MGT338 - Business Finance I

Investors often use accounting statements to evaluate a firm in one of two ways: Compare the firm with itself by analyzing how the firm has changed over time. Compare the firm to other similar firms using a common set of financial ratios. Profitability Ratios Information used here comes from the income statement. Gross Margin This tells us a firm’s ability to sell a product for more than cost of producing it. Operating Margin This reveals how much a company earns before interest and taxes from

3.2: Interest Rates & the Time Value of Money The Time Value of Money (TVM) In general, a dollar today is worth more than a dollar in one year. If you have $1 today, you can invest it. For example, if you deposit it in a bank account paying 7% interest, you will have $1.07 at the end of one year. We call the difference in value between money today and money in the future the time value of money. The Interest Rate: An Exchange Rate Across Time The rate at which we can exchange money today for mon

4.1: The Timeline We can represent a stream of cash flows on a timeline, a linear representation of the timing of the expected cash flows. Suppose you loan your brother $10,000 today and receive two instalments of $6,000 at the end of each of the next two years. 4.2: The Three Rules of Time Travel Rule 1: Only Cash Flow Values at the Same Point in Time Can Be Compared or Combined Our first rule is that it is only possible to compare or combine values at the same point in time. Rule 2: To Move a

5.1: Interest Rate Quotes and Adjustments The Effective Annual Rate (EAR) Interest rates are often stated as an effective annual rate (EAR), which indicates the total amount of interest that will be earned at the end of one year. In Chapters 3 & 4, all interest rates were EARs. Adjusting the Effective Annual Rate to an Effective Rate Over Different Time Periods Imagine an effective annual rate of 5%. A $100,000 investment after 2 years grows to: This shows that earning an effective annual rate

Notation CPN = Coupon Payment on a Bond rn = Interest Rate or Discount Rate for a Cash Flow that Arrives in Period n n = # of Periods PV = Present Value YTM = Yield to Maturity NPER = Annuity Spreadsheet Notation for # of Periods or Dates of the Last Cash Flow P = Initial Price of a Bond RATE = Annuity Spreadsheet Notation for Interest Rate FV = Face Value of a Bond PMT = Annuity Spreadsheet Notation for Cash Flow YTMn = Yield to Maturity on a Zero-Coupon Bond with n Periods to Maturity APR = An

Notation Pt = Stock Price at the End of Year t rE = Equity Cost of Capital n = Termination Date or Forecast Horizon g = Expected Dividend Growth Rate Divt = Dividends Paid in Year t EPSt = Earnings per Share on Date t PV = Present Value EBIT = Earnings before Interest & Taxes FCFt = Free Cash Flow on Date t Vt = Enterprise Value on Date t τc = Corporate Tax Rate rwacc = Weighted Average Cost of Capital gFCF = Expected Free Cash Flow Growth Rate EBITDA = Earnings before Interest, Taxes, Depreciat

8.1: NPV and Stand-Alone Projects The Net Present Value (NPV) Decision Rule When making an investment decision, take the alternative with the highest NPV. Choosing this alternative is equivalent to receiving its NPV in cash today. In the case of a stand-alone project, we must choose between accepting and rejecting the project. The NPV rule then says we should compare the project’s NPV to zero (the NPV of doing nothing) and accept the project if its NPV is positive. Applying the NPV Rule Research