Introduction to Financial Management and Key Concepts

I. Introduction
to
Financial
Management

Finance-‐
the
study
of
how
individuals
and
business
allocate

money
over
time

Three
(3)
Basic
Questions
Addressed
by
Finance:

1. What
long-‐term
investment
should
the
firm
undertake?

(CAPITAL
BUDGETING)

2. How
should
the
firm
raise
money
to
fund
these

investments?

(CAPITAL
STRUCTURE)

3. How
can
the
firm
best
manage
its
cash
flows
as
they

arise
in
its
day-‐to-‐day
operations

(WORKING
CAPITAL
MANAGEMENT)

Three
(3)
Types
of
Business
Organizations:

1. Sole
Proprietorship—owned
by
single
individual
who
is

entitled
to
all
of
the
firm’s
profits
and
is
also
responsible

for
all
the
debts.

2. Partnership—two
or
more
who
come
together
as
co-‐
owners
for
the
purpose
of
operating
a
business
for
profit

3. Corporation—an
artificial
being
with
legal
functions

separate
and
apart
from
its
owners
(the
shareholders
/

stockholders)

Four
(4)
Basic
Principles
of
Finance

1. Money
Has
Time
Value
–
a
dollar
received
today
is

worth
more
than
a
dollar
received
in
the
future
and
vies

versa.

2. There
is
a
Risk-‐Return
Tradeoff
–
we
won’t
take

additional
risk
unless
we
expect
to
be
compensated
with

additional
return

3. Cash
Flows
Are
the
Source
of
Value
–
Profit
Is
an

accounting
concept
designed
to
measure
a
business’s

performance
over
an
interval
of
time.
Cash
flow
is
the

amount
of
cash
that
can
actually
be
taken
out
of
the

business
over
this
same
interval.

4. Market
Price
Reflect
Information
–
Investors
respond
to

new
information
by
buying
and
selling
their
investment.

The
speed
with
which
investors
act
and
the
way
that

prices
respond
to
the
information
determines
the

efficiency
of
the
market.

II. Stocks

Security—is
a
negotiable
instrument
that
represents
a

financial
claim
(stocks
or
debt
agreements)

Two
(2)
Types
of
Security
Markets:

1. Primary
Market
–
market
that
is
new
as
opposed
to

previously
issued,
securities
are
bought
and
sold

for
the
first
time

2. Secondary
Market
–
all
subsequent
trading
of

previously
issued
securities
takes
place.

How
Security
Markets
Link
Corporations
and
Investors:

a)
The
firm
sells
securities
to
investors
(a
primary

market
transaction
of
debt
or
equity
of
the

corporation)

b) The
firm
invests
the
funds
raised
from
transaction

into
businesses

c) The
firm
distributes
the
cash
earned
from
its

investments
(investors
gain
cash
through
cash

dividends
or
repurchase
of
shares
of
previously

issued
stock)

d) Securities
trading
in
the
secondary
market
(after

(a)
investors
may
resell
debt
or
equity
purchased

from
corporation)

Two
(2)
Types
of
Securities:

1. Debt
Securities
–
a
firm
borrows
money
by
selling

debt
securities
in
the
debt
market.

a. Bonds—a
long
term
(10
yrs.
or
more)

promissory
note
issued
by
the
borrower,

promising
to
pay
the
owner
of
the
security

a
predetermined
amount
of
interest
each

year

2. Equity
Securities
–
represents
ownership
of
the

corporation

a. Common
Stock
–
represents
residual

ownership
of
firm.
Usually
entitles
the

owner
to
vote
at
shareholder’s
meetings

and
to
receive
dividends.

b. Preferred
Stock–
holds
preference
over

common
stock
in
terms
of
the
right
to
the

distribution
of
cash
(dividends)
and
the

right
to
the
distribution
of
proceeds
in
the

event
of
the
liquidation
and
sale
of
the

issuing
firm.
Generally
does
not
have

voting
rights,
but
has
a
higher
claim
on

assets
and
earnings
than
the
common

shares.

Stock
Valuation
—The
more
people
that
want
to
buy
stock,

the
higher
its
price
will
be.

