Financial Modeling Projections And Analysis Flashcards
Step one for the stages of cash flow: inception of the project
Invoice + shipping + installation (outflow)
Add: increase in working capital (outflow)
Subtract: cash proceeds on sale of old (net of tax) (inflow)
——————————————————————-
Net initial outflow
What are the stages of cash flow?
Step 1: Inception of the project
Step 2: operations
Step 3: disposal of the project
How do you find the net proceeds on sale of old (net of tax)? in order to complete step one for the stages of cash flow?
Proceeds on sale (inflow)
- tax paid on gain (GxT) (outflow)
+ tax saved on loss (LxT) (inflow)
Step Two for the stages of cash flow: Operations
Pre tax cash invlow x (1-T) (inflow)
+ Depreciation x T (inflow)
Step Three for the stages of cash flow: Disposal of the project
One time terminal year inflow The direct effect for the cash inflow created on the sale - direct expense \+ tax savings \+ decr. working captial \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ Terminal year net inflow
What is the shortcut to compute the after tax cash flows?
Multiply pre tax cash flow by (1- Tax rate)
What is a component of total after tax cash flows?
Multiply noncash tax shield items (such as depreciation) by the tax rate
What is the 3 steps of the comprehensive concept- Cash flows for Capital Budgeting?
Step 1: Determine total cash outflow
Step 2: Computing after tax cash inflows after consideration of both the net cash inflows and deprecation tax shield
Step 3: Computing the impact of salvage value in the final year.
How do you calculate the Net Present Value Method?** Memorize**
Step 1: Calculate after tax cash flows = annual net cash flow x (1- Tax rate)
Step 2: Add depreciation benefit = Deprecation x tax rate)
Step 3: Multiply results by appropriate present value of an annuity
Step 4: Subtract initial cash outflow
Result: Net present Value
How do you estimate the cash flows?
1: Initial outflow
2. Annual inflow
3. one time TYCF
How do you interpret the NPV method?
gain= positive results= sum of PVFCF> initial outflow loss= negative results= initial outflow > PVFCF
Why is the NPV method of capital investment valuations considered to be superior to the Internal Rater of Return method?
Because it is flexible enough to consistently handle either uneven cash flows or inconsistent rates of return for each year of the project
How do you calculate the profitability index?
present value of the net initial investment
PI > 1 means + NPV
PVFCF> Cost
What is the objective of the Internal Rate of Return? (IRR)
it focuses the decision maker on the discount rate at which the present value of the cash inflow equals the present value of the cash outflows.
LESS reliable than the NPV method
How do you interpret IRR for investment decisions?
Accept when IRR> Hurdle Rate
Reject when IRR < Hurdle Rate
What is the hurdle rate of return?
The desired (or minimum) rate of return that is set to evaluate investments or projects. The rate can be adjusted to reflect risk or to compensate for expected inflation.
What is the payback period method?
It focuses decision makers on both liquidity and risk.
The formula is :
Net initial investment
_____________________
Increase in annual net after tax cash flow
The lower the better.
Advantages and Limitations on payback period method?
Advantages: easy to use and understand, emphasis on liquidity
Disadvantages: time value of money is ignored (unless DCF used), project cash flows occurring after initial investment is recovered are not considered, total project profitability is neglected
What is discounted payback method?
This variation computes the payback period using expected cash flows that are discounted by the projects cost of capital. The measure focuses decision makers on the number of years needed to recover the investment from discounted net cash flows.
Increased leverage amplifies returns but increases
risk
There are two parts to operating Leverage. What are they?
Fixed salary- TC “independent” of sales
“Variable” (commissions)- TC “dependent” on sales
Examples: 1. Sales goes up Fixed cost - no change EBIT goes up 2. Sales goes down Fixed costs- no change EBIT goes down
What is the formula for Degree of operating leverage (DOL)?
% change in Sales
What does the higher degree of operating leverage imply?
that a relatively small changes in sales (increase or decrease) will have a greater effect on profits and shareholder value.
The higher the firms degree of operating leverage….
The greater its profitability (but also the greater the risk)
What is the formula for a firms degree of financial leverage (DFL)?
