+ → Net income = Taxable income - Taxes = (Sales - COGS - Depreciation - Interest paid) -

(Sales - COGS - Depreciation - Interest paid) x Tax rate

Chapter 2
/40/

- Muốn tính Cash flow from asset cần tính:

+ Operating cash flow = EBIT + Depreciation - Taxes
+ EBIT = Sales - COGS - Depreciation
+ Net Capital Spending = Ending net fixed assets - Beginning net fixed assets +
Depreciation
+ Change in NWC = Ending net fixed assets - Beginning net fixed assets
+ Cash flow from assets = Operating cash flow - Net capital spending - Change in NWC

- Balance sheets: Tính cả hai năm

+ Total assets = Net fixed assets + Current Assets
+ Total liabilities and shareholders’ equity = Current liabilities + Long-term debt + Equity
+ Shareholders’ Equity: Total assets - Total Liabilities = Current Assets + Net Fixed Assets -
(Current Liabilities + Long-term Debt)

+
- The income statement: Tính năm sau cùng - Cash flow to creditors = Interest paid − Net new borrowing
+ Net income = Taxable income - Taxes + Net New Borrowing = Change in Long-term Debt = Long-term debt năm sau - Long-term
+ Net income = Dividends + Addition to retained earnings (cuối bảng) → Addition to debt năm trước
retained earnings = Net income - Dividends
+ EBIT = Sales - COGS - Depreciation
+ EBT = EBIT - Interest Expense
+ Taxable income = EBIT - Interest paid
+ Taxes = Taxable income x Tax rate - Cash flow to stockholders = Dividends paid − Net new equity raised
+ Dividends paid = Dividends năm cuối
 + 1) Net new equity raised = Total equity - Additions to retained earnings Change in NWC = (Ending Current Assets – Ending Current Liabilities) – (Beginning Current
+ Total equity = Equity năm sau - Equity năm trước Assets – Beginning Current Liabilities)
+ Addition to retained earnings = Net income - Dividends = ($4,810 – $2,230) - ($5,360 – $2,970) = -190
+ 2) Net New Equity Raised = Change in Common Stock + Change in Additional Paid-In
Surplus 8. Cash Flow to Creditors
+ Change in Common Stock = Ending Common Stock + Ending Additional Paid-In Capital Cash flow to creditors = Interest paid − Net new borrowing = Interest expense - Change in
+ Change in Additional Paid-In Surplus = Beginning Common Stock + Beginning Long-term Debt = 255,000 - ($2.21M – $1.87M) = –$85,000
Additional Paid-In Capital
9. Cash Flow to Stockholders
As a check, notice that cash flow from assets ($492) equals cash flow to creditors plus cash flow to Cash flow to stockholders = Dividends paid − Net new equity raised
stockholders ($1,217 − 725 = $492). = Dividends paid − (Change in Common Stock + Change in Additional Paid-In Surplus)
= $545,000 – [($805,000 + $4,200,000) – ($650,000 + $3,980,000)]= $170,000

Exercise Chap 2 10. Calculating Total Cash Flows

Cash Flow from Assets (CFFA) = Operating Cash Flow − Net Capital Spending − Change in NWC
1. Building a Balance Sheet
→ Operating Cash Flow = CFFA + Net Capital Spending + Change in NWC
a) Shareholders’ Equity = Total Assets − Total Liabilities = Current Assets + Net Fixed Assets -
OCF = (Cash flow to creditors + Cash flow to stockholders) + NCS + change in NWC = (- $85,000
(Current Liabilities + Long-term Debt) = 4,900 + 27,300 - 4,100 + 10,200 = $17,900
+ $170,000) + $1,250,000 + $45,000 = $1,380,000
b) net working capital = current assets - current liabilities = 4,900 − 4,100= 800
11. Market Values and Book Values
2. Building an Income Statement
a) Book Value of Total Assets = Net Fixed Assets (book) + Net Working Capital (book) =
Net income = Taxable income - Taxes = (Sales - COGS - Depreciation - Interest paid) - (Sales -
3,400,000 + 235,000 = $3,635,000
COGS - Depreciation - Interest paid) x Tax rate
b) - The machinery (fixed assets) can be sold for $5.1 million → this is market value of fixed
= (796,000 − 327,000 − 42,000 - 34,000) - 796,000 − 327,000 − 42,000 - 34,000) x 21% =
assets
$310,470
- If current assets and current liabilities were liquidated today, the company would receive
$1.15 million → this is the market value of NWC
3. Dividends and Retained Earnings
Market Value Total (Sum of Market Value of NWC and Fixed Assets) =
Addition to retained earnings = Net income - Dividends = 310,470 − 95,000 = 215,470
5,100,000+1,150,000 = 6,250,000

