CHAP ONE: GENERAL INTRODUCTION TO CORPORATE FINANCE

1.1 Overview of finance

- Finance is a branch of economics concerned with resource allocation as
well as resource management, acquisition and investment. Simply,
finance deals with matters related to money and the markets.
- Finance is the science of funds management.
- Mobilizing, allocating, and managing capital efficiently.

* The main techniques and sectors of the financial industry.

● Techniques:
Lenders Bank Borrowers
2% interest <---------- 7% spread < -------- 9% interest
● Sectors:
+ Governments( public finance)
+ Businesses( corporate finance)
+ Individuals(personal finance)
+ Other organizations( schools, non-profit organizations)

1.2 Personal finance

- Personal finance refers to the financial management of which an
individual or a family unit is required to obtain, budget, save and spend
monetary resources over time, taking into account various financial risks
and future life events.
* Components of personal finance
- Financial position: Your net worth and your household cash flow
+ Financial planning: A dynamic process requiring regular
monitoring an reevaluation
+ Tax planning: Lowering tax costs through tax reduction programas
+ Investment and Accumulation goals: planning and investing for
financial goals
- Adequate protection: can be protected in event of an emergency( natural
disasters, death,...)
- Retirement Planning and Estate planning
1.3 Public finance
- Public finance is the field of economics concerned with how the
government raises money- how that money is spent- and the effects of
these activities on the economy and society.
- It is concerned with:
+ Identification of required expenditure of a public sector entity
+ Source of that entity’s revenue
+ The budgeting process
+ Debt issuance for public works projects

1.3.1 Financial economics

- Studies the interrelation of financial variables: prices; interest rates and
shares, as opposed to those concerning the real economy.
- Concentrates on influences of real economic variables on financial ones.
- It studies:
+ Valuation:
What cash flows will it produce?
How risky is the asset?
How does the market price compare to similar assets?
Are the cash flows dependent on some other asset or event?
+ Financial markets and instruments:
Commodities
Stocks
Bonds
Money market instruments
+ Financial institution and regulation:
Financial econometrics is the brand of financial economics that
uses econometric techniques to parameterize the relationship.
- It is also known as Quantitative finance or quantitative analysts:
+ A main branch of applied mathematics concerned with the
financial markets
+ The study of financial data with the tools of mathematics, mainly
statistics
+ eg: FV, PV, NPV
1.3.3 Experimental finance
- Experimental finance is a branch of experimental economics with the
goals to understand human and market behavior in settings relevant to
finance.
- Aims to establish different market settings and environments to observe
experimentally
- Analyze agent’s behavior and the resulting characteristics of trading
flows, information diffusion and aggregation, price setting mechanism
and return processes.

1.3.4 Behavior finance

- A field of finance that proposes psychology-based theories to explain
stock market anomalies
- Studying how the psychology of investors or managers affects financial
decisions and markets.
- Includes such topics as:
+ Empirical studies
+ Models of how psychology affects trading and prices
+ Forecasting based on these methods
+ Studies of experimental asset markets and use of models to forecast
experiments

1.3.5 Intangible asset finance

- Intangible asset finance is the area of finance that deals with intangible
assets such as patents, trademarks, goodwill, reputation, etc.

1.4 Corporate finance

- Corporate finance is an area of finance dealing with financial decisions
business enterprises make and the tools and analysis used to make
decisions.
- The primary goals: to maximize corporate value while managing the
firm’s financial risks.
- Corporate finance decisions:
+ Capital investment decisions:
The investment decision
The dividend decision
The financing decision
 + Working capital decisions

1.4.1 Investment decision/ capital budgeting

- The investment decision(capital budgeting):
+ Identify investment opportunities:
Potential projects
Cash flow assessment
+ Account for amount risk and timing of return
+ How much to invest(fund demand)

1.4.3 The dividend decision

1. Pay dividend
2. Reinvest in profitable projects
- Business growth
- Share price increases
- Shareholder return increases
* What is working capital?
- Working capital is the amount a firm invests in short-term or current
assets that are required for day-to-day operation.

1.4.4 Working capital management

- Definition: Working capital management are all decisions relating to
working capital and short-term financing.
- Goals: WCM is to ensure the firm
+ is able to operate
+ has sufficient cash flow to service long term debt; and
+ can satisfy both maturing short-term debt and upcoming
operational expenses.
- W.C.M consists of:
+ Cash management
+ Inventory management
+ Debtor management
+ Short-term financing
- Risk management
+ Risk management is the process of measuring risk and then
developing and implementing strategies to manage that risk.
 + Financial risk management focuses on risks that can be managed
by using the traded financial instruments.

1.5 Financial risk management

- Financial risks:
+ Commodity prices
+ Interest rates
+ Foreign exchange rates
+ Stock prices
- Business risk is a direct result of previous investment and financing
decisions.
- Both disciplines share the goal of enhancing or preserving firm value.
- All large corporations have risk management teams and small firms
usually practice informal.
- Methods:
+ The most cost- effective financial risk management methods
usually involve derivatives that trade on well-established financial
markets.
+

1- buget 5- capital budgeting

2- finance 6- financing decision

3-budget
4- financing

2.1 Sole proprietorships

- A sole proprietorship is a type of business entity that is owned and run by

one natural person and in which there is no legal distinction between the
owner and the business. The owner is in direct control of all elements and
is legally accountable for the finances of such business and this may
include debts, loans, loss etc.
- Characteristics:
+ Owner is the manger
+ Owner by one person
+ Owner keeps all profits
+ Relatively unlimited control
+ No separation of owner from business
+ Owner is responsible for all debts/liabilities
+ Business and personal property can be seized in case of going
bankrupt.
- Examples:
+ Small service and retail shop
+ Bakery
+ Restaurant
+ A small tea stall
+ Street hawker
+ Roadside produce stand
- Advantages of sole proprietorship:
+ Easy to established
+ Full control over all business decisions
+ Owners keep all profits
+ Flexibility
+ Tax advantage
- Disadvantages:
+ Difficult to raise money
+ Responsible for every aspect of the business
+ Limited skills and knowledge
+ Limited life
+ Unlimited personal liability
+ Liability is the legally bound obligation to pay debts.

