Corporate Finance and Portfolio management

CF1 CF2 CFn

1. Net Present Value NPV CF0 ......
(1 r) 1
(1 r) 2
(1 r) n
Invest if : NPV > 0 Do not invest if: NPV< 0

n
CFt
2. Internal Rate of Return (1 IRR)
t 0
t
0

Invest if: IRR > r Do not invest if: IRR< r

Average net income

3. Average Accounting Rate of Return (AAR)=
Average book value

PV of future cash flows NPV

4. Profitability Index PI= 1
Initial Invesments Initial Invesment
Invest if: PI > 1.0 Do not invest if: PI< 1.0

5. Cost of Capital (WACC) w d rd (1 t) w p rp w e re

where wd = target debt proportion in total capital
rd = the before-tax marginal tax rate t = the companys marginal tax rate
wp = target preferred stock proportion in total capital
rp = the marginal cost of preferred stock re = the marginal cost of equity
we = target common stock proportion in total capital

6. Capital Asses Pricing Model Approach E(R i ) R F i ER M R F

where
I = the return correlation of stock i to changes in the market return
E(RM) = the expected return on the market E(RM)-RF = the expected market risk premium

D1 D2
7. Dividend Discount Model Approach V0 = ......
1 re 1 re
where
V0 = the intrinsic value of a share Dt = the shares dividend at the end of period t
re = the cost of equity
D1
8. P0
re g
D1
9. re g
P0

1
10. asset equity
1 (1 t) D

E


Annualized standard deviation
of equity index
11. Country equity premium= Sovereign yield spread
Annualized standard devation of
the soverign bond market in terms

of the development market currency
12. The cost of preferred stock is the preferred stock dividend divided by the current
Dp
preferred stock price : rp
Pp
13. We can estimate the growth rate in the dividend discount
model by using published forecasts of analysts or by the sustainable growth rate:

D
g 1 ROE
EPS
Current assests
14. Current Ratio =
Current liabilities

Cash Short-ter m marketable invesments Re ceivables

15. Quick Ratio =
Current liabilities
Credit Sal es
16. Accounts receivable turnover =
Average receivables
Cost of goods sold
17. Inventory turnover =
Average inventory
Accounts r eceiveable Accounts r eceivable
18. Number of days of receivables = =
Average day's sales on credit Sales on credit / 365
Inventory Inventory
19. No. of days of inventory = =
Average day's cos t of goods sold Cost of goods sold / 365

20. Operating cycle = Number of days of inventory + Number of days of receivables

21. Net operating cycle = Number of days of inventory + Number of days of receivables - Number
of days of payables
 Face value - Purchase price 360
22. Money Market yield =
Purchase price Number of days to maturity
Face value - Purchase price 365
23. Bond Market yield =
Purchase price Number of days to maturity
Face value - Purchase price 360
24. Discount- basis yield =
Face value Number of days to maturity

365

Discount Number of days
25. Cost of trade credit = 1 beyonddiscountperiod 1
1 Discount

Net income Net income

Average shareholde rs' equity Revenues
26. Return on equity =
Revenues Average total assets

Average total assets Average shareholde rs' equity
n
27. Standard Deviation = 2 [R
i 1
i E(R i )] 2 Pi

Cov ij
28. rij=
i j
where rij= the correlation coefficient of returns
i = the standard deviation of Rit j = the standard deviation of Rjt
29. port w12 12 w22 22 2w1 w 2 r1,2 1 2

Derivatives and Alternative Investments

1. FRA payoff formula (from the perspective of the party going )

Days in underlying rate
Underliying rate at expiration Forward contract rate
Notional Principal = 360
Days in underlying rate
1 Underlying rate ate xpriation
360
2. Minimum and Maximum Values of Options
Option Minimum value Maximum Value
European call c0 0 c0 S 0
American call C0 0 C0 S 0
European put p0 0 p0 X /(1 r ) T
American put P0 0 P0 X
3. Put-call parity = c0 + X/ (1+r)T =p0 +s0
NOI
4. Appraisal price =
Market cap rate

