I. Introduction  to  Financial  Management    Finance-­‐  the  study  of  how  individuals  and  business  allocate  money  over  time    Three  (3)  Basic  Questions  Addressed  by  Finance:  1. What  long-­‐term  investment  should  the  firm  undertake?    (CAPITAL  BUDGETING)  2. How  should  the  firm  raise  money  to  fund  these  

investments?  (CAPITAL  STRUCTURE)  3. How  can  the  firm  best  manage  its  cash  flows  as  they  

arise  in  its  day-­‐to-­‐day  operations  (WORKING  CAPITAL  MANAGEMENT)    

Three  (3)  Types  of  Business  Organizations:  1. Sole  Proprietorship—owned  by  single  individual  who  is  

entitled  to  all  of  the  firm’s  profits  and  is  also  responsible  for  all  the  debts.  

2. Partnership—two  or  more  who  come  together  as  co-­‐owners  for  the  purpose  of  operating  a  business  for  profit  

3. Corporation—an  artificial  being  with  legal  functions  separate  and  apart  from  its  owners  (the  shareholders  /  stockholders)    

Four  (4)  Basic  Principles  of  Finance  1. Money  Has  Time  Value  –  a  dollar  received  today  is  

worth  more  than  a  dollar  received  in  the  future  and  vies  versa.  

2. There  is  a  Risk-­‐Return  Tradeoff  –  we  won’t  take  additional  risk  unless  we  expect  to  be  compensated  with  additional  return  

3. Cash  Flows  Are  the  Source  of  Value  –  Profit  Is  an  accounting  concept  designed  to  measure  a  business’s  performance  over  an  interval  of  time.  Cash  flow  is  the  amount  of  cash  that  can  actually  be  taken  out  of  the  business  over  this  same  interval.  

4. Market  Price  Reflect  Information  –  Investors  respond  to  new  information  by  buying  and  selling  their  investment.  The  speed  with  which  investors  act  and  the  way  that  prices  respond  to  the  information  determines  the  efficiency  of  the  market.  

 II. Stocks  

Security—is  a  negotiable  instrument  that  represents  a  financial  claim  (stocks  or  debt  agreements)    Two  (2)  Types  of  Security  Markets:  

1. Primary  Market  –  market  that  is  new  as  opposed  to  previously  issued,  securities  are  bought  and  sold  for  the  first  time  

2. Secondary  Market  –  all  subsequent  trading  of  previously  issued  securities  takes  place.  

 How  Security  Markets  Link  Corporations  and  Investors:  

a)  The  firm  sells  securities  to  investors  (a  primary  market  transaction  of  debt  or  equity  of  the  corporation)    

b) The  firm  invests  the  funds  raised  from  transaction  into  businesses  

c) The  firm  distributes  the  cash  earned  from  its  investments  (investors  gain  cash  through  cash  dividends  or  repurchase  of  shares  of  previously  issued  stock)  

d) Securities  trading  in  the  secondary  market  (after  (a)  investors  may  resell  debt  or  equity  purchased  from  corporation)    

Two  (2)  Types  of  Securities:  1. Debt  Securities  –  a  firm  borrows  money  by  selling  

debt  securities  in  the  debt  market.  a. Bonds—a  long  term  (10  yrs.  or  more)  

promissory  note  issued  by  the  borrower,  promising  to  pay  the  owner  of  the  security  a  predetermined  amount  of  interest  each  year    

2. Equity  Securities  –  represents  ownership  of  the  corporation  

a. Common  Stock  –  represents  residual  ownership  of  firm.  Usually  entitles  the  owner  to  vote  at  shareholder’s  meetings  and  to  receive  dividends.    

b. Preferred  Stock–  holds  preference  over  common  stock  in  terms  of  the  right  to  the  distribution  of  cash  (dividends)  and  the  right  to  the  distribution  of  proceeds  in  the  event  of  the  liquidation  and  sale  of  the  issuing  firm.  Generally  does  not  have  voting  rights,  but  has  a  higher  claim  on  assets  and  earnings  than  the  common  shares.  

