Fina 4210 Test 1 Review

Project valuation

firms acquire productive capacity by assembling necessary assets

Enterprise valuation

acquisitions of entire businesses, acquiring the productive assets of an existing firms

How much of large investment projects fail to achieve their hoped-for results

over half

Potential causes of large investment projects not reaching potential

managers "go with their gut," investments in risky projects, uncertain future events, incomplete information

Five key issues to consider when a company is making a major investment

1. Does the "story" make sense?, 2. What are the risks involved in undertaking the investment?, 3. How can the investment be financed?, 4. How does the investment affect near-term earnings?, 5. Does the investment have inherent flexibilities?

Three-Phase Investment valuation process

Investment Origination and Analysis, managerial review and recommendation, managerial decision and approval

Financial statement analysis

the process of analyzing a firm's financial statements to learn about how well the firm is being managed and the firm's future performance potential

Fixed asset formula

FA of the previous year + Capex spending - Depreciation

Problems that can be detected by financial statement analysis

uncollectible accounts receivable, unsellable inventory, overstated book values of PPE, excessive probability of financial distress due to debt financing

Days Sales Outstanding

(AR/Sales) * 365, if a company is increasing their A/R a lot for earnings management, it will negatively affect their DSO

Inventory Turnover

COGS / Inventory

Days Payable Outstanding

(AP/Sales) * 365

Solving for accounts receivable using days sales outstanding

A/R= DSO * (Sales / 365)

Liquidity Ratios

current ratio, quick ratio, cash ratio

Current ratio

current assets / current liabilities

Quick ratio

(current assets - inventory) / current liabilities

Cash ratio

cash / current liabilities

Long-Term solvency Capitalization ratios

debt ratio, debt-to-equity ratio, asset multiplier

Long-Term solvency Coverage ratios

TIE ratio, EBITDA Coverage

Total debt ratio

debt / assets

Debt-to-equity ratio

debt/equity

Asset multiplier

assets/equity

TIE ratio

EBIT / interest expense

EBITDA coverage

(EBIT + depreciation expense) / Interest expense

A firm's ability to make their interest payment depends on two things

the level of its cash flows and the volatility of those cash flows

Asset and Liability Management Ratios

Inventory Turnover, Receivables Turnover, Payables Turnover

Inventory Turnover

CoGS/Inventory

Receivables Turnover

Sales/Receivables

Payables Turnover

CoGS/AP

Days Inventory Outstanding

(Inventory/COGS) * 365, How long does it take to convert inventory to a sale?

Days Sales Outstanding

How long does it take us to collect?, (AR/Sales) * 365

Days Payable Outstanding

How long are we taking to pay for our Inventory?, (AP/COGS) * 365

Cash Conversion Cycle

How long does it take to go from paying for our inventory to getting paid for our sales?, DSO + DIO - DPO

Profit margin

Net Income / Revenue

EBITDA Margin

EBITDA / revenue

Return on assets

Net income / assets

Return on equity

Net income / equity

Dupont equation

Return on assets * (assets / equity) OR (NI/Sales) * (Sales/Assets) * (Assets / Equity) OR Profit margin * Asset Turnover * Equity multiplier

P/E ratio

Share price / EPS

Market-to-Book ratio

Market cap / book equity

Market capitalization

shares outstanding * share price

Enterprise value

market value of entire firm

EV multiples

an example of one of these is EV/EBITDA

Discounted Cash Flow (DCF) process

forecast free cash flows, solve for WACC, discount FCF using WACC to estimate the value of the project

Relevant cash flows

cash flows directly generated by the investment, indirect effects that the investment may have on a firm's other lines of business

Incremental Cash Flows

projected revenues and costs of a new product, includes potential cannibalization of other existing products, sunk costs are not incremental cash flows and should be ignored

Free Cash Flow formula for a firm

EBIT * (1-T) = NOPAT, NOPAT + depr. - Capex - ΔNWC = FCF

Free cash flow formulas for a project

FCF = EBIT(1 - T) + Dep/Amort. -∆ONWC - CAPEX

Operating net working capital formula

(current assets - cash) - (current liabilities - current portion of interest bearing debt)

Contribution margin in Year T formula

(price per unit in year T - Variable cost per unit in Year T) / (price per unit in year T)

CapEx formula

Ending PP&E − Beginning PP&E + Depreciation Expense

After-Tax Salvage Value formula

Salvage Value - Tax rate * (SV-BV)