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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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New York Cash Exchange: 2016Essential Learning for CTP CandidatesSession #5: Thursday Morning (6/02)
Overview of Basic CTP Math from ETM4 Chap 07: Earnings Credits
Chap 09: Working Capital
Chap 18: Fin. Statements
Chap 19: Financial Analysis
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Essentials of Treasury Management, 3rd Ed. (ETM4) is published by the AFP which holds the copyright and all rights to the related materials.
As a prep course for the CTP exam, significant portions of these lectures are based on materials from the Essentials text.
ETM4: CalculationsChapters 7, 9 , 18 & 19
These slides cover most of the basic calculations in ETM4 – Examples include both those from the text and additional problems.
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Due to time constraints, we will NOT be able to cover all of the examples in this session. Students are encouraged to spend some time on their own reviewing these problems at a later date.
ETM4: Chapter 7 CalculationsManaging Relationships with Service Providers
Earnings CreditCollected Balance Required
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Earnings Credit
Where:EC = Earnings creditCB = Average collected balancesRR = Reserve requirementECR = Earnings credit rateD = Number of days in the month
DEC = CB × (1 RR) × ECR365
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Earnings CreditAssume the following scenario:
Average ledger balance $250,000Deposit float $ 30,000Reserve requirement 10%Earnings credit rate 5%Service charges for the month $ 1,000Days in month 30
Average Collected Balance Calculation:Average ledger balance $250,000Less: Deposit float ($30,000)Equals: Average collected balance $220,000
DEC = CB × (1 RR) × ECR 365
30= $220,000 × (1 0.10) × 0.05365
= $220,000 × 0.90 × 0.0041095 = $813.68
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Source: ETM4 - © AFP
Collected/Available Balances Required
Where:CB = Average collected balances required to pay service chargesAB = Average available balances required to pay service chargesSC = Service chargesECR= Earnings credit rateRR = Reserve requirementD = Number of days in the month
SCCB =DECR × × (1 RR)
365SCAB =
DECR × 365
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Collected/Available Balances RequiredAssume the following scenario:Monthly service charges $1,000Earnings credit rate 5%Reserve requirement 10%Days in month 30
SCCB =DECR × × (1 RR)
365
$1,000=
300.05 × × (1 0.10)365
= $270,373
SCAB =DECR ×
365
$1,000=
300.05 × 365
= $243,333
7© 2016 - The Treasury Academy, Inc. - All Rights Reserved
Source: ETM4 - © AFP
ETM4: Chapter 7Managing Relationships with Service Providers
Additional Calculations
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Assume ledger balance = $1.2M, deposit float = $0.4M, R/R = 10%, ECR = 0.5%, 31 days in the month. Calculate the earnings credits.
A. $295.89B. $305.75C. $339.73D. $3,057.53
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EC = CB x (1 RR) x ECR D365
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Earnings CreditAssume the following scenario:
Average ledger balance $1,200,000Deposit float $ 400,000Reserve requirement 10%Earnings credit rate 0.5%Days in month 31
Average Balance Calculations:Average ledger balance $1,200,000Less: Deposit float ($400,000)Equals: Average collected balance $800,000Less: Reserve Requirement ($80,000)Equals: Average available balance $720,000
DEC = CB × (1 RR) × ECR 365
31= $800,000 × (1 0.10) × 0.005365
= $305.75
DEC = AB × ECR 365
31= $720,000 × 0.005365
= $305.75
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Assume ledger balance = $1.2M, deposit float = $0.4M, R/R = 10%, ECR = 0.5%, 31 days in the month. Calculate the earnings credits.
A. $295.89B. $305.75C. $339.73D. $3,057.53
No reserve requirement
30 days rather than 31
Used 5% rather than 0.5%
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Assume R/R = 10%, ECR = 0.4%, 30 days in the month. Calculate the collected balance required to support $1,200 in services.
