FINM 1 Financial Management Final Exam Reviewer PDF

FINAL EXAM REVIEWER FOR THE FIRST SEMESTER TIME VALUE OF MONEY - The concept that the money you have now is worth more than the identical sum in the future due to its potential earning capacity - “A Peso today is always worth more than a Peso tomorrow.” VARIABLES 1. PRESENT VALUE - Th...

FINAL EXAM REVIEWER FOR THE FIRST SEMESTER TIME VALUE OF MONEY - The concept that the money you have now is worth more than the identical sum in the future due to its potential earning capacity - “A Peso today is always worth more than a Peso tomorrow.” VARIABLES 1. PRESENT VALUE - This is your current starting amount. It is the money you have in your hand at the present time, your initial investment for your future. 2. FUTURE VALUE - This is your ending amount at a point in time in the future. It should be worth more than the present value, provided it is earning interest and growing over time. 3. THE NUMBER OF PERIODS (N OR T) - This is the timeline for your investment (or debts). It is usually measured in years, but it could be any scale of time such as quarterly, monthly, or even daily. 4. INTEREST RATE (I OR R) - This is the grow rate of your money over the lifetime of the investment. 5. PAYMENT AMOUNT (PMT) - These are a series of equal, evenly spaced cash flows, and uneven cash flow. FINM 1 – FINANCIAL MANAGEMENT 1  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER TYPES OF TIME VALUE OF MONEY 1. LUMP SUM - A single payment made at a particular time. - There is no cash flow in between Present Value and Future Value. 1.1.PRESENT VALUE LUMP SUM - Payment is made at the beginning of the timeline FV = Future Value I = Interest Rate M = Number of Period within a year N = Number of years 1.2.FUTURE VALUE LUMP SUM - Payment is made at the end of the timeline Examples: FINM 1 – FINANCIAL MANAGEMENT 2  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER FINM 1 – FINANCIAL MANAGEMENT 3  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER 2. ORDINARY ANNUITY - A series of equal payments made at the end of consecutive periods over a fixed length of time. 2.1. PRESENT VALUE ORDINARY ANNUITY 2.2.FUTURE VALUE ORDINARY ANNUITY FINM 1 – FINANCIAL MANAGEMENT 4  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER Examples: 3. ANNUITY DUE - A series of equal and consecutive payments that last for a certain period, but the payments start at the beginning of each time period and the last payment stops one period before the end of the specified time period. 3.1.PRESENT VALUE ANNUITY DUE FINM 1 – FINANCIAL MANAGEMENT 5  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER 3.2.FUTURE VALUE ANNUITY DUE Examples: FINM 1 – FINANCIAL MANAGEMENT 6  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER 4. PERPETUITY - A perpetual annuity - A series of equal infinite cash flows that occur at the end of each period and there is equa; interval of time between the cash flows. - There is no end point for the cash flows. 4.1.PRESENT VALUE PERPETUITY Examples: TIME VALUE OF MONEY SAMPLE PROBLEMS 1. Sarah just inherited PHP 50,000 from her grandmother's estate. She is considering investing this money for her retirement, which is 20 years away. If she can earn an annual interest rate of 6%, how much would this PHP 50,000 be worth in today's terms? (PV FINM 1 – FINANCIAL MANAGEMENT 7  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER LUMP SUM – PRESENT VALUE Given: FV = 50,000 I = 6% N = 20 years M=1 Answer: 15,590.24 ) 2. Jessica is planning to take out a loan to purchase a car. The car costs $25,000, and she plans to make monthly payments at the beginning of each month for 5 years. The annual interest rate on the loan is 7%. What should be the monthly payment amount if she wants to take out the loan? (PV AD ANNUITY DUE – PRESENT VALUE Given: PV = 25,000 I = 7% N =5 M = 12 ANSWER: 492.16 3. John is planning to