173A - Review

February 14, 2007Please NOTE this is not a document limiting

what will be on the midterm. Anything covered in book or class is fair game. It is mostly 170

review to this point

Goal: Maximize SHW (=Stock Price); Minimize Agency Conflict. EVA????

• Economic Value Added• Profit over and beyond paying for the cost of capital• $NOPAT - $Cost of Capital• NOPAT=EBIT-Taxes• $Cost of Capital = Capital (NWC+FA) * % WACC• Capital: CA-CL+FA=LTD+Equity (CA+FA=CL+D+E)• CofC: cost of debt after tax, cost of equity, impact of risk• How do you impact the components???

What else

• Risk Return Tradeoff= Expected Return (weighted average)= Required Rate of Return (CAPM!)= Portfolio Return/RRR (weighted average)= Expected Return = Required Rate of Return (Price?)= Undervalued vs Overvalued Securities= Fisher Effect and Impact of Inflation on RRR= Risk aversion change and RRR

Marriage of FCF and TVMDiscounted Cash Flow

Applies to valuing ALL Financial Assets(Future Cash Flows & Required Rates)

PV =

CF

1+ r ... +

CF

1+r1 n

12

21

CF

rn .

0 1 2 nr

CF1 CFnCF2Value

...

+ ++

What is the value of Bond, and What is its return?

• Value of bond = PVa of INT + PV of Par

• What if Coupon Rate = Discount Rate

• What if CR < Discount Rate

• What if CR > Discount Rate

• YTM, YTC

Excel Solution

Time and Value of 10 Yr Bond

Value of Bond in Given Year:

N 7% 10% 13%

0 $1,211 $1,000 $837

1 $1,195 $1,000 $846

2 $1,179 $1,000 $856

3 $1,162 $1,000 $867

4 $1,143 $1,000 $880

5 $1,123 $1,000 $894

6 $1,102 $1,000 $911

7 $1,079 $1,000 $929

8 $1,054 $1,000 $950

9 $1,028 $1,000 $973

10 $1,000 $1,000 $1,000

YTM in Excel

YTM = Current Yield + Capital Gains Yield

• Therefore

Capital Gains Yield = YTM-CY

• CY = INT/Price

Semiannual and Monthly Bonds

1. Multiply years by 2 to get periods = 2n.2. Divide nominal rate by 2 to get periodic rate = rd/2.3. Divide annual INT by 2 to get PMT = INT/2.

1. Multiply years by 12 to get periods = 12n.2. Divide nominal rate by 12 to get periodic rate = rd/12.3. Divide annual INT by 12 to get PMT = INT/12.

Valuing Stocks and Expected Return

• Constant Growth Stock

• Non-constant Growth

• Dividend Yield vs. Capital Gains Yield

Constant Growth : P0=D1/(rrr-gr) Price in Future Year: Pn=D(n+1)/(rrr-gr)

D 0 = $2.00        

g = 6%        

r s = 13.0%        

           

P 0 =D 1

=D 0 (1+g)

=$2.12

( r s - g ) ( r s - g ) 0.07

           

P 0 = $30.29        

Non-constant Growth: Individual PVs plus CG PV

186

187

188

189190191192193194195196197198199

200

A B C D E F G H ID 0 $2.00

r s 13.0%

gs 30% Short-run g; for Years 1-3 only.

gL 6% Long-run g; for Year 4 and all following years.30% 6%

Year 0 1 2 3 4Dividend $2.00 2.6 3.38 4.394 4.6576

PV of dividends$2.3009

2.64703.0453 4.6576

$7.9932 P4 = 66.5377 = Terminal value =$46.1140 7.0% = r - gL

$54.1072 = P0

Dividend Yield vs Capital Gains Yield

• Dividend Yield = Next Div/Today’s Price

• Future DY = Div (n+1)/Pn

• Capital Gains Yield = (Price1-Price0)/Price0

• Future Period CGY = [Price(n+1)-Pricen]/Pricen

Income Statement

2006 2007

INCOME STATEMENT

Net sales $3,432,000 $5,834,400

Cost of Goods Sold $2,864,000 $4,980,000

Other Expenses $340,000 $720,000

Depreciation $18,900 $116,960

Total Operating Costs $3,222,900 $5,816,960

Earnings before interest and taxes (EBIT) $209,100 $17,440

Less interest $62,500 $176,000

Earnings before taxes (EBT) $146,600 -$158,560

Taxes (40% ) $58,640 -$63,424

Net Income $87,960 -$95,136

Tax rate 40% 40%

Balance Sheet

5657585960616263646566

6768697071727374757677

A B C D E F G2006 2007

AssetsCash and equivalents $9,000 $7,282Short-term investments $48,600 $20,000Accounts receivable $351,200 $632,160Inventories $715,200 $1,287,360Total current assets $1,124,000 $1,946,802Gross fixed assets $491,000 $1,202,950Less: Accumulated depreciation $146,200 $263,160Net plant and equipment $344,800 $939,790Total assets $1,468,800 $2,886,592

Liabilities and equityAccounts payable $145,600 $324,000Notes payable $200,000 $720,000Accruals $136,000 $284,960Total current liabilities $481,600 $1,328,960Long-term bonds $323,432 $1,000,000Common Stock $460,000 $460,000Retained Earnings $203,768 $97,632Total Equity $663,768 $557,632Total Liabilites and Equity $1,468,800 $2,886,592

Cash Flow Statement

858687888990919293949596979899100101102103104105106107108109110111

A B C D E F G2007

Operating Activities Net Income before preferred dividends ($95,136)Noncash adjustments Depreciation and amortization $116,960Due to changes in working capital Change in accounts receivable ($280,960) Change in inventories ($572,160) Change in accounts payable $178,400 Change in accruals $148,960Net cash provided by operating activities ($503,936)

Long-term investing activities Cash used to acquire fixed assets ($711,950)

Financing Activities Change in short-term investments $28,600 Change in notes payable $520,000 Change in long-term debt $676,568 Payment of cash dividends ($11,000)Net cash provided by financing activities $1,214,168

Net change in cash and equivilents ($1,718)Cash and securities at beginning of the year $9,000

Cash and securities at end of the year $7,282

And Back to EVA: EVA = $ NOPAT - $CostOfCapitalCA+FA = CL+LTD+E OR (CA-CL)+FA = LTD+E

• Operating Working Capital= Excludes Short Term Investments (CA)= Excludes Notes Payable (CL)

• Total Operating Capital = OWC+FA

• $ NOPAT = $EBIT (1-Tax%)

• $ CoC = $TOC * %WACC

• MVA vs. EVA?

• MVA = # shares * stock price – Equity

Ratios, Common Size and % change all tell the same story

• Liquidity, Asset Management, Debt, Profitability• Common size: TA=100%, Sales = 100%• Percent Change: (This Year – Last Year)/Last

Year• DuPont=ROE=PM*TATO*EM can start the

analysis• PM measures profitability, TATO asset

management, EM debt use (leverage)• Then you peel the onion further