FIN3 PRELIM

Relationship between FV & PV

Capital Budgeting  Future Value of Money (let’s call it FV)
 Present Value of Money (let’s call it PV)
Capital budgeting Techniques  FV = Future Value
 Investment decisions are generally called capital  PV = Present Value
budgeting decisions  K = Discounted Rate in %
 How do you decide - whether you should invest in Project  n = Number of Years
A or Project B ?
 Criteria: Future Value
o NPV - What is the value of the return on
investment.
o IRR - % of Return on investment.
o Profitability Index - Profit ratio for every
dollar spent.
o Payback period - Time to recover your
investments, A Break even point.
1. Opportunity cost
 High risk (high reward), low risk (low reward)
 Sample;
o Invest in a Bank – Bank Annual Returns: 8%
o Invest in a Project - Project Annual Returns :
10%
 What is the opportunity cost if you invest in the Bank?
 What is the opportunity cost if you invest in the Project?
 So, where should you invest your money?

2. Cash Flows
 Discounted Cash Flow
o Discounted Cash flow is nothing but the
Opportunity Cost. Present Value
o Rate of return that an organization could have
earned on the investment, if not invested in the
current project.
o In other words, it’s the rate of return that an
organization is willing to loose in an expectation
to earn more by investing in this project.
o It is the lost opportunity on the capital that is
being invested in the projects.
o Other names for Discounted cash flow
 Opportunity Cost of Capital
 Cost of Capital
o Example: Let’s say If an organization earns 10%
interest per annum on its capital by putting the
money in bank instead of investing in the
project. What is the opportunity cost of the
capital?
10% - You are correct.
Since it is the minimum that an organization
could have earned if invested the money in the
bank.
 Non Discounted cash flow
o In Non discounted cash flow, the interest rate,
opportunity cost or Discounted cash flow is not
taken in to consideration.

Consideration for Capital budgeting

 Discounted Cash flow
o NPV - Net present Value
o IRR - Internal Rate of Return
o PI – Profitability Index
 Non-Discounted Cash flow
o Payback period (Payback period is usually
calculated considering the Non discounted cash
flow.
Net Present Value
3. Time Value of Money  Net Present Value (NPV) = “Present Value of all cash
 A Dollar sitting in your wallet is worth more today than the inflows – Present Value of all cash outflow”
same dollar tomorrow.  Example: Salary Slip
 Can you tell Why? Net Salary = Gross Salary – Deductions
o Depreciation.  Similarly, The Present Value of all cash inflows is the
o Money grows over time when it earns Gross Present Value and if you deduct cash outflows it
interest. becomes your Net Present Value.
 So, the time value of money brings us to the concept of  Criteria:
o Future Value of Money. o If NPV > 0 (NPV is +ve, Accept the Project)
o Present Value of Money. o If NPV < 0 (NPV is –ve, Reject the Project)
 o If NPV = 0 (Accept the Project, considering
other non tangible benefits)
 Greater the NPV, Better the Prospects
Internal Rate of Return
 IRR - % of Return on investment.
 To put it simple: It is the percentage of Return of your
investment.
 How do we calculate IRR?
o If you remember from NPV example, we
mentioned that the NPV is dependent on
Discounted rate
o If we increase the discount rate the NPV value
decreases
o We need to increase /decrease the discount
rate to a level where NPV becomes zero
o The discount rate at which NPV becomes zero
is in fact the Internal rate of return
 In other words, IRR is the opportunity cost at which the
NPV becomes Zero.

 Note:
o For Constant rate of Cash inflow for every year,
Internal Rate of Return can be calculated with
the help of a formula.
o For Uneven rate of Cash inflows for every year,
IRR can be calculated by little trail & error
adjustments.
 Accept the project when Internal rate of return >
Discount rate or Opportunity cost of capital.
 Reject the project when Internal rate of return <
Discount rate or Opportunity cost of capital.
 May accept the project when Internal rate of return =
Discount rate or Opportunity cost of capital.

