Finance Flashcards
When reviewing an investment opportunity, which factors should be considered?
- Maturity - how long will the cash be invested and when should any investments mature?
- Preservation of initial capital - can the company afford to lose its initial investment?
- Liquidity - how liquid do the investments need to be and how quickly will cash be required?
- Income type - is there a type of investment the individual/ entity would like to receive?
- Level of risk - how much risk can the individual/ entity tolerate?
- Tax impact - what are the tax implications of this investment (when sold, or when income earned)
What does beta represent (WACC)?
beta is a measure of the amount of the volatility, or systematic risk, involved in a specific investment in comparison to the risk of the entire market.
What is WACC? How does WACC affect a company?
WACC - weighted average cost of capital
Ideally, the lower a WACC is the better for a company - represented the minimum rate of return.
How do you calculate basic EPS?
= Net earnings (loss) available to common shareholders / WACSO (weighted averaged common shares outstanding)
How do you calculate net earnings available to common shareholders?
= net income (loss) of entity - dividends on cumulative preferred shares - dividends declared on non-cumulative preferred shares.
How do you calculate WASCO?
= shares outstanding * adjustment factor (like a stock split or stock dividend) * fraction of the year (can used days or months)
How do you calculate diluted EPS?
- Calculate basic EPS
- Identify all PCS (items that may entitle people to common shares - i.e., convertible debt
- Calculate individual EPS for all of the PCS items identified
- Order the incremental EPS (lowest = most dilutive to highest = least dilutive)
- Starting at basic EPS, add incremental EPS and calculate provisional EPS - keep going until you compute all, or until the provisional is greater than the incremental.
How can you determine dilutive vs. anti-dilutive incremental EPS?
If incremental EPS > basic EPS = anti-dilutive (don’t include)
If incremental EPS < basic EPS = dilutive (include)
How do you calculate income available to common shareholders for convertible bonds?
= face value of bond * interest rate * (1 - tax rate)
How do you calculate income available to common shareholders for convertible bonds?
= face value of bond * interest rate * (1 - tax rate)
What valuation method should be used when the entity is NOT a going concern?
- Liquidation method (orderly or forced)
When to use the adjusted net asset method, and how to perform valuation?
- Used when an entity is not an income earning entity, but still a going concern; generally the entity does not maintain active operations
- Valuation = FMV of assets (less the disposition costs) - liabilities + adjustments related to tax consequences of selling assets/ liabilities
How to calculate valuation under capitalized cash flows approach?
- Determine annual cash flows (removing unusual, non-routine items) and apply capitalization rate to expected annual future cash flow of the entity
How to calculate valuation under the discounted cash flows approach?
- To calculate, use estimates of future cash flows and discount at appropriate rate (similar in nature to NPV?)
What are some limitations of using a capitalized earnings approach valuation?
- Generally we are only looking at 1 year of data (sales might reflect a “normal” year, or they might not be accurate)
- Ask yourself: what are the estimates and assumptions used in the calculation? (ie, if you are saving on a certain expense, the actual could be higher or lower than expected)
- What is the multiplier is not appropriate (too large/ too small)? It could be based on larger or smaller companies, companies with more or less future growth, companies in different geographical locations
- Are the #’s you are using audited? once audited, NI could change
- Considering all of these limitations, is their a valuation method that could be better?
