Full Finance Course - 11 Hour Video transcript

Welcome to our course in corporate finance and welcome to module one. You can see the title cash flows and the financial statements. Our course and corporate finance in general is very interested in the future cash flow of a business of a financial instrument. It's sort of we value financial assets based on cash flow. And one of the most valuable tools we have in finance is financial statements produced by accountants.

Now accountants are not as obsessed with cash flow as we are here in finance. And so as a consequence we have to take accounting information and make sure we understand it well and convert that over to cash flow information. So that's a fundamental concept that we're covering here in chapter one. You will hear in your finance course in this one in your classroom if you're taking the course at a university or college you'll hear this phrase all through finance course the phrase is present value of future cash flows that's the value of any financial asset the value of anything really the present value of the future cash flows and I just thought I'd pose a pretty straightforward dilemma uh and this is a question that finance seeks to answer so if we have a friend.

Let's just say we have a good friend and they say, "I promise to pay you $1,000 in 365 days, one year from now, I'm going to give you $1,000." And it's a friend we love. It's a friend that we trust and we believe them when they say that. And they say, "How much money would you give me today in order for me to fulfill that promise?" So, in other words, what is this thousand promise? By the way, I I know what you're thinking.

We're living in an age of AI. You're probably thinking, "Oh, this guy, he had AI draw a portrait of Grover Cleveland here, the person on the thousand dollar bill." No, no, no. I know that's what it looks like, but I did that all by hand. Uh, but you might not believe me, but I'm telling you the truth. So, in any event, our friend promises to pay us $1,000 in 365 days. What's that worth to us today? Well, that's a question finance seeks to answer.

But I I hope you're saying, "Well, it's got to be less than a,000, right?" Like, put a number on. Imagine your best friend says, "I'll give you $1,000 a year from now." How much would you give that person today in order to cash in on that promise? Would it be $950? Would it be $900, $800? What how much would you discount that? How much of a discount would you need in order to say, "Okay, I'll I'll take the deal." Um, that's the question fundamentally finance is obsessed with.

And if you say, "Well, I'd only do it for $600, right? I don't really trust my friend. Well, imagine there's a market full of people and your friend's putting it out to lots of offers. Maybe somebody else will do it for seven. Maybe somebody else will do it for eight. What's the right price, right? What's the right price on this promise? That is the fundamental question of finance. Now, this is a pretty simple thing to value, but you can imagine it gets much more complex and in fact it gets much mathier.

Uh when I was a kid, I always wanted to get into something that involved math and money. I chose accounting. I should have chose finance. Finance involves a lot of math. And I would suggest to you, your professor, if they allow it, you're going to want to learn how to use a financial calculator. It'll be very useful for your test. Now, I'll show you how to do all the exercises we do by hand, but you'll see how much quicker it is.

So, we'll do it by hand. We'll also do exercises in our financial calculator. So, when you want to learn finance, my suggestion is get very good with a financial calculator. I'll use the BA2 Plus and I'll show you how to use that through our videos. Uh, but, you know, if you have a Casio or some other brand, they're all very similar. They certainly all produce the same results. So, uh, find out what your professor will allow or not.

And if they allow you to use a financial calculator, for goodness sakes, it's a great tool that you ought to use. I'll show you how to do everything by hand, but a financial calculator will help. So, with all that having been said, I'm so excited that you're with me. Module one, we're going to learn how to convert financial statement information and to understand financial statement information and how to convert it into something more useful for finance, which is cash flow information.

Let's get started. and I can't wait to get going. See you in the next video. Welcome to module one of our class in corporate finance. And this is the very first problem, problem 11A. You can click the link in the description to download a copy of this workbook for yourself. This problem has us looking at operating cash flows. Now, I want to explain why we're going to look at operating cash flows. If you just want to solve the problem, probably skip ahead four or five minutes.

We'll work through the problem. It's it's a very quick problem. But I I feel like at the very start of the class, we should explain like why why are we doing this? So, I want to discuss just the concept of cash flow and why it's so important in finance and that'll sort of set the table for the rest of this chapter. So, if you take a finance course, you're going to find your instructor very obsessed with cash flows. Just about every problem we look at in a finance course in some form or another is going to discuss the cash flows of an investment or of a company or something like this.

Uh and it's a really important concept in finance and the idea is that to value a company to value an asset to value an investment value its cash flows. Now I come at this from the perspective of an accountant. I'm an accountant. I'm a CPA. I'm not a CFA. So, I do want to let you know that I am not a finance professional. I'm an accounting professional, an accounting educator. I'm making these videos uh because students have requested that I make them.

And so, I've had to work closely with a friend and colleague who who helped me develop the material. Uh but he's the expert, not me, in any of it. Um, in finance, cash flow is a crucial concept because it's very real. In accounting, a lot of things are based on estimates and projections. Oh, how many debts do I think are going to go bad next year? Or how many years do I think I'm going to use this building? They're all guesses.

And finance folks say, well, the the realest thing you can have is money, right? The company generates money. They pay it to you, the shareholder, as a dividend. That's real. and that's something of value. That's what we want to base all of our work around is the cash flow that the company's generating, not some accountants estimates that are ingrained in the profits. So, uh what our first chapter has us doing in this course is just going from those accounting numbers which are definitely useful in accounting to cash flow numbers which are much more useful in finance.

So, you'll find in most finance classes, you'll be doing calculations like this early on, taking accounting, income statements, and balance sheets and moving them over into cash flow information. Not cash flow statements, that's another accounting uh financial statement, but cash flow information. Converting accounting information into finance information. So, um a few more concepts and then we'll jump into the problem.

Uh the first thing is just this concept of okay, a company uses its assets to generate money, right? It uses its assets to generate money. And what can it do with the excess money it generates? Well, it can use it to buy more assets and to sort of satisfy its own assets. So, it can use it all on the left side of the equation. But if it has extra money, it will often pay money out to creditors or pay money out to shareholders or likely both.

Well, from finance perspective, we're often playing the role of creditor or stockholder, right? We buy bonds in a company. That's that's we're creditors or we can buy stocks in a company. Then we're investors. So, we're very interested in how good the company is at using its assets to generate cash flow because that's money that's going to come to us potentially. So, we're very interested in the cash flow of the company because, you know, it's it's important to us as investors or potential investors or lenders or potential lenders.

So, how do I figure out the cash flow from assets? Well, this can get further broken down. And this is question one of our class has us looking at operating cash flow. We'll get to that in just a minute. Uh question two, we'll look at capital spending. Three, change in networking capital. and question and these are 1-1 1-2 1-3. Question 1-4 has us looking at all three of them. So, let's focus in on operating cash flow.

This is the cash flow the company generates from its day-to-day business. So, Walmart sells stuff to us. That's their cash flow. Uh, you know, from their day-to-day business. They pay their employees money. Maybe they buy goods from their suppliers and they sell stuff to us, right? Those are the operating cash flows, the main operating cash flows of a big retailer like Walmart or Home Depot. So operating cash flow is just the company basically doing what it does to make money.

Capital spending is them buying capital assets like buying a new store or buying a new equipment to go in the store. And obviously that's one way they could use uh their cash flows. And lastly, change in networking capital. is a little more technical, but it's uh basically the the short-term assets and short-term liabilities, current assets and current liabilities, how much money they have flowing in and out of those accounts.

Uh but this video is focused on or this problem one is focused on operating cash flow. So, with the preamble out of the way, let's get down to business. So, we're using we're figuring out how much money the company's day-to-day business is generated generating. And the starting point here is an accounting income statement. So let's read the question and see how we do. Stranger Company has sales revenues of $30,000. The operating expenses are 21 including depreciation of three.

Company has interest of $1,000 and the tax rate is 25%. What's the operating cash flow? Okay, to figure this out, basically they've given us an accounting income statement. Let's prepare that income statement. So, we have sales of $30,000. And the income statement is the summary of revenues and expenses. And take your revenues, your amount your company earned, minus your expenses, your costs. And that tells you how profitable the company was.

So, let's figure out the accounting profits of this company. Sales are 30K. Operating expense, what does it say? 21,000. But it says including depreciation of three. I want to split out the depreciation. It's going to become relevant later. So, our operating expense is excluding depreciation. 21 - 3 are 18,000. Our depreciation expense, I'm being very short-handed here because we're just asked to calculate something.

Calculate operating cash flow. We're not asked to prepare in good form an income statement or something like that. If they had asked me for good format, I would, you know, spend more time on dollar signs and underlines and things like this. But in any event, sales minus operating expenses minus depreciation is 30 - 18 - 3. 30 - 21 that's $9,000. And that is our um EBIT. Now, EBIT stands for earnings before interest in tax.

