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Corporate Finance Technical Foundations > FSA Part 2 > Flashcards

FSA Part 2 Flashcards

1
Q

A ratio that calculates how well the company controls costs relative to turnover, and how well it uses its assets to generate profits

  1. Profitability ratios
  2. Gearing ratios
  3. Investor ratios
A
  1. Profitability ratios
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2
Q

A margin that measures the profit a company generates after deducting the cost of goods sold. The margin is most appropriate for retail and manufacturing companies and less useful in services industries

  1. Operating profit margin
  2. Gross profit margin
  3. Return on capital employed
  4. Return on equity
A
  1. Gross profit margin
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3
Q

Year 2022 2021 2020
Gross Profit 1,015,0 1,008.7 966.9
Turnover 3,500.0 3,453.7 3,406.5

Calculate the gross profit margin

A

Year 2022 2021 2020
Margin 29.0% 29.2% 29.3%

Analysts would have to investigate whether this very slight decline was an industry-wide phenomenon or one specific to example. there could be many reasons, such as commodity price movements or competitor pressure, and a full understanding will require more extensive research

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4
Q

A margin that measures a company’s level or profitability after both cost of production and operating expenses have been deducted from turnover

  1. Operating profit margin
  2. Gross profit margin
  3. Return on capital employed
  4. Return on equity
A
  1. Operating profit margin
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5
Q

Year 2022 2021 2020
Operating Profit 590.0 574.8 529.8
Turnover 3,500.0 3,453.7 3,406.5

Calculate the gross profit margin

A

Year 2022 2021 2020
Margin 16.9% 16.6% 15.6%

Operating margins are improving, whereas gross margins are declining somewhat, indicating the
company is controlling its operating costs effectively to make up for the pressure on product costs

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6
Q

A margin that calculates the operating profit (EBIT) generated by the company as percentage of the capital invested in it. note that this profit is show before deducting of financing costs, taxation, or dividends; this ratios focuses on the performance of the underlying business operations, relative to the total capital invested in these business operations

  1. Operating profit margin
  2. Gross profit margin
  3. Return on capital employed
  4. Return on equity
A
  1. Return on capital employed
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7
Q

Year 2022 2021 2020
Operating Profit 590.0 574.8 529.8
ROCE 960.0 959.4 935.4

Calculate Return on capital employed

A

Year 2022 2021 2020
Margin 61.5% 59.9% 56.6%

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8
Q

True or false

Capital employed is non-current assets plus net current assets (current assets minus current liabilities)

A

True

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9
Q

A margin that calculates the profit attributable to shareholders as a percentage of the equity capital invested. In comparison with ROCE, this calculation focuses on profit after interest and tax, to establish the return that shareholders are generating on their investment

  1. Operating profit margin
  2. Gross profit margin
  3. Return on capital employed
  4. Return on equity
A
  1. Return on equity
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10
Q

Example Co’s profit attributable to ordinary shareholders was 401.1 million and shareholders’ funds/equity were 232.3

Calculate Return on Equity

A

Profit Attributable to shareholders divided by Shareholders Equity

401.1/232.3= 172.7

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11
Q

A measure of how easily a company can meet its short-term obligations as they fall due

  1. Operating profit margin
  2. Gross profit margin
  3. Return on capital employed
  4. Return on equity
  5. Liquidity
A
  1. Liquidity
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12
Q

Year 2021 2020
Current assets 1,067.3 1,041.2
Current liabilities 832.9 758.1

Calculate the current ratio

A

Year 2021 2020
Current ratio 1.28x 1.37x

Although the ratio has deteriorated since the previous year, at 1.28x, it still suggests that the company should be able to meet its current liabilities using its existing current assets

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13
Q

A ratio that measures the company’s ability to meet its short-term obligations as they fall due. however, it assumes that not all current assets are equally liquid and that some may not be capable of being turned into cash in time.

