Gross Profit

Gross Profit = Revenue - Cost of Goods Sold

Gross Profit Margin

Gross Profit Margin = Gross Profit / Revenue

Operating Profit (EBIT)

Operating Profit (EBIT) = Gross Profit - SG&A

Operating Profit Margin

Operating Profit Margin = Operating Profit (EBIT) / Revenue

Effective Tax Rate

Effective Tax Rate = Income Taxes / Earnings Before Tax

Net Income Margin

Net Income Margin = Net Income / Revenue

EBITDA

EBITDA = EBIT + D&A

EBITDA Margin

EBITDA Margin = EBITDA / Revenue

LIFO vs. FIFO in an inflationary environment

FIFO results in lower COGS, higher gross profit and more taxes

PIK Interest - Impact in Income Statement

PIK interest is treated as interest expense on the Income Statement

PIK Interest - Tax consequences for recipient

PIK interest is taxed as ordinary income to the recipient when accrued

Adjusting Net Income for a one-time pre-tax expense

When adjusting Net Income for a one-time, pre-tax charge, Net Income will increase by (amount of expense) x (1 - tax rate)

Adjusting Net Income for a one-time, net, charge

When adjusting Net Income for a one-time, net charge, Net Income will increase by the amount of the charge

Adjusting EBIT or EBITDA for a one-time, pre-tax charge

When adjusting EBIT or EBITDA for a one-time, pre-tax charge, EBIT or EBITDA will increase by the amount of the charge

Adjusting EBIT or EBITDA for a one-time, net charge

When adjusting EBIT or EBITDA for a one-time, net charge, EBIT or EBITDA will increase by (amount of the charge) / (1 - tax rate)

Calculation of net new shares issued under Treasury Stock Method

New Shares Issued = (Stock Price - Strike Price) / Stock Price x Number of Options

P/E Ratio

P/E = Stock Price / Earnings Per Share OR Equity Value / Net Income

Equity Value (Using P/E)

Equity Value = Net Income x P/E Ratio

PEG Ratio

PEG Ratio = (P/E Ratio) / Expected Earnings Growth

Best Value using PEG Ratio

Best Value using the PEG Ratio is the company with the LOWEST ratio

Dividend Payout Ratio

Dividend Payout Ratio = Annual Dividend / BASIC EPS

Earnings Retention Ratio

Earnings Retention Ratio = 1 - Dividend Payout Ratio

Book Value of Equity

Book Value of Equity = Shareholders’ Equity = Assets - Liabilities

Price/Book Value

Price/Book Value = Stock Price / Book Value

Application of Price/Book Value

P/B multiple is most often applied for financial services companies, such as banks, broker dealers and insurance companies.

Enterprise Value using Total Debt

EV = Equity Value + Total Debt + Preferred Stock + Noncontrolling Interest - Cash

Net Debt

Net Debt = Total Debt - Cash

Enterprise Value using Net Debt

EV = Equity Value + Net Debt + Preferred Stock + Noncontrolling Interest

Earnings Yield

Earnings Yield = Earnings Per Share / Stock Price OR 1 / PE Ratio

Goodwill

Created when an asset is purchased for a price in excess of either its market value (for a public company) or book value (for a private company)

Causes an increase in goodwill

Goodwill increases when the purchase price increases

Causes a decrease in goodwill

Goodwill decreases when the value of the asset increases

Source or use of cash? Increase in accounts receivable

Use of cash

Source or use of cash? Decrease in accounts payable

Use of cash

Source or use of cash? Decrease in accrued liabilities

Use of cash

Source or use of cash? Decrease in inventories

Source of cash

Source or use of cash? Deterioration in net working capital

Source of cash

Source or use of cash? Increase in prepaid expenses

Use of cash

Source or use of cash? Decrease in accounts receivable

Source of cash

Source or use of cash? Increase in accounts payable

Source of cash

Source or use of cash? Increase in accrued liabilities

Source of cash

Source or use of cash? Increase in inventories

Use of cash

Source or use of cash? Improvement in net working capital

Use of cash

Source or use of cash? Decrease in prepaid expenses

Source of cash

Deferred tax asset or liability? Acceleration of an expense for account purposes

Deferred tax asset

Deferred tax asset or liability? Acceleration of an expense for tax purposes

Deferred tax liability

Deferred tax asset or liability? Acceleration of revenue for accounting purposes

Deferred tax liability

Deferred tax asset or liability? Acceleration of revenue for tax purposes

Deferred tax asset

Calculation of Treasury Stock

Treasury Stock = Common Stock - Shareholders’ Equity

Calculation of Capital Surplus (Additional Paid-in Capital)

