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## FIN 331 in a Nutshell

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**FIN 331 in a Nutshell**Financial Management I Review**FIN 331 in a Nutshell - Index**• Financial Statements, Ratios, & AFN • Time Value of Money • Bond Valuation • Risk & Return (SML/CAPM) • Stock Valuation • WACC • NPV, IRR, MIRR • Cash Flow Estimation Click on the selected topic to go directly to that section**Financial Statements, Cash Flow, and Taxes**Key Financial Statements Balance sheet Income statements Statement of cash flows Index**The Annual Report**• Balance sheet • Snapshot of a firm’s financial position at a point in time • Income statement • Summarizes a firm’s revenues and expenses over a given period of time • Statement of cash flows • Reports the impact of a firm’s activities on cash flows over a given period of time**Sample Balance Sheet**Assets = Liabilities + Owner’s Equity**Sample Income Statement**Net income=Dividends + Retained earnings**Statement of Cash Flows**• Provides information about cash inflows and outflows during an accounting period • Required since 1988 • Developed from Balance Sheet and Income Statement data**Statement of Cash Flows**Reconciles the change in Cash & Equivalents**Statement of Cash Flows**• Reconciles the Income Statement and Balance Sheet to the flow of cash • The Matching Principle requires estimates and accruals to prepare Financial statements • Financial Analysis is concerned with Cash Flow Why is it important???**Statement of Cash Flows**“A positive net income on the income statement is ultimately insignificant unless a company can translate its earnings into cash, and the only source in financial statement data for learning about the generation of cash from operations is the statement of cash flows”**Deficits**Covered by new debt and cash**Net Operating Working Capital**If the Asset side had included “Short-term investments” they would have been excluded as well.**Operating Capital (also called Total Net Operating Capital)**• Operating Capital = NOWC + Net fixed assets • Operating Capital • (2005) = $800 + $1,000 = $1,800 million • (2004) = $650 + $870 = $1,520 million • Net Investment in Operating Capital = Op Cap (2005) – Op Cap (2004) = $1,800 - $1,520 = $280 million**NOPAT = EBIT(1 - Tax rate)**NOPAT05 = $283.8(1 - 0.4) = $170.3 m OCF05 = NOPAT + Deprec + Amort = $170.3 + $100 = $270.3 Net Operating Profit after Taxes (NOPAT) & Operating Cash Flow**EBIT = $283.8 m T = 40% Depreciation = $100 m**Capital Expenditures = FA + Deprec = $130+$100 = $230 NOWC = $800 - $650 = $150 m FCF = [$283.8(1-.4)+$100] –[$230-$150] = -$109.7 m Free Cash Flow (FCF) for 2005**Analysis of Financial Statements**Ratio Analysis Limitations of ratio analysis Qualitative factors Index**Five Major Categories of Ratios**• Liquidity • CR - Current Ratio • QR - Quick Ratio or “Acid-Test” • Asset management • Inventory Turnover • DSO – Days sales outstanding • FAT - Fixed Assets Turnover • TAT - Total Assets Turnover • Debt management • Debt Ratio • TIE – Times interest earned • EBITDA coverage (EC)**Five Major Categories of Ratios**• Profitability • PM - Profit margin on sales • BEP – Basic earning power • ROA – Return on total assets • ROE – Return on common equity • Market value • P/E – Price-Earnings ratio • P/CF – Price – cash flow ratio • M/B – Market to book**Liquidity Ratios**• CR = Current Ratio = CA/CL • QR = Quick Ratio or “Acid-Test” = (CA-INV)/CL**Asset Management Ratios**• Inventory Turnover = Sales/Inventories • DSO = Days sales outstanding = Receivables /(Annual sales/365) • FAT = Fixed Assets Turnover = Sales/Net Fixed Assets • TAT = Total Assets Turnover = Sales/Total Assets**Debt Management Ratios**• Debt Ratio = Total Liabilities/Total Assets • TIE = Times interest earned = EBIT/Interest • EBITDA coverage = EC (EBITDA + lease pmts) . (Interest + principal pmts + lease pmts)**Profitability Ratios**• PM = Profit margin on sales = NI/Sales • BEP = Basic earning power = EBIT/Total Assets • ROA = Return on total assets = NI/Total Assets • ROE = Return on common equity = NI/Common Equity**Market Value Metrics**• P/E = Price-Earnings ratio = Price per share/Earnings per share • P/CF = Price–cash flow ratio = Price per share/Cash flow per share • M/B = Market to book = Market price per share Book value per share**The 5 Major Categories of Ratios and What Questions They**Answer**Potential Problems and Limitations of Ratio Analysis**• Comparison with industry averages is difficult if the firm operates many different divisions • “Average” performance ≠ necessarily good • Seasonal factors can distort ratios • Window dressing techniques**Problems and Limitations (Continued)**• Different accounting and operating practices can distort comparisons • Sometimes difficult to tell if a ratio value is “good” or “bad” • Different ratios give different signals • Difficult to tell, on balance, whether a company is in a strong or weak financial condition**Qualitative Factors**• Revenues tied to a single customer? • Revenues tied to a single product? • Reliance on a single supplier? • Percentage of business generated overseas? • Competitive situation? • Legal and regulatory environment?