Stock  Valuation  —The  more  people  that  want  to  buy  stock,  the  higher  its  price  will  be.    

𝑃𝑟𝑖𝑐𝑒/  𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠  𝑅𝑎𝑡𝑖𝑜   =𝑀𝑎𝑟𝑘𝑒𝑡  𝑃𝑟𝑖𝑐𝑒  𝑝𝑒𝑟  𝑆ℎ𝑎𝑟𝑒𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠    𝑃𝑟𝑖𝑐𝑒  𝑝𝑒𝑟  𝑆ℎ𝑎𝑟𝑒

 

 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠  𝑝𝑒𝑟  𝑆ℎ𝑎𝑟𝑒  

=𝑁𝑒𝑡  𝐼𝑛𝑐𝑜𝑚𝑒 − 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠  𝑜𝑛  𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑  𝑆𝑡𝑜𝑐𝑘

𝐴𝑣𝑒𝑟𝑎𝑔𝑒  𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔  𝑆ℎ𝑎𝑟𝑒𝑠  

 III. Financial  Ratios  (Analysis,  etc)  

A. Liquidity  Ratio  –  Measures  of  the  ability  of  the  firm  to  pay  its  bills  in  a  timely  manner  when  they  come  due  

𝐶𝑢𝑟𝑟𝑒𝑛𝑡  𝑅𝑎𝑡𝑖𝑜 =𝐶𝑢𝑟𝑟𝑒𝑛𝑡  𝐴𝑠𝑠𝑒𝑡𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡  𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠  

   

𝐴𝑐𝑖𝑑  𝑇𝑒𝑠𝑡  𝑅𝑎𝑡𝑖𝑜 =𝐶𝑢𝑟𝑟𝑒𝑛𝑡  𝐴𝑠𝑠𝑒𝑡𝑠   − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡  𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠  

   

𝐴𝑣𝑒𝑟𝑎𝑔𝑒  𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛  𝑃𝑒𝑟𝑖𝑜𝑑

=𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠  𝑅𝑒𝑐𝑖𝑒𝑣𝑎𝑏𝑙𝑒

𝐴𝑛𝑛𝑢𝑎𝑙  𝐶𝑟𝑒𝑑𝑖𝑡  𝑆𝑎𝑙𝑒365  𝑑𝑎𝑦𝑠

 

 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠  𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒  𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟  𝑅𝑎𝑡𝑖𝑜  

=𝐴𝑛𝑛𝑢𝑎𝑙  𝐶𝑟𝑒𝑑𝑖𝑡  𝑆𝑎𝑙𝑒𝑠𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠  𝑅𝑒𝑐𝑖𝑒𝑣𝑎𝑏𝑙𝑒

 

 

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦  𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟  𝑅𝑎𝑡𝑖𝑜   =𝐶𝑜𝑠𝑡  𝑜𝑓  𝐺𝑜𝑜𝑑  𝑆𝑜𝑙𝑑

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠  

 B. Capital  Structure  Ratio  –  The  mix  of  debts  and  equity  

securities  a  firm  uses  to  finance  its  assets    

𝐷𝑒𝑏𝑡  𝑅𝑎𝑡𝑖𝑜   =𝑇𝑜𝑡𝑎𝑙  𝐷𝑒𝑏𝑡𝑇𝑜𝑡𝑎𝑙  𝐴𝑠𝑠𝑒𝑡𝑠

 

   

𝑇𝑖𝑚𝑒𝑠  𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡  𝐸𝑎𝑟𝑛𝑒𝑑   =𝑁𝑒𝑡  𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔  𝐼𝑛𝑐𝑜𝑚𝑒/𝐸𝐵𝐼𝑇

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡  𝐸𝑥𝑝𝑒𝑛𝑠𝑒  

 C. Assets  Management  Efficiency  Ratios  –  Measures  how  

well  assets  are  managed  to  generate  sales    

𝑇𝑜𝑡𝑎𝑙  𝐴𝑠𝑠𝑒𝑡  𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟   =𝑆𝑎𝑙𝑒

𝑇𝑜𝑡𝑎𝑙  𝐴𝑠𝑠𝑒𝑡𝑠  

 

