Corporate Finance Test 1 Important Terms + Ratios

Front 1

Return on Equity (ROE)

Back 1

The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.
** Does not include preferred stock in SHE**

=Net Income/Shareholder's Equity

Front 2

Return on Assets (ROA)

Back 2

An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's annual earnings by its total assets, ROA is displayed as a percentage.
= Net Income/Total Assets
*Add back interest expense to ignore the cost of borrowing in the calculation*

Front 3

Market to Book (M2B)

Back 3

A ratio used to find the value of a company by comparing the book value of a firm to its market value. Book value is calculated by looking at the firm's historical cost, or accounting value. Market value is determined in the stock market through its market capitalization.

= Book Value/Market Value

In basic terms, if the ratio is above 1 then the stock is undervalued; if it is less than 1, the stock is overvalued.

Front 4

Return on Invested Capital (ROIC)

Back 4

A calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments. The return on invested capital measure gives a sense of how well a company is using its money to generate returns.
One downside of return on capital is that it tells nothing about where the return is being generated. For example, it does not specify whether it is from continuing operations or from a one-time event, such as a gain from foreign currency transactions.

= EBIT (1-tax rate) / Equity + IBD

Front 5

Basic Earnings per Share

Back 5

Used to calculate how much earnings per share were earned within the period.

= (After-tax Net Income - Preferred Dividends) / # of Shares Outstanding

Front 6

Diluted Earnings per Share

Back 6

Same as above but removes things that "dilute" eps, like convertible preferred stocks, convertible bonds, and stock warrants (options).

Front 7

Net Profit Margin (NPM)

Back 7

After Tax Net Income / Sales

Ratio shows how much profit a company makes for every dollar in revenue

Front 8

P/E Ratio

Back 8

Share price / EPS OR Market Cap / Net Income

Shows how much investors are willing to pay per dollar of earnings

Front 9

Asset Turnover

Back 9

Sales / Total Assets

Determines how efficiently a firm uses its assets
*Low values indicate that the firm is not generating much profit per dollar of assets.

Front 10

Financial Leverage Ratio

Back 10

Assets / Equity

Front 11

EV

Back 11

Market Cap + IBDebt - Cash

Front 12

Dupont Analysis

Back 12

NPM (Profit/Sales) x Total Asset Turnover (Sales/Assets) x Financial Leverage (Assets/Equity)

Front 13

EBIT

Back 13

Earnings Before Interest and Tax: Revenue-CGS-Operating expenses-Depreciation + Amortization

Front 14

EBITDA

Back 14

Earnings Before Interest, Tax, Depreciation, and Amortization

Front 15

Gross Profit Margin

Back 15

(Revenue- COGS) ÷ Revenue

Front 16

Quick Ratio (Acid Test)

Back 16

(Cash+ Marketable Securities +Receivables) ÷ Current Liabilities

Front 17

Current Ratio

Back 17

Current Assets÷ Current Liabilities

Front 18

Cash Ratio

Back 18

(Cash + Cash Equivalents) ÷ Current Liabilities

Front 19

Working Capital

Back 19

Current Assets- Current Liabilities

Front 20

Accounts Receivable Turnover

Back 20

Net Credit Sales ÷ Avg. Accounts Receivable

Front 21

Inventory Turnover

Back 21

COGS ÷ Inventory
OR Sales ÷ Inventory

Front 22

Accounts Payable Turnover

Back 22

Total Purchases ÷ Accounts Payable

Front 23

Debt to Equity

Back 23

Total debt (B.S.) ÷ Total Equity (B.S.)

Front 24

Debt to Assets

Back 24

Total Liabilities ÷ Total Assets

This measure helps to assess a company’s financial risk bearing, or how much debt they take on.

Front 25

Times Interest Earned

Back 25

EBITDA ÷ Interest

High values show that a firm can pay interest payments.

Front 26

Financial Leverage (Equity Multiplier)

Back 26

Total Assets ÷ Total Equity

Front 27

Market Capitalization

Back 27

The number of shares outstanding x Market price per share

Front 28

PEG (P/E to Growth)**

Back 28

PE Ratio (Share Price ÷ EPS) ÷ Annual EPS growth

The ratio of a firm’s P/E to an expected growth rate
*Indicates overpriced or underpriced stock price
The lower the ratio, the more undervalued the stock is

Front 29

Debt to Market Equity

Back 29

Liabilities ÷ Market Capitalization (number of outstanding shares x share price)

Front 30

Sustainable Growth

Back 30

(ATNI ÷ Stockholder’s Equity) x (1- Dividend Payout Ratio
*Dividend Payout Ratio= Dividends ÷ ATNI

Front 31

Actual Growth

Back 31

Sales (Year 1) ÷ Sales (Year 2)

Front 32

Sole Proprietorship

Back 32

Business owned and run by one person. No separation b/w firm and owner. Unlimited personal liability for the firm's debts on owners part. Limited to the life of the owner.

Front 33

Partnership

Back 33

Business owned and run by more than one person. All partners are personally liable for debt. Ends with the withdrawal or death of any partner.

