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**indicates the rec'bles quality &
**

the success of the co. in

collecting o/s rec'bles. Faster

Remember TSA - turnover gives credibility to

Turnover =

the current & acid test ratios

Sales(numerator

) divided by Ave

(denominator)

**Accts Rec'bles
**

Turnover

reducing A/R wud improve TO ratio

numerator is sales

except for AP &

Inventory (COGS)

denominator is

average of the

name of the

formula

**this measures of how
**

quickly inventory is sold is

an indicator of co.

performance. The higher the

turnover in gen, the better

the performance

**a high ratio indicates effecive
**

assets use to generate sales

Inventory

Turnover

Total Assets

Turnover

A/P Turnover

Compute COGS if not given

Net Cr Sales

COGS

Net Sales

COGS

Ave Net Receivables

Ave Inventory

Ave Total Assets

Ave Net A/P

**AVERAGE TURNOVER IN DAYS -just reverse the turnover ratio and divide the deno
**

indicates the ave. no. of days

required to collect A/R; the

more he sales are o/s. the

longer the rec'bles are o/s

A/R Turnover in

days aka Days

Sales O/S

numerator is

average of the

name of the ratio

denominator of

turnover ratio

divided by 365

days

**indicates the average no. of
**

days required to senn

inventory

**indicates the no. of days bet.
**

Acq'n of inventory and

realization of cash fr selling of

inventory

Inventory

+ Turnover in days = Operating Cycle

Inventory

Conversion Period

same result as days

of COS in Inventory

= Ave Inventory

over (COGS/365)

Ave Net Receivables

Ave Inventory

365

Net Cr Sales/365

COGS/365

Inventory Turnover

**Measures the time from cash outlay to cash collection in days. The CCC can be shortened in
**

increasing inv. turnover, collecting Rec'bles more quickly or deferring remitances on payables for a

longer period o time. Can be calculated by simply adding the results of 365/INV TO ; 365/A/R TO

and 365/ A/P TO. Use to evaluate co. liquidity - the ability of the co meet its obligation as they

become due.

**Cash Conversion Cycle (CCC)
**

.

**Annual Percentage Rate (APR) o
**

quick paymt discount

.

how long does it take for a co to buy inventory on credit fr a vendor, sell that inventory on credit, collect cash for the sale

and use the proceeds to pay the vendor for the purchase

Inventory Conversion

+

Period

Receivables

Collection Period

Payables Deferral

Period

.

365

Pay period less Discount

x

Period

**RETURN - same formula as "TURNOVER" but instead of sales in the numerator, use
**

is the profitability ratio that

**Remember RNA produces a % output making it
**

- Return = easy to campare companies

that differ in sizes

NI(numerator)

divided by

Average(denomi

nator)

Return of Total

Assets (ROA)

measures co.'s % return

relative to its capital

investment risk without

regard to the method of

financing (Income over

Invested Capital)

Return on

Investment

(ROI)

**a critical measure for determining a co.'s effectiveness; measure of
**

the rate of return earned by a company on the equity component of

its capital structure. Shows how well a co. is using its funds to

generate earnings.

Return on Equity

(ROE)

Return on Common

Equity

**evaluates profitability of a firm
**

Numerator is Net

Income

Net Income (NI)

NI + Int (1-Tax Rate)

Net Income

NI-Preferred Dividends

Denominator is

average of name of

the ratio

Ave Total Assets

**Ave Invested Capital
**

(LT Liab + Equity)

