BIWS Basics (All Topics) Flashcards
What is the effect of a dividend recap on the 3 financial statements?
IS: No Impact
CFS: Financing Section - plus 100 in cash from debt raise; subtract 100 from dividend
BS: no change to assets; L+E - liabilities are up 100 from debt raise, equity is down 100 from dividend.
both sides balance
How does a $10 increase in AR affect the 3 financial statements?
IS: Revenue goes up by $10, Pre-Tax Income is up $10. Assuming 40% tax rate, Net Income is up $6.
CFS: Net Income is up $6 but A/R is up $10 which reflects a use of cash. CFO is down net $4. Cash is down $4.
BS:
Assets - Cash is down $4 from CFS. AR is up $10. Assets are up net $6.
L+E - Retained earnings are up $6 from Net Income.
Both sides balance.
What are some of the assumptions of CAPM?
a. Security markets are perfectly competitive
b. Markets are frictionless; No taxes or transaction costs
c. Investors are myopic; All investors have only one and the same holding period
d. Investments are limited to publicly traded assets with unlimited borrowing and lending at the risk-free rate
e. Everyone has perfect information; All investors have access to same information; All investors analyze information in the same manner
How do the 3 financial statements link together?
a. Net income from the income statement flows into the balance sheet and the cash flow statement.
i. On the balance sheet, net income flows into shareholders equity via retained earnings. Retained earnings is equal to the previous period’s retained earnings plus net income from this period less dividends from this period.
ii. In terms of the cash flow statement, net income is the first line used to calculate cash flow from operations.
b. On the balance sheet, working capital items will flow into the cash flow from operations section.
i. Increases in current assets will reflect a deduction in cash flow while an increase in current liabilities will reflect a source of cash
c. On the balance sheet, changes in items such as debt, PP&E and shareholders equity will be reflected in the investing and financing sections of the cash flow statement
i. Capex flows into the investing section and will increase PP&E on your balance sheet
ii. Deprecation will reduce PP&E on balance sheet and be reflected in the operating section of the cash flow statement and on the income statement as well
iii. Debt
iv. Equity
What is an ideal candidate for an LBO?
- stable and predictable cash flows
- low-risk business
- non much need for ongoing investment such as capex
- opportunities for margin expansion
- sound management team
- asset base to use as collateral for debt
How do you calculate WACC?
(Cost of Equitiy * % of Equity) + (((Cost of Debt * (1-tax rate)) * % Debt) + (Cost of Preferred Stock * % of Preferred Stock)
How do you arrive at Cost of debt for WACC?
i. Calculating or arriving at the cost of debt: Theory is the rate should represent the rate the company would pay if it issued additional debt or preferred stock. 3 Reasonable Methods
1. Using current coupon if company already has outstanding debt
2. Using the YTM on current debt (probably a more accurate reflection of what a company would pay to raise new debt)
3. More academic approach: take the risk-free rate and then add a default spread based on the company’s credit rating
How do you find cost of equity for WACC?
ii. Finding Cost of Equity
1. Cost of Equity = Risk-Free Rate + Levered Beta * (Market Risk Premium)
a. Levered and Unlevered Beta: Beta reflects two risks: inherent business risk and risk from leverage
i. Use peer companies to un-lever beta and find the inherent business risk without the risk of leverage
1. Unlevered Beta = Levered Beta / (1 + Debt/Equity Ratio * (1 – tax rate))
ii. Re-lever beta based on median unlevered beta from comparable companies
1. Re-Levered Beta = Unlevered Beta * (1 + Debt/Equity Ratio * (1 – tax rate))
How does Inflation work?
a. Persistent rise in overall prices for goods and services or more importantly lower buying power of the dollar
b. It occurs when aggregate demand for goods and services rises more rapidly than productive capacity
i. Employment increases and more people have discretionary income
ii. Goods are below their market clearing price and incremental demand pulls prices higher
iii. As prices rise, supply increases
c. Inflation can manifest itself in different ways; consumer goods, the production cycle or wages
d. When inflation is discussed in the media people are typically talking about CPI
e. Two basic theories of how inflation is created
i. Demand-pull theory
1. Demand outstrips supply and prices go up
ii. Cost-push theory (many economists reject cost-push)
1. Increases in cost of raw materials and labor drives up prices
Similar companies in the same industry, why are their EV/EBITDA multiples different?
EBITDA Related
1. margins
2. growth
3. market share
4. capex
EV Related
1. Unfunded Pension Obligations
2. Capital leases vs. operating leases
3. Market Cap: illiquidity in one name affecting stock price
4. company specific events
a. target of a merger
b. key executive steps down suddenly
c. accounting scandalWhat are some of the costs of inflation?
- Creditors lose: their returns are diminished
- debtors gain (they get an interest free loan)
- decline in purchasing power and standard of living for people with fixed incomes
What does Beta illustrate?
How do you unlever beta and re-lever beta?
a. Levered and Unlevered Beta: Beta reflects two risks: inherent business risk and risk from leverage
i. Use peer companies to un-lever beta and find the inherent business risk without the risk of leverage
1. Unlevered Beta = Levered Beta / (1 + Debt/Equity Ratio * (1 – tax rate))
ii. Re-lever beta based on median unlevered beta from comparable companies
1. Re-Levered Beta = Unlevered Beta * (1 + Debt/Equity Ratio * (1 – tax rate))
Which firm has a higher cost of capital? one with more fixed costs or one with more variable costs?
- a firm with higher fixed costs will have a higher cost of capital
- firms with higher fixed costs are said to have high operating leverage; cost to acquire new customer is lower and margins should expand quicker in a growing economy
Explain differences between fixed and variable costs
- fixed costs are independent of output; machinery, buildings, rent
- variable costs vary with output; wages, materials
Give examples of companies with fixed and variable costs
- high fixed costs: manufacturing, healthcare services, electric utilities
- high variable costs: Costco
a. inventory and part-time labor make up significant portion of cost structure which makes it adaptable to macro changes
