Level 116 Level 118
110 words 0 ignored
Ready to learn Ready to review
Check the boxes below to ignore/unignore words, then click save at the bottom. Ignored words will never appear in any learning session.
Earnings per share
EPS = Net Income - Dividends on Preferred Stock / Average Price
What is the "current ratio?"
Describes liquidity, not profitability, coverage or debt.
Debt to equity
Total Debt/net worth.
A measure of financial leverage
What is the "debt to equity ratio?"
used to determine the value of real estate or other property; transferring items purchased for use over an extended period of time from the cash basis income statement and recording them as assets on the balance sheet
Return on equity
Net income divided by shareholders equity
Acid test ratio
Current assets less inventory/current liabilities
Market Price/earning per share
Market price/book value per share. The ratio gives investors an idea of the relationship between the company value per share and the market value at which shares are currently trading.
responsiveness of a stocks expected return to changes in teh value of the complete marekt portfolio of that stock
Fed Funds Rate
the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis.
measures the nation's economy's performance because it is determined by the market value of all final goods and services made within the borders of the nation. GDP is focused on output rather than who prod…
GNP is basically the GDP of the country plus income earned from overseas investments by residents, minus income earned within the domestic economy by overseas residents.
Balance Sheet Equation
Assets = liabilities + shareholder's equity
Net Working Capital (NWC)
Current assets - current liabilities
∆Net Working Capital
Ending NWC - beginning NWC
mature companies with high div. payout ratios (such as utilities)
Average Tax rate
tax payment / taxable income
Cash flow from assets
cash flow to creditors + cash flow to stockholders
Operating cash flow
EBIT + depreciation - taxes
Net capital spending
ending net fixed assets - beginning net fixed assets + depreciation
Cash flow to creditors
interest paid - net new borrowing
Cash flow to stockholders
dividends paid - net new equity raised
Total Debt Ratio
(Total assets - total equity) / total assets
Debt Equity Ratio
Total debt / Total Equity
Total Assets/Shareholders Equity
EBIT / Interest
Times interest earned ratio
Cash Coverage Ratio
(EBIT + Depreciation) / Interest
Cost of goods Sold / Inventory
Days' Sales in inventory
365 days / Inventory turnover
Sales / Accounts receivable
Day's Sales in receivables
365 days / Receivables turnover
Total Asset turnover
Sales / Total Assets
Total Assets / Sales
Net Income/Net Sales
Return on Assets (ROA)
Defined as net income divided by assets.
Return on Equity ( ROE)
Net income / Total Equity
Net Income/Shareholders Equity
Price Earnings ratio
Price per share / Earnings per share
Market value per share / Book value per share
Internal growth rate
(ROA×b) / (1- ROA × b)
Sustainable Growth Rate
SGR = ROE x Retention ratio or ROE x (1-Payout ratio
Dividend payout ratio
Cash dividends / Net income
Addition to retained earnings / Net income
ending NWC - beginning NWC
change in net working capital (NWC)
New equity raised
ending equity - beginning equity - increase in equity from operations
taxable income - taxes - RE
value of net working capital
NWC = current assets - current liabilities
Sales - Costs - depreciation - interest - taxes
addition to RE
taxable income - taxes - dividends
What is the formula for ROE?
What is the formula for the EBITDA multiple?
What is the formula for the EBIT multiple?
What is the formula for the P/E multiple?
equity value/Nett income or Share price/Earnings per share
What are the pros for using Multiples?
Fast and easy indexing of companies. Requires a minimum of calculations
What are the cons of using multiples?
Multiples are a VERY quick and dirty method for valuing a company. Furthermore, companies need to be VERY similar in order use Multiples
What is the formula for Gordon's Growth model?
Re=Rf+B(Rm-Rf). Often CAPM is used to determine the required return on equity for a company.
What is the formula for CAPM and what is it often used for in Corporate Finance?
WACC= Re*We + Rd*Wd*(1-Tc)
What is the general formula for after-tax WACC?
Are there other ways to determine WACC?
Indirectly WACC can be calculated using Gordons dividend growth Model. Alternatively, Arbitrage pricing theory as well as the Fama-French model can be used to determine the WACC.
Cashflow * 1/(r-g)
What is the formula for a growing perpetuity?
What does the pecking order theory state?
Cost of financing increases with assymetric information. Companies prioritize their sources of financing, first preferring internal financing, and then debt, lastly raising equity as a "last resort". Hence: internal financing is used first; when …
Why is equity considered last resort in pecking order theory?
Equity is a less preferred means to raise capital because when managers (who are assumed to know better about true condition of the firm than investors) issue new equity, investors believe that managers think …
APV=Base case NPV+PV impact
What is adjusted present value - and what is the generalized formula?
