When reviewing an investment opportunity, which factors should be considered?
- Maturity - how long will the cash be invested and when should any investments mature?
- Preservation of initial capital - can the company afford to lose its initial investment?
- Liquidity - how liquid do the investments need to be and how quickly will cash be required?
- Income type - is there a type of investment the individual/ entity would like to receive?
- Level of risk - how much risk can the individual/ entity tolerate?
- Tax impact - what are the tax implications of this investment (when sold, or when income earned)
What does beta represent (WACC)?
beta is a measure of the amount of the volatility, or systematic risk, involved in a specific investment in comparison to the risk of the entire market.
What is WACC? How does WACC affect a company?
WACC - weighted average cost of capital
Ideally, the lower a WACC is the better for a company - represented the minimum rate of return.
How do you calculate basic EPS?
= Net earnings (loss) available to common shareholders / WACSO (weighted averaged common shares outstanding)
How do you calculate net earnings available to common shareholders?
= net income (loss) of entity - dividends on cumulative preferred shares - dividends declared on non-cumulative preferred shares.
How do you calculate WASCO?
= shares outstanding * adjustment factor (like a stock split or stock dividend) * fraction of the year (can used days or months)
How do you calculate diluted EPS?
- Calculate basic EPS
- Identify all PCS (items that may entitle people to common shares - i.e., convertible debt
- Calculate individual EPS for all of the PCS items identified
- Order the incremental EPS (lowest = most dilutive to highest = least dilutive)
- Starting at basic EPS, add incremental EPS and calculate provisional EPS - keep going until you compute all, or until the provisional is greater than the incremental.
How can you determine dilutive vs. anti-dilutive incremental EPS?
If incremental EPS > basic EPS = anti-dilutive (don’t include)
If incremental EPS < basic EPS = dilutive (include)
How do you calculate income available to common shareholders for convertible bonds?
= face value of bond * interest rate * (1 - tax rate)
How do you calculate income available to common shareholders for convertible bonds?
= face value of bond * interest rate * (1 - tax rate)
What valuation method should be used when the entity is NOT a going concern?
- Liquidation method (orderly or forced)
When to use the adjusted net asset method, and how to perform valuation?
- Used when an entity is not an income earning entity, but still a going concern; generally the entity does not maintain active operations
- Valuation = FMV of assets (less the disposition costs) - liabilities + adjustments related to tax consequences of selling assets/ liabilities
How to calculate valuation under capitalized cash flows approach?
- Determine annual cash flows (removing unusual, non-routine items) and apply capitalization rate to expected annual future cash flow of the entity
How to calculate valuation under the discounted cash flows approach?
- To calculate, use estimates of future cash flows and discount at appropriate rate (similar in nature to NPV?)
What are some limitations of using a capitalized earnings approach valuation?
- Generally we are only looking at 1 year of data (sales might reflect a “normal” year, or they might not be accurate)
- Ask yourself: what are the estimates and assumptions used in the calculation? (ie, if you are saving on a certain expense, the actual could be higher or lower than expected)
- What is the multiplier is not appropriate (too large/ too small)? It could be based on larger or smaller companies, companies with more or less future growth, companies in different geographical locations
- Are the #’s you are using audited? once audited, NI could change
- Considering all of these limitations, is their a valuation method that could be better?
Why is time value of money important for RRSP?
- RRSP allows for tax deferring (you get a tax break now, but are tax consequences in the future) - helpful for retirement planning, investing, etc
What ratios can be used to evaluate working capital (current assets - current liabilities)?
- current ratio = current assets/ current liabilities
- quick ratio = quick assets/ current liabilities
- AR turnover = sales on credit/ average AR
- days in AR = 365/ AR turnover
- AP turnover = purchases (CY COGS + CY inventory - PY inventory)/ average AP
- days in AP = 365/ AP turnover
- inventory turnover = COGS/ average inventory
- days in inventory = 365/ inventory turnover
What does the quick ratio illustrate?
Company’s ability to cover short-term liabilities, with its short-term assets, without needing to sell its inventory
What does the current ratio illustrate?
A company’s ability to use its short-term assets, to cover its short-term liabilities
What does the AR/ AP / inventory ratio(s) illustrate?
- the amount of time AR takes to collect, the time it takes AP to be paid by the company, and the amount of time inventory sits before it is sold
When evaluating the above, think about:
*payment terms (TVM it is better to hold on to $ for longer before paying),
*receivable terms (standard collection is generally 30 ish days, does the company have collectability terms, are there any issues with late payments, is the entity short on cash)
* inventory (is industry standard given, do a gut-check of like what is a long time - like more than 9 months/year, what’s the impact of storing excess inventory, is any of it spoilable/ will increase obsolescence