𝐹𝑖𝑥𝑒𝑑  𝐴𝑠𝑠𝑒𝑡  𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟   =𝑆𝑎𝑙𝑒

𝑁𝑒𝑡  𝑃𝑙𝑎𝑛𝑡  𝑎𝑛𝑑  𝐸𝑞𝑢𝑖𝑝𝑚𝑒𝑛𝑡  

 D. Profitability  Ratio  –  Answer  the  question  “has  the  firm  

earned  adequate  returns  on  its  investments?”    

𝐺𝑟𝑜𝑠𝑠  𝑃𝑟𝑜𝑓𝑖𝑡  𝑀𝑎𝑟𝑔𝑖𝑛   =𝐺𝑟𝑜𝑠𝑠  𝑃𝑟𝑜𝑓𝑖𝑡

𝑆𝑎𝑙𝑒𝑠  

 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔  𝑃𝑟𝑜𝑓𝑖𝑡  𝑀𝑎𝑟𝑔𝑖𝑛  

=𝑁𝑒𝑡  𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔  𝐼𝑛𝑐𝑜𝑚𝑒/𝐸𝐵𝐼𝑇

𝑆𝑎𝑙𝑒𝑠  

 

𝑁𝑒𝑡  𝑃𝑟𝑜𝑓𝑖𝑡  𝑀𝑎𝑟𝑔𝑖𝑛   =𝑁𝑒𝑡  𝐼𝑛𝑐𝑜𝑚𝑒

𝑆𝑎𝑙𝑒𝑠  

 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔  𝑅𝑒𝑡𝑢𝑟𝑛  𝑜𝑛  𝐴𝑠𝑠𝑒𝑡𝑠  

=𝑁𝑒𝑡  𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔  𝐼𝑛𝑐𝑜𝑚𝑒/𝐸𝐵𝐼𝑇

𝑇𝑜𝑡𝑎𝑙  𝐴𝑠𝑠𝑒𝑡𝑠  

 

𝑅𝑒𝑡𝑢𝑟𝑛  𝑜𝑛  𝐸𝑞𝑢𝑖𝑡𝑦   =𝑁𝑒𝑡  𝐼𝑛𝑐𝑜𝑚𝑒

𝐶𝑜𝑚𝑚𝑜𝑛  𝐸𝑞𝑢𝑖𝑡𝑦  

 E. Market  Value  Ratio  –  Answers  the  question  “how  are  

the  firm’s  shares  valued  in  the  stock  market?”    𝑃𝑟𝑖𝑐𝑒/  𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠  𝑅𝑎𝑡𝑖𝑜  

=𝑀𝑎𝑟𝑘𝑒𝑡  𝑃𝑟𝑖𝑐𝑒  𝑝𝑒𝑟  𝑆ℎ𝑎𝑟𝑒𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠    𝑃𝑟𝑖𝑐𝑒  𝑝𝑒𝑟  𝑆ℎ𝑎𝑟𝑒

 

 

𝑀𝑎𝑟𝑘𝑒𝑡  𝑡𝑜  𝐵𝑜𝑜𝑘  𝑅𝑎𝑡𝑖𝑜   =𝑀𝑎𝑟𝑘𝑒𝑡  𝑃𝑟�𝑐𝑒  𝑝𝑒𝑟  𝑆ℎ𝑎𝑟𝑒𝐵𝑜𝑜𝑘  𝑉𝑎𝑙𝑢𝑒  𝑝𝑒𝑟  𝑆ℎ𝑎𝑟𝑒

 

