Finance 335

Exam 1 Review
Chapter 1
Agency relationships
 An agency relationship exists whenever a principal hires an agent to act on their
behalf.
 Within a corporation, agency relationships exist between:
Shareholders and managers

 Managers are naturally inclined to act in their own best interests.

But the following factors affect managerial behavior:
 Managerial compensation plans
 Direct intervention by shareholders
 The threat of firing
 The threat of takeover

Financial Goals of the Corporation

 The primary financial goal is shareholder wealth maximization, which translates
to maximizing stock price.

Chapter 5
FV = PV(1+i)n n= number of periods (years)
Financial Calculator - BA II PLUS
Calculate the future value of $100 in 2 years earning 10% interest per year
2nd FV (clears calculator of any numbers)
2ND I/Y 1 Enter CE/C (computes interest
on yearly basis)
2nd . 4 Enter CE/C (4 decimal places)
2 N (2 year period)
10 I/Y (10% interest rate)
- 100 PV (100 is the present value amount)
CPT FV (computes future value = 121)

Present Value - find the amount of money to invest today to have $1000 in 5 years if
the investment earns 10%.
PV = FV(1/1+i)N
Financial Calculator
2nd FV (Clears calculator)
5 N ( 5 years)
10 I/Y (10% interest)
1000 FV (1000 in 5 years)
CPT PV (Finds present value amt=$620.92)
72 / % = number of years to double
investment
Annuity: FV = PMT [(1+i) n – 1] / i

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Find the future value of four $100 payments made at the end of each year for four years if
you earn 10% per year
2nd FV (clear calculator)
4 N (4 payments)
10 I/Y (10% interest)
- 100 PMT (100 payments)
CPT FV (Calculates future value = $464.10)

PV = PMT [(1 - (1/1+i)t ] / i

2nd FV (clears calculator)
4 N (4 payments)
10 I/Y (10% interest)
100 PMT ($100 payments)
CPT PV (calculates present value = 316.98)

Loan: PV of Annuity

PV (Perpetuity) = Payment / Interest Rate

Present value of a 10%, 3-year cash flow:

Yr Cash flow
1 1000
2 2000
3 1000
3313.30
BA II Plus
CF
2nd CE/C [Clears Calculator]
2nd . 4 Enter

CF [CFo=0.0000]
arrow down [C01 0.0000]
1000 Enter [C01 = 1000]
arrow down [F01= 1.000]
arrow down [C02 0.0000]
2000 Enter [C02= 2000]
arrow down [F02= 1.000]
arrow down [C03 0.0000]
1000 Enter [C03= 1000]
NPV [I = 0.00000]
10 Enter [I = 10.0000]
arrow down [NPV= 0.0000]
CPT [NPV= 3313.30]

Effective annual rate = (1 + i/m)m - 1 m = number of compounding periods in year

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Chapter 3
NOPAT = EBIT (1 – Tax rate) NCF = Net Income + Depreciation
OCF = NOPAT + Dep
NOWC = Current Assets – Accounts Payable – Accruals
Net Operating Working Capital

Operating Capital = NOWC + Net Fixed Assets

Economic Value Added (EVA)
EVA = Funds Available - Cost of
to Investors Capital Used
EVA = NOPAT – [After-tax Cost of Capital * (Operating Capital)]

Market Value Added (MVA)

MVA = Market value - Equity capital
of equity supplied
Market Value of Equity = # of shares of Common Stock Outstanding * Price per share
Equity Capital Provided = Common Stock + Retained Earnings (Balance Sheet)

Problems.
The Klaven Corporation has operating income (EBIT) of $750,000. The company's
depreciation expense is $200,000. Klaven is 100 percent equity financed, and
it faces a 25 percent tax rate. Assume that the firm has no amortization
expense. What are its net income, its net cash flow, and its operating cash
flow? 750,000- (.25*750000) = net income [EBIT = EBT no interest]
OCF = (750000 * (1-.25)) + 200,000 =