Relationship between IRR, Discount rate and NPV

 If IRR > Discount rate or Opportunity cost of capital 🡪 The
NPV is always Positive.
 If IRR < Discount rate or Opportunity cost of capital 🡪 The
NPV is always Negative.
 If IRR = Discount rate or Opportunity cost of capital 🡪 The
NPV is Zero.
o Note: As long as the NPV is Positive, the
project is financially viable.
o The moment that NPV becomes Negative, the
Project is NOT financially viable.
  If NPV is same for the given projects, choose the project
with highest IRR.
 If NPV, IRR remains the same for the given projects,
choose the projects with early pay back period.
 NPV = All Cash Inflows – Cash Outflows
 PI = All Cash Inflows / Cash Outflows
 IRR = Discount rate at which the NPV becomes zero, this
tell us what is the percent of return for the project.
 Payback period is a major consideration for every project,
business or organization, it tells us how soon we can
recover our investment and this investment can be utilized
for other business needs/projects later on

Quick Recap – Concepts Learned

 Opportunity Cost / Discounted Cash flow
 Time Value of Money
 Calculating Future value
 Calculating Present value

Based on the above concepts, we learnt how to solve

Capital Budgeting techniques.
 Net Present Value - NPV
 Internal Rate of Return - IRR
 Profitability Index – PI
 Payback Period – PBP
Profitability Index (PI)
 For every dollar spent, how much are we getting back
 Criteria
o If PI > = 1, Accept the Project.
o If PI < 1, Reject the Project.

Payback Period
 The time it takes for the project to generate money to pay
for itself.
 Payback period is the number of years required to recover
the cash outflow invested in the project.
 The project would be accepted if its payback period is less
than the maximum or standard payback period set by
Industry, Senior Leadership.
 In terms of Projects ranking, it gives highest ranking to the
project with the shortest payback period.
 Note: In general, the discounted cash flow is not
considered for Pay back period. Some do, but most don’t!

Important: Few tips to Remember

 Always choose projects with highest NPV.
FIN 3 MIDTERM readers, whether the company is profitable during the
Financial analysis and reporting financial year. Investors can also see how well a
company's management is controlling expenses to
Definition of financial statements determine whether a company's efforts in reducing the
 Financial statements are written records that convey cost of sales might boost profits over time.
the business activities and the financial performance
of a company. Financial statements are often audited by What are the items that can be found in a income statement?
government agencies, accountants, firms, etc. to ensure 1. Revenue - Operating revenue is the revenue earned by
accuracy and for tax, financing, or investing purposes. selling a company's products or services. The operating
 Financial Statements includes the following revenue for an auto manufacturer would be realized
o Balance Sheet through the production and sale of autos. Operating
o Income Statement revenue is generated from the core business activities of a
o Cash flow company.
o Non-operating revenue is the income earned
o Statement of changes in Equity
from non-core business activities. These
o Notes to financial Statements and
revenues fall outside the primary function of the
supplementary schedules
business. Some non-operating revenue
examples include:
Balance sheet
 Interest earned on cash in the bank
 The balance sheet provides an overview of a company's
 Rental income from a property
assets, liabilities, and shareholders' equity as a snapshot
 Income from an advertisement
in time. The date at the top of the balance sheet tells you
display located on the company's
when the snapshot was taken, which is generally the end
property
of the reporting period.
2. Expenses - Primary expenses are incurred during the
 The balance sheet is particularly important because it
process of earning revenue from the primary activity of the
keeps you and other stakeholders informed of your
business
financial position. Keeping this information updated can
o COGAS
help you make better management decisions. In addition,
o selling, general and administrative expenses
it can help improve your operational efficiency, borrowing,
and overall financial health. (SG&A),
o depreciation or amortization,
What are the items that can be found in a balance sheet? o research and development (R&D).
1. Assets - An asset is a resource that a company owns that  Typical expenses include employee wages, sales
provides economic value. This includes cash, equipment, commissions, and utilities such as electricity and
property, rights or anything that a company can expect to transportation.
generate revenue or reduce expenses. Examples of
assets are cash, accounts receivable and property. Income statement sample
2. Liabilities – the A liability is something a person or
company owes, usually a sum of money. Liabilities are
settled over time through the transfer of economic benefits
including money, goods, or services. Examples of
Liabilities are accounts payable, notes payable and other
claims against an enterprise as a result of a previous
contract.
3. Equity - the residual interest in the assets of the
enterprise after deducting all liabilities. It contains owners’
contribution to the business, increase by the income from
operation, and decrease by the owner’s withdrawal and
losses.

