ROICisameasureofhowmuchcashacompanygetsbackforeachdollaritinvestsinitsbusiness.

You're
probablysaying,"ThatsoundssosimilartoROAandROE,whynotjustusethose,sincethey'repostedon
justabouteveryfinancialWebsite?"IagreethatusingROAorROEwouldbeeasier,butinmybookthey
justdon'tcutit.Firstofall,thenumeratorinbothoftheseratiosisnetincome.Inmanycasesacompany's
netincomehasnothingtodowithhowprofitableitsoperationsare.Therecanbesomanythingsgoingon
"belowtheline"interestincome,discontinuedoperations,minorityinterest,andsoonthatnetincome
canmakecompanieswithunprofitableoperationslookprofitable,andviceversa.
Further,ROAmeasureshowmuchnetincomeacompanygeneratesforeachdollarofassetsonitsbalance
sheet.Theproblemwithusingthismetricisthatcompaniescancarryalotofassetsthathavenothingtodo
withtheiroperations,soROAisn'talwaysanaccuratemeasureofprofitability.
ROElooksathowmuchprofitacompanymakesperdollarofshareholders'equity.TheoreticallyROEisa
greatmetricbecauseitmeasureshowefficientlyacompanyisusingshareholders'moneytogenerate
profitsandasinvestors,that'ssomethingweshouldcareabout.ButROEhasitslimitations,too.By
carryinghighdebtlevelsandrepurchasingshares,managementcanincreaseacompany'sfinancial
leverage,andthusitsROE,buttoomuchofeithercanproduceanunreasonablyhighROEthatdoesn't
accuratelyrepresentthecompany'sprofitability.
Asfarasnetprofitmargingoeswhichisnetincomedividedbysalesfrankly,Icouldn'tcareless.Sureit
measureshowefficientacompanyiswitheachdollarofrevenues,butthat'sthemoneyitscustomersgive
it.Asaninvestor,Icareaboutwhatthecompanydoeswithinvestors'money.Andsincenetprofitmargin
doesn'ttellusanythingaboutthebalancesheet,youwouldneverknowifacompanyispostinggreat
marginssimplybecauseit'sinterminablyshovelingcashintoitsbusiness.Thatcan'tgoonforever.
SohowdowecalculateROIC?Forthe"return"partofROIC,wedon'tusenetincome,butratherearnings
aftertaxesbutbeforeinterestpayments.Wedothissothatcompanieswon'tbepenalizedforhavingalotof
debt(andthushighinterestpayments).Forthe"investedcapital"part,wetakeallofthecompany'sassets,
thensubtractallcurrentliabilities(thoseduewithinayear)exceptforshorttermdebt.Dividingaftertax
incomebyinvestedcapitalgivesusROIC.Here'swhatitlookslike:
1.Aftertaxincome=(operatingincome)x(1taxrate)
2.Investedcapital=totalassets(currentliabilitiesshorttermdebt)
3.ROIC=aftertaxincome/investedcapital
Valuation- Price of a stock has a low correlation compared to its value. Value is subjective, price is
objective. Investors make money in the market by exploiting the differences in price and value.
If Value>price then buy If Value<price then sell

Valuation consists of DCF and multiples- A=L+E where liabilities (debt) is assumed
DCF is discounted cash flow, (Equity free cash flow to the firm or FCFF.
Networking capital is current assets minus current liabilities
Funds needed to run the business on a daily basis

FCFF=EBIT (1-tax rate) + Depreciation expense-investment capex investment in

networking capital
FCFF=EBIT is Dep
(1)Forecast financials three years or five years
(2) calculate FCCFF projected
Valuation three-year forecast
1. Enterprise value
FCFF /(1+WCC)^1 + FCFF_2/(1+WACC)^2 + FCFF_3/(1+WACC)^3 + TV^3/
1+WACC^3
WACC-Weighted average cost of capital average financial costs to the firm
2. Firm value equals future cash+current Cash
Which is equal to enterprise value+ cash and marketable securities
3. Equity value= Firm value- debt both short and long
4. Equity value P share= Equity value divided by number of shares outstanding
*NOPAT=ebit after tax
Other valuation approaches are multiples, p/e, Ebidta, ebit
P/E= 12x
Eps projected = $12/ps

v=p/e fwd X Eps proj I.E. 12X2 $24/Sh equity

Ex2 EBIDTA=2,000,000
Shares outstanding : 1,000,000
Ebidta multiple =10x
V=20million/1mil