Total Equity

Ave Common Equity

**indicates profit rate & used
**

when used with the asset

turnover ratio, indicates rate

of return on assets

Profit Margin

OR

Profit Margin

x Investment Turnover

****Assets valuation can
**

impact ROI and ROA results

result RATIOS involves managing CA (esp cash) & CL so that a co. Adequate Working capital (WC) reserves mitigates risk. High leverage means higher risk but greater possible returns Operating leverage A co. with high operating leverage must produce sufficient sales sales revenue to over its high fixed operating costs but will be highly profitable once those fixed costs are met. Labor-inensive industries generaaly have low opearating leverage. down risk up Conservative WC mgt increase the ratio of CA to non CA (nore CA financed by non CL : WC up. current ratio up . Firms hat rely more heavily on fixed costs as opposed to variable costs will have higher levarage. risk down WC risks less WC inreases risks by exposing a co to the likelihood of a possible failure to meet current obligations and increases risks bec. current ratio. can meet its current obligations in an efficient manner. retains profit after paying taxes Net Income (NI) Pretax income Interest burden Pretax Income x EBIT x after crossing out.. ability to meet current obligation w/o liquidating its inventory = .Net Income (NI) Sales invested capital capital can also be computed as ave working capital plus ave PPE Ideal to invest in SBUs with higher ROI or ROE measures the effect on a firm's proftability caused by a change in sales. potemtially reduce returns and thereby increase profitability Aggressive WC mgt increae the ratio of CL to nonCL (more CA financed with CL : WC down. measures the extent to w/c co uses debt in its capital structure (must be w/in risk appetitie Financial Leverage Ave Total Assets Equity Extended Dupont Retu Tax burden x x reflects how much in pretax inc a co retains after paying interest to debt holders extent to w/c a co. The current and quick r Working Capital (WC) Managementwealth. Capital intensive industries often have high operating leverage. It Quick (Acid Test) Ratio used in working capital analysis to evaluate firm's short-term liquidity.

liquidity and safet Dsiadvantage of high cash levels = ROA down Either speeding up cash inflows or slowing down cash outflows increases cash balances Method to speed collection Customer screening and credit policy . higher current ratio is better.are bank requirement related to a loan . concern of treasurer . drafts (increases payable float) .Current ratio or WC ratio measures the no. the % of customers avaling disc & rest do not avail disc to meet payments arising fr ordinary vourse of buisiness cash maybe needed to take advatange of temporary opportunities to maintain safety cushion to meet unexpected needs. improving ratio an inc ability to pay off CL. dec in CA or combination of both.is the difference bet the balance of checks o/s which have not cleared in the bank and deposits made b .use of draft delays a cash disbursement and increases payable float Overdraft protection . = = if only terms of discount is given. of times CA exceed CL and way of measuring short-term solvency and also shows ability of the firn to generate cash to meets its short-term obligations. line of credit & zero balance account Tools for Cash Management Float . increase in short-term debt.OD loans is activated when an OD occurs and maybe automatically paid with next deposits compensating balances . decline in of ratio implies a reduced ability to generate cash. and attributable to using LT borrowing to repay shot-term debt cost of credit discount aka cost of not taking discount aka memorize Annual Percentage Rate (APR) of quick paymt discount Average collection period in days Motives for holding cash Transaction motive Speculative motive Precautionary motive .bank requires a certain balance to be maintain Interest paid to compute effective int rate with a compensating balance ex loan of $200k @ 12% w/ 20 % compensating balance Net proceeds . prompt billing and payment discount Expedite deposits Electronic Fund Transfer & Lockbox systems Methods to delay disbursements defer payment.

the lower the ratio .A/R Management balancing credit and collection policies to optimize ave colletion period and numbre of days' sales in receivables factor (sell) its receivables to get more quicly but its costly therefore this shld be the last resort sale of A/R to a fac lockbox system . position.is used to accelerate the inflow of funds Trade credit is the primary source of short-term credit for small firms Debt-to-Equity ratio indicates the degree of protection to creditors in case of solvency. = Asset base = Hurdle Income = Total target income = . the > the level of solvency and the greater the presumed ability to pay debts = Operating Cash flow to total debt Time Interest earned = the ratio reflects the ability of a company to cover interest charges. The lower this ration the better the co. = Debt ratio aka Debt-to-Assets ratio the ratio indicates how much of the total assets are financed by the creditors = Debt-to-total-capital ratio measure of financial leverage. The next annual dividend is expected to be $4. the ratio provides indication related to org's LT debt-paying ability.25 and is expected to grow at a rate of 7%. The corporate tax rate is 30%. It uses income bef interest and taxes to reflect the amt of income available to cover interest expense = cost of factoring = Cost of equity capital = Using DCF.estimate the cost of equity capital of a firm with the stock of $85.