Money raised in excess of par value (i.e. Offer price - par value)

Impact to Balance Sheet when a company repurchases stock

Shareholders’ equity falls by the acquisition price of the shares

Impact to Balance Sheet when a company declares a dividend

Dividends Payable increases, Retained Earnings decreases

Impact to Balance Sheet when a company pays a dividend

Dividends Payable decreases, Cash decreases

Impact to Balance Sheet when a company issues stock

Cash increases, Par Value & Capital surplus both increase

Calculation of ending Retained Earnings

Ending Retained Earnings = Beginning Retained Earnings + Net Income - Dividends

Calculation of ending Shareholders’ Equity

Ending Shareholders’ Equity = Beginning SE + Net Income - Dividends (same calc as Retained Earnings)

Calculation of Enterprise Value using Sales

Enterprise Value = Sales x (EV/Sales multiple)

Calculation of Enterprise Value using EBIT

Enterprise Value = EBIT x (EV/EBIT multiple)

Calculation of Enterprise Value using EBITDA

Enterprise Value = EBITDA x (EV/EBITDA multiple)

Interest Coverage Ratio

Interest Coverage Ratio = EBITDA / Interest Expense

Invested Capital

Invested Capital = Avg Shareholders’ Equity + Avg Net Debt

EBIAT (Earnings Before Interest After Tax)

EBIAT = EBIT - Taxes at Marginal Rate

Return on Assets (ROA)

Return on Assets = Net Income / Avg Total Assets

Return on Equity (ROE)

Return on Equity = Net Income / Avg Shareholders’ Equity

Return on Invested Capital (ROIC)

ROIC = EBIT / Invested Capital OR EBITDA / Invested Capital

Return on Capital (ROC)

ROC = Net Income / Invested Capital

Calculation of Operating Cash Flows

Operating Cash Flow = Net Income + D&A - Increase in Net Working Capital

Calculation of Change in Net Working Capital

Change in NWC = Increase in Current Assets - Increase in Current Liabilities

Accounts Receivable Turnover

A/R Turns = Sales / Accounts Receivable

Days Sales Outstanding (DSO)

DSO = (A/R) / Sales x 365 OR 365 / (A/R Turns)

Inventory Turnover

Inventory Turns = COGS / Inventory

Days Inventory Held (DIH)

DIH = Inventory / COGS x 365 OR 365 / Inventory Turns

Accounts Payable Turnover

A/P Turns = COGS / Accounts Payable

Days Payable Outstanding (DPO)

DPO = (A/P) / COGS x 365 OR 365 / (A/P Turns)

Current Ratio

Current Ratio= Current Assets / Current Liabilities

Acid Test Ratio / Quick Ratio

Quick Ratio = (Current Assets - Inventories) / Current Liabilities

Calculation of Shares Outstanding after a Public Offering

Pro Forma Outstanding Shares = Previous Shares + Primary Shares Issued (do not count secondary shares)

Calculation of Offer Price per Share

Implied Equity Value / Pro Forma Outstanding Shares

Equity Value (using Enterprise Value)

Equity Value = Enterprise Value - Total Debt - Preferred Stock - Noncontrolling Interest + Cash

Weighted Average Cost of Capital (WACC)

WACC = (after-tax cost of debt x % of debt) + (cost of equity x % of equity)

After-tax Cost of Debt

After-tax Cost of Debt = Current Yield x (1 - tax rate)

Current Yield of a Bond (CY)

CY = Annual Interest / Market Price

Cost of Equity (using CAPM)

Cost of Equity (CAPM) = risk-free rate + (beta x market risk premium)

Market Risk Premium (MRP)

