2 - Financial Statements & Valuation Flashcards
This deck focuses on financial statement analysis and the various valuation methodologies, including trading comps, transaction comps, and discounted cash flow (DCF) analysis.
Gross Profit
Gross Profit = Revenue - Cost of Goods Sold
Gross Profit Margin
Gross Profit Margin = Gross Profit / Revenue
Operating Profit (EBIT)
Operating Profit (EBIT) = Gross Profit - SG&A
Operating Profit Margin
Operating Profit Margin = Operating Profit (EBIT) / Revenue
Effective Tax Rate
Effective Tax Rate = Income Taxes / Earnings Before Tax
Net Income Margin
Net Income Margin = Net Income / Revenue
EBITDA
EBITDA = EBIT + D&A
EBITDA Margin
EBITDA Margin = EBITDA / Revenue
LIFO vs. FIFO in an inflationary environment
FIFO results in lower COGS, higher gross profit and more taxes
PIK Interest - Impact in Income Statement
PIK interest is treated as interest expense on the Income Statement
PIK Interest - Tax consequences for recipient
PIK interest is taxed as ordinary income to the recipient when accrued
Adjusting Net Income for a one-time pre-tax expense
When adjusting Net Income for a one-time, pre-tax charge, Net Income will increase by (amount of expense) x (1 - tax rate)
Adjusting Net Income for a one-time, net, charge
When adjusting Net Income for a one-time, net charge, Net Income will increase by the amount of the charge
Adjusting EBIT or EBITDA for a one-time, pre-tax charge
When adjusting EBIT or EBITDA for a one-time, pre-tax charge, EBIT or EBITDA will increase by the amount of the charge
Adjusting EBIT or EBITDA for a one-time, net charge
When adjusting EBIT or EBITDA for a one-time, net charge, EBIT or EBITDA will increase by (amount of the charge) / (1 - tax rate)
Calculation of net new shares issued under Treasury Stock Method
New Shares Issued = (Stock Price - Strike Price) / Stock Price x Number of Options
P/E Ratio
P/E = Stock Price / Earnings Per Share OR Equity Value / Net Income
Equity Value (Using P/E)
Equity Value = Net Income x P/E Ratio
PEG Ratio
PEG Ratio = (P/E Ratio) / Expected Earnings Growth
Best Value using PEG Ratio
Best Value using the PEG Ratio is the company with the LOWEST ratio
Dividend Payout Ratio
Dividend Payout Ratio = Annual Dividend / BASIC EPS
Earnings Retention Ratio
Earnings Retention Ratio = 1 - Dividend Payout Ratio
Book Value of Equity
Book Value of Equity = Shareholders’ Equity = Assets - Liabilities
Price/Book Value
Price/Book Value = Stock Price / Book Value
Application of Price/Book Value
P/B multiple is most often applied for financial services companies, such as banks, broker dealers and insurance companies.
Enterprise Value using Total Debt
EV = Equity Value + Total Debt + Preferred Stock + Noncontrolling Interest - Cash
Net Debt
Net Debt = Total Debt - Cash
Enterprise Value using Net Debt
EV = Equity Value + Net Debt + Preferred Stock + Noncontrolling Interest
Earnings Yield
Earnings Yield = Earnings Per Share / Stock Price OR 1 / PE Ratio
Goodwill
Created when an asset is purchased for a price in excess of either its market value (for a public company) or book value (for a private company)
Causes an increase in goodwill
Goodwill increases when the purchase price increases
Causes a decrease in goodwill
Goodwill decreases when the value of the asset increases
Source or use of cash? Increase in accounts receivable
Use of cash
Source or use of cash? Decrease in accounts payable
Use of cash
Source or use of cash? Decrease in accrued liabilities
Use of cash
Source or use of cash? Decrease in inventories
Source of cash
Source or use of cash? Deterioration in net working capital
Source of cash
Source or use of cash? Increase in prepaid expenses
Use of cash
Source or use of cash? Decrease in accounts receivable
Source of cash
Source or use of cash? Increase in accounts payable
Source of cash
Source or use of cash? Increase in accrued liabilities
Source of cash
Source or use of cash? Increase in inventories
Use of cash
Source or use of cash? Improvement in net working capital
Use of cash
Source or use of cash? Decrease in prepaid expenses
Source of cash
Deferred tax asset or liability? Acceleration of an expense for account purposes
Deferred tax asset
Deferred tax asset or liability? Acceleration of an expense for tax purposes