4. Per-Share Earnings and Dividends 12. Calculating Total Cash Flows

a) Earnings per share:
Given:
Sales = $305,000
Costs = $176,000
Other expenses = $8,900
Depreciation = $18,700
b) Dividends Per Share: Interest expense = $12,900
Taxes = $23,345
Dividends = $19,500
New equity issued = $6,400
Debt repaid = $4,900
Net Fixed Assets increase = $46,000
5. Calculating OCF
Operating cash flow = EBIT + Depreciation - Taxes = (Sales - COGS - Depreciation) + a. Operating Cash Flow
Depreciation - (Sales - COGS - Depreciation - Interest paid) x Tax rate EBIT = Sales − Costs − Other Expenses − Depreciation = 305,000 − 176,000 − 8,900 −
= (46,200 - 23,100 - 2,200) + 2,200 - (46,200 - 23,100 - 2,200 - 1,700) x 22% = $18,876 18,700 = 101,400

6. Calculating Net Capital Spending OCF = EBIT + Depreciation − Taxes

Net Capital Spending = Ending Net Fixed Assets – Beginning Net Fixed Assets + Depreciation = OCF = 101,400 + 18,700 − 23,345 = 96,755
3,300,000−2,400,000+319,000 = $1,219,000 b. Cash Flow to Creditors
Net new borrowing = –$4,900 (because debt was redeemed, not issued)
7. Calculating Additions to NWC
 Cash Flow to Creditors = Interest Paid − Net New Borrowing 15. Residual Claims
CFC = 12,900 + 4,900 = 17,800 Shareholders’ Equity = Assets − Liabilities
c. Cash Flow to Stockholders Liabilities (obligations to creditors) = $7,800
Cash Flow to Stockholders = Dividends Paid − Net New Equity Raised
CFS = 19,500 - 6,400 = 3,100 a. If assets = $9,400:
d. Addition to Net Working Capital (NWC) = Change in NWC Equity = 9,400 - 7,800 =1,600
CFFA = Cash Flow to Creditors + Cash Flow to Stockholders = 17,800 + 13,100 = 30,900
b. If assets = $6,700:
CFFA = OCF − Net Capital Spending − Change in NWC Equity = 6,700 - 7,800 = −1,100
→ Change in NWC = OCF − Net Capital Spending − CFFA = 96,755 − 46,000 − 30,900 =
19,855 16. Net Income and OCF
Sales = $705,000
13. Using Income Statements COGS = $445,000
Net Income = Addition to Retained Earnings + Dividends Paid = 5,700 + 1,980 = 7,680 Admin & Selling Expenses = $95,000
Depreciation = $140,000
Taxes = 22% of EBT Interest Expense = $70,000
Net Income = EBT × (1−Tax Rate) Tax Rate = 25%
⇒ 7,680 = EBT × (1−0.22) = EBT × 0.78
EBT = 9,846.15 a. Net Income Calculation
EBIT = Sales − Costs − Depreciation
EBIT = EBT + Interest Expense = 9,846.15 + 4,400 = 14,246.15 = 705,000 − 445,000 − 95,000 − 140,000 = 25,000

EBIT = Sales − Costs − Depreciation EBT = EBIT - Interest Expense = 25,000 − 70,000 = −45,000
14,246.15 = 64,000 − 30,700 − Depreciation Since EBT is negative, tax = 0.
⇒ Depreciation = 64,000 − 30,700 − 14,246.15 = 19,053.85
Net Income = EBT − Taxes = −45,000−0 = −$45,000
14. Preparing a Balance Sheet
b. Operating Cash Flow (OCF)
OCF = EBIT + Depreciation − Taxes
Assets Liabilities & Equity
● EBIT = $25,000
Cash $127,000 Accounts Payable $210,000
● Depreciation = $140,000
Accounts Receivable $115,000 Notes Payable $155,000 ● Taxes = $0

Inventory $286,000 Total Current Liabilities $365,000 OCF = 25,000+140,000−0 = $165,000

Total Current Assets $528,000 c. Explanation

● The net income is negative ($–45,000) because the firm had high interest expenses
($70,000), which exceeded operating profit (EBIT) of only $25,000.
● Despite this, the operating cash flow is strong ($165,000) because:
Tangible Net Fixed Assets $1,610,000 Long-Term Debt $830,000 ○ OCF excludes interest expense (since it's a financing activity),
○ And adds back non-cash depreciation ($140,000).
Patents and Copyrights $660,000 Total Liabilities $1,195,000

Total Non-Current Assets $2,270,000 So, although Raines Umbrella Corp. reported a net loss, its core operations still generated solid
cash, indicating it might be operationally viable but financially stressed due to debt.
Common Stock $235,000
17. Accounting Values versus Cash Flows
Retained Earnings $1,368,000 Known from earlier:
● Operating Cash Flow (OCF) = $165,000
Total Equity $1,603,000 ● Net Income = –$45,000
● Dividends Paid = $102,000
Total Assets $2,798,000 Total Liabilities + Equity $2,798,000
● Net Capital Spending = $0
● Change in Net Working Capital = $0
 ● No new stock issued Cash Flow to Creditors = Interest Paid − Net New Borrowing

OCF = Cash Flow to Creditors + Cash Flow to Stockholders No new debt was issued, so any change in long-term debt is 0. ⇒Cash Flow to Creditors = 2,650

