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Financial Analysis > Formulas > Flashcards

Formulas Flashcards

1
Q

Abnormal ROE Valuation of Firm in Steady State

If ROE is expected to remain constant and dividend policy constant (so Sustainable Growth Rate is constant)

A

MVE = BVE + BVE(ROE – re)/re – g

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2
Q

If all other forecast ratios are held constant, forecast growth rate for year t

A

forecast growth rate for year t will be the SGR for year t-1.

All relevant forecasting ratios (sales growth, profit margin, operating assets / sales, debt ratio etc) for the current year must have the same value as those ratios for the previous year for this generalisation to be true.

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3
Q

Sustainable Growth Rate

A

ROE x (1 - Dividend Rate)

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4
Q

Cost of Debt

A

Net Interest Expense / Average Net Debt

must be net of taxes b/c after tax cash flows are discounted

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5
Q

Forecast Abnormal Earnings in in particular year

A

Net Income - Cost of Equity x Opening BVE

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6
Q

Value of Firm with Forecast Abnormal earnings

A

Value of Firm =

BVE + PV(Abn Earn 1-10) + PV of Terminal Abn Earn Stream

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7
Q

Abnormal ROE

A

ROE - Cost of Equity

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8
Q

Growth BVE

A

Opening BVEt / Opening BVE in Year One (Beginning of Year 1/ day we are valuing the firm)

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9
Q

Valuation using Abnormal ROE

A
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10
Q

Terminal Value Under Abnormal ROE Method

3% terminal sales growth with persistent profit margin means

A

3% terminal sales growth with persistent profit margin means that Abnormal ROE stays the same, but BVE Growth Factor increases by 3% each year, so (Abn ROE x BVE Growth Factor) is growing by 3% forever

PV10 = 0.0185 / (0.0896 – 0.03) =0.3112

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11
Q

total value multiplier is

A

Multiplier (Years 1- 10) + Multiplier (Terminal)

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12
Q

ROE

Value of Equity is

A

BVE0 + 0.2233 (multiplier) x BVE0

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13
Q

Value per share =

A

FCFE / cost of equity

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14
Q

Given the assumed constant dividend policy and constant ROE,

A

Book value of equity will grow at the sustainable growth rate (SGR).

(Terminal)

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15
Q

for deferred tax effects what happens if the net effect on current profit is an increase?

A

If the net effect of adjustments is an increase in net profit,

Higher accounting profit = higher tax expense to be recorded

– Higher tax expense = lower current net profit after tax

– Change in After Tax Profit = -$2202 x Eff. Tax Rate = -$2202 x 29.5%

  • Decrease Current Profit $649
  • Decrease Deferred Tax Assets $649
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16
Q

for deferred tax effects what happens if the net effect on current profit is a decrease?

A

If the net effect of adjustments is an decrease in net profit,

Lower accouting profit = lower expense to be recorded

– lower tax expense = higher current net profit after tax

– Change in After Tax Profit = $2202 x Eff. Tax Rate = $2202 x 29.5%

  • Increase Current Profit $649
  • Increase Deferred Tax Assets $649
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17
Q

for deferred tax effects what happens if the net effect on opening retained earnings is a decrease?

A

Lower retained profits = lower prior period tax expenses

Lower tax expense = higher accumulated profits (retained earnings)

– Change in Accumulated After Tax Profit = $60,355 x 29.5% (Eff. Tax Rate) = $17,789

• Increase Opening Retained Earnings $17,789 • Increase Deferred Tax Assets $17,789

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18
Q

Reclassify Lease Liability - current v
non current

what this involves

A

PV of lease payments due within one year

Increase current liability

Decrease non current liability

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19
Q

Capitalise Closing Lease Liability and Asset

A

Increase Non-current assets

Increase non current liabilities

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20
Q

Add back rent expense associated with current year lease payments

A

if operating leases are brought onto the balance sheet, the rent expense associated with them should be removed. Eliminating an expense makes profit go up.

Lease payment at the end of pervious year = beginning of this year

Increase current profit

Decrease retained earnings

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21
Q

Recognise interest

A

PV of future payments at the end of last year/beginning of this year

Decrease current profit

Increase retained earnings

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22
Q

Recognise depreciation

A

PV of lease payments at the end of this year - adjustment for lease assets / remaining years

Reduce the asset value to 0 in remaining years

Decrease current profit

Increase retained earnings

OR cost of asset - 0 / useful life

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23
Q

net effect on current year profit of all of our adjustments is -$44.92 (Rent Adj + Int Adj + Dep Adj + Tax Adj), logically the opening retained earnings for next year (2017) should be adjusted

A

the net effect on current year profit of all of our adjustments is -$44.92 (Rent Adj + Int Adj + Dep Adj + Tax Adj), logically the opening retained earnings for next year (2017) should be adjusted by the same amount (-$44.92).

