KEY EQUATIONS B

CHAPTER 2 4. The ratio of net working capital to total assets:

Net working capital to total assets
1. The balance sheet identity or equation:
Net working capital
= ​ _________________
       ​ [3.4]
Assets = Liabilities + Shareholders’ equity[2.1] Total assets

2. The income statement equation: 5. The interval measure:

Interval measure
Revenues – Expenses = Income [2.2] Current assets
= ________________________
​   
     ​ [3.5]
Average daily operating costs
3. The cash flow identity:
6. The total debt ratio:
Cash flow from assets = Total debt ratio
Cash flow to creditors + Total assets − Total equity
__________________
Cash flow to stockholders [2.3] = ​          ​ [3.6]
Total assets

where: 7. The debt-equity ratio:

a. Cash flow from assets = Operating cash Debt-equity ratio
flow (OCF) − Net capital spending − Total debt  ​
=  ​ _________ [3.7]
Change in net working capital (NWC) Total equity
(1) Operating cash flow = Earnings 8. The equity multiplier:
before interest and taxes (EBIT) + Equity multiplier
Depreciation − Taxes Total assets  ​
(2) Net capital spending = Ending net =  ​ _________ [3.8]
Total equity
fixed assets − Beginning net fixed
9. The long-term debt ratio:
assets + Depreciation
Long-term debt ratio
(3) Change in net working capital =
Long-term debt
Ending NWC − Beginning NWC ​ _____________________
=       ​ [3.9]
Long-term debt + Total equity
b. Cash flow to creditors = Interest paid −
Net new borrowing 10. The times interest earned (TIE) ratio:
c. Cash flow to stockholders = Dividends ​  EBIT  ​ [3.10]
Times interest earned ratio = ______
paid − Net new equity raised Interest
11. The cash coverage ratio:
Cash coverage ratio
CHAPTER 3 EBIT + Depreciation
______________
= ​         ​ [3.11]
Interest
1. The current ratio:
Current assets  ​
_______________ 12. The inventory turnover ratio:
Current ratio ​=​  
​    [3.1]
Current liabilities Inventory turnover
Cost of goods sold
2. The quick or acid-test ratio: = _____________
​         ​ [3.12]
Inventory
Current assets – Inventory
_____________________
Quick ratio =
​ ​   
​      ​ [3.2] 13. The average days’ sales in inventory:
Current liabilities
Days’ sales in inventory
3. The cash ratio:
365 days
Cash = ______________
​   
   ​ [3.13]
Cash ratio = _____________
​     ​ [3.3] Inventory turnover
Current liabilities

B-1
B-2 APPENDIX B  Key Equations

14. The receivables turnover ratio: 2. The internal growth rate:

Receivables turnover ROA × b  ​
Internal growth rate = _________
​    [4.2]
Sales 1 − ROA × b
= ​ ______________
    ​ [3.14]
Accounts receivable
3. The sustainable growth rate:
15. The days’ sales in receivables: ROE × b  ​
Days’ sales in receivables Sustainable growth rate = ________
​    [4.3]
1 − ROE × b
365 days
_______________
=   
​     ​ [3.15]
Receivables turnover
16. The net working capital (NWC) turnover ratio: CHAPTER 5
​ Sales  ​
NWC turnover = _____ [3.16] 1. The future value of $1 invested for t periods at a rate of r
NWC
per period:
17. The fixed asset turnover ratio:
Future value = $1 × (1 + r)t [5.1]
​    Sales
Fixed asset turnover = ___________  ​ [3.17]
Net fixed assets 2. The present value of $1 to be received t periods into the
18. The total asset turnover ratio: future at a discount rate of r:
PV = $1 × [1 ∕(1 + r)t] = $1 ∕(1 + r)t [5.2]
​  Sales  ​
Total asset turnover = _________ [3.18]
Total assets 3. The relationship between future value and present value
19. Profit margin: (the basic present value equation):
​ Net income
Profit margin = _________  ​ [3.19] PV × (1 + r)t = FVt [5.3]
Sales PV = FVt ∕(1 + r)t = FVt × [1 ∕ (1 + r)t]
20. Return on assets (ROA):
Net income ​
Return on assets = ​ _________ [3.20]
Total assets CHAPTER 6
21. Return on equity (ROE): 1. The present value of an annuity of C dollars per period for
​ Net income  ​
Return on equity = _________ [3.21] t periods when the rate of return or interest rate is r:
Total equity Annuity present value
22. The price-earnings (PE) ratio:
Price per share ( 1 – Present value
   r ​  ​
factor
= C × ​ ​ ____________________ )
PE ratio = _____________
  