Since no new equity was issued, cash flow to stockholders is just dividends: Cash Flow to Stockholders = CFFA − Cash Flow to Creditors = −2,166 − 2,650 = −4,816

Cash Flow to Stockholders = 102,000 But dividends paid = 1,888, so this negative number implies the company raised equity capital to
cover the excess.
Cash Flow to Creditors = OCF − Dividends
= 165,000 − 102,000 = 63,000 19. Calculating Cash Flows
a. What is owners’ equity for 2017 and 2018?
Cash Flow to Creditors = Interest Paid − Net New Borrowing Owners’ Equity=Total Assets−Total Liabilities
63,000 = 70,000 − Net New Borrowing
⇒ Net New Borrowing = 70,000 − 63,000 = 7,000 2017:

Yes, it is possible for Raines Umbrella Corp. to pay $102,000 in dividends, but only because: ● Current assets = 1,206
● Net fixed assets = 4,973
The company borrowed an additional $7,000 in long-term debt during the year. ● Current liabilities = 482
● Long-term debt = 2,628
That borrowing, combined with OCF, gave the company enough cash to cover dividends and
Total Assets 2017 = 1,206 + 4,973 = 6,179
interest.
Total Liabilities 2017 = 482 + 2,628 = 3,110
Owners’ Equity 2017 = 6,179 − 3,110 = 3,069
18. Calculating Cash Flows
a. Net Income
2018:
EBIT=Sales−COGS−Depreciation=33,106−23,624−5,877=3,605
● Current assets = 1,307
EBT=EBIT−Interest=3,605−2,650=955
● Net fixed assets = 5,988
● Current liabilities = 541
Taxes=955×22%=210.1
● Long-term debt = 2,795

Net Income=955−210.1=744.9≈745 Total Assets 2018 = 1,307 + 5,988 = 7,295

Total Liabilities 2018 = 541 + 2,795 = 3,336
b. Operating Cash Flow (OCF) Owners’ Equity 2018 = 7,295 − 3,336 = 3,959
OCF = EBIT + Depreciation − Taxes
OCF = 3,605 + 5,877 − 955×22% = 9,272 b. What is the change in net working capital (NWC) for 2018?
NWC = Current Assets − Current Liabilities
c. Cash Flow from Assets (CFFA)
CFFA=OCF−Net Capital Spending−Change in NWC 2017:
Net Capital Spending = End NFA − Begin NFA + Depreciation = 24,394 − 19,820 + 5,877 = 10,451 NWC 2017 = 1,206 - 482 = 724

Begin NWC = 6,970 − 3,920 = 3,050 2018:

End NWC = 8,612 - 4,575 = 4,037 NWC 2018 = 1,307 - 541 = 766
Change in NWC = 4,037 - 3,050 = 987
Change in NWC:
CFFA=9,272−10,451−987=−2,166
ΔNWC = 766 - 724 = 42
Is this possible?
c. Fixed asset sale and cash flow from assets
Yes. A negative CFFA means the firm invested more in fixed assets and working capital than it
generated from operations. It likely used external financing (debt or equity) to fund this. ● New fixed assets purchased in 2018 = 2,496
● Ending Net Fixed Assets = 5,988
d. Cash Flow to Creditors and Stockholders ● Beginning Net Fixed Assets = 4,973
● Depreciation = 1,363
● Tax rate = 21%

Chapter 3
1. Calculating Liquidity Ratios

2. Calculating Profitability Ratios

 6. Calculating Market Value Ratios

given:

● Additions to retained earnings = $415,000

● Dividends paid = $220,000
3. Calculating the Average Collection Period
● Ending total equity = $5,600,000
● Shares outstanding = 170,000
● Stock price = $65
● Sales = $7,450,000

Net Income = Additions to Retained Earnings + Dividends Paid = 415,000 + 220,000 = 635,000

4. Calculating Inventory Turnover

5. Calculating Leverage Ratios

 9. Sources and Uses of Cash
1. Decrease in Inventory (+$375)
Source of Cash
Selling inventory brings in cash.
+375

2. Decrease in Accounts Payable (-$220)

Use of Cash
Paying off liabilities uses up cash.
-220

3. Increase in Notes Payable (+$290)

Source of Cash
Borrowing money increases cash.
+290

4. Increase in Accounts Receivable (-$270)

Use of Cash
More money tied up in receivables = less cash.
-270

Net Change in Cash: +375−220+290−270= +175

10. Calculating Average Payables Period

11. Enterprise Value-EBITDA Multiple

Enterprise Value = Market Value of Equity + Debt − Cash
7. DuPont Identity
= 645,000 + 215,000 - 53,000 = 807,000
ROE = Profit Margin × Total Asset Turnover × Equity Multiplier
= 0.061×2.10×1.27 ≈ 0.1627 or 16.27%
EBITDA = EBIT + Depreciation and Amortization = 91,000 + 157,000 = 248,000
8. DuPont Identity
ROE = Profit Margin × Total Asset Turnover × Equity Multiplier