Sample balance sheet

Cash flow
 Cash flow is the movement of money in and out of a
company. Cash received signifies inflows, and cash spent
signifies outflows. The cash flow statement is a financial
statement that reports on a company's sources and usage
of cash over some time.
 The CFS allows investors to understand how a company's
operations are running, where its money is coming from,
and how money is being spent. The CFS also provides
insight as to whether a company is on a solid financial
footing.

Income statement What are the items that can be found in a cash flow statement?
 An income statement is a financial statement that  Operating Activities
shows you the company's income and expenditures. It o The operating activities on the CFS include any
also shows whether a company is making profit or loss for sources and uses of cash from running the
a given period (it could be quarterly or annualy). The business and selling its products or services.
income statement, along with balance sheet and cash flow Cash from operations includes any changes
statement, helps you understand the financial health of made in cash, accounts
your business. receivable, depreciation, inventory,
 The purpose or importance of an income statement is to and accounts payable. These transactions also
provide financial information to investors, creditors, and include wages, income tax payments, interest
 payments, rent, and cash receipts from the sale
of a product or service.

 Investing Activities
o Investing activities include any sources and Statement of changes in equity sample
uses of cash from a company's investments into
the long-term future of the company. A purchase
or sale of an asset, loans made to vendors or
received from customers, or any payments
related to a merger or acquisition is included in
this category.
o Also, purchases of fixed assets such
as property, plant, and equipment (PPE) are
included in this section. In short, changes in
equipment, assets, or investments relate to cash
from investing.
 Financing Activities Notes to financial statement
o Cash from financing activities includes the  The notes are used to make important disclosures that
sources of cash from investors or banks, as well explain the assumptions used to prepare the financial
as the uses of cash paid to shareholders. statements of a company. Common notes to the
Financing activities include debt issuance, financial statements include accounting policies,
equity issuance, stock repurchases, loans, depreciation of assets, inventory valuation, subsequent
dividends paid, and repayments of debt. events, etc.
 The notes to the financial statements communicate
Cashflow sample information necessary for a fair presentation of financial
position and results of operations that is not readily
apparent from, or not included in, the financial statements
themselves.

Sample notes to financial statement

 Expenses

 Note 1 – Advertisement Expense

o - DXPA contract for 3 months P 2,000
o - Radyo Natin contract for 3 months P 2,000
 Note 2 – Miscellaneous Expense
o Tip for the delivery P 500
o Snacks for the whole month P 1,000

Advantages of accounting in business:

