Financial Analysis Flashcards
Profitability Index
NPV
IRR
What holds the highest importance?
NPV/Initial Investment discounted (cannot be less than 1)
NPV FCF - NPV Investment (cannot be negative)
Cash Flows * Rate = Initial Investment
Profitability index
NPV NEXT
Cost Push Inflation
Factors that create a price increase
Cash Flows and depreciation
taxes paid is an outflow therefore effects cash flows
Cash Flow for Asset Disposal
Disposal Cost - Outflow
Salvage/Scrapping - Inflow
Basis + Disposal - Salvage * Tax % - Tax Savings from Loss INFLOW
Ranking Method
Screening Method
Find the actual profitability (profitability index)
Method don’t need to rely on time value of money
Accounting Rate of Return
Net Income/Initial Investment
IGNORE PRESENT VALUE
TRICK:
Depreciation usually goes with multiple choice answer
Higher depreciation higher outflow = HIGHER TAX DEDUCTION
Payback
IRR TRICK
Initial Investment/Cash Flow
IGNORE PRESENT VALUE
USED TO DETERMINE IRR FACTOR
Varying degrees of risk for investments should be calculated by using
Discount Rates that adjust for the risk
DISCOUNT RATE is the minimum required return on a project
Discount Rate and NPV relationship
Inverse; as you want a greater return the future value of the item will decrease
IRR
the purpose to have the present value = to the initial cash outlay, therefore wanting a zero balance
Relationship to positive NPV = means that the IRR is greater then the hurdle rate and the discount rate is
reduced
A time-adjusted rate of return from an investment
Present Value of inflows - Present Value of DISCOUNTED costs
Taxable Amounts
Gains
Losses
1 - Produce a tax liability that must be subtracted
2 - Produce a taxable deduction which can be added to the value or subtracted from the cash outflow
How to get PV rate
Investment Value/FCF (do not subtract out depreciation)
GDP deflator/inflator
Deflator - measures inflation
Inflator - not terminology used
IRR and NPV relationship
direct
positive NPV = higher IRR
negative NPV = lower IRR
Capital Budgeting Risk assessment
payback method
1- Floating Bonds
2 - Zero Coupon
1- Have a constant market value because interest rates fluctuate with changes in the market
2 - no interest payable
Which is risker long term or short term
Matching
Long-term; unless discussing the renewable option which makes short term credit more viable
Short-term should be matched with current
Long-term should be matched with noncurrent
Participating preferred shares dividends received
Cumulative preferred stock dividends receive
varies with companies earnings
fixed
Affirmative Covenant
requires company to maintain a certain level of working capital
WACC
Equity
Debt
DEBT factors in tax rate
Noncallable versus callable yield
noncallable will always have a lower yield because there is more risk however no option
1 - Treynor
2 - Sharpe
3 - Jensen
1 - Risk produced by fluctuations in the market & individual stock
(Portfolio return - Risk-free rate) ÷ Beta
2 - risk measure is the standard deviation of the portfolio rather than beta.
3 - measures the absolute value of performance of a portfolio on a risk-adjusted basis
Depreciation deductible amount formula
NI - depreciation * tax rate = deductible amount
IMPROVES THE CASH FLOW
Salvage Value Role in NPV
always is included as an INFLOW
efficient market hypothesis
WEAK
SEMI STRONG
STRONG
Market beliefs related to efficient markets take three forms: weak-form efficiency suggests that information about past prices would not be of use in predicting future performance;
semi-strong efficient markets suggest that all publicly available information is incorporated in market prices; and
strong-form efficient markets suggest that all available information is incorporated in current market prices
When PV multiplier is not given
payment/ 1 + %
payment/1+%1+%
payment/1+%1+%*1+%
Define: Compounding Returns
Time Value of Money
Firm’s target or optimal capital structure
minimum weighted cost of capital
Why is equity more expensive then debt financing
debt guarantees a minimum payment and equity is paid after debt is settled
Financial leverage
involves using borrowed funds to finance asset acquisition(s) which will generate returns exceeding the cost of borrowing. Thus, a higher debt to total assets ratio points toward the likelihood of more extensive financial leverage usage.
