Viktigste temaer Flashcards
Net working capital
Net working capital = Current assets - Current liabilities
Positive net working capital is not neccesarily good.
Reasons:
- Excessive Inventory
- Suboptimal Capital Allocation
- Collection Issues
- Industry Comparison
- Potential for Short
- Term Liabilities
- Liquidity vs. Solvency
Equity formula
= assets - debt
Profitability measures (ROA, ROE, profit margin, EBIT)
Return on Asset (ROA) = Net income / Total Assets
Return on Equity (ROE) = Net income / Total Equity
Profit margin = Net income / sales
Earnings before intrest and taxes (EBIT) = Net income + intrest + tax = Revenue - cost of goods sold - indirect operaing cost
Profitability index (PI)
PI is used to evalutate a projects profitability.
Criteria:
* The PI must be over 1 for the project to be accepted.
Ranking:
* The bigger the PI, the better.
Pros:
- Easy to understand and communicate
- Good tool when evalutaing multiple independent projects.
- Useful when availbale investment funds are limited
Cons:
- Problems with mutually exclusive investments
EXTRA:
- With capital rationing PI is a useful method for adjusting NPV
- When choosing mutually exclusive projects and using the profitability index on the incremental cash flows with PI > 1, we get the same result as using NPV
Price earnings (PE) ratio
Relates earnings per share to price.
Interpreting the PE-ratio:
Historically a company has a fair price if the P/E ratio is between 10 – 17.
Below 10:
- The company’s earnings are thought to be in decline, and the company’s future might be in question.
- Or, current earnings are substantially above historical earnings (e.g. through asset sales).
Over 17:
* The stock is overvalued or the earnings have increased since the last earnings figure was published.
- Or, the stock is a growth company where earnings are expected to increase in the future.
Over 25:
- High expected future growth in earnings (e.g. Facebook).
- May be a speculative bubble.
Dividend growth model (DGM)
A way of evalutaing a common stock. There are three valuations based on DGM (see picture).
Flaws:
* Need to agree on r (discount rate) and g (growth rate)
* What if r < g?
DGM will set company value = negative
* What if the company don’t pay dividend?
DGM will set company value = 0
* What if the company provides other cash flows than dividends?
Total payout model
* How about extra opportunities?
NPVGO
Capital asset pricing model (CAPM)
CAPM tells us the relationship between the risk of one single asset compared to the risk in the market.
Expected return E(R) = RF + beta(RM-RF)
RF - risk free rate (10yr bond yield)
RM - avrg historical return
(RM-RF) - market risk premium (expected reward for taking extra risk)
CAPM can also be described as the cost of equity. I.e. what an investor expects to get in return for the investment in your company.
CAPM can be used to calculate discount rate or expected rate of return.
The Beta:
- The beta measures an asset’s sensitivity to market fluctuation.
- Beta= 1, will move just like the market.
- An asset with a beta = 2, will have twice as much risk compared to the market portfolio. If the market rises by 1%, the asset will rise by 2%. If the market falls by 2%, the asset will fall by 4%.
What is a sensitivity analysis?
With scenario analysis, one variable is examined for å broad range of values.
Algorithm for sensitivity analysis:
1. Specify the NPV equation, including cash flow equation
2. Specify base values for stochastic variables in the NPV equation (base assumptions)
3. Calculate NPV using base values
4. For each stochastic variable:
- Decide upon alternative outcomes for the variable (e.g. -20% drop, +20% rise etc.)
- Calculate the NPV under alternative outcomes
- Under sensitivity analysis, one input is varied at a time while all other inputs are assumed to meet their expectations (base assumption)
5. Analyze the effect of alternative outcomes on NPV
- Find which variables have the greatest effect, e.g. by using a ”spider” (also called “star”) diagram.
