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Finance 9/4/14

Chapter 3 Equity Multiplier


Equity multiplier- (watch first 5 min of lecture)
Profitability measures how well a firm is doing to make money. How
efficiently the firm uses its assets to make money.
Profitability ratiosProfit margin- NI/Sales
Return on assets (ROA)= Net Income
Total assets
Return on Equity (ROE)= Net Income
Total equity
ROE looks at the return on shareholder capital, If a manager is running
effectively the ROA and ROE are successful. Since wwii no company
that runs under 10% ROA has not lasted.
Market Value Ratios
EPS: Earnings per share, the eps takes the number and puts it on a per
share basis
EPS= Net income(after preferred dividends)
avg Shares outstanding
EPS Average =i.e. 1.50/sh
EPS wallstreet estimate = 1.49/sh
If this happens the stock price would go up, congruently if the
eps avg<ws avg Stock price
assumption is that if you have beaten the estimate, going forward your
expected to continue to beat the estimate. Wallstreet is forward
thinking and this is why the stocks will go up value based on the eps
estimates. Incidentally most firms beat their estimate by a penny.
Price earnings multiply measures how much investors are willing to
pay for a dollar of earnings.
p/e = current stock price = 88/11 =8x
eps
High P/E stocks : Growth stock
Low P/E stocks : Value stock

Peg Ratio- priceearnings ratio earnings growthrate ( )


Market value to book value ratio
book value per s h are

market v alue per s h are

for a dollar book value per share, you want greater market value per
share
Market ValueBook Value- A=L+E
Enterprise value- Price you would pay if you were to buy a publicly
traded company today.
100
50
- 20 =130 is net price
Enterprise value = mkt value of stock + mkt value of their debt Cash
+ marketable securities
Enterprise value
= trying to measure the value of the operating assets
EBITDA
relative to the operating cash flow (ebitda) generated from the assets.
EBITDA Ratio= EV/EBITDA : smaller the number the better. Operating
assets are generating higher returns.
Used to rank or compare companies.
Working Capital Management
Cash conversion cycle- sales to cash ratio- accounts receivable
turnover (in Days) + inv turn (in days)- A/P turnover (in Days)
Chapter 4 Long-term Financial planning and growth
Planning includes:
Budgets (1yr)
Strategic plans 3yr 5yrs- failed after 2008 ifthen or ififthen led to
present day trend to catastrophe planning.
Budgets focus on growth: the traditional view is focus on market share
the main concept is profitability. Profitability focuses on margins and
efficiency.
Profitable Growth is the sweet spot of running a business (very difficult
to do)

Top down bottom up :comes from the people in the trenches


Developing Proforma Financial Statements (forecasting into the future)
Starting place is sales forecast
o Factors to consider when forecasting sales
Prior year: sales growth rate
Level of economic activity (recession vs. expansion)
Available capacity (do you have the physical
inventory to meet product numbers) (physical plant,
human capital, and financial capital)
New products
Multiple divisions
Industry dynamics
Pro-Forma Income Statement
Percentage of sales approach income statement
2013

% of sales

sales 1,000
costs 800
taxable 200
taxes (34%)
$68
NI $132
Dividends
$44
Addition to
RE $88

800/1000

pro forma -2014


1000x1.25=1,250
.8x1250=1000
$250
x34%=85
$165
$55
$110
Assumptions-sales 25%
Cost of sales =8%, tax

rate=34%
Dividend payout

132
=.33
44

Pg 99 Balance sheet pro forma projection looking at account behavior


as a % of sales

Conceptually if the account behavior is consistent over time,


behavior will be consistent the next year. We look at
forecasting through sales, implying there is no major economic
activity affecting your sales.
% of Sales
Cash
A/R
INV

160
440
600

160/1000=1.6
440/1000=.44
600/1000-.66

NON SPONTANEOUS pro forma


A/P 300
N/P 100
LTD 800
Common stock Surplus
800

Pp&
e

1,80
0

1800/1000=1.
8

R/E 1000

.16x1250
.44x1250
.6x1250
total

Cash 200
A/R 550
INV 750
1500

1.8x1250

Pp&e 2,250

Total liability
3,000
Total
asse
ts

3,00
0

3000/1000=3
00

Total assets 3750

DO we have enough financing?


Two types of accounts for forecasting to consider
1. Spontaneous accounts: accounts whose balances vary directly
with sales: cash, A/R, Inv, Fixed assets, accounts payable (if you
sell more stuff, youre more likely to generate more on these
accounts)
2. Non spontaneous accounts: accounts whose balance do NOT
vary directly with sales: Notes payable, Long term debt, common
stock, etc (these accounts involve the decisions of management)

Full Capacity Sales pg 102


FCS: equal to

current sales
capacity utilization

capacity utilization will be

given
Example: capacity utilization= 70%
Current sales = $1,000
Full capacity sales = 1,000/70 = 1,428.57 (max sales before new
capacity)
Projected sales were 1,250 so no added PP&E is needed
Two important measures for internal growth rate and external growth
rates
Internal growth rate- IGR : rate at which a firm can grow by financing
projects from internally generated funds, without any external
financing.
IGR=

SBR or Sustainable Growth Rate- rate the firm can grow without selling
stock to the public while maintaining a constant debt/equity ratio.
SGR=

ROE x B
1ROE xB

Example 1) D/E