V= ebidta (multiple) X ebidta divided by# of shares

=20.00 p/s

Assumption of multiples
1. structurally Industry will remain the same
2. All the firms in the industry have the same level of debt
3. Investor sentiment will be the same going forward as it has been historically
ETF Exchange traded funds- scale pricing used to be the way mutual funds were traded
prior to the inspection of ETFs

In-kind- no cash involved

SPDR- S&P Depository receipt
The S&P is the index the SPDR minutes
NASDAQ 100QQQQ
DJIA diamonds
Vanguard vipers lions tigers
Formation of an ETF is in-kind transaction
Bonds- debt interest rate sensitivity
Int up

bond price up

Bond portfolio strategy for construction

1. ladder strategy: invest in number bond at each maturity level
2. Barbell: by maturities are concentrated at two extreme maturities
3. Bullet strategy: the bond maturity to concentrate at a specific maturity
*** when the investment horizon matches the maturity of the bond is said to be
immunized****
Profitability measures how well a firm is doing to make money. How efficiently the firm
uses its assets to make money.

Profitability ratios-

Profit 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 share

market value per share

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 relative to the
EBITDA
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)
Fundamentals of Finance Lecture Two Notes 8-28-14

Balance Sheet: Be able to group numbers together and form a balance sheet. 1) Is the
company profitable? Look at retained earnings, total assets, investments in PP&E. Has
the company paid down any debts? The balance sheet is a main source of generating
income for a firm.

2) What determinations can you form looking at the balance sheet?

On an exam: What is the balance sheet telling you about the firms financial position.
Whats the indication of profitability using the b/s.
- When a firm carries more long term debt than current debt it signifies a longer term
cycle of selling its inventory or products. The turnover of goods takes longer aka
Walmart.

-All balance sheets are recorded at historical cost. Used because of the GAAP
principals.

Example Walmart
Revenue cost of Revenue = GP operating expenses= Operating income ( income
generated from operations) If IT was generating income it would not be in this category).
Chapter 5 Finance Class Notes 9/11/14

(1) Profit Margin: pm internally generated funds SGR

(2) Dividend policy: dividend payout Return Ratio Internally generated
funds ^
3. financial policy : amount of financial leverage (goes UP) sgr^
4. Total asset turnover: more sales for dollar of assets (asset efficiency) (UP)SGR
(up)

Ch 5

Time Value of money 012345

$

Inflation- decrease of purchasing power over time

-increase in prices
measurement done (CPI) consumer price index (measures retail prices) and (PPI)
measures producers prices

Future Value: amount of money one will have in the future.

FV= PV (1+r)^t
Where
PV=present value
R= interest rate
Time period
Future value
Example
John invests 100.00 in a savings account that pays 10% interest. How much
money will john have in 5yrs
FV=pv(1+r)^t

side note (1+r)^t is the compounding factor

=100(1+.10)^5
=161.05
Compound interest is interest principal and on the interest.
Simple interest- is interest only on the principal. 100x.10=$10 simple interest after 5yrs
would be 150

Present value- value today of future cash flows discounted at some interest rate
Pv= fv / (1+r) Discounting
Example : bob needs 1k in 3yrs, if he can earn 15% on these funds, how much should he
invest today? PV= 1,000 / (1+.15)^3 pv=1,000{.6575} pv=$657.50

These are all lump sum amounts

Pv=fv/ (1+r)^t
T^ =pv (down)

Fv= pv(1+r)^t
t^=fv^
r^=fv^

Pv= fv/(1+r)^t or pv=FV{1/(1+r)^t

Find the discount rate R

Example: john is offered a financial product that will pay him 200 in 8yrs if he invests
100 today, 1. What is the return on this product? 2. Did john double his money.
PV=100
FV-200
t= 8yr
r=?

pv= fv / (1+r)^t

100=200
^(1+r)^8
(1+ r)8