12. Equity Multiplier and Return on Equity

 Long-term debt 10.57% 9.38%

Common stock + paid-in surplus 10.79% 10.42%

Retained earnings 64.70% 65.81%

Total Equity 75.49% 76.23%

Total Liabilities + Equity 100.00% 100.00%

14. Preparing Standardized Financial Statements

Common-Base Year Balance Sheet (2018 based on 2017)

Account 2018 (as % of 2017)

Assets

Cash (14,105 / 12,157) × 100 = 116.0%

13. Preparing Standardized Financial Statements Accounts receivable (32,815 / 29,382) × 100 = 111.7%
Common-Size Balance Sheet for 2017 and 2018 (% of Total Assets)
A common-size balance sheet expresses each item as a percentage of total assets. Inventory (57,204 / 54,632) × 100 = 104.7%

Total Current Assets (104,124 / 96,171) × 100 = 108.3%

Account 2017 2018
Net plant and equipment (375,830 / 367,241) × 100 = 102.3%
Assets
Total Assets (479,954 / 463,412) × 100 = 103.6%
Cash 2.62% 2.94%

Accounts receivable 6.34% 6.83% Liabilities & Equity 2018 (as % of 2017)

Inventory 11.79% 11.92% Accounts payable (49,276 / 46,382) × 100 = 106.2%

Total Current Assets 20.75% 21.69% Notes payable (19,784 / 18,246) × 100 = 108.4%

Net plant and 79.25% 78.31% Total Current Liabilities (69,060 / 64,628) × 100 = 106.9%
equipment
Long-term debt (45,000 / 49,000) × 100 = 91.8%
Total Assets 100.00% 100.00%
Common stock + surplus (50,000 / 50,000) × 100 = 100.0%

Retained earnings (315,894 / 299,784) × 100 = 105.4%

Liabilities & Equity 2017 2018
Total Equity (365,894 / 349,784) × 100 = 104.6%
Accounts payable 10.00% 10.27%
Total Liabilities + Equity (479,954 / 463,412) × 100 = 103.6%
Notes payable 3.94% 4.12%
15. Preparing Standardized Financial Statements
Total Current Liabilities 13.94% 14.39%
 Account Common-Size (2018) Common-Base (2017 = 100%)
Grouping Totals
Cash 2.94% 116.0% - Sources of Cash
Increase in accounts payable: +2,894
Accounts receivable 6.83% 111.7% Increase in notes payable: +1,538
Increase in retained earnings: +16,110
Inventory 11.92% 104.7% Total Sources = 2,894 + 1,538 + 16,110 = 20,542

Total Current Assets 21.69% 108.3% - Uses of Cash

Increase in accounts receivable: –3,433
Net plant and equipment 78.31% 102.3%
Increase in inventory: –2,572
Total Assets 100.00% 103.6% Increase in net PPE: –8,589
Decrease in long-term debt: –4,000
Increase in cash: –1,948
Total Uses = 3,433 + 2,572 + 8,589 + 4,000 + 1,948 = 20,542
Accounts payable 10.27% 106.2%
- Explanation:
Notes payable 4.12% 108.4% The total change in assets from 2017 to 2018:
479,954−463,412=+16,542
Total Current Liabilities 14.39% 106.9%

Long-term debt 9.38% 91.8% The total change in liabilities and owners’ equity:
(69,060+45,000+365,894)−(64,628+49,000+349,784)=479,954−463,412=+16,542
Common stock + surplus 10.42% 100.0% Cash increased by $1,948, but that is a use, not a source in this context. The balance sheet
equation holds:
Retained earnings 65.81% 105.4% Assets=Liabilities+Equity
So, all the movements in non-cash accounts must explain how the increase in cash
Total Equity 76.23% 104.6% happened—and they do, since sources = uses.
Total Liabilities + Equity 100.00% 103.6%
17. Calculating Financial Ratios
a. Current Ratio = Current Assets / Current Liabilities
16. Sources and Uses of Cash
Year Formula Value

Account 2017 2018 Change Source / Use 2017 96,171 / 64,628 1.49

Cash 12,157 14,105 +1,948 Use (increase in cash is not a source) 2018 104,124 / 69,060 1.51

Accounts Receivable 29,382 32,815 +3,433 Use (more cash tied up in receivables)
b. Quick Ratio = (Current Assets – Inventory) / Current Liabilities
Inventory 54,632 57,204 +2,572 Use (more inventory = cash outflow)
Year Formula Value
Net Plant & Equipment 367,241 375,830 +8,589 Use (purchase of equipment = cash
outflow) 2017 (96,171 – 54,632) / 64,628 = 41,539 / 64,628 0.64