A. $392,473B. $405,555C. $3,650,000D. $4,055,555
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SCCB =DECR × × (1 RR)
365SCAB =
DECR × 365
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Collected/Available Balances RequiredAssume the following scenario:Monthly service charges $1,200Earnings credit rate 0.4%Reserve requirement 10%Days in month 30
SCCB =DECR × × (1 RR)
365
$1,200=300.004 × × (1 0.10)365
= $4,055,555
SCAB =DECR ×
365
$1,200=300.004 × 365
= $3,650,000
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Assume R/R = 10%, ECR = 0.4%, 30 days in the month. Calculate the collected balance required to support $1,200 in services.
A. $392,473B. $405,555C. $3,650,000D. $4,055,555
Calculated Available Balance
Used 4% rather than 0.4%
Used 4% rather than 0.4% & 31 days
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Practicing the Calculations
The more times you work through a calculation, the more comfortable you will be with it
Develop your own versions of the calculations and double check your math
Share calculations with others that are studying for the exam
Make a list of Study Buddies!!
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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ETM4: Chapter 9 CalculationsWorking Capital Metrics
Float Neutral CalculationCost of DiscountCash Conversion Cycle (CCC)Days Sales OutstandingAging ScheduleA/R Balance PatternNetting Calculation
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Focus of Treasury on Cash Flow Timeline
Treasury focus is on the payment portion of the cycle
Calculation: Float Neutral Calculation TD = total days difference in payment timing r = Opportunity cost as an annual rate
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1Discount 1
r1 TD
365
Float Neutral Calculation Assume r = 12% and TD = 3 days
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1Discount 1
12%1 3
365
11 1 0.99901467
1.0009863
0.00098533
0.001 (Rounded) or 0.10%
If the buyer is allowed to take a discount of 0.10 %, they would be indifferent (in present value terms) between paying by check or by electronic transfer (a speedup of 3 days in loss of value)
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Cost of a Buyer Not Taking a Cash Discount
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D 365Discount Cost = 100 D N T
2 365= 100 2 30 10
2 365= = .0204 18.25 =.3723 or 37.23%98 20
WhereD = Discount percentage is 2%N = Net period is 30 daysT = Discount period is 10 days
The cost of not taking the discount can be compared with the organization’s opportunity cost to borrow short-term funds. If we assume a rate of 8% for this example, then borrowing cost would be less than the cost of not taking the discount – so the organization should borrow the funds and take the discount.
Source: ETM4 - © AFP
When Should a Buyer Forgo an Offered Discount?
Short-term investment rates above annualized discount rate
Buyer’s cost of short-term borrowing greater than annualized discount rateBuyer can “stretch” payables
enough to sufficiently lower annualized discount rate
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Benefit to Seller of Offering a Cash Discount
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Disc Pmt
Total Amount of Full Pmt × 1 Disc RatePV
Annual Opp Cost1 Days in Disc Period ×
365
Disc Pmt
$100,000 1 .02 $98,000PV
1 .0041096.151 10
365
$98,000$97,598.91
1.0041096
Assume credit terms of 2/10, net 30 and opp. cost = 15%
Present Value of Receiving Discounted Payment Amount
Source: ETM4 - © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Benefit to Seller of Offering a Cash Discount
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Assume credit terms of 2/10, net 30 and opp. cost = 15%
Present Value of Receiving Full Payment Amount
Full Pmt
Total Amount of Full PmtPV
Annual Opp Cost1 Days in Net Period ×
365
Full Pmt
$100,000 $100,000PV
1 .0123288.151 30
365
$100,000$98,782.13
1.0123288
NPV = PVDay 10 – PVDay 30 = $97,598.91 – $98,782.13 = – $1,183.22Source: ETM4 - © AFP
Cash Conversion Cycle (CCC)
Days’ InventoryDays’ ReceivablesDays’ PayablesCalculations of the Cash Conversion
Cycle (CCC)Cash Turnover Ratio
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Days’ Inventory Days’ Receivables
Days’ Payables Cash Conversion Cycle
“Working Capital Gap”
Cash Conversion CycleElements in the cash conversion cycle:
Days’ Inventory
Days’ Receivables
Days’ Payables
Inventory365
Cost of G oods Sold
Accounts Receivable 365Sales
Accounts Payable365
Cost of G oods Sold
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Cash Conversion Cycle
Elements in the cash conversion cycle:
Days’ Inventory
Days’ Receivables
Days’ Payables
Days 103.15 3659,200
2,600 365
COGS
Inv
Days 41.36 36515,000
1,700 365
Sales
A/R
Days 63.48 3659,200
1,600 365
COGS
A/P
25© 2016 - The Treasury Academy, Inc. - All Rights Reserved
Source: ETM4 - © AFP
Cash Conversion Cycle (CCC)
Calculates the time required to convert cash outflows (necessary to produce goods) into cash inflows (through the collection of accounts receivable)
CCC Days' Inv. Days' Rec. - Days' Pay.