%change in EBIT
What are the two parts to Financial leverage?
- Fixed = debt = Interest Expense independent of profit
2. Variable= equity= Div. Dependent on profit
The higher degree of financial leverage……
implies that a relatively small change in earnings before interest and taxes will have a greater effect on profits and shareholder value
Examples:
1. EBIT goes up
IE no change
EPS goes up
- EBIT goes down
IE no change
EPS goes down
What is the formula for a firms degree of combined leverage? (DCL)
% Change in Sales
What is operating leverage?
the degree to which a firm uses fixed operating costs, as opposed to variable operating costs
What is financial leverage?
the degree to which a firms use of debt to finance the firm magnifies the effects of a given percentage change in earnings before interest and taxes on the percentage change in its earnings per share.
What is combined total leverage?
the use of fixed operating costs and fixed financing cost to magnify returns to the firms owners.
What are operating leverage decisions often the result of?
industry characteristics rather then management decisions
What are financial leverage decisions often the result of?
foundational to capital structure and are influenced by the amount of operational leverage (risk) implied by the industry.
What is weighted average cost of capital? (WACC)
It serves as a major link between the long tern investment decisions associated with a corporations capital structure and the wealth of a corporations owners
What is the formula for WACC?
Cost of equity multiplied by the percentage equity in capital structure + weighted average cost of debt multiplied by the percentage debt in capital structure. see example on page B3-24
Always select ratio where WACC is lowest
How do you calculate the weighted average interest rate (or the YTM- market rate)?
Debt cash available
How do you calculate the after tax cash flow
YTM (or weighted average interest rate) x (1-Tax rate)
How do you determine the cost of long term debt?
General rule: cheapest: interest cost tax deductible or assume least risk.
What is the formula for calculating the after tax cost of debt?
Pretax cost of debt x (1-Tax rate)
The higher the tax rate, the more incentive exists to use….
debt financing
What is the formula notation for after tax cost of debt?
kdx
What is the formula notation for pre tax cost of debt?
kdt
How do you calculate the cost of preferred stock?
Dps (preferred stock cash dividends0/ Nps (net proceeds of preferred stocks
What are the three common methods of computing kre (Cost of retained earnings)?
- Capital asset pricing model (CAPM)
- Discounted cash flow (DCF)
- Bond yield plus risk premium (BYRP)
What is the capital asset pricing model formula for the cost of retained earnings?
kre= risk free rate+ risk premium kre= krf + (bi x PMR) kre= krf+ [bi x (km-krf)]
What is the discounted cash flow for the cost of retained earnings?
kre= (D/P) +g
Cost of retained earnings= (Dividentd per share expected at the end of one year / current market value or price of the outstanding common stock) + the constant rage of growth in dividends
What is the bond yield plus risk premium for the cost of retained earnings?
kre= kdt + PMR
pre tax cost of long term debt + market risk premium
What is the ROI (return on investment) formula?
income/ investment capital
or
profit margin x investment turnover
What is return on asset ratio?
average total assets
Adjustments to the ROI denominator raise the bar on asset, project or company performance. The higher the denominator used in the ROI computation…
the lower the return
What is Net book Value?
historical cost less accumulated deprecation
What is Gross book value?
historical cost prior to reduction for accumulated depreciation
What is replacement cost?
the cost to replace assets at their current level of utility
What is liquidation value?
the selling price of productive assets
what are the limitations of ROI?
- the use of ROI exclusively as a measure of the performance can inadvertently focus managers purely on maximizing short-term returns
- Overemphasis of managers on investment balances
- profitable units are reluctant to invest in additional productive resources because their short term result will be to reduce ROI
Formula for residual income
net income (from the income statement) - required return
Formula for required return?
net book value x hurdle rate
The steps for the formula for economic value added are?
