Financial Ratios

Liquidity Ratios: the extent to which a company is able to pay off its short term obligations.

Current Ratio: Current Assets/Current Liabilities
Quick Ratio: Current Assets-Inventory/Current Liabilities
Cash Equivalents Ratio: Cash + Cash Equivalents/Current Liabilities
Net Working Capital: Current Assets – Current Liabilities

Solvency Ratios

Debt Ratio: Total Liabilities/Total Assets
If a company has a debt ratio of 0.4. It can be said that 40% of assets are contributed by external
capital
Debt-To-Equity: Total Liabilities/Total Equity
The higher the number, the higher the debt and thus the risk
Equity Multiplier: Total Assets/Total Equity
The extent to which assets are contributed by total equity
Times Interest Earned Ratio: EBIT/Interest Cost
Cash Coverage Ratio: EBIT+Depreciation/Interest Cost

Efficiency Ratios

Inventory Turnover: Costs of Goods Sold/Average Inventory
the amount of times inventory is sold and replaced
Days in Inventory: 365/Inventory Turnover
Receivable Turnover: Net Credit Sales/Average Receivables
The amount of times a company receives its receivables in a year
Total Assets Turnover Ratio: Sales/Total Assets
How much does $1 of assets generate in revenue
Operating Cash Flow: EBIT+Depreciation-Tax

Profitability Ratios

Profit Margin: Net Income/Sales (Revenue)
How much of the revenue is kept as net income
Return on Assets: Net Income/Total Assets
With $1 of assets, how much of net income is generated
Return on Equity: Net Income/Total Equity
With $1 of equity, how much of net income is generated

Market Prospect Ratios

Earnings Per Share: Net Income/Shares Outstanding
Net income generated per share
Price Earnings Ratio: Price per share/Earnings per share
How much investors are willing to pay for $1 of earnings
Price per Share: EPS/r

008333)^6-1 Then in the annuity formula.12 Delayed Annuities Roberta will receive a 4-year annuity of $500 per year. do an annuity over 10 period with an interest rate of 12.008333 EAR (semi-annual rate) -> (1. use thex semi-annual rate.36% If there are six $5000 semi-annual payments with a discount rate of 10% compounded monthly Monthly rate = 0. If the r is 0. and t=12 since (6*semi-annual) . The annual interest rate is 6%. The interest rate over 2 years: (1. The annuity stretches out over 20 years.1 Annuity Due Mark received $50 000 a year for 20 years. how much will it be worth at t=0 Simple Interest: FV = CF ∗ (1 + rt) Compound Interest: FV = CF ∗ (1 + 𝑟)𝑡 CF no constant cash flow: PV = (1+r)t CF Perpetuity: PV = r 𝐶𝐹 Growing Perpetuity: PV = 𝑟−𝑔 1 1− (1+𝑟)𝑡 Annuity: PV = CF ∗ [ 𝑟 ] 1+𝑔 𝑡 1−( ) 1+𝑟 Growing Annuity: PV = CF ∗ [ ] 𝑟−𝑔 𝑟 Semi-Annual payments: FV = CF ∗ (1 + )𝑚𝑡 ( one time deposit of $1000) 𝑚 𝑟 Effective Annual Rate: periodic investments (annual deposits of $25 000) EAR = [1 + ]𝑚 − 1 𝑚 (1+𝑟)𝑡 −1 Then. what is the PV of her annuity? .95 . plug the r into: FV = CF [ 𝑟 ] Continuous Interest Payments: FV = CF ∗ 𝑒 𝑟𝑡 𝐶𝑡 Annual Percentage Rate: PV = Co + ∑𝑇𝑖=1 (1+𝐴𝑃𝑅)𝑖 example 4. The first payment occurs immediately Therefore: $50 000 + 19 𝑦𝑒𝑎𝑟 𝑎𝑛𝑛𝑢𝑖𝑡𝑦 Infrequent Annuities Ann receives an annuity of $450 payable once every 2 years.1/12 = 0. beginning at year 6.Discount the present value of the annuity back to date 0: PV = 5 1.Future & Present Value Future Value: how much will $100 be worth in 5 years Present Value: if you received $100 in 5 years.36% Therefore.Calculate a 4-year annuity 1584.06) − 1 = 12.1.06 ∗ 1.

