BEC 5 - Ratios

Asset Turnover

net sales/average total assets or net sales/total assets net sales = sales - (returns, allowances, and discounts) *Don't confuse Net Sales with Gross Margin. Recall Gross Margin is after cost of goods sold. Net sales is after discounts, and returns.

· Quick Ratio (AKA acid test)

o (Current Assets - inventor) / Current Liabilities

· Inventory Turnover Ratio

o COGS / Average Inventory § Average inventory = (beginning + ending)/2

· Current Ratio

o Current Assets / Current Liability

Cash Ratio

(Cash + Cash Equivalents) / Current Liabilities

Depreciation method Sum of the years digit

(Cost - Residual) (years left / sum of years) (50,000 - 5,000) * 5/15 = 15,000

Return on Investment (Dupont approach)

(Net income/Sales) * (Sales/Average total assets) hence, Return on Sales * Asset Turnover

Return on Equity

(net income - preferred dividends) / average common stockholders' equity

AP Turnover Ratio

* COGS/Average AP Average AP = (Beginning + Ending)/2

Internal Rate of Return (IRR) 1. Considers salvage value? 2. Considers Depreciation? 3. Equation

1. Yes 2. No depreciation in equation 3. Equation Inflow changes to percent in which Inflow = Inflow/x NPV = Inflow - Outflow 0 = Inflow/x - Outflow

Gordon Growth Model Dividends are equal to $5, and the current share price is $50. Dividends are expected to grow at 2% forever. According to the dividend growth model, what is the investor's required rate of return?

50 = (5*1.02) / (RROR-.02) RROR

Economic Order Quantity (2APS) Equation Asher Industries sells 45,000 Smart Phones in its California establishment, evenly throughout the year. Their desired safety stock is 1,250 units, their average cost of processing a purchase order is $24 and the cost of carrying one unit in inventory for one year is $6. What is Asher Industries' economic order quantity?

A - quantity selling P - price/cost of carrying a unit S - safety stock determines the optimal number of inventory units to be ordered at one time to minimize the total of inventory carrying costs and restocking (ie, ordering) costs.

Current Liabilities

Accounts Payable Unearned Revenue Taxes Payable Dividends Payable

Debt Ratio

Ass to the bottom total liabilities/total assets

Depreciation Method Double Declining

Carrying value * (2/useful life) 50,000 * (2/5) = 20,000 *no residual value

Examples of Equity

Common Stock Retained Earnings

Pay back Period Major Corp. purchased a machine for $5,000 which they will depreciate on the straight-line basis over an estimated useful life of five years. The machine has no salvage value. They expect the machine to generate after-tax net cash inflows from operations of $2,000 in each of the five years. Major's incremental borrowing rate is 10%. Information on present value factors is as follows:

Ignores net present value Initial investment / expected yearly income 5,000/2,000 = 2.5

Price Earnings Ratio (Basic - aka earnings per share) P/E Ratio

Stock Price / earnings per share tricky questions will include dividend to throw you off.

Selling Price

Cost of product/Cost % of sales ex. Cost = $178 Gross Margin 40% Cost Percent of Sale 60% 178/.60 = $296.67

Cash Conversion Cycle Inventory Conversion Period Account Receivable Collection Period Accounts Payable Deferral Period Roger's Appliance Warehouse has an inventory conversion period of 60 days, an accounts receivable collection period of 25 days and an accounts payable deferral period of 29 days. How long is their Cash Conversion Cycle?

Inventory Conversion Period = Avg. Inventory /COGS per day AR Collection Period = Avg. AR / Avg. credit sales per day Accounts Payable Deferral Period = Avg. AP / purchases per day (can be COGS/365) CCC = Inventory Conversion Period + AR Collection Period - Accounts Payable Deferral Period 60 + 25 - 29 = 56 days

Long Term Debt to Equity Ratio

Long Term Debt / Total Equity

Return on Assets (ROA) hint net

Net Income / Average Assets profitability ratio = in percentage form

Return on Sales (ROS)

Net Income/Sales or Operating Profit / Sales

Accounts Receivable Turnover (AKA AR Turnover)

Net Sales / Average Accounts Receivable net sales = sales - (returns, allowances, and discounts) *Don't confuse Net Sales with Gross Margin. Recall Gross Margin is after cost of goods sold. Net sales is after discounts, and returns. Questions will confuse by including COGS in in question for AR turnover.