In accounting, I in accounting class, I would call this operating income, but in a finance class, we're going to call it EBIT. But we're essentially referring to the same thing. There's maybe some small differences here or there, but for all intents and purposes, we're talking about the same thing. Uh, so earnings before interest in tax. Well, then let's take away interest, which was a,000 to get us down to 8, which is our earnings before tax.

Take away the I because we we did take away the interest. And that brings us down to our taxes. Our taxes were 25%. 25% of 8,000 I can do in my head. It's 2,000. A quarter of 8 is two. And that brings us to our bottom line, our net income, our earnings, our profits. This company made $6,000. Okay. So there we have a beautiful sort of uh income statement, but we haven't answered the question. What are the operating cash flows?

There are so many ways a person could calculate this. I'm going to show you the one that I've seen most commonly in finance textbooks and it says start with EBIT and work from there. So, that's what we'll do. We'll start from EBIT and we'll work from there. Um, so if I have my EBIT, which was $9,000, now I need to look above EBIT and below EBIT. I'm going to look above Ebbit and I'm going to say is is there anything up there that should have been excluded?

Well, sales typically that involves cash flow. Most my operating expenses involve cash flow because you know, so again, think of Walmart. They sell stuff to you. Well, they get money from you when you buy a bag full of their stuff. Operating expenses, they pay their employees. They pay them with money. So that involves cash flow. The one that sticks out though is depreciation. There's no cash flow with depreciation. Depreciation is called a non-cash expense.

So, it's a special expense and we're going to deal with depreciation throughout the course. So, it's just worth knowing. Okay, depreciation never involves cash. So, EBIT isn't cash flow because it includes depreciation. So, we want to know cash, right? So, let's take that depreciation out of our EBIT. Now, how how do I take it out? Well, I went 30 - 18 uh minus 3 is 9. Well, let's pretend I didn't have that. It would be 30 - 18. it should be 12.

So, this should be 12. So, I'm going to actually have to add back depreciation. So, I add depreciation of 3,000. So, now my subtotal is 12, right? So, it's again, there's many different ways we could calculate this. This is one of um okay, let's look below the line. We got two more expenses. We got interest because this is earnings before interest and tax. We got interest and tax. Interest can involve cash, but it's not considered an operating cash flow.

It's not considered part of the day-to-day business of the company. Uh, and it's it's a payment out to creditors, right? So, it's something different. It's a different kind of cash flow. Taxes, though, are operating cash flows. This $2,000 in taxes is a $2,000 deduction from our cash. So - 2,000 equals 9 + 3 is 12 - 2 is 10. That is my operating cash flow which we will abbreviate in this course as OCF. So the formula is EBIT plus depreciation minus taxes.

Now later in the course we will go through so many different ways to calculate this. You can really calculate OCF in myriad different ways, but it becomes a really useful and powerful number. Right now, okay, you know, we're just like we're calculating it going through like an intellectual exercise. Later in the class, we will use this number to do powerful things. So, I hope you'll stick with me because I want to do powerful things together.

And just uh you know, if you're planning to stick with me, I hope you'll hit one of those buttons. Thanks for watching. Have a great day. See you in the next video. Bye-bye. Let's examine problem 12A, net capital spending. Let's actually take a look at the lay of the land. At the start of the chapter, I had said, well, we're very interested in a company's cash flow, particularly their cash flow from assets, which is composed of operating cash flow, which we tackled in problem one. capital spending or net capital spending which we're tackling now and in problem three we'll look at change in working capital.

So we are here this is what we're working on. Uh and so just a a type of cash flow a company may have. They have to buy assets. So let's contemplate what that looks like in terms of the math. When I'm solving these I like to tell a story. I'll do it this slow way, which is the storytelling way, and then I'll do it the fast way, which is there's a quick easy formula, but I I actually wouldn't memorize the formula. I would just know the story.

So, we're interested in this account on the balance sheet. Let me read the question. It says, "A comparative balance sheet for Sleepy Company is shown below. Here we have our balance sheet, which summarizes the assets, that's the stuff of value that the company owns. Liabilities, that's what they owe. and the equity is what's left over. That's the shareholders piece of the pie. We're interested though just in this line in this question.

Uh a review of the company's income statement showed depreciation of $30,000 and it says what is the net capital spending? Okay, so I like to tell the story of this line item I had. Here's the story. I had $180,000 in assets last year. This year I had depreciation of 30. So I would think borrowing any capital spending, right? If I didn't spend any money, I would have $150,000 in assets. But I don't have $150,000 in assets.

I actually have $200,000 in assets at the end of this year. So again, last year started at 180. I depreciated them by 30. I would expect to end up at 150, but I didn't end up at 150. I ended up in 200. Well, what happened? I must have bought $50,000 in assets. So, my net capital spending, net capital spending, I'm answering the question now is 50. Done. That's the answer. Okay. So, that was solving it. I don't even think it's that slow, but that's the way I think of it.

When I read textbooks, they often will give a formula here. I don't think the formulas is useful, but maybe it'll be useful for you. So, here we go. Here's how you solve it by formula. You say change in fixed assets or net fixed assets. So, the change in net fixed assets was plus $20,000, right? It went from 180 to 200. That's plus 20. Uh, plus depreciation. That's the formula. So, 20 + 30 is 50. Okay. So, we got it both ways.

I think this way makes sense, though. You know, when I think about it, I don't think I don't think of the formula. I think about what really happened. And what I would love to really happen, oh, what a segue is if you like this, hit one of those buttons. All right. Thanks for watching. Bye-bye. Let's take a look at problem 13A. We're computing the change in networking capital. I just want to give you the lay of the land.

Remember where we are and where we're going. In problem 1, we learned how to calculate operating cash flow. In problem one, two, we learned how to calculate capital spending. Problem 13, we're looking at cash flows related to changes in networking capital. And when we get to it, problem 14 is going to combine them all. And when we combine them all, we get cash flow from assets. But this problem is all about change in networking capital. and it's probably the easiest of the three components of cash flow from assets.

Let's get down to business. A comparative balance sheet for Ignite Company is shown below. And there's a balance sheet. It says, "What's the change in networking capital?" Well, what's the networking capital? And networking capital is current assets minus current liabilities. That equals our net working capital. So, this company's current assets uh for let's do 2029 and 2028. Let's do 2028. Current assets are 20,000.

Current liabilities. So, there's the current assets. There's the current liabilities. Current liabilities are 12. So, the net working capital is eight. And it's just sort of a number that's used to like how much money do I have to work with, right? If I took all my assets, sold them off, paid off all my current debts, how much money would I have to play with? And it's it's a useful number to know. So, the networking capital of this company is $8,000.

Uh, and in 2029, it's going to be 15 minus 10. 15,000US$10,000 is $5,000 in networking capital. Okay. What was the change in the networking capital? Well, it went from eight down to five. The change was it decreased by $3,000. The change in networking capital is it decreased oops not by 30,000 but by $3,000 decrease. Okay. Uh we've solved 13A. What was the change in networking capital? It went down by $3,000. an easy or easier problem than most.

And what else is easier than most? Hitting one of those buttons for me. Thanks so much for watching. Have a great day. Goodbye. In this video, we're going to work on a problem you can download from tonybell.com. Go to the website, click the PDF link, and you'll notice there's no sign in, no sign up. The PDF just pops right up. You'll scroll down and find whatever problem it is that we're working on. As you scroll through the problems, you'll notice many are free and open, like the one you're watching now, but some are members only.

I think the free and open ones are enough for most people, but if you can't get enough of me and you'd like to join and get access to those membersonly videos, click the join button underneath the YouTube play box. All right, thanks so much for watching. Let's get started. Let's have a look at problem 14A. We're calculating all kinds of cash flow. The first three parts are just review of what we've already learned in previous problems.

So I'm going to jump right into them. Uh so the question gives us financial statements and income statement and a comparative balance sheet and it says compute OCF operating cash flow. Okay, we're going to learn so many different ways to calculate this during the course but the way we introduce in chapter 1 is one of the more simple and straightforward. It says we start with EBIT and this is going back to problem one.

So you can flip back to that if you want a more detailed explanation here. But we start with EBIT which is 350. We add back the depreciation because of course depreciation is included in EBIT but it doesn't involve cash. So we're going to add back um 100,000 and then we deduct interest or not interest pardon me. We deduct taxes. Was I thinking deduct income taxes? So I'm going to minus 85,000. And remember what we're calculating.

Operating cash flow is the cash flow generated by the dayto-day business of the company. I got a cough. I'm going to mute my mic for a half a sec. That's better. Um, okay. So let's sum these up. 350 plus 100, that's 450 minus 85. Oh dear, I'm going to have to use my calculator. 350 plus 100 minus 85. 365. That's our operating cash flow. The day-to-day business of our company has generated 365 grand in positive cash flow.

It's possible this could be negative. Like we could have negative EBIT. We, you know, uh that's very possible, but in this case it was positive. That's what you're hoping for if you're certainly running your own business. Unless you're some sort of weird tech startup that's burning money initially, uh you want generally to see positive operating cash flows out of a business. Okay, so there we are. We've generated 365 grand in operating cash flow.