103.15 41.36 63.48 81.03 Days
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Source: ETM4 - © AFP
365 D aysC ash Turnover =
C ash C onversion C ycle
365= = 4.5 T im es81.03 D ays
Days’ Sales Outstanding (DSO) Assume that a company has outstanding receivables of $285,000 at the end of the first quarter and credit sales of $310,000 for the quarter. Using a 90-day averaging period, the DSO for this company can be computed as follows:
Sales During Period $310,000Avg. Daily Credit Sales = = = $3,444.44Number of Days in Period 90
Outstanding A/R $285,000DSO = = = 82.74 DaysAvg. Daily Credit Sales $3,444.44
Average Past Due = DSO Avg. Days of Credit Terms
= 82.74 Days 60 Days = 22.74 Days
If the company’s credit terms are net 60, the average past due is computed as follows:
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Source: ETM4 - © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Aging ScheduleSeparates A/R into current and past-due receivables in 30-day increments (on a customer or aggregate basis) and can determine the percent past due
Age of A/R Amount of A/R % of Total A/R
Current $1,750,000 70%
1-30 Days Past Due 375,000 15%
31-60 Days Past Due 250,000 10%
Over 60 Days Past Due 125,000 5%
Total $2,500,000 100%
28© 2016 - The Treasury Academy, Inc. - All Rights Reserved
Source: ETM4 - © AFP
A/R Balance Pattern for March
29© 2016 - The Treasury Academy, Inc. - All Rights Reserved Source: ETM4 - © AFP
Before Netting
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Source: ETM4 - © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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With Multilateral Netting
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Source: ETM4 - © AFP
ETM4: Chapter 9 CalculationsWorking Capital Metrics
Additional Calculations
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Assume a company is offered a 1.3% discount for paying on day 30 rather than day 90. At what opportunity cost would the company be indifferent between these two payment dates?
A. 4%B. 6%C. 8%D. 10%
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Assume a company is offered a 1.3% discount for paying on day 30 rather than day 90. At what opportunity cost would the company be indifferent between these two payment dates?
A. 4%B. 6%C. 8%D. 10%
Example of just trying all the answers to find the correct one.
Alternative approach is to use discount cost formula
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Float Neutral Calculation Assume: r = 8% and TD = 60 days
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1Discount 1
8%1 60
365
11 1 0.98702
1.01315
0.01298 = 1.3% (Rounded)
If the buyer is allowed to take a discount of 1.3 %, they would be indifferent (in present value terms) between paying electronically today or on day 60 by check (a speedup of 60 days in loss of value)
A company is offered terms of 1/10, Net 40, but routinely takes 50 days to pay without incurring any penalties. What is the cost of not taking this discount?
A. 7.4%B. 7.9%C. 9.2%D. 12.3%
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Discount Cost = D100 D
365N T
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Cost of a Buyer Not Taking a Cash Discount
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D 365Discount Cost = 100 D N T
1 365= 100 1 50 10
1 365= = .0101 9.125 = .09216 or 9.2%99 40
WhereD = Discount percentage is 1%N = Net period is 50 daysT = Discount period is 10 days
The cost of not taking the discount can be compared with the organization’s opportunity cost to borrow short-term funds. If we assume a rate of 8% for this example, then borrowing cost would be less than the cost of not taking the discount – so the organization should borrow the funds and TAKE the discount.
A company is offered terms of 1/10, Net 40, but routinely takes 50 days to pay without incurring any penalties. What is the cost of not taking this discount?
A. 7.4%B. 7.9%C. 9.2%D. 12.3%
Example of being sure to read the problem. Use the actual days taken, not the stated terms.