 Aid to management – it provides financial information to
the management to do its daily work properly and
efficiently. The financial information helps the
management in planning, organizing, evaluating,
controlling or correcting various business activities.
 Reference - It removes the limitation of memory by
recording business transactions chronologically, serves as
future reference, facilitates comparative study of business
financial status, and helps in assessing the value of the
business at the time of the sale.
 Basis for tax assessment - it helps in assessing the tax
liability.
 Evidential matter – can be used for evidence in court.
Statement of changes in equity  Tool to evaluate management performance – It shows
 A statement of change in equity (also referred to as the financial condition of a business.
statement of retained earnings) is a business' financial
statement that measures the changes in owners'
equity throughout a specific accounting period. It
covers the following elements: Net profit or loss. Dividend
payments. Equity withdrawals.
 A statement of equity is important to report a
corporation's financial standing and identify their
sources of financing. This detail matters because it
defines how a business operates financially, whether that
be through borrowing funds or that a business is fiscally
self-reliant.
Fin3 FINAL securities, and accounts receivables by total current
liabilities.
1  The quick ratio is an indicator of a company's short-term
Financial ratios liquidity position and measures a company's ability to meet
 Financial ratios offer entrepreneurs a way to evaluate their its short-term obligations with its more liquid assets.
company's performance and compare it other similar  Interpretation:
businesses in their industry. Ratios measure the A quick ratio of 1 or above indicates that the
relationship between two or more components of company has sufficient liquid assets to satisfy its
financial statements. They are used most effectively short-term obligations. An extremely high quick
when results over several periods are compared. ratio, on the other hand, isn't always a good
sign. This is because a very high ratio could
What are the 5 essential ratios for every business: indicate that the company is resting on a
 Liquidity Ratios significant amount of cash.
 Leverage Ratios
 Efficiency Ratios Sample problem with solution and conclusion for quick ratio.
 Profitability Ratios  If Dodong’s Company has P70,000 cash and cash
 Market Value Ratios equivalents, P30,000 A/R and P70,000 total current
liabilities. What is its Quick ratio? And what does quick
Liquidity ratios ratio result concludes?
 Liquidity ratios are a measure of the ability of a
company to pay off its short-term liabilities. Liquidity Quick Ratio Formula:
ratios determine how quickly a company can convert the
assets and use them for meeting the dues that arise. The Quick Ratio = (More Liquid Assets such as Cash, A/R,
higher the ratio, the easier is the ability to clear the debts Marketable Securities) / Current Liabilities
and avoid defaulting on payments. Quick Ratio = P100,000 / P70,000
 The importance of it is that Your liquidity ratio tells you Quick Ratio = 1.43
whether you have the ability to meet your upcoming
liabilities. Typically, this means you have sufficient cash, Conclusion: Therefore, it clearly shows that Dodong’s company has
bank deposits or assets that can quickly be converted to sufficient more liquid assets to satisfy its short term obligations.
cash to pay your bills. If you don't, your business could hit
difficulties and could even be forced to cease trading. 3. What is a cash ratio?
 The cash ratio is a measurement of a company's liquidity.
What is the importance of knowing the liquidity ratios? It specifically calculates the ratio of a company's total cash
 Your liquidity ratio tells you whether you have the ability and cash equivalents to its current liabilities.
to meet your upcoming liabilities. Typically, this means  If the company is forced to pay all current liabilities
you have sufficient cash, bank deposits or assets that can immediately, this metric shows the company's ability to do
quickly be converted to cash to pay your bills. If you don't, so without having to sell or liquidate other assets.
your business could hit difficulties and could even be  Interpretation:
forced to cease trading In general, a cash ratio equal to or greater than
1 indicates a company has enough cash and
What are the important types of liquidity ratios. cash equivalents to entirely pay off all short-term
 Current Ratio debts. A ratio above 1 is generally favored,
 Quick Ratio while a ratio under 0.5 is considered risky as the
 Cash Ratio entity has twice as much short-term debt
compared to cash.
1. What is a current ratio?
 Current Ratio = Current Assets / Current Liabilities
Sample problem with solution and conclusion for Cash ratio.
 The current ratio is the simplest liquidity ratio to calculate
 If Dodong’s Company has P70,000 cash and cash
and interpret. Anyone can easily find the current
equivalents and P70,000 total current liabilities. What is its
assets and current liabilities line items on a company’s
Cash ratio? And what does Cash ratio result concludes?
balance sheet. Divide current assets by current liabilities,
and you will arrive at the current ratio. Cash Ratio Formula:
 Interpretation:
If Current Assets > Current Liabilities, then Cash Ratio = Cash and Cash equivalents / Current Liabilities
Ratio is greater than 1.0 -> a desirable Cash Ratio = P70,000 / P70,000
situation to be in. If Current Assets = Current Cash Ratio = 1
Liabilities, then Ratio is equal to 1.0 -> Current
Assets are just enough to pay down the short Conclusion: Therefore, it is giving us the information that Dodong’s
term obligations. Company has enough cash and cash equivalents to pay its Short
term debts.
Sample problem with solution and conclusion for current ratio.
 If Dodong’s Company has P220,000 total current assets
and P70,000 total current liabilities. What is the Current
ratio? And what does the current ratio concludes?