​    ​ [3.22]
Earnings per share
23. The market-to-book ratio:
{ 1 – [1∕(1 + r)t]
________________
= C × ​    ​ 
   r ​  ​ } [6.1]
Market value per share 2. The future value factor for an annuity:
Market-to-book ratio = ________________
  
​     ​ [3.23]
Book value per share Annuity FV factor
24. Enterprise value: = (Future value factor – 1)∕r [6.2]
Enterprise value = Total market value of the stock + = [(1 + r)t – 1]∕r
Book value of all liabilities − 3. Annuity due value = Ordinary annuity value
Cash [3.24] × (1 + r) [6.3]
25. The EBITDA (earnings before interest, tax,
4. Present value of a perpetuity:
depreciation, and amortization) ratio:
PV for a perpetuity = C∕r [6.4]
Enterprise value
____________
EBITDA ratio = ​     ​ [3.25] 5. Growing annuity present value

[ )]
EBITDA
26. The DuPont identity: ( 1+g t
1 – ​​ ​ _____ ​  ​​​
1+r
= C × ​  ​ ___________
r – g ​  ​ [6.5]
​ Net income
ROE = __________ ​  Sales  ​ × ______
 ​ × ______ ​  Assets  ​ [3.26]
Sales Assets Equity
6. Growing perpetuity present value
Return on assets ​ r C
= _____
– g ​ [6.6]
= Profit margin
× Total asset turnover 7. Effective annual rate (EAR), where m is the number of
× Equity multiplier times the interest is compounded during the year:
EAR = [1 + (Quoted rate∕m)]m – 1 [6.7]
CHAPTER 4
8. Effective annual rate (EAR), where q stands for the con-
1. The dividend payout ratio:
tinuously compounded quoted rate:
Dividend payout ratio
EAR = eq − 1 [6.8]
​  Cash
=       dividends
___________  ​ [4.1]
Net income
 APPENDIX B   Key Equations B-3

CHAPTER 7 3. Discounted payback period:

Discounted payback period = Number of years that
1. Bond value if bond has (1) a face value of F paid at
pass before the sum of an investment’s discounted
maturity, (2) a coupon of C paid per period, (3) t periods
cash flows equals the cost of the investment
to maturity, and (4) a yield of r per period:
Bond value 4. The average accounting return (AAR):
= C × [1 – 1∕(1 + r)t]∕r + F∕(1 + r)t Average net income
_________________
AAR =   ​   ​
  
​ Present
  
      value ​   ​   
Present value ​ 
       Average book value
= + [7.1]
of the coupons of the face amount 5. Internal rate of return (IRR):
2. The Fisher effect: IRR = Discount rate or required return such that the net
1 + R = (1 + r) × (1 + h) [7.2] present value of an investment is zero
R = r + h + r × h [7.3] 6. Profitability index:
R ≈ r + h [7.4] PV of cash flows  ​
Profitability index = ​ ________________
  
  
Cost of investment
CHAPTER 8
1. Per-share present value of common stock, where D1 is the
cash dividend paid at the end of the period, and R is the CHAPTER 10
required return: 1. Bottom-up approach to operating cash flow (OCF):
P0 = (D1 + P1)∕(1 + R) [8.1] OCF = Net income + Depreciation [10.1]
2. Per-share present value of common stock with zero 2. Top-down approach to operating cash flow (OCF):
growth, where the dividend is constant and R is the OCF = Sales − Costs − Taxes [10.2]
required return: 3. Tax shield approach to operating cash flow (OCF):
P0 = D∕R [8.2] OCF = (Sales – Costs) × (1 – Tc)
3. The dividend growth model: + Depreciation × Tc [10.3]
D × (1 + g) ______
D
P0 = ___________
​  0  ​ = ​  1  ​ [8.3]
R–g R–g
CHAPTER 11
4. The dividend growth model can be modified slightly
1. Accounting break-even point:
to give the price of a stock as of Time t:
Q = (FC + D)∕(P – v) [11.1]
Dt × (1 + g) ______
D
Pt = ​ ___________
 ​ = ​  t+1  ​ [8.4] 2. Project operating cash flow (OCF), ignoring taxes:
R–g R–g
OCF = (P – v) × Q – FC [11.2]
5. Two-stage growth model:

[ )]
3. Relationship between operating cash flow (OCF)

(
t
D 1+g Pt and sales volume, ignoring taxes:
P0 = ______
​  1  ​× ​ 1 – ​​ ​ ______1 ​  ​​​  ​+ _______
​   ​ [8.5]
R – g1 1+R (1 + R)t Q = (FC + OCF)∕(P – v) [11.3]
6. The two-stage growth model can be modified to give the 4. Cash break-even point:
price of a stock at Time t: Q = FC∕(P – v)
D D × (1 + g1)t × (1 + g2) 5. Cash break-even point:
Pt = ______ _____________________
​  0
​  t+1  ​ =        ​ [8.6]
R – g2 R – g2 Q = (FC + OCF*)∕(P – v)
7. Required return: where
R = D1∕P0 + g [8.7] OCF* = Zero NPV cash flow
8. Stock valuation using benchmark PE evaluation: 6. Degree of operating leverage (DOL):
Price at Time t = ​P​  t​​= Benchmark PE ratio × E
​ PS​ t​​ [8.8] DOL = 1 + FC∕OCF [11.4]

CHAPTER 9 CHAPTER 12
1. Net present value (NPV):
1. Total dollar return on an investment:
NPV = Present value of future cash flows
Total dollar return = Dividend income +
– Investment cost
Capital gain (or loss) [12.1]
2. Payback period:
2. Total cash if stock is sold = Initial investment +
Payback period = Number of years that pass before the
Total return [12.2]
sum of an investment’s cash flows equals the cost of
the investment
B-4 APPENDIX B  Key Equations

3. Standard deviation of returns, SD(R) or σ:

______ 4. The market value of a firm’s debt and equity:
SD(R) = √​​ Var(R) ​​ V = E + D [14.4]
4. Variance of returns, Var(R) or σ2: 5. The percentages of a firm’s capital represented by debt
​__​ ​__​
​  1  ​ [(R1 – R​
Var(R) = _____ ​ )2 + · · · + (RT – R​
​ )2] [12.3] and equity:
T–1 100% = E∕V + D∕V [14.5]
5. Geometric average return: 6. The weighted average cost of capital (WACC):
Geometric average return = [(1 + R1) × WACC = (E∕V ) × R ​ E​ ​+ (D∕V ) ×
(1 + R2) × . . . × ​RD​ ​× (1 – T
​ ​C​) [14.6]
(1 + RT)​]1∕T
​ ​− 1 [12.4]
7. The weighted average cost of capital (WACC) with pre-
6. Blume’s formula: ferred stock:
​  T – 1  ​× Geometric average +
R(  T   ) = ______ WACC = (E∕V ) × R ​ E​ ​+ (P∕V ) × R ​ ​P​+
N–1 (D∕V ) × R
​ ​D​× (1 – ​TC​ ​  ) [14.7]
​  N – T ​ × Arithmetic average
______ [12.5] 8. Calculating a firm’s “adjusted” taxes:
N–1
Taxes* = EBIT × TC [14.8]

CHAPTER 13 9. Adjusted cash flow from assets (CFA):