3-10 Bailey Corporation recently reported the following income statement (dollars are
in thousands):
Sales $14,000,000
Operating costs excluding depreciation and amortization 7,000,000
EBITDA $ 7,000,000
Depreciation and amortization 3,000,000
EBIT $ 4,000,000
Interest 1,500,000
EBT $ 2,500,000
Taxes (25%) 625,000
Net income $ 1875,000
Bailey's total operating capital is $20 billion and its after-tax cost of capital is
10 percent. Therefore, Bailey's total after-tax dollar cost of operating capital
is $2 billion. During the past year, Bailey made a $1.3 billion net investment
in its operating capital.
a. What is Bailey's NOPAT for the year? NOPAT = 4,000,000(1-.25)
b. What is Bailey's net cash flow for the year? NCF = 1875000 + 3,000,000
c. What is Bailey's operating cash flow for the year? NOPAT + DA
d. What is Bailey's EVA for the year? 3.0 billion – [.10*(20 billion)] =

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Chapter 4
Liquidity Ratio
Current ratio = Current assets / Current liabilities

Asset Management Ratios

INV. Turnover = Sales / Inventories
DSO = Receivables / Average sales per day
FA turnover = Sales / Net fixed assets
TA turnover = Sales / Total assets

Debt & Debt Coverage Ratios

Debt ratio = Total debt / Total assets
TIE = EBIT / Interest expense

EBITDA = (EBITDA+Lease pmts)

coverage Int exp + Lease pmts + Principal pmts

Profitability Ratios
BEP = EBIT / Total assets
ROA = Net income / Total assets
ROE = Net income / Total common equity
Market Value Ratios
P/E = Price / Earnings per share
P/CF = Price / Cash flow per share
M/B = Mkt price per share / Book value per share
Extended Dupont Ratio
ROE = (Profit margin) x (TA turnover) x (Equity multiplier)

Problems:
4-13 The H.R. Pickett Corporation has $500,000 of debt outstanding, and it pays an
interest rate of 10 percent annually. Pickett's annual sales are $2 million, its
average tax rate is 30 percent, and its net profit margin on sales is 5 percent. If
the company does not maintain a TIE ratio of at least 5 times, its bank will refuse
to renew the loan, and bankruptcy will result. What is Pickett's TIE ratio?
Net Income = $2,000,000 * .05 = 100,000 EBT(1-.3) = NI so EBT = 100,000/.7= 142,875
Interest = Debt * interest rate = 500,000 * .10 = 50,000 EBIT = 142,875 + 50,000 = 192,875

Formula Sheet
NOPAT = EBIT (1 – Tax rate) NCF = Net Income + Depreciation
OCF = NOPAT + Dep
NOWC = Cash + AR + Invent – Accounts Payable – Accruals
Net Operating Working Capital
Operating Capital = NOWC + Net Fixed Assets Div per Share = Divs/#of Share
Avg Tax Rate = Taxes/Taxable Income
Economic Value Added (EVA)
EVA = Funds Available - Cost of
to Investors Capital Used

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 EVA = NOPAT – [After-tax Cost of Capital * (Operating Capital)]
Add To RE = Net Income - Dividends
Market Value Added (MVA)
MVA = Market value - Equity capital
of equity supplied
Market Value of Equity = # of shares of Common Stock Outstanding * Price per share
Equity Capital Provided = Common Stock + Retained Earnings (Balance Sheet)
FV = PV(1+i)n PV = FV(1/1+i)N Effective annual rate = (1 + i/m)m - 1
72 / % = number of years to double investment
Annuity: FV = PMT [(1+i) n – 1] / i PV = PMT [(1 - (1/1+i)t ] / i
Liquidity Ratio
Current ratio = Current assets / Current liabilities
Asset Management Ratios
INV. Turnover = Sales / Inventories
DSO = Receivables / Average sales per day
FA turnover = Sales / Net fixed assets
TA turnover = Sales / Total assets
Debt & Debt Coverage Ratios
Debt ratio = Total debt / Total assets
TIE = EBIT / Interest expense
EBITDA = (EBITDA+Lease pmts)
coverage Int exp + Lease pmts + Principal pmts
Profitability Ratios
BEP = EBIT / Total assets PM = NI/Sales
ROA = Net income / Total assets
ROE = Net income / Total common equity
Market Value Ratios
P/E = Price / Earnings per share
P/CF = Price / Cash flow per share

M/B = Mkt price per share / Book value per share

Extended Dupont Ratio
ROE = (Profit margin) x (TA turnover) x (Equity multiplier)