Formulas Part I Flashcards
Determine how many shares will be required for a new issue.
- Divide the funds required by the subscription price of the new shares.
- The result is the number of new shares that are required to be issued.
Determine how many rights will be needed to purchase 1 share of a new issue
Shareholders always get 1 right for each existing share that is outstanding.
- Divide the amount of old shares currently outstanding by the amount of new shares to be issued
- the result is the amount of rights that will be required to purchase a single share of the new issue.
Determine the theoretical value of a right during the rights on period.
aka. the price of a right
R{subs}o is the theorectical rights price, to determine it:
- Find the sum of the common share price during the rights on period minus the subscription price
- Then divide the result of 1 by: the number of rights required to buy 1 share plus 1
- the result is the theorietical rights price during the rights on period.
determine the common share price during the ex-rights period.
- subract the rights price from the rights on common share price
- the result is the common share market price during the ex-rights period.
How would I check to see if the market price of the rights after ex-rights are correct relative to the market price of the shares?
- subtract the subscription price from the market price of the share
- divide the result by the number of rights required to buy a share
The result is the market price of a right…and should be the same as the rights price determined before ex rights.
Determine a firms debt to equity ratio
divide debt over equity
1 = 50% debt, 50% equity
greater than 1 is more debt than equity
less than 1 is more equity than debt
Determine the earnings per share. Relate this to a dividend payment
EPS
NI / outstanding shares.
dividend payments are % of the EPS. 100% being full
Determine Return on Equity
ROE
NI / total equity (the number of shares x the market value of the shares) - debt
Express as a percentage
How do you measure the degree of financial leverage of a firm?
•Leverage amplifies the variation in both EPS and ROE
Method 1
- decide on the scenario you wish to compare. (current).
- The percentage change in EPS divided by the percentage change in EBIT
DFL = {(alt EPS - current EPS)/Current EPS} / {alt EBIT - current EBIT)/Current EBIT}
A higher number means the firm is leveraged more with debt.
Determine the Degree of financial leverage of a firm
Method 2
Use this method on the numbers in a proposed captial structure.
- The EBIT of the proposed sturcture / the same EBIT - the interest expense of any debt
A higher number means the firm is leveraged more with debt.
What is break even EBIT? What is the relevenace? How is it calculated?
EBIT - intrest cost - taxes / shares outstanding
- Find EBIT where EPS is the same under both the current and proposed capital structures
- If we expect EBIT to be greater than the break-even point, then leverage is beneficial to our stockholders
- If we expect EBIT to be less than the break-even point, then leverage is detrimental to our stockholders
- equate the EPS of both scenarios being compared.
How would you determine the PPS? Relate this to the firm value?
determine the cost of a given number of shares (usaully the amount of debt generated via share buyback)
divide that number by the amount of shares bought back.
To relate this to the firm value.
multiply the price obtained by the amount of shares outstanding. and then add in any debt.
What is the formula for M&M prop II? Explain the elements, When would you use this?
See attached. You would use this to determine the cost of equity of a firm. For an all equity firm Re = Ra, and Ra is determined by dividing EBIT/value of stock.
Re = the cost of equity capital
Ra = the required rate of return on the firms assets
Rd = the firms cost of debt
D/E = the firms debt to equity ratio
Tc = corporate tax rate.
Equity and Asset beta formula
s
weighted average cost of capital
WACC = Ra
E = equity mix
V = equity + debt mix
Re = return on equity determine in 16.8 from previous problem (the Ra)
Tc = tax rate
How do you determine the value of the interest tax shield?
Tc = tax rate
Rd = cost of debt as %
D = debt
simplify to tax rate x debt
Demonstrate how the levered firm in Prop I has more value than the unlevered firm
Vl = value of the levered firm
Vu = value of the unlevered firm
+
PV of the tax sheild
Determine the Value of a firm for prop 1
Value of the unlevered firm is
EBIT x (1 - Tc ) / Ru
Tc = tax rate
Ru = the cost of capital
The cost of equity , prop II with taxes
Ru = cost of capital
Rd = cost of debt
D = debt
E = equity
Tc = tax rate
