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FNCE 5101 – Class Notes

7/13/10 Ch 2

7/13/2010 3:02:00 PM

Financial Statements  Balance Sheet – firm’s financial position at a specific point in time o “As of 12/31…” o snapshot as of a certain day o left side shows assets o right side shows liabilities and shareholder’s equity o **A=L+SE**  equity is the owner’s claims against the assets  liabilities are the creditor’s claims against the assets  a firm finances its assets with both liabilities and equity o assets are listed in order of liquidity  liquidity: how quickly they can be converted to cash for an amount close to what you paid for it  Account receivable – money owed to company by its customers o liabilities must be listed by the order in which they are due  Account payable – money a company owes its suppliers o Retained Earnings – amount of earnings retained and invested back into the business and not paid out in dividends to shareholders  Evidence of growth, used to invest in future growth o Total common equity – common stock + retained earnings o Total Equity – TCE + preferred stock Income Statement – statement of a company’s revenue and expenses over a period in time o Revenue – Expenses = Net Income Sales - operating expenses (rent, salaries, utilities, lease payments, supplies, depreciation + amortization) - interest (bowing from a bank, issuing bonds) - taxes - preferred dividends

DA o EBT = EBIT – I o Net Income = EBT * (1 – tax rate) o Ex. and financing activities on cash flows over a period of time o Operating – cash flows generated by and used in normal course of business  Includes: net income (adjusted for D/A). 4 (pg 79)  EBITDA = 7. tax = $40%  Interest Expense = $1m o Ex. = 2m  tax = 40%  DA = 2. changes in inventories and accounts receivables. 3 (pg 79)  NI = $3m  EBIT = $6m. taxes. investing.5m  NI = 1.5m Statement of Retained Earnings – how much of a company’s earnings were retained and not paid out in dividends o RE (prev yr) + NI (curr yr) – common dividends (curr yr) = curr RE o Ex.o o o o o Net Income depreciation – cost of using an asset  applies to tangible assets amortization – cost of using intangible assets preferred dividends – considered to be an expense because a company is under an obligation to pay them if there is preferred stock outstanding EBITDA – earnings before interest. Exp. Div = 20m o Addition to RE = RE (curr yr) – RE (prev yr) Statement of Cash Flows – reports effect of operating. 6 (pg 79)  Comm. depreciation.8m  Int. and changes in   . and amortization EBIT = EBITDA .

& cash paid in the payment of dividends. inventory  MS = low-risk. net income  NCF – NI + DA  Ex.accounts payable and accruals (liabilities for unpaid expenses: interest/salaries/rent payable) o Investing – includes purchases or sales of fixed assets o Financing – includes cash raised during the yr by issuing bonds or stock. short-term notes payable (<1yr). accruals a company with a low ratio lacks liquidity in the sense that it cannot convert its assets into cash quick enough to meet its maturing obligations  compare it to industry average or do a trend analysis of the company o QUICK ratio = same as current ratio. buying back stocks or bonds. 10 (pg. and in paying off notes payable o Net cash flow vs. marketable securities. Managers 5 types of ratios  liquidity: how quickly they can be converted to cash for an amount close to what you paid for it o can company pay debts as they come due? o CURRENT ratio = current assets / current liabilities  current assets are: cash. A/R. but inventory is removed from CA because it is the least liquid Asset management: how effectively a firm manages its assets  NCF = 650k  . short-term investment  fixed assets ARE NOT current  current liabilities are accounts payable. Stockholders. 79)  Ch 3 Who are interested in ratios?  Creditors. borrowing from banks (notes payable).

12 . 93) = receivables / sales per day  how well firm is managing its receivables  how long it takes from time of credit sale to when cash is received  compare to industry average o Fixed Asset Turnover  how effectively a firm manages its net fixed assets  problems:  assets are posted at cost.3.o INVENTORY TURNOVER =  Problems with ratio:  sales in numerator is as of day reported in balance sheet.6. so if an old company bought assets eons ago.10. firm will have used funds for other issues HW: self-test 1. lender can assume depreciation generated funds will be there to pay loan  long term lenders cannot make this assumption and will use TIE.9.7. maybe we should use cost of goods sold instead of sales  this overstates ratio o Days sales outstanding (pg. ratio will be inflated o total asset turnover = sales / total assets  sales generated from each $ of assets used  debt management o debt – total debt / total assets  how is firm financed o times interest earned = EBIT / interest expense  funds available to pay interest expense  how well does firm have interest expense covered o EBITDA Coverage = (EBIT + DA + lease payments) / (interest expense + principle + lease payments)  there is more to it than interest expense. ch 3: problems 1. Maybe use an average?  since inventory is purchased at cost.8.4. they may want to pay down principle and lease payments o TIE and EBITDA Coverage are used by lenders  if looking to lend a short-term loan.5.