invest 10,000 in a high-yield savings account. The account offers an annual interest rate of 8%. If he keeps the money in the account for 10 years, how much will it grow to? (FV L) LUMP SUM – FUTURE VALUE Given: PV = 10,000 I = 8% N = 10 FINM 1 – FINANCIAL MANAGEMENT 8  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER M=1 ANSWER: 21,589.25 4. Maria decides to save 500 at the end of each year for her daughter's education. She plans to do this for the next 15 years. If the savings account offers an annual interest rate of 4%, what will be her total savings after 15 years? (F ANNUITY ORDINARY – FUTURE VALUE Given: PMT = 500 I = 4% N = 15 M=1 ANSWER: 10,011.79 V AO) 5. Tom is planning his retirement savings and wants to know how much he needs to invest annually in a savings account to have $50,000 in 10 years. The savings account offers an annual interest rate of 6%. What should be the annual investment amount if he wants to achieve this goal? ( ANNUITY ORDINARY – PRESENT VALUE Given: PV = 50,000 I =.06 N = 10 M=1 ANSWER: 6,793.40 6. Michael takes out a loan for $20,000. The loan terms require him to make monthly payments at the beginning of each month for 5 years. The annual interest rate on the loan is 6%. What will be the value of all his payments at the end of the loan term? (FV FINM 1 – FINANCIAL MANAGEMENT 9  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER ANNUITY DUE – FUTURE VALUE Given: PV = 20,000 I = 6% N=5 M = 12 MONTHLY PAYMENT = 384.73 ANSWER: 26,976.83 AD) 7. Sophia wants to invest some money today in a savings account that will grow to $10,000 in 5 years. What annual interest rate does she need if she invests $7,000 today? (PV L) LUMP SUM – INTEREST RATE GIVEN: PV = 7000 FV = 10000 N=5 ANSWER: 0.0739 or 7.40% BONDS VALUATION INTRODUCTION - Growing companies must acquire land, buildings, equipment, inventory, and other operating assets. - The debt markets are a major source of funding for such purchases. - A company issues bonds when it needs to borrow money from public or private investors. FINM 1 – FINANCIAL MANAGEMENT 10  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER WHO ISSUES BONDS? - A bond is a long-term contract under which a borrower agrees to make payments of interest and principal, on specific dates, to the holders of the bond. - For example, on January 5, 2013, Laban Lang Inc. issued $200 million of bonds. For convenience, we assume that LabanLang sold 200,000 individual bonds for $1,000 each. - In exchange for $200 million, LabanLang promised to make annual interest payments and to repay the $200 million on a specified maturity date. FOUR MAIN TYPES OF BONDS 1. TREASURY BONDS - Treasury bonds are issued by the government. - Almost no default risk. 2. CORPORATE BONDS - Corporate bonds are issued by corporations. - Corporate bonds are exposed to default risk. - Different corporate bonds have different levels of default risk, depending on the issuing company’s risk. - Default risk is often referred to as “credit risk,” and the larger the credit risk, the higher the interest rate the issuer must pay. 3. MUNICIPAL BONDS - Municipal bonds, or “munis,” are issued by state and local governments. (issued by LGU- General Obligation Bond - Revenue Bonds – Bonds issued by LGU to finance govt projects and payments are dependent to project’s income 4. FOREIGN BONDS - Foreign bonds are issued by foreign governments or foreign corporations. - Foreign corporate bonds are, of course, exposed to default risk, and so are some foreign government bonds. KEY CHARACTERISTICS OF BONDS 1. PAR VALUE - The par value is the stated face value of the bond. - We generally assume a par value of $1,000. - The par value generally represents the amount of money the firm borrows and promises to repay on the maturity date. 2. COUPON INTEREST RATE - Laban Lang’s bonds require the company to pay a fixed number of dollars of interest every