KEY EQUATIONS B

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

APPENDIX
1. The balance sheet identity or equation: Net working capital to total assets
Assets 5 Liabilities Net working capital
5 _________________ [3.4]
1 Shareholders’ equity [2.1] Total assets
2. The income statement equation: 5. The interval measure:
Revenues 2 Expenses 5 Income [2.2] Interval measure
3. The cash flow identity: Current assets
5 ________________________ [3.5]
Average daily operating costs
Cash flow from assets 5
6. The total debt ratio:
Cash flow to creditors 1 [2.3]
Cash flow to stockholders Total debt ratio
Total assets 2 Total equity
where 5 ______________________ [3.6]
Total assets
a. Cash flow from assets 5 Operating cash
flow (OCF) 2 Net capital spending 2 7. The debt-equity ratio:
Change in net working capital (NWC) Debt-equity ratio
(1) Operating cash flow 5 Earnings
5 Total debtyTotal equity [3.7]
before interest and taxes (EBIT) 1
Depreciation 2 Taxes 8. The equity multiplier:
(2) Net capital spending 5 Ending net
Equity multiplier
fixed assets 2 Beginning net fixed
assets 1 Depreciation 5 Total assetsyTotal equity [3.8]
(3) Change in net working capital 5 9. The long-term debt ratio:
Ending NWC 2 Beginning NWC
Long-term debt ratio
b. Cash flow to creditors 5 Interest paid 2
Long-term debt
Net new borrowing 5 _________________________ [3.9]
c. Cash flow to stockholders 5 Dividends Long-term debt 1 Total equity
paid 2 Net new equity raised 10. The times interest earned (TIE) ratio:
EBIT [3.10]
Times interest earned ratio 5 _______
CHAPTER 3 Interest
1. The current ratio: 11. The cash coverage ratio:
Current assets
Current ratio 5 _______________ [3.1] Cash coverage ratio
Current liabilities EBIT 1 Depreciation
2. The quick or acid-test ratio: 5 __________________ [3.11]
Interest
Current assets 2 Inventory 12. The inventory turnover ratio:
Quick ratio 5______________________ [3.2]
Current liabilities
Inventory turnover
3. The cash ratio: Cost of goods sold
5 ________________ [3.12]
Cash Inventory
Cash ratio 5 _______________ [3.3]
Current liabilities 13. The average days’ sales in inventory:
Days’ sales in inventory
365 days
5 ________________ [3.13]
Inventory turnover

B-1

ros95047_aapB_B1-B6.indd 1 27/05/15 11:10 AM

 B-2 APPENDIX B Key Equations

14. The receivables turnover ratio: CHAPTER 4

Receivables turnover 1. The dividend payout ratio:
Sales
5 _________________ [3.14] Dividend payout ratio
Accounts receivable
5 Cash dividendsyNet income [4.1]
15. The days’ sales in receivables:
2. The internal growth rate:
Days’ sales in receivables
365 days ROA 3 b
Internal growth rate 5 ____________ [4.2]
5 __________________ [3.15] 1 2 ROA 3 b
Receivables turnover
3. The sustainable growth rate:
16. The net working capital (NWC) turnover ratio:
ROE 3 b
Sustainable growth rate 5 ____________ [4.3]
Sales
NWC turnover 5 _____ [3.16] 1 2 ROE 3 b
NWC
4. The capital intensity ratio:
17. The fixed asset turnover ratio:
Total assets
Capital intensity ratio 5 __________
Sales
Fixed asset turnover 5 _____________ [3.17] Sales
Net fixed assets
1
5 ________________
18. The total asset turnover ratio: Total asset turnover
Sales
Total asset turnover 5 __________ [3.18]
Total assets
19. Profit margin: CHAPTER 5
1. The future value of $1 invested for t periods at rate
Net income
Profit margin 5 __________ [3.19]
Sales of r per period:

