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Buisness Finance Formulas 1
Buisness Finance Formulas 1
By IQRA JAHANGIR
Suppose a Corporation has a taxable income of $200,000. So the Tax calculation will be:
$ 50,000 x 15% = $ 7,500
($ 75,000 – 50,000) x 25% = 6,250
($ 100,000 – 75,000) x 34% = 8,500
($ 200,000 – 100,000) x 39% = 39,000
$ 61,250
Our total tax is $61,250
Average tax rate is $61,250 / 200,000 = 30.625%
Marginal rate is 39%
Corporation A Corporation B
Earnings before interest and taxes $400,000 $400,000
- Interest Expense 100,000 0
Earning before taxes (taxable income) 300,000 400,000
- Taxes @35% 105,000 140,000
Earning after taxes $195,000 $260,000
Corporation A Corporation B
Earnings before interest and taxes $400,000 $400,000
- Interest Expense 100,000 0
Earning before taxes (taxable income) 300,000 400,000
- Taxes @35% 105,000 140,000
Earning after taxes $195,000 $260,000
+ Dep. charged without cash outlay 100,000 0
Cash flow $295,000 $260,000
Difference $35,000
Current Ratio
Current Assets
Current Ratio= ------------------------
Current Liabilities
Quick (or Acid-Test) Ratio
Cash Ratio
Cash
Cash Ratio= -----------------------
Current Liabilities
EBIT + Depreciation
Cash Coverage ratio = -----------------------------------------
Interest
If we know sales were turned over 3.2 times during the year, we can calculate easily
how long it took to turnover on average.
365 days
Days’ Sales in Inventory = --------------------------------
Inventory Turnover
Receivables Turnover
Sales
Receivables Turnover = -------------------------------
Accounts Receivables
365 days
Days’ Sales in Receivables = -------------------------------
Receivables Turnover
Total Assets
Capital Intensity Ratio = --------------------
Sales
Profit Margin
Net income
Profit Margin= --------------------
Sales
Return on Assets
Return on Assets (ROA) is a measure of profit per dollar of assets:
Net income
Return on Assets = --------------------
Total Assets
Return on Equity
Return on equity (ROE) is a measure of how the stockholders fared during the year.
Net income
Return on Equity = --------------------
Total Equity
Earnings Per Share
Net income
EPS = ---------------------------
Shares Outstanding
Price-Earning Ratio
Total equity
Book Value = ------------------------------------
No. of shares outstanding
Market-to-Book ratio
Net Income
ROE = --------------------
Total Equity
Multiplying it by Assets / Assets (without changing anything)
Net Income Net Income Assets
ROE = -------------------- = ---------------- x -----------
Total Equity Total Equity Assets
So, we have expressed ROE as a product of two other ratios – ROA and the equity
multiplier
We can further decompose ROE by multiplying the top and bottom by total sale:
Sales Net Income Assets
ROE = -------- x ---------------- x ----------------
Sales Assets Total Equity
Rearranging a bit,
Net Income Sales Assets
ROE = --------------- x ----------- x ----------------
Sales Assets Total Equity
This last Expression is called Du Pont identity after the Du Pont Corporation, which
popularized its use.
Dividend Payout
Cash Dividends
Dividend Payout ratio = -----------------------
Net Income
Retention Ratio
Retained Earnings
Retention ratio = -----------------------
Net Income
The retention ratio is also known as the plowback ratio, as this is the amount which is
plowed back into the business
Q: LMN Corporation pays out 40% of net income in form of dividends. What is its
retention ratio?
A: If payout ratio is 40%, retention ratio is
1 – 40% = 60%
Q: If net income of LMN is $800, how much did stockholders actually receive?
A: Dividends are $800 x 40% = $320
ROA x b
Internal Growth rate = ------------------
(1 – ROA) x b
ROE x b
Sustainable Growth rate = ------------------
(1 – ROE) x b
Simple interest.
I=Pxrxt
Where
Compound interest.
I = P x rt
Future Value
FV = P(1 + rt)
FV = C0× (1 + r)
Where C0 is cash flow today (time zero) and r is the appropriate interest rate.
Generalizing the future value of an investment over many periods:
FV = C0× (1 + r)t
Where
Present Value
•
FV
PV = ----------------
(1+rt)
General formula for calculating present value of C cash flow in t periods time is:
1
PV = C1 �
( 1+ r )
t
1 /(1 + r)t is used to discount a future cash flow, so it is called the discount factor Or
present value interest factor (PVIF r,t),
Calculating the present value of a future cash flow to determine its worth today is
commonly called discounted cash flow (DCF) valuation
What we called the present value factor is just the reciprocal of the future value factor.
Future value factor = (1 + r)t
Present value factor = 1/(1 + r)t
If we let FVt stand for the future value after t periods, then the relationship between the
future value and the present value is:
PV x (1 + r)t = FVt
PV = FVt / (1 + r)t = FVt x [1/ (1 + r)t]
This is also known as basic present value equation.
FV = C0 �( 1 + r )
t
I. Symbols:
II. Future value of C dollars invested at r percent per period for t periods:
FVt = C* (1 + r)t
The term (1 + r)t is called the future value factor.
PV = C/(1 + r)t
The term 1/(1 + r)t is called the present value factor.
IV. The basic present value equation giving the relationship between present and
future
value is:
PV = FVt/ (1 + r)t
Perpetuities
Perpetuity PV = C / r
I. Symbols
PV = Present value, what future cash flows bring today
FVt = Future value, what cash flows are worth in the future
r = Interest rate, rate of return, or discount rate per period
t = Number of time periods
C = Cash amount
If a rate is quoted as 10% compounded semiannually, then what this means is that
the investment actually pays 5% every six months.Is 5% every six months the
same thing as 10% per year?
$1 x 1.10 = $1.10
$1 x 1.052 = $1.1025
10% compounded semiannually is equivalent to 10.25% compounded annually.
10.25% is called effective annual rate (EAR)
Valuing a Bond
If a bond has
– a face value of F paid at maturity
– a coupon of C paid per period
– t periods to maturity
– a yield of r per period
Its value is
Bond value = C x [1 – 1/(1+r)t]/r + F/ (1+r)t
Valuing Bonds
Bond value = C x [1 – 1/(1+r)t]/r + F/ (1+r)t
= Present value of coupons + Present value of face amount
Where:
C = the promised coupon payment
F = the promised face value
t = number of periods until the bond matures
r = the market’s required return, YTM
Note that no matter what the stock price is, the present value is essentially zero if we push
the sale of stock far enough away.
• So, the current price of stock can be written as the present value of the dividends
beginning in one period and extending out forever
• Alternatively, we can say that the price of stock today is equal to the present value of all
of future dividends.
D1 D2 D3 D4
= + + +
( 1+ R) ( 1+ R) (1+ R) (1+ R)
1 2 3 4
Since dividend is always the same, the stock can be viewed as an ordinary perpetuity with
a cash flow equal to D every period.
• So the per share value is
P0 = D/R
Where R is the required rate of return