year (or, more typically, every 6 months). - When this coupon payment, as it is called, is divided by the par value, the result is the coupon interest rate. - For example, LabanLang’s bonds have a $1,000 par value, and they pay $100 in interest each year. The bond’s coupon interest is $100, so its coupon interest rate is $100/$1,000 = 10%. - The coupon payment, which is fixed at the time the bond is issued, remains in force during the life of the bond. FINM 1 – FINANCIAL MANAGEMENT 11  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER - In some cases, a bond’s coupon payment will vary over time. - For these floating-rate bonds, the coupon rate is set for, say, the initial 6-month period, after which it is adjusted every 6 months based on some market rate. - Some bonds pay no coupons at all but are offered at a substantial discount below their par values and hence provide capital appreciation rather than interest income. - These securities are called zero coupon bonds (“zeros”). Most zero coupon bonds are Treasury bonds, although a few corporations, such as Coca-Cola, have zero coupon bonds outstanding. - Some bonds have a step-up provision: If the company’s bond rating is downgraded, then it must increase the bond’s coupon rate. - In general, any bond originally offered at a price significantly below its par value is called an original issue discount (OID) bond. 3. MATURITY DATE - Bonds generally have a specified maturity date on which the par value must be repaid. - Laban Lang bonds issued on January 5, 2013, will mature on January 5, 2028; thus, they have a 15-year maturity at the time they are issued. - Original maturity - Time to maturity - Most bonds have original maturities (the maturity at the time the bond is issued) ranging from 10 to 40 years, but any maturity is legally permissible. 4. PROVISIONS TO CALL OR REDEEM BONDS - Most corporate bonds contain a call provision, which gives the issuing corporation the right to call the bonds for redemption. - The call provision generally states that the company must pay the bondholders an amount greater than the par value if they are called. - Call price is normally higher than face value of the bond but decreases the closer the bond is to maturity. - The additional sum, which is termed a call premium, the difference between the face value and call price. - Call premium is often set equal to 1 year’s interest if the bonds are called during the first year, and the premium declines at a constant rate of INT/N each year thereafter (where INT = annual interest and N = original maturity in years). - For example, the call premium on a $1,000 par value, 10-year, 10% bond would generally be $100 if it were called during the first year. The issuer will pay the investors $1,100. If on the second year, $90 during the second year (calculated by reducing the $100, or 10%, premium by one-tenth), and so on. However, bonds are often not callable until several years (generally 5 to 10) after they are issued. This is known as a deferred call, and the bonds are said to have call protection. OTHER PROVISIONS AND FEATURES CONVERTIBLE BONDS - Owners of convertible bonds have the option to convert the bonds into a fixed number of shares of common stock. FINM 1 – FINANCIAL MANAGEMENT 12  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER - Convertibles offer investors the chance to share in the upside if a company does well, so investors are willing to accept a lower coupon rate on convertibles than on an otherwise identical but nonconvertible bond. WARRANTS - When you buy a bond with an attached warrant, the warrant gives you the right to buy a certain number of fixed-price shares of the stock of the company that issues the bond. - The warrants provide a gain if the price of the stock rises. INCOME BONDS - An income bond is required to pay interest only if earnings are high enough to cover the interest