What about capital spending? How have we used that money? Well, one way we might use our money is to buy assets, right? And so this has us analyzing the change in net fixed assets. I always tell myself the story of net fixed assets. You can see it started at 550, ended at 600. Well, it started at 550, but it would have gone down by the amount of the depreciation. So if I had 550 and I depreciated them for 100 grand, I should be si sitting at 450 to end the year, right?

Just the math of it says I'd be at 450 if I didn't buy anything new. But I'm at 600. How did I get from 450 to 600? I bought a bunch of new assets. How many new assets did I buy? 150. Right? Just the difference there. That is our net capital spending. All right. On to the next. Uh cash flows from the change in working capital. Uh so this is working capital is the difference between current assets and current liabilities.

So for 2028 our working capital is 503US 235 current assets minus current liabilities it is 268 for 2029 and this is our working capital I'm just calculating there uh 785US 387 just a difference there 398 8. So our working capital went from 268 to 398. Our change in working capital was a positive here. 398 minus 268 a positive 130. Our working capital went up by 130K. Okay. So we've solved the first three. Uh just reminding you what's happening here.

Uh, operating cash flow, cash flows from the day-to-day business. Our day-to-day business generated $365,000 in positive cash flow. Net capital spending is us buying fixed assets. We bought $150,000 in fixed assets. And change in networking capital, probably the trickiest of three of the three to explain. If you're working capital needs go up, it means your c it's actually negative for your cash flow. Just like, you know, uh, capital spending, you're buying fixed assets.

Well, that's negative cash flow. uh working capital increasing as it did here. Also negative cash flow. Going to mute my mic for another half second. Okay, let's continue on to uh cash flow to creditors. Uh so this involves debt, right? It's debt repayments, interest payments. That's really what we're looking at. So debt repayments and interest payments. Let's take a look at what happened here. So, I have long-term debt that went from 575 to 610.

Oh, no. There's not a debt repayment. My debt's going up. Let's take a look at our interest. Our interest is 50. Okay, so we've actually got some work to do. This is more challenging. If debt went down, it's actually really easy. You say, "Oh, how much did debt go down?" That's a repayment. Well, debt going up is like a negative repayment. It's new borrowing. So, I didn't give cash to my creditors. I got cash from my creditors, right?

They gave me or loaned me $35,000, but I also had to pay off $50,000 in interest. Now, that is being paid back. So, $35,000 coming in from my creditors minus 50 going back to my creditors gives me cash flow to creditors of just $15,000. Again, I want to I want to stress this one because it can be a little confusing. My long-term debt went up. If it went down, it means I'm paying it back, right? Your debt goes down because you paid it back.

Your debt goes up, you're borrowing money. So, this isn't cash flow to creditors. This 35, this is cash flow from creditors. So, I have 35K coming in from my creditors. I have 50K to my creditors. So this one is like a uh plus cash, right? They're giving me 35. Uh the 50 is minus cash. I'm paying them 50. So on net 15k to creditors and that's what we were asked to solve for cash flow to citors. So that one could be a little confusing I suspect.

Let's do cash flow to stockholders and see what happened here. Our common shares. So shareholders equity accounts here are the relevant ones are common shares paid in surplus and dividends. So common shares went up by 10 grand paid in surplus by 30. That's money coming from my shareholders. So on total that's 40k from shareholders. 110k goes to the shareholders in the form of a dividend. So on net 110 110k in dividends to shareholders uh and then there's 40k in investments from shareholders and the idea there again is common shares goes up and paid in surplus goes up because shareholders are contributing money into the company.

So on net I paid 110 out in the form of dividends. 40k uh came in from them in the form of investments. On net 70k went out to shareholders in total. Okay. So our cash flow uh to stockholders is $70,000. Okay. So the final piece of the p maybe I'll take a bit of a step back here. Uh so in calculating cash flow to creditors, it's just about the change in debt and the interest, right? If there's more debt, it means we're taking money from our creditors.

If there's less debt, we're paying off our creditors and then you add interest to that to figure out cash flow to creditors. For stockholders, it's all about common shares, in this case, paid in surplus. the changes there uh track with investments from our shareholders and uh dividends are also the other way you might pay shareholders or stockholders. So there we have it. We've solved E. Let's move on to F. Show how OCF net capital spending and change in working capital are related to cash flow to creditors and cash flow from or to stockholders.

Okay, so I want to go back to like one of the first slides we showed this chapter and we sort of said corporate finance is obsessed with cash flow. It is and we got to manipulate or move cash flow from our accounting financial statements to get figures that are useful in corporate finance. So that's just what we're doing here. Okay. So let's actually use this first sort of set of formulas and we'll figure out our cash flow from assets.

It wasn't asked specifically, but that's sort of what this question is driving to. You wouldn't know that your first time through though. Uh, our cash flow to creditors we calculated down here of 15 and stockholders is 70. So, 15K 70K and that's just what we calculated. So, our cash flow from assets is $85,000. So again, a really important number in um finance is just cash flow from assets. It's uh uh just a useful number for a lot of our our our calculations later on in the course.

So there we have it. We figured out our cash flow from assets. Uh now let's sort of show how that's related to those other three numbers we calculated. So we had operating cash flows of 365. This is positive cash flow for the company. We had capital spending of 150. Well, spending it's in the name there. That's 150 negative to the company's cash flow. And we had said working capital changing by 130 going up by 130 is also bad for cash flow. means more money tied up in working capital.

This is not good for cash flow. So 365 minus $150 minus 130 and I end up on 85. So I combine all three of those, I get $85,000. And if I scroll back up, you can see I got $85,000 up there, $85,000 down here. These match. That's the idea. And so there are some I think tricky corporate finance problems where they'll give you like all but one of these and you have to be able to say oh I know these combined to get cash flow from assets and then I can solve for the missing variable on you know one side of the equation or the other.

I think that's a little bit tricky but it certainly is a plausible type of question. I think this way of asking is more reasonable though. So show how OCF net capital spending and change in working capital the answers from A to C are related to the answers D to E. The answer is they both combine you know uh ABC D A or ABC you combine those answers you get cash flow from assets. D and E you combine I think I got these back.

No that's right. D and E you combine the answers to uh also get cash flow from assets. That's the idea of that final piece. Just wanted to show how they all kind of come together. All right, I hope this video helped. I hope it helped things come together for you a little bit. And if it did, I hope you'll give me a thumbs up. Thanks for watching. See you in the next video. Bye-bye. Let's take a look at problem 15A. You can download this and all of my problems in the workbook.

It's just linked below or go to tonybell.com. You'll find a PDF file. No signups, none of that stuff. Let's jump into the problem. Consider the following personal tax brackets. Uh, and there's a bunch of tax brackets. It says, assume a person governed by these tax brackets earns $175,000 this year. How much tax do they owe? Okay, the rookie mistake is you find 175 on the table. You'd say, "Oh, it's somewhere on this line of the tax bracket.

We would earn 175K. Therefore, 175 * 45% that's how much I owe taxes. That's not how tax brackets work. For our first $50,000 we earn, we pay 20%. For our next 50 uh 28% for our next 50 37 and so only 25,000 of our 175, the last 25 is taxed at 45%. So it's 50k at 20%. It's 50k at 28%. It's 50k at 37%. And then just, you know, to get to 175, it's our last 25K at 45%. So, let's do some math. 50 * 20%, that's $10,000. 50 * 28%, $14,000.

I did it quick in my head there. I should have trusted myself. 50 * 37% $18,500. And last but not least, 25,000 * 45%. Is 11,250. Okay. So then our total tax bill here is going to be 10,000 + 14,000 plus 18,500 plus 11250. Our total tax bill is 53750. But oh we've answered it. Question one. How much tax do they owe? 53750. What's their average tax rate? Well, you take that 53 grand and you divide by how much we earned, 175 grand.

So, take 53 divided by 175 and on average it's 30.7%. What is our marginal tax rate? Our marginal tax rate is the tax rate on the next dollar we earn. So, if let's just say we got a consulting contract and we were able to make $10,000 more dollars, right? Some extra contract. So, we weren't going to make 175, we're going to make 185. What's the taxes on that new $10,000 we make? The tax rate is 45%. That's sort of where we're sitting on the tax scale.

So, uh the marginal tax rate is any new money that comes in, what's the tax rate going to be on that 45%. Which rate, the average or the marginal, should we use when doing project analysis in corporate finance? The answer here is marginal. I'll just blurt out the answer. Let me explain why. When we're looking at new projects, we're looking at typically additional projects. So, it's like that new consulting gig. If I bring in $10,000 extra dollars, what am I taxed at?