Used 40 day net period
Did not take out discount period
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ETM4: Chapter 18Financial Accounting & Reporting
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Sample Balance Sheet
“Snapshot”Assets:
Current assetsFixed assetsDepreciable fixed
assetsIntangible assets
Liabilities:Current liabilitiesLong-term liabilities
EquityAssets = Liabilities +
Shareholders’ Equity
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Source: ETM4 - © AFP
Sample Income Statement
A record of revenues and expenses
Shows the net change in shareholders’ equity from operations over a specified period
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Source: ETM4 - © AFP
Sample Statement of Cash FlowsShows sources and
uses of cash
Sections:
Operating
Investing
Financing
Cash from operations calculated by adding back non-cash charges (e.g., depreciation)
Cash, not earnings, repays debt
This example shows the indirect format
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Source: ETM4 - © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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ETM4: Chapter 19 CalculationsFinancial Planning and Analysis
Time Value (PV & FV)Breakeven PointNPV, IRR, PIRatios & Ratio Analysis
Liquidity, Efficiency, Debt Management,
Performance, DuPont
Return vs. Residual Income Measures
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Future Value
n
2
Future Value = PV × (1 + i)
= $100 × (1 + .10)
= $100 × 1.21 = $121
What is the future value of $100 if it can be invested for two years, compounded annually, at a rate of 10% per year?
Where: FV = Future value PV = Present valuei = Periodic interest raten = Number of periods
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$100 x (1.10)5
$100 x (1.10)(1.10)(1.10)(1.10)(1.10)$100 x
Present Value
What is the present value of $2,382 to be received after three years, discounted at a rate of 6.00% annually?
Where:FV = Future valuei = Periodic interest raten = Number of periods
n 3
$2,382FVPresent Value = = 1 + i 1 + 0.06
$2,382= = $2,0001.191
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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PV of a Stream of Payments
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31 2 n1 2 3 n
CC C CPV ... ...
(1 i) (1 i) (1 i) (1 i)
1 2 3
$200 $400 $600PV
(1 .12) (1 .12) (1 .12)
$200 $400 $600
1.12 1.2544 1.4049
$178.57 $318.88 $427.08 $924.53
As an example, assume the following annual cash flows: $200 in year one, $400 in year two and $600 in year three. If the appropriate discount rate is 12%, then the PV of the stream would be:
Breakeven Analysis
Fixed CostsUnit B/E Point = Selling Price Per Unit Variable Cost Per Unit
$10,000= $10 $6
= 2,500 Units
Breakeven point: Level of activity for an operation at which costs exactly equal benefits
© 2016 - The Treasury Academy, Inc. - All Rights Reserved 47
Source: ETM4 - © AFP
Net Present Value (NPV)Evaluates the present value
(PV) of all inflows and outflows of a project using the weighted average cost of capital as a discount rate
If the only cash outflow takes place in the present :
NPV = PV of Cash Inflows PV of Cash Outflows
31 2 n1 2 3 n
NPV = PV of Cash Inflows Cash Cost
CC C CNPV = + + + ... + Cost
(1+ i) (1+ i) (1+ i) (1+ i)© 2016 - The Treasury Academy, Inc. - All Rights Reserved 48
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Net Present Value (NPV)
A 1 2 3 4 5
B 1 2 3 4 5
$300 $300 $400 $100 $100NPV = + + + + $1,000(1 + .10) (1 + .10) (1 + .10) (1 + .10) (1 + .10)
= $ 48.42
$1,000 $1,000$300 $300 $400NPV = + + + + (1 + .10) (1 + .10) (1 + .10) (1 + .10) (1 + .10)
$1,000
= $1,124.98
Year 1 Year 2 Year 3 Year 4 Year 5
Project A $300 $300 $400 $100 $100
Project B $300 $300 $400 $1,000 $1,000
Assume an initial outlay of $1,000 and a cost of capital of 10%
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Source: ETM4 - © AFP
Profitability Index (PI)
Present Value of Cash InflowsProfitability Index = Present Value of Cash Outflows