FINANCIAL  ANALYSIS  Questions:   Category  of  Ration  Used  to  

Address  the  Questions  

1. How  liquid  is  the  firm?  Will  it  be  able  to  pay  its  bills  as  they  come  due?  

Liquidity  Ratio  

2. How  has  the  firm  finance  the  purchase  of  its  assets?  

Capital  Structure  Ratio  

3. How  efficient  has  the  firm’s  management  been  in  utilizing  its  assets  to  generate  sales?  

Asset  Management  Efficiency  Ratios  

4. Has  the  firm  earned  adequate  returns  on  its  investments?  

Profitability  Ratio  

5. Are  the  firm’s  managers  creating  value  for  shareholders?  

Market  Value  Ratio  

 IV. Quick  Ratio  

Since  Current  ratio  assumes  that  firms  account  receivables  will  be  collected  and  turned  into  cash  on  a  timely  basis  and  inventories  can  be  sold  without  delay,  QUICK  RATIO  takes  into  account  that  inventories  might  not  be  very  liquid.      

𝑄𝑢𝑖𝑐𝑘  (𝐴𝑐𝑖𝑑  𝑇𝑒𝑠𝑡)  𝑅𝑎𝑡𝑖𝑜

=𝐶𝑢𝑟𝑟𝑒𝑛𝑡  𝐴𝑠𝑠𝑒𝑡𝑠   − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡  𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠  

V. Cash  outflows    

STATEMENT  OF  CASH  FLOW  Ending  cash  balance  of  2009  (beginning  balance  of  2010  

    $94.50  

A)  Operating  Activities        Net  Income   $204.75      

Increase  in  accounts  receivables   (22.50)      Increase  in  inventories   (148.50)      No  change  in  other  current  assets  

-­‐      

Depreciation  expense   135.00      Increase  in  Accounts  Payable   4.50      No  Change  in  accrued  expenses   -­‐      

Cash  Flow  From  Operating  Activities  

  $173/25    

B)  Investing  activities  Purchase  of  plant  and  equipment   (175.50)      Cash  Flow  from  Investing  Activates  

  (175.50)    

C)  Financing  Activities  Increase  in  short-­‐term  notes   (9.00)      Increase  in  long-­‐term  notes   51.75      Cash  Dividends  paid  to  share  holders  

($45.00)      

Cash  Flow  from  Financing  Activities  

  ($2.25)    

       Increase  (decrease)  in  cash  during       ($4.50)  

the  year  End  Cash  Balance  for  2010       $90.00  

   

VI. Financial  Statements  Four  (4)  basic  financial  statements  and  basic  information  for  each  i. Income  Statement  –  includes  the  revenue,  expense,  

and  profit  made  by  the  firm  over  a  specific  period  of  time  

ii. Balance  Sheet  –  is  a  snapshot  of  the  firms  assets,  liabilities,  and  owner’s  equity  for  a  particular  date  

iii. Cash  Flow  Statement  –  cash  received  and  spent  over  a  specific  period  of  time.  § Operating  Activities  –  includes  sales  and  

expenses  (cash  activity  that  affects  net  income)  § Investment  Activities  –  includes  cash  flow  that  

arise  out  of  the  purchase  and  sale  of  long-­‐term  assets  such  as  plant  and  equipment  

§ Financing  Activities  –  represents  changes  in  debts  and  equity.  It  includes  the  sale  of  new  shares  of  stock,  the  repurchase  of  outstanding  shares,  and  the  payment  of  dividends  

iv. Statement  of  Shareholder’s  Equity  –  provides  detailed  accounts  on  firm’s  activities  such  as:  § Common  and  Preferred  stock  accounts  § Retained  earning  accounts  § Changes  in  owner’s  equity  that  do  not  appear  in  

the  income  statement  Three  (3)  uses  of  financial  statements  in  management  

1) Financial  Statement  Analysis  –  asses  current  performance  

2) Financial  Control  –  monitor  and  control  operations  using  accounting  measures  

3) Financial  Forecasting  or  Planning  –  financial  statements  are  universally  understood  format  for  describing  operations  and  is  used  as  a  prototype  for  financial  planning  models  

VII. Dividends  Dividends—a  portion  of  corporation’s  earnings  that  are  distributed  to  its  shareholders    𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠  𝑝𝑒𝑟  𝑆ℎ𝑎𝑟𝑒