CFA* = EBIT + Depreciation – Taxes* –
1. Risk premium:
Change in NWC – Capital spending
Risk premium = Expected return −
= EBIT + Depreciation – EBIT × TC –
Risk-free rate [13.1]
Change in NWC – Capital spending [14.9]
2. Expected return on a portfolio:
10. Simplified adjusted cash flow from assets (CFA):
E(​RP​  ​) = x 1 × E(​R1​  ​) + x2 × E(​R2​  ​) + · · ·
CFA* = EBIT × (1 – TC) + Depreciation –
+ x​ n​  ​× E(​Rn​  ​) [13.2]
Change in NWC – Capital spending [14.10]
3. Risk and return:
11. The value of a firm today is:
Total return = Expected return +
CFA*1 CFA*2
Unexpected return [13.3] V0 = __________
​   ​ + ____________
​      ​ +
1 + WACC (1 + WACC)2
R = E(R) + U
4. Components of an announcement: CFA*3
____________
CFA*t + Vt
​      ​ + . . . + ​ ___________
  t ​ [14.11]
Announcement = Expected part + Surprise [13.4] (1 + WACC) 3 (1 + WACC)
5. Systematic and unsystematic components of return: 12. Firm value, using the growing perpetuity formula:
R = E(R) + Systematic portion + CFA*t+1
Unsystematic portion [13.5] Vt = __________
​   ​  [14.12]
WACC – g
6. Total risk: 13. Weighted average flotation cost, fA:
Total risk = Systematic risk + Unsystematic risk [13.6] ​f​A​= (E∕V ) × ​f​E​+ (D∕V ) × f​​D​ [14.13]
7. The reward-to-risk ratio:
E(Ri) – Rf
Reward-to-risk ratio = _________
​   ​ CHAPTER 15
βi
1. Rights offerings:
8. The market risk premium:
a. Number of new shares:
SML slope = E(RM) – Rf
Number of new shares
9. The capital asset pricing model (CAPM):
​ Funds to be raised  ​
= _______________
   [15.1]
E(Ri ) = Rf + [E(RM ) – Rf ] × βi [13.7] Subscription price
b. Number of rights needed:
Number of rights needed to buy a share of stock
CHAPTER 14
​  Old shares  ​
= __________ [15.2]
1. Required return on equity, ​RE​ ​(dividend growth model): New shares
​RE​ ​= ​D1​ ​∕P
​ ​0​ + g [14.1] c. Value of a right:
2. Required return on equity, ​RE​ ​: Value of a right = Rights-on price −
​RE​ ​= ​Rf​​+ ​βE​ ​× (​R​M​– ​Rf​​  ) [14.2] Ex-rights price
3. The cost of preferred stock, RP:
​R​P​= D∕​P​0​ [14.3]
 APPENDIX B   Key Equations B-5

CHAPTER 16 2. The Baumol-Allais-Tobin (BAT) model:

a. Opportunity costs:
1. Modigliani-Miller propositions (no taxes):
Opportunity costs = (C∕2) × R [19A.1]
a. Proposition I:
VL = VU b. Trading costs:
Trading costs = (T∕C) × F [19A.2]
b. Proposition II:
RE = RA + (RA – RD) × (D∕E ) [16.1] c. Total cost:
Total cost = Opportunity costs +
2. Modigliani-Miller propositions (with taxes):
Trading costs [19A.3]
a. Value of the interest tax shield:
Present value of the interest tax shield d. The optimal initial cash balance:
__________
= TC × D [16.2] ​​ (2T × F )∕R ​​ 
C* = √ [19A.4]
b. Proposition I:
VL = VU + TC × D [16.3] 3. The Miller-Orr model:
c. Proposition II: a. The optimal cash balance:
RE = RU + (RU – RD) × (D∕E ) × C* = L + (3∕4 × F × σ2∕R)(1∕3) [19A.5]
(1 – TC) [16.4] b. The upper limit:
U* = 3 × C* – 2 × L [19A.6]
c. The average cash balance:
CHAPTER 18
Average cash balance = (4 × C* – L)∕3 [19A.7]
1. Basic balance sheet identity:
Net working capital + Fixed assets
= Long-term debt + Equity [18.1] CHAPTER 20
2. Net working capital: 1. The size of receivables:
Net working capital = (Cash + Other current assets) Accounts receivable = Average daily sales ×
− Current liabilities [18.2] ACP [20.1]
3. Cash identity: 2. NPV of switching credit terms:
Cash = Long-term debt + Equity + a. Cash flow with old policy = (P – v)Q [20.2]
Current liabilities −
b. Cash flow with new policy = (P – v)Q´ [20.3]
Current assets other than cash −
Fixed assets [18.3] c. Present value of switching:
PV = [(P – v)(Q´ – Q)]∕R [20.4]
4. The operating cycle:
Operating cycle = Inventory period + d. Cost of switching:
Accounts receivable period [18.4] Cost of switching = PQ + v(Q´ – Q) [20.5]
5. The cash cycle: e. NPV of switching:
Cash cycle = Operating cycle − NPV of switching = –[PQ + v(Q´ – Q)] +
Accounts payable period [18.5] [(P – v)(Q´ – Q)]∕R [20.6]
6. Total cash collections: f. Break-even point of switching:
Cash collections = Beginning accounts receivable + Q´ – Q = PQ∕[(P – v)∕R – v] [20.7]
1/2 × Sales [18.6] 3. NPV of granting credit:
a. With no repeat business:
NPV = –v + (1 – π)P∕(1 + R) [20.8]
CHAPTER 19
b. With repeat business:
1. Float measurement: NPV = – v + (1 – π)(P – v)∕R [20.9]
a. Average daily float:
Total float ​ 4. The economic order quantity (EOQ) model:
Average daily float = ​ _________ [19.1] a. Total carrying costs:
Total days
Total carrying costs
b. Average daily float:
= Average inventory
Average daily float
× Carrying cost per unit
= Average daily receipts
= (Q∕2) × CC [20.10]
× Weighted average delay [19.2]
B-6 APPENDIX B  Key Equations