  1. Cash and cash equivalents are assumed to be liquid
  2. Receivables (which are shown net of provisions for bad and doubtful debts) are assumed to be relatively liquid
  3. Inventory is assumed not to be liquid; selling raw materials, work-in-progress or finished goods to raise cash will take time and may result in a loss of value
A

Quick Ratio/Acid test

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14
Q

A ratio that examines how far a company is exposed to financial risk; by evaluating how much debt it has relative to the amount of its equity, and whether it is able to service this debt without undue stress

  1. Profitability ratios
  2. Gearing ratios
  3. Investor ratios
A
  1. Gearing ratios
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15
Q

True or false

As the gearing ratio increases, it can expose the company to higher risks of financial failure. But, in general, debt is cheaper in the longer term than equity, so gearing up by borrowing capital is often a cheap way to expand the firm’s capital base.

A

True

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16
Q

True or false

In examining the company’s exposure to financial risk, we should examine both gearing ratios and interest cover.

Gearing expresses the amount of debt as either a percentage or a ratio of the company’s capital and it is helpful to see whether this percentage is increasing or decreasing

Interest cover examines the proportion of interest payment to operating profit and demonstrates whether the company is able to meet its interest obligations

A

True

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17
Q

Example Co’s total debt (total interest-bearing debt (short term debt + long term debt)) for 2021 was 596.4 and total shareholders’ equity was 232.4 calculate debt to equity ratio

A

Total Debt/Shareholders Equity 596.4/232.4 = 256.6%

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18
Q

True or false

Net debt/equity ratio is used when a company has significant amounts of cash on its statement of financial position, this is available to pay interest and repay debt, which reduces its exposure to financial risk. if this is the case, it may be more useful to take this cash into account in calculating a net debt/equity ratio

A

True

19
Q

Example Co’s total debt (total interest-bearing debt (short term debt + long term debt)) for 2021 was 596.4 and total shareholders’ equity was 232.4 and cash was 49.3 calculate net debt to equity ratio

A

Total Debt - Cash/Shareholders Equity
596.4-49.3/232.4 = 235.4%

20
Q

This ratio indicates the degree to which the company’s pre-interest earnings/profits cover annual interest chargers

  1. Debt to Equity Ratio
  2. Net Debt/Equity Ratio
  3. Interest Cover
A
  1. Interest Cover
21
Q

A ratio that is useful when the company’s loan agreements include an interest cover covenant which stipulates that operating profit must be maintained at, say, 4x interest expense

A

Interest Cover

22
Q

Year 2021 2020
EBIT 574.8 529.8
Interest expense 24.3 25.3

Calculate interest cover

A

Year 2021 2020
Interest Cover 23.7x 20.9x

Cover ratios are improving, and this suggests that the company has only limited financial risk

23
Q

A ratio that gives an indication of the company’s ability to meet its repayment obligations if its debt to …. is 1x, the company could (broadly, and in theory) repay its debt in full out of one year’s. if its debt to …. is 8x, it will take the company eight years to repay it and this is clearly more highly geared and more risky

  1. Debt to Equity
  2. Net debt to EBITDA
  3. Net debt to equity
A
  1. Net debt to EBITDA
24
Q

ExampleCo has the following
Total Debt: 596.4
Cash: 49.3
EBIT: 574.8
Non-cash items (D&A, Impairments): 121.6

Calculate Debt to EBITDA

A

596.4 of total debt minus 49.3 cash for net debt, divided by 574.8 EBIT plus non-cash items 121.6 for EBITDA equals 0.786

25
Q

True or false

if profits remain constant but more shares are issued, the EPS figure will increase.

If profits remain constant, but shares cancelled during the year, the EPS ratio will fall

A

False

If the profits remain constant but more shares issued, the EPS figure will FALL

If profits remain constant, but shares cancelled during the year, the EPS ratio will increase

26
Q

True or false

When new shares have been issued as a result of a bonus issue, this bonus element must be eliminated to make the calculation of EPS comparable with that for previous or subsequent years

A

True

27
Q

True or false

The EPS calculation aims to match the earnings generated by the company with the number of shares contributing to the earnings.

A

True

28
Q

An investor ratio that shows the annual profit per share attributable to ordinary shareholders

  1. P/E Ratio
  2. Dividend yield
  3. Diluted EPS
  4. EPS
A
  1. EPS

The formula for calculating EPS is as follower:
Profits for ordinary shareholders divided by weight average number of shares

29
Q

An investor ratio that takes into account both the ordinary shares currently in issue, and those that it may obliged to issue in the future

  1. P/E Ratio
  2. Dividend yield
  3. Diluted EPS
  4. EPS
A
  1. Diluted EPS
30
Q

Mayflower plc has profit after tax of £1,500,000. It currently has 2,000,000 shares in issue.