=  𝑇𝑜𝑡𝑎𝑙  𝐶𝑜𝑚𝑚𝑜𝑛  𝑆𝑡𝑜𝑐𝑘  𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠

𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔  𝑆ℎ𝑎𝑟𝑒  

 VIII. ROA,  ROE  

 

𝑅𝑒𝑡𝑢𝑟𝑛  𝑜𝑛  𝐸𝑞𝑢𝑖𝑡𝑦   =𝑁𝑒𝑡  𝐼𝑛𝑐𝑜𝑚𝑒

𝐶𝑜𝑚𝑚𝑜𝑛  𝐸𝑞𝑢𝑖𝑡𝑦  

 

𝑅𝑒𝑡𝑢𝑟𝑛  𝑜𝑛  𝐴𝑠𝑠𝑒𝑡𝑠   =𝐴𝑣𝑒𝑟𝑎𝑔𝑒  𝑁𝑒𝑡  𝐼𝑛𝑐𝑜𝑚𝑒𝐴𝑣𝑒𝑟𝑎𝑔𝑒  𝑇𝑜𝑡𝑎𝑙  𝐴𝑠𝑠𝑒𝑡𝑠

 

 

IX. Time  Value  of  Money    A  dollar  received  today,  other  things  being  the  same,  is  worth  more  than  a  dollar  received  years  from  now.      

X. EAR  Effective  Annual  Rate—indicates  the  interest  rate  paid  or  earned  in  one  year  without  compounding      

𝐸𝐴𝑅 = 1 +𝑄𝑢𝑜𝑡𝑒𝑑  𝐴𝑛𝑛𝑢𝑎𝑙  𝑅𝑎𝑡𝑒

𝐶𝑜𝑚𝑝𝑖𝑛𝑑𝑖𝑛𝑔  𝑃𝑒𝑟𝑖𝑜𝑑  𝑝𝑒𝑟  𝑌𝑒𝑎𝑟  (𝑚)

!

− 1  

 XI. Future  value  of  ordinary  annuity  

Ordinary  Annuity  –  payments  are  made  at  the  end  of  each  month.  

𝑭𝑽𝒏 = 𝑷𝑽 𝟏 + 𝒊 𝒏    

XII. Annuity  vs  Perpetuity  a) Annuity  is  defined  as  a  series  of  equal    dollar  or  peso  

payments  that  are  made  at  the  end  of  equidistant  points  in  time  such  as  monthly,  quarterly,  annually  over  a  finite  period  of  time  such  as  three  years  while    

b) Perpetuity  is  simply  an  annuity  that  continues  forever  or  has  no  maturity.  

 XIII. Present  value  of  cash  flows  

𝑷𝑽 = 𝑭𝑽𝒏𝟏

(𝟏 + 𝒊)𝒏  

     

𝑭𝑽𝒏 = 𝑷𝑽 𝟏 + 𝒊 𝒎𝒎𝒏    

Intraperiod  Compounding  –  compounding  that  occurs  more  than  once  a  year.    

XIV. Bonds  An  obligation  made  binding  by  a  money  forfeit;  also:  the  amount  of  money  guarantee    

Bond  Value = i1 − 1

1 + YTM!"#$%&!

YTM!"#$%&

+ Principal1

1 + YTM!"#$%&!  

 BASIC  FEATURES:  1. Bond  Indenture—is  the  legal  agreement  between  

the  firm  issuing  the  bonds  and  the  trustee  who  represents  the  bond  holders  

2. Claims  on  Assets  &  Income—If  the  borrowing  firm  is  unable  to  repay  the  debt,  the  claims  of  the  debt  holder  must  be  honored  before  thos  of  the  firm’s  stockholders  

a. If  interest  on  bond  is  not  paid,  bond  trustees  can  classify  the  firm  as  insolvent  and  force  it  into  bankrupcy  

3. Par  or  Face  Value—an  amount  that  must  be  repaid  to  the  bondholder  at  maturity  

4. Coupon  Interest  Rate—idicates  the  percentage  of  the  par  value  bond  that  will  be  paid  out  annually  in  the  form  of  interest  

