capital spending or working capital requirements.
OCF = EBIT + Depreciation (because it is not cash exp.) - Taxes;
OCF = NI + Depreciation - Change in other current assets + Changes in Current Liability;
Total Cash from Investing = -Change in Net Fixed Asset - depreciation
Total Cash from Financing Activities = Change in cash -Total Cash form Operation + Total Cash from Investing
Cash flow received from the firm’s assets must equal the cash flows to the firm’s creditors and stockholders:
CF(Assets)≡ CF(Bondholders) + CF(Shareholders)
CF(Assets)≡ OCF-Change in Net Working Capital - Net Capital Spending
Creditor - Debt (Interest)
CF(Creditors)=INT EXP - LT Debt
Stockholders - Equity (Dividends)
CF(Shareholders)= Div + Company Redeemed
Net Working Capital = Current Assets - Current Liability
Change in Net Working Capital = Current Net Working Capital - Prior Net Working Capital
Net Capital Spending = Net Fixed Asset Increased + Depreciation
Chapter 3a
Current ratio =
if current ratio is $1.3, that means the company has $1.3 in current assets for every $1 in current liabilities, or it has its current liabilities covered 1.31 times over.
We expect a current ratio of at least 1.
a current ratio of less than 1 would mean that net working capital (current assets less current liabilities) is negative.
Quick ratio (Acid-test) =
Cash Ratio =
Total Debt Ratio =
larger has more leverage.
if total debt ratio is 0.28, for every $1 in assets, the company has $0.28 in debt, therefore $0.72 in equity.
Debt/Equity ratio = =
Equity Multiplier = Debt/Equity ratio
Times Interest Earned =
Cash Coverage =
Inventory Turnover =
Measures how many times you turnover the inventory in a year.
The higher, more efficiently to manage the Inventory.
Days’ Sales in inventory =
how long the good sits in the inventory before it is sold.
if Days’ Sale in inventory is 100, it means inventory sits 100 days on average before it is sold.
Receivables Turnover =
use credit sale if possible, use ending balance receivables or average of beg and end.
if RT is 12 times, means we collect money and lend again 12 times a year.
Days’ sales in receivable (Average collet credit)=
Cash Cycle = inventory period + accounts receivable period - account payable period
the smaller, the better. if negative, meaning the company receive the money from sales earlier than they need to pay the inventory.
Total Asset Turnover =
Gross Profit Margin =
GPM is 23%, meaning every dollar in sale, the company keep $0.23 as net income.
the higher, more profitable for the company.
Operating Profit Margin =
Profit Margin=
ROA(Return on Assets or Return on investment) =
ROE(Return on Equity) =
Market Capitalization = price per share * shares outstanding
PE Ratio =
what the market think the future of the firm, how much investors are willing to pay per dollar of current earnings.
higher PEs means firm has more significant prospects for future growth.
Market-to-Book ratio=
Enterprise Value (EV) = Market Capitalization + Market value of Interest bearing debt - Cash.
EV Multiple =
ROA × Equity Multiplier;
→
ROE = Profit Margin × Total Asset Turnover × Equity Multiplier.
Chapter 3b
Set up projected financials Statements.
After 20% growth in sale,Income statement Sale increase 20%($1,000 × 120%), Costs are projected by profit margin ().
But Pro Forma Balance Sheet have different ways to changes based on financial decision the company will make.
Net Income $240 is retained, to Equity increse $240, to balance out with Assets, Debt has to be retired to $110.
Only $50 from net income goes to Equity, the rest $190 pay dividends, issued new debt.
Assume all assets, including fixed, vary directly with sales.
Accounts payable normally vary directly with sales.
Notes payable, long-term debt, and equity generally do not vary with sales because they depend on management decisions about capital structure.
The change in the retained earnings portion of equity will come from the dividend decision.
Dividend Pay Out Ratio =
Retention Ratio or Plowback Ratio = dividend pay out ratio.
External Financing Needed (EFN) is the difference between the forecasted increase in assets and the forecasted increase in liabilities and equity.
EFN = (Projected year) Total Asset - Total liabilities owner’s equity.
If LT debt and equity do not change:
EFN = growth in assets - growth in account payable - additions to retained earnings
Old Assets growth rate Old Account Payable growth rate Old Net Income growth rate payout rate)
EFN is Dividend Ratio, is Retention ratio.
How much the firm can grow assets using retained earnings as the only source of financing.
IGA= is the Retention Ratio.
How much the firm can grow by using internally generated funds and issuing debt to maintain a constant debt-to-equity ratio.
g = is the Retention Ratio.
Chapter 4 Discount Cash Flow
r is the rate per period, year in this case.
positive NPV → positive investment.
Compounding: Interest applies to the principle and interests from previous period
Compounding adds up faster than Simple Interest.
Future Value: FV(rate, nper, pmt, [pv])
Present Value: PV(rate, nper, pmt, [fv])
Number of Periods: NPER(rate, pmt, pv, [fv])
Required Rate: RATE(nper, pmt, pv, [fv])
if use cell to represent anything in the formula:, A1 will change to relative cell, $A$1 will not change the cell when drag the format.
r is the rate per periods, m is the numbers of periods in a year, T is the total years of investment
Example: compounded semi-annually:
Continuous Compounding:
Discounting:
Continuous Discounting:
In previous example:
this is equal to
Solve for EAR :
A constant Payment, starts next period, lasts forever, interest rate :
A Growing Payment at rate , starts next period, lasts forever, interest rate :
discount rate > growth rate
starting as the second payment, fit with Growing Perpetuity, second payment, calculate the PV then the current payment value.
A constant payment, fixed maturity, fixed rate:
Pay principle and interest once in some future date.
Every period same interest payment : principle * interest rate
last period with additional payment of the principle.
Every period pay constant amount of principle, the interest will be different because for every interest incurred period, outstanding loan balance is decreasing. Total payment is decreasing.
Total payment for each period is same, the portion of principle is increasing, the portion of interest is decreasing.
When given the loan amount, rate, total periods, then we can calculate the fixed payment for each period.
the first payment contains interest: total loan * int rate, and and portion of principle : pmt-int.
Chapter 5
Net Present Value (NPV) = Total PV of future CF’s - Initial Investment
Payback Period = number of years to recover initial costs;
Rule: Accept the project if payback period is shorter than cutoff date;
Accept the project if it pays back on a discounted basis within the specified time.(not use that much)
| @10% | Cumulative | ||
|---|---|---|---|
| initial cost | $(10,000) | $(10,000) | $(10,000) |
| Year 1 | 1,000 | 909.09 | (9,909.91) |
| Year 2 | 4,000 | 3,305.79 | (5,785.12) |
| Year 3 | 5,000 | 3,756.57 | (2,028.55) |
| Year 4 | 6,000 | 4,098.08 | 2,069.53 |
Do not take this project if the cutoff is 3 year.
IRR: the discount rate that sets NPV to zero
Accept the project if the IRR is greater than the required return(hurdle) rate
Using IRR fail to select between mutually exclusive projects. IRR is breaking when multiple positive/negative cashflow involved.
Scaling Problem: higher return with small limit of investment.
IRR 100% profit on maximum $1 invested, or IRR 50% profit on maximum $100,000 investment.
Choose the second project but not the higher IRR.
Timing Problem: front/back loaded
same investment with larger payment in different time points, the difference will be discounted.
Find NPV(A-B)=0, this is Crossover rate.
, Accept if PY>1, select highest PI.
Meaning for every dollar invested, the future profit is greater than $1.