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Unformatted text preview: FINA 4300.002 Spring 2015 November 12, 2015 Reference Sheet Exam 3 Sustainable Growth Rate (g*) – Various interpretations g* = change in equity / equitybop -‐‑ where bop = beginning of period equity g* = R x earnings / equitybop -‐‑ where R = the retention rate. R is the fraction of earnings retained in the business (retained earnings). It can also be depicted as: R = 1 – dividend payout ratio Dividend payout ratio = dividends / net income So: R = 1 – (dividends / net income) Since earnings / equity = ROE, g* = R x ROEbop g* = PRAT = profit margin x retention ratio x asset turnover x financial leverage = Net Income x Sales x Assets x (1 – dividend payout ratio) Sales Assets Equitybop • P and A summarize operating performance • R and T describe financial policies o R captures dividend policy o T reflects policies regarding financial leverage Holding Period Return: HPR = income + change in price beginning price Dividend Payout = Dividends / Net Income Dividend yield = dividend per share price per share EBIT = Net Income + existing interest (1 – tax rate) Return on Invested Capital (ROIC) = EBIT x (1 – tax rate) Debt + Equity Effects of Leverage • ROE = ROIC + (ROIC – i’) (D/E) • Net Income = (EBIT – i’D)(1 – t) • Where i’ is the after-‐‑tax cost of debt, (1-‐‑t)i. • EPS = [(EBIT – iD)(1-‐‑t)]/n • n = # shares Coverage Ratios • Times Interest Earned = EBIT Interest expense • Times burden covered = EBIT interest + principal (1-‐‑ t) 1 FINA 4300.002 Spring 2015 November 12, 2015 • Times Common Covered = EBIT interest + principal + dividends M&M’s Irrelevance Principle • In the absence of taxes and transaction costs, firm’s debt levels do not impact value. • What matters is aggregate amount of risk and return, not how they are divided among shareholder and creditors. • Total cash flows generated over time are the basis for the firm’s value. Higgins 5-‐‑Factor Model for Financing Decisions 1. Tax benefits 2. Distress Costs o Bankruptcy o Indirect Costs o Conflicts of Interest 3. Flexibility 4. Market Signaling 5. Management incentives Figures of Merit • Payback Period – time the company must wait before recouping its original investment. • Accounting Rate of Return = annual average cash inflow total cash outflow • Net Present Value • NPV = present value of cash inflows – present value of cash outflows • When: o NPV > 0, accept the investment o NPV < 0, reject the investment o NPV = 0, investment is marginal • Benefit Cost Ratio • BCR = present value of cash inflows present value of cash outflows • Internal Rate of Return (IRR): Discount rate at which the investment’s NPV equals zero. • If the investment’s IRR exceeds the opportunity cost of capital, the investment is attractive and vice versa. • If K = percentage cost of capital, then if: o IRR > K, accept the investment o IRR < K, reject the investment o IRR = K, the investment is marginal • IRR of Perpetuity • P = A / r • R = A / P • Where: o A = annual receipt o r = discount rate o P = present value 2 FINA 4300.002 Spring 2015 November 12, 2015 Determining Relevant Cash Flows 1. The cash flow principle: money has a time value; record investment cash flows when the money actually moves, not when the accountant using accrual concepts says they occur. 2. The with-‐‑without principle: Imagine two worlds, one in which the investment is made and one in which it is rejected. All cash flows that are different in these two worlds are relevant to the decision, and all those that are the same are irrelevant. Free Cash Flow FCF = Earnings after tax + noncash charges – investment After Tax Cash Flow ATCF = earnings after tax + depreciation 3 ...
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- Spring '14
- Financial Markets, Internal rate of return, FINA, dividend payout