Deferred tax liability
Deferred tax asset or liability? Acceleration of revenue for accounting purposes
Deferred tax liability
Deferred tax asset or liability? Acceleration of revenue for tax purposes
Deferred tax asset
Calculation of Treasury Stock
Treasury Stock = Common Stock - Shareholders’ Equity
Calculation of Capital Surplus (Additional Paid-in Capital)
Money raised in excess of par value (i.e. Offer price - par value)
Impact to Balance Sheet when a company repurchases stock
Shareholders’ equity falls by the acquisition price of the shares
Impact to Balance Sheet when a company declares a dividend
Dividends Payable increases, Retained Earnings decreases
Impact to Balance Sheet when a company pays a dividend
Dividends Payable decreases, Cash decreases
Impact to Balance Sheet when a company issues stock
Cash increases, Par Value & Capital surplus both increase
Calculation of ending Retained Earnings
Ending Retained Earnings = Beginning Retained Earnings + Net Income - Dividends
Calculation of ending Shareholders’ Equity
Ending Shareholders’ Equity = Beginning SE + Net Income - Dividends (same calc as Retained Earnings)
Calculation of Enterprise Value using Sales
Enterprise Value = Sales x (EV/Sales multiple)
Calculation of Enterprise Value using EBIT
Enterprise Value = EBIT x (EV/EBIT multiple)
Calculation of Enterprise Value using EBITDA
Enterprise Value = EBITDA x (EV/EBITDA multiple)
Interest Coverage Ratio
Interest Coverage Ratio = EBITDA / Interest Expense
Invested Capital
Invested Capital = Avg Shareholders’ Equity + Avg Net Debt
EBIAT (Earnings Before Interest After Tax)
EBIAT = EBIT - Taxes at Marginal Rate
Return on Assets (ROA)
Return on Assets = Net Income / Avg Total Assets
Return on Equity (ROE)
Return on Equity = Net Income / Avg Shareholders’ Equity
Return on Invested Capital (ROIC)
ROIC = EBIT / Invested Capital OR EBITDA / Invested Capital
Return on Capital (ROC)
ROC = Net Income / Invested Capital
Calculation of Operating Cash Flows
Operating Cash Flow = Net Income + D&A - Increase in Net Working Capital
Calculation of Change in Net Working Capital
Change in NWC = Increase in Current Assets - Increase in Current Liabilities
Accounts Receivable Turnover
A/R Turns = Sales / Accounts Receivable
Days Sales Outstanding (DSO)
DSO = (A/R) / Sales x 365 OR 365 / (A/R Turns)
Inventory Turnover
Inventory Turns = COGS / Inventory
Days Inventory Held (DIH)
DIH = Inventory / COGS x 365 OR 365 / Inventory Turns
Accounts Payable Turnover
A/P Turns = COGS / Accounts Payable
Days Payable Outstanding (DPO)
DPO = (A/P) / COGS x 365 OR 365 / (A/P Turns)
Current Ratio
Current Ratio= Current Assets / Current Liabilities
Acid Test Ratio / Quick Ratio
Quick Ratio = (Current Assets - Inventories) / Current Liabilities
Calculation of Shares Outstanding after a Public Offering
Pro Forma Outstanding Shares = Previous Shares + Primary Shares Issued (do not count secondary shares)
Calculation of Offer Price per Share
Implied Equity Value / Pro Forma Outstanding Shares
Equity Value (using Enterprise Value)
Equity Value = Enterprise Value - Total Debt - Preferred Stock - Noncontrolling Interest + Cash
Weighted Average Cost of Capital (WACC)
WACC = (after-tax cost of debt x % of debt) + (cost of equity x % of equity)
After-tax Cost of Debt
After-tax Cost of Debt = Current Yield x (1 - tax rate)
Current Yield of a Bond (CY)
CY = Annual Interest / Market Price
Cost of Equity (using CAPM)
Cost of Equity (CAPM) = risk-free rate + (beta x market risk premium)
Market Risk Premium (MRP)
MRP = S&P 500 Expected Return - risk-free rate
Unlevered Free Cash Flow (FCF)
Unlevered FCF = EBIT - Adjusted Taxes + D&A - Capex + Decrease in NWC
Two methods of calculating Terminal Value under DCF
Exit Multiple Method and Perpetuity Growth Method
Common Valuation Methodology for Financial Services Companies
Price / Book Value
For Company Acquisition, Adjusted EBITDA multiple (accounting for synergies)
Effective EBITDA multiple = (Purchase Multiple x EBITDA) / (EBITDA + Pre-Tax Synergies)
net annual sales/average receivables = _______
Account receivables turnover
This ratio aids in analyzing the liquidity of the accounts receivable by showing how often they turn over.