THERE IS TRADE-OFF BT CARRYING COSTS (THE COSTS OF HOLDING INVENOTRY) AND ORDERING COSTS (C OR ORDERING ADDITIONAL INV). but inventory must be rrdered more frequently. w/c increases ordering costs. The model can be applied to mgt of any exchangeable goods. if lead time becomes more variable. which will have a direct impact on inventory cost the cost of placing an order impacts order frquency.Inventory management- inventory depends on sales forecasts. lack of inventory can result in lost of sales and excessive inventory can result in burdensome invenotry investments and lost invenotry due to obsolescence or spoilage balancing the cost of carrying inventory against the cost of "stocking out" inventory turnover & no. then carrying costs are low. Levels are low. . the amt of stock needed to reduce the risk of stock outs will increase inventory level at w/c a co should order or manufacture additional inventory to meet demand and to avert incurring stockout costs = = Economic Order Quantity (EOQ) it anticipates orders at the point where carrying costs are nearest to restocking costs in order to minimize total inventory costs. WH MANAGING INVENToRY. The method assumes the periodic demand is known and annual sales volume isc a crucial variabl EOQ formula. . which affects order sizw and optimal inventory levels Tools or Inventory models and systems used in determination of the optimal level of inventory or Method of invnetory c Inventory turnover COGS / Ave Inventory Safety stock Reorder point co maintains safety stock to ensure mftg or customer supply requirements are met. If inv. For ex. of days' sales in inventory used to control inventory quanti Optimal level of inventory is affected by: usage rate of inventory per period of time the time required to receive the inventory the cost per unit of inventory. EOQ sttempts to minimize both ordering and carrying costs.

both DIRECT (the effect when co. the on-going periodic cash flows generated by the project and project Steps in Calculating a Capital Budgeting project's annual cash Flows: 1) Estimate net cash inflows 2) Subtract non cash tax deductible expenses to arrive at pretax income (ex depreciation and amorization 3) Compute income tax expense based on the tax rate 4) Subtract tax expense from net cash inflows to derive after-tax cash flows Example: Cash inflow Less: Cash outflow Sales Cost 1000000 900000 . with a capital project or represent a noncash activity that p Stages of cash flows ina capital investment project include inception of the project (at time period zero). It prevents oversupply or interruption of the enti OTHER FORMULA Capital Budgeting process after-tax cash flows over life of the rproject. It maintains a smaller level of inventorym hence it in Kanban Inventory Control gives visual signals that a component required in production must be replenished. The method is used to create a precise schedules of which item just-in-time (JIT) model was developed to reduce the lag time bet inventory arrival and inventory use. received cash. of units is needed. JIT ties delivery of components to the speed of assem requires a considerable degree of coordination bet manufacturer and supplier. pays out cash. or makes a cas (indirect cash flow effects included transactions that are indirectly asso. MRP systems are generally computer-based and a determines the inventory req't when a given no.materials req't planning (MR extends the idea of computreized inventory control to manufacturing operations.

the higher the PV factor. aka Time-adjusted Rate of Return = or = . rate of return that producesan NPV of 0. produces.investment should not be made (IRR > NPV required rate of return) Factor of Internal Rate of Return (IRR) = require multiple trial & error computations.000 not deducted since there is no cash involved in depreciation but depreciation Depreciation tax shield DDCF valuation method = determine the present value of all expected future cash flows using a predetermine discount After-tax cash flows = After-tax cost of debt (kdx) = Cost of preferred stock = Cost of preferred stock (kps) = Where: Present value of 1 or a lump sum Dps = Preferred stock cash dividiends n = number of years Present value of an annuity Net Present Value (NPV) = Positive NPV . it is evaluated in relation to mgt's req'd hurdle rate after the computation. the lower the computed rate (IRR).investment should be made (IRR > NPV required rate of return) Negative NPV .Pre-tax Income (Net Inflow) (1-tax rate) After-tax Cash Flow Add: depreciation tax shield (21000 x 40%) After-tax cash flow 40% tax rate 100000 60% 60000 8400 68400 * depreciation of $21.