𝑃𝑟𝑖𝑐𝑒/ 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑅𝑎𝑡𝑖𝑜 =
𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
=
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑜𝑛 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑆𝑡𝑜𝑐𝑘
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑆ℎ𝑎𝑟𝑒𝑠

III. Financial
Ratios
(Analysis,
etc)

A. Liquidity
Ratio
–
Measures
of
the
ability
of
the
firm
to

pay
its
bills
in
a
timely
manner
when
they
come
due

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

𝐴𝑐𝑖𝑑 𝑇𝑒𝑠𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑
=
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑖𝑒𝑣𝑎𝑏𝑙𝑒
𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒
365 𝑑𝑎𝑦𝑠

𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜
=
𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑖𝑒𝑣𝑎𝑏𝑙𝑒

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑 𝑆𝑜𝑙𝑑
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠

B. Capital
Structure
Ratio
–
The
mix
of
debts
and
equity

securities
a
firm
uses
to
finance
its
assets

𝐷𝑒𝑏𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

𝑇𝑖𝑚𝑒𝑠 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑎𝑟𝑛𝑒𝑑 =
𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒/𝐸𝐵𝐼𝑇
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒

C. Assets
Management
Efficiency
Ratios
–
Measures
how

well
assets
are
managed
to
generate
sales

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝑆𝑎𝑙𝑒

𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝑆𝑎𝑙𝑒
𝑁𝑒𝑡 𝑃𝑙𝑎𝑛𝑡 𝑎𝑛𝑑 𝐸𝑞𝑢𝑖𝑝𝑚𝑒𝑛𝑡

D. Profitability
Ratio
–
Answer
the
question
“has
the
firm

earned
adequate
returns
on
its
investments?”

𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 =
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
𝑆𝑎𝑙𝑒𝑠

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛
=

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 =
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐴𝑠𝑠𝑒𝑡𝑠
=

𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦 =
𝐶𝑜𝑚𝑚𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦

E. Market
Value
Ratio
–
Answers
the
question
“how
are

the
firm’s
shares
valued
in
the
stock
market?”

𝑃𝑟𝑖𝑐𝑒/ 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑅𝑎𝑡𝑖𝑜
=
𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

𝑀𝑎𝑟𝑘𝑒𝑡 𝑡𝑜 𝐵𝑜𝑜𝑘 𝑅𝑎𝑡𝑖𝑜 =
𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟 𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒

FINANCIAL
ANALYSIS

Questions:
Category
of
Ration
Used
to

Address
the
Questions

1. How
liquid
is
the

firm?
Will
it
be
able
to

pay
its
bills
as
they

come
due?

Liquidity
Ratio

2. How
has
the
firm

finance
the
purchase

of
its
assets?

Capital
Structure
Ratio

3. How
efficient
has
the

firm’s
management

been
in
utilizing
its

assets
to
generate

sales?

Asset
Management

Efficiency
Ratios

4. Has
the
firm
earned

adequate
returns
on

its
investments?

Profitability
Ratio

5. Are
the
firm’s

managers
creating

value
for

shareholders?

Market
Value
Ratio

IV. Quick
Ratio

Since
Current
ratio
assumes
that
firms
account
receivables

will
be
collected
and
turned
into
cash
on
a
timely
basis
and

inventories
can
be
sold
without
delay,
QUICK
RATIO
takes

into
account
that
inventories
might
not
be
very
liquid.

𝑄𝑢𝑖𝑐𝑘 (𝐴𝑐𝑖𝑑 𝑇𝑒𝑠𝑡) 𝑅𝑎𝑡𝑖𝑜
=

V. Cash
outflows

STATEMENT
OF
CASH
FLOW

Ending
cash
balance
of
2009

(beginning
balance
of
2010

$94.50

A)
Operating
Activities

Net
Income
$204.75

Increase
in
accounts
receivables
(22.50)

Increase
in
inventories
(148.50)

No
change
in
other
current

assets

-‐

Depreciation
expense
135.00

Increase
in
Accounts
Payable
4.50

No
Change
in
accrued
expenses
-‐

Cash
Flow
From
Operating

Activities

$173/25

B)
Investing
activities

Purchase
of
plant
and
equipment
(175.50)

Cash
Flow
from
Investing

Activates

(175.50)

C)
Financing
Activities

Increase
in
short-‐term
notes
(9.00)

Increase
in
long-‐term
notes
51.75

Cash
Dividends
paid
to
share

holders

($45.00)

Cash
Flow
from
Financing

Activities

($2.25)

Increase
(decrease)
in
cash
during

($4.50)

the
year

End
Cash
Balance
for
2010

$90.00

VI. Financial
Statements

Four
(4)
basic
financial
statements
and
basic
information
for

each

i. Income
Statement
–
includes
the
revenue,
expense,

and
profit
made
by
the
firm
over
a
specific
period
of

time

ii. Balance
Sheet
–
is
a
snapshot
of
the
firms
assets,

liabilities,
and
owner’s
equity
for
a
particular
date

iii. Cash
Flow
Statement
–
cash
received
and
spent
over

a
specific
period
of
time.

