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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?"

capitalization

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

Price-to-earnings ratio

Market Price/earning per share

Price-to-book ratio

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.

beta

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.

GDP

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

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

Income

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

Equity Multiplier

Total Assets/Shareholders Equity

EBIT / Interest

Times interest earned ratio

Cash Coverage Ratio

(EBIT + Depreciation) / Interest

Inventory turnover

Cost of goods Sold / Inventory

Days' Sales in inventory

365 days / Inventory turnover

Receivables turnover

Sales / Accounts receivable

Day's Sales in receivables

365 days / Receivables turnover

Total Asset turnover

Sales / Total Assets

Capital intensity

Total Assets / Sales

Profit Margin

Net Income/Net Sales

Return on Assets (ROA)

Defined as net income divided by assets.

Return on Equity ( ROE)

Net income / Total Equity

ROE

Net Income/Shareholders Equity

Price Earnings ratio

Price per share / Earnings per share

Market-to-book ratio

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

Retention ratio

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

Dividends paid

taxable income - taxes - RE

value of net working capital

NWC = current assets - current liabilities

NI

Sales - Costs - depreciation - interest - taxes

addition to RE

taxable income - taxes - dividends

Nett. income/Equity

What is the formula for ROE?

Enterprise value/EBITDA

What is the formula for the EBITDA multiple?

Enterprise value/EBIT

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

d/(r-g)

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.

Tax shield

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?

Direct costs

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.

NPV/initial investment

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

EV= Vd+Ve-Cash

How do you treat cash when calculating enterprise value and why?