The number 30.7% doesn't mean anything to the new project. All new dollars that this company brings in are going to be taxed at 45%. So that's the number you use in project analysis. That's the most appropriate number to use. And there'd be one more thing that's appropriate to use. I hope you use one of those buttons as you uh click away from this video. All right, thanks for watching. See you in the next video. Bye-bye.

Let's take a look at problem 19a. Computing common financial ratios. This is our first and I think only ratio question of the course. Ratios are very useful in financial analysis. And I just want to caution you if you're ever doing financial analysis, you never just want to compare one ratio. You want to compute our ratios this year and compare to last year. or as we're going to do in this video, compare the ratios of one company to the ratios of another.

So, it's it's always a comparison point that we're after here to really get information about the company. So, here we go. Uh below is condensed information for the balance sheet and income statement of June Enterprises. Um and there's our balance sheet and there is our income statement. Uh some additional information there. It says the CFO has required a list of key ratios from company's bigname competitor uh and would like to know how June Enterprises compares uh compute the ratios below uh and comment on the liquidity, financial leverage, turnover, profitability, and market value of June Enterprises.

Okay, so we got a big long list of ratios to compute. We've got our competitor numbers here. We're obviously going to be filling in our own numbers in the uh space provided here. Let's get after it. First, the current ratio. The current ratio measures the short-term debt paying ability. Do I have enough current assets? Those are things of value that are either cash today or going to become cash within the next 12 months.

Or uh do I have enough to pay my current liabilities, my short-term bills? Let's take a look. Our current assets are right here. Our current liabilities right there. Oops, not that's other. Sorry. Our total current liabilities are there. 3600 divided by 1,500 2.4. So I have 2.4 times uh the current assets as I do current liabilities. I am liquid, right? And and how do I know? Well, compared to my competitor, I'm more liquid than them.

I'm more able to cover my short-term debts. Let's do the quick ratio. The quick ratio is just a tougher version of the current ratio. It's also called sometimes the acid test ratio. It just says, listen, do the current ratio, but take inventory out of your current assets because if our company's in deep trouble, a lot of times when a company's in distress, they have a hard time selling their inventory. So, it doesn't really count as an asset when you are in real distress.

So, uh, take that out and see how you're doing. And so, 3600 minus 1,200 gives us 2400 as our numerator divided by,500. So, we're at 1.6. Little rule of thumb here is if it's one or more, you're doing okay. Even 0.8 or more, you're doing all right. So, we are quite liquid as far as this goes. The cash ratio says, do you have enough cash to pay the bills? We're not expecting this to be covering all of our current liabilities.

So in our case, I can see that it is uh 2,00 divided by 1,500 1.33. So uh if worst case the worst, you know, we don't collect any of our receivables, we don't sell of any of our inventories, we still just can pay all our bills for the next year just with cash. Uh interval measure. This says, are we able to cover our costs? I almost treat this like a burn rate. You know, in a tech company that's burning money, this is a measure of how quickly we're burning money.

How quickly are we going to burn through our current assets given our costs? And our operating costs would be our cost of goods sold as an operating cost. And our operating expenses, I exclude from this interest because it's not operating and taxes again, not day-to-day operating costs. And I exclude depreciation. And the reason is this is a cash burn. So depreciation, although it's a cost, it's not one that's going to cause me to be illquid, right?

It's liquidity is like cashlike stuff. And depreciation, we're not burning cash here. So it's COGS plus any operating expenses. In this case, our numerator is oh, sorry. Our numerator is current assets. Let me highlight that. Current assets. There you are. 3600. Maybe I'll highlight it yellow. And I'm going to divide by those costs that I've highlighted on the other side, which is uh 3400. So uh current assets divided by oh I've missed one key step.

I was like I'm going to get a crazy number here. Daily. So this is yearly cost divide by 365 to get daily cost. So 3,400 divided by 365. My daily cost 9.315. Uh and again this is in millions. So you know this is a big company $9 million a day in costs. Uh so 3600 divided by 9.315 gives us 386.5 386.5 days. This is again it says well if I was you know not making any sales not bringing in any money I could pay my costs I could pay my bills for over a year 386 days and again every ratio so far I've compared favorably to my competitor.

I'm doing better to than my competitor. Uh networking capital to total assets ratio. So networking capital is current assets minus current liabilities. So current assets not divided by but minus. So [Music] 3600US,500 2100 all divided by total assets which in this case is 7700. So I'm going to divide by 770 and I get 270.27 oops 0.273 I suppose. And this is just a measure of what percentage of our assets is working capital shortterm.

So it's a liquidity measure. And we are bigger is more liquid. We're more liquid. So I can just conclude on this. We are significantly in a significantly more liquid and therefore better position than our competitor as far as again liquidity goes. Okay, I'm gonna slide over and we're going to do the same thing with leverage ratios. So, I just scrolled the leverage ratios up to the top here and let's get after it. Uh, total liabilities divided by total assets.

Total liabilities, where are you? Okay, I got current liabilities. I got long-term debt. There we go. So, current plus long-term is total liabilities. And we're going to divide that by total assets. So 1.5 uh + 1.8 is 330 divided by 770 and I get 42.9% 42.9%. So uh this is a measure of leverage how much debt we're using and I generally think smaller is better here. Certainly smaller is less risky and we are less leveraged than our competitor and I view that as a good thing and that's that's debatable but I do view that as a good thing.

Okay, next one is total liabilities divided by total asset uh not total assets divided by shareholders equity. So again uh 3.3 million was our total liabilities our shareholders equity 4.4 million so it's 0.75. Now you can see the big difference here with our more leveraged competitor, right? Uh we've got more equity than we have debt. They've got way more debt than they have equity. Those two things should go together.

We have less leverage. Equity multiplier, another measure of leverage. Total assets divided by equity. So here is our total assets. 7.7 million divided by 4.4. 4 million and we get 1.75. Now, you're going to notice something and you'll see this if you do the V B version of the problem and you'll see this if you continue on this chapter in future questions. The debt to equity ratio is one less than the equity multiplier.

Mult equity multiplier is one more than debt to equity. uh I show in a future problem sort of um algebraically why this is true and it is true. Uh I'm not going to show it here but there's you know it's just simple math because assets equals liabilities plus equity. So the way that works together is u makes this possible. Okay. Long-term debt as a percentage of uh long-term debt plus equity. So okay here we go. long-term debt uh divided by long-term debt plus equity.

So 1.8 million divided by 1.8 plus 4.4 that's 6.2 million. So 1.8 Oops missed a zero there. 180 divided by 620 uh.29 0.29 29.03%. 29 03%. Next, EBIT divided by interest. There's my EBIT. There's my interest. Well, I can do this math in my head. It's 10. Our EBIT divided by our interest is 10. This is sorry, this is interest coverage ratio. It's a measure of how able we are to pay our interest. Well, we uh just with EBIT can cover our interest 10 times over.

Now, the next ratio says, well, you know, EBIT includes depreciation, and I don't have to worry about depreciation if I'm paying bills because depreciation is a non-cash expense. So, let's take that out of the equation, add it back into EBIT. So, I end up with 600 as my numerator divided by 50. 600 divided by 50 is 12. So, again, 500 + 100 divided by 50. Uh, I get 12 here. 12 times. Now, uh, as far as leverage goes, I am less leveraged than my competitor, right?

I have less debt overall. Uh, interestingly though, they, even though they have way more debt, are able to handle their interest load better than I am. And I think this is a harbinger. I think this is a sign of things to come. I don't know if I pronounced that word right. I don't even know if I used that word right. Harbinger. Harbinger. Harbinger. I don't Harbinger. I don't even know what it means. I'm going to I'm going to look it up.

Uh Harbinger of things to come. Skip ahead. Uh see. Oops. I don't want you to see my email. Harbinger. There we go. Harbinger. A person or thing that announces the approach of another. a forerunner of something. Yeah, this is a forerunner. This is a Harbinger. Did I pronounce it right? Let's see. Uh, yeah, I pretty much hit the nail on the head. Okay, I'm feeling feeling better about things. A harbinger of things to come.

And all that means is it's a forebearer of the fact that I think this company's going to be way more profitable than our company because their Ebbits have got to be way higher because I would think their interest bills higher, too. They have way more debt. uh they must be more profitable than us, but let's see how that goes. So, as far as debt paying ability goes, I would say we have a nicer looking balance sheet. We have less financial leverage, but they kind of tip your hat to them for interest coverage, but I think we are doing better at the top.

So, this one may be a minus for us. This one is a plus for us. And I I would say overall as far as leverage goes, we are less leveraged than they are. Okay. uh turnover ratios. So this is uh uh these are all efficiency ratios. How well do we sell through our inventories? How well do we collect our receivables? Any turnover, you're going to want to see bigger uh bigger is better. So uh let's do the first one. Cogs divided by inventory.

