🙋 Student Questions and Answers

Email office hour questions to robmgmte2700@gmail.com. PS1Q2=“Question 2 of Problem Set 1”

Saturday, Feb 10

Question 7 interpretation

❔ Q7
✔ The answer choices are given in millions of dollars. Therefore, you should treat 12.566.5 as 12 billion and 17,510.5 as 17 billion.

Question 9

🕣 Timestamp - 12:50 pm on Feb 10, 2024
❔ Maybe some discussion on question 9
✔ Covered in video

Question 18 interpretation

❔ I had a question regarding Q18 of assignment 1 (see below). Section C asks the question differently initially compared to the statement beside each box. Initially it asks how much the asset turnover will increase while after the boxes it appears to be stating what the new number will be but that makes the % portion of the question not make sense. Am I correct in assuming the question is not asking what the new asset turnover number is but how much it will increase/decrease from the original asset turnover number from both a number and percentage perspective?
✔ Calculate the old total asset turnover and the new and calculate the percentage change.
%Δ = (new - old)/old

Excel in Exams (blank sheet rule)

🕣 Timestamp - 2:30 pm on Feb 10, 2024
❔When you mention the exams are open book, does that mean that we can have excel files ready for calculation purposes (for example, financial ratios, enterprise value, etc)?
✔ You can use Excel, but all calculations must start out in a blank spreadsheet. You can not ahve Excel files ready for calculation purposes in Bruce’s advanced finance classes.

Open book exams

❔Instead of printing out hundreds of pages, during the test can we browse through word and/or powerpoint documents without proctorio interpreting that we are not following the right protocol?
✔ You are allowed to browse through word and PPTs, but you won’t have time! (Live students in the session agree~!)

Excel in Exams

❔do we need calculator or can we use excel for calculations during the test?
✔ Excel is fine.
Calculatator are, too!

7:39 pm

How did you calculate pretax income and taxes in the accelerated depreciation example.

✔ Generally, to calculate pretax income, you take revenue-direct and indirect operating expenses - interest expense = pretax income. Also, see video.

7:49

Liquidity ratios

See video.

There are various reasons why a company might fail. There may be logn term problems, but sometimes, a company may simply not have enough money to pay it’s bills right now. Liquidity ratios measure whether you will have enough money to pay your bills during this year.

How do you make a ratio to do this?

What are the bills that we will need to pay in the upcoming year?

Current liabilities.

How do we measure a firm’s ability to pay those current liabiltiies? They may make new cash and be able to paty their bills with the new income, but that’s hard to measure, so we can’t make a ratio out of that.

In terms of the balance sheet, we only have the current assets.

Therefore, our first liquidity ratio is the ratio between current assets and current liabilities.

The current ratio helps us know whether we can pay our current liabilities using our current assets.

The Quick ratio helps us know whether we can pay our current liabilities using our current assets, but ignoring inventories (because we don’t know if we’ll be able to sell the inventories)

The cash ratio asks whether we can pay our current liabilities using just the cash that we have. It assumes that we won’t necessarily be able to sell the inventory or even collect our AR. We may even hesisate to sell marketable securities, because we would sell them at a loss. The cash ratio assumes that we are paying off the liabilties using only cash.

8:02

The part that is tripping me up is “Its market-to-book ratio is 4.2.” Is that to be understood that the book value of the equity could be determined by first finding the market value of equity (share price x shares outstanding) and then dividing this number by 4.2, since it’s saying the market equity 4.2x higher than the book equity?

✔Yes.

I would approach this via “plug and chug,” where I write down an equation, plug numbers in, and chug away with algebra.

Plug and chug: (http://robmunger.com/plugchug )

Equation → markettobook = MC/bookvEquity
Plug 🔌 → 4.2 = 27B/bookvEquity
Solve 🚂 → bookvEquity = 27B/4.2
🧠 →

8:06

🙋 I think I’m being thrown off on the wording again on debt vs market values. Could you go over the difference in this context (book equity vs market equity)?

We can only measure the value of debt through book values because debt markets are more thinly traded, and contain a wider variety of securities, so it can be hard to get a good price for the market value of debt. Also, if a company is investment grade, the book value of debt can provide a good proxy for the market value anyway. Therefore, we’ll often use book value of debt. (ie you can use the book value of debt in both calculations.)

In questions a and b, market value and book value are referring to the equity.

You’re already familiar with the market value of a company’s equity. You calculate the market value of equity like you calculate the market value of a bunch of bananas. If you are buying 7 bananas and they cost $1 each, than the market value is just p×q = $1×7 = $7. for a corporation, we call this Market Cap.

$MC = P×\#Shares\; Outstanding$

However, in this problem they just tell you the market cap. They call it “Market Equity”

The book value of equity just another name for Stockholder’s Equity or Shareholder’s Equity. Book Equity = Assets - Liabilities.

🙋 Equity Multiplier

✔ There are two versions. Dupont uses the one that is Assets/SHE.

🙋 Q18: I referenced the forms online through EDGAR and I’m wondering about the wording of the last part. “If Costco’s managers wanted to increase its ROE by 1.8 percentage point, how much higher would their asset turnover need to be?” Does this mean adding 1.8% or increasing by a factor of 1.8%? I understand we need to replace ROE in the DuPont Identity with this new number and solve for the new asset turnover, I’m just not sure what the new ROE needs to be based on the wording.

It literally means ROE → ROE +1.2%.

In other words, if the old ROE was 1, then what would it take to raise the ROE to 1+1.2% = 1.012

Literally just add .012 to the ROE.

🙋 Which formula should I sue for ROA?

✔ ROA = Net Income/Assets

🙋 Hi Rob! Are we supposed to be doing readings from the textbook?! I was focusing on Bruce’s lecture slides and your notes

✔ Only if you want. It’s 100% up to you.

HOWEVER if this is your first course after e2000, then I would definitely do the readings. The book is wonderful, and it will give you extra familiarity and confidence with the material.

🙋 Would “net working capital” be a good thing for a company to have, as it reflects their liquidity and operational efficiency?

✔ It’s important for a company to have the right amount of NWC.

NWC allows a company to do business. As we saw with the liquidity ratios, it’s important for a company to have adequate current assets. NWC is just the difference between current assets and current liabilities:

NWC = CA - CL

Therefore, it is important for a firm to have adequate NWC.

HOWEEVER, NWC is expensive.

As we saw when we looked at the statement of cash flows, whenever a firm has more NWC, its operating cash flows decline. This is bad! We want operating cash flow today, so most firms try to decrease their NWC.

Luckily, firms can determine their assets and liability mix and therefore choose their level of Net Working Capital.

If you flip the P/E ratio formula over, you get the earnings yield formula, which is a percentage.

P/E = Price per share/EPS = Market Cap/Total earnings

Earnings Yield = EPS/Pricr per share = Total Earnings/Market Cap