Payback Period-even cash flows(CF) time required to recover cost of an investment. or = = = + EVA = perforamce meeting stds Stock up : . the lower the computed rate (IRR). performance objectives have been met Required return for Residual Income hurdle rate = target rate or discount rate in computing NPV Economic Value added (EVA) is a residual income technique used for capital budgeting & perofrmance evaluation. where : = = % in capital structure = If P/S is given in the problem.0 which means that the PV of the inflows is > PV of the outflows Residual Income income in excess of desired minimum return historical weighted ave. hence. It measures actual dolars that an invetment earns hence high return invetment will not be rejected by hig-return divisions. breakup equity as to PS and CS. Cost of equity associated with invested capital. if the anount of the income fr investment exceeds the computed required return.EVA = not meeting stock down Required Return for EVA = Profit before interest but after tax Increase stock value/firm value Weighted Average Cost of Capital (WACC) is the average cost of debt and equity financing associated with the firm's existing assets and operations. IRR < hurdle rate = reject = Profitability Index = is also referred to as the "excess present value index" or simply PV index. = Discounted Payback Period same formula with payback period. just multiply the figures by the PV factor = Present Value Factor The higher the PV factor. Increases to the invetment or decreases to the cash flows serve to increase the PV factor = IRR -= discount rate at which NPV of the investment is equal to zero (0) IRR = discount rate at which NPV of the investment = zero (0) IRR > Hurdle rate (accept . ofen used in risky investmentm focuses on liquidity and risks. cost of capital is usually used as the target or hurdle rate. neglects total project profitability. It represents the residual (excess) income of project earnings in excess of cost of capital (incld. % in capital . Company hope that this ratioi will be over 1.

Cost of Retained Earnings (kre) Method 1: Capital Assets Pricing Model (CAPM) Cost of Retained Earnings (Kre)Method 2 : Discounted Cash Flow (DCF) Cost of Retained Earnings (kre)Method 3: Bond Yield Plus risk premium (BYRP) Market rate of interest = = = Risk-free rate + Risk-free rate + Risk-free rate + D=1 current + g Mrket value or price of the P0 outstanding common P Where: 0 stock D1 = the dividend pe share expected at the e g = the constant rate of growth in dividends = Pretax cost of long-term debt + market risk = risk-free rate of interet + inflation premium Lockbox systems expedites cash inflows (minimize collection float) Concentration banking is the method by w/c a single bank is designated as a central bank as a means of controllng zero balance account banking represents an account that maintains a zero bal and accompanied by a master or parent account the the availability of of idle cash Opportunity cost is the potential benefit lost by selecting a particular course of action ex revenue that will not Relevant cost those costs that will change in reponse to the selection of different courses of action Incremental Cost represent the change on cost associated with different alternatives Differential Cost represent the change in costs associated with 2 separate courses of action Avoidable costs represents the costs that can be averted by selecting different courses of action operating leverage the degree to which a firm used fixed operating costs as opposed to variable operating costs high operating leverage = high fixed operating costs & low variable operating costs .