Uh again, if you've taken this with me before, if you've done ratios with me before, you'll know I calculate this slightly different in accounting. I follow along with just textbooks in the field and in finance in accounting they will say cogs divided by average inventory. You take the average from two years and in my finance textbooks they just give you one year of data and you just use the one year and so be it. As long as you're being consistent I don't think it's a huge deal.

Uh 2200 divided by 12 uh 1,200 1.83 times. So we're very close to our competitor here. Not a huge difference, but they're doing better than us. They're collecting more regularly than us. And I think that drives home in this next ratio. 365 divided by the inventory turnover. 365 divided by 1.83 199.5 days. This is saying how long is it taking us to sell our inventory? Uh how long is it sitting on the shelf or in a warehouse somewhere?

For us, it's about 200 days. For them, it's 187. They're selling quicker than us. That's better. So, we're doing worse. Sales divided by uh AR for uh receivables turnover. There's our sales. There's our AR. 4,000 divided by 300. 13.33 times. Bigger is better. And And I think again this next ratio will drive it home. divide 365 divided by 13.3333 I get 27.38. What does this tell us? It tells us on average when somebody owes us money, it's taking us 27 days to collect the money.

Our competitors 45 days. Again, a measure of management efficiency and maybe policies. Uh sales divided by networking capital. So, uh let's see how we do here. sales 4,000. Networking capital is again current assets minus current liabilities. So 3600US 1500 is 2100 is my denominator. 2,100 my numerator 4,000. 4,000 divided by 2100 bigger is going to be better here. 1.9 times uh for the compet or for us 1.905 times and our competitor 6.67 times.

It means how effectively are you using your working capital to generate sales and they're doing a much better job as we predicted. Their income statement I predict is way better than ours. That's just the vibe I'm getting from the ratios we've seen so far. Uh, next, sales divided by fixed assets. How well are we using our fixed assets to generate sales? Uh, sales divided by Where's our fixed assets? There they are. Uh, so 4,000 divided by 4,100 N75 976.976 times.

So for every dollar I have invested in assets, I generate 97 cents in sales. My competitor generates a dollar in sales. So they're doing marginally better than us. This is interesting uh that it was close. Uh okay, let's keep going. Sales divided by total assets. Our sales are 4,000. Our total assets 7,700. 4,000 divided by 0.519 for every dollar I have invested in assets I generate 50 cents in sales that's what we're learning here and again the competitor is doing better marginally better total assets divided by sales capital intensity ratio how many dollars worth of assets does it take to generate a sale this is just the inverse of the previous one uh so uh sales or assets rather 7700 divided by sales 4,000 and I get 1.925 so it takes me $1.90 of assets to generate a dollar in sales you would rather this number be lower so almost across the board outside of receivables collections my competitor is doing better here so uh relative position we're doing worse As far as uh this goes, as far as uh turnover ratio goes, and this is measures of operational efficiency, right?

Are we using our assets efficiently? Are we selling through inventories well? Are we uh stocking the right amounts of inventory? Are we collecting receivables? Well, that's what we're measuring here. Okay, one last page of ratios. We got three categories, though. Let's start with profitability ratios. Predicted we'd do worse. Maybe we aren't going to do worse. Let's see. um net income divided by sales. First one is our profit margin.

So for every dollar I sell, how many dollars in profit do I produce? 325 divided by 4,000. Okay. Yeah, we are significantly worse than our competitor here. Uh uh 8.125% versus 17%. They're double, right? Like for every dollar they sell, they make 17 cents. For every dollar we sell, we make eight cents. This is way worse. Um return on assets net income divided by total assets. So net income divided by total assets 325 divided by 7700 uh 4.22%.

Oops, wrong pen. 4.22% versus 11%. We're way less profitable again, right? where this is how effectively you're using your assets to generate a profit. You know, how many dollars worth of assets does it take for you to generate a dollar in profit? So, uh for every dollar I've invested in assets, I generate 4 cents of profit. Not great compared to my competitor. Uh net income divided by shareholders equity, 325 divided by 4400.

Uh 7.4% we'll call it. 7 point let's go at 7.39%. And that compares very unfavorably to our competitor at 44%. So they're blowing the doors off us as far as profitability goes. We're not nearly as profitable as our main competitor. Okay. Market value. How much does the stock market like us? That's what I consider this first one. And it's market price divided by earnings per share. Our market price is 45 bucks. our earnings per share.

Now, the market price is just right there. Our earnings per share is two. So, 45 divided by 2.17. They're giving us a 20.7 times multiple. So, we don't earn very well, but the stock market seems to like us for some reason. This is um you know, I'd buy the competitor stock if I were looking at an investment. They're much more profitable. But there could be some other reason, right? There might be a we might be based in a country that's politically more stable where they're in a less stable country.

There might be, you know, uh regulators taking a good look at their business and maybe threatening uh lawsuits against them. Who knows, right? There's myriad reasons why one company might have a higher price to earnings ratio than other. But all else equal, you're happier if the stock market values you. It means there's something that investors think you have going for you. And hopefully you do. Okay. The next ratio, market price per share, 45 bucks divided by book value per share.

So same 45 bucks. Book value per share is our equity divided by the number of shares outstanding. 440 divided by 150 million shares outstanding. And 440 this is in millions. So that's why we can just do that straight calculation. Our book value per share is $29.33. So 45 divided by 29.3333 [Music] uh 1.53 1.53. So ours is a little bit worse here. Our book value is uh maybe higher than that of our competitor. Last one.

And this is just trying to figure out why ROE is so much worse or so different. Right? It explains the difference in ROE and does it in an interesting I think a very nice way. So we take the pieces of ROE. This is called the Dupont identity. So let's take those pieces for us. Profit margin. So our profit margin is right here. 8.125%. We're going to multiply that by asset turnover. So let me find the asset turnover. Total asset turnover.

Here it is. 0.519. [Music] We're going to multiply that by the equity multiplier. And our equity multiplier is right here, 1.75. So there we go. And uh let's multiply those through. times 519 times 1.75. And what we find is we get 7.38%. This is our return on equity, right? It's it's off by 01%. 7.38% and that's off by again 01% even though it should match. It should be our roe. It's just some roundings gone on. So let's look at the pieces and see if we can piece together what's happen.

Our profit margin 8% competitor's profit margin 17%. So that's one reason their ROE is higher. Their profit margin is way higher. Asset turnover 0.5 versus 06 not that different but then equity multiplier way different. Ours is 1.75 there's 4.03 theirs is double ours. So the two reasons that we're doing worse than our competitor. One they're just better at generating profit than us. Right? They're they're um when they make a dollar in sales they generate a higher profit margin double ours.

And the second is, and this was a choice, they're more highly leveraged than us, right? They have uh uh more debt, less equity, and that means they have a higher equity multiplier. So, the leverage thing might be a choice, but you can certainly see they're outperforming us financially to uh result in double the profit margin. Okay, we have done all of the ratios and for goodness sakes, where are we in the video? 24 minutes.

If you've hung in there for 24 minutes, I hope it's been useful to you. And if it's been useful to you, for goodness sakes, if it hasn't been useful to you, please watch some other channel. I'm not trying to waste your time here. Uh but if it has been useful, don't be shy about smashing one of those buttons for me. It's a huge favor to me. All right, have a great day. Thanks for watching and I'll see you in the next video.

Bye for now. In the first lecture of any corporate finance class, your professor will say something like, "The goal of a company is to maximize shareholder value." And in fact, it's not just your professor. If you read the textbook, your textbooks will say things like, and this is pictures I took out of my own textbooks, the primary objective of the corporation, value maximization, or another textbook, goals of the corporation. and shareholders want managers to maximize market value.

And it's not just your professors and it's not just your textbooks. It's also our AI chat over overlords. Uh I asked one, what's the main goal of corporate finance? It answered, the primary goal of corporate finance is to maximize shareholder value. So you hear this phrase over and over and over again when you're beginning corporate finance. And if you're like me, it kind of rubs you the wrong way. At least it rubs me the wrong way.

I think, oh, it's, you know, feels like a evil, greedy person wearing a monle holding a satchel full of money made up this phrase and it it bugged me. But the more I understand business, uh, the more I understand that this is, I would say neither good nor bad. It is just a reality of how businesses operate. And it's more to do with the mechanical way a business works. And so in this video, I just hope to explain why it is the way it is.

So this will be a video all about the why. We always say the goal of a company is to maximize shareholder value. Is it good or bad? I'm not going to make that value judgment here, but it is. And it's important to understand why. And it's not greedy capitalists with monles underneath it all. It's just it's a logical outcome of how businesses operate. So how do the businesses operate? Well, here you are, a potential shareholder in a business, and you decide, "Yes, I'd like to buy some shares in that big fancy tech company I've been hearing so much about, Apple or Amazon or Meta or Netflix or something like this." And you decide, "Yes, I will buy a share in that company." And when you buy the share of the company, there you are in the corner, you of course join a diverse group of shareholders. thousands, tens of thousands, hundreds of thousands of uh other shareholders are also owners of the company.