Accounts Payable 46,382 49,276 +2,894 Source (holding off paying = keeping 2018 (104,124 – 57,204) / 69,060 = 46,920 / 69,060 0.68
cash)
c. Cash Ratio = Cash / Current Liabilities
Notes Payable 18,246 19,784 +1,538 Source (borrowed cash)
Year Formula Value
Long-term Debt 49,000 45,000 –4,000 Use (paid off debt)
2017 12,157 / 64,628 0.19
Common Stock 50,000 50,000 0 No effect
2018 14,105 / 69,060 0.20
Retained Earnings 299,784 315,894 +16,110 Source (net income retained)
d. NWC to Total Assets = (Current Assets – Current Liabilities) / Total Assets

Year Formula Value

2017 (96,171 – 64,628) / 463,412 = 31,543 / 463,412 0.068

2018 (104,124 – 69,060) / 479,954 = 35,064 / 0.073

479,954 Long-term debt ratio = Long-term debt / (Long-term debt + Total equity)
0.35 = Long-term debt / (Long-term debt + 3419.6) → Long-term debt = 1841.32
e. Debt-to-Equity Ratio = Total Debt / Total Equity
Total Liabilities = Current Liabilities + Long-Term Debt
Equity Multiplier = Total Assets / Total Equity Total Liabilities = 955 + 1,841.32 = 2,796.32
Year D/E Ratio Equity Multiplier
Total Assets = 2,796.32 + 3,419.6 = 6,215.92
2017 113,628 / 349,784 = 0.32 463,412 / 349,784 = 1.32
Total Assets = Current Assets + Net Fixed Assets
2018 114,060 / 365,894 = 0.31 479,954 / 365,894 = 1.31 ⇒ Net Fixed Assets = 6,215.92 − 1,241.5 = $4,974.42

f. Total Debt Ratio = Total Debt / Total Assets 21. Profit Margin

Long-Term Debt Ratio = Long-Term Debt / Total Assets

Year Total Debt Ratio LTD Ratio

So, the grocery chain makes 1.5 cents for every dollar of sales.
2017 113,628 / 463,412 = 0.25 49,000 / 463,412 = 0.11
Let’s test this:
2018 114,060 / 479,954 = 0.24 45,000 / 479,954 = 0.094 Child’s earning per $50 = $1.50
Grocery chain’s profit on $50 = 1.5%×50=0.015×50=0.75
18. Using the DuPont Identity So yes, $1.50 is exactly twice $0.75.
Equity Multiplier = 1 + Debt-equity ratio = 1+0.57 = 1.57
Total equity = Total assets/Equity Multiplier = 2,974/1.57 = 1894.27 Is the claim correct?
Net income = ROE x Total equity = 11% x 1894.27 = $208.37 Mathematically, yes — the profit margin confirms the child makes twice as much as the grocery
chain earns in profit per $50.
19. Days’ Sales in Receivables

But is it misleading?

Yes, the claim is potentially misleading for several reasons:

1. Net income ≠ markup: The chain may have a high markup on goods, but its costs (rent,
labor, logistics, etc.) reduce the net income to just 1.5%. They're using net profit margin to
Credit Sales = 65% × Sales = 0.65 × 2,889,705.88 = 1,878,308.82
imply they barely make money.

2. Emotional manipulation: The ad implies groceries are not overpriced because their profit is
small. But low profit margins are typical in grocery businesses, and price fairness depends
on markup, not net income.

3. Cost allocation: Consumers care more about whether they’re getting fair value — not what
20. Ratios and Fixed Assets the grocery store earns after taxes and overhead.

22. Return on Equity

 24. Cost of Goods Sold

→ Firm B has the greater ROE (≈ 16.36%) compared to Firm A (≈ 14.29%).

Even though Firm A uses more debt (higher leverage), Firm B’s higher asset return (ROA) results
in better returns for equity holders.

23. Calculating the Cash Coverage Ratio

25. Ratios and Foreign Companies

1. Calculate the Profit Margin

 d. Total Asset Turnover
= Sales / Total Assets
= 506,454 / 627,868 ≈ 0.81

e. Inventory Turnover
= COGS / Inventory
= 359,328 / 42,632 ≈ 8.43

f. Receivables Turnover
= Sales / Accounts Receivable
= 506,454 / 27,766 ≈ 18.24

Long-Term Solvency Ratios:

g. Total Debt Ratio

2. Does the Foreign Currency Matter? = Total Liabilities / Total Assets
= (83,416 + 145,000) / 627,868
No, the profit margin is a ratio, so it is currency-neutral — the result is the same whether you = 228,416 / 627,868 ≈ 0.36
measure in pounds, dollars, euros, etc., as long as both net income and sales are in the same
currency. h. Debt-Equity Ratio
= Total Debt / Total Equity
So, quoting values in a foreign currency does not affect the profit margin itself. = 228,416 / 399,452 ≈ 0.57

i. Equity Multiplier
3. Convert the Net Loss to Dollars = Total Assets / Total Equity
= 627,868 / 399,452 ≈ 1.57

Coverage Ratios:

j. Times Interest Earned Ratio

= EBIT / Interest
= 102,663 / 19,683 ≈ 5.22

k. Cash Coverage Ratio

= (EBIT + Depreciation) / Interest
= (102,663 + 44,463) / 19,683 ≈ 147,126 / 19,683 ≈ 7.47