Current Ratio Formula:

Current Ratio = Current Assets / Current Liabilities

Current Ratio = P220,000 / P70,000
Current Ratio = 3.14

Conclusion: Therefore, it clearly shows that Dodong’s company has

more than enough capability to pay its short term obligations or pay
its current liabilities.

2. What is a Quick ratio?

 The quick ratio is calculated by dividing a company's more
liquid assets like cash, cash equivalents, marketable
2 For example, if you sell 1,000 units over a year while having a
EFFICIENCY RATIO overage of 200 units on-hand at any given time during that year,
 An efficiency ratio measures a company’s ability to use its your inventory rate would be 5.
asset to generate income. 1,000
 It is typically used to analyze how well a company uses its Inventory Turnover= =5
assets and liabilities internally. An efficiency ratios can 200
calculate the turnover of receivables, the repayment of Therefore, this result tends to point strong sales in its business.
liabilities, the quantity and usage of equity, the general use
of inventory and machinery. 3. ACCOUNTS PAYABLE TURNOVER
 This ratio can also be used to track and analysis the  Accounts payable during a period. Ideally, a company
performance of commercial and investment bank. wants to generate enough revenue to pay of its accounts
payable quickly, but not so quickly the company misses
Formula: out on opportunities because they could use that money to
Efficiency Ratio= Expenses/Revenue invest in other endeavors.
 Since a bank’s operating expense are in the numerator  Creditors and investors will look at the account's payable
and it revenue is in the denominator , a lower efficiency turnover ratio on a company’s balance sheet to determine
ratio means the bank is operating better. whether the business is in goods standing with its
 For example, if bank has a net revenue of P100 million creditors and suppliers.
and expenses of P65 million, the efficiency ratio would be:  Higher figures indicate that a company pays its bills on a
 Efficiency Ratio: P65,000,000/P100,000,000 = more-timely basis, and thereby has less debt on the book.
0.65
 Therefore, 0.65 indicate that the bank is Formula:
operating better .

TYPES OF EFICIENCY RATIO

 Accounts Receivable Turnover  In some cases, cost of goods sold (COGS) is use in the
 Inventory Turnover numerator in place of net credit purchases. Average
 Accounts payable turnover accounts payable is the sum of accounts payable at the
 Working capital turnover beginning and end of an accounting period, divide by 2.
 Fixed asset turnover
Example, Company A reported annual purchases on credit of
 Total asset turnover
$123,555 and returns of $10,000 during the year ended
December 31, 2017. Accounts payable at the beginning of the
1. ACCOUNTS RECIEVABLE TURNOVER RATIO
end of the year were $12,555 and $25,121, respectively. The
 The accounts receivable turnover ratio measures the
company wants to measure how many times it paid its creditors
number of times a company collects its average accounts
over the fiscal year.
receivable balance. It is a quantification of company’s
effectiveness in collecting outstanding balance from client.
 A high ratio may indicate that corporate collection
practices are efficient.
 A low ratio could be the result of inefficient collection
process. • Therefore, over the fiscal year, the company’s accounts
payable turned over approximately 6.03 times during the
Formula: year. The turnover ratio would likely be rounded off and
Accounts Receivable Turnover = simply stated as six.
Net Credit Sales
4. WORKING CAPITAL TURNOVER
Average Accounts Recievable  Working capital turnover measures how effective a
business is at generating sales for every dollar of working
For Example, let’s say your company had P100,000 in net credit capital use.
sales for the year with average accounts receivable of P25,000. To  A higher working capital turnover ratio is better and
determine your accounts receivable turnover. indicates that a company can generate a larger number of
sales.
P 100,000
Accounts Receivable Turnover = =4 Formula:
25,000
Therefore, this indicate that the company corporate collection
practices are efficient.

