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Kelly's Finance Cheat Sheet V6

Kelly's Finance Cheat Sheet V6

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06/10/2015

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Chapter 2: Financial Statements, Taxes & Cash Flow

Income
= Revenue
–
Expenses

Earnings per share
= NI/total shares outstanding

Dividend/Share
= Total dividends/total shares o.

Cash flow from assets
= OCF - NCS -
NWC
=
Cash flow to creditors + CF to stockholders

CF to creditors
= Interest
–
net new borrowings

CF to stockholders =
Dividends
–
net new equity

OCF
= EBIT + Depreciation
–
TaxesBottom-up = Net Income + Depreciation +
Interest
Top-down = Sales
–
Cost - TaxesTax Shield = (Sales
–
cost)(1
–
T) + (Depr x T) + (
Interest
+ T)

NCS
= End net fixed assets
–
Begin NFA + Depre

NWC
= Ending NWC
–
Beginning NWC= End (CA
–
CL)
–
Begin (CA-CL)

Avg tax rate
= Tax/taxable income

Marginal tax rate
= Tax payable on next dollar earned
Chapter 3: Ratios
ST Solvency

Current ratio
= Current assets/Current liabilities
o

To creditor
–
high ratio better, but maybe inefficient cash useLow ratio - not a bad sign for company with large reserve of untapped borrowing power

Quick ratio
= (CA-Inventory)
–
CL
Cash ratio
= Cash/CL
o

Large, slow-moving inventory
ST trouble

NWC to total assets
= NWC/TA

Interval measure
= CA/Avg daily operating costLT Solvency

Total debt ratio
= (TA
–
TE)/TA
o

x% of assets financed by debt, rest by equity
o

Debt-equity ratio
= TD/TE = TD ratio/(1- TD ratio)
o

Equity Multiplier
= TA/TE = (TE + TD)/TE = 1 + D/E

LT Debt ratio
= LT Debt/(LT Debt + TE)Coverage Ratio (likelihood of default)

Times Interest Earned ratio
= EBIT/Interest

Cash coverage
= (EBIT + Depre)/InterestTurnover Ratios

Inventory turnover
= COGS/Inventory

Receivables turnover
= Credit sales/Acct receiv

Payable turnover
= COGS/Acct payable

Days’ sales in
___
= 365 days/___ turnov.Asset Turnover Ratios

NWC turnover
= Sales/NWC

Fixed asset turnover
= Sales/Net fixed asset

Total asset turnover
= Sales/TA
o

Every \$1 in TA generate \$x in salesProfitability Ratios

Profit margin
= Net income/Sales

ROA
= Net income/TA
ROE
= NI/TE = ROA x EMMarket Value Ratios

Market-to-book ratio
= Mkt value per share ÷ bk value per share

Price-sales ratio
= Price per share/Sales per share

PEG ratio
= Price-earnings ratio/earnings growth rate

Price-earnings ratio
= Price/share ÷ earnings/shareDu Pont Identity

ROE
= Profit Margin (operating efficiency) x TAT (asset useefficiency) x Equity Multiplier (financial leverage)
o

(NI/sales) x (sales/assets) x (TA/TE)

Chapter 4: LT Financial Planning & Growth

Internal growth rate
=
    

o

b
= plowback (retention) ratio
o

b
= 1- dividend payout ratio
o

b
o

Max. growth rate attain with no ext. financing

Sustainable growth rate
=
    

o

Max. growth rate attain with no ext. equity financing whilemaintaining a constant D/E ratio
Chapter 5/6: TVM


,



, PV factor = 1/(1 + r)
t

Rule of 72
: Time taken to double \$ = 72/r%

Annuit
y,




=

 

Annuity due
= start of each period

= Ordinary annuity x (1 + r)

Growing annuity
,
 
Perpetuity,


Growing perpetuity
,



EAR =



APR
=
 



APR/quoted rate
= period rate x no. of periods/year

Continuous compound
g
,




Partial Amortization

–
Balloon payment (PV of remaining)
Chapter 8: Interest Rates & Bonds

Coupon rate (pmt)
= Annual coupon/Face value (\$1000)

YTM (r)
= Rate required in mkt for bond (find r on fin cal.)
o

Current Yield + Capital Gains Yield
o

Affected by i/r, default, inflation, taxability, liquiditypremiums / bond values move inversely with interest r

Interest payments are tax deductible (1 - tax rate) x payment

Current yield
= (Coupon/current price)
YTM

Capital gain yield
= (New price
–
original price)/original price

Effective current yield = EAR

Bond value (pv)
=





o

= PV of coupons + PV of face amount

Bonds of similar risk will be priced to yield a similar returnregardless of coupon rate / interest rate decline buy zero, LT

