basfin1 reviewer for finals
DESCRIPTION
From power points and "financial management: principles and application book" Pointers to review: 1. Introduction to Financial Management 2. Stocks 3. Financial Ratios (Analysis, etc) 4. Quick Ratio 5. Cash outflows 6. Financial Statements 7. Dividends 8. ROA, ROE 9. Time Value of Money 10. EAR 11. Future value of ordinary annuity 12. Annuity vs Perpetuity 13. Present value of cash flows 14. Bonds 15. Bond's yield to maturity 16. Book value per share 17. Preferred vs Common stock 18. Annual Rate of return 19. Risk & Return 20. Payback period 21. Capital Budgeting 22. NPV 23. Cost of Capital 24. Dividend policy (Ex dividend date) 25. Retained EarningsTRANSCRIPT
I. Introduction to Financial Management Finance-‐ the study of how individuals and business allocate money over time Three (3) Basic Questions Addressed by Finance: 1. What long-‐term investment should the firm undertake? (CAPITAL BUDGETING) 2. How should the firm raise money to fund these
investments? (CAPITAL STRUCTURE) 3. How can the firm best manage its cash flows as they
arise in its day-‐to-‐day operations (WORKING CAPITAL MANAGEMENT)
Three (3) Types of Business Organizations: 1. Sole Proprietorship—owned by single individual who is
entitled to all of the firm’s profits and is also responsible for all the debts.
2. Partnership—two or more who come together as co-‐owners for the purpose of operating a business for profit
3. Corporation—an artificial being with legal functions separate and apart from its owners (the shareholders / stockholders)
Four (4) Basic Principles of Finance 1. Money Has Time Value – a dollar received today is
worth more than a dollar received in the future and vies versa.
2. There is a Risk-‐Return Tradeoff – we won’t take additional risk unless we expect to be compensated with additional return
3. Cash Flows Are the Source of Value – Profit Is an accounting concept designed to measure a business’s performance over an interval of time. Cash flow is the amount of cash that can actually be taken out of the business over this same interval.
4. Market Price Reflect Information – Investors respond to new information by buying and selling their investment. The speed with which investors act and the way that prices respond to the information determines the efficiency of the market.
II. Stocks
Security—is a negotiable instrument that represents a financial claim (stocks or debt agreements) Two (2) Types of Security Markets:
1. Primary Market – market that is new as opposed to previously issued, securities are bought and sold for the first time
2. Secondary Market – all subsequent trading of previously issued securities takes place.
How Security Markets Link Corporations and Investors:
a) The firm sells securities to investors (a primary market transaction of debt or equity of the corporation)
b) The firm invests the funds raised from transaction into businesses
c) The firm distributes the cash earned from its investments (investors gain cash through cash dividends or repurchase of shares of previously issued stock)
d) Securities trading in the secondary market (after (a) investors may resell debt or equity purchased from corporation)
Two (2) Types of Securities: 1. Debt Securities – a firm borrows money by selling
debt securities in the debt market. a. Bonds—a long term (10 yrs. or more)
promissory note issued by the borrower, promising to pay the owner of the security a predetermined amount of interest each year
2. Equity Securities – represents ownership of the corporation
a. Common Stock – represents residual ownership of firm. Usually entitles the owner to vote at shareholder’s meetings and to receive dividends.
b. Preferred Stock– holds preference over common stock in terms of the right to the distribution of cash (dividends) and the right to the distribution of proceeds in the event of the liquidation and sale of the issuing firm. Generally does not have voting rights, but has a higher claim on assets and earnings than the common shares.
Stock Valuation —The more people that want to buy stock, the higher its price will be.
𝑃𝑟𝑖𝑐𝑒/ 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑅𝑎𝑡𝑖𝑜 =𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
=𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑜𝑛 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑆𝑡𝑜𝑐𝑘
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑆ℎ𝑎𝑟𝑒𝑠
III. Financial Ratios (Analysis, etc)
A. Liquidity Ratio – Measures of the ability of the firm to pay its bills in a timely manner when they come due
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜 =𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝐴𝑐𝑖𝑑 𝑇𝑒𝑠𝑡 𝑅𝑎𝑡𝑖𝑜 =𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑
=𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑖𝑒𝑣𝑎𝑏𝑙𝑒
𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒365 𝑑𝑎𝑦𝑠
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜
=𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑖𝑒𝑣𝑎𝑏𝑙𝑒
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑 𝑆𝑜𝑙𝑑
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠
B. Capital Structure Ratio – The mix of debts and equity
securities a firm uses to finance its assets
𝐷𝑒𝑏𝑡 𝑅𝑎𝑡𝑖𝑜 =𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝑇𝑖𝑚𝑒𝑠 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑎𝑟𝑛𝑒𝑑 =𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒/𝐸𝐵𝐼𝑇
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒
C. Assets Management Efficiency Ratios – Measures how
well assets are managed to generate sales
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =𝑆𝑎𝑙𝑒
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =𝑆𝑎𝑙𝑒
𝑁𝑒𝑡 𝑃𝑙𝑎𝑛𝑡 𝑎𝑛𝑑 𝐸𝑞𝑢𝑖𝑝𝑚𝑒𝑛𝑡
D. Profitability Ratio – Answer the question “has the firm
earned adequate returns on its investments?”
