Fin Mgmnt Ppt2 - Sapna Mallya

8/2/2019 Fin Mgmnt Ppt2 - Sapna Mallya

1/36

Financial ManagementProf. Sapna U. Malya


2/36

Analysis of Financial Statements using

RATIOSTopics covered:

Meaning of Ratio

Why Ratio?

Different types of ratios: Liquidity Ratios

Asset Management Ratios

Debt Management Ratios

Profitability Ratios Market Value Ratios

Du pont Equation

Limitation of Ratio Analysis


3/36

Different Types of Ratios:

Current Assets / Current Liabilities

EBIT / Interest

Price per share / Earnings per shareEBIT / Total Assets

Sales / Inventories

Sales / Net Fixed Assets


4/36

Liquidity Ratios

Current Ratio = Current Assets / Current Liabilities

Quick/ Acid Test Ratio = (Current Assets less inventories) /

Current Liabilities


5/36

Asset Management Ratio Inventory turnover ratio = Sales / Inventory

Debtors turnover ratio = Sales / Debtors

Days Sales Outstanding (DSO) = Receivables / Average sales per day

Creditors turnover = Purchases / Creditors

Fixed Assets turnover = Sales / Net fixed assets

Total Assets turnover = Sales / Total assets


6/36

Debt Management Ratios Debt Ratio = Total Debt / Total Assets

Debt Equity = Debt / Equity or Debt / (Debt + Equity)

Interest Coverage Ratio = EBIT / Interest charges

Debt Service Coverage Ratio (DSCR) =

EBIDTA + Lease payments / Interest + Principal payments + Lease

payments


7/36

Profitability Ratios Profit margin = NPAT / Sales

Basic Earning Power ( BEP) = EBIT / Total Assets

Return on Total Assets =

Net income available to Equity / Total Assets

Return on Equity = Net income available to Equity / Equity


8/36

Market Value Ratios Price earnings ratio = Market price per share / Earnings per share

Price / Cash flow ratio = Price per share / Cash profit per share

Market / Book ratio = Market price per share / Book value per

share


9/36

Du Pont equation ROA = Net profit / Total Assets

ROA = Net profit * Sales

Sales Total Assets

ROA = Profit margin * Total Assets Turnover

OR

ROA = Net profit / Capital Employed


10/36

Du Pont equation.. Other side to it ROE = Net profit / Equity( or Total Assets)

ROE = Net profit * Sales

Sales Total Assets

ROE = Net profit * Sales * Total assets

Sales Total Assets Equity

Equity multiplier = Total assets / Equity

Therefore ROE = ROA * Equity multiplier


11/36

Certain questions to ponder over Is a high inventory turnover always better?

Why would the inventory turnover ratio be more important when

analysing a grocery chain than an insurance company?

There is an increase in current ratio and a drop in its total assets turnover

ratio. However, the companys sales, cash and marketable securities,

DSO and fixed assets turnover ratio have remained constant. What

explains these changes?

If a firm takes steps to improve its ROE, does this mean that shareholder

wealth will also increase?


12/36

Limitations of Ratio Analysis

Benchmarking required for analysis

Inflation may distort comparative analysis

Window dressing techniques can be adopted to make ratios

look stronger

Different accounting practices can distort comparison

Difficult to generalise whether a ratio is good or bad


13/36

Time Value of Money

Topics covered:

Concept of Time Value of Money

Present Value

Future Value

Annuity Present Value

Annuity Future Value


14/36

A Rupee today is more valuable than a rupee a yearhence. Why ?

Current consumption is preferred to future consumption.

Purchasing power of money is greater today than a yearhence due to inflation.

Capital can be employed productively to generate

positive returns.Thus rupee discounts from time to time

Concept of Time Value


15/36

Concept of Time Value

Time value thus brings to light two importantvalues:

Present ValueFuture Value


16/36

Present Value & Future Value

Value of money at present that is at this point of time

is said to be the present value..

Future Value therefore is the value of money infuture..


17/36

What is the value of Re.1 received a year later if

the rupee discounts at 10%?

