Final Flashcards
(41 cards)
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