MRP = S&P 500 Expected Return - risk-free rate

Unlevered Free Cash Flow (FCF)

Unlevered FCF = EBIT - Adjusted Taxes + D&A - Capex + Decrease in NWC

Two methods of calculating Terminal Value under DCF

Exit Multiple Method and Perpetuity Growth Method

Common Valuation Methodology for Financial Services Companies

Price / Book Value

For Company Acquisition, Adjusted EBITDA multiple (accounting for synergies)

Effective EBITDA multiple = (Purchase Multiple x EBITDA) / (EBITDA + Pre-Tax Synergies)

net annual sales/average receivables = _______

**Account receivables turnover**

This ratio aids in analyzing the liquidity of the accounts receivable by showing how often they turn over.

A firm has just issued 6%, 10-year coupon bonds, which are trading at $950. The firm is in the 30% tax bracket. Its after-tax cost of debt equals ________.

After-tax cost of debt is calculated as the current yield of a bond tax effected (keep in mind the interest is tax-deductible).

Current Yield = Annual Interest/ Market Price

Current Yield = $60/ $950 = 6.3%

After-tax cost of debt = Current Yield x (1 - tax rate)

After-tax cost of debt = 6.3% x (1 - 30%) = 4.4%

A stock split will cause a change in the total dollar amounts shown in which of the following balance sheet accounts?

- Paid-in capital
- Retained earnings
- Cash
- Common stock

**none**

If a stock rises above a certain nominal amount, management may declare, for example, a two-for-one stock split, where the number of shares outstanding doubles and the stock price is halved. Each stockholder would have twice as many shares, but each share is worth half as much. Theoretically, a stock split should not affect the value of a firm. They are generally used after a sharp price run-up to produce a large per-share, nominal price reduction.

If a company converted a short-term note into a long-term note, this transaction would increase what?

**both working capital and the current ratio**

This transaction reduces current liabilities, but does not change current assets and, therefore, increases working capital and increases the current ratio. Remember, the current ratio measures current assets available to cover current liabilities, a test of near-term solvency. The ratio indicates to what extent cash on hand and disposable assets are sufficient to pay off near-term liabilities. Higher ratios indicate a better buffer between current obligations and a firm’s ability to pay them. The quality of current assets is a critical factor in interpreting this analysis.

Which of the following statements is most correct?

- An increase in the risk-free rate is likely to increase the cost of equity financing.
- The weighted average cost of capital does not depend on the risk-free rate.
- The weighted average cost of capital is calculated on a before-tax basis.
- An increase in the risk-free rate is not likely to increase the cost of equity financing.

**1**

An increase in the risk-free rate will increase the required rate of return since the required return equals the risk-free rate plus a risk premium. This will result in an increase in the cost of the common stock component.

Which ratio is formulated by: current assets / current liabilities?

**current ratio**

What is an example of a factor that might reduce a company’s WACC?

**A reduction in the market risk premium**

If the risk premium decreases, the required return on common equity will be reduced.

What is the formula for **Accounts Receivable Turnover**?

**Sales / Average Accounts Receivable**

What is the formula for **Inventory Turnover**?

**Cost of Goods Sold / Average Inventory**

What is capital surplus?

Capital surplus, also referred to as additional paid in capital, is all the proceeds above par that are received by a company.

Define:

**Book Value**

**Book value**, also referred to as **shareholders’ equity**, is the total amount of equity that has been invested into a company plus any retained earnings that have accumulated through operations.

It can be calculated as Total Assets - Total Liabilities

Define

**Quick Ratio**

**(Current Assets - Inventory) / Current Liabilities**

A company has long-term assets of $3.8mm and total assets worth $6.9mm. It also has shareholder’s equity of $3.9mm and long-term liabilities of $1.6mm. Calculate current ratio:

**2.2x**

Current Assets = Total Assets of $6.9mm - LT Assets of $3.8mm = $3.1mm

Total liabilities = Total Assets of $6.9mm - SE of $3.9mm =$3mm

Current Liabilities = $3mm - LT Liabilities of $1.6mm = $1.4mm

Current Ratio = CA of $3.1mm/CL of $1.4mm = 2.2x

Inventory turnover is computed using

**cost of goods sold**

Inventory turnover is computed as cost of goods sold divided by average inventory.