And what you quickly realize, and if you've ever owned anything where you owned a part of something, so my brother, sister, and I, we all share in a vacation property. We all take turns and take a week or two at the vacation property each summer. Well, what you learn very quickly is like our vacation property, there are three owners. We disagree on everything. we can't get along. It's very difficult to own something together with other people and that's with people I love.

When I own Apple, I don't love all the other shareholders. I don't even like them. So, how are we supposed to work together? And the answer is, well, we don't agree on much of anything. We don't agree how Apple should be run yet. We're the owners of the company. When you're the shareholder, you are the owner of a company. So because this group simply can't be expected to agree on anything, what happens is the group and we'll go through the mechanics of this in a future chapter.

The group has to elect a small small group to represent their interests. So what they do is they'll run an election to choose a board of directors. And these this board of directors should be experienced in business similar to the business you're investing in. They should be smart, ethical people that will protect your interests as shareholders. Now, the question the board has to ask is, well, what do our shareholders want?

Right? Like, okay, we've been chosen to represent their interests. What do the shareholders want? And the answer could be, you know, you imagine Apple, oh, should we make bigger iPhones or smaller iPhones? Well, I want smaller iPhones. This is a mini iPhone. They don't even make them anymore. really chokes me. Uh maybe more people want larger iPhones. Who knows what people want, right? And this shareholder group is not going to agree, oh, we should make smaller or larger iPhones.

Uh in fact, this shareholder group's not going to agree on much of anything. So that leaves the board in a weird spot. They have to represent the interests of a group of people that agrees on nothing, right? they can't get agreement on strategic direction or small details that the company might be interested in. Well, what can this group agree on? So, the board would be wise to ask themselves like, what would this group of shareholders agree on?

And there's one thing every single one of these shareholders ought to want and I would argue does want. 100% of them would like to see the stock price go up. Why do they want to see the stock price go up? Well, they bought stock, right? All you have to do, just do it once in your life. Buy a share of something. Buy a share of Apple or Amazon or Facebook or whatever company you want to buy. Buy one stock and you'll see it in yourself.

You'll say, "I'd like to see this stock price go up." So, every single one of these people, they don't agree on anything. They don't agree, should we make small phones, big phones. They don't agree, should we uh build the factory here, there, or anywhere. They don't agree on any of that, the design or anything like that. They all agree the stock price should go up. And that's what's at the root of the introductory question.

So the shareholders, the group that owns the company, these are, you know, again, you own 51% of the shares. It's your company to run. this group of diverse people with totally different interests are in 100% or close to it, 100% alignment in one thing. They bought the share hoping the price would go up. So, they elect a board of directors and the board of directors goes, well, the shareholder group doesn't agree on anything, but they all agree that the stock price they'd like to see it go up.

The board then, this is the mechanics of how a company works. The board has the power to hire and fire the CEO, the chief executive officer. The CEO's job is to run the company. The CEO hires and fires, you know, the marketing manager and the HR manager and the design product designers, all that stuff. The CEO is the top person of the company that's able to do that. Uh, but the board can hire and fire the CEO and the CEO oversees the company.

So again, just to sort of reiterate this relationship, hopefully that all fits on a screen and is reasonably visible to you. You, this little guy in the corner, are a shareholder of the company because there's thousands potentially sh thousands of shareholders with diverse interest. Even if there's two or three shareholders, they can't agree on much. Uh the shareholder group will elect a board of directors. The board of directors role is to advise and help the CEO in representing the shareholders interest.

So the shareholders select the board. The board represents shareholders interests. How do they do that? They hire a CEO that they think will help shareholders do the one thing they can agree on which is maximize the value of the shares. Now at a functional level though the board is really important. The board helps the CEO run the company. And I thought I'd show you Apple's current board of directors. So, the CEO of the company is Tim Cooks.

Tim Cook sits on the board of directors. But the name I actually wanted to hone in on is this person on the board of directors, Al Gore. If you don't know who Al Gore is, he was pre uh vice president of the United States. He was very nearly president of the United States. missed by uh maybe hundreds or a few thousand votes in Florida way back when. Uh anyway, a very politically connected figure. Well, why do you think Al Gore is on the board of directors advising Apple?

Because Al Gore surely doesn't know more about chips or phone production than you or I do. Uh but the reason Al Gore is there is because Apple's such a huge and powerful company. They're important to the United States government. So, wouldn't it be useful to understand or to have somebody on your team who understands lawmakers and regulators how they're going to behave? That's why Al Gore can give advice to Tim Cook, not on what chips to put on the phone, but on uh how to operate within government, right?

How how to maneuver the US government. Uh they also have the CEO of Boeing. Well, Boeing, you know, it's one of the few companies that would be similar to Apple in terms of supply chain and ordering parts and needing parts to be very specific specs. So, again, that's why a Boeing CEO can ad give Tim Cook advice. Uh, this Susan Wagner of Black Rockck, BlackRock's one of the biggest investing companies in the world, so she can advise Tim Cook on what investors are looking for, right?

And so, all these people can give their expertise and lend their advice to help the company run better. And ultimately, if I can zoom properly, there we are. Sorry, I was having a hard time finding it. Ultimately, the idea is this board represents the shareholder group and advises the CEO as to how the CEO should run their company better. That's it. So, at the end of this, I hope you're seeing, and again, I'm not trying to make a judgment call as to whether this is good or bad.

It just is. This is the reality of running a company. The shareholders are the owners. They elect a board to represent their interest and the only thing the shareholders agree on is that they'd like to see the stock price go up. Now, it can be done in any way, right? It doesn't have to be, oh, we need to maximize profits. We need to cut costs. We need to be mean to our employees or something like this. Uh it just means these folks would like to see their stock price go up and they hire people to represent them.

That's why the goal of a company is to maximize shareholder value. Welcome to module two of our corporate finance course. As you can see the title of the module projecting financial statements. I just want to remind you and this is a phrase I'll repeat over and over again and I'm sure your professor will when we're valuing something. It's the present value of future cash flows to figure out the value of a bond or any another financial instrument or when we're determining the value of a company.

If we want to invest in the shares of a company which finance people are interested in doing uh it is all about present value of future cash flows. Well, a question that might occur to you is, well, future cash flows, right? We're we're trying to figure out the money that's going to come into a company or or as a result of a financial instrument in the future. And so, we use accounting information, but accounting information is all based on the past.

We get financial statements for last year. We don't get financial statements for next year. And so something we have to do is take those past financial statements and project them forward. That's what module two is all about. And it's not as simple as it might seem. So if I take this balance sheet and I go, okay, let's just say next year everything's going up by 20%. Say, right? So last year my assets were 200. Well, if they go up by 20%, this year they're going to be 240.

Right? Just multiply that by 20%, you get 40. And then add it, okay, it went up to 240. Liabilities up 20%, so that's uh 150 + 30 is uh 180. And equity up uh 20%, so that's up by 10, right? 50 * 20% is 10. So that goes up to 60. And sure enough, our balance sheet balances 240 on the asset side. Assets equals liabilities plus equity, of course. 180 and 60 is 240. Yep. Our balance sheet balances. You might think, "Oh, good job by me, right?

My balance sheet balanced. Okay, I'm done the exercise." But what we learn in this chapter is it's actually more complicated than this. If we just do a uh projection in this way, right, where we just go, oh, plus 20% to everything, all done. The financial statements break down because they depart from reality. So, what are ways this financial statement might have departed reality? Well, the first one is the liabilities.

What if we can't borrow any more money? Right? We're at the top of our borrowing capacity. Well, that's a problem. And and when we project forward, we have to say, "Oh, are we going to need to borrow new money? Can we get new money?" And so, this represents likely new borrowing. The fact that we go from 150 to 180. The other thing that breaks down is the equity because of course equity involves the income statement. It links the income statement to the balance sheet through an account called retained earnings.

And if you just project forward 20%, well, it's going to depend on what happened on the income statement and how many dividends we wish to pay. And so it's not so simple as just to go everything plus 20%, everything plus 10%. And so what we'll learn this chapter is those complications, right? We want to figure out the present value of future cash flows. Our accountant friends who prepare financial reports give us past transactions.

We've got to project them forward to figure out the present value of future cash flows. That's what chapter 2 is all about. I'm looking forward to getting into it. Thanks for watching. See you in the next video. In this video, we're going to work on a problem you can download from tonybell.com. Go to the website, click the PDF link, and you'll notice there's no sign in, no sign up. The PDF just pops right up. You'll scroll down and find whatever problem it is that we're working on.

As you scroll through the problems, you'll notice many are free and open like the one you're watching now. But some are membersonly. I think the free and open ones are enough for most people, but if you can't get enough of me and you'd like to join and get access to those membersonly videos, click the join button underneath the YouTube play box. All right, thanks so much for watching. Let's get started. Let's take a look at problem 21A.

