Int. Reporting and Control Flashcards
What does Beta measure? What does it tell us?
Undiversified risk.
Investors diversify their risks efficiently along the market portfolio (portfolio risk); thus only risks that investors cannot diversify have to be priced in (undiversified risk)
A stock with a beta of 2 will move 2% if the market moves by 1%. Larger beta means larger risk. Beta = 1 = market. Beta >1 –> aggressive asset. Beta defensive asset
Pitfall: Beta is based on historical figures
How do you calculate the expected return on equity capital?
Expected return = Risk free rate of return + ß * equity risk premium
Extra return = Expected return of the market portfolio - risk free rate of return
How do you calculate the Weighted Average Cost of Capital (WACC)?
Pre-Tax WACC:
E/(E+D) * rE + D/(E+D) * rD
No matter the debt:equity ratio, the pre-tax WACC stays the same.
With tax WACC:
E% * rE + (1-t) * D% * rD
There is a sweet spot.
Why does the capital structure matter?
Free Cash Flow is affected by:
- danger of bankruptcy
- tax (debt)
- agency problems (manager)
Why does tax matter?
Interest on debt is usually tax deductible –> tax shield (up to 9,6% company’s value)
Trade-off: Control v risk of bankruptcy
Cost of bankruptcy:
- Fire sale of assets
- Legal fees, lawyers, consulting costs
- Increased risk taking by managers
- “Brain-drain”
- Loss of customers
What is the terminal value?
= The value existing after the definite time of cash flows.
E.g. A remaining business after the last year of the Discount Cash Flow (IRR, NPV) calculation
Rule of thumb: 10 years as individual years, then just terminal value.
Important when looking at start-up businesses, e.g. Zalando; high terminal value.
How do you calculate the Terminal Value?
Last year’s free cash flow * (1 + growth rate)
__________________________________
Discount rate - growth rate
But don’t take a growth rate above GDP growth!
Discount rate can be WACC
How do you calculate the value of perpetuity?
Terminal Value / Enterprise value
= value of the perpetual period
Relevant, because the later the cash flow, the more uncertain it is.
NB: for Zalando, it’s 80-90% of the company!
How do you determine the enterprise value?
a) Calculate directly:
EV = Market value of equity + debt - cash and marketable securities.
= Market capital + debt - cash (equiv.)
= costs to take over a company.
b) Multiples: EBIT multiples, turnover multiples, “user multiples”, “page impression multiples”
Market-to-book ratio =
Market Value of Equity / Book value of equity
Usually value of project A/EBIT project A = multiple.
Project B value = EBIT * multiple.
How can you include inflation in your calculations?
Separate rates for staff costs
OPEX (operative expenditure)
CAPEX (capital expenditure)
How do you calculate Free Cash Flow from EBIT?
FCF = EBIT - tax + depreciation - capital expenditure - change in working capital
FCF = EBIT * (1-t) + depreciation - capital expenditure - change in net working capital
How do you derive EBIT?
Turnover (net sales) - Cost of sales --------------------------------------------- = Gross profit - Selling, general and admin expenses - R&D - Depreciation/amortisation \+ Other income ---------------------------------------------- = Operating income \+ share of associated companies = EBIT
What is net working capital?
NWC = Current assets - current liabilities
= the money that is needed to run the business and so finance the cash cycle.
Cash cycle = time between cash out and cash in.
What is the operating cycle?
The time between purchase and payment
What are some definitions of Net Working Capital?
Accounts receiveables days = Accounts receivable/Average daily sales
Inventory days = Inventory/ Average daily cost of goods sold
Accounts payable days = Accounts payable / Average daily CoGS