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 =𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
𝑆𝑎𝑙𝑒𝑠
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛
=𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒/𝐸𝐵𝐼𝑇
𝑆𝑎𝑙𝑒𝑠
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 =𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝑆𝑎𝑙𝑒𝑠
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐴𝑠𝑠𝑒𝑡𝑠
=𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒/𝐸𝐵𝐼𝑇
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦 =𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝐶𝑜𝑚𝑚𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦
E. Market Value Ratio – Answers the question “how are
the firm’s shares valued in the stock market?” 𝑃𝑟𝑖𝑐𝑒/ 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑅𝑎𝑡𝑖𝑜
=𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
𝑀𝑎𝑟𝑘𝑒𝑡 𝑡𝑜 𝐵𝑜𝑜𝑘 𝑅𝑎𝑡𝑖𝑜 =𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟�𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
FINANCIAL ANALYSIS Questions: Category of Ration Used to
Address the Questions
1. How liquid is the firm? Will it be able to pay its bills as they come due?
Liquidity Ratio
2. How has the firm finance the purchase of its assets?
Capital Structure Ratio
3. How efficient has the firm’s management been in utilizing its assets to generate sales?
Asset Management Efficiency Ratios
4. Has the firm earned adequate returns on its investments?
Profitability Ratio
5. Are the firm’s managers creating value for shareholders?
Market Value Ratio
IV. Quick Ratio
Since Current ratio assumes that firms account receivables will be collected and turned into cash on a timely basis and inventories can be sold without delay, QUICK RATIO takes into account that inventories might not be very liquid.
𝑄𝑢𝑖𝑐𝑘 (𝐴𝑐𝑖𝑑 𝑇𝑒𝑠𝑡) 𝑅𝑎𝑡𝑖𝑜
=𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
V. Cash outflows
STATEMENT OF CASH FLOW Ending cash balance of 2009 (beginning balance of 2010
$94.50
A) Operating Activities Net Income $204.75
Increase in accounts receivables (22.50) Increase in inventories (148.50) No change in other current assets
-‐
Depreciation expense 135.00 Increase in Accounts Payable 4.50 No Change in accrued expenses -‐
Cash Flow From Operating Activities
$173/25
B) Investing activities Purchase of plant and equipment (175.50) Cash Flow from Investing Activates
(175.50)
C) Financing Activities Increase in short-‐term notes (9.00) Increase in long-‐term notes 51.75 Cash Dividends paid to share holders
($45.00)
Cash Flow from Financing Activities
($2.25)
Increase (decrease) in cash during ($4.50)
the year End Cash Balance for 2010 $90.00
VI. Financial Statements Four (4) basic financial statements and basic information for each i. Income Statement – includes the revenue, expense,
and profit made by the firm over a specific period of time
ii. Balance Sheet – is a snapshot of the firms assets, liabilities, and owner’s equity for a particular date
iii. Cash Flow Statement – cash received and spent over a specific period of time. § Operating Activities – includes sales and
expenses (cash activity that affects net income) § Investment Activities – includes cash flow that
arise out of the purchase and sale of long-‐term assets such as plant and equipment
§ Financing Activities – represents changes in debts and equity. It includes the sale of new shares of stock, the repurchase of outstanding shares, and the payment of dividends
iv. Statement of Shareholder’s Equity – provides detailed accounts on firm’s activities such as: § Common and Preferred stock accounts § Retained earning accounts § Changes in owner’s equity that do not appear in
the income statement Three (3) uses of financial statements in management
1) Financial Statement Analysis – asses current performance
2) Financial Control – monitor and control operations using accounting measures
3) Financial Forecasting or Planning – financial statements are universally understood format for describing operations and is used as a prototype for financial planning models
VII. Dividends Dividends—a portion of corporation’s earnings that are distributed to its shareholders 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
= 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑡𝑜𝑐𝑘 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠
𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑆ℎ𝑎𝑟𝑒
VIII. ROA, ROE
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦 =𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝐶𝑜𝑚𝑚𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐴𝑠𝑠𝑒𝑡𝑠 =𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
IX. Time Value of Money A dollar received today, other things being the same, is worth more than a dollar received years from now.