20. Return on assets (ROA): Future value 5 $1 3 (1 1 r)t [5.1]

Net income 2. The present value of $1 to be received t periods in
Return on assets 5 __________ [3.20] the future at a discount rate of r:
Total assets
21. Return on equity (ROE): PV 5 $1 3 [1y(1 1 r)t] 5 $1y(1 1 r)t [5.2]
Net income
Return on equity 5 __________ [3.21] 3. The relationship between future value and present
Total equity value (the basic present value equation):
22. The price-earnings (PE) ratio: FVt
Price per share PV 5 _______ 5 FVt 3 [1y(1 1 r)t] [5.3]
PE ratio 5 ________________ [3.22] (1 1 r)t
Earnings per share
23. The market-to-book ratio: CHAPTER 6
Market-to-book ratio 1. The present value of an annuity of C dollars per period for
t periods when the rate of return or interest rate r is:
Market value per share
5 ___________________ [3.23] Annuity present value
Book value per share
24. Enterprise value: (
1 2 Present value factor
5 C 3 ____________________
r )
Enterprise value 5 Total market
value of the stock 1 Book value {
1 2 [1y(1 1 r)t]
5 C 3 ______________
r } [6.1]
of all liabilities 2 Cash [3.24]
2. The future value factor for an annuity:
25. The EBITDA ratio: Annuity FV factor
Enterprise value 5 (Future value factor 2 1)yr [6.2]
EBITDA ratio 5 ______________ [3.25]
EBITDA 5 [(1 1 r)t 2 1]yr
26. The Du Pont identity: 3. Annuity due value 5 Ordinary annuity value
ROE 5 __________ Sales 3 ______
Net income 3 ______ Assets [3.26] 3 (1 1 r) [6.3]
Sales Assets Total Equity
4. Present value for a perpetuity:
ø

ö
ý

Return on assets PV for a perpetuity 5 Cyr 5 C 3 (1yr) [6.4]

ROE 5 Profit margin 5. Growing annuity present value

f )g
3 Total asset turnover
3 Equity multiplier (
11g t
1 2 _____
11r
5 C 3 ___________ [6.5]
r2g

ros95047_aapB_B1-B6.indd 2 27/05/15 11:10 AM

 APPENDIX B Key Equations B-3

6. Growing perpetuity present value 6. Profitability index:

[
1
5 C 3 _____
r2g 5r2g ] C
_____ [6.6] PV of cash flows
Profitability index 5 ________________
Cost of investment
7. Effective annual rate (EAR), where m is the number
of times the interest is compounded during the year:
CHAPTER 10
EAR 5 [1 1 (Quoted rateym)]m 2 1 [6.7] 1. Bottom-up approach to operating cash flow (OCF):
8. Effective annual rate (EAR), where q stands for the OCF 5 Net income 1 Depreciation [10.1]
continuously compounded quoted rate:
2. Top-down approach to operating cash flow (OCF):
EAR 5 e q 2 1 [6.8]
OCF 5 Sales 2 Costs 2 Taxes [10.2]
CHAPTER 7 3. Tax shield approach to operating cash flow (OCF):
1. Bond value if bond has (1) a face value of F paid at OCF 5 (Sales 2 Costs) 3 (1 2 T)
maturity, (2) a coupon of C paid per period, (3) t periods
1 Depreciation 3 T [10.3]
to maturity, and (4) a yield of r per period:
Bond value
5 C 3 [1 2 1y(1 1 r)t]yr 1 Fy(1 1 r)t [7.1] CHAPTER 11
Bond value 1. Accounting break-even level:
Present value Present value Q 5 (FC 1 D)y(P 2 v) [11.1]
5 1
of the coupons of the face amount
2. Relationship between operating cash flow (OCF)
2. The Fisher effect: and sales volume:
1 1 R 5 (1 1 r) 3 (1 1 h) [7.2] Q 5 (FC 1 OCF)y(P 2 v) [11.3]
R5r1h1r3h [7.3]
R<r1h [7.4] 3. Cash break-even level:
Q 5 FCy(P 2 v)
CHAPTER 8 4. Financial break-even level:
1. The dividend growth model:
Q 5 (FC 1 OCF*)y(P 2 v)
D0 3 (1 1 g) ______
D1
P0 5 ___________ 5 [8.3] where
R2g R2g
2. Required return: OCF* 5 Zero NPV cash flow
R 5 D1yP0 1 g [8.7] 5. Degree of operating leverage (DOL):
DOL 5 1 1 FCyOCF [11.4]
CHAPTER 9
1. Net present value (NPV):
CHAPTER 12
NPV 5 Present value of future cash flows
1. Variance of returns, Var(R) or !2:
2 Investment cost
1 [(R 2 __
Var(R) 5 _____ R )2 1 · · ·
2. Payback period: T 2 1 __1
Payback period 5 Number of years that pass before 1 (RT 2 R )2] [12.3]
the sum of an investment’s cash flows equals the cost
2. Standard deviation of returns, SD(R) or !:
of the investment
SD(R) 5 ÏWWW
Var(R)
3. Discounted payback period:
Discounted payback period 5 Number of years that 3. Geometric average return:
pass before the sum of an investment’s discounted Geometric average return 5 [(1 1 R1) 3
cash flows equals the cost of the investment (1 1 R2) 3 . . . 3
4. The average accounting return (AAR): (1 1 RT)]1/T 2 1 [12.4]
Average net income 4. Blume’s formula:
AAR 5 _________________
Average book value N2T
T 2 1 3 Geometric average 1 ______
R(T) 5 ______
5. Internal rate of return (IRR): N21 N21
3 Arithmetic average [12.5]
IRR 5 Discount rate of required return such that
the net present value of an investment is zero

