6.2 Lecture_12_Thursday_20_August

6.2 Lecture_12_Thursday_20_August - FINC 202 Lecture...

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Unformatted text preview: FINC 202 Lecture 12 (2009) Financial Ratios (2) • One handout = “T3­1 Balance Sheet” 1 EBITDA Coverage Ratio Revisited • The EBITDA Coverage Ratio solution in Lecture 11 had debt repayments set at zero and ignored Notes Payable. in the handout. This is because sinking fund payments are set at zero • Please look at the expansion of the notes on this ratio in a separate file in LEARN. 2 Profitability Ratios: M, BEP, ROA & ROE Profit Margin on Sales Sometimes called “M” Net Income available to common shareholders M= Sales NPAT − Preferred Dividend = Sales 3 Profit margin vs. industry average? 2009 P.M. 2008 -8.9% 2007 Ind. 2.6% 3.5% Very bad in 2008, but projected to ________________________________ 4 EBIT BEP Ratio = Total Assets The rate of return on all cash invested on a before-tax basis. This rate of return is for all investors (debt-holders + Shareholders etc) But it is averaged out over all types of investor. 5 BEP vs. Industry Average? 6 2009 BEP 19.1% 2008 2007 -24.1% 14.2% Ind. • • • BEP removes effect of taxes and financial leverage. Useful for comparison. Projected to be ___________________ Room for ________________________ 7 Return on Assets: ROA NPAT ROA = = TA NPAT Sales × Sales TA 8 Calculate Return on Assets 9 NPAT ROE = Equity = NPAT Sales × Sales Equity A very useful expanded form of ROE is called the Du Pont Equation: NPAT Sales TA ROE = × × TA E Sales 10 10 ROE Solution: 2009 ROA ROE Both 2008 2007 Ind. -18.1% 6.0% 9.1% -391.4% 13.3% 18.2% 11 11 ____________________________. Du Pont System • shows relationship between ROE and NP margin asset turnover financial leverage firm can improve ROE by raising NP margin on sales extracting more sales from existing assets replacing equity with debt The Du Pont System is just ____________ ___________________________________ 12 12 • • Profit Equity ( TATO ) = ROE Margin Mulitplier NPAT Sales TA × × = ROE Sales TA E 2007 2.6% × 2008 − 8.9% × 2009 3.6% × Ind 3.5% × 2.3 × 2.2 2.0 × 21.6 2.0 × 2.3 2.6 × 2.0 = 13.3% = −391.4% = 16.3% = 18.2% Profit Margin is now good; but there is still an inferior TATO and the Equity Multiplier indicates there is still too much use of Debt in the capital structure 13 13 Caveats concerning ROE • • ROE and shareholder wealth are often highly correlated But it is dangerous to use ROE as a sole measure of a firm’s Why? 1. ROE does not take risk into account • Apart from bringing in a measure of leverage via the equity multiplier Higher leverage can increase ROE This comes with performance for its shareholders _______________________________________ 14 14 1. 2. The ROE of a project tells us nothing about the size of the project relative to the size of other projects with similar ROEs. If ROE determines management bonuses, it may become a perverse incentive: A manager will defend a high existing ROE averaged out from Projects A, B and C By turning down Project D which has an ROE which would drag the average down Even though Project D is a positive NPV project. Therefore firm value should be seen as a function of ROE, Size and Risk (see pp125­127 text) …and _____________________________ 15 15 More on the Debt Management Ratios concerning Leverage Total Liabilities Debt Ratio = Total Assets Debt Debt to Equity Ratio = Equity 16 16 The Debt Ratio (from Lecture 11) D 1, 445 + 500 = TA 3, 497 = 55.6% D/TA 2009 2008 2007 Ind. 55.6% 95.4% 54.8% 50.0% 17 17 Debt Ratio versus D/E Ratio • To convert from Debt Ratio to D/E ED + =1 TA TA E D ⇔ = 1 − TA TA D TA = E 1− D TA D Example If D TA = 0.2 = 1 − 0.2 = 0.8 then E TA and ... ( ) ⇒D E 0.8 = 0.25 or 25% 18 18 = 0.2 A tricky issue concerning Debt, Equity and tricky Total Assets Total • • Total Assets (TA) = Total Debt + Total Equity But Total Debt = CL + Long­term Debt In the Finance discipline, Capital Structure is determined on Equity and Debt that excludes spontaneous liabilities L* Current Liabilities are only included to the extent they contain Short­term negotiated Debt • Ie, Notes Payable 30­day Bills etc