this can indicate trouble controlling costs or significant use of debt  Return on Assets = Net Income / Total Assets o want to maximize this number  this can be done by maximizing on profit margin or on asset turnover b/c ROA = net profit margin * asset turnover ratio (dupont equation) o Return on Equity = Net Income / Common equity  want to maximize this number  this can be done by maximizing on profit margin or on asset turnover or on financial leverage b/c ROE = net profit margin * asset turnover ratio * financial leverage (extended dupont equation)  financial leverage aka equity multiplier = assets / equity  if this ratio is higher than 1. this indicates a company has a lot of debt  basic earning power = EBIT / total assets o ability of firms assets to earn operating income o useful when comparing companies with different debt and tax structures Market value  Price-to-earnings = price per share / earnings per share o price per share = market price o EPS = Net Income / # of shares outstanding o high for firms with high growth potential price-to-cash flow = price per share / earnings per share o price per share = market price o EPS = (Net Income + D/A) / # of shares outstanding market-to-book = market price per share / book value per share o BVS – common equity / # of shares outstanding   .8% = $0.038 in income per $1 of sales o if % is below industry average.7/15/10 Profitability Ratios  Net Profit Margin = Net Income / Net Sales o 3.

indifferent an asset’s risk and rate of return can be analyzed o on a stand-alone basis o as part of a portfolio Expected RoR & risk. good (undervalued) if expected = required. and require higher rates of return as an incentive if expected < required. no good (overvalued) if expected > required. stand-alone  Expected ROR = the sum of (each probability * corresponding ROR)  Low st dev = lower risk  if looking at companies with different st devs and exp RORs. look at company with the lowest coefficient of variation (CV)  CV = ST DEV / EXP ROR     . so we should use them to ask questions.o amount investors are willing to pay per book value of each share Financial statements are backward looking. not look for answers Ch 6 Companies can raise capital in 3 ways  borrow from bank   o expect to receive principal and interest issue stocks o expect to receive capital gains and dividend payments ssue bonds o expect to receive principal and interest payments rate of return = (amount received – amount invested) / amount invested  actual – achieved based on what was earned  expected – predicted based on statistics  required – based on risk o risk – probability of earning a low/negative return  risk aversion – investors don’t like risk.

indicates risk aversion  the steeper the slope. CC=-1.0  ex.Expected RoR & risk. the other goes down 10% o if CC=0.9. 1 goes up 10%. the higher ROR is required for the same CC o effect of inflation: risk-free rate will increase. the more diversified the portfolio is.0  ex. so does the other o if returns on 2 stocks were perfectly negatively correlated.0). the less risk the stock contributes to the portfolio Calculating required return  security market line equation (pg 247) o derived from capital asset pricing model o req ROR = risk-free rate + (return on market – risk-free rate)*CC  ROM-RFR = market risk premium o slope of SML = MRP.11   . portfolio  expected ROR: sum of weight * expected ROR  Correlation: tendency of two variables to move together o correlation coefficient (CC) = measure of degree of relationship between two variables o -1. there is no relation to movement o the lower CC is (closer to -1. the more risk averse. but can be measured o measure by degree at which stock moves with market o the lower the coefficient.2. CC=1.3. 1 goes up 10%.0<CC<1.10. slope will not change HW: 1. and SML will increase parallel to original line.4.0 o if returns on 2 stocks were perfectly correlated. hence lower the risk Diversifiable risk (firm-specific) can be virtually eliminated by diversifying Market risk – inherent in market o cannot be eliminated.

76 Annuity – series of payments. 110. 115.25. 105. equal intervals   ordinary – fixed payments occur at the end of the time period annuity due .fixed payments occur at the beginning of the time period .Ch 4 Time-value of money Compound interest:  Ex. how much will you have at the end of 3yrs? 100. equal amounts. invest $100 for 3yrs @ 5%.

7/13/2010 3:02:00 PM .

7/13/2010 3:02:00 PM .