26. Calculating Financial Ratios

Profitability Ratios:
Short-Term Solvency Ratios: l. Profit Margin
= Net Income / Sales
a. Current Ratio
= 62,235 / 506,454 ≈ 12.29%
= Current Assets / Current Liabilities
= 108,235 / 83,416 ≈ 1.30 m. Return on Assets (ROA)
= Net Income / Total Assets
b. Quick Ratio
= 62,235 / 627,868 ≈ 9.91%
= (Current Assets − Inventory) / Current Liabilities
= (108,235 − 42,632) / 83,416 ≈ 65,603 / 83,416 ≈ 0.79 n. Return on Equity (ROE)
= Net Income / Total Equity
c. Cash Ratio
= 62,235 / 399,452 ≈ 15.57%
= Cash / Current Liabilities
= 37,837 / 83,416 ≈ 0.45
27. DuPont Identity
Asset Utilization Ratios: ROE = Profit Margin × Total Asset Turnover × Equity Multiplier
Profit Margin = Net Income / Sales
= 62,235 / 506,454 ≈ 12.29% or 0.1229

Total Asset Turnover = Sales / Total Assets

= 506,454 / 627,868 ≈ 0.81

Equity Multiplier = Total Assets / Total Equity

= 627,868 / 399,452 ≈ 1.57

Chapter 5
Smolira Golf Corp.’s ROE of 15.57% is driven by: 1. Simple Interest versus Compound Interest
FV simple = P × (1 + r × t) = 7,500 × (1 + 0.09 × 8) = 12,900
● A healthy profit margin of 12.29%,
● Moderate asset utilization (turnover of 0.81), and
● Conservative leverage (equity multiplier of 1.57).

28. Statement of Cash Flows

Difference Earned: 14,992.54 - 12,900 = 2,092.54
29. Market Value Ratios
2. Calculating Future Values
FV=PV×(1+r)^t

Present Value Years Interest Rate Future Value

$2,328 11 13% $8,743.72

$7,513 7 9% $13,738.66

$74,381 14 12% $407,187.86

$192,050 16 6% $488,340.48

3. Calculating Present Values

Years Interest Rate Future Value Present Value

13 9% $16,832 $5,505.62

4 7% $48,318 $36,847.13

29 13% $886,073 $22,897.96

 40 21% $550,164 $782.23

4. Calculating Interest Rates

Row Interest Rate

1 11.85%

2 7.12%

3 11.38%

4 10.72% 8. Calculating Interest Rates

5. Calculating the Number of Periods

9. Calculating the Number of Periods

→ t = 37.74 years
Row Years 10. Calculating Present Values

1 13.39 years

2 -

3 31.96 years

4 28.74 years
11. Calculating Present Values
6. Calculating Interest Rates

→ r = 0.0901 or 9.01% → PV ≈ 455.91

12. Calculating Future Values
7. Calculating the Number of Periods FV = 50×(1.043) ^115 = $3,249
13. Calculating Interest Rates and Future Values

r = 1.0807 − 1 = 0.0807 =8.07%

= $11,592,000

14. Calculating Rates of Return

 Chapter 6
= −4.46% 1. Present Value and Multiple Cash Flows

15. Calculating Rates of Return

1. Rate of appreciation from 1787 (minting) to 1979 sale

2. Rate of return for the 1979 buyer (1979 to 2014)

3. Overall rate from 1787 to 2014

16. Calculating Rates of Return

17. Calculating Present Values

2. Present Value and Multiple Cash Flows

18. Calculating Future Values

19. Calculating Future Values

20. Calculating the Number of Periods

≈ 20.78 years
Total wait from now = 2 + 20.78 = 22.78 years
3. Future Value and Multiple Cash Flows 4. Calculating Annuity Present Value
Forever:
PV = C/r = 4350/6% = 72500

NCHUNG LÀ t-1 Ý MÁ hiểu ngầm, đừng nhầm FV nhaa

 8. Calculating Annuity Values

5. Calculating Annuity Cash Flows

9. Calculating Annuity Values

10. Calculating Perpetuity Values

6. Calculating Annuity Values

= 252415
7. Calculating Annuity Values
11. Calculating Perpetuity Values

12. Calculating EAR

 15. Calculating APR

13. Calculating APR

Why is this misleading?

The APR (15.77%) looks lower than the actual cost of borrowing (17.1%), because:
● APR doesn’t account for compounding during the year—it simply annualizes the periodic
rate.
● For loans with frequent compounding (like daily), the EAR is significantly higher than the
14. Calculating EAR APR.
● Uninformed borrowers might think 15.77% is the full annual cost, not realizing they are
effectively paying 17.1%.