that behave like very short­term Bonds Long­term Debt ____________________________ 19 19 • Therefore for WACC and for Capital Structure in general: E wS = D+E and D wd = D+E And if preference stock exists : E wS = ; D + E + EPREF EPREF D wd = ; wd = D + E + EPREF D + E + EPREF Debt excludes CL except for Notes Payable However, textbooks often _______________ ____________________________________ 20 20 Calculate Debt Ratio for WACC, and the D/ E Ratio in same way D Notes Payable + ( Long − term Debt ) = ( D + E ) Notes Payable + ( Long − term Debt ) + Equity = 600 + 500 600 + 500 + 1552 D 600 + 500 = E 1552 = 0.71 = 41.48% 2009 Notes Payable Long-term Debt Equity D/(D+E) = D/E = 600 500 1552 41.48% 0.71 2008 720 1000 133 92.82% 12.93 2007 200 323 664 44.06% 0.79 21 21 Market value ratios P/E Ratio Price/Cash­flow per Share Ratio Market to Book Ratio P P ratio = E EPS 22 22 Calculate the P/E ratio. P0 = $12.17 NPAT EPS = = N P P0 = = E EPS . 23 23 Price/Cashflow Ratio Share Price P/CF = NPAT + Dep n Shares Outstanding P = n NPAT + Dep N 24 24 NPAT + Depreciation Cash Flow per share = N = = Pr ice P0 Ratio = Cash Flow Cash Flow per share = = 25 25 Market to Book (M/B) Ratio Market to Book (M/B) Ratio P M /B= BV ps P = Shareholders ' Equity N 26 26 The higher the value of M/B, the greater the esteem investors have of the firm Common Equity E Book Value per Share = = N N 1,552 = 250 = $6.21 Market Price per share Market − to − Book Ratio = Book Value per Share P0 = MV PBV = = 27 27 Book-to-Market Ratio • This ratio is the inverse of the Market­to­book ratio The M/B ratio tends to be favoured by US researchers. The lower the value of the B/M ratio, the more value investors put on the firm: • M should _________________________ Think back to finance’s “Objective Function” 28 28 Book-to-Market Ratio Book Value per Share Market − to − Book Ratio = Market Price per share = = 29 29 P/E P/CF M/B 2009 12.0x 8.21x 1.96x 2008 -0.4x -0.6x 1.7x 2007 9.7x 8.0x 1.3x Ind. 14.2x 11.0x 2.4x • • P/E: How much investors will pay for $1 of earnings. High is good. P/CF: How much investors will pay for $1 of cash flow. ___________________________ • • M/B: How much paid for $1 of BV. Higher is better. P/E and M/B are high if ROE is high, risk is low. 30 30 Typical industry average P/E ratios C2000 or 2001 Industry P/E ratio Banking 17.15 Computer Software Services 33.01 Drug 41.81 Electric Utilities (Eastern U.S.) 19.40 Internet Services* 290.35 Semiconductors 78.41 Steel 12.71 Tobacco 11.59 Water Utilities 21.84 * Because many internet companies have negative earnings and no P/E, there was only a small sample of internet companies. 31 31 What are some potential problems and What limitations of financial ratio analysis? limitations • • • • • • Comparison with industry averages is difficult if the firm operates many different divisions. Often difficult to identify industry category The whole industry might be sick “Industry Average” performance not necessarily good. Seasonal factors can distort ratios. Different operating and accounting practices distort comparisons. “Window dressing” techniques can make statements and ratios look better. Sometimes hard to tell if ____________________________ Difficult to tell whether company is, on balance, in strong or weak position. 32 32 What are some qualitative factors analysts What should consider when evaluating a company’s likely future financial performance? likely • • • • • • • Are the company’s revenues tied to 1 key customer? To what extent are the company’s revenues tied to 1 key product? To what extent does the company rely on a single supplier? What percentage of the company’s business is generated overseas? How much competition is there in the industry? What are the industry’s _________________________ Are there changing issues concerning the Legal and regulatory environment? 33 33 Final Comments on Ratio Analysis • ratio analysis useful when comparisons made over time (trend analysis) against targets against ___________________________ …But the issues outlined in the previous two slides have to be taken into account 34 34 ...
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