This has us doing proforma financial statements, just projected financial statements. A really useful skill to have, right? to be able to say okay next year what happens if our sales are up by 10% or 20% or 15% or whatever what will happen to the rest of our accounts what will our financial statements look like then and what are the implications of it so uh let's go through 41A Liam company uh company's financial statements are shown below and there we have an income statement and a balance sheet and it says assuming sales are projected to increase by 20% and that all items on the income statement and balance sheet.

So all items that we're seeing above will also increase by 20%. Not the greatest assumption. You know, some things will go up by more or less than sales, but this is a good starting point, right? Just to learn what financial statements look like uh with this type of change. Okay. So, if our sales are going to go up by 20%, how do we make them increase from 5,000 to a uh you know, plus 20%. What does that look like? Well, 5,000 you're going to add 20%.

So, you're going to add a,000 to that. The way you do that in terms of a calculator is just go 5,000 times 1.2, right? 120% is 1.2. They're going to be $6,000 next year. If they increase by 20%. Costs, if they're expected to move with uh sales, which is pretty reasonable assumption for most companies, costs go up again by 1.2, they're going to be at 5400. sales minus uh costs and expenses gives us our income before tax. 6,000 - 5,400 is 600.

And you can see this is also a 20% increase from the year before. Taxes are 20% of that. They're going to be 120. And 600 minus 120 is 480. Okay, there we have it. Everything has gone up by 20%. Um let's look at our balance sheet now. If everything goes up by 20%. Current assets going up by 20%. What does that look like? Well, they're going to go up to 1,200. That's 20% more than a,000. The uh fixed assets are going to go up to 3600.

And again, that's just 20% more. 3,000 times 1.2. So, pretty straightforward what we're doing so far. I hope it is. Anyway, uh uh 1,200 plus 3600 gives us 4800. There we have it. our current liabilities going up by 20%, 500 uh plus 20% well that's 600. Uh our long-term debt 2600 going up by 20% so multiplied by 1.2 is 3120 and 900 multiplied by 1.2 is 1080. Adding this up, hopefully the assets equals liabilities plus equity.

Hopefully our balance sheet balance is 600 plus 3120 plus 1080. That gives us 4,800. Yes, indeed. Good feeling our balance sheet does balance. Okay, so we've answered the first part. Uh prepare proforma statements. We did that. Now again, how useful is this? How realistic is this? It's a good starting point for us. But if in reality, we could be a lot more surgical about this. We could say, "Oh, our uh revenues are going to go up 20%, but maybe our costs are only going to go up 15%." Right?

Because there's a lot of fixed costs or whatever, right? And we could make various estimates, but it's a useful skill to have. So uh we get to the end and it says part two here to uh compute the amount of the dividend required to make the balance uh to balance the statements if dividends are the plug variable. Okay, this is often confused by students when they're beginning. If I get students to project financial statements, they often will uh plug their shareholders equity to make a balance sheet balance. like they sort of go, "Okay, I I know what assets are and I know how they're going to change.

I know how liabilities change, but equity I'm just going to plug and make it work." And that's essentially what we've done. We've plugged the equity by plugging uh dividends. So, let's think about how equity works. And this is something you need to know. our beginning equity plus net income. I'm going to say equals just a subtotal minus dividends. Now, I don't need the subtotal. It's just going to help me discuss this.

Equals our ending equity. So, our beginning equity was $900. We're expecting it to go up to 1080. So, our beginning equity was $900. We add net income. Our net income is $480. So, 900 + 480 gives us $1380. Now, if we did not pay a dividend, then our ending equity should be 1380. But our ending equity isn't 1380, it's 1080. So, we must have paid a dividend because we know our ending equity is 1080. That's known here. Our dividends are the plug variable.

Well, what's the plug that makes this work? We must have paid under this scenario a $300 dividend. Okay, so to answer the question says, compute the amount of the dividend required to balance the statements if dividends are the plug variable. Well, 300 bucks. That would be the dividend. Now, let's look at part three. It says uh do the proform statements in part one make sense if the dividend payout was 30%. So the company and remains unchanged.

So the company always pays a 30% dividend. Does this work? Well, what is a 30% dividend? It's 30% of net income. That's what they're talking about. So 480* 30% 480*.3 it's 144 uh dividend. Does that work? Does that make our statement work? If we plugged in 144 here, would we match? No, we would have higher equity and and our balance sheet would no longer balance. So, the question is, uh, do they make sense? No, they don't make sense.

If the dividends only $144, then the proformas no longer work. So, that's a problem. Out of curiosity, what is our dividend payout ratio at 300? Well, uh, it's a $300 dividend on $480 in net income. 300 divided by480. That gives us us a payout ratio of 62.5%. Way higher, double, more than double the 30% payout ratio. So, what does this mean in practical matters? It means probably our financial statements are going to look a little bit different from this because we probably won't pay out a 60% dividend.

If we're going to be consistent and pay out a 30% dividend, it means we'll have more cash, more current assets with which to play, right? You can do something, invest in long-term assets or you can, you know, do something else. But but the bottom line is we'd likely have higher than $1,200 in current assets if we paid a smaller than 62% dividend. Okay, that's it for parts part A uh one, two, and three there. Let's move on to part B.

Uh has us looking at the sort of same set of statements but doing different things here. Slightly different things. So it says instead of part A, assume uh 20% increase in sales. So actually that was the same a dividend rate payout ratio of 40%. So not the uh 62% or the 30% that we had in the previous version. So just the different scenario here costs expenses current assets and current liabilities and net fixed assets will vary directly with sales.

Okay. So as we're projecting a 20% increase in sales all of our costs and expenses current assets current liabilities and fixed assets are going to just go up by 20%. Long-term debt. Well, I can't cross that out. Long-term debt and shareholders equity don't vary directly with sales. Okay, so it's a different task we've been assigned here. Same task, but they've given us different information, I suppose. Let's see if we can solve it.

Uh, so we'll start with the income statement. And the income statement is identical because sales, costs, and expenses, that's all that's on an income statement, all go up by 20% exactly as they did in this previous version. So, we're we're going to prepare the same income statement. So, sales up by 20%, so 20% increase here gives us 6,4500* 1.2 5400. 500 * 1.2 is uh 600. And the math works going down. 100 * 1.2 is 120.

And uh 480 is our number here. 480. Okay. So, we've done the income statement rather quickly. Uh let's just remember what else goes up. Current assets and current liabilities. Current assets and current liabilities go up by 20%. So, current assets goes to 1,200. Current liabilities goes to 600 under this scenario. uh net fixed assets also goes up by 20%. So 3,000 goes up to uh 3600. Now this is important. We now know our total assets is 4,800.

And something you should be doing immediately if you're pretty confident, and I am pretty confident in that total assets number, write it over here as well because the balance sheet has to balance. And that's going to become a key to sort of help us solve this problem, right? That's a piece of the puzzle that you might miss is that if you know your total assets or you know your total liabilities and equity, you you know the other because the balance sheets got a balance.

Okay. So, um what are we left with? We don't know our debt and we don't know our equity except we have the tools to figure out the equity because we know the dividend payout ratio is 40%. So, let's figure out our equity. Our equity starts at $900. We're going to use the same formula as above. Let me just remind you of what it is. Beginning equity plus net income. We subtotal minus dividends to get ending equity. So, beginning equity was uh 900 plus net income.

Add net income and our net income is 480. 480. We subtotal and 900 + 480 is 1380. We deduct dividends. Now we know our dividends. Our dividend payout ratio is 40% and our projected net income is 480. So 480 * 40%. Will give us our dividend amount. *.4 is 192. That's our dividend. 192. So our ending equity is 1380 minus 1921 1380 minus 192. It's 1188. Okay, so our ending equity is 11.88. Oops, could put the comma in the wrong spot there. 1188.

So now I know, okay, I'm just missing one number, right? I know my total liabilities and equity is 4,800. I know my current liabilities are 600. I know my equity is 11.88. I just got to plug my plug variable here is long-term debt. So let's figure it out. Now the way we're going to get there is just go 4,800 minus, 1100 minus 600. So 4,800 minus, 1188 minus 600 to get that missing number. The missing number is 3 012.

So there we have it. This is harder to do. Part B was definitely harder to do, particularly if you've never done it before, but we did it. We need to have 3,000 roughly $3,000 in debt in order to make this thing work. 312. So prepare proforma statements done. Compute external financing needed. That's just saying how much new debt do we need? Well, we add 2600. We're going to need 3,000. So 3012 minus 2600, we're going to need $412 of new debt.

