Finance Exam I

Let's do what we can

What are the 3 primary areas of finance

• corporate finance

• Investments

• Institutions

Goal of corporate finance

maximize shareholder wealth for publicily traded firms or to maximize owner wealth for privately held companies

subdisciplies within Investments

asset manage: someone who invests funds in an attempt to earn positive returns

asset pricing: dollar value on an asset

mutual funds

portfolios of assets that are professionally managed for others to invest in

venture capital

profesionnally managed investment capital that is typically invested in very young new ventures

free cash flow to the firm FCFF

the amount of money left over after operations for shareholders and creditors

FCFF = EBIT - Taxes + Depreciation - capex - change in NWC

capex = gross Fixed assets 2024 - gross fixed assets 2023

or

capex = Net Fixed Assets 2024 - Net Fixed Assets 2023 + Depreciation

change in NWC = (CA - CL) 2024 - (CA - CL) 2023

Free cash flow equity FCFE

money leftover after operations and after paying creditors that is available for shareholders

NI + Depr - capex - change in net working capital + change in LT Debt

EVA economic value added

Economic Value Added (EVA) is a financial metric that measures a company's true economic profit by calculating the difference between its net operating profit after taxes (NOPAT) and its total cost of capital (both debt and equity). It represents the value created in excess of the required return for investors

EVA= Nopat - [wacc x costly capital]

nopat = EBIT - taxes

wacc is given to you

costly capital = Notes payable + long term debt + equity (aka interest incruing capital)

Dupont

breaks down ROE

ROE = NI/E

Dupont equation = NI/S x S/A x A/E

NI/S = net profit margin and shows profitibility

S/A = asset turnover and show efficiency

A/E show leverage multiplier

Balance sheet equation

Assets = Liabilities + Equity

Return on Assets

NI/S x S/A

Percent of Sales Forecasting

Step 1: increase of Sales

• will always be given to me

Step 2: Project spontaneous accounts

• Calculate % of sales for spontaneous accounts

  • current assets, fixed assets (if told yes), accounts payable, accrued expenses.

  • % of sales = spontaneous account/present sales

• Projected spontaneous accounts

  • % of sales * Projected sales

Step 3: Discretionary Accounts

• Notes Payable, long-term debt, equity

• they remain the same

Step 4: Project Retained Earnings

• Projected RE (BS) = RE (old) + RE*(IS)

• RE = NI - Dividends

• NPM = NI/S or NI = S * NPM

Step 5: Calculate Projected Balance sheet

• add together projected assets = added together projected liabilities and equity

Step 6: Calculate DFN

• projected assets - projected liabilities - projected equity

• the plug is what will be used to pay

• aka the financing needed to cover projected needs

SGR

ROE (1-b)

where b is divident payout ratio (dividends/netincome)

How Reduce DFN?

1.      Reduce growth

2.      Review fixed assets

3.      Review dividends

4.      Price changes (usually results in growth reduction)

Current Ratio (liquidity ratio)

current ratio = current assets / current liabilities

shows whether the company can meet its short-term obligation using cash/near cash assets

higher ratios interpreted as better liklihood that the firm will be able to meet its short-term obligations

quick ratio (liquidity ratio)

(current assets - inventory) / current liabilities

answers the same thing as the current ratio (ability to meet its short-term obligations using cash/near cash assets), but with a stricter definition of liquidity

average collection period (liquidity ratio)

AR / daily credit sales

the numbers of days it takes on average for the company to collect its receivables

annual credit sales / 365 = daily credit sales

we generally consider all sales are on credit

Accounts Receivable Turnover (liquidity Ratio)

credit sales/accounts receivable

describs the number of times a firm’s accounts receivable turns per year.

gives redundant info as average collection period

to conver ARturnover int collection period 365/ARturnover

inventory turnover (liquidity ratio)

COGS/Inventory

the number of times it turns (or sells) its inventiry annually

TAT Total Asset Turnover (efficiency)

sales/total assets

how many dollars in sales the firm generates per dollar of assets it owns

Fixed asset turnover (efficiency ratio)

sales/fixed assets

computes sales produced per dollar of fixed assets

OIROI Operating Income Return on Investment (efficiency/profitability)

operating income/ total assets

operating income = EBIT

tells us how much pretax, prefinancing profit the company generates per dollar of asset

Debt Ratio

total debt/total assets

shows what proportion of the firm is financed with debt

Times interest earned

ebit/interest expense

how many times a company covers or could pay its interest expense given its earnings

ROA

NI/Total Assets

compares a firm’s annual NI to the toal asset base used to generate that income. good for benchmarking

ROE

Net income/ total equity

looking for effectiveness of the firm’s financing policy. hard to compare firm to firm, use freaking dupont

gross margin

gross profit/sales

how much gross profit made per dollar of sales

operating margin

ebit/sales

how much made after operating expenses per dollar

net margin

NI/Sales

after taxes and interest per dollar