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Chapter Summaries for Final Exam A summary of all the relevant chapters for the final exam.

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FINE 2000
Bert Kohen

LEVERAGE RATIOS (HOW HEAVILY THE COMPANY IS IN DEBT): Long-term debt ratio = (LTD + value of leases) LTD + value of leases + preferred equity + common equity Value of total leases; the amount of every dollar of long-term capital which is in the form of LTD Debt-equity ratio = LTD + value of leases Equity Total debt ratio = Total liabilities Total assets The amount of debt financing (as compared to equity financing) Time interest earned (TIE) ratio = EBIT Interest payments The extent to which interest is covered by earnings (banks prefer to lend to firms whose earnings are far in excess of interest payments) Cash coverage ratio = EBIT + depreciation and amortization Interest payments The extent to which interest is covered by the cash flow from operations Fixed charge coverage ratio = EBIT + depreciation and amortization Interest payments + (current debt repayment + current lease obligations)/(1-tax rate) How many times greater EBIT plus depreciation and amortization is relative to the fixed charges the company is obliged to make LIQUIDITY RATIOS (HOW EASILY A FIRM CAN LAY ITS HANDS ON CASH): NWC to total assets ratio = Net working capital* Total assets A rough measure of the companys potential reservoir of cash; NWC as a proportion of total assets *Net working capital = current assets current liabilities Current ratio = Current assets Current liabilities Quick ratio = Cash + marketable securities + receivables Current liabilities Interval measure = Cash + marketable securities + receivables Avg. daily expenditures from operations Measures whether liquid assets are large relative to the firms regular outgoings (how long, in days, the firm could keep up with its bills using only its cash and other liquid assets) Cash ratio = Cash + marketable securities Current liabilities A low cash ratio may not matter if the firm can borrow on short notice EFFICIENCY RATIOS (HOW PRODUCTIVELY A FIRM IS USING ITS ASSETS): Asset turnover ratio = Sales Total assets The amount of sales generated per dollar of assets A high ratio compared with other firms in the same industry could indicate that the firm is working close to capacity and it may prove difficult to generate further business without additional investment Average collection period = Receivables Avg. daily sales* The speed with which customers pay their bills * A/R in terms of daily sales; ending A/R divided by 365 days. A relatively low figure usually indicates a highly efficient collections department Inventory turnover ratio = COGS Inventory The value of the goods drawn out of inventory Efficient firms turn over their inventory rapidly and dont tie up more capital than they need in raw materials or finished goods Days sales in inventories = Inventory COGS/365 How many days sales are represented by inventories PROFITABILITY RATIOS (THE FIRMS RETURN ON ITS INVESTMENTS): Net profit margin = Net income Sales Shareholders earnings for every dollar of sales Operating profit margin = Net income + interest Sales Operating profits generated by the company Return on assets (ROA) = Net income Total assets Profits as a percentage of assets or funds invested Makes the apparent profitability of a firm a function of its financing as well as its operating decisions Operating return on assets = Net income + interest Total assets Measures the return on all of the firms assets, not just its equity investment Return on invested capital (ROIC) = Net income + interest Short-term debt + LTD + preferred and common equity The return earned on total capital A high return on assets does not always mean that you could buy the same assets today and get a higher return, nor does a low return imply that the assets could be employed better elsewhere (but it does suggest that you should ask some searching questions) In a competitive industry, firms can expect to earn only their cost of capital Return on equity (ROE) = Net income Equity The return on shareholders equity Payout ratio = Dividends Earnings The proportion of earnings that is paid out as dividends Plowback ratio = Earnings dividends Earnings Earnings on paid out as dividends Growth in equity from plowback = Earnings dividends x Earnings Earnings Equity How rapidly shareholders equity is growing as a result of plowing back part of its earnings each year DUPONT SYSTEM ROA = Sales x Net income Assets Sales ROA = Asset turnover x net profit margin ROE = Assets x Sales x Net income Equity Assets Sales ROE = Assets/Equity x ROA = Leverage ratio x asset turnover x net profit margin If a company can earn more income on its sales, its net profit margin will increase, raising ROE If it can increase the volume of sales generated by its existing assets, its asset turnover will increase and so too will ROE Increasing leverage will also increase ROE, provided that the firms ROA is higher than its cost of debt Net working capital = Current assets current liabilities Sales (Variable costs) (Fixed costs) (Depreciation) EBIT (Interest) EBT (Taxes) Net Income Sales VC FC D = EBIT
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