2. INVENTORY TURNOVER RATIO

 The inventory turnover ratio is the number of time a  Working capital turnover = Net annual sales / Working
company has sold and replenished its inventory over a capital. In this formula, the working capital is calculated by
specific amount of time. The formula can also be used to subtracting a company’s current liabilities from its current
calcite the number of days it will take to sell the inventory assets
on hand.
 It measures of efficiently a company can control its Example, Let say that Company A has P12 million in net sales over
merchandise, so it is important to have a high turn. This the previous 12 months. The average working capital during that
shows company does not overspend by buying too much period was P2 million.
too much inventory and waste resources by storing non- P 12,000,000
salable inventory. Working Capital Turnover = =6.0
 A higher ratio tends to point strong sales and a lower
2,000,000
one to weak sales. Therefore, the company A’s working capital ratio that resulted to 6.0
indicates that their company can generate a large number of sales.
Formula:
Inventory Turnover = 5. FIXED ASSET TURNOVER
 The fixed asset turnover ratio is an efficiency ratio that
Number of Units Sold measures a companies return on their investment in
Average Number of UnitsOn hand property, plant, and equipment by comparing net sales
with fixed assets. In other words, it calculates how
 efficiently a company is a producing sales with its 3
machines and equipment. LEVERAGE RATIOS
 The fixed asset turnover ratio reveals how efficient a
company is at generating sales from its existing fixed WHAT IS LEVERAGE RATIOS?
assets.  Leverage Ratio measures firm’s ability to pay its long-term
 A higher ratio implies that management is using its fixed debt.
assets more effectively. A high Fixed Asset Turnover ratio  Leverage ratio known as long-term solvency ratios.
does not tell anything about a company's ability to
generate solid profits or cash flows. WHAT IS THE IMPORTANCE OF KNOWING THE LEVERAGE
RATIOS?
Formula:  The leverage ratio category is important because
Net Sales companies rely on a mixture of equity and debt to
Fixed Asset Turnover = Asset ¿ finance their operations, and knowing the amount of
Average ¿ debt held by a company is useful in evaluating whether it
can pay off its debts as they come due.

Let us take the example of two companies ABC Inc. and XYZ [Link] THREE COMMONLY USED MEASURES LEVERAGE RATIOS:
illustrate the concept of fixed asset turnover ratio. Both companies 1. Total Debt Ratio
belong to the same industry of ice cream manufacturing. Calculate 2. Debt-Equity Ratio
the fixed assets turnover ratio of both of those businesses on the 3. Equity Multiplier
basis of the above given information. Also, calculate which company
utilizes its fixed assets better. According to the latest annual reports, 1. DEBT RATIO
the following information is available:  It shows the total amount of debt a company has relative
BALANCE SHEET to its assets.
 INTERPRETATION:
 A debt ratio of greater than 1.0 or 100% means
a company has more debt than assets while a
debt ratio less than 100% indicates that a
company has more assets than debt.
Formula:
Total Liabilities
Debt Ratio =
Total Assets
EXAMPLE: If Company A has P300,000 total assets and P90,000
For ABC Inc.: total liabilities. What is the debt ratio? And what does the debt ratio
$ 50 , 000,000 concludes?
Fixed Asset Turnover Ratio = =2.27
22,000,000 SOLUTION:
Total Liabilities
For XYZ Inc.: Debt Ratio =
Total Assets
$ 70,000,000
Fixed Asset Turnover Ratio = =2.92 P 90,000
24,000,000 Debt Ratio =
P 300 , 00
Therefore, XYZ Inc.’s fixed asset turnover ratio is higher than that of Debt Ratio = 0.3 or 30%
ABC Inc. which indicates that XYZ Inc. was more effective in the use
of its fixed assets during 2019. CONCLUSION: Therefore, it clearly shows that Company A has
more than enough capability to pay its liabilities or debts.
6. TOTAL ASSETS TURNOVER
 Total Asset Turnover is a financial ratio that measures 2. DEBT-EQUITY RATIO
the efficiency of a company's use of its assets in  It is calculated by dividing the company’s shareholder
generating sales revenue or sales income to the equity by the total debt, thereby reflecting the overall
company. leverage of the company and thus its capacity to raise
 The asset turnover ratio can be used as an indicator of the more debt.
efficiency with which a company is using its assets to  INTERPRETATION:
generate revenue.  A good debt-equity ratio is anything lower than
 The higher the asset turnover ratio, the more efficient a 1.0. A ratio of 2.0 or higher is usually considered
company is at generating revenue from its assets. risky.
Conversely, if a company has a low asset turnover ratio, it Formula:
indicates it is not efficiently using its assets to generate Total Liabilities
sales. Debt-Equity Ratio =
Total Equity
Formula:
EXAMPLE: If Company A has P300,000 total equity and P150,000
total liabilities. What is the debt-equity ratio? And what does the
debt-equity ratio concludes?