000.00 = $ 44.555 x 3.000.000.5700) 3.300.60 = $ 12.57 Answer: PV cash savings/inflows annual savings x 3.00 900.306.300.00 PV of annuity of $1 @ 12% for 5 yearas 3.(10000 x .00 TO prove: 12305.00 PRE-TAX and AFTER-TAX CASH FLOWS : Cash Inflow Less:Cash Outflow Net Cash Inflow 40% Tax rate (Sales) (Cost) Pre-tax Cash Flows 1.000.000. It is also referred to as time-adjusted rate o NPV as discounted based upon a predetermined rate (discount or hurdle rate) & compared to investment on t Payback measures return of capital in years on either a discounted or undiscounted basus Acctg Rate of Return .00 100.financial leverage as the degree to which a firm uses debt to to finance the company combined (total) leverage results from use of both fixed operating costs and fixed financing costs tomagnify retuns to t Capital Budgeting techniques (use WACC as the hurdle rate) IRR utilize PV concepts to value both investments & the related cash flows.000.60 annual savings Annual savings need to make the I nvestment realize 12% = PV net cash outflows = 50000 .60 PV of $1 in 5 years at 12% 0.used GAAP basis of income Annual Savings needed to make the invetment realize a 12% yield where PV of cash savings inflows = PV of he net cash Given: Cost $ 50.60 = 50000 .00 Residual value at the end of 5 years $ 10.57) = (50000 .00 x (1-40%) = .5700 $ 44.

000.00 54.is the discount % used in NPV calculation Rate of return of the project > hurdle rate = Positive NPV ( > 0 ) = make investment Rate of return of the project .000.000.000.00 5.000 x 40%) + x Hurdle rate .00 36.00 90. 0 ) = do not make investment Internal Rate of Return = NPV = 0 Discounted Cash Flow models NPV use time value concepts IRR use time value concepts PI required detailed LT forecasts of projects cash flows for longer term projects.00 (10. hurdle rate = Negative NPV ( .Less: Non-cash tax deductibe Depreciation Amortizatiomn Pre-tax income Taxable Income Tax rate 40% Net Income 5.000. cash flow projection migh b .

e and divided by 2) indicates how effectively working capital is used Investment Turnover Working Capital (WC)Turnover Net Sales Net Sales Ave Invested Capital (LT Liab + Equity) Ave Working Capital divide the denominator by 365 A/R Collection Period Accounts Payable Deferral Period 365 365 A/R Turnover A/P Turnover .

use net income this ratio allows for increased analysis of changes in the percentages. 100 less Discount % numerator. The net profit margin inidcates the percent return on each sale while the asset turnover indicates the effective use of assets in generating that sale Dupont Return on Assets Profit Margin measure operating efficiency x Total Assets Turnover measure of the degree of effciency w/ w/c a co. is using its assets is defined as the degree to w/c a firm's use of debt to finance the firm magnifies th effects of a given % change in EBIT on the % change in EPS Dupont Return on Equity . Working Capital Discount Current Assets less Current Liabilities .ratio indicates how effectively working capital is used entage Rate (APR) of scount .

risk down ations and increases risks bec.Profit Margin x Asset Turnover x Financial Leverage or Return on Assets (ROA) Net Income (NI) Sales x or x Financial Leverage Net Sales Ave Total Assets x Ave Total Assets Equity Extended Dupont Return on Equity Operating Income margin x Asset Turnover x Financial Leverage is a measure of firm profits earned on sales after paying operating costs EBIT Sales Sales x Ave total assets er crossing out.results to NI / Equity Ave total assets x Equity t manner. TH goal is maximize the shareholder ereby increase profitability own risk up up . It may reduce a firms ability to obtain addional shor-term financing (Cash + Marketable Securities + Net Rec'bles) / Current Liab . The current and quick ratios are used in working capital analysis.

000 15% 160.Current Assets / Current Liabilities 360 or 365 (Total pay period . 2/10 = 70% customers avail & n/30 = 30% customers avail 10 x 70% = 7 30 x 30% = 9 7 + 9 = 16 ave collec surer .liquidity and safety ment discount alance account k and deposits made but which have not yet cleared in the bank aid with next deposits alance to be maintained in cash & cannoat be used as WC 200000 x 12% 24.Discount%) Ex.Discount period) Discount % x (100% .000 = Effective interest rate 200000x (100%-20%) .