**Financial Planning and Forecasting**Forecasting sales Projecting the assets and internally generated funds Projecting outside funds needed Deciding how to raise funds Index**The AFN Formula**If ratios are expected to remain constant: AFN = (A*/S0)∆S - (L*/S0)∆S - M(S1)(RR) Required Assets Retained Earnings Spontaneously Liabilities**Variables in the AFN Formula**• A* = Assets tied directly to sales • S0 = Last year’s sales • S1 = Next year’s projected sales • ∆S = Increase in sales; (S1-S0) • L* = Liabilities that spontaneously increase with sales**Variables in the AFN Formula**• A*/S0: assets required to support sales; “Capital Intensity Ratio” • L*/S0: spontaneous liabilities ratio • M: profit margin (Net income/sales) • RR: retention ratio; percent of net income not paid as dividend**Key Factors in AFN**• ∆S = Sales Growth • A*/S0 = Capital Intensity Ratio • L*/S0 = Spontaneous Liability Ratio • M = Profit Margin • RR = Retention Ratio**Time Value of Money**• Timelines • Future Value • Present Value • Present Value of Uneven Cash Flows**Time Lines: Timing of Cash Flows**0 1 2 3 I% CF0 CF1 CF2 CF3 • Tick marks occur at the end of periods • Time 0 = today • Time 1 = the end of the first period or the beginning of the second period +CF = Cash INFLOW-CF = Cash OUTFLOWPMT = Constant CF**Basic Definitions**Present Value(PV) • The current value of future cash flows discounted at the appropriate discount rate • Value at t=0 on a time line Future Value(FV) • The amount an investment is worth after one or more periods. • “Later” money on a time line**Future Value: General Formula**• FV = future value • PV = present value • I = period interest rate, expressed • as a decimal • N = number of periods • Future value interest factor = (1 + I)N • Note: “yx” key on your calculator FV = PV(1 + I)N**Texas Instruments BA-II Plus**FV = future value PV = present value PMT = periodic payment I/Y = period interest rate N = number of periods One of these MUST be negative N I/Y PV PMT FV**Excel Spreadsheet Functions**=FV(rate,nper,pmt,pv) =PV(rate,nper,pmt,fv) =RATE(nper,pmt,pv,fv) =NPER(rate,pmt,pv,fv) • Use the formula icon (ƒx) when you can’t remember the exact formula**Future Values – Example**Suppose you invest $100 for 5 years at 10% How much would you have? Formula Solution: FV =PV(1+I)N =100(1.10)5 =100(1.6105) =161.05**Future Value – Example**Suppose you invest $100 for 5 years at 10%. How much would you have? Calculator Solution • 5 N • 10 I/Y • -100 PV • 0 PMT • CPT FV = 161.05**Future Value:Important Relationship 1**For a given interest rate: • The longer the time period, • The higher the future value FV = PV(1 + I)N For a given I, as N increases, FV increases**Future ValueImportant Relationship 2**For a given time period: • The higher the interest rate, • The larger the future value FV = PV(1 + I)N For a given N, as I increases, FV increases**Present Values**• The current value of future cash flows discounted at the appropriate discount rate • Value at t=0 on a time line • Answers the questions: • How much do I have to invest today to have some amount in the future? • What is the current value of an amount to be received in the future?**Present Values**FV = PV(1 + I)N • Rearrange to solve for PV PV = FV / (1+I)N PV = FV(1+I)-N • “Discounting” = finding the present value of one or more future amounts**Present Value: One Period Example**• You need $10,000 for the down payment on a new car • You can earn 7% annually. • How much do you need to invest today? • 1 N; • 7 I/Y; • 0 PMT; • 10000 FV; • CPT PV = -9345.79 PV = 10,000(1.07)-1 = 9,345.79 =PV(0.07,1,0,10000)**Present Value:Important Relationship 1**For a given interest rate: • The longer the time period, • The lower the present value For a given I, as N increases, PV decreases**Present ValueImportant Relationship 2**For a given time period: • The higher the interest rate, • The smaller the present value For a given N, as I increases, PV decreases