Example of the Total Asset Turnover Ratio A business that has net SOLUTION:
sales of P10,000,000 and total assets of P5,000,000 has a total Total Liabilities
asset turnover ratio of 2.0. This calculation is usually performed on Debt-Equity Ratio =
an annual basis.
Total Equity
P 10,000,000 P 150,000
Debt-Equity Ratio =
Asset Turnover Ratio= =2
5,000,000 P 300,000
Debt-Equity Ratio = 0.5
Therefore, the company is efficient in generating revenue from its
assets.
CONCLUSION: Therefore, Company A is not risky to its business
and has enough equity to maintain the good business.

3. EQUITY MULTIPLIER
 A financial ratio that measures how much of a company’s
assets are financed through stockholders’ equity.
 INTERPRETATION:
 If equity multiplier is higher than 1.0 it signifies
that the company is financed by debt rather than
equity on purchasing assets.
If equity multiplier is lower than 1.0 the company
is financed by equity rather than debt on
purchasing assets.
Formula:
Total Assets
Equity Multiplier =
Total Equity
EXAMPLE: If Company A has P250,000 total equity and P500,000
total assets. What is the equity multiplier? And what does the equity
multiplier concludes?

SOLUTION:
Total Assets
Equity Multiplier =
Total Equity
P 500,000
Equity Multiplier =
P 250 , 000
Equity Multiplier = 2

CONCLUSION: Therefore, Company A’s assets are financed more

by debt rather than equity.
4  Interpretation:
Profitability Ratios  A return on equity ratio of 15% to 20% above is
usually considered good and its indicates that a
WHAT IS PROFITABILITY RATIOS? company is more effective at generating profit
 The Profitability Ratios shows how efficiency company from its existing equity. At 5%, the ratio would
generates profit and values for shareholders. be considered low and it indicates that the
company did not use the capital efficiently
IMPORTANCE OF PROFITABILITY RATIOS invested by the shareholders.
 The profitability shows how successful a business is in Formula:
earning profits over a period of time in relation to operation RETURN ON NET INCOME
costs, revenue, and shareholders’ equity. The higher the EQUITY = TOTAL EQUITY
ratio, the better it is for the company because it shows that Return on equity = x100 to get the percentage.
the business is highly capable of generating profits
regularly. Example
Samsung Electronics in 2015 has Net income of P18,695 and
Objectives: Total equity of P179,060. How much is their Return on equity?
1. Profit Margin RETURN ON 18,695
2. Return on asset EQUITY = 179,060
3. Return on equity = 10.44%
Conclusion:
1. Profit Margin A 10.44% ROE indicates that the company earns P10.44 on
 Net Profit Margin (also known as “Profit Margin” or every P100 of its share equity/capital.
“Net Profit Margin Ratio”)
 is a financial ratio used to calculate the percentage of
profit a company produces from its total revenue. It
measures the amount of net profit a company obtains per
peso of revenue gained.
 Interpretation:
 a 10% net profit margin is considered average,
a 20% margin
is considered high (or “good”), and a 5% margin
is low.
Formula:
PROFIT NET INCOME
MARGIN = NET SALES
Profit margin =x100 to get the percentage.