expense. - If earnings are not sufficient, then the company is not required to pay interest. INDEXED BONDS - Indexed bonds are also called purchasing power bonds. - The interest payments and maturity payment rise automatically when the inflation rate rises, thus protecting the bondholders against inflation. BOND VALUATION - The value of any financial asset—a stock, a bond, a lease, or even a physical asset such as an apartment building or a piece of machinery—is simply the present value of the cash flows the asset is expected to produce. TIME LINE, CASH FLOWS, AND VALUATION FORMULAS FOR A BOND - For a standard coupon-bearing bond, the cash flows consist of interest payments during the life of the bond plus the amount borrowed when the bond matures (usually a $1,000 par value): Where rd= bond’s required rate of return N = Number of years INT = Interest paid each year M = Maturity The following general equation, written in several forms, can be used to find the value of any bond, VB: +Present Value of Interest Payments + Present Value of Principal Payment at maturity =Total Present Value of the Bond (Price of the bond) BOND PRICE FORMULA FINM 1 – FINANCIAL MANAGEMENT 13  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER INTEREST RATE CHANGES AND BOND PRICES Rd and coupon Case rate Bond will sell at: Calculation 1. Bond selling at Going market rate A fixed-rate bond Coupon rate = 10% price equal to par of interest, rd, is will sell at its par Market Interest rate, rd = value. equal to the value. 10% coupon rate Bond’s Value 1000 2. Bond selling Going market rate A fixed-rate bond’s Coupon rate = 10% for a price below of interest, rd, price will fall below Market Interest rate, rd = its par value rises above the its par value, and it 15% coupon rate is called a discount Bond’s Value=$707.63 bond 3. Bond selling for Going interest A fixed-rate bond’s Coupon rate = 10% a price above its rate, rd, falls price will rise above Market Interest rate, rd = 5% par value below the coupon its par value, and it Bond’s Value =$ 1518.98 rate is called a premium bond - The coupon rate remains fixed after the bond is issued, but interest rates in the market move up and down. - An increase in the market interest rate (rd) will cause the price of an outstanding bond to fall, whereas a decrease in rates will cause the bond’s price to rise CHANGES IN BONDS VALUE OVER TIME - The arithmetic of the bond value increase should be clear, but what is the logic behind it? FINM 1 – FINANCIAL MANAGEMENT 14  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER - Because rd has fallen to 5%, with $1,000 to invest you could buy new bonds like LabanLang’s (every day some 10 to 12 companies sell new bonds), except that these new bonds would pay $50 of interest each year rather than $100 given by LabanLang’s bond. - Naturally, you would prefer $100 to $50, so you would be willing to pay more than $1,000 for a LabanLang bond to obtain its higher coupons. All investors would react similarly; as a result, the LabanLang bonds would be bid up in price to $1,494.93. BONDS WITH SEMIANNUAL COUPONS - To illustrate, assume now that LabanLang’s bonds pay $50 interest every 6 months rather than $100 at the end of each year. - Each semiannual interest payment is only half as large, but there are twice as many of them. The nominal, or quoted, coupon rate is 10%, semiannual payments. - The Equation 5-1 would be modified as: BOND YIELDS - Unlike the coupon interest rate, which is fixed, the bond’s yield varies from day to day depending on current market conditions. - Moreover, the yield can be calculated in three different ways, and three “answers” can be obtained. - These three different yields are: o Yield to Maturity (YTM) o Yield to Call (YTC) o Current Yield (CY) YIELD TO MATURITY - What is the rate of interest would you would earn on your investment if you bought a bond and held it to