CORPORATE FINANCE (FIN201)

FORMULA SHEET
Session 3: Chapter 3 Session 4: Chapter 4
- Simple interest:
Ratio Numerator Denominator
F V = P V × (1 + n × r)
Short-term solvency ratios
Current ratio Current assets Current liabilities - Compound interest:
n
Quick ratio Current assets - Inventory Current liabilities F V = P V × (1 + r)
Cash ratio Cash Current liabilities - Compounding an investment m times a year for T years:
Financial leverage ratios
Total debt ratio Total debt or (Total assets - Total equity) Total assets r m×T
Debt-Equity ratio Total debt Total equity F V = P V × (1 + )
m
Equity multiplier Total assets Total equity
Times interest earned Earnings before interest and taxes Interest
- Continuous compounding:
Cash coverage (EBIT + depreciation + amortization) Interest r×t
Turnover ratios FV = PV × e
Inventory turnover Cost of goods sold Inventory - Effective annual rates (EAR)
Days sales in inventory 365 Inventory turnover r m
Receivables turnover Sales Receivables EAR = (1 + ) −1
m
Days’ sales in receivables 365 Receivables turnover
Total asset turnover Sales Total assets - Ordinary Annuity:
Days in inventory Days in period Inventory turnover
Profitability measures
Profit margin Net income Sales C C C C
PV = + + + ... +
Return on assets Net income Total assets 1+r (1 + r)2 (1 + r)3 (1 + r)t
Return on equity Net income Total equity " #
EBITDA margin EBITDA Sales 1 − (1 + r)−t
Market value ratios PV = C ×
r
Price-to-earnings ratio Market price per share Earnings per share
Market-to-book ratio Market price per share Book value per share " #
(1 + r)t − 1
FV = C ×
r

M arket capitalization = M arket price per share × Shares outstanding - Annuity Due:
" #
- Dupont identity 1 − (1 + r)−t
N et income T otal assets PV = C × × (1 + r)
ROE = × r
T otal assets T otal equity
" #
ROE = ROA × Equity multiplier (1 + r)t − 1
FV = C × × (1 + r)
r
N et income Sales Assets
ROE = × × - Perpetuity:
Sales Assets T otal equity C C C C
PV = + + + ... =
ROE = P rof it margin × T otal assets turnover × Equity multiplier 1+r (1 + r)2 (1 + r)3 r
- Perpetuity Due:
- External Financing Needed (EFN) C × (1 + r)
PV =
r
Assets Spontaneous liabilities - Growing annuity:
EF N = ×∆Sales− ×∆Sales−P rof it margin×P rojected Sales×(1−d)
Sales Sales
  t 
where: 1 − 1+g
Spontaneous liabilities: liabilities that naturally move up and down with sales (e.g., account payable) C C × (1 + g) C × (1 + g)2 C × (1 + g)t−1 1+r
PV = + + + ... + =C×
 
(1 + r)2 (1 + r)3 (1 + r)t r−g

(1 + r)
∆Sales = Salest+1 − Salest
" #
(1 + r)t − (1 + g)t
N et income FV = C ×
P rof it margin = r−g
Sales
Cash dividends - Growing perpetuity:
d = Dividend payout ratio =
N et income
C C × (1 + g) C × (1 + g)2 C × (1 + r)k−1 C
Addition to retained earning PV = + + + .... + + ... =
1 − d = Retention ratio or P lowback ratio = 1+r (1 + r)2 (1 + r)3 (1 + r)k r−g
N et income
Session 5: Chapter 6 Session 7: Chapter 10 and 11
Operating cash flows (OCF) - Average return:
PT
The top-down approach i=1 Ri R1 + R2 + ... + RT
R= =
OCF = EBIT − T axes + Depreciation T T
OCF = (Sales − Cash costs − Depreciation) − T axes + Depreciation - Variance: the squared deviations of a security’s return (R1 , R2 , R3 , ..., RT ) from its average return
(R):
OCF = Sales − Cash costs − T axes (R1 − R)2 + (R2 − R)2 + (R3 − R)2 + ... + (RT − R)2
2
V ar = σ =
The bottom-up approach T −1
OCF = N et income + Depreciation
- The standard deviation of returns = the square root of the variance:
OCF = (Sales − Cash costs − Depreciation) × (1 − TC ) + Depreciation s
√ (R1 − R)2 + (R2 − R)2 + (R3 − R)2 + ... + (RT − R)2
The tax shield approach SD = σ = V ar =
T −1
OCF = Sales − Cash costs − (Sales − Cash costs − Depreciation) × TC - The Expected Return of an asset is the sum of the probability of each return occurring times the
probability of that return occurring.
OCF = (Sales − Cash costs) × (1 − TC ) + Depreciation × TC
n
X
- Net Present Value (NPV): E(R) = P (Ri ) × Ri
i=1
t=N
X CFt
N P V = −I + - The Variance of an asset.
t=1
(1 + r)t
To find the variance, we find the squared deviations from the expected return. We then multiply
CF1 CF2 CFN each possible squared deviation by its probability, and then add all of these up.
N P V = −I + + + ... +
1+r (1 + r)2 (1 + r)N n
X 2
σE(R) = [Ri − E(Ri )] × P (Ri )
If CF1 = CF2 = ... = CFN = CF 1