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24
Q

Dupont System

ROA

A

profit before leverage/ average total assets

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25
Q

ROE

Dupont System

A

Net Profit – Pref. Divs) / Average Ordinary shareholders’ equity

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26
Q

ROE

Forecasting in Abnormal ROE Valuation

A

Net income/ Opening BVE

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27
Q

If ROE > cost of equity, and current ROE is a good predictor of future ROE,

A

he market value of the firms equity > book value of the firm’s equity

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28
Q

ROA

Dupont

A

Profit before leverage (Net Profit + + Gross Interest expense x 1 - effective tax rate + minority) interest

/ average total assets

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29
Q

ROA

Dupont

A

Profit before leverage (+ Gross Interest expense x 1 - tax rate)

/ average assets

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30
Q

Effective tax rate

A

Tax Expense/Net Profit Before Tax

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31
Q

Common earnings leverage

A
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32
Q

Capital Structure Leverage

A

Average Total Assets / Average Ordinary Equity

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33
Q

ROE =

A

Adj ROA x Common earnings leverage x Capital structure leverage

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34
Q

ROA breakdown

Dupont

A
  • Profit Margin: Average $ profit per $ of sales

– Asset Turnover: $ Sales for Each $ of Assets

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35
Q

ROA

profit margin

A

ProfitB4Leverage/

Sales

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36
Q

ROA

asset turnover

A

Sales / average total assets

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37
Q

Breakdown of Profit margin

A

Profit margin = coverage x EBIT/sales

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38
Q

Breakdown of Profit margin

EBIT/ sales

A
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39
Q

Gross Profit / Sales (gross profit margin) is described as a measure of

A

production efficiency, because this is where efficiencies achieved in the cost of producing/acquiring goods for sale will be reflected

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40
Q

EBIT/Gross Profit is described as a measure of

A

operating efficiency because it capture any economies achieved in SG&A type expenses.

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41
Q

difference between NOPAT margin and Dupon net profit margin

A

NOPAT Margin adds back the after-tax value of NET Interest Expense

Dupont adds back the after-tax value of GROSS Interest Expense.

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42
Q

Cost of Doing Business

A

Expenses from Core Activities excl. COGS, Depn & Impairment. Sales /

Sales

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43
Q

Alternative Approach to Decomposing ROE

ROE =

A

ROE = Operating ROA + Spread x Net Fin. Leverage + Unexpected ROE

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44
Q

Alternate ROE

Net Profit

A

Net Operating Profit + Net Unusual Profit (both including Profit to Minority Interests)

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45
Q

Alternate ROE

Net Interest Expense After Tax

A

Interest Exp – Interest Rev.) x (1 - Effective Tax Rate)

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46
Q

Alternate ROE

Net Operating Profit After Tax (NOPAT)

A

Net Operating Profit + Net Interest Exp. After Tax

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47
Q

Alternate ROE

Operating Working Capital

A

(Curr. Assets – Cash Equiv) – (Curr. Liab – S.T. Debt and Curr Portion of L.T. Debt)

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48
Q

Alternate ROE

Net Long-Term Operating Assets

A

Total Long-Term Operating Assets – Non-Interest Bearing Liabilities

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49
Q

Alternate ROE

Net Debt

A

Total Interest-Bearing Liabilities – Cash & Cash Equiv.

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50
Q

Alternate ROE

Total Net Operating Assets

A

Operating Working Capital + Net Long-term Operating Assets

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51
Q

Alternate ROE

Net Capital

A

Net Debt + Shareholders Equity

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52
Q

Alternate ROE

Operating ROA

A

NOPAT / Total Net Operating Assets

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53
Q

Alternate ROE

Net Financial Leverage

A

Net Debt / Equity

net debt/ opening equity (opening BVE)

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54
Q

Alternate ROE

Unexpected ROE

A

NUP / Equity

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55
Q

Alternate ROE

Spread

A

Operating ROA – Effective Interest Rate After Tax

56
Q

Alternate ROE

Net Op. Asset T/O

A

Net operating assets / sale

57
Q

Spread

Operating ROA - effective interest rate after tax

Find Effective Interest Rate after tax

A

Net Interest Expense After Tax / Net Debt

58
Q

Value per share =

A

FCFE / cost of equity

59
Q

After tax cost of debt

A

pre-tax cost of debt x (1-0.3)