maturity? - This rate is called the bond’s yield to maturity (YTM). - The yield to maturity can be viewed as the bond’s promised rate of return, which is the return that investors will receive if all the promised payments are made. FORMULA: " !! $+ WHERE: # C = Coupon/Interest Payments %C' = F = Face Value P = Price of the Bond " +! N = Years to Maturity ! FINM 1 – FINANCIAL MANAGEMENT 15  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER YIELD TO CALL - If you purchased a bond that was callable and the company called it, you would not have the option of holding the bond until it matured. Therefore, the yield to maturity would not be earned. - If current interest rates are well below an outstanding bond’s coupon rate, then a callable bond is likely to be called, and investors will estimate its expected rate of return as the yield to call (YTC) rather than as the yield to maturity. To calculate the YTC, solve this equation for rd: FORMULA: #$ ! !" WHERE: #+ C = Coupon/Interest Payments % CP = Call Price C'# = MP = Market Value of the Bond #$ + !" N = Years to Maturity ! EXAMPLE: - Consider a callable bond that has a face value of $1,000 and pays a coupon of 10%. The bond is currently priced at $1,175 and has the option to be called at $1,100 five years from now. Note that the remaining years until maturity does not matter for this calculation #$ ! !" #+ % C'# = #$ + !" ! 𝑌𝑇𝐶 = 7.47% - The YTC is 7.47%—this is the return you would earn if you bought the bond at a price of $1,175 and it was called 5 years from today. STOCK VALUATION CAPITAL - The long-term funds of a firm ; all items on the right-hand side of the firm’s balance sheet, excluding current liabilities. DEBT CAPITAL - All long-term borrowing incurred by a firm, including bonds. EQUITY CAPITAL FINM 1 – FINANCIAL MANAGEMENT 16  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER - The long-term funds provided by the firm’s owners, the stock-holders. COMMON STOCK - Stock represents shares of ownership in a corporation and stockholders claim dividends on a portion of profits. - Investors get right to elect the board members, who oversee the major decisions made by management. - In case of insolvency and bankruptcy, common shareholders are the last one to recover the money. PREFFERED STOCK - A hybrid instrument with some degree of ownership in a company but doesn’t come with the same voting right. - Preferred Share investors are usually guaranteed a fixed dividend forever. - Preferred shareholders are paid off before the common shareholders during insolvency and bankruptcy. COMMON STOCK VALUATION - A share of common stock is more difficult to value in practice than a bond because: o Common Stocks do not have promised cash flows in advance. o The life of investment is essentially forever because common stock has no maturity. o There is no easy way to observe the rate of return that market requires. Techniques Methods Balance Sheet Techniques Book Value Liquidation Value Discounted Cash Flow Technique Dividend Discount Model Free Cash Flow Model Relative Valuation Technique Price Earnings Ratio Price-Book Value Ratio Price Sales Ratio BALANCE SHEET TECHNIQUES BOOK VALUE - The book value per share is simply the net worth of the company divided by the number of outstanding equity share. 𝐍𝐞𝐭 𝐖𝐨𝐫𝐭𝐡 Book value per share = 𝐍𝐮𝐦𝐛𝐞𝐫 𝐨𝐟 𝐨𝐮𝐭𝐬𝐭𝐚𝐧𝐝𝐢𝐧𝐠 𝐬𝐡𝐚𝐫𝐞 Illustration: The net worth of the Company A is 27 million and the number of outstanding equity share of Company A is 2 million. What is the book value per share of the Company A? Solution: FINM 1 – FINANCIAL MANAGEMENT 17  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER Net worth of the company = 27 million No. of Outstanding Shares = 2 Millions 34 5677689 Book Value Per Share= 3 5677689: = 13.50 LIQUIDATION VALUE: - Liquidation value is the total worth of company’s asset if it were to go out of business and assets sold. 