Module 7a - Business Finance

Free Cash Flow (FCF) formula

FCF = OCF - ΔNOWC - ΔNFA - Depr.

Operating Cash Flow (OCF) formula

OCF = NOPAT + Depr.

Net Operating Profit After Tax (NOPAT) formula

NOPAT = EBIT (1-Tax Rate)

Net Operating Working Capital (NOWC) formula

All current operating assets - current non-interest liabilities

(cash + A/R + Inventory) - (A/P + Accruals)

Change in Net Operating Working Capital (ΔNOWC) formula

ΔNOWC = current NOWC - past NOWC

Net Investment in Operating Capital (NIOC) formula

NIOC = ΔNOWC + ΔNFA

if ΔNFA increases?

FCF decreases = firm is losing cash

Steps for calculating FCF

1) calculate NOPAT
2) calculate ΔNOWC
3) calculate ΔNFA
4) calculate FCF

Economic Value Added (EVA) formula

operating income after tax - capital costs
funds available to investors - cost of capital used

(EBIT)(1-T) - (WACC)(Capital)

EBIT v. EVA

Earnings Before Interest and Taxes (EBIT)
- Taxes
- Bondholders
- Stockholders
= Economic Value Added (EVA)

What are actions to increase EVA?

- cut costs
- raise revenues
- lower financing costs
- shed assets to retire debt
- lower capital by repurchasing stocks

What are munis?

state and loval government bonds that are exempt from federal income tax

Muni v. Yield

Muni Yield = Corporate Yield (1-T)

if the tax rate > T, buy munis
if the tax rate < T buy capital bonds

Tax v. Taxable Bonds

bonds' yield may dominate depending on the buyer's tax bracket

What do liquidity ratios indicate?

the firm's capacity to meet short-run obligations

Current Ratio formula

current assets / current liabilities

Quick Ratio / Acid Test formula

(current assets - inventory) / current liabilties

What do asset management ratios indicate?

how effectively the firm is using its assets

Inventory Turnover Ratio (ATR) formula

sales / inventory

Accounts Reveivable Turnover Ratio formula

Sales / ATR

Days Sales Outstanding Ratio formula

A/R / (Sales / 360)

Fixed Assets Turnover Ratio formula

sales / Net FA

Total Assets Turnover Ratio formula

sales / total assets

What do debt management ratios indicate?

the firm's capacity to meet both long-run and short-run debt obligations

Debt Ratio formula

total debt / total assets

Time Interest Earned Ratio formula

EBIT / inverntory

what do profitability ratios indicate?

the net return or profit generated by sales and assets

Profit Margin formula

NI / sales

Return on Assets (ROA) formula

NI / tota assets

profit margin x total asset turnover

Return on Equity (ROE) formula

NI / common equity

profit magin x total asset turnover x equity multiplier

What do market value ratios indicate?

the additional value investors have gained because of actions by the firm

Earning Per Share (EPS) formula

NI / share outstanding

Price to Earnings Ratio formula

price / EPS

Book Value Per Share (BVPS) formula

common equity / shares

Market to Book Ratio formula

price / BVPS

Market Value Added formula

Total MV - Total BV

Equity Multiplier formula

total assets / common equity

What is DuPont analysis used for?

1) expense control (profit margin)
2) asset utilization (total asset turnover)
3) debt utilization (equity multiplier)

What is the trade off between profit margin and total asset turnover?

higher PM = lower TAT (ex. tech company)
lower PM = higher TAT (ex. grocery store)

What does high PM and low TAT indicate?

- high capital intensity
- monopoly
- faces capacity constraint on asset turnover
- strategic focus on PM

What does low PM and high TAT indicate?

- low capital intensity
- pure competition
- faces competitive constraint on PM
- strategic focus on asset turnover

What are adjustments for inflation?

- inventory valuations
- depreciation
- debt financing

What are some cautions when using industry comparisons?

- definition of industry
- calculations of industry averages
- distribution of ratios
- definition of ratios
- seasonal factors
- "window dressing"