A firm has just issued 6%, 10-year coupon bonds, which are trading at $950. The firm is in the 30% tax bracket. Its after-tax cost of debt equals ________.
After-tax cost of debt is calculated as the current yield of a bond tax effected (keep in mind the interest is tax-deductible).
Current Yield = Annual Interest/ Market Price
Current Yield = $60/ $950 = 6.3%
After-tax cost of debt = Current Yield x (1 - tax rate)
After-tax cost of debt = 6.3% x (1 - 30%) = 4.4%
A stock split will cause a change in the total dollar amounts shown in which of the following balance sheet accounts?
- Paid-in capital
- Retained earnings
- Cash
- Common stock
none
If a stock rises above a certain nominal amount, management may declare, for example, a two-for-one stock split, where the number of shares outstanding doubles and the stock price is halved. Each stockholder would have twice as many shares, but each share is worth half as much. Theoretically, a stock split should not affect the value of a firm. They are generally used after a sharp price run-up to produce a large per-share, nominal price reduction.
If a company converted a short-term note into a long-term note, this transaction would increase what?
both working capital and the current ratio
This transaction reduces current liabilities, but does not change current assets and, therefore, increases working capital and increases the current ratio. Remember, the current ratio measures current assets available to cover current liabilities, a test of near-term solvency. The ratio indicates to what extent cash on hand and disposable assets are sufficient to pay off near-term liabilities. Higher ratios indicate a better buffer between current obligations and a firm’s ability to pay them. The quality of current assets is a critical factor in interpreting this analysis.
Which of the following statements is most correct?
- An increase in the risk-free rate is likely to increase the cost of equity financing.
- The weighted average cost of capital does not depend on the risk-free rate.
- The weighted average cost of capital is calculated on a before-tax basis.
- An increase in the risk-free rate is not likely to increase the cost of equity financing.
1
An increase in the risk-free rate will increase the required rate of return since the required return equals the risk-free rate plus a risk premium. This will result in an increase in the cost of the common stock component.
Which ratio is formulated by: current assets / current liabilities?
current ratio
What is an example of a factor that might reduce a company’s WACC?
A reduction in the market risk premium
If the risk premium decreases, the required return on common equity will be reduced.
What is the formula for Accounts Receivable Turnover?
Sales / Average Accounts Receivable
What is the formula for Inventory Turnover?
Cost of Goods Sold / Average Inventory
What is capital surplus?
Capital surplus, also referred to as additional paid in capital, is all the proceeds above par that are received by a company.
Define:
Book Value
Book value, also referred to as shareholders’ equity, is the total amount of equity that has been invested into a company plus any retained earnings that have accumulated through operations.
It can be calculated as Total Assets - Total Liabilities
Define
Quick Ratio
(Current Assets - Inventory) / Current Liabilities
A company has long-term assets of $3.8mm and total assets worth $6.9mm. It also has shareholder’s equity of $3.9mm and long-term liabilities of $1.6mm. Calculate current ratio:
2.2x
Current Assets = Total Assets of $6.9mm - LT Assets of $3.8mm = $3.1mm
Total liabilities = Total Assets of $6.9mm - SE of $3.9mm =$3mm
Current Liabilities = $3mm - LT Liabilities of $1.6mm = $1.4mm
Current Ratio = CA of $3.1mm/CL of $1.4mm = 2.2x
Inventory turnover is computed using
cost of goods sold
Inventory turnover is computed as cost of goods sold divided by average inventory.
