Basic Finance Study Sheet
Investing Decision should a new computer be purchased, should the firm develop a new
drug, or should the firm shut down an unprofitable factory
Financing Decision should the firm borrow money from a bank or sell bonds, should
the firm issue preferred stock or common stock, should the firm buy or lease a new
machine that is committed to acquiring
Real Asset a trademark, a truck, undeveloped land, an experienced and hardworking
Financial Asset a share of stock, a personal IOU, the balance in an account, a bank loan
Corporate Organizations gives permanence. The corporation continues to exist if
managers are replaced of if stockholders sell their ownership interests to other investors
Agency Problems managers are agents for stockholders, but the managers may act in
their own interests rather than maximizing value
Primary Market market for the sale of new securities by corporations
Secondary Market market in which previously issued securities are traded among
Flow of Savings starts with investors, goes to the corporation and then they reinvest it.
Or, it can start from investors. Go to either financial markets or financial institutions, and
then to corporations through reinvestment.
Intermediary an organization that raises money from investors and provides financing
for individuals, corporations, or other organizations
Opportunity Cost of Capital expected rate of return that shareholders can earn in the
financial markets on investments with the same risk as the firm’s capital investments
Balance Sheet *Left Side> current assets, cash and securities, receivables, inventories,
fixed assets, tangible and intangible assets. *Right Side> current liabilities, payables,
shortterm debt, long term liabilities, shareholders equity
Common Size Balance Sheet assets=cash and marketable, receivables, inventory, other
current assets, total current assets, fixed assets, tangible fixed, property plant and
equipment, less accumulated depreciation, net tangible fixed, intangible asset, long term
investments other assets. Liabilities= debt due, accts payable, long term debt, deferred
income taxes. Shareholder’s Equity= common stock, retained earnings, treasury stock.
Book Value value of assets or liabilities according to the balance sheet
Market Value current price of an asset or liability Income Statement measures the profitability of the company during the year. It shows
the difference between revenues and expenses. This includes: Net Sales, cogs, selling and
gen and admin expenses, depreciation, EBIT, interest expense, taxable income, taxes, net
Statement of Cash Flowsmeasures the sources and uses of cash during the year.
Marginal Tax Rateadditional taxes owed per dollar of additional income
19) Firm’s Net Income? Find taxable income. Income taxes x 20% = 10,000
Net Income= taxable income – taxes
Firm’s Revenues? Revenue=??? – Cogs –Admin Expense – Depr. Expense – Int.
Expense= taxable Income which is 10,000. 10,000 + 13,000= 23,000
Firm’s EBIT? Revenuescogsadmin exp. depr expen= EBIT which is 11,000
Market Capitalization total market value of equity, equal to share price times number
of shares outstanding
Market Value Added market capitalization – book value of equity
Economic Value Added (EVA) aftertax operation income – a charge for the cost of
capital employed. AKA Residual Income
ROA after tax operation income as a percentage of total assets. After tax operating
Asset Turnover Ratio shows how much sales are generated by each dollar of total
assets. Sales/total assets at start of year.
Inventory Turnover compares level of inventory with the cost of goods sold. Cogs/
Inventory at start of year
Receivables Turnover sales for which you have not been paid. Sales/ receivables at start
Operating Profit Marginaftertax operating income as a percentage of sales. Profit
Margin = net income/ sales. Operating Profit Margin= aftertax operating income/ sales.
Du Pont Formual ROA equals the product of asset turnover and operating profit
margin. ROA= aftertax operating income/ assets which in turn equals = sales/assets
(asset t/o) x aftertax operating income/sales (operating prof. margin)
Leverage Measures usually measured by the ratio of longterm debt to total longterm
capital. This ratio measures how much financial leverage the firm has taken on.
LongTerm Debt Ratio longterm debt/ longterm debt + equity
LongTerm Debt Equity Ratio longterm debt/ equity
Times Interest Earned Ratio EBIT/ Interest Payments. ROENet Income/Equity= (Leverage) Assets/equity X (Asset TO)sales/assets X (OPM)
aftertax operating income/ sales X (debt burden) net income/ after tax operating income.
Extended version of the Du Pont formula. Breaks down the ROE into four parts.
Liquidity access to cash or assets that can be turned into cash on short notice.
Current Ratio Current Assets/ Current Liabilities
Quick Ratiocash + marketable securities + receivables/ current liabilities
Sustainable Growth Ratethe firms growth rate if it plows back a constant fraction of
earnings, maintains a constant return on equity, and keeps its debt ratio constant.
Earnings Dividends/ Equity
Market Value Added= market value of equity – book value of equity
Market to book Ratio= market value of equity / book value of equity
ROA= aftertax operating income / total assets
ROE= net income/ equity
EVA= aftertax operating income –cost of capital X capital
Op Prof Margin= aftertax operating income/sales
Asset Turnover= sales/total assets at start of year
Receivables Turnover= sales/ receivables at start of year
Inventory Turnover= cogs/inventory at start of year
Payout Ratio= dividends/earnings
Sustainable Growth= (1payout ratio) X ROE
18) TIE? Int. Exp.= rate of interest X amount
= .08 X 10 Million= 800,000
TIE= EBIT/ Interest Exp.
Cash Coverage? EBIT + Depreciation / Int. Exp.
=1mill + 200,000/800,000=1.5
Fixed Payment Coverage? EBIT + Depreciation/Int. Exp +retirement of debt
1million + 200,000/ 800,000 + 300,000=1.09
Future Value amount to which an investment will grow after earned interest. =present
value X (1+r)^t
Present Value value today of a future cash flow.
=future value after t periods/ )1+r)^t
PV of Perpetuity= C/r=cash payment/interest rate
Present Value of tyear annuity= C[1/r1/r(1+r)^t]
Future Value of annuity of $1 a year= present value of annuity of 1 a year X
(1+r)^t=[1/r1/r(1+r)^t] X (1+r)^t=(1+r)^t1/r
Present Value of annuity due= (1+r) X present value of annuity
Future Value of annuity Due= future value of ordinary annuity X (1+r)
1+Real Interest Rate= 1+nominal interest rate/1+Inflation Rate
Real Interest Rate= Nominal interest rateinflation rate Compound Interest interest earned on interest
Simple Interest interest earned only on the original investment; no interest is earned on
Discount Cash Flow present value of a future cash flow
Discount Rate interest rate used to compute present values of future cash flows
Discount Factor present value of a $1 future payment. = 1/(1+r)^t
Multiple Cash Flowsto find the value at some future date of a stream of cash flows,
calculate what each cash flow will be worth at that future date and then add up these
Annuity equally spaced level stream of cash flows with a finite maturity
Perpetuity stream of level cash payments that never ends
Cash Payment from Perpetuity= interest rate X present value
PV of Perpetuity= cash payment/ interest rate
Annuity Factor present value of a $1 annuity
Present Value of Tyear Annuity= C[1/r – 1/r(1+r)^t
=payment x annu