16. Calculating Future Values

 i = 17% per month rồi nên không chia 12 nữa
17. Calculating Future Values
20. Calculating Loan Payments

PVA = C({1 – [1/(1 + r)]t } / r) → C = 1602

= [1+(5.2%/12)]^12-1 = 0.0533 = 5.33%

21. Calculating Number of Periods

18. Calculating Present Values

→ t ≈ 57 months
22. Calculating EAR

19. EAR versus APR

 EAR = [1 + (.10/12)]^12 – 1 = .1047 or 10.47%

23. Valuing Perpetuities

26. Calculating Annuity Present Values

t=16

27. Discounted Cash Flow Analysis

First, convert the nominal quarterly rate to an effective annual rate (EAR):
● Quarterly rate = 9%/4 = 2.25% per quarter
● EAR = (1 + 0.0225)^4 - 1 = 1.0225^4 - 1 ≈ 0.09308 or 9.308%

Calculate present value of each cash flow using PV = FV/(1+EAR)^n

Year Cash Flow Present Value Calculation Present Value

1 $815 815/(1.09308)^1 $745.71
2 $990 990/(1.09308)^2 $828.53
3 $0 0/(1.09308)^3 $0.00
24. Calculating Annuity Future Values 4 $1,520 1520/(1.09308)^4 $1,065.83

Sum the present values:

Total PV = $745.71 + $828.53 + $0 + $1,065.83 = $2,640.07

28. Discounted Cash Flow Analysis

Total PV = $2,314.20 + $0 + $3,187.56 + $1,643.24 = $7,145.00

25. Calculating Annuity Future Values

The compounding is monthly, while the deposits are annual.

To solve this, we need to:

● Adjust either the deposit frequency to monthly, or

● Convert the interest rate to effective annual rate (EAR) to match annual deposits.

EAR = [1 + (APR / m)]^m – 1

Chapter 7
1. Interpreting Bond Yields
1. Is the yield to maturity (YTM) the same thing as the required return?
In general, yes.
The yield to maturity (YTM) is the internal rate of return (IRR) earned by an investor who buys the
bond at the current market price and holds it to maturity.
The required return (also known as the required yield) is the return investors demand for investing
in the bond, given the risk, interest rates, and market conditions.
When a bond is fairly priced, YTM equals the required return.

2. Is YTM the same thing as the coupon rate?

No, they are not the same.
The coupon rate is fixed and determines the bond’s annual interest payment (e.g., a 10% coupon
on a $1,000 bond pays $100 annually).
The YTM changes based on the bond's current price in the market. If the bond trades at:

Par, then YTM = Coupon Rate

Premium, then YTM < Coupon Rate
Discount, then YTM > Coupon Rate
3. Suppose today a 10% coupon bond sells at par. Two years from now, the required return on the
same bond is 8%.

What is the coupon rate on the bond then?

● The coupon rate stays the same — 10% — because it is fixed when the bond is issued.

What is the YTM then?

● The YTM will be 8%, because that’s the new required return for the bond in the market.
→ YTM = 2.97%
● Since market interest rates have dropped (from 10% to 8%), the bond will now sell at a
5. Coupon Rates
premium (above par), but the fixed coupon payments and new market price together will
the coupon rate = 4.29%
give a YTM of 8%.
the coupon rate = coupon payments (C) / par value (FV)
2. Interpreting Bond Yields
6. Bond Prices
What happens:
● Coupon rate = 4.9%
● The market value of your bond will decrease.
● Par value (Face value) = $1,000
● It will now sell at a discount — far below its face value.
● Time to maturity = 15 years originally, but 1 year has passed, so 14 years remaining
● Payment frequency = Semiannual → 2 periods per year
Why does this happen?
● YTM (Yield to Maturity) = 4.5% annual = 2.25% per period
The bond pays fixed coupon payments — in this case, 7% of face value (e.g., $70/year on a
● Coupon payment = 4.9% of $1,000 annually = $49/year → $24.50 per period
$1,000 bond).
● Number of periods remaining = 14 years × 2 = 28 periods
But if new bonds in the market are offering 15%, your 7% bond becomes less attractive, because:

● New investors can get much higher returns elsewhere.

● To make your bond competitive, its price must drop, so that the YTM (what the new investor
earns by buying your bond at a discount) rises to match the new 15% rate.

In simple terms: 7. Bond Yields

● Your bond still pays $70/year.
● But now, $70 is worth less compared to the $150/year a 15% bond would pay.
● So buyers will only want your bond if they can get it at a much lower price.