ros95047_aapB_B1-B6.indd 3 27/05/15 11:10 AM

 B-4 APPENDIX B Key Equations

CHAPTER 13 CHAPTER 15
1. Risk premium: 1. Rights offerings:
Risk premium 5 Expected return a. Number of new shares:
2 Risk-free rate [13.1] Number of new shares
2. Expected return on a portfolio: Funds to be raised
5 _______________ [15.1]
Subscription price
E(RP) 5 x1 3 E(R1) 1 x 2 3 E(R2) 1 · · ·
1 xn 3 E(R n) [13.2] b. Number of rights needed:

3. Risk and return: Number of rights needed to buy a share of stock

Old shares
5 __________ [15.2]
Total return 5 Expected return 1 Unexpected New shares
return [13.3] c. Value of a right:
R 5 E(R) 1 U Value of a right 5 Rights-on price 2 Ex-rights
price
4. Components of an announcement:

Announcement 5 Expected part 1 Surprise [13.4] CHAPTER 16

1. Modigliani-Miller propositions (no taxes):
5. Systematic and unsystematic components of return:
a. Proposition I:
R 5 E(R) 1 Systematic portion 1 Unsystematic VL 5 VU
portion [13.5]
b. Proposition II:
6. Total risk: RE 5 RA 1 (RA 2 RD) 3 (DyE ) [16.1]
Total risk 5 Systematic risk 2. Modigliani-Miller propositions (with taxes):
1 Unsystematic risk [13.6] a. Value of the interest tax shield:
7. The reward-to-risk ratio: Present value of the interest tax shield
E[Ri] 2 Rf 5 (TC 3 D 3 RD)yRD [16.2]
Reward-to-risk ratio 5 _________ 5 TC 3 D
bi
b. Proposition I:
8. The market risk premium: VL 5 VU 1 TC 3 D [16.3]
SML slope 5 E(RM) 2 Rf c. Proposition II:
RE 5 RU 1 (RU 2 RD) 3 (DyE )
9. The capital asset pricing model (CAPM): 3 (1 2 TC) [16.4]
E(Ri ) 5 Rf 1 [E(RM) 2 Rf ] 3 bi [13.7] CHAPTER 18
1. The operating cycle:
CHAPTER 14 Operating cycle 5 Inventory period
1. Required return on equity, RE (dividend growth model): 1 Accounts receivable period [18.4]
2. The cash cycle:
RE 5 D1yP0 1 g [14.1]
Cash cycle 5 Operating cycle
2. Required return on equity, RE (CAPM): 2 Accounts payable period [18.5]
RE 5 R f 1 bE 3 (RM 2 R f ) [14.2]
CHAPTER 19
3. Required return on preferred stock, RP: 1. Float measurement:
RP 5 DyP0 [14.3] a. Average daily float:
4. The weighted average cost of capital (WACC): Total float
Average daily float 5 _________ [19.1]
Total days
WACC 5 (EyV) 3 RE 1 (DyV) 3 RD
b. Average daily float:
3 (1 2 TC) [14.6]
5. Weighted average flotation cost, fA: Average daily float
E 3 f 1 __D3f 5 Average daily receipts
fA 5 __ [14.13] 3 Weighted average delay [19.2]
V E V D