Equity and Fixed income

n
D1 D2 D3 D Dt
1. Dividend Discount Model (DDM) Vj
1 k 1 k 1 k
2 3
......
1 k t 1 1 k t

n
FCFE
2. Present value of Free Cash Flows to Equity V j 1 k
t 1
t
j

Pi D /E
2. Justified/ Fundamental (P/E) 1 1
E1 kg

4. (Shareholders equity)- (Total value of equity claims that are senior to common stock) = Common
shareholders equity

5. (Common shareholders equity)/ (Number of common stock shares outstanding) = Book value per
share

6. Coupon rate = Yield required by market Price = Par value

Coupon rate < Yield required by market Price < Par value (discount)
Coupon rate > Yield required by market Price > Par value (premium)

7. Price of callable bond = Price of option-free bond Price of embedded call option

8. Price of putable bond = Price of option- free bond + Price of embedded put option

Tax exempt yield

9. Taxable-equivalent yield =
1 - Marginal tax rate

1
1 1 i no.of periods
10. Present value of an annuity = Annuity payment
i

Maturity v alue
11. Valuing a Zero- Coupon Bond
1 i no. of years 2
Where i is the semiannual discount rate
Annual dollar coupan interest
12. Current yield =
Price
 Yield on a bond - equivalent basis
2

13. Yield on an annual-pay basis 1 1
2

100100 Price 100

14. Spread for life = Quoted margin
Maturity Price

15. Z-spread = OAS + Option cost

1
1 z m t m t t
16. t f m m
1
1 z m
Price if yields decline - Price if yields rise
17. Effective duration =
2Initial priceChange in yield in decimal
1 1 PVCF1 2 PVCF2 ..... n PVCFn
18. Macaulay duration =
1 Yield/k k Price

Macaulay duration
19. Modified duration=
1 Yield/k
20. Portfolio Duration = w1 D1 w2 D2 w3 D3 ..... wk Dk

Financial Reporting and Analysis

1. Assets = Liabilities + Owners equity Revenue Expenses = Net income (loss)

Net income - Preferred dividends

2. Basic EPS
Weighted average number of shares outstanding

Net income After tax int rest on

convertibl e debt Pr eferred di vidends
3. Diluted EPS =
Weighted a verage number of shares
outs tan ding New common shares that
could have been issued at conv ersion

4. Diluted EPS =
Netincome Preferred dividends
Weighted average number of shares
outstanding New shares that
could have been issued at option excersice
Shares that could have been purchased
with cash received upon excersice
 Net income Gross profit
5. Net profit margin = 6. Gross profit margin=
Revenue Revenue
7. FCFF= NI + NCC + Int (1-Tax rate)- FCInv WCInv
8. FCFF = CFO + Int (1-Tax rate) - FCInv
9. FCFF = CFO- FCInv + Net borrowing Net debt repayment

10. Definitions of commonly Used Activity Ratios

Activity Ratios
Inventory Turnover
Days of inventory on hand (DOH)
Receivables turnover
Days of sales outstanding(DSO)
Payables turnover
Number of days payables
Working capital turnover
Fixed asset turnover
Total asset turnover
Numerator Denominator
Cost of goods sold Average inventory
Number of days in period Inventory turnover
Revenue Average receivables
Number of days in period Receivables turnover
Purchases Average trade payables
Number of days in period Payables turnover
Revenue Average working capital
Revenue Average net fixed assets
Revenue Average total assets

11. Definitions of commonly Used Liquidity Ratios

Liquidity Ratios Numerator Denominator
Current ratio Current assets Current liabilities
Quick ratio Cash + Short-term marketable investments + Receivables Current liabilities
Cash ratio Cash + Short-term marketable investments Current liabilities
Defensive Cash + Short-term marketable investments + Receivables Daily cash
interval ratio expenditures
Additional Liquidity Measures
Cash Conversion cycle (net DOH + DSO Number of days of payables
operating cycle)