Which working capital ratio is calculated as sales divided by average accounts receivables?
Accounts receivables turnover
Company ABC has an annual sales of $550mm, cost of goods sold of $300mm, and average inventory of $90mm. What is the company’s inventory turnover ratio?
$300mm/$90mm = 3.33
The inventory turnover ratio is calculated as cost of goods sold divided by average inventory.
Company ABC has sales of $200mm, cost of goods sold of $50mm, average inventory of $90mm, and average account receivables of $75mm. What is the company’s receivables turnover?
$200mm / $75mm = 2.67
Receivables turnover is equal to sales divided by average accounts receivable.
In a comparison of 2014 with 2013, Sulzer Co.’s inventory turnover ratio increased substantially although sales and inventory amounts were essentially unchanged. What change would explain the increasing ratio?
COGs has increased
The inventory turnover ratio is equal to the cost of goods sold divided by the average inventory. If inventory is unchanged, an increase in cost of goods sold increases the inventory turnover ratio.
The accounts payable turnover is calculated as
COGS / Average Accounts Payable
A company has an average accounts receivables of $300mm and sales of $900mm. What is the company’s days sales oustanding?
($300mm/$900mm) x 365 = 121.67
DSO = (average accounts receivable / sales) x 365
The dividend discount model assumes that:
the value of a share of common stock is the present value of all future dividends.
Last year a company paid a $2 dividend, which is expected to grow by 5% each year. Assuming a discount rate of 11%, calculate the company’s implied stock price in accordance with the dividend discount model.
$35
Dividend discount model = (annual dividend x (1 + growth rate)) divided by (discount rate - growth rate)
Dividend discount model = ($2 x 1.05) / (11% - 5%) = $35
Liquidity of a company is generally defined as a measure of _____________.
the ability to pay current liabilities
Liquidity means having enough cash available to pay debts when they are due.
Company ABC expects to earn $300mm in cash flow each year in perpetuity. Assuming a discount rate of 10%, what is the company’s implied valuation?
$300mm/10% = $3bn
If a company has a negative working capital, would its current ratio be greater or less than 1.
The firm’s current ratio is less than 1.
Working capital = current assets - current liabilities. If working capital is negative, then current liabilities exceed current assets, implying a current ratio of less than 1.
When calculating the debt to equity ratio in a WACC calculation, does one use market value of equity or book value of equity?
Market Value
For WACC, always use market value of equity (shares x price) not book value of equity from the balance sheet.
Which ratio is typically used in the valuation of financial firms?
Price/Book Value
Which type of company typically has higher multiples: growth or value?
Growth companies typically have high multiples while value companies typically have low multiples
The market risk premium is
the spread of the expected market return over the risk-free rate
How does a DCF analysis determine valuation?
It values the company based on its expected future free cash flows discounted to prresent value
If a company declares a dividend, what impact does this have on their balance sheet?
Retained earnings falls
The interest coverage ratio is calculated by dividing what by interest expense?
EBITDA
Assuming a company has exercisable employee stock options, which will be greater, basic or diluted EPS?
Basic EPS
If employee stock options are exercised that will lead to more shares oustanding and therefore a lower EPS calculation for diluted EPS.
Which ratio is calculated as gross profit divided by sales?
gross profit margin
Economic value added (EVA)
EBIAT - (Capital Invested x WACC)
Rank operating profit margin, net profit margin, and gross profit margin from highest to lowest
Gross profit margin then operating profit margin then net profit margin
Define:
Weighted average cost of capital (WACC) is defined
The weighted average of a company’s cost of debt and cost of equity
Cash outflows for payments of dividends are reflected on which section of a cash flow statement?
Cash flows from financing activities
Which of the financial statements depicts a given point in time?
Balance Sheet
Only the balance sheet depicts the company’s financial position at one point in time. All others show what happens over a period of time.