Advantages and disadvantages of sensitivity analysis
Advantages of sensitivity-analysis:
- Recognizes the uncertainty of variables
- Shows how significant any variable is in determining a project’s NPV
- Does not depend on probabilities associated with outcomes of variables
- Can be used when there is little information, resources and time for more sophisticated techniques
Disadvantages of sensitivity-analysis:
- Variables are often interrelated
- No explicit probabilistic measure for values (probability distr.) or risk exposure
- How likely is a pessimistic, optimistic or expected value and how likely is the corresponding outcome value?
Monte Carlo simulation
Monte Carlo attempts to model real-world uncertainty and is seen as a step beyond sensitivty or scenario analysis.
Algorithm for Monte Carlo:
1. Specify the basic model
2. Specify a probability distribution for each variable in the model
3. The computer draws on outcome
4. Repeat the procedure
6. Calculate NPV
Advantages: Possibility to define advanced/complex NPV-estimation, and includ correlation.
Disadvantages: Relies on correct prob.distr. in (2). May become too complex. Time consuming
Operational cash flow (OCF)
After the initial investment, the project/company is dependent on the operational cash flow (OCF) from its investment.
MM Proposition I & II (No Taxes)
1. The company’s capital structure does not impact its value. Since the value of a company is calculated as the present value of future cash flows, the capital structure cannot affect it.
VL = VU
2. The company’s cost of equity is directly proportional to the company’s leverage level (amount of equity). An increase in leverage/debt induces a higher default probability to a company. Therefore, investors tend to demand a higher cost of equity (return) to be compensated for the additional risk.
MM Propositions I & II (with taxes)
1. M&M Theorem 1 (with taxes) says that a levered company has a higher value than an unlevered company, due to the tax shield.
The value of a company increases with debt (due to the tax shield).
VL = VU + (D x TC)
2. M&M Theorem 2 (with taxes) risk of the company increases with debt as the expected return for shareholders increases. The increased risk is reduced due to the tax shield.
The Pecking Order Theory
Theory stating that firms prefer to issue debt rather than equity if internal financing is insufficient.
Rule 1: Use internal financing
Rule 2: Issue debt next and equity last
Internal financing is easier to use and at no extra costs.
Debt is preferrable as it has a signaling effect. Showing that they are confident in paying the intrest.
Equity last because issuing stocks leads to a decrease in stock
value, and current shareholders lose value.
Weighted average cost of capital (WACC)
A way to calculate the cost of capitol for a company. Takes into account cost of debt, cost of equity and preffered stocks.
What is EAR?
Effective annual rate
What we have is a loan with a monthly interest rate of 1.5% or a yearly interest rate of 18%.
This is equivalent to a loan with an annual interest rate of 19.56%.
PV of different cash flows
Bond valuation - primary principle and formula
Bond value is determined by the present value of the coupon payments plus the present value of the par/face value (PV of future cash flows).
Interest rates are inversely related to present (i.e., bond) values.
The lower the coupon rate, the greater the interest rate risk.
The longer the time to maturity the greater the interest rate risk.
NPV method (project selection)
Minimum acceptance:
NPV > 0
Ranking criteria:
Highest NPV
Must estimate:
- cash flows
- discount rate
- initial investment
Reinvestment assumption:
The NPV rule assumes that all cash flows can be reinvested at the discount rate.
Why use NPV?
- Accepting positive NPV projects benefits shareholders.
- NPV uses cash flows
- NPV uses all relevant cash flows of the project
- NPV discounts the cash flows properly
Payback Period Method
Payback period method = number of years to recover initial cost
Minimum acceptance:
Set by management; a predetermined time period.
Ranking criteria:
Set by management; often the shortest payback period is preferred.
Disadvantages:
- Ignores time value of money
- Ignores cash flows after the payback period
- Biased against long term projects
- Requires an arbitrary accpetance criteria
- A project accepted based on the payback criteria may not have a positive NPV
Advantages:
- Easy to understand
- Biased towards liquidity
Discounted Payback Period Method
How long does it take the project to pay back its initial investment, taking into account time value of money.
Minimum acceptance:
Set by management; a predetermined time period
Ranking criteria:
Set by management; often shortest payback is preferred.
By the time you have discounted the cash flow, you might as well calculate the NPV.