§ Operating
Activities
–
includes
sales
and

expenses
(cash
activity
that
affects
net
income)

§ Investment
Activities
–
includes
cash
flow
that

arise
out
of
the
purchase
and
sale
of
long-‐term

assets
such
as
plant
and
equipment

§ Financing
Activities
–
represents
changes
in

debts
and
equity.
It
includes
the
sale
of
new

shares
of
stock,
the
repurchase
of
outstanding

shares,
and
the
payment
of
dividends

iv. Statement
of
Shareholder’s
Equity
–
provides

detailed
accounts
on
firm’s
activities
such
as:

§ Common
and
Preferred
stock
accounts

§ Retained
earning
accounts

§ Changes
in
owner’s
equity
that
do
not
appear
in

the
income
statement

Three
(3)
uses
of
financial
statements
in
management

1) Financial
Statement
Analysis
–
asses
current

performance

2) Financial
Control
–
monitor
and
control
operations

using
accounting
measures

3) Financial
Forecasting
or
Planning
–
financial

statements
are
universally
understood
format
for

describing
operations
and
is
used
as
a
prototype
for

financial
planning
models

VII. Dividends

Dividends—a
portion
of
corporation’s
earnings
that
are

distributed
to
its
shareholders

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
=
𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑡𝑜𝑐𝑘 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠
𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑆ℎ𝑎𝑟𝑒

VIII. ROA,
ROE


𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐴𝑠𝑠𝑒𝑡𝑠 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

IX. Time
Value
of
Money

A
dollar
received
today,
other
things
being
the
same,
is

worth
more
than
a
dollar
received
years
from
now.

X. EAR

Effective
Annual
Rate—indicates
the
interest
rate
paid
or

earned
in
one
year
without
compounding

𝐸𝐴𝑅 = 1 +
𝑄𝑢𝑜𝑡𝑒𝑑 𝐴𝑛𝑛𝑢𝑎𝑙 𝑅𝑎𝑡𝑒
𝐶𝑜𝑚𝑝𝑖𝑛𝑑𝑖𝑛𝑔 𝑃𝑒𝑟𝑖𝑜𝑑 𝑝𝑒𝑟 𝑌𝑒𝑎𝑟 (𝑚)
!
− 1

XI. Future
value
of
ordinary
annuity

Ordinary
Annuity
–
payments
are
made
at
the
end
of
each

month.

𝑭𝑽 𝒏 = 𝑷𝑽 𝟏 + 𝒊 𝒏

XII. Annuity
vs
Perpetuity

a) Annuity
is
defined
as
a
series
of
equal

dollar
or
peso

payments
that
are
made
at
the
end
of
equidistant

points
in
time
such
as
monthly,
quarterly,
annually

over
a
finite
period
of
time
such
as
three
years
while

b) Perpetuity
is
simply
an
annuity
that
continues
forever

or
has
no
maturity.

XIII. Present
value
of
cash
flows

𝑷𝑽 = 𝑭𝑽 𝒏
𝟏
(𝟏 + 𝒊) 𝒏

𝑭𝑽 𝒏 = 𝑷𝑽 𝟏 + 𝒊
𝒎
𝒎𝒏

Intraperiod
Compounding
–
compounding
that
occurs
more

than
once
a
year.

XIV. Bonds

An
obligation
made
binding
by
a
money
forfeit;
also:
the

amount
of
money
guarantee

Bond Value = i
1 −
1
1 + YTM!"#$%&
!
YTM!"#$%&
+ Principal
1
1 + YTM!"#$%&
!

BASIC
FEATURES:

1. Bond
Indenture—is
the
legal
agreement
between

the
firm
issuing
the
bonds
and
the
trustee
who

represents
the
bond
holders

2. Claims
on
Assets
&
Income—If
the
borrowing
firm
is

unable
to
repay
the
debt,
the
claims
of
the
debt

holder
must
be
honored
before
thos
of
the
firm’s

stockholders

a. If
interest
on
bond
is
not
paid,
bond

trustees
can
classify
the
firm
as
insolvent

and
force
it
into
bankrupcy

3. Par
or
Face
Value—an
amount
that
must
be
repaid

to
the
bondholder
at
maturity

4. Coupon
Interest
Rate—idicates
the
percentage
of

the
par
value
bond
that
will
be
paid
out
annually
in

the
form
of
interest

5. Maturity
and
Repayment
of
Principal—indicates
the

length
of
time
until
bond
issuer
returns
he
par
value

to
the
bondholder
and
terminates
or
redeems
the

bond

6. Call
Provision
and
Conversion
Features-‐-‐

is
most

valueable
when
the
bond
is
sold
during
a
period
of

abnormally
high
rate
of
interest,

such
that
there
is

reasonable
expectation
that
rates
will
fall
in
the

future
before
bond
matures.

a. Conversion
Features-‐-‐

allos
the

bondholders
to
convert
the
bond
into
a

prescribed
number
of
shares
of
the
firm’s

common
stock

TYPES
OF
BONDS

1. Secure
vs
Unsecured

a. Secured
bond
has
specific
assets
pledged
to

support
repayment
of
the
bond.

b. Unsecured
bond
applies
debenture
(any
form

of
unsecured
long-‐term
debt).