Future Value of Re.1 = Present Value + InterestFV of Re.1 = PV of Re.1 + 10% on Re.1

FV = 1 + 1(10/100)

FV = PV + 1(10/100)

FV = PV + PV(10/100)FV = PV (1+ 10/100)

FV = PV (1 + r )



18/36

Similarly PV = FV / (1+r)

And if this is to be calculated for the nth year it will be

PV = FV / (1+r)n

PV = FV * 1 /(1+r)n



19/36

Annuity Future value

0 1 2 3 4 5 6

-100

Interest 5 5.25 5.51 5.79 6.08 6.38

Total 105.00 110.25 115.76 121.55 127.63 134.01

F.V2 = F.V.1( 1 + r )= P.V(1+r) (1+r)

= P.V. (1+r)^2

Therefore F.V.(n) = P.V. (1+r)^n


20/36

Applications of Present Value in Business

How much can you borrow for an asset?

Period of Loan amortisation.

Finding the interest rate.


21/36

Applications of Future Value in Business

Knowing what lies in store for you

How much should you save annually

Finding the interest rate

Annual deposit in the sinking fund


22/36

Conclusion

Present Value and Annuity Value is calculated assuming

that the discounting is done at the end of each year and

not any time during the year.

Higher the Discounting rate..

Lower the Present Value factor..


23/36

Stock Valuation

Concepts to be known:

Common Stock / Equity

Preferred Stock

Pre-emptive right

Closely held company

Publicly owned company

Primary market (IPO) Secondary market


24/36

Valuation of Common stock / Equity

Models used for valuation:

Zero Growth or Constant Dividend Model

Constant Growth Model / Gordon Model

Valuation of stocks with non constant growth

Capital Asset Pricing Model

Other Approaches to valuing Equity:

P/E Multiple

EVA Approach


25/36

Zero Growth or Constant Dividend Model

Dividends received annually

Dividends received in perpetuity

No growth in dividends

There is an expectation of the investor from the company

P0 = D1/ ke

P0 = Price of the stock today

D1 = Dividend received in future

ke = expected return by the investor


26/36

Constant Growth Model / Gordon Model


Dividends received in perpetuity

There is a growth in dividends which is constant


P0 = D1/ (keg)





27/36

Valuation of stocks with non constant growth


Dividends received for n periods

There is a change in dividends which is not constant


P0 = D1 + D2 + Dn

(1+ke)^1 (1+ke)^2 (1+ke)^n





28/36

MVA & EVA as a valuation technique

MVA( Market Value Added)

Market value of stockEquity share capital

EVA (Economic Value Added)NOPAT(Capital Employed * Cost of capital)

= EBIT(1T)(Capital Employed * Cost of capital)


29/36

Cost of Capital

Types of Capital

Debt

Preference Capital Retained Earnings

Equity Capital


30/36

Cost of CapitalDebt (kd)

Debt is long term in nature

Interest is paid on debt at a fixed rate

Interest is tax deductible

kd = I (1T)

But if the debt is traded and has a different market

price with maturity period, then the value of debt is

the YTM of that debt which is:rd = I + ( Face value F Current market price P0 ) / n

0.6 P0 + 0.4 F

kd = rd (1-t)


31/36

Cost of CapitalPreference kp

Preference capital forms a part of owners funds

Dividends at a fixed rate are paid to these financers

Dividends are always paid after tax

kp = D / P

But if the preference is traded and has a different

market price with maturity period, then the value of

preference is the YTM of that preference which is:rp = I + ( Face value F Current market price P0 ) / n

0.6 P0 + 0.4 F


32/36

Cost of CapitalRetained Earnings (Ks)

Profits accumulated every year

Profits accumulated are after payment of interest, tax and

preference dividend

Profits belonging to the owner

ks = ke(except ke at times increases due to floatation cost)


33/36

Cost of CapitalRetained Earnings (Ks)

Various approaches used for valuation are:

CAPM

Bond Yield Plus Risk Premium Approach

Dividend Yield Plus Growth Rate Approach


34/36

Cost of CapitalEquity (ke)

P0 = D1/ (keg)

ke = (D1 / P0) + g

ke = (D1 / P0f) + g


35/36

Capital Asset Pricing Model ( CAPM)

ke = kf + (km-kf)

ke = Expected rate of return from equitykf= Risk free rate of return ( Treasury bills, PPF account)

km - kf= Market risk premium

= Stocks Beta


36/36

Weighted Average Cost of CapitalWACC

WACC = wdkd+ wpkp + weke

Weights can be according to book values or market values.

However market values are more relevant for new issues of

capital/ new sources of finance

Documents

Fin Mgmnt Ppt2 - Sapna Mallya