What is the share price before and after deciding to accept the market campaign? 10 EPS Share price of Sarro when firm acts as a cash cow: = 100 = 0. therefore EPS is 10. In other words.1 = 1 000 000 Thus.Bonds & Stocks 1 1− 𝐹 (1+𝑟)𝑡 Level-Coupon Bonds: PV = C ∗ [ ]+ 𝑟 (1+𝑟)𝑡 F Zero-Coupon Bonds: PV = (1+𝑟)𝑡 𝐶 Consols: PV = 𝑟 𝐷𝑖𝑣 Dividend Growth Model: Price of share = 𝑟−𝑔  g = retention ratio ∗ return on retained earnings o retention ratio: % of the net income that remains in the company Net Income o return on retained earnings: Total Assets (ROA) Cash Cow: all earnings per share are paid out to the shareholders and not any part of the net income EPS Div remains in the organisation r = r . There are 100 000 shares.1 = 1 100 000 1 100 000 Value of marketing campaign at date 0: 1. The firm will have an opportunity at date 1 to spend $1 million on a new marketing campaign. NPVGO per share is $10 (1 000 000/100 000 shares) The share price is: 100+10=$110 . The new campaign will increase earnings in each period by $210 000. The firm’s discount rate is 10%. EPS = Dividend EPS Share price after growth opportunity: R + NPVGO Sarro expects to earn $1 million per year in perpetuity if it undertakes no new investment opportunities.1 R 210 000 The value of marketing campaign at date 1: −1 000 000 + 0.

The project can be extended 2. Profit = sum of net incomes/number of operating years o Av. Cash flows may increase with time Other Investment Rules:  Payback Period: the time needed to earn back the initial investment o does not take into account the time value of money o cash flows after the payback period are not taken into account o arbitrary  Discounted Period: slight better. reject o IRR should not be used for mutually exclusive projects. several problems arise: . but only to decide whether a single project is worth investing o When cash flows of a project change sign more than once. there will be multiple IRRs.Sunk costs: costs made before the moment of decision . . It is also based on all cash flows of a project.NPV & Other Investment Rules Capital Budgeting – the decision-making process for accepting or rejecting projects 𝐶𝑖 Net Present Value: −𝐶𝑜 + ∑𝑡𝑖=1 (1+𝑟)𝑖  accept if NPV > 0  reject if NPV < 0 NPV uses cash flows rather than accounting profits. accept o Financing project: if IRR > r. accept o If AAR < r.Allocated costs: the new project takes sales away from the existing product 1+nominal interest rate Inflation: − 1 1+inflation percentage Question 3 of the exam . The project can be terminated 3. in a way that it does take into account the time value of money Average Profit  Average Accounting Return: Average Investment o Av. reject  Internal Rate of Return o Investment project: if IRR > r. it does not take into account the duration of the project. However.Opportunity costs: costs someone sacrifices by choosing or something over something else . When determining incremental cash flows from a new project. Any adjustments in the future are called real options: 1.Side effects: the addition to Newco's plant is for the purpose of producing a new product. It must be considered whether the new product may actually take away or add to sales of the existing product. Investment = investment/2 o If AAR > r.

then it is called a portfolio The extent to which shares are related to each other could be determined with covariance and correlation Covariance: ∑ ω1(Ra. t = 1 − Ra) ∗ (Rb. then the share has a beta of 1. It is a number that indicated the volatility of a share compared to the market. 𝜌𝑎𝑚 ∗ 𝜎𝑎 ∗ 𝜎𝑚 𝛽= 𝜎𝑚2 Systematic Risk: type of risk that concerns the entire financial market. the more risk  Calculate the arithmetic mean ((𝑅𝑡=1−𝑅2 )+((𝑅𝑡=2−𝑅2 )+((𝑅𝑡=𝑛−𝑅2 )  Calculate the variance: 𝑡−1  Calculate the standard deviation: 𝜎 = √Variance If an investor owns several stocks. t = 1 − Rb) + ωn(Ra. Eg: recessions Unsystematic Risk: type of risk specific to an investment . If a specific share price increases at the same rate as the market. t = n − Rb) Cov(RaRb) Correlation: σ(Ra)∗σ(Rb) The diversification effect only occurs when the correlation between two securities is below 1. Variance of portfolio: 𝑋𝑎2 𝜎𝑎2 + 𝑋𝑏 2 𝜎𝑏 2 + 2(𝑋𝑎𝑋𝑏𝜌𝑎𝑏𝜎𝑎𝜎𝑏) Capital Asset Pricing Model: takes into account the risk while calculating the returns 𝑅 = 𝑅𝑓 + 𝛽(𝑅𝑚 − 𝑅𝑓) R = expected return on a share or portfolio Rf = the risk-free rate β = Measure of risk Rm – return on the market portfolio R = Rf+SlopeCML(σa) SlopeCML = (Rm-Rf)/σm Beta: is a measure of risk of a stock or portfolio. t = n − Ra) ∗ (Rb.Risk and Returns 𝐷𝑖𝑣𝑡+1 𝑃𝑡+1− 𝑃𝑡 Return: the amount an investor earns on its investment: 𝑅𝑡 + 1 = + 𝑃𝑡 𝑃𝑡 Arithmetic mean Geometric mean: [(1 + 𝑅𝑡 = 1) ∗ (1 + 𝑅𝑡 = 2) ∗ (1 + 𝑅𝑡 = 𝑛)]1/𝑡 − 1 Holding Period Return: [(1 + 𝑅𝑡 = 1) ∗ (1 + 𝑅𝑡 = 2) ∗ (1 + 𝑅𝑡 = 𝑛)] − 1 Risk: the more volatile the stock.

Chapter 10 graphs Security Market Line Capital Market Line .