Lecture 1 & 2
Accounting
- Records the past
- Works with real amounts
Finance
- Discounting future cashflows
- Works with real forecasts
Primary vs secondary markets
Primary markets:
Securities are sold to investors Money that is raised goes to the issuing firm
First Share issue is called an Initial Public Offering (IPO)
Second share issue is called a Seasoned offering
Secondary markets:
Investors trade securities with each other Money that is raised goes to the
seller of securities
Share prices
The balance sheet equation: Assets = Liabilities + Equity
Current Assets = Current Liabilities + Net working capital (NWC)
Shareholder’s equity = Total assets – Total liabilities
Book value = based on accounting figures drawn from accounting standards
Market values = based on prices or market valuations
Income statement:
EBT = Earnings before tax
EBIT = Earnings before interest and tax
EBITA = Earnings before deduction of interest, tax and amortisation
Statement of cash flows
Total cashflow comes from: Operating activities, investing activities, financing
activities
,Cash Flow Working Capital WC is a snapshot; CF is the earning ability
over a period of time.
Cash Flow Profit Depreciation decreases profit but not the CF
Ratio analysis
Profitability ratios:
Profit margin = Net Income / Sales = Operating efficiency
Return on Asset = Net income / Total Assets = Asset use efficiency
Return on equity = Net income / Total Equity = Equity efficiency
Financial Leverage Ratios
Debt-equity ratio = Debt / Equity
Total debt ratio = Debt / Equity + Debt Debt / Total Assets
Equity multiplier = Total Assets / Equity
Market Value Ratios
Earnings per share (EPS) = Net Income / Shares outstanding
Price Earning (PE) Ratio = Price per share / EPS
Du Pont identity: Long form
Du Pont identity: Short form
,Future Value and Compounding
Future Value (FV) = The amount an investment is worth after one or more
periods
Year 0: Invest 100,- @10%
Year 1: Y1 = Y0 (1+r)
Tear 2: Y2 = Y0 (1+r)²
Thus Vt = V0 (1+r )t
Simple interest = Interest earned only on the original principal amount invested
Compound interest = Interest earned on both the principal and the interest
reinvested from prior periods
Future Value Interest Factor (FVIF)
Where Vt is the value after t periods; r is the interest rate
FVIF(r,t) = (1+ R)t
, Banks frequently offer saving accounts that compound interest every day, month
or quarter.
Example: You invest $500 for seven years to earn an annual interest rate of 8%,
and the investment is compounded semi-annually. What will be the FV of this
investment?
Making interest rates comparable
The Annual Percentage Rate (APR) indicates the amount of interest paid or
earned in one year without compounding. APR is also known as the nominal or
stated interest rate.
You cannot compare two loans / investments based on APR if they do not share
the same compounding period.
In order to make them comparable, you need to calculate their equivalent rate
using an annual compounding period. In other words: You need to calculate the
Effective Annual Rate (EAR)
Discounting present values
Suppose you need 70 dollars to buy a book next year, you expect to earn 10% on
your money. How much do you need to save today in order to have 70 dollars
next year?
70/1.1=63.64
In 2 years, you receive 1,000 at a discount rate of 10% what is the present value
of this?
1000/1.1² = 826.45
Present value for multiple periods
Vt
Vo =
(1+r )t
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