Ratio of the PV gained to the cost required to obtain that value; shows value gained per dollar of investment
If the only cash outflow is in the present (period 0):
A
B
$951.57PI = = 0.952$1,000
$2,124.98PI = = 2.125$1,000
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Internal Rate of Return (IRR)Discount rate (i) for NPV = 0
or
PV of Cash Inflows = PV of Cash Outflows
=
A 1 2 3 4 5
B 1 2
NPV = PV of Cash Inflow Cost = 0
$300 $300 $400 $100 $100NPV = + + + + $1,000 0(1 + i) (1 + i) (1 + i) (1 + i) (1 + i)
i = 7.7%
$300 $300 $400NPV = + + (1 + i) (1 + i) (1 + i
=
3 4 5
$1,000 $1,000+ + $1,000 0) (1 + i) (1 + i)
i = 38.1%
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Source: ETM4 - © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Capital Expenditure Analysis Summary
MethodProject
Acceptance Criterion
Project A Project B
Net Present Value (NPV)
NPV > 0 $ – 48.43 $1.124.98
Profitability Index (PI)
PI > 1 0.952 2.2125
Internal Rate of Return (IRR)
IRR > WACC* 7.7% 38.1%
* Weighted Average Cost of Capital (WACC) = 10% in the example
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Source: ETM4 © AFP
Liquidity or Working CapitalCurrent Ratio
Measures the degree to which current obligations are covered by current assets
Total Current AssetsCurrent Ratio =
Total Current Liabilities
$8,000= = 2.35
$3,400
© 2016 - The Treasury Academy, Inc. - All Rights Reserved 53
Source: ETM4 - © AFP
Liquidity or Working Capital: Quick Ratio
Measures the degree to which a company’s current liabilities are covered by its most liquid current assets
(Cash) + (S-T Investments) + (A/R)Quick Ratio =
Total Current Liabilities
($1,500 + $1,300 + $1,700)= = 1.32
$3,400
© 2016 - The Treasury Academy, Inc. - All Rights Reserved 54
Source: ETM4 - © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Liquidity or Working Capital: Cash Flow to Total Debt Ratio
Measures ability to repay debt (a relatively low ratio indicates an inability to repay debt and can predict financial failure; a higher ratio would imply more safety)
(Net Income + Depreciation)CF to Total Debt Ratio =
Short-Term Debt + Long-Term Debt
($850 + $200) $1,050= = = 0.184
$1,800 + $3,900 $5,700
© 2016 - The Treasury Academy, Inc. - All Rights Reserved 55
Source: ETM4 - © AFP
Liquidity or Working Capital: Working Capital
Indicates the dollar amount by which current assets exceed current liabilities
Working Capital = Current Assets Current Liabilities
= $8,000 $3,400 = $4,600
© 2016 - The Treasury Academy, Inc. - All Rights Reserved 56
Source: ETM4 - © AFP
Efficiency and Asset Management: Total Asset Turnover
RevenuesTotal Asset Turnover =
Total Assets
$15,000= = 0.968 Times
$15,500
Measures how many times the asset base is turned over with the flow of revenue
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Source: ETM4 - © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Efficiency and Asset Management: Fixed Asset Turnover
RevenueFixed Asset Turnover =
Net Property, Plant & Equip
$15,000= = 2.0 Times
$7,500
Focuses on how efficiently fixed assets, or plant and equipment, are used
© 2016 - The Treasury Academy, Inc. - All Rights Reserved 58Source: ETM4 - © AFP
Efficiency and Asset Management: Current Asset Turnover
RevenuesCurrent Asset Turnover =
Current Assets
$15,000= = 1.88 Times
$8,500
Measures how many times the stock of most liquid assets is turned over with the flow of revenue
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Source: ETM4 - © AFP
Efficiency and Asset Management: Cash Conversion Efficiency
Cash ConversionCash Flow from OperationsEfficiency =
Sales
$550= $15,000
= 0.37 or 3.7%
Measures the efficiency with which a company converts sales into cash
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Source: ETM4 - © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Debt Management: Total Liabilities to Total Assets
Total LiabilitiesTotal Liabilities to Total Assets =
Total Assets
$7,300= = .471 or 47.1%
$15,500
Measures the percentage of all liabilities relative to total investments or total assets