Mayflower has £700,000 of convertible debt in issue, with a coupon of 3%. This is convertible at a rate
of £4/share. The interest is subject to corporation tax at 28%

Calculate Basic EPS, and diluted EPS

A

Basic EPS
1,500,000/2,000,000 equals 75p

Diluted EPS
1st step
700,000 of convertible debt in issue divided a rate of 4/share Equals 175,000 new shares issued, increase the denominator to 2,175,000

2nd step
700,000 multiplied by a coupon of 3% multiplied by corporation tax (1-28%), equals 15,120 interested saved, increase the numerator to 1,515,120

Diluted EPS is, therefore 69.66p 1,515,120/2,175,000

31
Q

A ratio sometimes referred to as the multiple of the company’s earnings that the market is prepared to pay for its shares

  1. P/E Ratio
  2. Dividend yield
  3. Diluted EPS
  4. EPS
A
  1. P/E Ratio

And is calculated as Share Price/EPS

32
Q

True or false

P/E is a helpful way for analysts to compare valuations of company share prices. A company whose P/E ratio is high is generally viewed as a cheap stock, while a company whose P/E ratio is low might be viewed as expensive

A

False

A company whose P/E ratio is high is generally viewed as an expensive stock, while a company whose P/E ratio is low might be viewed as cheap

33
Q

True or false

The P/E ratio takes into account a market share price which is a much more volatile figure than published profits

A

True

34
Q

A ratio that will show whether a company is generating a high or a low return to its shareholders in the form of income, compared with its peer group

A

Dividend Yield

35
Q

True or false

Dividend yield is often paid to shareholders in cash, but some companies offer their shareholders the option of receiving dividends in the form of new ordinary shares. This is known as a scrip dividend

A

True

36
Q

True or false

Net dividend is the dividend shown before deduction of income tax; the gross dividend is the dividend after the deduction of tax

A

False

Gross dividend is the dividend shown before deduction of income tax; the net dividend is the dividend after deduction of tax

37
Q

ExampleCo paid a gross dividend per share of 78p in 2021. its share price is 22.50

calculate gross dividend yield

A

Dividend per share/Share price
78/22.50x100 = 3.47%

38
Q

A ratio that measures how far a company’s net dividend is covered by its profits for the year, ie, what proportion of the profits is paid out as dividends and what proportion is retained for reinvestment in the business

  1. Dividend yield
  2. P/E
  3. EPS
  4. Dividend cover
A
  1. Dividend cover
39
Q

ExampleCo paid a dividend per share of 78p in 2021, compared with an EPS of 222.0p.

Calculate dividend cover

A

EPS/dividend per share
222.0/78= 2.85x

40
Q

Total value of the company’s trading operations, funded by both debt and equity. At its simplest, it is calculated by adding the value of the company’s market capitalization to the value of its net debt

A

Enterprise Value

41
Q

Total value of the company’s ordinary shares, calculated by multiplying the company’s current share price by the number of shares in issue

A

Market Cap

42
Q

22.50 current share price
185,000,000 million shares in issue
596,400,000 total debt
49,300,000 cash and cash equivalents
121,600,000 D&A and impairments
EBIT 574,800,000

Calculate EV/EBIT and EV/EBITDA

A

1st - calculate market cap
22.50 x 185,000,000 = 4,165,600,000

2nd - calculate enterprise value
4,165,600,000+(596,400,000-49,300,000) = 4,709,600,000

3rd - calculate EV/EBIT
4,709,600,000/574,800,000 = 8.19x

4th - calculate EV/EBITDA
4,709,600,000/(574,800,000+121,600,000) = 6.76x

43
Q

A measure that is widely used in analyzing companies whose value is strongly linked to their balance sheet investments

  1. Dividend yield
  2. P/E
  3. EPS
  4. P/B
A
  1. P/B

Corporate Finance Technical Foundations (4 decks)

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