Topic 1 - Financial Statements Analysis & Financial Models

Question 1

In an efficient capital market, stock price returns should reflect what?

Answer 1

reflect all public info. & are the ‘true’ return

Question 2

what is the formula for EPS?

Answer 2

EPS = (NI / End number of shares)

Question 3

what is the formula for Debt Ratio?

Answer 3

Debt Ratio = (TA – TE) / TA

firm finances ___% of its assets with debt

Question 4

what is the formula for Debt/Equity?

Answer 4

Debt/Equity = TD / TE
firm finances ___% of its equity with debt
higher value = more risky firm

Question 5

what is the formula for Equity Multiplier [EM] ?

Answer 5

Equity Multiplier [EM] = TA / TE = 1 + TD/TE

A higher multiplier indicates more assets are financed by every equity dollar

Question 6

what is the formula for Times Interest Earned?

Answer 6

Times Interest Earned = EBIT / Interest

Question 7

what is the formula for Cash Coverage?

Answer 7

Cash Coverage = (EBIT + Depreciation) / Interest

high value not always good, low risk = low return

Question 8

what is the formula for Total Asset Turnover [TAT]?

Answer 8

Total Asset Turnover [TAT] = Sales / TA

asset efficiency, higher value good

Question 9

what is the formula for Profit Margin [PM]?

Answer 9

Profit Margin [PM] = Net Income / Sales

Operating efficiency, higher value good

Question 10

what is the formula for Return on Assets (ROA)?

Answer 10

Return on Assets (ROA) = NI / TA

Question 11

what is the formula for Return on Equity (ROE)? (3)

Answer 11

Return on Equity (ROE) = NI / TE
ROE = ROA ×EM
ROE = PM ×TAT ×EM
Short-Term Efficiency

Question 12

what is the formula for Price-Earnings or P/E Ratio (trailing)?

Answer 12

Price-Earnings or P/E Ratio (trailing) = Current share price / most recent EPS

Question 13

what is the formula for Price/Book (or Market/Book) of equity? what does it measure?

Answer 13

(P/B) = Current share price / Book equity per share

commonly used to measure value of growth opportunities

Question 14

what is the formula for EBITDA?

Answer 14

EBITDA = EBIT + Depreciation & amortization

Question 15

what is the formula for Market capitalisation?

Answer 15

Market capitalization = Price per share ×Number of shares outstanding

Question 16

what is the formula for Enterprise Value (EV)?

Answer 16

Enterprise Value (EV) = Market capitalization + Market value of interest bearing debt – cash

Question 17

what is the formula for EV Multiple?

Answer 17

EV Multiple = EV / EBITDA

Question 18

Which accounting line-items vary directly with sales? (4) how do the first 2 impact PM?

Answer 18

• Costs may vary directly with sales (means PM is constant)
• interest expense may vary with the debt level. (If so, the profit margin is not constant)
• Assets
• AP

Question 19

How is NET income calculated?

Answer 19

Revenue
- COGS
- Expenses
- Depreciation
= EBIT
- Interest expense
= Taxable income
- Tax expense
= Net Income

Question 20

when would you expect to see negative EFN eliminated?

Answer 20

when there is sufficiently higher revenue growth

Question 21

how do increases in PM, TAT, Financial Leverage and Dividend retention affect a firms growth?

Answer 21

• PM: growth increases
• TAT: growth increases
• Financial Leverage: if optimal should have a neutral effect
• Dividend retention: reduces growth

Question 22

How does higher growth affect NPV?

Answer 22

should increase the NPV, as long as increased growth isn’t achieved through higher risk leading to a higher discount rate.

Question 23

What does the internal growth rate tell us?

Answer 23

how much a firm can grow its assets using retained earnings as the only source of finance

Question 24

What is the formula for IGR?

Answer 24

IGR = ROA x b / (1 - (ROA x b))

Question 25

What does the sustainable growth rate tell us?

Answer 25

how much a firm can grow its assets using internal financing and issuing only enough debt to maintain a constant debt ratio

Question 26

What is the formula for SGR?

Answer 26

SGR = ROE x b / (1 - (ROE x b))

Question 27

what allows the SGR to become larger than IGR?

Answer 27

when there is debt financing

Question 28

when will both SGR and IGR increase?

Answer 28

when the Net income of a firm increases

Question 29

What happens in actual growth rate is higher than SGR?

Answer 29

the firm will need external financing in the next period

Question 30

What happens in actual growth rate is lower than SGR?

Answer 30

company is potentially less profitable than it could be

Question 31

which four factors can increase SRG?

Answer 31

• increase external financing (equity and debt) if +NPV
• Reduce dividend payout
• increase PM (i.e. reduce expenses)
• sell asset surplus to decrease required assets

Question 32

when is IGR = SGR?

Answer 32

when there is not debt financing

Question 33

when are IGR and SGR = 0?

Answer 33

when the firm doesn’t retain any funding

Question 34

when retention ratio increases what is the impact on EFN?

Answer 34

EFN would decline, more internal funding sources available, and it will have to take on more debt to keep the debt/equity ratio constant