3. Valuing Bonds
Par value = €1,000
Time to maturity = 23 years
Coupon rate = 3.8%
Coupon payment = 3.8%×1,000 = €38 annually
Yield to maturity = 4.7% annually

4. Bond Yields
Price = 105.43% of ¥100,000 = ¥105,430
Par Value = ¥100,000
Coupon Rate = 3.4% annually → Coupon payment = ¥3,400/year
Maturity = 16 years
Payments = Annually
Each period is about 2.415%, so YTM = 4.83%

8. Coupon Rates
 10. Valuing Bonds

11. Valuing Bonds

9. Zero Coupon Bonds

12. Calculating Real Rates of Return

13. Inflation and Nominal Returns

R: nominal rate
r: real rate
h: inflation rate
r nominal = 5.57%

14. Nominal and Real Returns

15. Nominal versus Real Returns

2. Stock Values

● D1=2.34 (next dividend)

● P0=37 (current price)
● g = 4.5% = 0.045
Chapter 8
1. Stock Values

3. Stock Values

Type Value

Dividend Yield 6.32%

Capital Gains Yield 4.50%

Total Return 10.82%

4. Stock Values

5. Stock Valuation
Required Return = Dividend Yield + Dividend Growth Rate
R = 0.056 + 0.037

6. Stock Valuation

● Current stock price P0 = 74

● Required return r = 10.6%
● Total return = Dividend yield + Capital gains yield
● The total return is evenly split → each is half of 10.6% = 5.3%
● Dividend yield = 5.3% = 0.053
● Capital gains yield (growth rate) = 5.3% = 0.053

7. Stock Valuation

This is a finite dividend problem — Burnett Corp. will pay a constant dividend for 13 years,
then stop paying dividends forever. Since the dividend ends after a known period, we use the 8. Valuing Preferred Stock
present value of an annuity formula.

9. Stock Valuation and Required Return

10. Voting Rights

 12. Stock Valuation and PE

13. Stock Valuation and PS

11. Voting Rights

14. Stock Valuation

15. Nonconstant Growth
16. Nonconstant Dividends

17. Nonconstant Dividends

 3. Calculating Payback
Chapter 9: Net Present Value and Other
Investment Criteria
1. Calculating Payback

Year Cash Flow Cumulative Cash Flow

0 –8,300 –8,300

1 2,100 –6,200

2 3,000 –3,200

3 2,300 –900

4 1,700 +800

2. Calculating Payback

4. Calculating Discounted Payback

5. Calculating Discounted Payback

6. Calculating AAR
 9. Calculating NPV and IRR

7. Calculating IRR

→ IRR = 20.23%
Since IRR > required return, the project should be accepted according to the IRR rule.

8. Calculating NPV

You would be indifferent at a discount rate of 13.45%, since that’s when NPV = 0.

10. Calculating IRR

11. Calculating NPV

 If the required return is less than 10.1%,
→ Project A has a higher NPV, so the company should choose Project A.

If the required return is greater than 10.1%,

→ Project B has a higher NPV, so the company should choose Project B.

● Choose Project A: when discount rate < 10.1%

● Choose Project B: when discount rate > 10.1%
● Indifferent: when discount rate = 10.1%

14. Problems with IRR

a. Net Present Value (NPV) Analysis

12. NPV versus IRR

a. IRR for each project
IRR of Project A ≈ 18.13%
IRR of Project B ≈ 23.93%

Decision using IRR rule:

Since Project B has a higher IRR, the company should accept Project B under the IRR rule.

Is this decision necessarily correct?

No, because IRR can be misleading for mutually exclusive projects. It doesn’t consider the scale or
timing of cash flows as effectively as NPV.

b. NPV at a required return of 11%

NPV of Project A ≈ $6,331
NPV of Project B ≈ $8,139

Decision using NPV rule: b. Internal Rate of Return (IRR) Analysis

The company should accept Project B, because it has a higher NPV.

c.
 16. Problems with Profitability Index

The IRR decision rule states that a project should be accepted if the IRR exceeds the required rate
of return. However, in this case both IRRs (-27.71% and -24.38%) are negative and significantly
lower than the required return of 12%.

15. Calculating Profitability Index

c. Explanation for Different Answers in (a) and (b)

Profitability Index (PI) vs. NPV:
● PI measures the benefit per dollar invested (efficiency).
● NPV measures the total dollar value added (absolute profitability).

Scale of Projects:
● Project I requires a larger initial investment ($63,000) but generates higher total cash flows.
● Project II requires a smaller initial investment ($15,500) but generates proportionally higher
returns per dollar invested (higher PI).

Mutually Exclusive Projects:

● When projects are mutually exclusive, NPV is the preferred metric because it maximizes
total wealth.
● PI may favor smaller projects with higher efficiency, but this can lead to lower total value
creation compared to larger projects.

Conclusion:
● PI suggests Project II because it offers better returns per dollar.
● NPV suggests Project I because it adds more total value to the firm.

The difference arises because PI does not account for project scale, while NPV does.

17. Comparing Investment Criteria

● Project B has a shorter discounted payback period (2.74 years vs. 3.72 years).
● Choose Project B based on the discounted payback criterion.
 ● While other criteria favor Project B, they ignore the scale of the project and absolute value
added.

Reason:
● NPV directly measures the increase in firm wealth, which is the primary goal of financial
management.
● Other metrics (IRR, PI, payback) can be misleading for mutually exclusive projects due to
differences in project size or cash flow timing.

19. MIRR

Chapter 14
1. Calculating Cost of Equity

f. Final Choice:
● Choose Project A because NPV is the most reliable criterion for mutually exclusive
projects, as it maximizes total firm value.
2. Calculating Cost of Equity

3. Calculating Cost of Equity