12. Definitions of commonly Used Solvency Ratios

Solvency Ratios Numerator Denominator
Debt Ratios
Debt-to-assets ratioa Total debtb Total assets
Debt-to-capital ratio Total debtb Total debtb + Total shareholders equity
Debt-to-equity ratio Total debtb Total shareholders equity
Financial leverage ratio Average total assets Average total equity
Coverage Ratios
Interest coverage EBIT Interest payments
Fixed charge coverage EBIT + Lease payments Interest payments + Lease payments
 13. Definitions of commonly Used Profitability Ratios
Profitability Ratios Numerator Denominator
10
Return on Sales
Gross profit margin Gross profit Revenue
Operating profit margin Operating income11 Revenue
Pretax margin EBT (earnings before tax but after interest) Revenue
Net profit Income Net Income Revenue
Return on Investment
Operating ROA Operating income Average total assets
ROA Net income Average total assets
Return on total capital EBIT Short and long -term debt and equity
ROE Net income Average total equity
Return on common equity Net income-preferred dividends Average common equity

14. ROE = Net profit margin * Asset turnover * leverage

15. ROE = Tax burden * Interest burden * EBIT margin * Asset turnover * Leverage

Quantitative analysis
N
1
1. Population Mean: calculated as X
N
X
i 1
i

Where there are N members in the population and each observation is Xi i =1, 2, N.
Sum of all the deviations is zero.

1 n
2. Sample Mean: calculated as X Xi
n i 1
n
3. Weighted Mean: calculated as X weighted wi X i
i 1

4. Geometric Mean: calculated as G n X 1 X 2 X 3 ... X n

Where there are n observations and each observation is Xi.

5. Mean Absolute Deviation: is the average of the datas absolute deviations from the mean.
1 n
MAD Xi X
n i 1
6. Population Variance: is the average of the populations squared deviations from the mean.
N

X
1
2 i
2

N i 1
The population standard deviation is simply the square root of the population variance.

7. Sample Variance: is the average of the sample datas squared deviations from the sample mean.

X i X 2
n
1
The sample standard deviation is s2
n 1 i 1
8. Covariance describes the co-movement between 2 random numbers, given as :
Cov(X1, X2) = 12
Cov( X , Y ) E[( X X )(Y Y )]
Cov( X , Y ) E ( XY ) X Y
9. Correlation coefficient is a unit-less number, which gives a measure of linear dependence between
two random variables. (X1, X2) = Cov(X1, X2) / 12

10. Portfolio Expected Return:

E(rp) = wA rA + (1-wA )rB
Portfolio Variance: r2 wA2 A2 1 wA 2 B2 2wA 1 wA CovrA , rB
p

r2 wA2 A2 1 wA 2 B2 2wA 1 wA AB A B
OR
p

s
11. Coefficient of variation CV
X
( rp rf )
12. Sharpe measure SM
p
13. Addition Rule
Used to Get Compound Probabilities for Union of Events: P(A OR B) = P(A U B) = P(A) + P(B) - P(A B)
For Mutually Exclusive Events: P(A OR B) = P(A U B) = P(A) + P(B)

14. Sum Rule & Bayes Theorem

P( B) P( A B) P( Ac B) P( B / A) P( A) P( B / Ac ) P( Ac )

P( B / A) P( A)
P( A / B )
P( B / A) P( A) P( B / Ac ) P( Ac )
Out of a group of 100 patients being treated for chronic back trouble, 25% are chosen at random to
receive a new, experimental treatment as opposed to the more usual muscle relaxant-based therapy
which the remaining patients receive. Preliminary studies suggest that the probability of a cure with the
standard treatment is 0.3, while the probability of a cure from the new treatment is 0.6.

15. Discrete Probability Distributions

Probability distribution for a Binomial random variable is given by: P( X x)nC p x (1 p)n x
x

16. Normal Distribution Random Variable

General Normal random variable X ~ N (, 2)
X can be standardized to a Standard Normal random variable. X
Z
Resulting variable has mean zero and variance equal to 1.
17. Confidence Intervals

s
The standard error of the mean (sx) is given by: sx
n
18. Errors in Estimation
Type I and Type II Errors
Type I error occurs if the null hypothesis is rejected when it is true
Type II error occurs if the null hypothesis is not rejected when it is false

Significance Level
-> Significance level
The upper-bound probability of a Type I error
1 - ->confidence level
The complement of significance level

19. The sample variance for a pooled estimater is given as s 2 (n1 1) s1 (n2 1) s2
2 2

n1 n2 2
20. Hypothesis Tests for Variances