b. Total restocking cost: 3. Value of a call option (simple case):

Total restocking cost S0 = C0 + E∕(1 + R f )
= Fixed cost per order C0 = S0 – E∕(1 + R f ) [24.5]
× Number of orders 4. Value of a call that is certain to finish in the money:
= F × (T∕Q) [20.11] Call option value
c. Total costs: = Stock value
Total costs = Carrying costs – Present value of the exercise price
+ Restocking costs C0 = S0 – E∕(1 + Rf )t [24.6]
= (Q∕2) × CC + F × (T∕Q) [20.12]
d. Q*:
Carrying costs = Restocking costs CHAPTER 25
(Q*∕2) × CC = F × (T∕Q*) [20.13] 1. Put-call parity condition (PCP):
e. The optimal order size Q*: a. Share of stock + A put option
______
2T × = Present value of strike price + A call option [25.1]
Q* = √
​​ ​  ______F
 ​ ​​  [20.14]
CC b. S + P = PV(E  ) + C [25.2]
5. Net incremental cash flow = P′Q × (d − π) [20A.1]
6. NPV = −PQ + P′Q × (d − π)/R [20A.2] c. Stock price:
S = PV(E ) + C – P [25.3]
d. S + P = E × e –Rt
+ C [25.4]
CHAPTER 21
2. The Black-Scholes call option formula:
1. Expected percentage change in the exchange rate: C = S × ​N(d​1​) – E × e–Rt × ​N(d​  2​) [25.5]
a. [E(​S​1​) – S​​  ​0​]∕S​0​= ​h​FC​– ​h​US​[21.1]
PCP and the balance sheet identity: _
b. E(​S​1​) = S​ ​0​× [1 + (​h​FC​– ​h​US​)] [21.2] ​d​1​= [ln(S∕E ) + (R + σ2∕2) × t]∕(σ × ​​√ t ​​  )
2. Purchasing power parity (PPP): _
​d​2​= ​d​1​ – σ × ​​√ t ​​​ [25.6]
E​(S​t​) = S​ ​0​ × [1 + ​(h​FC​– ​h​US​)]t[21.3]
3. PCP and the balance sheet identity:
3. Interest rate parity (IRP) condition: a. Value of risky bond + Put option
a. Exact, single period: = Value of risk-free bond [25.7]
​​F​1​∕S​0​= (1 + R
​ ​FC​)∕(1 + ​R​US​)[21.4]
b. Value of risky bond = Value of risk-free bond
b. Approximate, single period: – Put option
​(F​1​ – ​​S​0​)∕S​0​= ​R​FC​– ​R​US​[21.5] = E × e–Rt – P [25.8]
c. ​F​1​= ​S​0​× [1 + ​(R​FC​– ​R​US​)][21.6] c. Value of assets (S ) = Value of stock (C )
4. International Fisher effect (IFE): + (E × e–Rt – P ) [25.9]
​RUS
​ ​– ​hUS
​ ​= ​R​FC​– ​h​FC​[21.7] d. Value of assets (S )
= Value of stock (C )
+ Value of bonds (E × e–Rt – P ) [25.10]
CHAPTER 24
1. Value of a call option at maturity:
a. C1 = 0 if S1 – E ​≤​0 [24.1]
CHAPTER 26
b. C1 = S1 – E if S1 – E > 0 [24.2] 4. The NPV of a merger:
2. Bounds on the value of a call option: NPV = V  ​
​ *B​​  – Cost to Firm A of
a. Upper bound: the acquisition [26.1]
C0 ​≤​S0 [24.3]
b. Lower bound:
C0 ≥ 0 if S0 – E < 0 [24.4]
C0 ≥ S0 – E if S0 – E ≥ 0