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Source: ETM4 - © AFP
Debt Management: Long-Term Debt to Capital
-
-
Long Term DebtL / T Debt to Capital =
Long Term Debt + Equity
$3,900= = .322 or 32.2%
$3,900 + $8,200
Measures the percentage of a company’s capitalization that is provided by long-term debt
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Source: ETM4 - © AFP
Debt Management: Debt to Tangible Net Worth
Total DebtDebt to Tangible N/W =
Total Equity Intangible Assets
$1,800 + $3,900= = .695 or 69.5%
$8,200 0
Measures a company’s debt as a percentage of its tangible net worth
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Source: ETM4 - © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #05
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Debt Management/Coverage: Times Interest Earned (TIE) Ratio
Operating ProfitTIE =
Interest Expense
EBIT =
Interest Expense
$1,600= = 5.33 Times
$300
Measures a firm’s ability to service debt through interest payments
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Source: ETM4 - © AFP
Debt Management/Coverage: Fixed Charge Coverage Ratio
EBIT + Lease PmtsFixed Charge Coverage =
Interest Expense + Lease Pmts
$1,600 + $500 $2,100= = = 2.625 Times
$300 + $500 $800
Measures a firm’s ability to service all fixed-charge items with operating profits
* Assuming $500 of annual lease payments© 2016 - The Treasury Academy, Inc. - All Rights Reserved 65
Source: ETM4 - © AFP
Performance: Gross Profit Margin
Gross Profit $5,800Gross Profit Margin = =
Revenues $15,000
= .387 or 38.7%
Measures the percentage of revenues remaining after the cost of goods sold is deducted from revenue – it is also a typical common-size ratio measure
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Source: ETM4 - © AFP
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Performance: Operating & EBITDA Profit Margins
EBITOperating Profit Margin =
Revenues
$1,600= = 0.107 or 10.7%
$15,000
Measures the flow of commonly used operating income measures in relation to the flow of revenue
EBITDAEBITDA Margin =
Revenues
$1,800= = 0.120 or 12.0%
$15,000© 2016 - The Treasury Academy, Inc. - All Rights Reserved 67
Source: ETM4 - © AFP
Performance: Net Profit Margin
Net IncomeNet Profit Margin =
Revenues
$850=
$15,000
= .057 or 5.7%
Measures the flow of net income in relation to the flow of revenue
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Source: ETM4 - © AFP
Performance: Return on Total Assets
Net IncomeReturn on Total Assets =
Total Assets
$850=
$15,500
= .055 or 5.5%
Measures net income in relation to the stock of assets
© 2016 - The Treasury Academy, Inc. - All Rights Reserved 69Source: ETM4 - © AFP
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Performance: Return on Common Equity
Earnings Avail. to Common S / HsReturn on Common Equity =
Common Equity
Net Income Preferred Dividends=
Total Equity Preferred Stock
$850 0= = 0.104 or 10.4%
$8,200 0
Measures earnings available to common shareholders (net income less any preferred stock dividends) expressed as a percentage of common equity
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Source: ETM4 - © AFP
Integrated Ratio Analysis: DuPont Equation
Return on Total Assets = Return on Sales Total Asset Turnover
Net Income Total Revenues =
Total Revenues Total Assets
= 0.057 0.968 = 0.055 = 5.5%
Looks at the return on total assets as a product of the return on sales and total asset turnover
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Source: ETM4 - © AFP
Performance Measurement
Return on Investment (ROI)
Residual Income (RI)
Free Cash Flow (FCF)
Economic Value Added (EVA)
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Performance Measurement Return on investment (ROI)◦ ROI over a partial period may be misleading.◦ ROI does not include charge for cost of capital.◦ Positive NPV project can be rejected if it lowers overall ROI
Residual Income (RI)◦ Assigns charge for invested capital.◦ RI is a dollar amount, and any profitable project after
deducting cost of capital will increase RI.