Which working capital ratio is calculated as sales divided by average accounts receivables?

**Accounts receivables turnover**

Company ABC has an annual sales of $550mm, cost of goods sold of $300mm, and average inventory of $90mm. What is the company’s inventory turnover ratio?

$300mm/$90mm = **3.33**

The inventory turnover ratio is calculated as cost of goods sold divided by average inventory.

Company ABC has sales of $200mm, cost of goods sold of $50mm, average inventory of $90mm, and average account receivables of $75mm. What is the company’s receivables turnover?

$200mm / $75mm = **2.67**

Receivables turnover is equal to sales divided by average accounts receivable.

In a comparison of 2014 with 2013, Sulzer Co.’s inventory turnover ratio increased substantially although sales and inventory amounts were essentially unchanged. What change would explain the increasing ratio?

**COGs has increased**

The inventory turnover ratio is equal to the cost of goods sold divided by the average inventory. If inventory is unchanged, an increase in cost of goods sold increases the inventory turnover ratio.

The accounts payable turnover is calculated as

**COGS / Average Accounts Payable**

A company has an average accounts receivables of $300mm and sales of $900mm. What is the company’s days sales oustanding?

($300mm/$900mm) x 365 = **121.67**

DSO = (average accounts receivable / sales) x 365

**The dividend discount model assumes that:**

**the value of a share of common stock is the present value of all future dividends.**

Last year a company paid a $2 dividend, which is expected to grow by 5% each year. Assuming a discount rate of 11%, calculate the company’s implied stock price in accordance with the dividend discount model.

**$35**

Dividend discount model = (annual dividend x (1 + growth rate)) divided by (discount rate - growth rate)

Dividend discount model = ($2 x 1.05) / (11% - 5%) = $35

Liquidity of a company is generally defined as a measure of _____________.

**the ability to pay current liabilities**

Liquidity means having enough cash available to pay debts when they are due.

Company ABC expects to earn $300mm in cash flow each year in perpetuity. Assuming a discount rate of 10%, what is the company’s implied valuation?

$300mm/10% = **$3bn**

If a company has a negative working capital, would its current ratio be greater or less than 1.

**The firm’s current ratio is less than 1.**

Working capital = current assets - current liabilities. If working capital is negative, then current liabilities exceed current assets, implying a current ratio of less than 1.

When calculating the debt to equity ratio in a WACC calculation, does one use market value of equity or book value of equity?

**Market Value**

For WACC, always use market value of equity (shares x price) not book value of equity from the balance sheet.

Which ratio is typically used in the valuation of financial firms?

**Price/Book Value**

Which type of company typically has higher multiples: growth or value?

Growth companies typically have high multiples while value companies typically have low multiples

The market risk premium is

the spread of the expected market return over the risk-free rate

How does a DCF analysis determine valuation?

**It values the company based on its expected future free cash flows discounted to prresent value**

If a company declares a dividend, what impact does this have on their balance sheet?

**Retained earnings falls**

The interest coverage ratio is calculated by dividing what by interest expense?

**EBITDA**

Assuming a company has exercisable employee stock options, which will be greater, basic or diluted EPS?

**Basic EPS**

If employee stock options are exercised that will lead to more shares oustanding and therefore a lower EPS calculation for diluted EPS.

Which ratio is calculated as gross profit divided by sales?

**gross profit margin**

Economic value added (EVA)

EBIAT - (Capital Invested x WACC)

Rank operating profit margin, net profit margin, and gross profit margin from highest to lowest

**Gross profit margin then operating profit margin then net profit margin**

Define:

Weighted average cost of capital (WACC) is defined

**The weighted average of a company’s cost of debt and cost of equity**

Cash outflows for payments of dividends are reflected on which section of a cash flow statement?

**Cash flows from financing activities**

Which of the financial statements depicts a given point in time?

**Balance Sheet**

Only the balance sheet depicts the company’s financial position at one point in time. All others show what happens over a period of time.