60
Q

FCFE

Net Debt

A

Net Debt Ratio x Total Net Operating Assets

61
Q

FCFE

Net Income

A

= NOPAT – Net Interest Expense After Tax

62
Q

FCFE

Net Interest Expense After Tax

A

After Tax Cost of Debt x Opening Net Debt

63
Q

FCFE

New Investment 2016

A

Total Net Operating Assets at Beginning of 2017 - Total Net Operating Assets at Beginning of 2016

64
Q

FCFE

Increase in Net Debt 2016

A

Net Debt at Beginning of 2017 – Net Debt at Beginning of 2016

65
Q

Dividend Payout Ratio

A

Dividends paid / net income to common

Dividend Payout Ratio = Dividends Paid/ Opening Equity

66
Q

Debt Ratio

A

Debt Ratio = Net Debt/ Net Total Operating Assets

67
Q

Opening Equity

A

Total Net Operating assets - Net Debt

68
Q

Net Interest Expense after Debt (with net Debt)

A

Net Debt x After Tax Cost of Debt

69
Q

Net income

for valuation

A

NOPAT + Net Interest Expense After Tax

70
Q

Net income to shareholders

Net Income - Preference Dividends

A
71
Q

What is the implicit interest rate for Lease adjustments

A

Interest Exp / Ave Total Debt

or net interest expense / ave total debt

72
Q

under consolidated accounting, all of the assets of subsidiary companies are

A

added to the ‘group’ assets, even if the parent owns less than 100% of the subsidiary

73
Q

When to adjust minority interest

A

Adj ROA = net profit + gross interest exp (1 - effec tax rate) + minority interest / average total assets

If minority interests have already been deducted when calculating Net Profit in the Consolidated accounts:

  • Add the ‘profit to minority interests’ to your numerator

• If minority interests have not been deducted in the calculation of Net Profit, there’s no need to make an adjustment.

74
Q

If cost of doing business ratio of 14.92%, what does this mean

A

For each $1 of sales, 14.92 cents is spent on things like: employee wages, power, rent, cleaning, stationery etc

– These are the direct costs of being open for business

75
Q

Common Size Analyses

A

State all Income Statement items as percentages of Sales

• State all Balance Sheet items as percentages of total assets

76
Q

Net Unusual Profit After Tax

A

Sum of one-off items (e.g. discontinued ops.) after effect of tax is deducted.

77
Q

Treatment of Preference Shares Under Alternate ROE Breakdown

A
  • Preference Share Capital is treated as Long-Term Debt
  • Preference Dividends are treated as interest expense.
78
Q

Key ratios useful for analysing the management of working capital include:

A

– Operating Working Capital to Sales

  • Accounts receivable turnover

– Inventory turnover

– Accounts Payable Turnover

79
Q

Key working capital ratio alternate ROE

– Accounts receivable turnover

A

Expressed alternately as Days Sales in Receivables (‘Days Receivables) = Average Receivables / Average Sales per Day

80
Q

Key working capital ratio alternate ROE

Inventory turnover

A

Expressed Alternately as ‘Days in Inventory’ (‘Days Inventory’) = Average Inventory / Average COGS per day

81
Q

Key working capital ratio alternate ROE

Accounts Payable Turnover

A

Expressed Alternately as ‘Days in Payables’ (‘Days Payables’) =

Average Payables / Average COGS per day

82
Q

Operating Cycle:

A

ave. number of days between purchasing goods and collecting the cash from our customers

83
Q

Calculate operating cycle

A

Days receivables + days inventory

84
Q

net operating cycle calculation

A

Days receivables + days inventory - days payables

85
Q

net operating cycle

A

: ave no. of days between when *WE* pay cash for inventories and when our customers pay us cash for those goods (also known as ‘cash conversion cycle’)

– The shorter the net operating cycle, the lower the cost of financing our investment in working capital

86
Q

Large increase in Days in Receivables

• Indicate

A

channel stuffing, heavy discounting to boost revenues at year end

87
Q

Large increase in Days in Inventory

A

• Suggests either:

– Expected growth in sales next year

– Trouble selling this year’s stock

– Overproduction at year end to split fixed production costs across a greater number of units of inventory

88
Q

Is Net Operating Cycle Always Positive?