2.2 Partnership

- Definition: A type of business organization in which two or more

individuals pool money, skills, and other resources, and share profit and
loss in accordance with terms of the partnership agreement.
 - Characteristics:
+ The owners are also the managers. The firm and partners are the
same.
+ Partnership agreement set out:

Responsibilities in making decisions

How profits are divided

- Advantages:
+ Easy and low cost to establish
+ Risks are spread among partners
+ Profits are taxed once as personal income tax
+ Profits belong to the partners
+ Share risks with others
+ Be a good choice when not having enough money to start a
business.
- Disads:
+ Unlimited liability
+ Life is limited to the life of owners
+ Difficulties in transferring ownership
+ Equity raised is limited to the owner’s personal wealth
+ Disagreement between partners in the issues of business
management

2.3 Corporation

3.1 Financial market

CHAPTER TWO: FINANCIAL ANALYSIS

1. Overview of financial analysis

- Financial analysis is the process of evaluating business, projects, budgets,

and other finance related to entities to determine their suitability for
investment.
- What can managers do based on the financial analysis?
1. Continue or discontinue its main operation or part of its business
2. Make or purchase certain materials in the manufacture of its
product;
3. Acquire or rent/lease certain machineries and equipment in the
production of its goods;
 4. Issue stocks or negotiate for a bank loan to increase its working
capital;
5. Make decisions regarding investing or lending capital;
6. Other decisions that allow management to make an informed
selection on various alternatives in the conduct of its business
- Goals: Financial analysts often assess the firm’s:
+ Profitability - its ability to earn income and sustain growth in both
short term and long-term. A company's degree of profitability is
usually based on the income statement, which reports on the
company's results of operations;
+ Solvency - its ability to pay its obligation to creditors and other
third parties in the long-term;
+ Liquidity - its ability to maintain positive cash flow, while
satisfying immediate obligations;
+ Stability- the firm's ability to remain in business in the long run,
without having to sustain significant losses in the conduct of its
business. Assessing a company's stability requires the use of both
the income statement and the balance sheet, as well as other
financial and non-financial indicators.
- Methods:
+ Financial analysts often compare the financial ratios
- Past performance
- Future performance
- Comparative performance
+ Financial analysts can also use:
- Ratios analysis
- Percentage analysis:
+ Horizontal analysis
+ Vertical analysis

2. The balance sheet

- The balance sheet is the major financial statement, reflecting

comprehensively the financial position of a business with total assets,
liabilities and equity at a given point in time.
ASSETS = LIABILITIES + OWNERS’ EQUITY
- Description of the balance sheet:
1. In the horizon form
2. In the vertical form
- Book Values
+ Book value is the value of the asset or the total amount of
shareholders’ equity which are recorded on the balance sheet.
+ Book values are based on historical or original values.
+ Of a common stock: It is the amount that shareholders would
receive for each share if the firm’s assets were sold.
+ Of a firm: It is the firm’s net worth reflected in its balance sheet as
owners’ equity.
+ Of a liability: It is a full amount of a liability less sums already
paid.
- Market values:
+ Market values measure the current values of assets and liabilities in
the open and competitive market.
+ Market values are determined by current values based on the
supply and demand of the markets.
- E.g: If you bought a house 10 years ago for $300,00. Now you can sell it
for $500,000.
→ Book value: $300,000
→ Market value: $500,000
- BV vs MV in Liabilities
+ The accountant simply records the amount of money that you have
promised to pay
- Short-term liabilities, this figure is close to the Market
Values of that promise
- Long-term liabilities, Market Values can be higher or lower
than Book Values.
- The difference between the MV and BV is the MV of the shareholder’s
claim, which is expressed clearly in the shareholder’s equity. It measures
the cash( shareholders have contributed) + the cash( company retained).
- In principle, it operates efficiently and has high growth potential =>
high value of shares => the high market value of the company and vice
versa.
- MV vs BV Balance Sheet
Situation: According to GAAP, your firm has:
Equity: $6 billion
Debt: $4 billion
Assets: $10 billion
The MV your firm has:
100 million shares
Price: $7.5 per share
Debt: $4 billion.
=> What is the MV?
3. The income statement

- The income statement is a company’s financial statement that indicates

how the revenue is transformed into the net income.
- is a summary of a management’s performance as reflected in the
profitability of an organization over a certain period.
- itemizes the revenues and an expense of past that led to the current profit
or loss, and
- indicates what may be done to improve the results

- Profits versus Cash flow

+ The firm’s cash flow can be quite different from its net income:
- The income statement does not recognize capital
expenditures as expenses.
- The income statement uses the actual method of accounting.
+ Accountants do not simply count the cash coming in and the cash
going out of the firm. The cash payment consists of current
expenditures, which are deducted from current profits.

4. Cash flow statement

- The statement of cash flows shows the firm’s cash inflows and outflows
from operations as well as from its investments and financing activities
- It is a summary of the actual or anticipated incomings and outgoings of
cash in a firm over an accounting period(month, quarter, year)
- It answers the questions:(1) Where the money came(will come) from? (2)
Where it went(will go)?
- The statement of cash flows reports the sources and uses of cash by
operating activities, investing activities, financing activities and certain
supplemental information for the period specified in the heading of the
statement
- The importance of C.F Statement: C.F Statement helps users assess:
+ The entity’s ability to generate future cash flows
+ The entity’s ability to pay dividends and meet obligation
+ The reasons for the difference between net profit, and net cash
provided by operating activities
+ The cash investing and financing transactions during the period
5. Taxes

- Tax is a compulsory monetary contribution to the state’s revenue,

assessed and imposed by a government on the activities, enjoyment,
expenditure, income, occupation, privilege, property, etc., of individuals
and organizations
- Tax is a part of income which is legally stipulated and compulsorily paid
by citizens to the government in order to finance the public expenditures
- Taxes:
+ Corporate tax
+ Personal tax
For every exercise of Tax Calculation, you have to calculate: (1) the total tax
paid to the Government?; (2) the marginal tax paid to the Government? and (3)
the average tax rate?

ex: 275 000$

(1)= 22,500+ 39%*175,000= 90,500

(2)= 39% * 175,00 = 68,250(the marginal tax rate is the highest tax rate that
paid for any additional income.)

