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Series 86 > Chapter 5 > Flashcards

Chapter 5 Flashcards

1
Q

Changes in operating activities

A

A section on the cash flow statement that describes the changes in WC. An increase in AR on the CFS (a decrease on the b/s) is a source of cash. An increase of inventory on the CFS (a decrease on the b/s) is a source of cash. An increase in accounts payable (a decrease on the b/s) is a use of cash.

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2
Q

Accounts receivable turnover ratio

A

Net credit sales ÷ avg. accounts receivable

  • This ratio provides good insight into whether a decline in accounts receivable is because customers are paying their credit charges quicker OR because business is slowing. Oftentimes, this ratio is compared to an industry benchmark.
  • If this ratio increases, it shows the firm is collecting cash quicker, whereas a decrease shows the firm is collecting cash slower.
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3
Q

Average accounts receivable

A

(Opening accounts receivable balance + closing accounts receivable balance) ÷ 2

  • This ratio provides good insight into whether a decline in accounts receivable is because customers are paying their credit charges quicker OR because business is slowing.
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4
Q

Inventory turnover ratio

A

COGS ÷ Avg. inventory

  • Useful to determine if the buildup in invetory is a result of a slowdown in sales, or is the buildup because of additional inventory purchases in order to keep pace w/ demand.
  • Oftentimes, this ratio is compared to an industry benchmark.
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5
Q

Average inventory

A

(Operating inventory + closing inventory) ÷ 2

  • Useful to determine if the buildup in invetory is a result of a slowdown in sales, or is the buildup because of additional inventory purchases in order to keep pace w/ demand.
  • Oftentimes, this ratio is compared to an industry benchmark.
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6
Q

Accounts payable turnover

A

COGS ÷ Avg. accounts payable

  • A decrease in this ratio is positive.
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7
Q

Avg. accounts payable

A

(Opening payables + closing payables) ÷ 2

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8
Q

Asset turnover ratio

A

Net sales ÷ Avg. assets

  • Higher ratio is positive
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9
Q

Average assets

A

(Assets BOP + Assets EOP) ÷ 2

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10
Q

Net CF formula

A

CFO - change in WC + CFI - CFF

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11
Q

FCFF formula:

A

FCFF = EBIT * (1 - T) + D&A - CAPEX - net change in WC

In many cases, NOPAT as used instead of EBIT * (1 - T)

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12
Q

NOPAT formula

A

Net income + interest expense + nonrecurring costs + tax paid on investment and interest income - investing and interest income - tax shield from interest expense.

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13
Q

Operating profit/EBIT calculation

A

Net sales - operating expense

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14
Q

True or false: EBITDA is a good representative of CF?

A

False, EBITDA is a profitability metric that eliminates the effects of financing and accounting decisions.

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15
Q

Return on invested capital (ROIC)

A

NOPAT ÷ invested capital

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16
Q

Invested capial definition

A

Total assets - non-interest-bearing current liabilities - excess cash

17
Q

Match the following metrics w/ the appropriate industry comparison:
1. P/B
2. P/FFO
3. Normalized, relative P/E
4. P/S
5. Earnings yield
6. EV/EBITDA
7. EV/Sales
8. PEG
a. companies w/ negative earnings
b. Companies w/ high P/E ratios
c. Basic industry, Cap intensive
d. Financial services companies
e. Cyclical companies
f. Retail companies
g. Start ups
h. REITs

A

1 - d
2 - h
3- e
4 - a/g
5 - a
6 - c
7 - f
8 - b

18
Q

Firm A has 2 business segments:
- It’s mining business contributes 90% of the firm’s earnings
- It’s financial services division generates much lower revenues, but a significantly higher profit margin.
What’s the best approach to valuing Firm A:
- A sum of the parts method should be used if the divisions have different growth rates
- A sum of the parts method should be used if different valuation methods are used.
- A DCF method is preferable since each remaiing segment is profitable
- EV/EBITDA should be used due to the significance of the company’s industrial base

A

B.

19
Q

Which of the folowing statements is NOT true in a rising rate environment:
A. There’s a negative impact on DCF
B. WACC will decline
C. The PV of pension liabilities will decline
D. The Rf will be higher

A

B

20
Q

Long-term debt-to-capitalization ratio

A

Long-term debt ÷ (equity + long-term debt)

21
Q

Interest coverage ratio

A

EBIT ÷ interest expense

22
Q

Rate of economic value added

A

The ROIC-to-WACC spread (ROIC - WACC) can be used show if a company is generating economic value.

Formula: ROIC - WACC

ex: If firm A has ROIC of 12% and WACC of 8%, 12% - 8% = 4% - 4 cents of value is created for each dollar invested. If firm B has a ROIC of 4% and a WACC of 8%, 4% - 8% = -4% - 4 cents of value is destroyed per dollar invested.

  • If the spread is positive, returns exceed cost of capital.
23
Q

Residual income

A

The amount of earnings that exceeds the investors’ required return. The ROIC-to-WACC spread can also be used to calculate residual income.

Formula: When leveraged: RI = ROIC-to-WACC * FCFF
OR
(ROIC - WACC) * invested capital

  • Residual income goes one step further than the ROIC-to-WACC spread by estimating the amount of economic value added, rather than just the rate.
  • Residual income is advantageous when the teminal value is difficult to estimate and/or dividends are inconsistent and when operating CF is negative.
24
Q

Economic value added (EVA) formula

A

NOPAT - (WACC * invested capital)
OR
(ROIC - WACC) * invested capital

25
Q

Market value added

A

PV of EVA

  • Therefore, enterprise value can be caluclated by calculating the expected EVA for a series of years, finding their PV and summing their results.
26
Q

ROIC-to-WACC ratio

A

ROIC ÷ WACC

ROIC ÷ WACC = EV ÷ invested capital

  • A ratio > 1 indicates the firm is creating value. A ratio < 1 indicates the company is destorying value.
  • The ratio can be used to estimate the EV of a company: EV = invested capital (ROIC ÷ WACC).
27
Q

EPS calculation

A

(NI - preferred dividends) ÷ Avg. # of CS outstanding

28
Q

Dividend yield %

A

Annual dividend ÷ Current market price of CS

29
Q

How to calculate ROIC-to-WACC if a company acquires more debt

A
  1. Find the projected net sales (new total debt ÷ last year’s debt as a % of sales)
  2. Find the projected NOPAT (#1 * last year’s NOPAT as a % of sales)
  3. ROIC = #2 * invested capital (make sure to include the new debt)
  4. # 3 ÷ new WACC
30
Q

True or false: An additional debt offering would likely significantly decrease the ROIC-to-WACC ratio?

A

False, it would likely significantly increase the ratio.

31
Q

Invested capital formula

A

TA - non-interest-bearing CL - excess cash

32
Q

True or false: If a proposed acquisition lowers the ROIC-to-WACC ratio, it is a good idea?

A

False, it’s not a good idea since it will be destroying economic value.

Series 86 (7 decks)

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