Final Flashcards
ROE using the DuPont formula is:
Return on Assets * Income Statement Leverage * Balance Sheet Leverage
Is ROA influenced by financing activities?
No, ROA = NOPAT/Total Assets, NOPAT neutralizes for financing activities
What is the formula for NOPAT, and what does it approximate?
NOPAT approximates earnings before interest after taxes (EBIAT). The rough calculation for NOPAT is: NOPAT = Operating profit x (1 - Tax Rate)
What’s the formula for ROE starting from ROA?
ROE = ROA * I/S Leverage * B/S Leverage
to calculate your firm’s ROE, multiply Net Profit Margin times Return on Assets (ROA) times Financial Leverage.
Is profit margin a measure of asset efficiency and why/not?
Asset efficiency measures the ability of a company to generate sales from its assets, not profits.
Calculate ROE given: NI/Sales=8% Sales/Assets=1.6x Tax rate=35% Current ratio=2x ROA=0.20 Assets/Equity=1.8x Interest/Assets=3%
ROE = (NI/Sales)(Sales/Assets)(Assets/Equity) = 23.04%
What is the formula for days receivable?
(AR/Sales)*(Days = 365) = 73
What would we expect the fixed asset ratio for a software company to be and why?
Software will have fewer fixed assets and can generate a lot of sales (assuming it is a mature software company) - therefore the fixed asset turnover ratio will be high.
Fixed Asset Turnover = Sales / Net fixed assets.
Capex Ratio = Capital expenditures / Sales.
Average Age Ratio = Accumulated depreciation / Gross PP&E.
Average Age Ratio = Capital Expenditure / Depreciation.
What would we expect the fixed asset ratio for a retailing company to be compared to a utility and why?
It is likely that a retailing company will have a higher fixed asset turnover than a utility. This is assuming the retailer leases its locations and the locations are not capitalized on the B/S.
A fixed asset is a long-term tangible piece of property or equipment that a firm owns and uses in its operations
Can quality of earnings be evaluated by comparing cash to financing, net income, investing, operations, or cash from investing?
Quality of earnings is typically looked at through the lens of NI and CFO.
Operating Cash Index = (CFO - Dep)/NI
What are two indicators of increased bankruptcy risk?
Higher debt to equity ratio - High Superfluous debt can drown a company.
More fixed costs in the cost structure - Excessive fixed costs can drown a company if sales falter in times of market dislocation.
Does a higher current ratio increase or decrease the risk of bankruptcy?
Current ratio = Current assets / Current liabiliites
Higher current ratio = more liquid
In terms of investing and financing, what would we expect to see from a high growth firm?
A high growth firm is more likely to have negative CFO and positive CFF
What is a useful metric for evaluating a firm’s debt carrying capacity?
Interest coverage ratio
What’s the formula for current ratio?
current ratio = Current assets / Current liabilities
How is a company with negative working capital funding its current assets?
A firm with negative working capital is funding its current assets using current liabilities
Does financial leverage magnify both good and bad changes in performance?
Yes, financial leverage magnifies changes in performance, both good and bad.
What are two of the limitations of using PEG ratios in relative valuation?
- It does not control for risk and 2. It is affected by differences in market risk premiums
Where in the economic cycle are price to earnings multiples usually highest for cyclical firms?
The bottom - Price to earnings ratios are usually highest for cyclical firms at the bottom of the economic cycle
In carrying out relative valuation, one of the issues to consider is differential risk between the target firm and the comparable. Which of risk-free rate, risk premium, and beta could cause differences in risk between the two firms in the same country and at the same point in time?
Beta, growth, and quality of earnings all matter when comparing two firms in the country and at the same time.
The risk-free rate will be identical for both firms.
The price to book multiple is most useful for valuing which type of firm?
Price to book is most valuable for valuing banks
What does degree of operating profit measure?
How much the operating income of a company will change in response to a change in sales - impact of sales on company earnings
What’s the formula for degree of operating leverage?
