FIN 331 in a Nutshell

1. FIN 331 in a Nutshell Financial Management I Review

2. 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

3. Financial Statements, Cash Flow, and Taxes Key Financial Statements Balance sheet Income statements Statement of cash flows Index

4. 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

5. Sample Balance Sheet Assets = Liabilities + Owner’s Equity

6. Sample Income Statement Net income=Dividends + Retained earnings

7. Allied Food Products

8. Allied 2005 Per-Share Ratios

9. 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

10. Statement of Cash Flows Reconciles the change in Cash & Equivalents

12. 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???

13. 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”

14. Deficits Covered by new debt and cash

15. Net Operating Working Capital If the Asset side had included “Short-term investments” they would have been excluded as well.

16. 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

17. 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

18. 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

19. Analysis of Financial Statements Ratio Analysis Limitations of ratio analysis Qualitative factors Index

20. 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)

21. 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

22. Liquidity Ratios • CR = Current Ratio = CA/CL • QR = Quick Ratio or “Acid-Test” = (CA-INV)/CL

23. 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

24. 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)

25. 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

26. 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

27. The 5 Major Categories of Ratios and What Questions They Answer

28. 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

29. 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

30. 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?

31. Financial Planning and Forecasting Forecasting sales Projecting the assets and internally generated funds Projecting outside funds needed Deciding how to raise funds Index

32. 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

33. 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

34. 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

35. Key Factors in AFN • ∆S = Sales Growth • A*/S0 = Capital Intensity Ratio • L*/S0 = Spontaneous Liability Ratio • M = Profit Margin • RR = Retention Ratio

36. Time Value of Money • Timelines • Future Value • Present Value • Present Value of Uneven Cash Flows

37. 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

38. 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

39. 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

40. 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

41. 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

42. 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

43. 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

44. 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

45. 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

46. 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?

47. 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

48. 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)

49. 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

50. 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