Bonds selling at par can have any length of maturity

Longer time to mature
greater interest rate risk

Lower coupon rate
greater interest rate risk

Zero coupon bonds

need to sell more bonds and incurgreater repayment but has yearly cash inflow(in the form of interest tax shield of debt) instead of outflow

Interest payt of zero

P
1

–
P
0 ,
CF (in)

No. of bonds sold x taxrate x interest payment of zero bond

CF (out) of cupn bds:
No. of bonds x coupon payt x (1
–
tax rate)

Holding Period Yield:
r of new FV (sale price) & N (holding time)

Inflation
–
Fisher Effect
(1 + Nominal rate) = (1 + real rate) x (1 +expected inflation rate)

Know P
a
, estimate YTM
a
use it to find P
b

o

Dirty price

–
o

Clean price

–

price ‘quoted’ in mkt
= Dirty price
–
accrued interest (of coupon)
Chapter 8: Stock Valuation

Stock price
= PV of future dividends, R = required return

Dividend growth model
,


Cost of preferred stock
= dividend yield = D
1
/P
0

P
t
= D
0
x (1 + g)
t+1
/ ( R
–
g ) = P
0
x (1 + g)
t

Required return
, R =capital gains yield + dividend yield

Capital gains yield =
g
Dividend yield =
D
1
/P
0

Supernormal
, Dividend grows steadily aft t periods,





   

Chapter 9: Investment Decisions

Payback period / Discounted payback period
o

(+)tmv, easy to understand, reject (-) NPV
o

(-) arb pt, ignore CF aft, +NPV rej. cos too long

Avg Accounting Return
(Avg NI/Avg Book Value)

o

(+) easy to calculate, info available
o

(-) no tmv, bk value, not mkt or cashflow
o

Avg bk value = (initial + end)/2

IRR
(acpt if > required return or WACC) , NPV=0

o

(-) Nonconventional cash flow & Mutually exclusive projects
o

Crossover rate = IRR of NPV (B-A)
o

(+) related to NPV, easy to understand

Profitability Index
(NPV/Initial investment)

o

> 1 for +NPV, < 1 for
–
NPV
Chapter 10: Capital Budgeting (Investment decisions)

Pro forma (Sales, VC, FC, Depre, EBIT, T, NI)

X Sunk cost ,
Opportunity cost, Erosion Good prj, NPV > 0

EAC
= NPV cost on annual basis (PMT)

Aft tax salvage value = S x (1-T)

NWC returns to the firm at the end (depends on qn)
Chapter 12: Some Lessons from History

: excess return required from risky asset overrequired from risk-free investment (1: Risky asset earn riskpremium; reward for bearing risk) (2: Greater potential reward,greater the risk

Var(R) =
1/(T
–
1) x [(R
1

–

Mean)
2

+ … + (R
T

–
Mean)
2
]

Arithmetic avg return
(R
1
+ R
2

+ … R
T
)/T (>Geometric)

Geometric avg return
[(1 + R
1
) x (1 + R
2
) x … x (1 + R
T
)]
1/T

–
1
o

What actually earned per year on avg, compounded annually
o

AAR
too high for longer period, GAR
too low for shorter

Efficient capital mkt
: security prices reflect available info

Efficient mkts hypothesis
: actual capital mkt are efficient
–
NPVof projects are 0 (mkt value of investment & cost = 0)

Chapter 13: Return, Risk and SML

Expected return, E(R)
= Weighted avg of possible returns

= Expected return of stock
–
risk-free rate (R
)

Variance
,
= E[(R
–
E[R])
2
] =
 

Standard dev,
=
  

- measures volatility or total risk

Portfolio exp return =
weighted returns from each stock





Portfolio weights
,
     

Variance of 2-stock portfolio
,






Covar. btw returns R
1
and R
2
,
Cov
(R
x
,R
y
)
=
E[
(R
x

–
E[R
x
]) (R
y

–
E[R
y
])
] =


Correl. btw returns R
1
& R
2
,






Variance of N-stock portfolio
,








Variance of equally-weighted N-stock portfolio
,



    
    

Unless all stocks in portfolio hv perfect positive correlation of +1, risk of portfolio < weighted avg volatility of individual stocks

Diversification
unsystematic risks for each stock avged out

Portfolio with R
asset,
[
R
xp
] = (1
–

x
)
f
+
xE
[
R
p
]=
f
+
x
(
[
R
p
]
–

f
)

SD
[
R
xp
] =




=


 

Efficient portfolio
: no way to reduce portfolio volatility w/olowering expected return;
inefficient
: possible find another way

Efficient frontier
: set of efficient portfolios, those offeringhighest possible E(R) for given volatility, northwest edge of curve

Long
: positive investment
Short
: negative investment

Short sale
: sell a stock tt not owned then buy tt stock back later

Short sales
volatility of portfolio > volatility of stocks within

Sharpe ratio =
 

/
 
Reward-to-volatility ratio

Optimal portfolio:
Tangent to efficient frontier of risky invest.