(3)= 90,500/275,000= 32,9%(the average tax rate = the total tax paid divided by
the total taxable income, and then multiplied by the quotient.)

- Table 1 shows that there are special low rates of corporate tax for small
companies, but for large companies( those with income over $18.33
million) the corporate tax is 35 percent.

→ For every $100 that the firm earns it pays $35 in corporate tax.

5.2 Personal income tax

- Personal income tax or individual income tax is a direct tax levied on

income of a person who has taxable income for a relevant tax period.
ex: $100,000

SINGLE PERSON:

Average tax rate = (21,036.75/100,000)*100% = 21.04%;

Marginal tax paid to the Govt. = (100,000 - 91,150)*28% = 2,478 (dollars)

MARRIED WIDOWER

Average tax rate = (16,542.5/100,000)*100% = 16.54%;

Marginal tax paid to the Govt. = (100,000 – 75,300)*25% = 6,175 (dollars)

HOUSEHOLD

Average tax rate = (19,297.5/100,000)*100% = 19.3%;

Marginal tax paid to the Govt. = (100,000 – 50,400)*25% = 12,400 (dollars)

ex: $500,000

SINGLE PERSON:

Total tax paid to the Gov = 9,275* 10% + (37,650 - 9,275)* 15% + (91,150 -
37,650)* 25% +( 190,150- 91,150)*28% + (413,350 - 190,150)*33% +
(415,050- 413,350)* 35% +(500,000- 415,050)* 39.6% = 154,169.95( dollars)

Average tax rate = (154,169.95/500,000)*100% = 30.83%;

Marginal tax paid to the Govt. = (500,000 - 415,050)*39.6% = 33,640.2
(dollars)

MARRIED WIDOWER

Total tax paid to the Gov = 18,550*10% + (75,300 - 18,550)*15% + (151,900-

75,300)*25% + (231,450-151,900)* 28% +(413,350-231,450)* 33% +
(466,950-413,350)* 35% +( 500,000- 466,950)* 39.6% = 143,666.3 (dollars)

Average tax rate = ( 143,666.3/500,000)*100% = 28.73%;

Marginal tax paid to the Govt. = (500,000 – 466,950)*39.6% = 13,087.8

(dollars)

HOUSEHOLD

Total tax paid to the Gov = 13,250*10% + (50,400-13,250)*15% + (130,150-

50,400)*25% +( 210,800-130,150)*28% + (413,350- 210,800)*33% + (441,000
- 413,350)* 35% + (500,000 - 441,000)*39.6% = 149,300( dollars)

Average tax rate = (149,300/500,000)*100% = 29.86%;

Marginal tax paid to the Govt. = (500,000 – 441,000)*25% = 23,364 (dollars)

ex: $450,000

SINGLE PERSON:

Total tax paid to the Gov = 9,275* 10% + (37,650 - 9,275)* 15% + (91,150 -
37,650)* 25% +( 190,150- 91,150)*28% + (413,350 - 190,150)*33% +
(415,050- 413,350)* 35% +(450,000- 415,050)* 39.6% = 134,369.95( dollars)

Average tax rate = (134,369.95/450,000)*100% = 29.86%;

Marginal tax paid to the Govt. = (450,000 - 415,050)*39.6% = 13,840.2

(dollars)

6. Financial ratios

- Financial ratios are tools for an accountant to evaluate the performance of

a company.
- Some financial ratios( such as net sales to net worth ratio and net income
to net sales ratio) are called primary because they indicate the
fundamental causes underlying a company’s strengths and weaknesses.
6.1 Liquidity ratios

- The current ratio is a way of looking at the working capital and

measuring short-term solvency.
- Formula:

CURRENT RATIO = CURRENT ASSETS/ CURRENT LIABILITIES

- Eg: Vinamilk

Current ratio in 2018 = 20,559/10,639=1.93

Current ratio in 2019 = 24,721/14,442 = 1.71

- Quick ratio, often referred to as acid-test ratio, is obtained by subtracting

inventories from current assets and then dividing by current liabilities.
- Formula:

QUICK RATIO = ( CURRENT ASSETS - STOCKS)/ CURRENT

LIABILITY

- eg: vinamilk

Quick ratio in 2018 = (20,559-5,525)/ 10,639=1.41

Quick ratio in 2019 = (24,721- 4,983)/14,442=1.37

⇒ For every dong of current liabilities, Vinamilk has 1.37 dong of easily
convertible assets in 2019, and 1.41 dong in 2018.

- Cash ratio is one of liquidity ratios, which is a refinement of quick ratio,

indicating the extent to which the readily available funds can pay off the
current liabilities.
- Formula:

Cash ratio = Cash and cash equivalents/ current liabilities

- Eg: Vinamilk

Current ratio in 2018 = 1,522/10,639=0.14

Current ratio in 2019 = 2,655/14,442 = 0.18

⇒ For every dong of current liabilities, Vinamilk has naught point one eight
(0.18) in 2019 and naught point one four (0.14) in 2018
6.2 Efficiency ratios( he so hieu suat hoat dong)

- Efficiency ratios is the measurement of how well a company can manage

its income and expenses. The accounts monitored are accounts receivable
and accounts payable.
- Stock turnover ratio( Inventory ratio):
+ Shows how quickly the business sells its stock, and shows the
number of times a firm’s investment in inventory is recouped
during an accounting period.
+ ex: In 2012, company A had:
- The opening stock is 14,000
- The closing stock is 16,000
- Cost of sales is 450,000

→ Calculate its stock turnover ratio?