((Gross Profit Curr./Gross Profit Prev)-1)
/
((Sales Curr./Sales Prev.) - 1)
What can be said of a firm that increases revenue without increasing COGS?
a firm that increases revenue without increasing COGS has no variable costs in its cost structure
If operating leverage of a firm is 4, will quantity and price impact margins?
built into the business model - With operating leverage built into the business model, both quantity and price will have an impact on margins.
Will purchasing inventory with cash increase a firms quick ratio of 1?
Quick ratio = Quick assets/Current liabilities
Quick assets = Cash + mkt sec + A/R
Decrease in cash to purchase inventory would decrease the quick ratio
Will collecting A/R in cash increase a firms quick ratio of 1?
Quick ratio = Quick assets/Current liabilities
Quick assets = Cash + mkt sec + A/R
Swapping A/R for cash would have no effect on quick ratio.
Will purchasing inventory on credit increase a firms quick ratio of 1?
No - Purchasing inventory on credit would increase A/P, therefore decreasing the quick ratio
Quick ratio = Quick assets/Current liabilities
Quick assets = Cash + mkt sec + A/R
What could explain the fact that the market price of a firm is less than the valuation of the firm based on a comparable?
the market price of a firm is less than the valuation of the firm based on a comparable could be due to the firm being: 1. Undervalued, 2. Riskier, or 3. having lower growth prospects.
What is a formula for LT growth rate using P/E and PEG?
g = [P/E]/[PEG]
[PEG] = [P/E]/g [P/E] = Share Price/EPS = Net Income / Total # of Shares
What’s the formula for valuing a company given the firm’s EPS and a comparable firm’s P/E for the same year.
Comp P/E * EPS
PEFY1 Sketchers = 18.73x
EFY1 UA = 1.05
18.73*1.05 = $19.67
What is the formula for calculating value of equity using the residual income method?
Residual Income =
Cost of Equity +
Dividends
Book Value +
(Residual Income in Future Periods/(1+Cost of Equity)^t
/(1.1)^1
/(1.1)^2 = 1.21
/(1.1)^3 = 1.331
Residual Income
= Net Income - Cost of Equity
= Equity * [Required Rate on Equity = % Cost of Equity ]
Residual Income
= Net Income - .1
= Equity * .1
10 [Book Value Per Share] \+ 1.82 [z \+ 1.50
Book Value Per Share
Residual Income = Net Income - Equity Charge
Equity Charge = Equity Capital * Cost of Equity
ROE = Net Income / Shareholder’s Equity
Dividend Payout = Total Dividends / Net Income
Book Value Per Share = (Shareholders’ Equity - Preferred Equity) / Avg. # of Common Shares
Cost of Equity=10%
Dividend Pay
out = 30%
Book Value per share = $10 future ROEs = 30%, 25% and 10% to perpetuity.
What is the formula for Profit Margin from Net Income?
Profit Margin = Net Income + Interest Expense(1-Tax Rate)/Sales
Four steps in firm strategy analysis:
Product discriminator or low cost leader
degree of integration in the value chain
degree of geographical diversification
degree of industry diversification
Three categories of Dupont decomposition return on equity analysis
Return on Sales
Asset Turnover
Financial Leverage
What is the formula for ROA starting with Net Income?
ROA = Net Income - Interest Expense (1-Tax Rate)/Total Assets
What are the two parts of ROA?
ROA =
1. Net Income + Interest Expense (1-Tax Rate)/Sales
*
2. Sales / Total Assets
Why do we adjust the interest expense by the tax rate when calculating ROA?
We adjust the interest expense by the tax rate when calculating ROA because net income is after taxes and we want to calculate EBI
In competitive equilibrium, what should ROA approximate?
In competitive equilibrium the ROA for a firms should approximate the weighted average cost of capital.
What are four factors that can account for differences in ROA across firms?
- Industry Difference
- Monopoly Rent
- Accounting Differences
- Risk
are all factors that can account for differences in ROA across firms
What are four determinants of profit margin?
Four determinants of profit margin are:
- Industry Factors
- Sales Volume
- Sales Price
- Expenses