2. Priority
of
Claims
–
refers
to
the
place
in
line
where

the
bondholders
stand
in
securing
re-‐payment
out
of

the
dissolution
of
the
firm’s
assets.

3. Initial
offering
market
–
bonds
are
also
classified
by

where
they
were
originally
issued
(in
the
domestic

bond
market
or
elsewhere.

4. Abnormal
Risk
–
Junk,
or
high-‐yield,
bonds
have
a

below-‐investment
grade
bonding
rating
(facing

severe
financial
problems
and
suffering
from
poor

credit
ratings)

5. Coupon
level
–
bonds
with
a
zero
or
very
low

coupon
are
called
zero
coupon
bonds

6. Amortizing
or
Non-‐Amortizing

a. Amortizing
bonds,
like
a
home
mortgage
loan,

include
both
the
interest
and
a
portion
of
the

principal.

b. Non-‐amortizing
bond,
only
include
interest.

7. Convertibility
–
Convertible
bonds
are
debt

securities
that
can
be
converted
into
a
firm’s
stock
at

a
pre-‐specified
price

CURRENT
YIELD

Refers
to
the
ratio
of
the
annual
interest
payment
to
the

bond’s
current
market
price.

CY =
Annual Interest Payment
Current Market Price of Bond

XV. Bond's
yield
to
maturity

Bond Price =
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡!"#$ !
(1 + 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟𝑎𝑡𝑒)!
+
+ ⋯
+
1 + 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟𝑎𝑡𝑒 !
+
𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙

XVI. Book
value
per
share

Book Value per Share =
Common Shareholders!
Equity
Common Share Outstanding

XVII. Preferred
vs
Common
stock

Common
Stock—entitles
the
owner
to
vote
at
shareholder’s

meetings
and
to
receive
dividends.

a) Has
no
maturity
date

b) Life
is
limited
only
to
the
life
of
the
issuing
firm.

c) Common
dividends
have
no
maximum
or

minimums

d) Valuation
differs
from
the
the
valuation
of

preferred
stock
since
common
stock
has
no

promised
dividends.

Preferred
stock
–
generally
does
not
have
voting
rights,
but

has
a
higher
claim
on
assets
and
earnings
than
the
common

shares.

XVIII. Annual
Rate
of
Return

Rate
of
Return—Also
known
as
holding
period
return
is

simply
the
cash
return
divided
by
the
beginning
stock
price

𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛
= 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦!
+ 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦! + ⋯
+ 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦!

XIX. Risk
&
Return

Cash
Return
–
The
gain
or
loss
on
an
investment

𝐶𝑎𝑠ℎ 𝑅𝑒𝑡𝑢𝑟𝑛 =
𝐸𝑛𝑑 𝑃𝑟𝑖𝑐𝑒 + 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 − 𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒

Break
Even
Point

𝐵𝐸𝑃 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠 =
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡
1 − 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡
𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡

Standard
Deviation

𝜎 = ([𝑟! − 𝐸 𝑟 ]!×𝑃𝑏!) + ⋯ + ([𝑟! − 𝐸 𝑟 ]!×𝑃𝑏!)

Variance

𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = 𝜎!

XX. Payback
period

XXI. Capital
Budgeting

Typical
Capital
Budgeting
Process:

a) The
firm’s
management
identifies
promising

investment
opportunities

b) Once
an
investment
opportunity
has
been
identifies,

its
value-‐creating
potential,
what
some
refer
to
as
its

“value
position”
is
thoroughly
evaluated

Types
of
Capital
Investment
Project:

a) Revenue
enhancement
investment
projects

b) Cost-‐reduction
investment
projects

c) Mandatory
investments
that
are
a
result
of

government
mandates

Net
Present
Value
Criterion:
is
an
estimate
of
the
impact
of

the
investment
opportunity
on
the
value
of
the
firm

XXII. NPV

Net
Present
Value—It
compares
the
cost
of
investment
to

the
present
value
of
the
investment’s
inflows
and
outflow

as
time
passes.

