1: FRAMEWORK
BALANCE SHEET EQUATION
A = L + SE
INCOME STATEMENT EQUATION
REV EXPENSES = NET INCOME
SE STATEMENT
END RE = BEG RE + NET INC DIV
CF STATEMENT
Examples: NOT operating items: financial items (interest exp, interest income, dividend
income, investment gains/losses, income from minority investments, income from disc.
operations
Form: NOPAT = Operating profit x (1- tax rate) *USE EBIT AS PROXY
Form (book): NOPAT= NOPBT[Tax exp + (Pretax net nonop exp x stat. tax rate)
NOA (Net Operating Assets)
Def: Assets used in operating activities
Examples: (A) Receivs, inventories, prepaid exp, PPE (L) accts payable, income tax, pensions
NOT examples: (A) ST/LT invest in market securities, fin. invest (L) bonds pay, bank loans
Form: ROE =
NNE
Av . NNO
Form: NNEP =
Form: ROA =
NOPM =
Form: ROA =
ATI
Form: ATIP =
=
Average L
Interest exp (1tax rate)
Av . Liabilities
NOAT =
LEVERAGE (Decimals)
FL (Financial Leverage)
Form: FL =
Av .Total A
Av .Total SE
Debt-Equity Ratio
Form:
L
SE
L
A
Total A
SE
NOPAT
=
Av . NOA
Operating profit ( 1tax rate )
Net Operating ANet Operating L
Form: RNOA =
RETURN SPREAD
Def: Earnings positive economic profit (EP)
Form: ROA WACC (Weighted av. cost of capital)
Form: EP = Av. Total A x (ROA WACC)
FINANCING SPREAD
Def: Difference between what firm earns on investments and the cost of financing
Form: ATIP (After-tax cost of financing) = ATI / Avg. L
Form: Financing Spread: ROA ATIP
After-tax cost of financing: NNEP = NNE / Av. NNO
Financing Spread = RNOA - NNEP
When ROAT ATIP is positive, ROA greater than ROA and using debt well
PROFITABILITY RATIOS
Examples: Depreciation, write-off, restructuring charges, gains and losses on asset sale, other changes in
investment
Receivables/Sales
Gross profit/Sales
1-((Current A +PPE)/(Total A)
Sales
Depreciation/(Depreciation+PPE)
SG&A Expense/Sales
Leverage Index
Form: TIE =
Cash
OperationsCapex
Debt +ST Debt
LIQUIDITY RATIOS
EBITA/Net Revenue
Operating Margin
(FFO+Interest Exp)/Interest Exp (Funds from Ops + Interest Expense) / Interest Expense
CURRENT RATIO
Def: Comparing cash inflow to outflow in short term
Form: CURRENT RATIO =
Current Assets
Current Liabilities
FFO/Debt
RCF/Debt
Debt/EBITDA
Debt/Book Capitalization
Interest + Book Equity)
QUICK RATIO
Def: Focus on quick assets, excluding inventory and prepaid A, ability to meet
current Ls without liquidating
FFO = Net income from continuing operations plus dep, amort, deferred income taxes, other
noncash items
Operating Activities
Net Income
SOLVENCY RATIOS
LIABILITIES TO EQUITY RATIO
Def: How reliant a c is on creditor financing (v. equity)
Form: L-E RATIO =
Total Liabilities
SE
Depreciation
Accts receivable
Prepaid expense
Accts payable
Wages payable
X
X (Added adjustments)
Total Liabilities
SE
Profitable
Generates cash
Improving profitability
(gross profit/sales)x100%
Improving efficiency
Improving liquidity
__
INCOME STATEMENT
Revenue
Cost of Revenue
Gross Margin
Operating expenses
SG&A
R&D expense
Total op exp
Interest exp
Net income
Prepaid expenses
LT Liabilities
Bonds and notes payable
Cap lease obligations
Pension and other post-employment liabilities
Deferred income tax liabilities
LT liabilities of discontinued operations
SE
All equity accounts
Noncontrolling (minority) interest
FINANCING SPREAD EXAMPLE
Firm has 1000 of equity, and borrows 600 at 10% interest rate (7% after-tax interest rate). It
uses the funds to acquire A yielding 15% pre-tax ROA (10.5% after-tax ROA). (Income tax rate
= 30%).
Av. total A = 1000 equity + 600 liabilities = 1600
Net income = 0.7 (1600x0.15-600x0.10)=126
AT profits from A financed with equity = 1000 x 10.5% = 105
AT Profits from A financed with debt = 600 x (10.5-7%0 = 21
ROA numerator = Net income + aftertax itnerst = 126 + 42 = 168
ROA = 168 / 1600 = 10.5% ROE = 126 / 1000 = 12.6%
ROE > ROA, benefiting from positive financing spread of 3.5%
Note: Using formula ROE = ROA + (Financing spread x L/SE),
ROE = 10.5% + [(10.5-7%)x600/1000]=12.6%
Glamour stocks are defined as stocks with high price to book (P/B) values and Value stocks
as having low price to book ratios.