- Covariance
" #
1 − (1 + r)−n
N P V = −I + CF ×
r n
X
cov(A, B) = P (Ri ) × [E(Ri )A − E(R)A ] × [E(Ri )B − E(R)B ]
1
Session 6: Chapter 8 and 9
- Correlation
- Value of Bond:
cov(A, B)
" # ρAB =
1 − (1 + RB )−n F ace value σA × σB
Bond value = VB = C × +
RB (1 + RB )n - The Expected Return of a portfolio is a weighted average of the expected returns on individual
securities that make up the portfolio.
- Zero coupon bond (A bond that pays no coupons at all)
n
X
F ace value E(Rp ) = Xi × E(Ri )
Zero − coupon bond value = i=1
(1 + RB )n
- The Variance of a portfolio is related to the riskiness of the stocks and the degree of covariance or
- Value of Preference Share:
Dp correlation. The variance of returns on a portfolio with two stocks (A and B):
Pp =
Rp 2 2 2 2 2
σp = XA σA + XB σB + 2XA XB σAB
-Value of common stock: Constant growth (g: growth rate)
or:
D0 ∗ (1 + g) D1
VE = = 2 2 2 2 2
RE − g RE − g σp = XA σA + XB σB + 2XA XB ρAB σA σB

- Value of common stock: Zero growth

D
P0 =
R
Session 8: Chapter 13 Session 10: Chapter 21
- The relation between leverage and equity beta (β): - Net cash flows from lease alternative relative to purchase alternative (NAL).

S B • Buy:
βAsset = βEquity ∗ + βDebt ∗
S+B S+B Purchase price (-)
Depreciation tax benefit (+)
- The cost of equity capital:
RS = RF + β ∗ (RM − RF ) After-tax cost saving (+)

where: • Lease:
RS : Expected return on stock = E(RS ).
RF : Risk-free rate. Lease payment (-)
RM − RF : The difference between the expected return on the market portfolio and the risk-free rate Tax benefit of lease payment (+)
= the expected excess market return = market risk premium.
β: Stock’s risk (or volatility). After-tax cost saving (+)
- Cost of debt: Interest rate required on new debt issuance (i.e., yield to maturity on outstanding
debt). For bonds: the current yield to maturity = the cost of borrowing. - Value of lease payment:

• CFs of the lessee → Reservation Payment of Lessee (LM ax ).

" #
1 − (1 + Y T M )−N F ace value
Bond price = C ∗ +
Y TM (1 + Y T M )N • CFs of the lessor → Reservation Payment of Lessor (LM in ).
(RD = Y T M )
- Cost of preferred stocks (Preferred stock pays a constant dividend, D, in perpetuity.):
Session 11: Chapter 26 and 28
D
RP = Net working capital + Fixed assets = Long-term debt + Equity
P
- The Weighted Average Cost of Capital (WACC): Net working capital = Cash + Other current assets - Current liabilities

S P B Cash = Long-term debt + Equity + Current Liabilities - Other current assets - Fixed as-
W ACC = ∗ RS + ∗ RP + ∗ RD ∗ (1 − TC ) sets
B+P +S B+P +S B+P +S
Operating cycle = Inventory period + Accounts receivable period
Session 9: Chapter 16 and 17 Cash cycle = Operating cycle - Accounts payable period
Summary of Modigliani-Miller Propositions without Taxes:
- Assumptions:

• No taxes; No transaction costs; Individuals and corporations can borrow at same rate; No ban-
kruptcy costs and other agency costs; No asymmetric information; Efficient capital markets.

- MM Proposition I (No Taxes):

VU = VL
- MM Proposition II (No Taxes):
B
RS = R0 + ∗ (R0 − RB )
S
Summary of Modigliani-Miller Propositions with Corporate Taxes:
- Assumptions:

• Corporations are taxed at the rate TC on earnings after interest; There are no transaction or
bankruptcy costs; Individuals and corporations borrow at the same rate.

- MM Proposition I (with Taxes):

V L = V U + TC ∗ B

- MM Proposition II (with Taxes):

B
RS = R0 + ∗ (1 − TC ) ∗ (R0 − RB )
S
RS : Cost of equity.
R0 : Cost of capital for an all-equity (unlevered) firm.
RB : Cost of debt.
B
S : the firm’s debt-equity ratio.