Commercial Paper limits
use of those allowed to use by only large high credit worthy companies
Zero Balance Account
Depository Transfer check
Put only enough in account to cover checks payable
only to be deposited in one central bank
1- in-exchange premise
2- in-use premise
1 - assumes that the maximum value of the subject item would come from the purchaser’s perspective when the item is used alone.
2- assumes that the maximum value of the subject item would come from the purchaser’s perspective when the item is used in conjunction with other assets as a group.
1- Cost approach
2- The market approach
1- is a valuation method based upon what it would cost to replace the subject item with an asset of like function and capacity.
2- is a valuation approach that uses market comparisons of identical or comparable assets or liabilities
IRS Ruling 68-608
The past earnings used in the valuation process should fairly reflect the probable future earnings
Fair value versus FMV
Fair market value defines the seller as hypothetical, whereas fair value assumes a specific seller.
principal market
the holder of the asset or liability could find the greatest volume of asset sales or liability transfers of items similar to the one being valued
Financial leverage
Financial leverage refers to the extent to which debt and preferred stock (i.e., fixed income securities) are used in the capital structure. The larger the percentage of debt and preferred stock that is used for financing, then the greater the risk that the company will not earn enough to cover the fixed interest and dividend payments. The more leverage, the greater the risk, and the higher the cost of capital
DOL fixed and variable cost effect
A firm can change the DOL by changing the proportion of fixed costs to variable costs. The larger the proportion of fixed costs, the higher the DOL and the higher the breakeven point. The higher the proportion of variable costs, the lower the DOL and the lower the breakeven point
1- Market or systemic risk
2 - Company Risk
1- is risk that cannot be eliminated through diversification
2 - not offset through diversification
1- financial risk /interest rate risk
2 - business risk
3- marginal risk
1- concept of financial leverage and the cost of debt
2- uncertainty associated with the ability to forecast EBIT (earnings before interest and taxes) due to such things as sales variability and operating leverage EQUITY
3- risk that is assumed by the issuer of a foreign exchange contract or debt (forward contract) in the event that the investor goes bankrupt. It is related to the risk of the last dollar of a transaction defaulting DEBT
Cost of debt
Basis Points
current market value of the debt
Basis Points/100 = Percentage Value
Debt to Equity (Financial Leverage) and relation to risk
Higher Financial Leverage Higher Risk
Early predictor of inflation
wholesale price index
Deflation
Inflation
less money so higher purchasing power = lower prices
more money so lower purchasing power = high prices
Inflation is measured
HISTORICAL DOLLARS -
Carrying Cost
Setup Cost
increase w/ more
decrease w/ more
Return % from taking a discount
360/(total credit period - discount period) * % of discount/( 100 - discount %)
noncallable bond versus callable
noncallable less risky therefore lower yield
cost of preferred stock
% / SP - issue
Income Taxes
Income - Income Tax %
Outcome of IRR
make the PV FCF = initial investment
NPV of ZERO
cost of debt most frequently measured at
actual interest rate - tax savings
Deprecation and TR
used in the calculation of tax rate but not deducted from CASH FLOWS/ ONLY income tax is deducted
Tax credits
decrease IRR because it decreases amount deducted
Collection Ratio
Average Receivables/Daily Sales
Average Collections
Days in Year/ AR Turnover
Reorder Point
(Average weekly demand × Lead time) + Safety stock
Materials requirements planning (MRP)
EOQ
JIT
is a push system; i.e., the demand for raw materials is driven by the forecasted demand for the final product as programmed into the system.
Trade off between Carrying Costs & Ordering Costs
Demand Pull focuses on actual demand
Liquidity Ratio
Leverage Ratio
Assets
DEBT
Declaration of a Dividend
increase AP
NPV inflows valuation
inflows are valuated as being greatest in value earlier in the investment
mutual exclusive
choose one with the highest value
PAST COST IN CAPITAL BUDGETING
IGNORED BECAUSE SUNK
total borrowings
amount borrowed/ 100% - compensating balance
what constitutes as INVESTMENT
PPE & WORKING CAPITAL