Front 34

Limited Partnership

Back 34

Same thing as a partnership except two different kinds of owners, general and limited. If one is a limited partner, their liability is limited to their investment in the company.

Front 35

Limited Liability Company (LLC)

Back 35

A limited partnership but without a general partner. They also run the business.

Front 36

Corporation

Back 36

A legally defined, artificial being (legal separate entity) that is separate from its owners. It can enter into contracts, acquire assets, and incur obligations. Also enjoys protection under the U.S Constitution against the seizure of its property. It must be legally formed, and is therefore a lot more costly then say a sole proprietorship.

Front 37

Double Taxation

Back 37

Since a corporation is a separate legal entity, it is subject to taxation separate from its owners. In effect, stockholders of a corporation pay taxes twice. First on the profits of the corporation and then on the dividends of the shareholders.

Front 38

Financial Manager + Tasks

Back 38

They have three tasks in a company: make investment decisions, make financing decisions, and manage short-term cash needs.
He must ensure that the firm has enough cash on hand to meet its obligations day to day.
His goal: To maximize the wealth of the owners.

Front 39

Board of Directors

Back 39

A group of people who the ultimate decision making authority in the corporation.

Front 40

CEO

Back 40

Chief Executive Office: He is charged with running the corporation by instituting the rules and policies set by the board of directors.

Front 41

Agency Problem

Back 41

When managers, despite being hired as the agents of the stockholders, put their own self interest ahead of the interests of those shareholders.

Front 42

Hostile Takeover

Back 42

An individual or organization-- sometimes known as a corporate raider--ca purchase a large fraction of the company's stock and in doing so get enough votes to replace the board of directors and the CEO.

Front 43

Primary Market

Back 43

Refers to a corporation issuing new shares of stock and selling them directly to investors.

Front 44

Secondary Market

Back 44

Shares continue to trade in a secondary market between investors without the involvement of the corporation.

Front 45

Bid-Ask Spread

Back 45

The difference between the bid price and the asking price, the spread is considered a transaction cost that one has to pay in order to trade.

Front 46

Over-the-counter-markets

Back 46

A collection of dealers or market makers connected by computer networks and telephones.

Front 47

Important Difference between NYSE and NASDAQ

Back 47

On the NYSE there is only one market maker per stock, whereas on the NASDAQ stocks can and do have multiple market makers and they compete with each other.

Front 48

Banks + Credit Unions

Back 48

Source of money : Deposits (savings); they loan to people and businesses

Front 49

Insurance Companies

Back 49

Source of money: premiums and investment earnings ; invests mostly in bonds and some stocks, using the investment income to pay claims

Front 50

Mutual Funds

Back 50

Source of money: people's investments (savings) ; Buys stocks, bonds, and other financial instruments on behalf of its investors.

Front 51

Pension Funds

Back 51

Source of money: retirement savings contributed through the workplace ; Similar to mutual funds except with the purpose of providing retirement income

Front 52

Hedge Funds

Back 52

Source of money: investments by wealthy individuals and endowments ; Invests in any kind of investment in an attempt to maximize returns.

Front 53

Venture Capital Funds

Back 53

Source of money: investments by wealthy individuals and endowments ; Invests in start-up, entrepreneurial firms

Front 54

Private Equity Funds

Back 54

Source of money: investments by wealthy individuals and endowments ; Purchases whole companies by using a small amount of equity and borrowing the rest.

Front 55

Value Stocks

Back 55

Firms with a low M2B ratio

Front 56

Growth Stocks

Back 56

Firms with a high M2B ratio

Front 57

Management Discussion and Analysis

Back 57

The preface to the financial statements in which the company's management discuss the recent year, providing a background on the company and any significant events that may have occurred.

Front 58

Off-Balance Sheet Transactions

Back 58

Transactions or arrangements that can have a material impact on the firm's future performance yet do not appear on the balance sheet.

Front 59

Sarbanes-Oxley Act (SOX)

Back 59

The idea of the act was to improve the accuracy of information given to both boards and to shareholders. In three ways:
1) Overhauling incentive and independence in the auditing process 2) Stiffening penalties for providing false information, and 3) by forcing companies to validate their internal financial control processes.

Front 60

Arbitrage

Back 60

The practice of buying and selling equivalent goods in different markets to take advantage of the price difference.

Front 61

Discounting

Back 61

the process of finding the equivalent value today of a future cash flow.

Front 62

Perpetuity

Back 62

A stream of equal cash flows that occur at regular intervals and last forever*

Front 63

Present Value of a Perpetuity

Back 63

C / r

Front 64

Annuity

Back 64

A stream of cash flows consisting of a fixed number of equal cash flows paid at regular intervals

Front 65

Present value of an Annuity

Back 65

PV = C x (1/r) (1 - (1/(1+r^n)))

Front 66

Future value of an annuity

Back 66

FV = PV x (1+r)^n

Front 67

Growing Perpetuity

Back 67

A stream of cash flows that occur at regular intervals and grow at a constant rate forever.

Front 68

Present Value of a growing perpetuity

Back 68

PV = C / (r-g)