Step 1: investment x cost of capital= required return
Step 2: Income after taxes- required return= economic value added
A positive EVA (economic value added)
indicates that performance is meeting standards
A negative EVA (economic value added)
indicates that performance is not meeting standards
What is the Debt to Total Capital Ratio formula?
total capital (=debt+equity)
What is the debt to asset ratio?
total assets
What is the debt to equity ratio?
total shareholders equity
Debt to asset ratio- When you take less risk, you will have less debt but you will also have lower…
ROE
If Debt to Equity ratio and total debt is low, but shareholders equity is high… then
earnings is diluted because you have to divide the wealth with the shareholders
What is the goal of working capital management
maximize shareholder wealth
What is the definition of net working capital?
the difference between current assets and current liabilities
What is aggressive working capital management?
Increase the ratio of current liabilities to non current liabilities (more current assets financed with current liabilities).
Current ratio goes down= Working capital goes down
What is conservative working capital management?
Increase the ratio of current assets to non current assets (more current assets financed by non current liabilities)
current ratio goes up = working capital goes up
What is the formula for current ratio?
current liabilities
What is considered the best single indicator of the company’s ability to meet short term obligations?
current ratio
What does deteriorating current ratio imply?
A reduced ability to generate cash, can be attributable to increase in short term debt, decreases in current assets, or a combination of both
What can generate cash from core business?
improving current ratio
What is the quick (acid text) ratio?
current liabilities
or
current liabilities
What is working capital and risk as it pertains to current ratio?
- Less working capital increases risk by exposing the company to the likelihood of a possible failure to meet current obligations.
- Less working capital increases risk because it may reduce the firm’s ability to obtain additional short term financing.
What are the three motives of holding cash?
- Transaction motives- to meet payments arising from the ordinary course of business
- Speculative motive- to take advantage of temporary opportunities
- Precautionary Motives** - concern of treasurer- liquidity and safety.
What are the primary methods of increasing cash levels?
sell and collect quickly
- customer screening & credit policy
- prompt billing
- payment discounts- give to customer a discounted price, recieve from vender return
What is the formula for calculating the annual cost (APR) of a quick payment discount? ** Memorize**
[360/ (pay period - discounted period)] x [discounted / (100-discount %)}
What does factoring accounts receivable?
turning over the collections of accounts receivable to a third-party factor in exchange for a discounted short-term loan
What is the cash conversion cycle?
the length of time from the date of cash expenditure for production to the date of cash collection from customers
What is the cash conversion cycle formula? ** Know** really well***
inventory conversion period
+ receivables collection period
- payable deferral period
What is inventory conversion period?
measures the degree to which resources have been devoted to inventory to support sales
What is the inventory turnover formula?
average inventory
What is inventory conversion period?
365
__________
Inventory turnover
What is receivable turnover and receivable collection period?
measures of the effectiveness of a company’s credit policy. The receivable collection period measures the number of days after the typical credit sale is made until the firm receives payment
What is accounts receivable turnover formula?
average accounts receivable
What is the receivables collection period? (or days sales outstanding (DSO))
accounts receivable turnover
What is the payable deferral period?
measure of the effectiveness of a company’s attempt to delay payment to creditors
What is accounts payable turnover formula?
average accounts payable
What is the accounts payable deferral period?
accounts payable turnover
What is the core definition of management of accounts receivable?
converting accounts receivable into cash quickly enough to meet short term obligations without angering customers.
What is the core definition of management of accounts payable?
defer with out a penality
What is the goal of management of inventory?
average (minimal) inventory
which will create a higher Turn Over,
365/ Turner over
Reduce the days to sell
Most important thing to influence inventory levels?
Accuracy of sales forecasts
The lower the carrying cost of inventory
the more inventory companies are willing to carry
What are the factors that determine optimal levels of inventory?
Inventory turnover safety stock reorder point economic order quality materials requirements planning
What is the reorder point?
the inventory level at which a company should order or manufacture additional inventory in order to meet demand and avoid incurring stock out costs.
What is the reorder point formula?
safety stock = (lead time x sales during lead time)
What is the EOQ (economic order quantity)?
attempts to minimize both ordering and carrying costs.
What is the EOQ formula?
the square root of:
carrying cost per unit
What are common marketable securities ?
least risk - high risk: untied states treasury bills negotiable certificates of deposit banker's acceptances commercial paper equity sercurities of public companies eurodollars hedge transactions