5. Maturity  and  Repayment  of  Principal—indicates  the  length  of  time  until  bond  issuer  returns  he  par  value  to  the  bondholder  and  terminates  or  redeems  the  bond  

6. Call  Provision  and  Conversion  Features-­‐-­‐      is  most  valueable  when  the  bond  is  sold  during  a  period  of  abnormally  high  rate  of  interest,    such  that  there  is  reasonable  expectation  that  rates  will  fall  in  the  future  before  bond  matures.  

a. Conversion  Features-­‐-­‐    allos  the  bondholders  to  convert  the  bond  into  a  prescribed  number  of  shares  of  the  firm’s  common  stock    

TYPES  OF  BONDS  1. Secure  vs  Unsecured  

a. Secured   bond   has   specific   assets   pledged   to  support  repayment  of  the  bond.  

b. Unsecured   bond   applies   debenture   (any   form  of  unsecured  long-­‐term  debt).  

2. Priority  of  Claims  –  refers  to  the  place  in  line  where  the  bondholders  stand  in  securing  re-­‐payment  out  of  the  dissolution  of  the  firm’s  assets.  

3. Initial  offering  market  –  bonds  are  also  classified  by  where   they   were   originally   issued   (in   the   domestic  bond  market  or  elsewhere.  

4. Abnormal   Risk   –   Junk,   or   high-­‐yield,   bonds   have   a  below-­‐investment   grade   bonding   rating   (facing  severe   financial   problems   and   suffering   from   poor  credit  ratings)  

5. Coupon   level   –   bonds   with   a   zero   or   very   low  coupon  are  called  zero  coupon  bonds  

6. Amortizing  or  Non-­‐Amortizing  a. Amortizing  bonds,   like   a  home  mortgage   loan,  

include   both   the   interest   and   a   portion   of   the  principal.  

b. Non-­‐amortizing  bond,  only  include  interest.  7. Convertibility   –   Convertible   bonds   are   debt  

securities  that  can  be  converted  into  a  firm’s  stock  at  a  pre-­‐specified  price  

 CURRENT  YIELD  Refers  to  the  ratio  of  the  annual  interest  payment  to  the  bond’s  current  market  price.  

   

CY =Annual  Interest  Payment

Current  Market  Price  of  Bond  

   

XV. Bond's  yield  to  maturity  

Bond  Price =𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡!"#$  !

(1 + 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡  𝑟𝑎𝑡𝑒)!  

+𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡!"#$  !

(1 + 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡  𝑟𝑎𝑡𝑒)!  +⋯

+𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡!"#$  !

1 + 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡  𝑟𝑎𝑡𝑒 !  

+𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙

(1 + 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡  𝑟𝑎𝑡𝑒)!    

 XVI. Book  value  per  share  

 

Book  Value  per  Share =Common  Shareholders!  EquityCommon  Share  Outstanding

 

 XVII. Preferred  vs  Common  stock  

Common  Stock—entitles  the  owner  to  vote  at  shareholder’s  meetings  and  to  receive  dividends.  

a) Has  no  maturity  date  b) Life  is  limited  only  to  the  life  of  the  issuing  firm.    c) Common   dividends   have   no   maximum   or  

minimums  d) Valuation   differs   from   the   the   valuation   of  

preferred   stock   since   common   stock   has   no  promised  dividends.  

Preferred  stock  –  generally  does  not  have  voting  rights,  but  has  a  higher  claim  on  assets  and  earnings  than  the  common  shares.    

XVIII. Annual  Rate  of  Return  Rate  of  Return—Also  known  as  holding  period  return  is  simply  the  cash  return  divided  by  the  beginning  stock  price  

 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑  𝑅𝑎𝑡𝑒  𝑜𝑓  𝑅𝑒𝑡𝑢𝑟𝑛

= 𝑅𝑎𝑡𝑒  𝑜𝑓  𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦!+ 𝑅𝑎𝑡𝑒  𝑜𝑓  𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦! +⋯+ 𝑅𝑎𝑡𝑒  𝑜𝑓  𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦!  