𝐋𝐢𝐪𝐮𝐢𝐝𝐚𝐭𝐢𝐨𝐧 𝐕𝐚𝐥𝐮e Value realised from liquidation of all the assets − Amount to be paid to all the creditors and preference shareholder = Number of outstanding equity shares Illustration: Value Realised from liquidation of assets = 45 million Amount to be paid to creditors = 18 million Outstanding equity share = 1.5 millions ;? Liquidation Value = >.< = Rs. 18.00/share DISCOUNTED CASH FLOW TECHNIQUE CASH FLOWS VALUATION - The value of a share of common stock is equal to the present value of all the future cash flows(dividends) that it is expected to provide over an infinite time horizon. FORMULA: 𝑫𝟏 𝑫𝟐 𝑫𝟑 𝑫¥ 𝑷𝒐 = (𝟏D𝑲𝒔)𝟏 + (𝟏D𝑲𝒔)𝟐 + (𝟏D𝑲𝒔)𝟑 + ⋯ + (𝟏D𝑲𝒔)¥ Po = Value of common stock Dt = Per share dividend expected at the end of year t Ks = Required return on common stock COMMON STOCK VALUATION Cash Flows Valuation: Illustration You want to sell a stock after one year. You predict the stock will worth 70.00 at that time with dividend of 10.00 per share at the end of the year. If the required rate of return is 25%, then what is the value of share? (Single Year Calculation) Solution: Total Expected Cashflow = 80 Required rate of return = 25 % 𝑪𝒂𝒔𝒉 𝑭𝒍𝒐𝒘 (4[D>[) ?[ 𝐏𝐫𝐞𝐬𝐞𝐧𝐭 𝐯𝐚𝐥𝐮𝐞 𝐨𝐟 𝐭𝐡𝐞 𝐬𝐭𝐨𝐜𝐤 = (𝟏D𝑹𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝑹𝒂𝒕𝒆 𝒐𝒇 𝑹𝒆𝒕𝒖𝒓𝒏) = (>D.3.3< = 64 FINM 1 – FINANCIAL MANAGEMENT 18  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER GORDON GROWTH MODEL ZERO GROWTH MODEL - Assumes that dividend stay the same year in and year out, and they are expected to do so in the future. This is simply the capitalized value of its annual dividends. 𝐀𝐧𝐧𝐮𝐚𝐥 𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝𝐬 𝐏𝐨 = 𝐑𝐞𝐪𝐮𝐢𝐫𝐞𝐝 𝐑𝐚𝐭𝐞 𝐨𝐟 𝐑𝐞𝐭𝐮𝐫𝐧 Po = Value of a share of stock Illustration: If a stock paid a (constant) dividend of 80.00 a share and one wanted to earn 8% on the investment. What will be the value of the stock? Solution: Annual Dividend = 80.00 Required Rate of Return =8% 𝐀𝐧𝐧𝐮𝐚𝐥 𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝𝐬 𝟖𝟎 Value of share of stock= 𝐑𝐞𝐪𝐮𝐢𝐫𝐞𝐝 𝐑𝐚𝐭𝐞 𝐨𝐟 𝐑𝐞𝐭𝐮𝐫𝐧 = 𝟎.𝟎𝟖 = 1000 CONSTANT GROWTH MODEL - Here we assume that the growth rate will remain same and the dividend grows at a constant rate 𝑫𝟏 𝑫𝟏(𝟏D𝒈)𝟏 𝑫𝟏(𝟏D𝒈)𝟐 𝑫𝟏(𝟏D𝒈)𝒏 𝑷𝒐 = (𝟏D𝒓)𝟏 + (𝟏D𝒓)𝟐 + (𝟏D𝒓)𝟑 +……..+ (𝟏D𝒓)𝒏%𝟏 +……… The above formula simplifies to : 𝑫𝟏 𝑷𝒐 = 𝒓−𝒈 Illustration: Company A’s is listed at $40 per share. Furthermore, Company A requires a rate of return of 10%. Currently, Company A pays dividends of $2 per share for the following year which investors expect to grow 4% annually. Thus, the stock value can be computed: 𝟐 𝑷𝒐 = 𝟎.𝟏=𝟎.𝟎𝟒 𝑷𝒐 = $33.33 This result indicates that Company A’s stock is overvalued since the model suggests that the stock is only worth $33.33 per share. TWO STAGE GROWTH MODEL EXTENSION OF CONSTANT GROWTH MODEL - The two-stage dividend discount model requires very little information to calculate. All that is needed is the anticipated dividend payment one year from the current date, the required rate of return, and the anticipated dividend growth rates. 𝑫𝟏 𝑫𝟏(𝟏D𝒈𝟏)𝟏 𝑫𝟏(𝟏D𝒈𝟏)𝟐 𝑫𝟏(𝟏D𝒈𝟏)𝒏&𝟏 𝑷𝒏 𝑷𝒐 = [(𝟏D𝒓)𝟏 + (𝟏D𝒓)𝟐 + (𝟏D𝒓)𝟑 +……..+ (𝟏D𝒓)𝒏%𝟏 ] + (𝟏D𝒓)𝒏 FINM 1 – FINANCIAL MANAGEMENT 19  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER The above formula simplifies to : 𝟏%𝒈𝟏 𝟏={ }𝒏 𝑫𝟏(𝟏D𝒈𝟏)𝒏&𝟏 (𝟏D𝒈𝟐) 𝑷𝒏 𝑷𝒐 = 𝑫𝟏[ 𝟏%𝒓 ]+[ ][ ] 𝒓=𝒈𝟏 𝒓=𝒈𝟐 (𝟏D𝒓)𝒏 RELATIVE VALUATION TECHNIQUE PRICE EARNING RATIO - PE Ratio is the relationship between a company’s share price and earning per share (EPS) 𝐌𝐚𝐫𝐤𝐞𝐭 𝐏𝐫𝐢𝐜𝐞 𝐨𝐟 𝐭𝐡𝐞 𝐬𝐭𝐨𝐜𝐤 Price Earning Ratio = 𝐄𝐚𝐫𝐧𝐢𝐧𝐠 𝐏𝐞𝐫 𝐒𝐡𝐚𝐫𝐞 Illustration: Current Market Price of the Stock of A Ltd. = 90 Earning Per Share = 9 o[ Price Earning Ratio = o = 10 PRICE TO SALES RATIO - Price to Sales Ratio compares the price of a share to the revenue per share. 