Finance Week 3 Flashcards
What is the goal of a corporation?
Maximize shareholders wealth through good investing and financing decisions
How can you measure corporate performance?
Statements have info about corporations assets and liabilities, profitability and cash flows and so you can use these to calculate financial ratios that provide indication of managers performace
How can you use financial ratios?
They are objective but can be compared over time and with other firms in the same industry
What are the 2 measures for shareholders value added?
Market value of shareholders equity and market-to-book ratio
What is the market value of shareholders equity?
Market value of shareholders equity = # shares * price per share
What does the size of the market value of shareholders equity suggest?
Larger market value of, the wealthier and better for shareholders
What is the market to book ratio?
This is the market value of SE relative to its book value: Market-to-book ratio= market equity / book equity- measures how much shareholders wealth has been added per dollar shareholder invested
What are the measures for profitabilitiy?
accounting rates of return measures firms profitability per dollar of invested asset: Return on equity (most used), Return on capital, Return on assets, Economic value added
What is the return on equity?
net income/ book equity
What is the return on capital?
Net income / long term debt + book equity
What is the return on assets?
Net income / total assets
What is the Economic value added ?
Net income neglects investors opportunity cost of capital- return investors can expect on opportunities with similar risk. EVA measures income to investors (bondholders and shareholders) after deducting all costs including cost of capital:
EVA= net income + after tax-interest - (opportunity cost capacity * book equity)
What are measures for efficiency and profit margin?
Efficiency: asset turnover = sales / total assets- measures how much sales a company can generate per dollar of assets. Profit margin = net income/ sales. Measures how profitable a firm can transform dollar of sales into dollar of income
What is the Du Pont system for return on equity?
Allows us to decompose ROA into profit margin and asset turnover. ROA = net income / assets = (net income / sales) profit margin * (sales/ assets).
if low profit marging, FM may reduce costs, if low asset turnover, may think about how asset turned over faster.
What are measured for financial leverage?
Leverage ratios measure a firms ability to repay debt. This is important because if unable, default on debt obligations, leads to bankruptcy and shareholders lose investment. Includes debt ratio and times interest earned ratio.
What is the debt ratio?
Long term debt / long term debt + equity- measures how much percent of long term capital is in form of debt compared to equity.
What is the times interest earned ratio?
Times interest earned ratio= EBIT/ interest payments. It measures how well a firms earnings are able to meet interest payments.
What are measures for liquidity?
Firms ability to meet short term liabilities by selling assets on short notice at a price close to market value. (AR & inventories liquid) (real estate/ machines illiquid) includes NWC, current ratio and quick ratio
What is the Net working capital (NWC)
= Current assets - current liabilities. Measures how well short term liabilities are covered by liquid assets
What is the current ratio?
Current ratio = current assets / current liabilities. Measures how well short-term liabilities are covered by liquid assets.
What is the quick ratio?
Quick ratio = cash + marketable securities + AR/ current liabilities- measures how well short term L covered by most liquid A. Same as current ratio but excludes inventories
How can you use ratios?
compare to firms past and similar firms
What is the principle of time value of money?
A dollar today is worht more than a dollar in the future as you can invest money and earn interest on it.
What is the future value of initial investment in t years using interest rate r
Future value=initial investment * (1+r)t
What is the present value?
Present value = Future payment/ (1+r)t
What if there are multiple cash flows?
To add payments add different points in time, bring each payment to a common date by discounting payments to PV or compounding payments to FV
What do you do if given a problem where can pay now or later?
Find the PV of later payments and compare prices to see what would be better