 XIX. Risk  &  Return  

 Cash  Return  –  The  gain  or  loss  on  an  investment      𝐶𝑎𝑠ℎ  𝑅𝑒𝑡𝑢𝑟𝑛 =𝐸𝑛𝑑  𝑃𝑟𝑖𝑐𝑒 + 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 − 𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔  𝑃𝑟𝑖𝑐𝑒    Break  Even  Point    

𝐵𝐸𝑃  𝑖𝑛  𝑢𝑛𝑖𝑡𝑠 =𝐹𝑖𝑥𝑒𝑑  𝐶𝑜𝑠𝑡

1 − 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒  𝐶𝑜𝑠𝑡  𝑝𝑒𝑟  𝑈𝑛𝑖𝑡𝑆𝑒𝑙𝑙𝑖𝑛𝑔  𝑃𝑟𝑖𝑐𝑒  𝑝𝑒𝑟  𝑈𝑛𝑖𝑡

 

 Standard  Deviation  𝜎 = ([𝑟! − 𝐸 𝑟 ]!×𝑃𝑏!) +⋯+ ([𝑟! − 𝐸 𝑟 ]!×𝑃𝑏!)    Variance  𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = 𝜎!    

XX. Payback  period      

XXI. Capital  Budgeting  Typical  Capital  Budgeting  Process:  

a) The  firm’s  management  identifies  promising  investment  opportunities  

b) Once  an  investment  opportunity  has  been  identifies,  its  value-­‐creating  potential,  what  some  refer  to  as  its  “value  position”  is  thoroughly  evaluated  

Types  of  Capital  Investment  Project:  a) Revenue  enhancement  investment  projects  b) Cost-­‐reduction  investment  projects  c) Mandatory  investments  that  are  a  result  of  

government  mandates  Net  Present  Value  Criterion:  is  an  estimate  of  the  impact  of  the  investment  opportunity  on  the  value  of  the  firm    

XXII. NPV  Net  Present  Value—It  compares  the  cost  of  investment  to  the  present  value  of  the  investment’s  inflows  and  outflow  as  time  passes.        

   

OR    

   

A)  Independent  investment  project  is  one  that  stands  alone  and  can  be  undertaken  without  influencing  the  acceptance  or  rejection  of  any  other  project.      Choosing  Between  Mutually  Independent  Investment:  

1. Calculate  NPV;  2. Accept  the  project  if  NPV  is  positive  and  reject  if  it  

is  negative.    

   B)  Exclusive  investment  project  is  one  that  does  not  stand  alone  and  can  influencing  the  acceptance  or  rejection  of  any  other  project  when  undertaken.    i. If  mutually  exclusive  investments  have  equal  lives,  we  

simply  calculate  the  NPVs  and  choose  the  one  with  the  higher/highest  NPV.  EXAMPLE:  all  alternatives  last  for  10  years    

ii. If  mutually  exclusive  investments  do  not  have  equal  lives,  we  calculate  the  Equivalent  Annual  Cost  (EAC),  the  cost  per  year;  then  select  the  one  that  has  the  lower/lowest  EAC.  EXAMPLE:  one  alternative  last  for  10  years  while  the  other  only  last  for  6  years    

Choosing  between  Mutually  Exclusive  Investment:  1.  Compute  NPV  2.  Compute  EAC  as  per  equation  11-­‐2  

 

𝐸𝐴𝐶 =𝑃𝑉  𝑜𝑓  𝐶𝑜𝑠𝑡𝑠

(1 + 𝑘)! + (1 + 𝑘)! +⋯+ (1 + 𝑘)!  