' sales in receivables sale of A/R to a factor usuallt a bank Total Liabilities / Common stockholders equity Total Liabilities /Total Assets Total debt / Total Capital (Debt + Equity) Operating Cash Flow / Total Debt Earnings befor interest and taxed (EBIT) / Interest expense Net cost/average amount invested (Expected dividend / Current share price) + Growth rate ($4.07 0.12 working capital + PPE Asset base x Imputed interest rate Hurdle income + Residual income target (given) .25 / $85) + 0.

insurance cost. WHEN NOTRY) AND ORDERING COSTS (COSTS entory must be rrdered more osts. opportunity costs of ocking out" ntrol inventory quantities ventory levels Method of invnetory control ecomes more variable.ventory can result in burdensome carrying costs. The model can be applied to the sales volume isc a crucial variable n the . the amt of safety safety stock + (Lead time x Sales during lead time) Safety stock + (Lead time x Safe during lead time) minimize total inventory costs. incldng storage costs.

components to the speed of assembly line. It a precise schedules of which items will be needed and what times they will be needed. It reduces the need of manufacutrers to carry large inventories. rsupply or interruption of the entire manufacturing process as the result of lacking a componemt sh. depreciation tax shield) are analyzed generated by the project and the terminal value associated with the disposal or winding down of a amorization .e generally computer-based and are designed to control the use of raw materials in the production process. or makes a cash commnitment that is directly related to capital investment) and INDIRECT epresent a noncash activity that produces cash benefits or obligations ex. received cash. but ler level of inventorym hence it increases Inventory turnover and decreases invenotry as a % of total assets.

original cost of the asset or investment Net Incrememtal investment (investment required Net Annual Cash Flow .PV cash outflows = 0 PV of cash inflows . depreciation x tax rate a predetermine discount rate (ex.ion but depreciation tax shield was added since it is a tax savings.. required rate of return) Pretax cash flow x pretax cost of debt x (1-tax rate) (1-tax rate) Preferred stock dividends / net proceeds of Preferred stock Dps / Nps Nps = Net proceeds of preferred stock Future value / (1 + interest rate)n [ 1 Payment x 1 _ (1 + interest rate)n ] Interest Rate PV of future flows cash inflows . WACC.

Required return or Actual income earned by an investment .Net Initial Investment / Increase in annual net after-tax cash flow PV Initial Investment / PV of Increase in annual net after-tax CF Investment / Cash Flows Net incremental investment (investment required) / Annual CF PV of net future cash inflow / PV of net initial investment Annual after-tax cash flows / PV of net initial investment Net Income . % in capital structure for DEBT. hence. P/S & C/S would be computed .Required Return Investment (Debt and Equity) x $WACC Cost of equity x % equity in capital structure Weighted ave after-tax cost of debt x % debt in x capital structure Debt has tax savings when debt is used in financing a project debt / (debt + equity (Preferred stock and Common Stock) equity / (debt + equity (Preferred stock and Common Stock) CS.required return Net Book Value x Hurdle Rate Net operating profit after taxes (NOPAT) .

Risk-free rate) share expected at the end of one year te of growth in dividends -term debt + market risk premium eret + inflation premium as a means of controllng receipts ster or parent account the serves to fund any negative bal and is designed to maximize ex revenue that will not occur courses of action ses of action variable operating costs operating costs .Risk premium (Beta x Market Risk premium) Beta ( Market return .

NPV ws = PV of he net cash outflows After-tax Cash Flows 60.sts tomagnify retuns to the firm owners o as time-adjusted rate of return (PV of Cash Inflow = PV of Cash Outflow red to investment on the project to arrive at + or .000.00 Net Cash Inflow after tax of 40% .

00 3.00 64.560.4.000.00 240.000.79 242.00 2.560.00 Tax shield (dep or amort x tax rate) After-tax cash flow PV value of an annuity (series of inflow amt pv OF Future cash flow Initial Cash outflow or Investment NET PRESENT VALUE flow projection migh be either unavailable or unrealizable-limitation .000.

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