OR

A)
Independent
investment
project
is
one
that
stands
alone

and
can
be
undertaken
without
influencing
the
acceptance
or

rejection
of
any
other
project.

Choosing
Between
Mutually
Independent
Investment:

1. Calculate
NPV;

2. Accept
the
project
if
NPV
is
positive
and
reject
if
it

is
negative.

B)
Exclusive
investment
project
is
one
that
does
not
stand

alone
and
can
influencing
the
acceptance
or
rejection
of
any

other
project
when
undertaken.

i. If
mutually
exclusive
investments
have
equal
lives,
we

simply
calculate
the
NPVs
and
choose
the
one
with
the

higher/highest
NPV.

EXAMPLE:
all
alternatives
last
for
10
years

ii. If
mutually
exclusive
investments
do
not
have
equal

lives,
we
calculate
the
Equivalent
Annual
Cost
(EAC),

the
cost
per
year;
then
select
the
one
that
has
the

lower/lowest
EAC.

EXAMPLE:
one
alternative
last
for
10
years
while
the

other
only
last
for
6
years

Choosing
between
Mutually
Exclusive
Investment:

1.
Compute
NPV

2.
Compute
EAC
as
per
equation
11-‐2

𝐸𝐴𝐶 =
𝑃𝑉 𝑜𝑓 𝐶𝑜𝑠𝑡𝑠
(1 + 𝑘)! + (1 + 𝑘)! + ⋯ + (1 + 𝑘)!

XXIII. Cost
of
Capital

Cost
of
capital
is
the
weighted
average
of
the
required

returns
of
the
securities
that
are
used
to
finance
the
firm

𝑊𝐴𝐶𝐶 = 𝑘!× 1 − 𝑇 ×𝑤! + (𝑘!"×𝑤!")

WACC—weighted
average
cost
of
capital

kd—after
tax
cost
of
debt

wd—proportion
of
capital
raised
by
debt

kcs—cost
of
common
stock

wcs—proportion
of
capital
raised
by
common
stock

T
–
tax
rate

XXIV. Dividend
policy
(Ex
dividend
date)

XXV. Retained
Earnings

A
portion
of
net
income
that
has
been
retained
from
the

prior
years’
operation

𝑅𝐸 = 𝐵𝑒𝑔. 𝑅𝐸 + 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠

NPV = CF0 +
CF1
(1+ k)1
+
CF2
(1+ k)2
+.....+
CFn
(1+ k)n
NPV = CF0 +
CF1
(1+ k)1
+
CF2
(1+ k)2
+.....+
CFn
(1+ k)n

MOST
USED
FORMULAS
IN
THE
FINALS:
(That
I
remember)

𝑃𝑉 = 𝐹𝑉!
1
(1 + 𝑖)!

𝐹𝑉! = 𝑃𝑉 1 + 𝑖
𝑚
!"

𝐹𝑉! = 𝑃𝑉 1 + 𝑖 !


𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐴𝑠𝑠𝑒𝑡𝑠 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

𝑁𝑃𝑉 = 𝐶𝐹! +
𝐶𝐹!
1 + 𝐼𝑅𝑅 !
= 0

𝐼𝑅𝑅 =
𝐶𝐹!
−𝐶𝐹!
!
− 1

𝐸𝐴𝐶 =
𝑃𝑉 𝑜𝑓 𝐶𝑜𝑠𝑡𝑠
(1 + 𝑘)! + (1 + 𝑘)! + ⋯ + (1 + 𝑘)!

𝑄𝑢𝑖𝑐𝑘 (𝐴𝑐𝑖𝑑 𝑇𝑒𝑠𝑡) 𝑅𝑎𝑡𝑖𝑜
=

𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛
= 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛!×𝑝𝑟𝑜𝑏𝑎𝑏𝑜𝑙𝑖𝑡𝑦!
+ ⋯

𝑊𝐴𝐶𝐶 = 𝑘!× 1 − 𝑇 ×𝑤! + (𝑘!"×𝑤!")

Book Value per Share =
Common Shareholders!
Equity
Common Share Outstanding

Bond Value = i
1 −
1
1 + YTM!"#$%&
!
YTM!"#$%&
+ Principal
1
1 + YTM!"#$%&
!

𝑅𝐸 = 𝐵𝑒𝑔. 𝑅𝐸 + 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠

NPV = CF0 +
CF1
(1+ k)1
+
CF2
(1+ k)2
+.....+
CFn
(1+ k)n

Introduction to Financial Management and Key Concepts

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