EXAMPLE:
Samsung Electronics in 2015 Net income is P18,695 and sales is
P200,[Link] much is their profit margin?
PROFIT 18,695
MARGIN = 200,653
= 9.32%
Conclusion:
Therefore, in every peso they have generated a low profit
margin which is 9.32 %.

2. Return on Asset
 The term return on assets (ROA) refers to a financial ratio
that indicates how profitable a company is in relation to its
total [Link] measures the profit per peso of asset.
 Interpretation:
 A ROA of 5% or lower might be considered low,
while a ROA over 20% high and more efficient
to the company in generating profits.

Formula:
RETURN ON NET INCOME
ASSET = TOTAL ASSETS
Return on Assets = x100 to get the percentage.

EXAMPLE
Samsung Electronics in 2015 Net income is P18,695, and the
Total assets is P242,180. How much is their Return on Assets?
RETURN ON 18,695
ASSET = 242,180
= 7.72 %
Conclusion:
Therefore, in every peso of asset, they have generated a low
return on assets which is 7.72%.

3. Return on Equity
 Return on equity (ROE) is a measurement of how
effectively a business uses equity – or the money
contributed by its stockholders and cumulative retained
profits – to produce income. In other words, ROE indicates
a company’s ability to turn equity capital into net profit.
5 Therefore, the result shows a good BVPS and it indicates that
Market Value Ratios Company A is potentially undervalued stock.
 Market Value Ratios are used to evaluate the current
share price of a publicly held company stock. 3. Price Earnings or P/E Ratio
 Some common ratios include:  Relationship between the stock price and the company’s
 Earnings Per Share earnings.
 Book Value Per Share  Interpretation:
 Price Earnings  A P/E of 30 is high by historical stock market
standards. This type of valuation is usually
1. Earnings Per Share placed on only the fastest-growing companies
 This measures a company’s net income per share of by investors in the company’s early stages of
outstanding stock, indicating a company’s profitability to growth.
investors.  Super high: 100 or more
 Interpretation:  Very high: 50-100
 A good EPS growth rate is over 0.15 or 15%,  High: 25-50
and it will usually be preceded by a higher  Average: 15-25
revenue growth rate.
Formula: Formula:
Net Income−Preferred Dividends Stock Price
EPS= PE=
Average Outstanding Shares Earnings Per Share
Example: Example:
Company A Company A
Net Income = ₱25,000,000 Stock Prices = ₱40
Preferred Dividends = ₱1,000,000 EPS = ₱8
Outstanding Shares = ₱10,000,000 for half of the
year Stock Price
= ₱15,000,000 for the other PE=
half of the year Earnings Per Share
₱ 40
Net Income−Preferred Dividends PE=
EPS= 8
Average Outstanding Shares
PE=5
₱ 25,0000,000−1,000,000
EPS=
( 0.50 x ₱ 10,000,000 ) +(0.50 x ₱ 15,000,000) Conclusion:
Therefore, the result 5 indicates that the stock is trading 5 times
₱ 24,0000,000 higher than the company’s earnings.
EPS=
12,500,000
EPS=1.92
Conclusion:
Therefore, in every peso of EPS, Company A has a very good EPS
growth rate which is 1.92.

2. Book Value Per Share

 Compare a firm’s common shareholders equity to the
number of shares of outstanding
 Interpretation:
 Any value under 1.0 is considered a good BVPS
and it indicates a potentially undervalued stock.
However, value investors may often consider
stocks with a BVPS value under 3.0 as their
benchmark.

Formula:
'
Total Common Shareholde r s Equity
BVPS=
Number of Common Shares
Example:
Company A
Common Shareholder’s Equity = $15,000,000
Common Shares= $5,000,000

'
Total Common Shareholde r s Equity
BVPS=
Number of Common Shares
₱ 15,000,000
BVPS=
5,000,000
BVPS=3
Conclusion: