Christopher B. Stone ‘01 Present value of future cash flow r = discount rate n = number of periods Discounting: calculation of present values Compounding: calculation of future values

Christopher B. Stone ‘01 Annuities CF 0 CF t nnn n n PmT In advance In arrears

Christopher B. Stone ‘01 Internal rate of return IRR is that unique discount rate which, when applied to a series of future cash flows, yields a net present value of 0.

Christopher B. Stone ‘01 Financial management rate of return Only Series A is a “pure” IRR Series B and Series C have money extracted from the system Series C has money invested in the system after t 0 The IRR model assumes 1) That money invested in the system is held in an account bearing interest at the IRR before being invested; 2) That money extracted from the system is re-invested in an account yielding the IRR. FMRR bifurcates negative and positive cash flows

Christopher B. Stone ‘01 Financial management rate of return PVFV (50) (107.18)(7.18) Future valued at re-investment rate PV’ed at safe rate FMRR > re-investment rate for worthwhile investments

Christopher B. Stone ‘01 Hurdle rates The earnings you forego by deploying capital in a different way The rate you must get on an investment for the deal to make sense If hurdle rate < IRR, NPV is positive

Christopher B. Stone ‘01 Sensitivity analysis If you discount your cash the HR and get a + NPV, the NPV represents your profit over the life of the deal. If HR<IRR, + NPV HR is the positive cushion you have Annuitize this figure (calculate PmT) to get Net Uniform Series (NUS)

Christopher B. Stone ‘01 Recourse debt

Christopher B. Stone ‘01 Compounded interest

Christopher B. Stone ‘01 Capital asset pricing model Cost of capital Risk-free return USG securities Average rate of return on common stocks (S&P 500) Co-variance of returns against the portfolio (departure from the average) B < 1, security is safer than S&P 500 average B > 1, security is riskier than S&P 500 average Cost of equity capital = return expected on firm’s common stock Cost of capital = Risk-free return + compensation for additional risk beyond a USG bond Cost of capital = Risk free return + (β x market risk premium) Cost of capital = Risk free return + (β x margin by which stock market exceeds risk-free return

Christopher B. Stone ‘01 Lease financing

Christopher B. Stone ‘01 Income statement

Christopher B. Stone ‘01 Methods of inventory valuation

Christopher B. Stone ‘01 Benefits of FIFO and LIFO Must use the same method for financial & tax accounting

Christopher B. Stone ‘01 FIFO and LIFO calculations

Christopher B. Stone ‘01 Depreciation methods = Cost-salvage value Useful life = Cost-salvage value * remaining years of useful life n(n+1) 2 Keyed off the remaining balance in each year AFTER depreciation Does NOT use salvage value

Christopher B. Stone ‘01 Straight line & sum of the years depreciation Straight-line Sum of the years

Christopher B. Stone ‘01 Declining balance depreciation $12,000 x.375 = $4,500

Christopher B. Stone ‘01 Depreciation graphs

Christopher B. Stone ‘01 Capitalization vs. expenses

Christopher B. Stone ‘01 Merger accounting Defeat hostile takeovers by ensuring the combination doesn’t qualify for pooling

Christopher B. Stone ‘01 Pooling method Pooling: Uses book value, A inherits T’s retained earnings

Christopher B. Stone ‘01 Purchase method Purchase: Uses FMV, A doesn’t inherit T’s retained earnings

Christopher B. Stone ‘01 Goodwill

Christopher B. Stone ‘01 Stock and dividend issuance

Christopher B. Stone ‘01 Liquidity ratios Current ratio = Current assets Current liabilities Quick ratio = Current assets - inventory Current liabilities Cash flow liquidity ratio = Cash flow from operations* Current liabilities *From the cash flow statement

Christopher B. Stone ‘01 Leverage ratios Debt ratio = Liabilities Assets Debt/equity ratio = Liabilities Net worth

Christopher B. Stone ‘01 Financial leverage index Financial leverage index = Return on equity Adjusted return on assets = Net earnings* / equity** [Earnings + interest (1-tax rate)] / assets * Note this does not include pfd div **Or market cap Is a company trading positively on its leverage? I.e., is it bringing in capital at less than the return?

Christopher B. Stone ‘01 Activity ratios Accounts receivable turnover = Net sales* Accounts receivable *From the income statement Inventory turnover = COGS* Inventory Accounts payable turnover = Total expenses* Accounts payable

Christopher B. Stone ‘01 Operating cycle Capital infusion $ Sale Inventory Accounts receivable Avg. amount of time inventory is outstanding + Avg. amount of time receivables are outstanding Operating cycle =

Christopher B. Stone ‘01 Capital infusion $ Sale Cash conversion cycle Avg. amount of time inventory is outstanding + Avg. amount of time receivables are outstanding - (Avg. amount of time payables are outstanding) Cash conversion cycle = Accounts payable (Payment) Accounts receivable Inventory

Christopher B. Stone ‘01 Profitability ratios Gross profit margin = Gross profit Gross sales This is very much driven by variable costs / cost of goods sold. Overhead is NOT included. Measures profitability A business can be profitable and still trade negatively on its leverage

Christopher B. Stone ‘01 P/E ratio = Stock price per share Earnings per share Return on total assets = Earnings + interest Assets