A

No….firms with considerable power (particularly over suppliers) may have negative net operating cycles

89
Q

Alternate ROE

Net Long-Term Operating Assets to Sales

A

(Total Long-Term Assets – Non-Interest Bearing Liabilities) / Sales

90
Q

Average Asset Age

A

Average Age = Accumulated Depreciation / Depreciation Expense

91
Q

Average Asset age

A

provide information about the likelihood that a firm will need to replace/repair assets, or explain cross-firm differences in actual maintenance expenses

92
Q

– ROE = ROA x CEL x CSL (DuPont Breakdown)

– What if NPAT (ROA) is negative?

A

Capital Structure Leverage multiplies the effect of the losses.

• ROE much more sensitive to small variations in ROA if CSL is large.

93
Q

Current ratio

A

current assets / current liabilities

94
Q

Quick ratio

A

Cash + Short-term investments + Accts. receivable / Current liabilities

95
Q

Cash ratio

A

Cash + Marketable securities / Current liabilities

96
Q

Operating cash flow ratio

A

Cash flows from operations / Current liabilities

97
Q

Liquidity of the same item may vary across firms

how

A

A firm that runs a very strict credit policy may have much more liquid receivables than does a firm who grants credit very easily

98
Q

Debt and Coverage Ratios

Liabilities-to-equity ratio

A

Total liabilities / Shareholders’ equity

99
Q

Debt and Coverage Ratios

Debt-to-equity ratio

A

Short-term debt + Long-term debt / Shareholders’ equity

100
Q

Debt and Coverage Ratios

Net-debt-to-equity ratio

A

Short-term debt + Long-term debt – Cash and marketable securities/

Shareholders’ equity

101
Q

Debt and Coverage Ratios

Debt-to-capital ratio =

A
102
Q

Debt and Coverage Ratios

Net-debt-to-net-capital ratio =

A
103
Q

A key point to remember when analysing a firm’s solvency ratios is the means by which the firm arrived at its present position

example

A

A successful firm that has increased debt levels to finance expansion is very different to a firm that has reached a D/E ratio of 5:1 due to making repeated financial losses (and thus reducing Equity each year).

104
Q

Two ratios that try to address the ability to pay interest on debts are:

A

Interest coverage ratio (earnings basis)

Interest coverage ratio (cash flow basis)

105
Q

Two ratios that try to address the ability to pay interest on debts are:

Interest coverage ratio (earnings basis)

A
106
Q

Two ratios that try to address the ability to pay interest on debts are:

Interest coverage ratio (cash flow basis)

A
107
Q

Sustainable growth rate

A

rate at which a firm can grow given the current level of profitability and current financing policies

– Function of the periodic profits re-invested in the firm’s operations

108
Q

Dividend payout ratio

A

Cash dividends paid/

Net income

109
Q

JB’s sustainable growth rate for 2013 is 25%

what does this mean

A

This is a historical measure…the current year’s profits and dividends have resulted in an increase in shareholder’s equity of 25% of the book value of equity

110
Q

JB’s sustainable growth rate for 2013 is 25%

Could theoretically

A

grow their shareholder’s equity by 25% next year, without external financing, if ROE stays the same

assuming that the opportunity for growth exists…i.e. there will be growth in demand for JB’s products

111
Q

Change in Equity

A

Change in Net Op. Assets – Change in Net Debt

Change in Equity = Chg(Sales x 1/ATO) + 0

Asset Turnover = Sales / Net Op Assets

112
Q

Components of change in equity

any meaningful growth in equity has to reflect either

A

– Growth in sales

– Growth in net operating assets required to support each dollar of sales (i.e. decrease in ATO)

113
Q

Change in equity

What if retains some of its earnings rather than paying dividends, but leaves this lying around in spare cash

A

This changes ‘Net Debt’ NOT ‘Net Operating Assets’

114
Q

Assume Asset Turnover = 1

this means

A

Need $1 of Net Operating Assets to support each $1 of sales

115
Q

In 2012, XYZ has no debt, Opening Equity of $100, earns an ROA and ROE of 20% and has Div Payout Ratio of 40%

closing equity

A

ROE = net income / opening BVE

net income = 20

Dividend payout ratio = dividends paid / net income

0.4 = x/ 20

x = 8

Closine equity = opening equity + 20 - 8 = 112 = amount of growth if sustainable growth rate

116
Q

In 2012, XYZ has no debt, Opening Equity of $100, earns an ROA and ROE of 20% and has Div Payout Ratio of 40%

– SGR = 20% * (1-40%) = 12%p.a.
– Closing Equity is $112 ($100 + $20 - $8).

