Objective: maximize firm value, increase stock price Decisions: Investment, Working Capital, Financing, DistributionPrincipal (shareholders) Agent (Manager): Career Concern, Empire Building, Private Benefits of Control, Shirking

Current Assets – Current Liabilities = Net working capital (Current = less than a year) Financial leverage: use of debt to acquire assetsAverage tax rate: total taxes paid / total taxable income. Marginal tax rate: amount of tax payable on the next dollar earned.Cash Flow from Assets = Cash Flow to Creditors + Cash Flow to ShareholdersCash Flow from Assets = Operating Cash Flow (EBIT + Dep - Tax) – Net Capital Spending (Ending Net Fixed Assets – Beginning NFA + Dep) – Change in Net Working Capital Cash Flow to Creditors = Interest Paid – Net New Borrowing Cash Flow to Shareholders = Dividend Paid – Net New Equity RaisedCurrent Ratio: Current Assets / Current Liabilities distorted by seasonal influences, slow-moving inventories built up out of proportion to market opportunities, abnormal payment of accounts payable just prior to the balance sheet date. Quick Ratio (Acid-Test Ratio): Current Assets – Inventory/ Current Liabilities Cash Ratio Cash / Current Liabilities Very short-term creditor might be interested in this ratio. Solvency Ratios : ability to meet long-term debt payment. Total Debt Ratio: Total Liabilities/Total Assets Debt-equity Ratio: Total Liabilities / Shareholders' Equity Times Interest Earned Ratio: EBIT/Interest operating profits decline without impairing ability to pay interest. Cash Coverage Ratio: (EBIT + Depreciation) / Interest Asset Management Ratios: how a firm manages its investment and fixed assetsInventory Turnover: Cost of Goods Sold/ Inventory how fast inventory items move through a business. Days’ Sales in Inventory: 365/ days Inventory Turnover average length of time items spent in inventory. Receivables Turnover: Sales/ Accounts Receivable how fast the firm collects on the credit sales. Average Collection Period: 365/ days Receivables Turnover Asset Turnover: Sales / Total Assets high-> efficient management using its investment in total assets to generate sales. Profitability Ratios Profit Margin: Net Income / Sales measures total operating and financial ability of management. Return on Assets (ROA): Net Income / Total Assets return on total assets after recognition of taxes and financing costs. Return on Equity (ROE): Net Income/ Total Equity ROE exceeds ROA reflects the use of financial leverage. Market Value Ratios Earnings Per Share (EPS): Net Income / Shares Outstanding Price-Earnings Ratio (PE): Price Per Share / Earnings Per Share willing to pay per dollar of current earnings. Price-Sales Ratio: Price Per Share / Sales Per Share used when the firm reported negative earnings for the period. Market-to-Book Ratio (MB): Market Value Per Share / Book Value Per Share book value per share: total equity / no. of shares outstanding. less than 1: not successful overall in creating value for its shareholders. Linking Ratios ROA = Profit Margin x Asset Turnover (Net Income / Sales) x (Sales / Total Assets) = (Net income / Total Assets) return on assets related to profitability & turnover. ROE (Du Pont Identity): Profit Margin x Asset Turnover x Equity Multiplier = ROE (Net Income / Sales) x (Sales / Total Assets) x (Total Assets / Total Equity) [operating efficiency, asset use efficiency, and financial leverage]Total equity taken from beginning: Sustainable Growth = Return on Equity x Retention Rate (g = ROE x b) Total equity taken from ending: Assumption: not alter capital structure

Future Value: Vt = V0 (1 + r)t (compounding: interest on interest)Present value & discounting: Longer the time period, the lower the present value. Higher the interest rate, smaller the present valueRule of 72: time it takes to double your money is given approximately by 72 / r.

Future value of cash flow: Present Value of cash flow: Annuity: value of cash flows is the same for a number of years. PV of annuity FV of annuityAnnuity Due = Ordinary Annuity (1+ r) cash flow starts from beginningPresent Value of a Perpetuity = C / r

EAR

APR

NPV: PV of all future cash flows - initial cost C [1r

(1 – 1¿¿

] – I ; -I + C1

1+r+C2

¿¿ year 2010: I year 2011: C1

Positive NPV: worth more than it costs, creates value (Accept). Negative NPV: destroy value (reject).Independent projects, take all positive NPV. Mutually exclusive projects, take highest and positive NPV.Equivalent Annuity (Different lives)

IRR: discount rate that makes the NPV 0 Accept if IRR > required returnNPV of the project decreases as we increase the discount ratediscount rate below the IRR, the NPV of the project is positiveNonconventional: cash flows change signs more than once, there will be more than one IRRMutually exclusive & nonconventional: X IRRCrossover point: NPV(A) = NPV (B)Payback period: length of time it takes to recover the initial investment payback<pre-specified accept1. ignores the time value of money.(use the discounted payback period) 2. It ignores the cash flows after the payback period. 3. The standard for payback period is arbitrary.AAR = Average net income / Average book value AAR > target AAR accept1. not a true rate of return and ignores the time value of money. 2. arbitrary cutoff rate. 3. based on accounting net income and book values, not cash flows and market values. PI measures the benefit per unit cost, based on the time value of money. PI = PV/I Accept PI>1Rank the project’s PI from highest to lowest, select from the top of the list until the capital budget is exhausted. Check if whole budget is exhausted.

Bond: certificate showing that a borrower owes a specified sum. make interest and principal payments on designated dates. (maturity)Pure discount bond (zero coupon): a single payment at a fixed future date. payment at maturity: face value or par value

P= F¿¿

F – P = interest

Corporate bonds offer cash payments not just at maturity, but also at regular times in between.

P =

Semiannual coupons use semiannual discount rate (/2), T x 2 (30 years, 60 semiannual cash flows)Inverse relation between bond price and discount rate. (Not symmetric too)coupon rate = discount rate, price = par value. coupon rate less than discount rate, price less than par value. Consol: bond that never stop paying a coupon, has no final maturity date. (perpetuity) P=C/rYield to maturity (YTM): average rate of return on a bond if it is bought now and held until maturity.common stock: ownership interest in a firm (Vote at company meetings. Collect periodic dividend payments. Sell the share at the owner’s discretion) (Residual claim. Limited liability. Voting rights.)Stock valuationZero growth: dividend is constant Div/rConstant growth:P0 is higher when: expected dividend per share is larger. risk-adjusted discount rate or required rate of return is lower. expected growth rate of dividend is higher. stock price will grow at the same constant rate as the dividend

Non-constant growth

Stock price & growth opportunities