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100 Financial Management models, diagrams and charts for powerful business presentations. Content: Financial Management, Finacial Market, Present Value, Perpetuity, Annuity, Compound Interest, Inflation, Bond Yield, Share Value, Free Cash Flow, IRR, Risk Valuation, Markowitz, SML, CAPM, Beta Risk, APT, Portfolio Theory, Economic Profit, Call Option, Straddle, Option Pricing, Theory, Leverage Ratio, Liquidity, Du Pont, Private Equity, Volatility, Working Capital, Valuation, Value Drivers, Risk/Return, Diversification, Corporate Finance, Yield, NPV, Cash Transfer, Accounting/nMore business diagrams to download on http://www.drawpack.com your visual business knowledge
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Financial Market – Present Value – Perpetuity – Annuity – Compound Interest – Inflation – Bond Yield – Share Value – Free Cash Flow – IRR – Risk Valuation – Markowitz – SML – CAPM – Beta Risk – APT – Portfolio Theory – Economic Profit – CallOption – Straddle – Option Pricing Theory – Leverage Ratio – Liquidity – Du Pont – Private Equity – Volatility – Working Capital – Valuation – Value Drivers – Risk/Return – Diversification – Corporate Finance – Yield – NPV – Cash Transfer – Accounting
The secondary market
The primary market
The firm
Investors
Investors
Investors
cash
cash
newly issued
securities
outstanding
securities
The Dual Functions of Financial MarketsValue today of a future cash flow.
Discount Factor
Present value of a $1 future payment.
Discount Rate
Interest rate used to compute present values of future cash flows.
Present
Value
=
PV
=
1
DF
t
(
1
)
r
+
´
PV
=
discount
factor
C
1
C
=
=
1
PV
DF
C
´
1
+
1
r
1
Present ValuePerpetuity  Financial concept in which a cash flow is theoretically received forever.
cash
flow
cash
flow
=
=
PV
of
Cash
Flow
Return
present va
lue
discount
rate
C
C
=
1
PV
=
r
r
PV
PerpetuityAnnuity  An asset that pays a fixed sum each year for a specified number of years.
é
ù
1
1
=
´

PV
of
annuity
C
ê
ú
(
)
t
+
r
r
1
r
ë
û
AnnuityInflation  Rate at which prices as a whole are increasing.
Nominal Interest Rate  Rate at which money invested grows.
Real Interest Rate  Rate at which the purchasing power of an investment increases.
1
+
nominal in
terest rat
e
+
1
real inter
est rate
=
1
+
inflation
rate
InflationIf we forecast no growth, and plan to hold out stock indefinitely, we will then value the stock as a PERPETUITY.
Div
EPS
=
=
1
1
Perpetuity
P
or
0
r
r
Assumes all earnings are paid to shareholders.
Valuing Common Stocks IIIInvestment opportunity (real asset)
Investment opportunities (financial assets)
Firm
Shareholder
Invest
Alternative: pay dividend to shareholders
Shareholders invest for themselves
NPV and Cash Transfers2000
1500
1000
500
NPV (,000s)
0
10
20
30
40
50
60
70
80
90
500
100
1000
1500
Discount rate (%)
2000
Internal Rate of Return40
20
Percentage Return
0
20
Common Stocks
Long TBonds
40
TBills
30
35
40
45
50
55
60
65
70
75
80
85
90
95
60
26
Year
Rate of Return 1926  1997The variance of a two stock portfolio is the sum of these four boxes:
Stock
1
Stock
2
=
x
x
σ
2
2
1
2
12
Stock
1
x
σ
1
1
x
x
ρ
σ
σ
1
2
12
1
2
=
x
x
σ
2
2
1
2
12
Stock
2
x
σ
2
2
x
x
ρ
σ
σ
1
2
12
1
2
Portfolio Risk I+
Expected
Portfolio
Return
(x
r
)
(
x
r
)
1
1
2
2
=
2
2
+
2
2
+
σ
x
σ
x
2
(
x
x
ρ
σ
σ
)
2
2
1
1
1
2
12
1
2
Portfolio
Variance
Portfolio Risk IIThe shaded boxes contain variance terms; the remainder contain covariance terms.
1
2
3
To calculate portfolio variance add up the boxes
4
STOCK
5
6
N
1
2
3
4
5
6
N
STOCK
Portfolio Risk IIIPrice changes vs. Normal distribution
600
500
400
# of Days (frequency)
300
200
100
0
10%
8%
6%
4%
2%
0%
2%
4%
6%
8%
10%
Daily % Change
Markowitz Portfolio TheoryLow Risk
High Return
High Risk
High Return
Low Risk
Low Return
High Risk
Low Return
Risk
Efficient Frontier IIISecurity market line
Market portfolio rate
Rm = 13.5%
Rf = 5%
Treasury bill rate
Beta
1
0
R = rf + B ( rm  rf )
Capital Asset Pricing Model (CAPM)(and other risky assets)
Stocks
(and other risky assets)
Wealth is uncertain
Standard
CAPM
Consumption
CAPM
Market risk makes wealth uncertain.
Wealth
Consumption is uncertain
Wealth = market
portfolio
Consumption
Consumption Betas vs. Market BetasExpected Risk
Premium = r  rf
= Bfactor1(rfactor1  rf) + Bf2(rf2  rf) + …
Return = a + bfactor1(rfactor1) + bf2(rf2) + …
Arbitrage Pricing TheoryExpected Returns and Betas prior to refinancing
Expected return (%)
20
Requity= 15
Rassets= 12.2
Rdebt= 8
0
0
0.2
0.8
1.2
Bdebt
Bassets
Bequity
Capital Structure & COCEVA
Residual
Income
=
Income
earned

Income
required
=
´
[
]
Income
earned

Cost
of
Capital
Investment
Risidual Income & EVAResidual Income or EVA = Net Dollar return after deducting the cost of capital.
Economic Profit = capital invested multiplied by the spread between return on investment and the cost of capital.
=
EP
Economic
Profit
=

´
(
ROI
r
)
Capital
Invested
Economic ProfitCash flow + Cash flow +
change in PV = change in book value =
Cash flow  Cash flow 
economic depreciation accounting depreciation
Economic income Accounting income
PV at start of year BV at start of year
INCOME
RETURN
Accounting MeasurementCosts of
financial distress
PV of interest
tax shields
Value of levered firm
Value of
unlevered
firm
Optimal amount
of debt
Debt
Financial DistressCall option value given a $85 exercise price.
Call option value
$20
85 105
Share Price
Call Option (long)Call option payoff (to seller) given a $85 exercise price.
Call option $ payoff
85
Share Price
Call Option (short)Put option payoff (to seller) given a $85 exercise price.
Put option $ payoff
85
Share Price
Put Option (short)Expanding the binomial model to allow more possible price changes
1 step 2 steps 4 steps
(2 outcomes) (3 outcomes) (5 outcomes)
etc. etc.
Binomial vs. Black ScholesStraight bond
bond
100
Bond Callable
at 100
75
50
25
Value of
straight bond
25
50
75
100
125
150
Straight Bond vs. Callable Bond+
r
1
+
i
foreign
foreign
equals
1
+
r
1
+
i
$
$
equals
equals
f
E(s
)
foreign
/
$
foreign
/
$
equals
S
S
foreign
/
$
foreign
/
$
Exchange Rate Relationshipdebt
Long term
debt ratio
=
long term
debt
+
equity
long term
debt
+
value of
leases
Debt equity
ratio
=
equity
Leverage Ratios ITotal debt
ratio
=
total assets
EBIT
=
Times interest earned
interest payments
EBIT
+
depreciation
Cash coverage
ratio
=
interest payments
Leverage Ratios IIcapital
net working
capital
=
to total
assets ratio
total assets
current
assets
Current ratio
=
current
liabilities
Liquidity Ratios I+
marketable
securities
+
receivables
Quick ratio
=
current
liabilities
cash
+
marketable
securities
Cash ratio
=
current
liabilities
cash
+
marketable
securities
+
receivables
Interval
measure
=
average daily
expenditures
from
operations
Liquidity Ratios II=
Asset turnover
ratio
average
total assets
sales
NWC
turnover
=
average
net working
capital
Efficiency Ratios Igoods sold
Inventory
turnover
ratio
=
average
inventory
average
inventory
Days\'
sales in
inventory
=
cost of
goods sold
/
365
average
receivables
Average
collection
period
=
average
daily sales
Efficiency Ratios II
tax
Net profit
margin
=
sales
EBIT

tax
Return on
assets
=
average
total assets
earnings
available
for common
stock
Return on
equity
=
average
equity
Profitability Ratios IPayout
ratio
=
earnings
earnings

dividends
Plowback
ratio
=
earnings
=
1

payout
ratio
earnings

dividends
Growth in
equity
from plowback
=
earnings
Profitability Ratios IIPE
Ratio
=
earnings per share
P
1
Div
1
0
Forecasted PE
ratio
=
=
x
r

g
EPS
aveEPS
1
1
per share
dividend
=
Dividend yield
stock price
Market Value Ratios I1
P
Price per
share
=
=
0
r

g
stock price
Market to
book ratio
=
book value
per share
market value
of assets
Tobins Q
=
estimated
replcement
cost
Market Value Ratios IIsales
EBIT

taxes
EBIT

taxes

interest
ROE
=
x
x
x
equity
assets
sales
EBIT

taxes
leverage
ratio
asset
turnover
profit
margin
debt
burden
Du Pont System IIA
B
C
Cumulative capital requirement
Year 1
Year 2
Time
Strategy A: A permanent cash surplus
Strategy B: Shortterm lender for part of year and borrower for remainder
Strategy C: A permanent shortterm borrower
Firm‘s Cumulative Capital Requirement25
Average inventory
12.5
Weeks
0
1
2
3
4
5
Value of bills sold = Q =
2 x annual cash disbursement x cost per sale
interest rate
Inventories & Cash Balances IIPayout Phase
General Partner put up 1% of capital
General Partner get carried interest in 20% of profits
Mgmt fees
Limited partners get investment back, then 80% of profits
Limited partners put in 99% of capital
Partnership
Partnership
Company 1
Company 2
Sale or IPO of companies
Investment in diversified portfolio of companies
Company N
Private Equity PartnershipDebtholders
They have fixed claims on
these cash flows
Cash flows form assets
Shareholders
They have residual claims on
these cash flows so that the
larger the cash flows, the
more value created
Increase in the Cash Flows from AssetsThe rest
of the world
Financial transactions
Financial accounting process
The balance sheet
Records assets and liabilities
at the date of the balance sheet.
Their difference is the book value
of equity at that date.
The income statement
Records revenues and expenses
over a period of time. Their
difference, which represents an
increase or a decrease in the book
value of equity, is the profit or
loss for the period.
A Simplified View of the Financial Accounting Process+ 31%
+ 26%
+ 10%
Less fixed
interest
expenses
and variable
tax expenses
SALES
Earnings
before interest
and taxes
Earnings
after taxes
Less variable
and
fixed
expenses
 10%
 26%
 31%
OPERATIONAL RISK
ECONOMIC RISK
BUSINESS RISK
FINANCIAL RISK
Sources of Risk That Increase Profit VolatilityDecember 31, 2001
Income Statement
Year 2002
Balance Sheet
December 31, 2002
Assets
$170
Liabilities
$100
Revenues
$480
Expenses
$469.8
Assets
$190
Liabilities
$113
Owner‘s equity
$70
Owner‘s equity
$77
Net Profit
$10.2
Retained earnings
$7
Dividends
$3.2
The Link Between the Balance Sheets and the Income StatementThe Standard Balance Sheet
Invested capital
or net assets
Liabilities
and owner‘s equity
Capital employed
Total assets
Cash
Shortterm debt
Cash
Shortterm debt
Working capital
requirement
(WCR)
Operating assets
less
Operating liabilities
Operating assets
Accounts receivable
plus
Inventories
plus
Prepaid expenses
Longterm financing
Longterm debt
plus
Owner‘s equity
Operating liabilities
Accounts payable
plus
Accrued expenses
Longterm financing
Longterm debt
plus
Owner‘s equity
Net fixed assets
Net fixed assets
The Managerial Balance Sheet Versus the Standard Balance Sheetactivities
Cash
Sales
Procurement
Production
Investing activities
Financial activities
Sources of cash inflow
$2
CASH
$472
$13
$18.2
$460.8
$12
Operating activities
Investing activities
Financial activities
Sources of cash outflow
New cash flow from financing
activities
($5.2)
Net cash flow from operating
activities
$11.2
New cash flow from investing
activities
($10)
Sources of Cash Inflow and Cash OutflowEarnings after tax
Owner‘s equity
ROE =
Financial leverage multiplier
Tax effects
Return on invested capital
Earnings before interest and tax
Invested capital
ROIC =
Operating profit margin
Capital turnover
Financial structure ratio
Financial cost ratio
Tax effect ratio
Earnings before interest and tax
Sales
Sales
Invested capital
Invested capital
Owner‘s equity
Earnings before tax
Earnings before interest and tax
Earnings after tax
Earnings before tax
Sales
Invested capital
Owner‘s equity
Cost of debt
Tax rate
Operating costs
Cash
Working Capital
requirement
Fixed assets
The Drivers of Return on Equityinstitutional investors
Insurance companies, pension funds,
Investment funds & venture capitalists
CASH
PRIVATE
PLACEMENT
Insurance policies
Retirement plans
Shares in funds
S
U
P
P
L
I
E
R
S
OF
F
U
N
D
S
F
I
R
M
S
CASH
CASH
CASH
Money Market
Instruments
SHARES
BONDS
CASH
CASH
The equity market
(Trading in shares of common stocks)
SHARES
SHARES
CASH
CASH
The corporate market
(Trading in corporate bonds)
BONDS
BONDS
CASH
CASH
The money market
(Trading in money market instruments)
Commercial
paper
Commercial
paper
Bank certificates
of deposit (CD)
CASH
Intermediation via
banks
and other lending institutions
BANK
DEPOSITS
DEBT OWED
TO BANKS
CASH
CASH
The Financial SystemDividend valuation model
Firm‘s earnings, cash
flows, or book value
Future expected
dividends
Equity
value
multiplied by the
discounted at the
Corresponding
market multiple
Cost of equity
equals
Present value
of debt
Discounted cash flow model
Adjusted present value model
Cash flows
from assets
Unlevered
asset value
less the
Firm‘s earnings, cash
flows, or book value
discounted at the
Unlevered
cost of equity
Levered
asset value
discounted at the
Corresponding
market multiple
Tax
savings
Present value
of tax savings
discounted at the
Cost of debt
Alternative Equity Valuation ModelsSales
Operating margin =
EBIT
Invested capital
(pretax ROIC)
Sales
Invested capital
Capital turnover =
Expected aftertax
ROIC
Tax effect = (1 – Taxe rate)
Return spread
(ROIC – WACC)
Percent of
debt financing
Market Value Added (MVA)
If the present value of the future stream of
expected return spreads is positive, MVA is
positive and the higher the growth, the more
value created.
If the present value of the future stream of
expected return spreads is negative, MVA is
negative and the higher the growth, the more
value destroyed.
Aftertax cost of debt
Weighted average
cost of capital
WACC
Estimated cost of equity
Percent of
equity financing
Economic, political, and
social environments
Market structure
Sustainability
of growth
Competitive advantages and
core competencies
EBIT = Earnings before interest and taxes (operating profit before tax);
Invested capital = Cash + Working capital requirement + net fixed assets;
WACC = (%Debt)(Aftertax cost of debt) + (%Equity)(Cost of equity).
The Drivers of Value CreationStep 1: Develop probability distributions for key factors.
Step 2: Randomly select values from these distributions.
Market
size
Selling
price
Fixed
costs
Probability
Value range
Market
growth
rate
Investment
required
Residual
value of
investment
Share
of market
Operating
costs
Useful life
of facilities
Step 3: Combine these factors and determine a net present value.
Step 4: Continue to repeat this process until a clear portrait of
the results is obtained.
Probability
Net present value
Step 5: Evaluate the resultant probability distribution.
CapitalBudgeting Simulationand
materials
purchased
using trade
credit
Saleable
product
(inventory)
Credit sales
(accounts
receivable)
Suppliers
Payment
for fixed
asset
purchases
Payment
for wages
and salaries
Payment
for heat
and power
Bad
debts
Payments
for credit
purchases
Cash
dividends
Collections
from
credit
sales
Cash
Cash
sales
Proceeds from
sale or issuance
of stock
Proceeds from
sale or issuance
of notes and
bonds
Payment
of taxes
Interest
and
principal
Stockholders
Creditors
Government
Cash Flow Diagramon shortterm financing
Temporary (shortterm)
financing
Permanent
current assets
DOLLAR
AMOUNT
Current
assets
Permanent plus
spontaneous financing
Fixed
assets
TIME
Aggressive Financing Strategy: Permanent Reliance on ShortTerm FinancingBond sales
Other debt contracts
Preferred stock sales
Common stock sales
In
Irregular outflows
Dividends
Interest
Principal on
debt
Share repurchase
Taxes
Out
Cash
balance
Purchase
Marketable
securities
Sale
Purchase
Labor and material
Credit
sales
Fixed assets
Inventory
Receivables
Depreciation
Sale
Cash sales
Collections
Cash and Marketable Securities ManagementDirect transfer
of funds
(2)
Indirect transfer
using the investment
banker
(3)
Indirect transfer
using the financial
intermediary
The business
firm (a savings
deficit unit)
The business
firm (a savings
deficit unit)
The business
firm (a savings
deficit unit)
Firm‘s
securities
Securities
Funds
Funds
Firm‘s
securities
(stocks,
bonds)
Marketable
securities
Marketable
securities
Funds
(dollars of
savings)
Intermediary‘s
securities
Securities
Funds
Funds
Savers
(savings
surplus units)
Savers
(savings
surplus units)
Savers
(savings
surplus units)
Three Ways to Transfer Financial Capital in the EconomyGrowth of
net
income
Multiyear
DCF of
economic
profit
Operating
value drivers
Net
income,
return on
sales
ROICWACC,
economic
profit (one year)
Low
Low
High
LEVEL 3
LEVEL 1
Margin
Margin
Invested
capital
ROIC
Margin
Invested
capital
Invested
capital
Generic
Businessunit
specific
Operating
value drivers
Various Levels of Value Driver IdentificationCall volume
% time in training
Number of
people
% time on breaks
Percent occupancy
% time on vacation
Personal
cost
% time paid
Average work
time per call
Cost per person
Absence/other
Number of
stations per SDC
Hourly rate
Number of
SDCs
Benefits
Equipment
cost per station
Service
Delivery
Center
expense
Station
cost
Equipment,
maintenance
experse per
station
Annual salary
Cost per SDC
Benefits
Total
CS
human
expense
Other equipment
expense
Span of control
Headquaters
expense
Number of employees
Overhead
expense
Regional
center
expenses
Salary expense
Supervisory
cost
Utilities
Number of
supervisors
Other
Area staff
center
expense
Building operating
expense
Number of employees
Allocated
G&A
Overhead
cost
Building
maintanance
expense
Equipment
Materials
Other
Customer Servicing – Human Expense FlowchartDriven
5
4
3
Low cost
Valuebased
2
1
Strong
selfreinforcement
process
Managed
bottom up
as well as
top down
Highest level
Good
Twoway
communications
Medium
Sup par
Lowest
Six Conditions for Excellent ValueBased Managementfree cash flow
160
150
140
130
100
90
70
Operating
value
Cash flow
to debtholders
85
80
Debt
value
74
69
43
36
20
Equity
value
Cash flow
to equity owners
75
70
66
61
57
54
50
Simple Entity Valuation of a SingleBusiness CompanyExcess
marketable
securities
Corporate
overhead
150
250
200
Unit D
1,500
300
300
Unit C
100
400
1,100
Unit B
700
Unit A
Common
equity
value
Total value
before
subtracting
corporate
overhead
Total
company
value
Entity Valuation of a Multibusiness CompanyCalculate NOPLAT and invested capital
(1)
Analyze
historical
performance
(2)
Forecast
performance
(3)
Estimate
cost of capital
(4)
Estimate
continuing
value
(5)
Calculate
and interpret
results
Design and
Development
Procurement
Manufacturing
Marketing
Sales and
Distribution
Issues
Producers
External
Shocks
STRUCTURE
CONDUCT
PERFORMANCE
Feedback
Feedback
Cooperation vs. Rivalry
StructureConductPerformance ModelNOPLAT
WACC  g
CV =
Aggressive
formula
Convergence
formula
NOPLAT
WACC
CV =
WACC
Time
Forecast
period
Continuingvalue period
Rates of Return Implied by Alternative ContinuingValue Formulas$3,000
$2,000
g = 6%
CONTINUING
VALUE ($)
g = 4%
g = 2%
g = 0%
$1,000
0
12
14
16
18
20
10%
RETURN ON NET NEW INVESTED CAPITAL
Impact of ContinuingValue AssumptionsNot economic
Growing
Entertainment
Sporting
goods
Most
firms
Information
processing
Soft
drinks
EARNINGS
GROWTH
= Inflation
CONSUMPTION
Not economic
Tobacco
Defense
Steel
< Inflation
Declining
= WACC
> WACC
< WACC
RETURN ON NEW CAPITAL
Low Entry costs High
Many Substitutes Few
Short Life cycle Long
High Price elasticity Low
Factors
affecting
returns
Relative Positions of Selected Industries Along ContinuingValue ParametersEnd of
forecast period
Date of
valuation
TIME
A Forecast Period that Will Result in a Poor Valuation of a Cyclical BusinessE (Return)
A
Beta
unchanged
Beta
unchanged
A
B
Beta
decreased
Rf
Rf
B
Beta
decreased
Total risk
Beta (undiversifiable risk)
Risk/Return TradeOffs of Hedging Programsvalue of
target
(without
any
takeover
premium)
Combined
value
Stand
alone
value of
acquiror
(premerger)
Value
of
synergies
Transaction
costs
Value of
next best
alternative
Value of
target to
acquiror
Price paid
including
premium
Net value
gained
from
acquisition
Framework for Evaluating the Value of an AcquisitionValue (NPV) of technology/project/product
NPV = Estimation of present value of a
business using discounted cash flows
Maximal value of technology =
NPV x Max Protection Factor
Max Protection Factor = Empirical
factor indicating maximal impact of
patents on NPV
Value of patents =
NPV x Pfmax x PPF
Patent Protection Factor = Measure of
the quality of the patent protection
Patent Valuation: DCF Method OverviewProtection
Factor
30%
Empirical curve
5%
Age of
Technology
Technology
under R&D
Mature
Technology
PatentValue = MaximalProtectionFactor x PatentProtectionFactor x NPVtec
Pval = Pmax x PPF x NPVtec
Patent Valuation: Maximal Protection FactorAlliance
leverage
High
LEVEL OF INVESTMENT
(OPTION PRICE)
Entry
stakes
Risk
pooling
Low
Internal
External
SOURCE OF OPTIONS
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