Earned Ratio
= EBIT/interest
exp
~no days comp can op on
its cash
Asset Mgmt Ratios
(Activity ratio, measure firm’s effectiveness in
managing assets)
Inventory
Turnover
= COGS/
Inventory
No. times comp sold avg
inv/year. Inv liquidity.
Days’ Sales in
Inventory
= 365/
Turnover
↓btr. No days to sell all
inv
Receivable
Turnover
= Sales/
Receivables
↑btr.
No times per year
collect rec.
Days’ Sales
Outstanding
(DSO)
= AR/Avg Daily
Sales
= 365/
Rec
Turnover
↓btr. DSO ↓: poor credit
policy. Avg days aft sales
to receive $
FA Turnover
= Sales/NFA
Effectiveness of asset to
gen. sale
TA Turnover
= Sales/TA
↑btr. If FA> TA, prob w
CA
AP Turnover
Times
= COGS/AP
Payable
Deferral
Period
= 365/
AP
Turnover Times
Profitability (
Measure how well biz earns return on investments, show
combined effect of liquidity, asset mgmt. & debts on operating results)
Profit Margin
= NI/Sales
Measure firm op efficiency
Basic Earning
Power
= EBIT/TA
Remove tax/fin leverage
effect
Return on
Assets (ROA)
= NI/TA
How efficient comp use A to
get profit
Return on
Equity (ROE)
= NI*/Total
Common
Equity
*NI avail to common SH,
need deduct preferred
dividend
Problems with ROE
Doesn’t consider risk, focus on returns only. Doesn’t consider
amt of capital invested
May encourage managers to make investmt decisions that
dont benefit SH
Market Value Ratios
…..PV Factor
P
E
=
price per share
earnings per share
how much investor willing to pay for $1 of earnings
An increase in stock’s required rate of return will lower P/E ratio
M
B
=
mkt price per share
book value per share
how much investor willing to pay for $1 book value equity.
Du Pont Identity
Links Profitability (ROE & ROA) and
Efficiency (TA TO)
ROE =
net income
(
¿
)
total equity
(
TE
)
= ROA x EM (Equity Multiplier)
= Profit margin x Total Asset turnover x EM
PM operating efficiency (how well it controls cost)
TA TO asset use efficiency (how well manages assets)
EM financial leverage (eg. If ROE increase due to EM,
provided firm is already well leveraged higher risk)
Ratio limitations/problems

If firm operates in many divisions, industry avg comparison
is difficult

Avg perf =/= good. Leader’s is better. Seasonal factors can
distort ratios
W3: Time value of Money
Int
/ disc rate/cost of capital/opp cost of capital/reqrd return

Simple Int
: FV = PV(n)(1+r)

Compound Int:
FV
n
=PV(1+r)
n
Annuities
(+ for inflow,  outflow)
Ord annuity
– same
CF at end
of each period (reg interval,
stop date) eg. Bonds
PV (Ord
annuity)
=
PMT
∗
1
−
PV Factor
r
¿
PMT
∗
1
r
∗
(
1
−
1
(
1
+
r
)
n
)
FV (Ord
annuity)
=
PMT
∗
1
r
∗[
(
1
+
r
)
n
−
1
]
Annuity due
 cash flow at
beg
of each period eg. Rental
<2
nd
PMT, 2
nd
ENTER>
PV/FV
Annuity Due
= PV/FV Ordinary
Annuity x (1+r)
Growing Annuity
Set of rates that grow at
constant
rate, g up to a certain
maturity
date.
C1 = first cash payment
Perpetuity
– set of equal payments paid forever
.
Growing
perpetuity
– set of payments, grow at constant rate each
prd, contd 4eva
PV = C/r
(C: periodic payment)
Growing Perpetuities
:
PV=
C
1
r
−
g
[
1
−
(
1
+
g
1
+
r
)
n
]
C
n
= C
1
x (1+g)
n
(r: discount rate, g: growth rate)
Effective Annual Rate (EAR):
actual rate paid/received aft
considering any compounding that may occur during the yr. m
= compounding frequency per yr
EAR = [1+
APR
m
]
m
1
(in decimals) = (1+Period
Rate)
n
1
** EAR/no. periods per yr =/= period rate
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 Winter '14
 Capital Asset Pricing Model, Investing