ros95047_aapB_B1-B6.indd 4 27/05/15 11:10 AM

 APPENDIX B Key Equations B-5

2. The Baumol-Allais-Tobin (BAT) model: c. Total costs:

a. Opportunity costs: Total costs 5 Carrying costs
Opportunity costs 5 (Cy2) 3 R [19A.1] 1 Restocking costs
5 (Qy2) 3 CC
b. Trading costs: 1 F 3 (TyQ) [20.12]
Trading costs 5 (TyC) 3 F [19A.2] d. The optimal order size Q*:
c. Total cost: WWWWWWW
Ï
2T 3 F
Q* 5 _______
CC [20.15]
Total cost 5 Opportunity costs
1 Trading costs [19A.3]
CHAPTER 21
d. The optimal initial cash balance:
1. Expected percentage change in the exchange rate:
C* 5 ÏWWWWWWWWWW
(2T 3 F)yR [19A.4]
a. [E(S1) 2 S0]/S0 5 hFC 2 hUS [21.1]
3. The Miller-Orr model:
b. E(S1) 5 S0 3 [1 1 (hFC 1 hUS)] [21.2]
a. The optimal cash balance:
2. Purchasing power parity (PPP):
C* 5 L 1 (3y4 3 F 3 s2yR)1y3 [19A.5]
E(St) 5 S0 3 [1 1 (hFC 2 hUS)]t [21.3]
b. The upper limit:
3. Interest rate parity (IRP):
U* 5 3 3 C* 2 2 3 L [19A.6]
a. Exact, single period:
CHAPTER 20 F1yS0 5 (1 1 RFC)y(1 1 RUS) [21.4]
1. The size of receivables:
b. Approximate, single period:
Accounts receivable
(F1 2 S0)/S0 5 RFC 2 RUS [21.5]
5 Average daily sales 3 ACP [20.1]
c. F1 5 S0 3 [1 1 (RFC 2 RUS)] [21.6]
2. NPV of switching credit terms:
d. Approximate, multiperiod:
a. Present value of switching:
Ft 5 S0 3 [1 1 (RFC 2 RUS)]t [21.7]
PV 5 [(P 2 v)(Q9 2 Q)]yR [20.4]
4. Uncovered interest parity (UIP):
b. Cost of switching:
E(St) 5 S0 3 [1 1 (RFC 2 RUS)]t [21.9]
Cost of switching 5 PQ 1 v(Q9 2 Q) [20.5]
5. International Fisher effect (IFE):
c. NPV of switching:
RUS 2 hUS 5 RFC 2 hFC [21.10]
NPV of switching 5 2[PQ 1 v(Q9 2 Q)]
1 [(P 2 v) [20.6]
3 (Q9 2 Q)]yR CHAPTER 24
1. Value of a call option at maturity:
3. NPV of granting credit:
a. C1 5 0 if (S1 2 E) # 0 [24.1]
a. With no repeat business:
b. C1 5 S1 2 E if (S1 2 E) . 0 [24.2]
NPV 5 2v 1 (1 2 p)Py(1 1 R) [20.8]
2. Bounds on the value of a call option:
b. With repeat business:
a. Upper bound:
NPV 5 2v 1 (1 2 p)(P 2 v)yR [20.9]
C0 # S0 [24.3]
4. The economic order quantity (EOQ) model:
b. Lower bound:
a. Total carrying costs:
C0 $ 0 if S0 2 E , 0 [24.4]
Total carrying costs C0 $ S0 2 E if S0 2 E $ 0
5 Average inventory
3. S0 5 C0 1 Ey(1 1 R f )
3 Carrying costs per unit
5 (Qy2) 3 CC [20.10] C0 5 S0 2 Ey(1 1 R f ) [24.5]

b. Total restocking costs: 4. Value of a call that is certain to finish in-the-money:

Call option value
Total restocking costs
5 Stock value
5 Fixed cost per order
2 Present value of the exercise price
3 Number of orders
C0 5 S0 2 Ey(1 1 Rf )t [24.6]
5 F 3 (TyQ) [20.11]

ros95047_aapB_B1-B6.indd 5 27/05/15 11:10 AM

 B-6 APPENDIX B Key Equations

CHAPTER 25 3. Value of a risk-free bond:

1. Put-call parity condition (PCP): a. Value of risky bond 1 Put option
a. Share of stock 1 A put option 5 Value of risk-free bond [25.7]
5 Present value of strike price 1 A call option [25.1] b. Value of risky bond 5 Value of risk-free bond
b. S 1 P 5 PV(E) 1 C [25.2] 2 Put option
c. Stock price: 5 E 3 e2Rt 2 P [25.8]

S 5 PV(E) 1 C 2 P [25.3] c. Value of assets (S) 5 Value of stock (C)

1 (E 3 e2Rt 2 P) [25.9]
d. S 1 P 5 E 3 e2Rt 1 C [25.4]
d. Value of assets (S)
2. The Black–Scholes call option formula:
5 Value of stock (C)
C 5 S 3 N(d1) 2 E 3 e2Rt 3 N(d2) [25.5]
1 Value of bonds (E 3 e2Rt 2 P) [25.10]
where
d1 5 [ln(SyE) 1 (R 1 s 2y2) 3 t]y(s 3 t ) [25.6]
d2 5 d1 2 s 3 ÏWt

ros95047_aapB_B1-B6.indd 6 27/05/15 11:10 AM