If a company’s P/E ratio is 12x and it has an EPS of $1.75, what is the company’ implied stock price? Given that the P/E ratio on a common stock is 12, the expected dividend payout ratio is 0.7, and the dividend growth rate is 6%, what is the required rate of return?

**$21**

Stock Price = P/E multipled by EPS

Cash received from the sale of fixed assets is found on which section of the cash flow statement?

**cash flows from investing activities**

A company has an EBIAT of $250mm, a D&A of $100mm, a tax rate of 30%, a Capex of $90mm, and an increase in net working capital of $20mm. What is the company’s unlevered free cash flow?

**$240mm**

Unlevered free cash flow = EBIAT + D&A - Capex - Increase in NWC

What are the three sections of the cash flow statement?

**Investing activities, financing activities, operating activities**

The primary purpose of the statement of cash flows is to .

provide information about a company’s cash receipts and cash payments during the accounting period

Assuming a fixed purchase price, what happens to goodwill as fair market value increases?

**Goodwill decreases**

A company earns net income in excess of the dividends it pays shareholder’s. How is this reflected on the company’s balance sheet?

**Retained earnings and therefore shareholders’ equity increases**

If a company buys back stock, is it’s balance sheet impacted by the market value of the repurchased shares or the actual acquisition cost?

**Actual acquisition cost**

Formula for levered beta

**Unlevered Beta x (1 + (1 - Tax Rate) x Debt/Equity)**

All else being equity, as company’s tax rate increases, what is the impact on the calculation of WACC?

**A tax rate increase would lead to a decrease in the after-tax cost of debt and, consequently, the company’s WACC would decrease.**

When a company repurchases stock and plans to permanently retire the shares, how is this reflected within shareholders’ equity?

**Par value amd capital surplus are reduced**

A company has 9% bonds outstanding that are trading at 101. Assuming the company is in the 35% tax rate, calculate its after-tax cost of debt.

**5.79%**

Current Yield = annual interest divided by market price of bond

Current Yield = $90/ $1010 = 8.91%

After-tax cost of debt = Current yield x (1 - tax rate)

After-tax cost of debt = 8.91% x (1 - 35%) = 5.79%

Assuming a company has an unlevered beta of 1.2, a tax rate of 35%, and a debt to equity ratio of 45%, calculate the company’s levered beta.

**1.55**

Levered Beta = Unlevered Beta x (1 + (1 - Tax Rate) x Debt/Equity)

A company currently pays $50mm in annual interest. If they issue stock to retire their outstanding debt, what would be the increase to net income assuming a tax rate of 35%?

$50mm x (1 - 35% tax rate) = **$32.5mm**

Perpetuity growth formula

**Free Cash Flow x (1 + Growth Rate)/ (Discount Rate - Growth Rate)**

Company XYZ has a stock price of $37, a book value of equity of $4M and market value equity of $6M. What is the company’s price to book value?

Market Value of Equity/ Book Value of Equity = **1.5x**

If ABC Company pays its rent in advance, how will its current assets on the balance sheet be affected?

There is no change to current assets as cash fell, but prepayment increased, which offset eachother

If current liabilities increase by more than current assets, what is the impact on net working capital and is that a source or use of cash?

**Net working capital falls, which is a source of cash**

Effective EBITDA multiple

Purchase Price/ (EBITDA + Pre-Tax Synergies)

A firm has a net income of $150, an increase in accounts receivables of $30, depreciation of $55 and a decrease in accounts payable of $25. It’s operating cash flow is

150 + 55 - 30 - 25 = **$150**

Operating cash flow = net income + noncash expenses - noncash revenues

A stock paid an $1.80 per share dividend this year. Dividends are expected to grow at 5% per year. Assuming a discount rate of 10%, what is the implied stock price calculated in accordance with the dividend discount model?

What is the value of the stock if the appropriate discount rate is 10% per year?

[Annual Dividend x (1 + growth rate)]/ (discount rate - growth rate) = **$37.80**

Debt/Tangible Net Worth

**Total Debt/ (Shareholders’ Equity - Goodwill and Intangible Assets)**

A company pays an annual dividend of $3 and has a dividend yield of 12%. Calculate the company’s stock price.

$3/12% = **$25**