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Finance Review of management  

CPI – benchmarked to 100 from 1982-1984. – 211 for January 2009 and also 211 for last year.

GDP – Keynesian fiscal multiplier effects, C+I+G+(Ex-Im), an increase in Government spending can have a multiplier effect on other components like C, I, and net exports. GDP is currently 14.2 trillion. Revised Q4 2008 GDP (-6.2%) because consumption was worse, net exports decreased, adjusted inventories, and less capital investment.

Preferred stock – guaranteed interest rate, which if not paid gets appended to the total money due. In case of bankruptcy, preferred stock is paid out first.
Common stock – ownership in a corporation. At the bottom of preference in case of bankruptcy.

Leverage ratio in an investment context (vs. accounting) - when you leverage yourself x:1, your gains will grow by x times but so will your losses

Short selling – you buy stock options on margin, and promise to pay back those shares at a later date.

Yield Curve (know components, significance, and current shape)

The yield curve graphs the various interest rates (yield) on Treasuries from 3 month to 30 years.  It reflects investor future expectations of the economy in that longer term yields should be higher than shorter term yields.  However, when the economy is in transition between expansion and recession, the curve may flatten.  When the curve is inverted, it suggests that a recession is coming.

Consumer Confidence Index (CCI) - benchmarked to 1985=100. CCI indicates future consumption behavior.  Consumption accounts for ~70% of the US GDP. Current reading is 25.0 Feb 2009.

Oil – oil is linked to costs for both consumers and businesses. The peak price occurred in summer of 2008 at $145/barrel. The current price is $45/barrel.


TED spread - Difference between 3-month Treasury Bill (risk free rate) and LIBOR (London Intraday Bank Offering Rate). A widening TED spread means liquidity drying up and pessimism is increasing. It indicates the degree of confidence commercial lenders have in the prevailing economic conditions. Peak - on Oct 10 2008 – 465 bps spread (4.65%). Currently 112 bps.

Stock market
DJIA – 7200
Last year DJIA - 12000
S&P - 750

Unemployment – currently 8.1%.
Full employment – 5%

Manufacturing index - Any reading above 50 signals growth, while a reading below 50 indicates contraction. 35.8 in February.

Engineering steps:
1.  Recognize the problem
2.  Define the goal or objective
3.  Assemble relevant data
4.  Identify feasible alternatives
5.  Select criterion to determine the best alternative
6.  Construct a model
7.  Predict each alternative’s outcomes or consequences
8.  Choose the best alternative
9.  Audit the result

Depreciable Asset – definition: Used for business purposes to produce income, useful life over 1 year, and is used up, depleted, or becomes obsolete.
Land is not depreciable!

Asset Disposal

    1. Asset disposed of at a market value greater than current book value but less than cost basis: depreciation recapture with the gain is taxed at the normal rate
  1. Asset disposed of at a market value greater than the cost basis: capital gain,  taxed at the capital gains rate


  1. Asset disposed of at a market value less than current book value: loss, and tax benefit / write-off

Individual taxes:
Adjusted Gross Income (AGI) = Gross income – retirement contribution
Taxable Income – AGI – personal exemption – itemized and standard deductions

Distinction between capital expenses and operating expenses
capital expenditures are land, equipment, etc with useful life over 1 year – in other words, they are long–term assets.  Capital impacts the balance sheet and operating is P&L only

Minimum cost life – number of years when EUAC is minimized.
Replacement analysis techniques
1 – If marginal costs are increasing, take Challenger’s minimum EUAC and compare with marginal cost of Defender.
2- If marginal costs are not increasing, use the Defender’s EUAC to see if it should be replaced immediately (if D’s minimum EUAC > C’s minimum EUAC). If not, revert back to marginal cost data of Defender AFTER minimum cost life of D’s EUAC (when marginal costs are increasing).
3- if defender marginal cost data does not exist, compare defender’s EUAC with challengers EUAC. Pick lower EUAC.

f= inflation rate
i’ = real interest rate (excluding inflation effects)
i = market interest rate

inflation is caused by money supply, currency exchange, businesses passing costs to consumers.

Sources of capital for companies

    1. Internal  - Cash flow from operations (retained earnings – becomes equity)
    2. External - Debt (bonds, bank loans, credit lines) and Equity (stock)


Cost of funds: Borrowed, cost of capital (use WACC to calculate), opportunity cost (interest rate of best rejected alternative). Use HIGHER of these 3 alternatives.

WACC = weighted average of all debt and equity funding sources / total capital
Debt taxes can be subtracted by multiplying that factor by (1-taxrate), equity cannot.
CAPM is the interest rate for cost of equity.
CAPM = rf * beta (rm – rf) where rf  = risk free rate,  rm = market rate, beta = volatility

Beta: (1.0 = moves in lock step with market)
Beta of -1 signals that 1% rise in the market translates into 1% decline in the stock

Balance Sheet
Assets = Liabilities + Equity
Current assets – can convert to cash in less than a year.
Fixed assets – can convert to cash in more than a year.
Assets are listed in order of decreasing liquidity.
Current liabilities are due in less than a year.
Long term liabilities are due in more than a year.
Working Capital = Current Assets – Current Liabilities

Income Statement
Gross profit = Total revenue – COGS
EBIT (operating income) = gross profit – OPEX (operating expenditures)
Net Income = EBIT (earnings before interest and taxes) – interest and taxes

Current ratio = current assets / current liabilities
Acid-test ratio= (current assets – inventory) / current liabilities
Debt to asset ratio (leverage ratio) = total debt / total assets
Debt to equity ratio (leverage ratio) = total debt / total equity
Interest coverage ratio = EBIT / interest payments
Gross profit margin = gross profit / total revenue
Net income margin = net income / total revenues

EPS (earnings per share) = net income / number of shares outstanding
P/E ratio (price per earning ratio) = market share price / EPS
Market Capitalization = number of shares outstanding x share price


  1. Companies raise rounds of capital by Series (A, B)
  2. Each Series has a different valuation
  3. Post-Money is the new value of the company
    1. Ex. Shareholders of X own 200 shares (100% of equity), Investor Y makes a $10M investment for 50 new shares
    2. Implied post-money valuation is 10M * (250/50) = $50M
  4. Pre-Money is the new value of the company less the investment amount
    1. Ex. $50M (post) - $10M (investment) = $40M
    2. Original shareholders diluted = 200/250 = now own 80%









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