Corporate Finance Crib Sheet

Key Concepts

Time Value of Money

Money today is worth more than the same amount in the future due to its potential earning capacity. Future Value (FV) and Present Value (PV) calculations are crucial.

• FV = PV (1 + r)^n (Future Value: Principal * (1 + interest rate)^number of periods)
• PV = FV / (1 + r)^n (Present Value: Future Value / (1 + interest rate)^number of periods)

Where 'r' is the discount rate (interest rate) and 'n' is the number of periods.

Risk and Return

Higher risk investments generally require higher expected returns to compensate investors.

• CAPM (Capital Asset Pricing Model): E(Ri) = Rf + βi(E(Rm) - Rf)
  • E(Ri) = Expected return of asset i
  • Rf = Risk-free rate
  • βi = Beta of asset i (measures systematic risk)
  • E(Rm) = Expected return of the market

Valuation

Determining the economic worth of an asset or company. Methods include:

• Discounted Cash Flow (DCF): Sum of present values of expected future cash flows. Requires projecting cash flows and determining an appropriate discount rate (WACC).
• Relative Valuation: Comparing a company's valuation multiples (e.g., P/E, EV/EBITDA) to those of its peers.

Capital Budgeting

Evaluating investment projects to decide which ones to undertake. Common methods:

• Net Present Value (NPV): PV of future cash inflows - Initial investment. Accept projects with NPV > 0.
• Internal Rate of Return (IRR): Discount rate that makes NPV = 0. Accept projects where IRR > Cost of Capital. (Use with caution; can give misleading results with unconventional cash flows.)
• Payback Period: Time it takes for an investment to generate enough cash flow to recover the initial cost. Simple, but ignores time value of money.

Working Capital Management

Managing current assets and current liabilities to ensure smooth operations.

• Cash Conversion Cycle: Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) - Days Payable Outstanding (DPO). A shorter cycle is generally better.

Capital Structure

The mix of debt and equity financing used by a company.

• Weighted Average Cost of Capital (WACC): The average rate of return a company expects to pay to finance its assets. Used as the discount rate in DCF valuation.
• WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc)
  • E = Market value of equity
  • D = Market value of debt
  • V = Total value of the firm (E + D)
  • Re = Cost of equity
  • Rd = Cost of debt
  • Tc = Corporate tax rate

Financial Ratios

Used to assess a company's financial performance and health.

• Liquidity Ratios: Current Ratio (Current Assets/Current Liabilities), Quick Ratio ( (Current Assets - Inventory)/Current Liabilities).
• Profitability Ratios: Gross Profit Margin (Gross Profit/Revenue), Net Profit Margin (Net Income/Revenue), Return on Equity (Net Income/Shareholder's Equity).
• Solvency Ratios: Debt-to-Equity Ratio (Total Debt/Shareholder's Equity).
• Efficiency Ratios: Asset Turnover Ratio (Revenue/Total Assets), Inventory Turnover Ratio (Cost of Goods Sold/Inventory).