• Can they grow in 2013?

– Assume Asset Turnover = 1 and never changes (i.e. Need $1 of Net Operating Assets to support each $1 of sales)

A

XYZ can support Sales growth of 12% in 2013, without having to borrow more, or change dividend policy

117
Q

In 2012, XYZ has no debt, Opening Equity of $100, earns an ROA and ROE of 20% and has Div Payout Ratio of 40%

SGR = 20% * (1-40%) = 12%p.a.

What if Sales only grows by 7%, and Profit Margin and ATO do not change??

A

– Change in Net Operating Assets = 7%

– ROA stays at 20%

– Net Debt is Decreased by an amount equal to 5% of opening equity (rather than being invested in operating assets needed to support sales, this part of 2012 retained earnings are represented by ‘cash’ not an operating asset)

– Chg Equity = Chg NOA – Chg Net Debt

– 12% = 7% - (-5%)

– 2013 ROE < 20%

118
Q

In 2012, XYZ has no debt, Opening Equity of $100, earns an ROA and ROE of 20% and has Div Payout Ratio of 40%

SGR = 20% * (1-40%) = 12%p.a.

What if Sales only grows by 7%, and Profit Margin and ATO do not change??

Why is ROE in 2013< 20%

A
119
Q
A
120
Q

if actual sales growth < last period SGR what happens to ROE

A

ROE will keep falling assuming profit margin and asset turnover held constant)

121
Q

A number of questions can be answered through analysis of the statement of cash flows.\

operating activities

A

How strong is the firm’s internal cash flow generation?

How well is working capital being managed?

122
Q

A number of questions can be answered through analysis of the statement of cash flows

Investing activities

A

How much cash did the company invest in long-term operating assets?

123
Q

A number of questions can be answered through analysis of the statement of cash flows.

Financing activities

A

What type of external financing does the company rely on?

Didthecompanyuseinternallygeneratedfundsforinvestments?

Didthecompanyuseinternallygeneratedfundstopaydividends?

124
Q

CFO B4 WC tells us

A

bout the (expected) cash flows resulting from sales, COGS and operating expenses that affect cash

  • During rapid growth, WC eats cash (Receivables + Inventory increase faster than payables)
  • During declines in sales, WC releases cash
125
Q

what is needed in cash flow analysis

A
126
Q

Adjust value of lease asset to reflect difference between depreciation and principal reduction

A

Asset/liability ratio is 88.7%.

Adjustment = - (1- 0.887) x PV of lease asset this year

Adjustment -21.496357

Decrease non-current assets, decrease retained earnings

127
Q

current ratio measures

A

company’s ability to pay short-term and long-term obligations

The higher the ratio, the more able a company is to pay off its obligations.

128
Q

current ratio

if over 1 and below

A

A ratio under 1 implies that a company would be unable to pay off its obligations if they become due at that point in time

129
Q

quick ratio

interpretation

A

The higher the ratio, the more financially secure a company is in the short term.

quick ratio of greater than 1.0 are sufficiently able to meet their short-term liabilities

130
Q

quick ratio

A

pay liabilities when due with quick assets - can easily converted to cash within 90 days or in the short-term.

131
Q

cash ratio

A

company’s ability to pay current liabilities using only cash and cash equivalents on hand. If

the company is forced to pay all current liabilities immediately, this metric shows the company’s ability to do so without having to sell or liquidate other assets.

132
Q

interpretation of cash ratio

A

If a company’s cash ratio is equal to 1, the company has exactly the same amount of current liabilities as it does cash and cash equivalents to pay off those debts.

If a company’s cash ratio is less than 1, there are more current liabilities than cash and cash equivalents. In this situation, there is insufficient cash on hand to pay off short-term debt.

If a company’s cash ratio is greater than 1, the company has more cash and cash equivalents than current liabilities. In this situation, the company has the ability to cover all short-term debt and still have cash remaining.

133
Q

too high liquidity can be bad because

A

company is inefficient in the utilization of cash or not maximizing the potential benefit of low-cost loans.

134
Q

why is inventory, receivable, prepaid assets excluded from cash ratio

A

These items may require time and effort to find a buyer in the market

money received from the sale of any of these items may be indeterminable.

135
Q

operating cash flow ratio measures

A

how well current liabilities are covered by the cash flow generated from a company’s operations.

Financial Analysis (10 decks)

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