𝐏𝐫𝐢𝐜𝐞 𝐩𝐞𝐫 𝐬𝐡𝐚𝐫𝐞 Price to Sales Ratio = 𝐑𝐞𝐯𝐞𝐧𝐮𝐞 𝐩𝐞𝐫 𝐬𝐡𝐚𝐫𝐞 𝐌𝐚𝐫𝐤𝐞𝐭 𝐂𝐚𝐩𝐢𝐭𝐚𝐥𝐢𝐳𝐚𝐭𝐢𝐨𝐧 Price to Sales Ratio = 𝐒𝐚𝐥𝐞𝐬 𝐑𝐞𝐯𝐞𝐧𝐮𝐞 VALUES OF A COMMON STOCK BOOK VALUE - Accounting value, Historical value = Net worth/ shares outstanding PAR VALUE - Face Value of stock on which dividends and earnings calculated ISSUE PRICE - Par value or Par value + Premium LIQUIDATION VALUE - Earnings available to shareholders after meeting prior claims like debts on liquidation MARKET VALUE - Price at which traded in the market REAL VALUE/ INTRINSIC VALUE - PV of all future benefits if shares are held. DECISION CRITERIA - If MV > IV – Sell, shares overpriced - If MV < IV, Buy, shares under-priced LOGIC - In efficient market, the MV closely reflects IV or fundamental value. - Larger the difference, the investor would take position on estimate of IV. FINM 1 – FINANCIAL MANAGEMENT 20  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER - More confident the investor is about the valuation model, the decision based on whether share underpriced/over-priced. - Overpricing / underpricing called mispricing in the market. - Rational investors belief, market price would move towards the IV in a fairly efficient market. CAPITAL BUDGETING BUDGETING - A management tool for planning and controlling future activity - A plan for saving, borrowing and planning BUDGET - A financial plan and a list of all planned expenses and revenues CAPITAL - Operating assets used for protection BUDGET - A plan that details projected cash flows during some period CAPITAL BUDGETING - Process of analyzing projects and deciding which ones to include in capital budget CONCEPT OF CAPITAL BUDGETING - The process of identifying, analyzing, and selecting investment projects whose returns (cash flows) are expected to extend beyond one year. CAPITAL BUDGETING PROCESS 1. Select projects based on a value-maximizing acceptance criterion. 2. Re-evaluate implemented investment projects continuously and perform post audits for completed projects CAPITAL BUDGETING: PROJECT CATEGORIZATION - Establishment of New Products & Services - Replacement Projects: Maintenance of Cost Reduction - Expansion of Existing Projects - Research and Development Projects - Long Term Contracts - Safety and/or Environmental Projects TYPES OF PROJECTS 1. INDEPENDENT PROJECT - The acceptance the one project’s does not eliminate the acceptance of others 2. MUTUALLY EXCLUSIVE PROJECT - The acceptance the one project’s eliminates the acceptance of others FINM 1 – FINANCIAL MANAGEMENT 21  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER NON-DISCOUNTING: PAYBACK PERIOD 1. PAYBACK PERIOD METHOD - It is defined as the number of years required to recover original cost invested in a project. It has two conditions When cash inflow is constant every year - PBP = Cash outflow/cash inflow (p.a.) When cash inflow are not constant every year stuvwxty wz{|}~ - 𝑃𝐵𝑃 = 𝐶𝑜𝑚𝑝𝑙𝑒𝑡𝑒𝑑 𝑦𝑒𝑎𝑟𝑠 z{|}~ }{ zt€ ‚tƒx ∗ 12 NON DISCOUNTING CRITERIA: ANNUAL RATE OF RETURN 2. AVERAGE RATE OF RETURN METHOD - ARR means the average annual earning on the project. Under this method, profit after tax and depreciation is considered. The average rate of return can be calculated in the following two ways: „…txƒ†t ‡x}{w ƒ{ tx ˆƒ€ - 𝐴𝑅𝑅 𝑜𝑛 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = „…txƒ†t z…t‰ Štz ∗ 100 „…txƒ†t ‡x}{w ƒ{ tx ˆƒ€ - 𝐴𝑅𝑅 𝑜𝑛 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = zw wƒ| z…t‰ Štz ∗ 100 DISCOUNTING CRITERIA: PAYBACK PERIOD 3. DISCOUNTED PAYBACK PERIOD METHOD - In discounted payback method, the cash inflows are discounted by applying the present value factors for different time periods. For this, discounted cash inflows are calculated by multiplying the P.V. factors into cash inflows. 4. NET PRESENT VALUE METHOD - It is the best method for evaluation of investment proposal. This method takes into account time value of money - NPV = PV of inflows – PV of outflows FINM 1 – FINANCIAL MANAGEMENT 22  FINAL EXAM REVIEWER FOR THE FIRST SEMESTER - Project with the higher NPV should be selected o Accept if NPV>0 o Reject if NPV1 o Rejected PI