 XXIII. Cost  of  Capital  

Cost  of  capital  is  the  weighted  average  of  the  required  returns  of  the  securities  that  are  used  to  finance  the  firm  

𝑊𝐴𝐶𝐶 = 𝑘!× 1 − 𝑇 ×𝑤! + (𝑘!"×𝑤!")    WACC—weighted  average  cost  of  capital  kd—after  tax  cost  of  debt  wd—proportion  of  capital  raised  by  debt    kcs—cost  of  common  stock  wcs—proportion  of  capital  raised  by  common  stock  T  –  tax  rate    

XXIV. Dividend  policy  (Ex  dividend  date)    

XXV. Retained  Earnings    

A  portion  of  net  income  that  has  been  retained  from  the  prior  years’  operation  

 𝑅𝐸 = 𝐵𝑒𝑔.𝑅𝐸 + 𝑁𝑒𝑡  𝐼𝑛𝑐𝑜𝑚𝑒 − 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠  

                                         

NPV =CF0 +CF1(1+ k)1

+CF2(1+ k)2

+.....+ CFn(1+ k)n

NPV =CF0 +CF1(1+ k)1

+CF2(1+ k)2

+.....+ CFn(1+ k)n

MOST  USED  FORMULAS  IN  THE  FINALS:  (That  I  remember)    

𝑃𝑉 = 𝐹𝑉!1

(1 + 𝑖)!  

 𝐹𝑉! = 𝑃𝑉 1 + 𝑖 𝑚

!"  

 𝐹𝑉! = 𝑃𝑉 1 + 𝑖 !  

 

𝑅𝑒𝑡𝑢𝑟𝑛  𝑜𝑛  𝐸𝑞𝑢𝑖𝑡𝑦   =𝑁𝑒𝑡  𝐼𝑛𝑐𝑜𝑚𝑒

𝐶𝑜𝑚𝑚𝑜𝑛  𝐸𝑞𝑢𝑖𝑡𝑦  

𝑅𝑒𝑡𝑢𝑟𝑛  𝑜𝑛  𝐴𝑠𝑠𝑒𝑡𝑠   =𝐴𝑣𝑒𝑟𝑎𝑔𝑒  𝑁𝑒𝑡  𝐼𝑛𝑐𝑜𝑚𝑒𝐴𝑣𝑒𝑟𝑎𝑔𝑒  𝑇𝑜𝑡𝑎𝑙  𝐴𝑠𝑠𝑒𝑡𝑠

 

 

   

𝑁𝑃𝑉 = 𝐶𝐹! +𝐶𝐹!

1 + 𝐼𝑅𝑅 ! = 0  

   

𝐼𝑅𝑅 =  𝐶𝐹!−𝐶𝐹!

!   − 1  

 

𝐸𝐴𝐶 =𝑃𝑉  𝑜𝑓  𝐶𝑜𝑠𝑡𝑠

(1 + 𝑘)! + (1 + 𝑘)! +⋯+ (1 + 𝑘)!  

 𝑄𝑢𝑖𝑐𝑘  (𝐴𝑐𝑖𝑑  𝑇𝑒𝑠𝑡)  𝑅𝑎𝑡𝑖𝑜

=𝐶𝑢𝑟𝑟𝑒𝑛𝑡  𝐴𝑠𝑠𝑒𝑡𝑠   − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡  𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠  

𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑  𝑅𝑎𝑡𝑒  𝑜𝑓  𝑅𝑒𝑡𝑢𝑟𝑛= 𝑅𝑎𝑡𝑒  𝑜𝑓  𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦!+ 𝑅𝑎𝑡𝑒  𝑜𝑓  𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦!+⋯+ 𝑅𝑎𝑡𝑒  𝑜𝑓  𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦!  

 𝑊𝐴𝐶𝐶 = 𝑘!× 1 − 𝑇 ×𝑤! + (𝑘!"×𝑤!")  

 

Book  Value  per  Share =Common  Shareholders!  EquityCommon  Share  Outstanding

 

 

Bond  Value = i1 − 1

1 + YTM!"#$%&!

YTM!"#$%&

+ Principal1

1 + YTM!"#$%&!  

 𝑅𝐸 = 𝐵𝑒𝑔.𝑅𝐸 + 𝑁𝑒𝑡  𝐼𝑛𝑐𝑜𝑚𝑒 − 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠  

NPV =CF0 +CF1(1+ k)1

+CF2(1+ k)2

+.....+ CFn(1+ k)n