If a company’s P/E ratio is 12x and it has an EPS of $1.75, what is the company’ implied stock price? Given that the P/E ratio on a common stock is 12, the expected dividend payout ratio is 0.7, and the dividend growth rate is 6%, what is the required rate of return?
$21
Stock Price = P/E multipled by EPS
Cash received from the sale of fixed assets is found on which section of the cash flow statement?
cash flows from investing activities
A company has an EBIAT of $250mm, a D&A of $100mm, a tax rate of 30%, a Capex of $90mm, and an increase in net working capital of $20mm. What is the company’s unlevered free cash flow?
$240mm
Unlevered free cash flow = EBIAT + D&A - Capex - Increase in NWC
What are the three sections of the cash flow statement?
Investing activities, financing activities, operating activities
The primary purpose of the statement of cash flows is to .
provide information about a company’s cash receipts and cash payments during the accounting period
Assuming a fixed purchase price, what happens to goodwill as fair market value increases?
Goodwill decreases
A company earns net income in excess of the dividends it pays shareholder’s. How is this reflected on the company’s balance sheet?
Retained earnings and therefore shareholders’ equity increases
If a company buys back stock, is it’s balance sheet impacted by the market value of the repurchased shares or the actual acquisition cost?
Actual acquisition cost
Formula for levered beta
Unlevered Beta x (1 + (1 - Tax Rate) x Debt/Equity)
All else being equity, as company’s tax rate increases, what is the impact on the calculation of WACC?
A tax rate increase would lead to a decrease in the after-tax cost of debt and, consequently, the company’s WACC would decrease.
When a company repurchases stock and plans to permanently retire the shares, how is this reflected within shareholders’ equity?
Par value amd capital surplus are reduced
A company has 9% bonds outstanding that are trading at 101. Assuming the company is in the 35% tax rate, calculate its after-tax cost of debt.
5.79%
Current Yield = annual interest divided by market price of bond
Current Yield = $90/ $1010 = 8.91%
After-tax cost of debt = Current yield x (1 - tax rate)
After-tax cost of debt = 8.91% x (1 - 35%) = 5.79%
Assuming a company has an unlevered beta of 1.2, a tax rate of 35%, and a debt to equity ratio of 45%, calculate the company’s levered beta.
1.55
Levered Beta = Unlevered Beta x (1 + (1 - Tax Rate) x Debt/Equity)
A company currently pays $50mm in annual interest. If they issue stock to retire their outstanding debt, what would be the increase to net income assuming a tax rate of 35%?
$50mm x (1 - 35% tax rate) = $32.5mm
Perpetuity growth formula
Free Cash Flow x (1 + Growth Rate)/ (Discount Rate - Growth Rate)
Company XYZ has a stock price of $37, a book value of equity of $4M and market value equity of $6M. What is the company’s price to book value?
Market Value of Equity/ Book Value of Equity = 1.5x
If ABC Company pays its rent in advance, how will its current assets on the balance sheet be affected?
There is no change to current assets as cash fell, but prepayment increased, which offset eachother
If current liabilities increase by more than current assets, what is the impact on net working capital and is that a source or use of cash?
Net working capital falls, which is a source of cash
Effective EBITDA multiple
Purchase Price/ (EBITDA + Pre-Tax Synergies)
A firm has a net income of $150, an increase in accounts receivables of $30, depreciation of $55 and a decrease in accounts payable of $25. It’s operating cash flow is
150 + 55 - 30 - 25 = $150
Operating cash flow = net income + noncash expenses - noncash revenues
A stock paid an $1.80 per share dividend this year. Dividends are expected to grow at 5% per year. Assuming a discount rate of 10%, what is the implied stock price calculated in accordance with the dividend discount model?
What is the value of the stock if the appropriate discount rate is 10% per year?
[Annual Dividend x (1 + growth rate)]/ (discount rate - growth rate) = $37.80
Debt/Tangible Net Worth
Total Debt/ (Shareholders’ Equity - Goodwill and Intangible Assets)
A company pays an annual dividend of $3 and has a dividend yield of 12%. Calculate the company’s stock price.
$3/12% = $25