X. EAR Effective Annual Rate—indicates the interest rate paid or earned in one year without compounding
𝐸𝐴𝑅 = 1 +𝑄𝑢𝑜𝑡𝑒𝑑 𝐴𝑛𝑛𝑢𝑎𝑙 𝑅𝑎𝑡𝑒
𝐶𝑜𝑚𝑝𝑖𝑛𝑑𝑖𝑛𝑔 𝑃𝑒𝑟𝑖𝑜𝑑 𝑝𝑒𝑟 𝑌𝑒𝑎𝑟 (𝑚)
!
− 1
XI. Future value of ordinary annuity
Ordinary Annuity – payments are made at the end of each month.
𝑭𝑽𝒏 = 𝑷𝑽 𝟏 + 𝒊 𝒏
XII. Annuity vs Perpetuity a) Annuity is defined as a series of equal dollar or peso
payments that are made at the end of equidistant points in time such as monthly, quarterly, annually over a finite period of time such as three years while
b) Perpetuity is simply an annuity that continues forever or has no maturity.
XIII. Present value of cash flows
𝑷𝑽 = 𝑭𝑽𝒏𝟏
(𝟏 + 𝒊)𝒏
𝑭𝑽𝒏 = 𝑷𝑽 𝟏 + 𝒊 𝒎𝒎𝒏
Intraperiod Compounding – compounding that occurs more than once a year.
XIV. Bonds An obligation made binding by a money forfeit; also: the amount of money guarantee
Bond Value = i1 − 1
1 + YTM!"#$%&!
YTM!"#$%&
+ Principal1
1 + YTM!"#$%&!
BASIC FEATURES: 1. Bond Indenture—is the legal agreement between
the firm issuing the bonds and the trustee who represents the bond holders
2. Claims on Assets & Income—If the borrowing firm is unable to repay the debt, the claims of the debt holder must be honored before thos of the firm’s stockholders
a. If interest on bond is not paid, bond trustees can classify the firm as insolvent and force it into bankrupcy
3. Par or Face Value—an amount that must be repaid to the bondholder at maturity
4. Coupon Interest Rate—idicates the percentage of the par value bond that will be paid out annually in the form of interest
5. Maturity and Repayment of Principal—indicates the length of time until bond issuer returns he par value to the bondholder and terminates or redeems the bond
6. Call Provision and Conversion Features-‐-‐ is most valueable when the bond is sold during a period of abnormally high rate of interest, such that there is reasonable expectation that rates will fall in the future before bond matures.
a. Conversion Features-‐-‐ allos the bondholders to convert the bond into a prescribed number of shares of the firm’s common stock
TYPES OF BONDS 1. Secure vs Unsecured
a. Secured bond has specific assets pledged to support repayment of the bond.
b. Unsecured bond applies debenture (any form of unsecured long-‐term debt).
2. Priority of Claims – refers to the place in line where the bondholders stand in securing re-‐payment out of the dissolution of the firm’s assets.
3. Initial offering market – bonds are also classified by where they were originally issued (in the domestic bond market or elsewhere.
4. Abnormal Risk – Junk, or high-‐yield, bonds have a below-‐investment grade bonding rating (facing severe financial problems and suffering from poor credit ratings)
5. Coupon level – bonds with a zero or very low coupon are called zero coupon bonds
6. Amortizing or Non-‐Amortizing a. Amortizing bonds, like a home mortgage loan,
include both the interest and a portion of the principal.
b. Non-‐amortizing bond, only include interest. 7. Convertibility – Convertible bonds are debt
securities that can be converted into a firm’s stock at a pre-‐specified price
CURRENT YIELD Refers to the ratio of the annual interest payment to the bond’s current market price.
CY =Annual Interest Payment
Current Market Price of Bond
XV. Bond's yield to maturity
Bond Price =𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡!"#$ !
(1 + 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟𝑎𝑡𝑒)!
+𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡!"#$ !
(1 + 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟𝑎𝑡𝑒)! +⋯
+𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡!"#$ !
1 + 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟𝑎𝑡𝑒 !
+𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙
(1 + 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟𝑎𝑡𝑒)!
XVI. Book value per share
Book Value per Share =Common Shareholders! EquityCommon Share Outstanding
XVII. Preferred vs Common stock
Common Stock—entitles the owner to vote at shareholder’s meetings and to receive dividends.
a) Has no maturity date b) Life is limited only to the life of the issuing firm. c) Common dividends have no maximum or
minimums d) Valuation differs from the the valuation of
preferred stock since common stock has no promised dividends.
Preferred stock – generally does not have voting rights, but has a higher claim on assets and earnings than the common shares.
XVIII. Annual Rate of Return Rate of Return—Also known as holding period return is simply the cash return divided by the beginning stock price
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛
= 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦!+ 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦! +⋯+ 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦!
XIX. Risk & Return
Cash Return – The gain or loss on an investment 𝐶𝑎𝑠ℎ 𝑅𝑒𝑡𝑢𝑟𝑛 =𝐸𝑛𝑑 𝑃𝑟𝑖𝑐𝑒 + 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 − 𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒 Break Even Point
𝐵𝐸𝑃 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠 =𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡
1 − 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡
Standard Deviation 𝜎 = ([𝑟! − 𝐸 𝑟 ]!×𝑃𝑏!) +⋯+ ([𝑟! − 𝐸 𝑟 ]!×𝑃𝑏!) Variance 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = 𝜎!
XX. Payback period
XXI. Capital Budgeting Typical Capital Budgeting Process:
a) The firm’s management identifies promising investment opportunities
b) Once an investment opportunity has been identifies, its value-‐creating potential, what some refer to as its “value position” is thoroughly evaluated
Types of Capital Investment Project: a) Revenue enhancement investment projects b) Cost-‐reduction investment projects c) Mandatory investments that are a result of
government mandates Net Present Value Criterion: is an estimate of the impact of the investment opportunity on the value of the firm
XXII. NPV Net Present Value—It compares the cost of investment to the present value of the investment’s inflows and outflow as time passes.
OR
A) Independent investment project is one that stands alone and can be undertaken without influencing the acceptance or rejection of any other project. Choosing Between Mutually Independent Investment:
1. Calculate NPV; 2. Accept the project if NPV is positive and reject if it
is negative.
B) Exclusive investment project is one that does not stand alone and can influencing the acceptance or rejection of any other project when undertaken. i. If mutually exclusive investments have equal lives, we
simply calculate the NPVs and choose the one with the higher/highest NPV. EXAMPLE: all alternatives last for 10 years
ii. If mutually exclusive investments do not have equal lives, we calculate the Equivalent Annual Cost (EAC), the cost per year; then select the one that has the lower/lowest EAC. EXAMPLE: one alternative last for 10 years while the other only last for 6 years
Choosing between Mutually Exclusive Investment: 1. Compute NPV 2. Compute EAC as per equation 11-‐2
𝐸𝐴𝐶 =𝑃𝑉 𝑜𝑓 𝐶𝑜𝑠𝑡𝑠
(1 + 𝑘)! + (1 + 𝑘)! +⋯+ (1 + 𝑘)!
XXIII. Cost of Capital
Cost of capital is the weighted average of the required returns of the securities that are used to finance the firm
𝑊𝐴𝐶𝐶 = 𝑘!× 1 − 𝑇 ×𝑤! + (𝑘!"×𝑤!") WACC—weighted average cost of capital kd—after tax cost of debt wd—proportion of capital raised by debt kcs—cost of common stock wcs—proportion of capital raised by common stock T – tax rate
XXIV. Dividend policy (Ex dividend date)
XXV. Retained Earnings
A portion of net income that has been retained from the prior years’ operation
𝑅𝐸 = 𝐵𝑒𝑔.𝑅𝐸 + 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠
NPV =CF0 +CF1(1+ k)1
+CF2(1+ k)2
+.....+ CFn(1+ k)n
NPV =CF0 +CF1(1+ k)1
+CF2(1+ k)2
+.....+ CFn(1+ k)n
MOST USED FORMULAS IN THE FINALS: (That I remember)
𝑃𝑉 = 𝐹𝑉!1
(1 + 𝑖)!
𝐹𝑉! = 𝑃𝑉 1 + 𝑖 𝑚
!"
𝐹𝑉! = 𝑃𝑉 1 + 𝑖 !
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦 =𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝐶𝑜𝑚𝑚𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐴𝑠𝑠𝑒𝑡𝑠 =𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝑁𝑃𝑉 = 𝐶𝐹! +𝐶𝐹!
1 + 𝐼𝑅𝑅 ! = 0
𝐼𝑅𝑅 = 𝐶𝐹!−𝐶𝐹!
! − 1
𝐸𝐴𝐶 =𝑃𝑉 𝑜𝑓 𝐶𝑜𝑠𝑡𝑠
(1 + 𝑘)! + (1 + 𝑘)! +⋯+ (1 + 𝑘)!
𝑄𝑢𝑖𝑐𝑘 (𝐴𝑐𝑖𝑑 𝑇𝑒𝑠𝑡) 𝑅𝑎𝑡𝑖𝑜
=𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛= 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦!+ 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦!+⋯+ 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦!
𝑊𝐴𝐶𝐶 = 𝑘!× 1 − 𝑇 ×𝑤! + (𝑘!"×𝑤!")
Book Value per Share =Common Shareholders! EquityCommon Share Outstanding
Bond Value = i1 − 1
1 + YTM!"#$%&!
YTM!"#$%&
+ Principal1
1 + YTM!"#$%&!
𝑅𝐸 = 𝐵𝑒𝑔.𝑅𝐸 + 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠
NPV =CF0 +CF1(1+ k)1
+CF2(1+ k)2
+.....+ CFn(1+ k)n