What is a real option?
A real option is the option to postpone, change or abandon an investment creating additional value.
APV-NPV = Option value
How can you calculate the value of a real option?
What is the value drivers for real options?
When there is high uncertainty about cash flows
Re = cost of equity
What is the cost for internal financing?
What is the minimum required rate of return for internally financed projects?
WACC, but WACC is NOT the hurdle rate for all projects. Projects can easily be considered higher risk than the company's "core"-business and the hurdle rate should therefore be higher.
What is the payout ratio?
Dividends Per Share (DPS) / Earnings Per Share (EPS)
What is the dividend yield?
Dividends Per Share (DPS) / Stock price
What is the argument for payout policies being irrelevant?
Investors can easily convert their shares to cash themselves. Dividends will therefore not have any impact on the value of the firm. (Consistent with Miller and Modigliani)
What are the 2 main arguments for payout policies decreasing value?
The dividends paid out will no longer be available for financing new investments. Hence, it will be more expensive to finane investments.
What are the 2 main arguments for payout policies increasing value?
Clientele effects: Some investors will prefer dividend paying stocks and will therefore pay a premium for a dividend paying stock
What is a stock split?
A stock split will change the amount of shares in a company by a given factor. Hence, a 1-2 split will double the amount of shares - hence halve the value of each share,…
What is a stock dividend?
The company will distribute additional shares to the firm's stockholders. Overall the same as a stock split, however, the total share capital will increase with stock dividends, which it would not in the case of a stock split.
Companies can only have debt or equity
What are Modigliani & Miller's assumptions for their theorem?
What is MM proposition I?
Based on the assumptions the value of a levered company will be equal to an unlevered company
What is MM proposition II?
The WACC will remain constant regardless of capital structure.
What are the main benefits of debt?
Increased bankruptcy costs
What are the main costs of debt?
The value of debt (the tax shield) will fall.
What happens to the tax shield if personal taxes are taken into account?
What are the costs of financial distress?
What is the investment decision rule for IRR?
Invest in any project with IRR above opportunity cost of capital.
How is the profitability index of an investment calculated?
What is a preferred stock?
A stock with "guaranteed" dividends (paid before commen stock). However, often no voting rights.
How is EPS calculated?
Earnings/Number of shares, where earnings can be defined in different ways. Typically, Net Income is used.
What is enterprise value?
Equity value + debt value
How do you calculate equity value using DCF?
First value enterprise value with DCF and thereafter deduct the net debt.
EBIT and EBITDA multiples
Which multiples are used to value the full company (enterprise value)?
P/E multiple as well as P/BV
Which multiples are used to value the equity alone?
What are the pro's of IRR?
Even if you don't know the discount rate, you an still find IRR. Easy to communicate/understand.
What are the con's of IRR?
Same string of cashflows can have different IRRs. Especially a problem if you have negative cashflows.
What are incremental cashflows?
Include All Indirect Effects
Total Cash Flow =
How is the free cash flow obtained?
Adjusted Accounting Profits - I:
How do you calculate cash flow from operations?
Beta can vary greatly over time
Which issues should you mind, when estimating Beta for a stock?
How should you estimate WACC (in practice)?
Weights: Calculate both basis market values and target capital structure
Which problems can principal-agent issues lead to?
Reduced effort, high salaries, empire building, avoiding risk
What is a free rider problem?
A free rider problem arises when the equity is divided in too many small bits, without a main shareholder to "control" management. Thereby the small investers rely on others to monitor the company. This…
In connection with dividends, what happens to the stock price, and when?
The stock price will drop relative to the dividend paid out. It will drop after the ex-div date (normally a week prior the paydate)
Investors can easily diversify their portfolios themselves
Why does many shareholders prefer companies NOT to hedge risks?
In relation to capital structure, why can it make sense to hedge?
It decreases the probability (thereby indirectly the cost) of bankruptcy. A hedged position will not count as a risky investment and will to a lesser degree draw on the debt capacity
In relation to pricipal-agency issues, why does it makes sense to hedge?
To avoid managers blaming "the market", "bad luck" or "a low oil price"
From management's point of view, why does it make sense to hedge?
Removes risk from non-core activities (like Forex, debt etc.) and instead let's the management focus on taking risk in the core-business
Buy a put option.
How should you hedge your position with options if you PRODUCE oil?
Sell a forward/future
How should you hedge your position with futures if you PRODUCE oil?
What does value at risk meassure?
The worst possible loss, for a given time horizon at a given probability.
What would a VAR of $5000, t= 1 month, P=95% mean?
That with 95% certainty the maximum loss for a 1 month period would be 5000
How do you treat cash when calculating enterprise value and why?