Investor will determine how much to invest along the tangent orthe
capital market line
depending on taste of risk

CAPM
=

 




 









- measuresystematic risk.
Beta of a portfolio,

Assumptions:
buy&sell at competitive mkt prices + borrow/lendat risk-free interest rate; only efficient portfolios are held for agiven volatility; homogeneous expectations regarding future
demand same efficient portfolio (not possible in real life)

SML
–

linear r/s between a stock’s
beta

and it’s
expected return

Chapter 15: Cost of Capital = cost of (equity + debt + pref stock)

Cost of equity
, Dividend Approach,
R
= (
D
1
/
P
0
) +
g

SML Approach,
(
R
) =
R
f
+
β
x [
(
R
M
)
–

R
f
]

Use
average
of SML and Dividend approach if cannot decide

Cost of debt
, YTM on bonds / Cost of Pref Stock, R
P
= D/P
0

WACC
=
(E/V)(R
E
) + (D/V)(R
D
)(1
–
T
C
)
+ (P/V)(R
P
)

Tend to accept unprofitable investments w/ risk > than firm

Reject some +NPV & accept some
–
NPV projects

Pure play approach

–
use of WACC tt unique to particular prj

Avg floatation cost,
A
= (E/V) x f
E
+ (D/V) X f
D

True cost = Amount needed / (1
–
floatation cost%)
Chapter 17: Financial Leverage & Capital Structure Policy

M&M I:
Value of levered firm is equal to unlevered firm

V
L
= V
U

> 1.firm’
s capt. struct. irrelevant 2.firm WACC is same

borrow & lend on their own

Since R

D
< R

E
, as D/V
, WACC
, V
Equity = EBIT/R
u

M&M II:
cost of equity,
R
E
= R
A
+ (R
A

–
R
D
) x (D/E),
R
A
-WACC

1.Cost of equ rises as debt use increase 2.risk of equ depends oni. Business risk (R
A
) ii.financial risk [(R
A

–
R
D
) x (D/E)]

Required return rate on firm’s asset R
A
, cost of debt R
D
and D/E

Solve for R
E
, calculate WACC -> remains same for diff D/E ratio

R
E
= R
U
+ (R
U
–
R
D
) x (D/E),
when R
U
= R
E
= WACC, interest r > R
D

M&M I w/ taxes,

V
L
= V
U
+ (T
C
x D)
> 1. debt fin is v advantag,optimal capital structure is 100% 2.lower WACC w/ more debt

PV of interest tax shield =
(T
C
x D x R
D
)/R
D
= T
C
x D

M&M II w/ taxes, R
E
= R
A
+ (R
A

–
R
D
) x (D/E) x (1
–
T
C
) >
same

V
U
= (EBIT
–
Taxes )/R
U
= [EBIT x (1-T
C
)] /R
U
V
L
= V
U
+ T
C
x D

E = VL
–
D, find E/D, find RE using M&MII w/ taxes, find WACC

Static theory:
Too much debt increase prob. of fin distress dueto bankruptcy (optimal: tax benefit of debt = cost of distress)

Chapter 18: Dividends & Dividend Policy

Declaration date
: declares payment;
ex-dividend date
: 2business days before date of record
–
buy on day or after nodividend;
date of record
: holder of stock determined;

Capital mkt imperfection
:
Low-payout
(personal income tax +floatation cost + dividend restrictions)
High-payout
(Corp tax +institutional investing requmt + transact. costs + current income)

Clientele effect
Payout does not matter assuming equilibrium

Residual dividend approach:
payout

aftr meeting invest. needsand maintain desired D/E ratio (Dividend stability consideration)

Compromise dividend approach:

Stock repurchase:
prefer repurchase

(akin a cash dividendprogram provided no taxes or other imperf.) homemade divide.

Stock dividend/stock split:
no change in equity (trading range)

Dividend policy does not matter
–
firm reinvest capital > payhigher dividends in the future bt offset of lower PV factorassociated w/ CF
Homemade dividends policy w/ perfect mkt
),( )( )(
common toisriskthats
of Fractionof Risk Totalheldof Amountportfoliotheof volatility theon tocontributis
Security
Piiiii piiiP
R RCorr  RSD x RSD
       