Net Income Net IncomeROI = = Invested Capital Long-Term Debt + Equity
$850 $850= = = 0.0702 or 7.02%$3,900 + $8,200 $12,100
RI = Net Income Invested Capital Cost of Capital
= $850 $12,100 .10 = $850 $1,210 = $360
© 2016 - The Treasury Academy, Inc. - All Rights Reserved 73Source: ETM4 - © AFP
Performance Measurement: Free Cash Flow
Free Cash Flow (FCF)◦ A type of RI analysis, but also includes adjustments
for noncash items, operating working capital investments and capital expenditures (CAPEX)◦ There are many different formulas used for FCF◦ Considered a better representation of the value of
the firm to shareholders
FCF = Net Income + (D&A) Change in Op W/C CAPEX
= $850 + $200 $500 $900 = $350
© 2016 - The Treasury Academy, Inc. - All Rights Reserved 74Source: ETM4 - © AFP
Economic Value Added (EVA)A measure of the incremental value that a
company’s investments add.What is the EVA for the following company? Long-term debt of $3,900,000
Equity of $8,200,000
Marginal tax rate of 34.615%
Weighted average cost of capital (WACC) of 10%
Operating income (EBIT) of $1,600,000
EVA = EBIT (1 Tax Rate) (WACC)(Long-term Debt + Equity)
= $1,600,000 (1 .34615) (.10)($3,900,000 + $8,200,000)
= $1,046,160 (.10)($12,100,000)
= $1,046,160 $1,210,000 = $163,840
© 2016 - The Treasury Academy, Inc. - All Rights Reserved 75Source: ETM4 - © AFP
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ETM4: Chapter 19Financial Planning and Analysis
Additional Calculations
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Liquidity or Working Capital: Quick Ratio
Measures the degree to which a company’s current liabilities are covered by its most liquid current assets
A company currently has Cash of $200,000, ST Investments of $500,000, A/R of $600,000, and Inventory of $700,000. If their bank has imposed a loan covenant which requires the company maintain a quick ratio of 1.5 or better, what is the maximum level of current liabilities they can have?
A. $666,667B. $866,667C. $1,333,333D. $2,000,000
77© 2016 - The Treasury Academy, Inc. - All Rights Reserved
This Slide Intentionally Blank
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Liquidity or Working Capital: Quick Ratio
(Cash) + (S-T Investments) + (A/R)Quick Ratio =
Total Current Liabilities
($200,000 + $500,000 + $600,000)= = 1.50
Total Current Liabilities
$1,300,0001.50 =
Total Current Liabilities
1.50 (Total CL) = $1,300,000
$1,300,000Total CL = = $866,667
1.50
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Liquidity or Working Capital: Quick Ratio
Measures the degree to which a company’s current liabilities are covered by its most liquid current assets
A company currently has Cash of $200,000, ST Investments of $500,000, A/R of $600,000, and Inventory of $700,000. If their bank has imposed a loan covenant which requires the company maintain a quick ratio of 1.5 or better, what is the maximum level of current liabilities they can have?
A. $666,667B. $866,667C. $1,333,333D. $2,000,000
80© 2016 - The Treasury Academy, Inc. - All Rights Reserved
Included Inventory
Subtracted Cash from Result B
Just added all items in problem
Practice Calculation
A company has a Return on Total Assets of 20%, Return on Sales of 10% and Net Income of $100,000. What is the level of Total Assets for this company?
A. $ 250,000B. $ 500,000C. $ 750,000D. $1,000,000
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Practice Calculation
A company has a Return on Total Assets of 20%, Return on Sales of 10% and Net Income of $100,000. What is the level of Total Assets for this company?
A. $ 250,000B. $ 500,000C. $ 750,000D. $1,000,000
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Integrated Ratio Analysis: DuPont Equation
Return on Total Assets = Return on Sales Total Asset Turnover
Net Income Total Revenues =
Total Revenues Total Assets
$100,000 Total Revenues 20% =
Total Revenues Total Assets
20% = 0.10 TATO =>
= =
TATO = 2.0
$100,000 Return on Sales = 0.10 =
Total RevenuesTotal Revenues = $1,000,000
Total Revenues $1,000,000 TATO = 2.0
Total Assets Total AssetsTotal Assets = $500,000
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Session Wrap-up
84
What did we learn in this session?
What topics do we need to learn more about?
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New York Cash Exchange: 2016Essential Learning for CTP Candidates
End of This Session
We will reconvene after a short break.
The topics will be
Let’s Go to the MarketsMoney Markets
Short-Term Investing and Borrowing
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