- Inventory ratio = 450,000/((14,000+16,000):2)= 30 times

- ex: vinamilk

inventory ratio in 2019 = 56,318/((4,983+5,525):2) = 10.72 times

⇒ The inventory ratio of 10.72 times means that there are 10.72 times
Vinamilk's stocks are turned over.

- Debtors turnover ratio( account receivable ratio)

+ shows how long( how many days) it is taking to collect debts from
customers.
+ indicates the number of times average debtors are turned over
during a year.

Debtors turnover ratio = Net sales/ Average debtors

Average debtors = ( Opening + Closing balance of debtors)/ 2

Net credit sales = total assets - sales return + cash sales

- Ex: In the year 2012, company A had its net credit sales of $50,000 and
the opening balance of debtor is $12,000 and the closing balance of
debtor is $8,000. What is its debtor turnover ratio? What does this
number mean?

-> debt turnover ratio of company A = 50,000/((12,000+8,000):2) = 5 times

→ The debt turnover ratio of 5 times means that there are 5 times Company
A's average debtors are turned over.
debt turnover ratio of Vinamilk in 2019 = (Net sales/Average debtors) =
56,318 / [(4,503+4,639)/2] = 12.32

- Interpretation of debtor turnover ratio

+ Higher debtor turnover ratio is good because higher debtor
turnover ratio means, more fastly, we are collecting money.
+ Lower debtor turnover ratio is not good because it tells us that we
have not managed debtors in better ways. Money from debtors is
not collected fastly.
- Creditor’s turnover ratio( account payable turnover)
- The creditor turnover ratio is a short-term liquidity measure used to
quantify the rate at which a company pays off its supplies. This illustrates
how effective a credit policy is

CREDITOR TURNOVER RATIO = TOTAL SUPPLIER PURCHASES/

AVERAGE ACCOUNT PAYABLES

Average account payable = (Beginning + Ending account payables)/ 2

- Creditor turnover ratio:

+ Shows investors how many times per period the company pays its
average payable amount.
+ measures the speed with which a company pays its suppliers.
+ If the turnover ratio declines from one period to the next, this
indicates that the company is paying its suppliers more slowly, and
may be an indicator of worsening financial conditions.
- Ex1 : The controller of ABC company wants to determine the company’s
accounts payable turnover for the past year. In the beginning of this
period, the beginning accounts payable balance was $800,000, and the
ending balance was $884,000. Purchases for the last 12 months were
$7,500,000.

Creditor turnover ratio of ABC Company =

7,500,000/((800,000+884,000):2)=8.91 times

→ The Creditor turnover ratio of 8.91 times means that there are 8.91 times
Company ABC's average creditors are turned over.

- Ex2: For example, if company A made $100 million in purchases from

suppliers during the previous year, and at any given point it held an
average account payable of $20 million. Assume that during the current
year, company A had a cost of goods sold( COGS) of $120 million,
accounts payable of $30 million for the start of the accounting period, and
 accounts payable of $50 million for the end of the period. To calculate
the average accounts payable for both the previous year and the fiscal
year? Compare these figures. What does the comparison mean?

Creditor Turnover Ratio for:

Previous Year: 100,000,000/20,000,000 = 5 times

Fiscal Year: 120,000,000/[(30,000,000+50,000,000)/2] = 3 times

Creditors’ turnover ratio = Total supplier purchases/Average account payables =

(5,525 – 4,983 + 29,745)/[(3,648+3,991)/2] = 7.93 (times/turns)

● Asset turnover ratio:

- The asset turnover ratio is a measure of how efficiently a company’s
assets generate revenue.
- It measures the number of dollars of revenue generated by one dollar of
the company’s assets.
- Example: Use the formula above and the information below to calculate
the asset turnover ratio this year. What does this mean?

Asset turnover ratio = Revenue/Average total assets =

56,400/[(44,699+37,366)/2] = 1.37(times)
6.3 Profitability ratios

- Profitability ratios are a class of financial metrics that are used to assess a
business’s ability to generate earnings compared to its expenses and other
relevant costs incurred during a specific period of time.
- Gross margin/ Gross profit margin/ Gross profit percentage
- Net profit margin/ Net profit percentage
- Return on capital employed( ROCE)
- Return on Assets( ROA)
- Return on Equity( ROE)
- Gross profit margin is a profitability ratio that measures how much of
every dollar of revenues is left over after paying cost of goods
sold( COGS)

Gross profit percentage = Gross profit/ Net sales * 100

Gross profit = Revenue - COGS

Net sales = total revenue - COGS - allowance - discount

example: Gross profit margin = ($5,000,000 - $2,000,000)/ $5,000,000 * 100 =

60%

Gross profit percentage = (Gross profit / Revenue) *100

2019: ((56,318 - 29,745) / 56,318) *100 = 47.2%

→ This number tells us that Company ABC has 60% of its revenues left
over after it pays the direct costs associated with making its shoes( ists cost
of goods sold( COGS). This gross profit, which equates to $3.0 million in the
above example( $5.0 million in revenues minus $2.0 million in COGS),
represents money left over that Company ABC can use for operating expenses,
interest, taxes, dividend payouts, etc.

- Net profit percentage/ Net profit margin : Net profit margin is the ratio of
net profits to revenues for a company or business segment. Typically
expressed as a percentage, net profit margins show how much of each
dollar collected by a company as revenue translates into profit.

Net profit percentage = Net profit/ sales *100

Example: A business has $100,000 in revenue, but it also has $20,000 in

operating costs, $10,000 in COGS and $14,000 in tax liability. What is the net
profit percentage?
Importance: Net profit margin is one the most important indicators of a
business’s financial health. It can give a more accurate view of how profitable a
business is and assess whether or not current practices are working.

NET PROFIT MARGIN/ NET PROFIT PERCENTAGE

Net profit percentage = (Net profit / Sales)*100

2019: (10,554 / 56,318)*100 = 18.74%

● Return on capital employed

- Return on capital employed( ROCE) is a financial ratio that measures a
company’s profitability and the efficiency with which its capital is
employed.

ROCE = EBIT/ Capital employed * 100

- Capital employed = Equity + non- current liabilities

- Capital employed = total assets - current liabilities
- Example: Bovey Corporation has earnings before interest and taxes of
$500,000 total assets of $4,500,000 and current liabilities of $200,000.
What is the ROCE?

Bovey’s return on capital employed is:

Return on capital employed = $500,000

EBIT/( $4,500,000 - $200,000) = 11.6%

For every dollar of capital employed, the company can generate/ produce
11.6 cents of earnings before interest and taxes.

RETURN ON CAPITAL EMPLOYED (ROCE)

Capital employed = Equity + Non-current Liabilities

Capital employed = Total assets - Current Liabilities

ROCE = (EBIT / Capital employed)*100

2019: (12,795 / (44,699 - 14,442))*100 = 42.29%

=> The ROCE in 2019 means that for every dollar of capital employed,
Vinamik can earn 42.29 cents of earnings before interest and taxes.
ROCE 2018 = EBIT / Capital employed *100
 = 12,051 / (37,366- 10,639 )*100 = 45.09%

=>The ROCE in 2018 means that for every dollar of capital employed,
Vinamik can earn 45.09 cents of earnings before interest and taxes.

● Return on Assets
- ROA measures how effectively the company produces income
from its assets.
- You calculate it by dividing net income( NI) for the current year by
the value of all the company’s assets(A) and the company’s
assets(A) and multiplying the quotient by 100.

ROA = Net Income/ Total assets * 100

- Example: Imagine that you are the president of a large company that
manufactures steel. Last year, your company had net income of $25,000,000,
and the total value of its assets such as paint, equipment and machinery totaled
$135,000,000. What was your return on assets last year?
- ROA = $25,000,000/ $135,000,000 = 0.1852( Times)

RETURN ON ASSETS (ROA)

ROA = (Net Income / Total assets)*100

2019: (10,554 / 44,699)*100 = 23.61%

The ROA in 2019 tells us that for every dollar of assets, Vinamilk can generate
25.72 cents of net income.

ROA 2018 = Net income / Total assets *100= 10,205/ [(34,667+37,366)/2] *

100 = 28.33%

=> The ROA in 2018 tells us that for every dollar of assets, Vinamilk can
generate 28.33 cents of net income.

● Return on equity( ROE)

- ROE measures how much a company makes for each dollar that investors
put into it. You calculate it by taking the net income earned( NI) by the
amount of money invested by shareholders( SI) and multiplying the
quotient by 100.
- Example: Imagine that your social media company just went public last
year, resulting in a total investment of $100,000,000. Your company’s net
income for the year was $10,000,000. What is the return on equity?
ROE 2019 = net income/shareholders’ equity*100 =
10,554/[(29,731+26,271)/2]*100=37.7%

=> The ROE in 2019 tells us that for every dollar of shareholders’ equity,
Vinamilk can generate 37.7 cents of net income.

ROE 2018 = net income/shareholders’ equity*100 =

10,554/[(28,873+26,271)/2]*100=38.3%

=> The ROE in 2018 tells us that for every dollar of shareholders’ equity,
Vinamilk can generate 38.8 cents of net income.

6.4 Solvency ratios

- The solvency ratio is one of the various ratios used to measure the ability
of a company to meet its long term debts and other obligations. The
solvency ratio indicates whether a company’s cash flow is sufficient to
meet its short-term and long-term liabilities.
- Types of solvency ratios: The solvency ratio is only one of the metrics
used to determine whether a company can stay solvent.
+ Debt/Equity ratio is debt ratio used to measure a company’s
financial leverage, which indicates how much debt a company is
using to finance its assets relative to the amount of value
represented in shareholders’ equity.
+ Formula: The formula for calculating D/E ratios can be represented
in the following way:

Debt to equity ratio = total debts/ total equity

Debt to equity ratio = (Long-term debt + short-term debt + Leases)/equity

- Example: New Centurion Corporation has accumulated a significant

amount of debt while acquiring several competing providers of Latin text
translations. New Centurion’s existing debt covenants stipulate that it
cannot go beyond a debt to equity ratio of 2:1. Its latest planned
acquisition will cost $10 million. New Centurion ‘s current level of
equity is $50 million and its current level of debt is $91 million. Calculate
the current D/E ratio.

D/E Ratio = (10+ 91)/ 50 = 2.02

 Debt to asset ratio = total debts/ total assets
+ debt to asset ratio: The debt to assets ratio indicates the proportion
of a company’s assets that are being financed with debt, rather than
equity. The ratio is used to determine the financial risk of a
business.
+ formula: The formula for calculating D/A ratios can be represented
in the following way:

example: ABC Company has total liabilities of $1,500,000 and

total assets of $1,000,000. What is the D/A ratio? What does it
indicate?

D/A ratio = $1,500,000/ $1,000,000 = 1.5

CHAPTER THREE: NET PRESENT VALUE AND OTHER

INVESTMENT CRITERIA
1. Net present value
- Example: An investment of $1,000 today at 10 percent will yield $1,100
at the end of the year; therefore, the present value of $1,1000 at the
desired rate of return( 10 percent) is $1,000. The amount of
investment($1,000 in this example) is deducted.
- Importance:
+ is a formula used to determine the PV of an investment by the
discounted sum of all cash flows received from the project.
+ is one of the most used measures for evaluating an investment
+ allows a company to assess the project profitability by discounting
future cash flow expectations.
- Formula: The formula for the discounted sum of all cash flows can be
rewritten as

NPV = Ct/( 1+r)^t - C0

in which

+ Ct = net cash inflow during the period t

+ C0 = total initial investment costs
+ r = discount rate
+ t = number of time periods
* How to calculate NPV

Step 1: Estimated value of cash flow at the end of each period.

Step 2: Calculate the present value of the cash flow over period of time( in
which: C is the value of the cash flow at the end of period t; t is the number of
periods; and r is the discount rate( also known as opportunity cost of capital or
required rate of return)

Step 3: Calculate NPV by subtracting the initial cash outflow from the present
value of it over period of time:

NPV = PV - initial cash flow(C0)

Example 1: Consider company Shoes For You’s who is determining whether

they should invest in a new project. Shoes For You’s will expect to invest
$500,000 for the development of their new product. The company estimates that
the first year cash flow will be $200,000 , the second year cash flow will be
$300,000 and the third year cash flow will be $200,000. The expected return of
10% is used as the discount rate.
ex: NPV = (200,000/1+10%)+(300,000/(1+10%)^2+ (200,000/(1+10%)^3=
80,015.02 - $500,000 = $80,015.02

- Advantages:
+ allow for the time value of the cash flows and consider all the cash
flows arising during the project
+ compare mutually exclusive projects, NPV gives the most correct
ranking
+ with specific capital investment, it is the most reliable method
+ is a direct measure of the dollar contribution to the stockholders
+ give the correct decision advice assuming a perfect capital market
+ give an absolute value that the firm can gain from the project
- Disadvantages:
+ It is very difficult to identify the correct discount rate to use
+ do not determine profitability rate of capital
+ do not show the relationship between profitability rate of capital
and weight average cost of capital
+ investors can not select projects that are not the same period of
investment and the capital of projects are limited
+ do not provide an overall picture of gain or loss of executing a
certain project.

* PRESENT VALUE:
- Def: Present value describes how much a future sum of money is worth
today
- The formula:
 PV = CF/(1+r)^n

- where:
+ CF = cash flow in future period
+ r = discount rate
+ n = number of periods

1.1 A comment on risks and present value

- The present value of a delayed cash flow can be found by multiplying
cash flow by a discount factor which expressed as the reciprocal of 1 plus
a rate of return

Discount factor = 1/( 1+ r)

Example 1: Assume that you would like to put money in an account today to
make sure your child has enough money in 10 years to buy a car. If you would
like to give your child $10,000 in 10 years, and you know you can get 5%
interest per year from a savings account during that time, how much should you
put in the account now?

The present value formula tells us:

PV = CF/( 1+r)^n

PV = $10,000/(1+5%)^10 =$6,139.13
Thus $6,139.13 will be worth $10,000 in 10 years if you can earn 5% each
year. In other words, the present value of $10,000 in this scenario is $6,139.13.

Ex 2: A company is considering construction of an office block. How much

would the company have to invest in this project in order to receive $400,000
when they sell this office block at the end of next 3 year? Support the loan
offers interest of 10%.

Abbreviation: PV of $400,000 in three years = ? If r = 10%

Solution:

The present value formula tells us:

PV = CF/( 1+r)^n

PV =$400,000/(1+10%)^3 =$300,525.92

The company has to invest $300,525.92 in this project in order to receive

$400,000 when they sell this office block at the end of next 3 year.

1.1 A comment on risks and present value

- Time value of money needs to be considered in every financial analysis

that covers more than one period.
- A basic principle: A risky dollar is worth less than a safe one.

* Example 1: Invest $100 today to get $120 a year from now.

- To make the right investment choice, you should know what is today’s
value at this future $120 & then compared with today’s investment of
$100.
- Today’s value of cash flow is called the present value (PV). The P of this
example must be less than $120 since today you could invest the money
to start earning interest immediately.

1.1 A comment on risks and present value

Back to the above example: Assume the discount rate is 6% and we have PV =
CF/(1+r)^n = $120/(1+0.06) = $113.2

Compare this PV with today investment of $100 => NPV is subtracted today’s
investment from the PV:

NPV = $113 - $100 = $13.2

Present value of a multiple cash flow
Ex 2: Company A has a multiple cash flow project with C1 = $300; C2 = $400;
C3 = $500; C4 = $400; r = 10%. Calculate the present value of this project.
With C1 = $300; C2 = $400; C3 = $500; C4 = $400; r = 10%. => PV =?
PV= 300/(1+10%) + 400/(1+10%)^2+500/(1+10%)^3+400/(1+10%)^4
= $ 1,252.17

Present value of perpetuities

* Formula:
Cash payment from perpetuity = interest rate x present value
= r x PV
→ PV = c/r = cash payment/ interest rate
Example: Suppose you invest $100m at the interest rate at 10%. You would
earn annual interest of 0.1 x 100 = $10m/year and could withdraw this amount
from your investment account each year without ever running down your
balance -> $100m investment could provide a perpetuity of $10m/year.
Calculate the cash payment from perpetuity:
1. PV= $20,000/ 6% = 333,333.3
2. PV= $80,000/ 5% = $1,600,000
3. PV= $80,000/ 15% = $
4. PV = $35,000/7% =
5. PV = $75,000/8% =
Present value of annuities

Example: you borrow an amount of money to buy a new car. You will pay off
the loan quickly by making 5 equal annual payments of $50 million. If the
interest is 18%, what will the PV of the loan be?
Solution: C = $50m, r = 18%, t = 5 years
PV...year annuity = C x Annuity factor
PV = $50 x [1/0.18 - 1/0.18 x (1+0.18)^5]
= $156.36 (million)

1. PV= $20,000 x (1/0.06- 1/((0.06x(1+0.06)^8) = $124,195.88

2. PV= $80,000 x (1/0.05- 1/((0.05x(1+0.05)^15) = $830,372.64
3. PV= $80,000 x (1/0.15- 1/((0.15x(1+0.15)^15) = $467,789.61
4. PV= $35,000 x (1/0.07- 1/((0.07x(1+0.07)^12) = $277,994.02
5. PV= $75,000 x (1/0.08- 1/((0.08x(1+0.08)^11) = $535,422.32
6. PV= $25,000 x (1/0.08- 1/((0.08x(1+0.08)^11) = $178,474.11

Opportunity cost of capital

- The rate r used to discount cash flow is the “ opportunity cost of capital”
- The reason is that it is the return that is being given up by investing in the
project
1.2 Valuing Long-lived projects
-
PV =$16,000/ 1.07+ $16,000/(1.07)^2+ $4,000/(1+0.07)^3= $409,323
NPV= $409,323- $350,000=$ 59,323 > 0
=> Mr.A should go ahead
PV =$20,000/ 1.09+ $25,000/(1.09)^2+ $30,000/(1+0.09)^3+
$15,000/(1.09)^4= $73,182.51
NPV= $73,182.51 - $80,000 = - $6,217.49 < 0
=> We shouldn’t go ahead
PV =$30,000/ 1.07+ $35,000/(1.07)^2+ $30,000/(1+0.07)^3+
$35,000/(1.09)^4+ $50,000/(1.07)^5= $145,447.32
NPV= $145,447.32 - $115,000 = $30,447.32 > 0
=> We should go ahead
project A:
PV =$20,000/ 1.07+ $25,000/(1.07)^2+ $20,000/(1+0.07)^3+
$30,000/(1.07)^4+ $30,000/(1.07)^5= $101,129.96
NPV= $101,129.96 - $100,000 = $1,129.96 > 0
Project B:
PV =$25,000*(( 1/7% - 1/7%*(1+7%)^5)= $102,504.94
NPV= $102,504.94 - $100,000 = $2,504.94 > 0
=> We should go ahead project B
Plan A:
NPV = 25,000/(1+0.09) + 35,000/(1+0.09)^2 + 40,000/(1+0.09)^3+
35,000/(1+0.09)^4+ 30,000/(1+0.09)^5- 150,000 = - 22,452.26 (dollars) < 0

Plan B:
NPV = 33,000 * [(1/9% - 1/9%*(1+9%)^5)] - 100,000 = 28,358.49 (dollars) > 0

⇒ We should choose project B, because it has a positive NPV.

2. Other Investment Criteria
2.1 Rate of return
+ r1 = 10%
NPV1 = - $300,000 + $150,000/(1+10%) + $150,000/(1+10%)^2 +
$160,000/(1+10%)^3 = $80,541
+ r2 =25 %
NPV 2 = - $300,000 + $150,000/(1+25%) + $150,000/(1+25%)^2 +
$160,000/(1+25%)^3 =- $2,000
IRR = 10% +(25%-10%)
NPV1 = -$350,000 + $16,000/( 1+7%) + $16,000/(1+7%)^2 +
$466,000/(1+7%)^3 = $115,420.56

With a zero discount rate the NPV is positive. So the IRR must be greater than
zero
3.
4. Replacing an old machine
5. Capital rationing
EXERCISE 2
+ Calculate NPVs for each project at 10% cost of capital

NPVA = -60 + 20/(1+10%) + 20/((1+10%)^2) + 20/((1+10%)^3) +

20/((1+10%)^4) + 20/((1+10%)^5) + 20/((1+10%)^6) = 27.105 (thousand)
NPVB = -72 + 45/(1+10%) + 22/((1+10%)^2) + 20/((1+10%)^3) +
13/((1+10%)^4) + 13/((1+10%)^5) + 13/((1+10%)^6) = 26.407 (thousand)

+ Calculate NPVs for each project at 15% cost of capital

NPVA = -60 + 20/(1+15%) + 20/((1+15%)^2) + 20/((1+15%)^3) +
20/((1+15%)^4) + 20/((1+15%)^5) + 20/((1+15%)^6) = 15.69 (thousand)
NPVB = -72 + 45/(1+15%) + 22/((1+15%)^2) + 20/((1+15%)^3) +
13/((1+15%)^4) + 13/((1+15%)^5) + 13/((1+15%)^6) = 16.43 (thousand)

+ Calculate the IRR of each project

Project A
Based on above calculation
Choose r1 = 10% => NPV1 = 27.105 > 0
Choose r2 = 40%
NPV2 = -60 + 20/(1+40%) + 20/((1+40%)^2) + 20/((1+40%)^3) +
20/((1+40%)^4) + 20/((1+40%)^5) + 20/((1+40%)^6) = -16.64 (thousand) < 0

10% < IRR < 40%

IRRA = r1 + (r2 – r1) x (/NPV 1/)/(/NPV1/ +/NPV2/)
IRRA = 10% + (40% - 10%) x (/27.105/)/(/27.105/ +/16

10% < IRR < 40%

IRRA = r1 + (r2 – r1) x (/NPV 1/)/(/NPV1/ +/NPV2/)
IRRA = 10% + (40% - 10%) x (/27.105/)/(/27.105/ +/16.64/)
IRRA = 28.59%

Project B
Based on above calculation
Choose r1 = 10% => NPV1 = 26.407 > 0
Choose r2 = 40%
NPV2 = -72 + 45/(1+40%) + 22/((1+40%)^2) + 20/((1+40%)^3) +
13/((1+40%)^4) +
10% < IRR < 40%
IRRB = r1 + (r2 – r1) x (/NPV 1/)/(/NPV1/ +/NPV2/)
IRRB = 10% + (40% - 10%) x (/26.407/)/(/26.407/ +/18.82/)
IRRB = 27.52%
- Based on NPV rule, we choose project A at 10% cost of capital because its
NPV is higher than project B(27.105% > 26.407%) but we choose project B at
15% cost of capital because its NPV is higher than project A (16.43% >
15.69%)
- Based on IRR rule, we choose project A because its IRR is higher than project
B(
- in order to the best project, we calculate the profitability
PI A at 10% = 27.105/60= 45.17%
PI B at 10% = 26.407/72 x 100 = 36.68%
PI A at 15% =15.69/60 x 100 = 26.15%
PI B at 15% = 16.43 /72 x 100 = 22.82%
=> choose project A because its has higher profitability than project B
16. NPV/IRR.
a. Calculate the net present value of the following project for discount rates of
0, 50, and 100 percent:

C0 C1 C2

–$6,750 +$4,500 +$18,000

- With r1=0%

We have NPV 1= -$6,750 + $4,500/(1+0%) + $18,000/(1+0%)^2 = $15,750

- With r2=50%

We have NPV 2= -$6,750 + $4,500/(1+0.5) + $18,000/(1+0.5)^2 = $4,250

- With r3=100%

We have NPV 3= -$6,750 + $4,500/(1+100%) + $18,000/(1+100%)^2 = $0

b. What is the IRR of the project?

- With r4 = 5%
We have NPV 4 = -$6,750 + $4,500/(1+5%) + $18,000/(1+5%)^2 =
$13,862.24
 Bases on the above results: 0%< IRR< 5%
IIR = r1 + (r4-r1) x NPV 1/(NPV 1+NPV 4) = 0%+ (5%-0%) *
$15,750/($15,750 + $13,862.24) * 100% = 2.66%

31. Multiple IRR. Consider the following cash flows:

C0 C1 C2 C3 C4

–22 +20 +20 +20 –40

Summary: C0 = - 22, C1 = 20, C2 = 20, C3 = 20, C4 = - 40

a. Confirm that one internal rate of return on this project is (a shade
above) 7 percent, and that the other is (a shade below) 34 percent.
* A shade below IRR
- Choose r1 = 8%, NPV > 0
We have NPV 1 = -22 + 20/(1+0.08) + 20/(1+0.08)^2 + 20/(1+0.08)^3 –
40/(1+0.08)^4 = 0.14
- Choose r2 = 6%, NPV < 0
We have NPV 2 = -22 + 20/(1+0.06) + 20/(1+0.06)^2 + 20/(1+0.06)^3 –
40/(1+0.06)^4 = - 0.22
- Bases on the above results: 6%< IRR< 8%
IIR = r1 + (r2-r1) x NPV 1/(NPV 1+NPV 2) = 6% + (8% - 6%) * 0.14/(0.42 +
0.22) * 100% = 7%
* A shade below IRR
- Choose r3 = 33%, NPV > 0
We have NPV 3 = -22 + 20/(1+0.33) + 20/(1+0.33)^2 + 20/(1+0.33)^3 –
40/(1+0.33)^4 = 0.06
- Choose r4 = 35%, NPV < 0
We have NPV 4 = -22 + 20/(1+0.35) + 20/(1+0.35)^2 + 20/(1+0.35)^3 –
40/(1+0.35)^4 = - 0.12
- Bases on the above results: 33%< IRR< 35%
IIR = r3 + (r4-r3) x NPV 3/(NPV 3+NPV 4) = 33%+ (35%-33%) * 0.14/0.14 +
0.12) * 100% = 34%
à One IRR on this project is 7% and the other is 34%

b. Is the project attractive if the discount rate is 5 percent?

- With r= 5%
We have NPV = -22 + 20/(1+0.05) + 20/(1+0.05)^2 + 20/(1+0.05)^3 –
40/(1+0.05)^4 = -0.443 < 0
Thus, if the discount rate is 5 percent, the project is not attractive because the
NPV = -0.443 < 0.
c. What if it is 20 percent? 40 percent?
- With r = 20%
We have NPV = -22 + 20/(1+0.20) + 20/(1+0.20)^2 + 20/(1+0.20)^3 –
40/(1+0.20)^4 = 0.84 > 0
- With r = 40%
We have NPV = -22 + 20/(1+0.40) + 20/(1+0.40)^2 + 20/(1+0.40)^3 –
40/(1+0.40)^4 = -0.63 < 0
à So If the discount rate 20%, the project is attractive because it has a positive
NPV
If the discount rate of 40%, the project is unattractive because it has a negative
NPV
d. Why is the project attractive at midrange discount rates but not at very
high or very low rates?

- If the opportunity cost of capital is less than a project's IRR, the project
has positive NPV and vice versa. → We compare the project IRR with the
opportunity cost of capital, we are effectively asking whether the project
has a positive NPV. The higher NPV of project is, the more attractive the
project is. At midrange discount rates, it gives us positive NPV, otherwise,
at very high or low rates the NPV is negative, since the project is attractive
at midrange discount rates.
 34. Replacement Decision. You are operating an old machine that is
expected to produce a cash inflow of $5,000 in each of the next 3 years
before it fails. You can replace it now with a new machine that costs
$20,000 but is much more efficient and will provide a cash flow of $10,000
a year for 4 years. Should you replace your equipment now? The discount
rate is 15 percent.
Firstly, we calculate the present value of the new machine:
PV of the new machine at the discount rate of 15%:
PV = $20,000 + $10,000/(1+0.15) + $10,000/(1+0.15)^2 +
$10,000/(1+0.15)^3+ $10,000/(1+0.15)^4 = $48,549.78
Annuity factor = 1/r – 1/r*(1+r)^t = 1/0.15 – 1/0.15*(1+0.15)^4 = 2.85
EAC = PV of cost/ annuity factor = $48,549.78/2.85 = 17,035

Year 0 1 2 3 4 PV at 15%

New $20,000 $10,000 $10,000 $10,000 $10,000 $48,549.78

machine

Equivalent - $17,035 $17,035 $17,035 $17,035 $48,549.78

4–year
annuity

- The cash flows of a new machine are equivalent to annuity of $17,035 per
year. An old machine costs $5,000 a year to run, with the new one costing
$17,035 a year.
à The answer is that we shouldn’t replace now with a new machine that costs
$12,035 more.

ACOUSTIC INNOVATION
(HUIZHOU) CO.,LTD