Return on Investment (ROI)

Net income/Avg. Investment Value or (Current val of invest. - cost of investment)/Cost of Investment

Examples of Long Term Debts

Non-current deferred revenue Bonds Payable

Net Present Value Noah Co. is negotiating for the purchase of equipment that would cost $100,000, with the expectation that $20,000 per year could be saved in after-tax cash costs if the equipment were acquired. The equipment's estimated useful life is 10 years, with no residual value, and would be depreciated by the straight-line method. Noah's predetermined minimum desired rate of return is 12%. Present value of an annuity of 1 at 12% for 10 periods is 5.65. Present value of 1 due in 10 periods at 12% is .322. A. Does NPV consider Depreciation B. Does NPV consider Salvage value

Only the NPV method uses a discount rate determined in advance (prior calculation) A. No depreciation B. Yes salvage value on last year

Residual Income

Operating Profit - Interest on Investment NOT contribution margin Could be income less imputed interest on its invested capital

Profitability Index (PI) Depreciation? Salvage?

Present Value of Future Cash Flows / Initial Investment NO, Depreciation in calculation YES, Salvage value adds to final year of inflows

Market Rate of Interest on a one year US treasury bill The risk free rate of interest 2% Inflation Premium 1% Default risk premium 3% Liquidity Premium 2% Maturity Risk Premium 1%

Risk free rate of interest + inflation premium .02 + .01 = .03

What does Beta measure in the capital asset pricing model?

The volatility of a stock relative to the market.

Cost of Loan (compensating balance) A company has an outstanding one year bank loan of 500,00 at a stated interest rate of 8%. The company is require to maintain a 20% compensating balance in its checking account. The company would maintain a zero balance in this account if the requirement did not exist. What is the effective interest rate of the loan?

Total Interest Paid / Net Funds Available net funds available = Total loan - compensating balance 1. Interest paid = 500,000 *.08 = 40,000 2. Net Funds = 500,000 - (500,000*.2) = 400,000 3. Effective Interest rate = 40,000/400,000 = 10%

Black Sholes Model Variables (VICES)

Volatility Interest Rate (Risk Free) Common Stock Price Expiration Strike Price

Pay Back Period Noah Co. is negotiating for the purchase of equipment that would cost $100,000, with the expectation that $20,000 per year could be saved in after-tax cash costs if the equipment were acquired. The equipment's estimated useful life is 10 years, with no residual value, and would be depreciated by the straight-line method. Noah's predetermined minimum desired rate of return is 12%. Present value of an annuity of 1 at 12% for 10 periods is 5.65. Present value of 1 due in 10 periods at 12% is .322.

calculated by dividing initial investment by expected yearly income or savings Initial investment / expected yearly income = how many years for investment to pay back (pay back period) Pay back period = 100,000/20,000 = 5 years

Working Capital or Net working capital

current assets - current liabilities current asset includes: cash short term investment AR inventories

Times Interest Earned A company has income after tax of $5.4 million, interest expense of $1 million for the year, depreciation expense of $1 million, and a 40% tax rate. What is the company's times-interest-earned ratio?

earnings before interest and taxes/interest expense add back to before taxes: .6x = 5.4M > 5.4M/.6 = 9MM add back interest = 9MM + 1MM = 10MM 10MM/1MM = 10

Cost Of Preferred Stock · ex preferred stock sold for $40 share with par of $20. Cost of issuing stock was $5/per - issued @ 9% preferred stock

· Dividend = par value * preferred stock % o 20 * .09 = 1.8 · Net issue price = sold value - cost of issuing o 40-5 = 35 · Dividend/net issue price o 1.8/35 = .0514 or 5.1%

Weighted Average Cost of Capital (WACC) A company with a combined federal and state tax rate of 30% has the following capital structure: Weight Instrument Cost of capital 40% Bonds 10% 50% Common stock 10% 10% Preferred Stock 20% what is the weighted average after tax cost of capital for this company?

· WACC = (weight of bonds * cost of capital) + (weight of common stock * cost of capital) + preferred stock * cost of capital) o If federal and state tax rate given will effect cost of bonds only § For instance, bond weight 40% * cost of capital 10% (1 - 30% federal and state tax rate) = .028 or 2.8%