The external financing needed, the new debt needed is 412. Just the the additional borrowing. And and so again, that's a problem for real businesses, right? They go, "Wow, if we everything goes according to plan, I need to borrow 400, you know, in this case, let's pretend it's all in thousands, $400,000. you better make sure you got a bank willing to lend you the $400,000 or your plan goes poof up in smoke. So that's why EFN is really important because you run out of money and you're dead as a company, right?

This companies get in crunches if they are unable to uh borrow when they need to borrow. Okay. Uh I don't know what's just happened here. There we go. I was just going to click over to this screen to say if you made it to the end of the video, I hope you liked it. I hope it was helpful. if it was helpful and if you did like it, please don't be shy. Hitting those buttons helps me out a whole heck of a lot. Have a great day.

Thanks for watching. Bye for now. Let's examine problem 22A. More on external financing needed. This time we may or may not need to buy some new fixed assets. And that's sort of the extra dilemma, the extra wrinkle thrown in here. Here we go. Fisher Company's financial statements are below and we got an income statement and a balance sheet. And it says the company expects sales to grow by 40% next year. So, we're going to have to recast the income statement with 40% sales growth.

Uh it says it's going to have a 25% payout ratio, dividend payout ratio, and all costs, current assets, current liabilities are expected to increase with sales implying long-term debt, equity, and net fixed assets are not. So, uh let's read on. It says assuming company is operating at 65% capacity usage for fixed assets. Compute the external financing needed and also at 95% will be our second part. But let's start with the income statement.

That should be easy here because 40% sales growth and 40% cost growth just means multiply everything by 1.4. Right? This is all plus 40%. So 7500 adding 40% we multiply by 1.4 4 we get 10,500 7,300 * 1.4 we get 10220 uh 10,500US 10220 is 280 that also happens to be income before taxes times 1.4 uh 60 * 1.4 4 gives us 84 and again taxes are 30% of income before taxes. So 280 *.3 it's also 84. Um net income 280 minus 84 280 minus 84 our new net income here is 196.

Okay we've projected our income statement. That'll be the same in both scenarios because uh uh we're only worried about capacity of fixed assets and that's going to create some potential borrowing. But let's uh let's go on to project our balance sheet. And we're given that current assets and current liabilities are going to go up by uh 40% in this scenario. They vary with sales. So sales are up 40%. We're going to need 40% more working capital for uh lack of a better word.

So 2,00 * 1.4 2800 and 1,500 * 1.4 is 2100. Okay. Now the milliondoll question before we can solve for the equity. Well, we could do the equity if we wanted, but before we do that, let's do net fixed assets. We have enough information to do that as well. The question says the company's operating at 65% of capacity with its fixed assets. So we got to answer the question, do we need to borrow or not borrow, buy any new fixed assets?

Do I need new fixed assets to sort of fill a 40% increase? Well, very simple calculation. We're at 65% of our maximum. And now it's saying we want to increase by 40%. Production's got to go up by 40%. Presumably, we need 40% more assets. Well, if production goes up by 1.4 times, 40% more, where am I at? 65 * 1.4, I'm at 91% of capacity. So, if I go from using my assets 65% to 90%, do I need to buy new ones? The answer is no.

I mean, we might have to replace or repair some, but no, we don't need to buy any new ones. we're we're operating at 60% capacity. Maybe we're operating, you know, two shifts and now we can just add a shift but still use the same assets. So no, I don't need to buy any new assets. That means my net fixed assets can remain at 4,000. So 2,800 plus 4,000 is 6800. My total liabilities and equity then will be 6800 in this scenario.

Uh we can solve also for equity. Remember, equity is beginning equity plus net income. I like to subtotal it here. Minus dividends equals ending equity. So, our beginning equity was 2,000. We're going to add net income. Our projected net income is 196. So, I get 21.96. This would be my equity if I didn't pay a dividend. But I do pay a dividend. We have a 25% dividend payout uh next year. So 25% of net income. So 196 time uh 25% gives us I always double underline that gives us an a dividend of 196 time.25 of 49 bucks.

So, I'm going to deduct $49 to get my ending equity. 2196 minus 49 uh 2147. There's our ending equity. So, our ending equity here, 2147. Now, it's just a plug. Right? Now, we're plugging for our long-term debt. And that's going to help us figure out the external financing needed. Uh, I just go 6,800 minus the two above minus 2100 minus 2147. That's going to solve it for us. 6,800 minus 2100US 214 uh 2147 gives us 25 53.

So, are we going to need to borrow some new money? Yes, but not much. Like I wouldn't be super worried if this was my project my projection. My EFN is uh 2553 minus 25500. I'm going to need 53 uh dollars or thousands or million, right? Like these are often in big numbers, but I'm going to need $53 in new financing according to this calculation. Okay. Now we're asked to do the exact same thing except this time we're at 95% capacity.

Let's see if I can get uh I'm just going to solve in the same spot but with a different color ink. See how I do with some uh maybe green ink. What do you think? Green. How's this look? Yellow. Yeah, that looks okay. Maybe a little bit thick. Let me make it a little thinner. Then we'll solve. Yeah, that's perfect. Okay. So, I'm going to solve in green ink the exact same problem. In fact, I don't need to do anything here.

The income statement is the same. The balance sheet though, my current assets, they grow by 40%, my current liabilities, they grow by 40%. Uh, let's look at what happens to net fixed assets. That's the key to the whole puzzle. That's the new thing. And let's think about this. We are at 95% capacity now and we're going to grow by 1.4 times. 95% times 1.4 times growth. 40% growth is going to put us at, let me get my calculator.

Oh, there it is. Uh 95 * 1.4. It's going to put us at 1.33x capacity. Meaning I got to grow my fixed assets by 1.33 times. So let's do that. We have $4,000 in fixed assets. I want them to go up by 1.33 to 5320. Our new total assets then 2,800 times or not times plus 2800 plus 5320 is 8120. Now it's all the same math on the other side. We just have to sort of redo it. Uh our current liabilities are 2100 same as before.

Our equity same as before. So it's going to be uh beginning equity 200 just as it was. Our net income because our income statements are the same is the same. Our dividend payout ratio remains the same. So our ending equity is still 21.47 in this new scenario. We've just got to plug then. We know our uh total assets now are 8120. They're higher, right, than the new total assets. So, our total liabilities and equity has to match that.

Has to be 8120. So, we're going to have a whole bunch of new borrowing. 8120 minus 2147 minus 2100 gives us our new borrowing needs. 3873. 3873 is our missing number there. So under this scenario, our EFN is uh 3873 is our new uh debt. Our old debt was 2500. So our new borrowing, our external financing needed here is 1373. Um this is significant, right? Especially if these are in thousands or millions of dollars, you're thinking, "My god, I got to borrow so much money to uh uh meet my needs to if I want to grow like this, I'm going to need a lot of new assets.

And if I need a lot of new assets, I'm going to need to borrow a lot of money. Uh my external financing needed here is 1373." And again, that's a problem or a challenge for the manager to make sure they have the capacity to borrow that much. And if they don't, they better change their plans. Okay, that's it for this video. Stay tuned for the next one. Bye for now and thanks for watching. Bye-bye. Let's take a look at problem 23A.

We're going over a couple of growth rate calculations. The calculations themselves aren't too hard, but kind of understanding what's going on might be a little harder. So, let's discuss the meaning of an internal growth rate and a sustainable growth rate. as we solve the problem. So I'm going to distinguish the two immediately. The difference between an internal growth rate and a sustainable growth rate is this. An internal growth rate is how fast a company can grow without taking on any new debt.

So it's what percentage in growth the company can experience without taking on any new debt. A sustainable growth rate is the rate of growth a company can have while taking on some new debt but maintaining the same debt to equity ratio. In other words, as the equity grows, the debt is allowed to grow along with it. Where an internal growth rate, the equity grows, the debt has to stay at the same level. So, um, we're going to project that a sustainable growth rate will always be larger than an internal growth rate.

Let's get to the problem and hopefully it sort of clears itself up as we go. So we were given financial statements given a dividend payout ratio and uh it says compute the company's internal growth rate. Now there's just a formula for this. At the end of the video uh I'll I'll show you I'll prove that this does indeed work but at this point you just want to kind of know the formula. So the formula for an internal growth rate is ROA return on assets times B.

I'll explain what B is divided by 1 minus RO A time B. So M lowercase B one minus the numerator. Okay. So ROA is return on assets. We learned to compute that last chapter. It's net income divided by uh total assets. So here it's net income divided by total assets. We can do the math. In fact, let's do the math. 350 divided by 2000 17.5%. Okay, so I'll put 0.175 uh 0.175 that's our ROA. What is the B? The B is called the plowback ratio or the plowback.

Um so if we have a dividend payout ratio of 30%, so it means of our profits 30% is getting paid out. It's our policy to pay out 30% of our profits in the form of dividends. How much are we plowing back in the company? How much are we keeping in the company? How much are we retaining in our company's retained earnings? Well, the answer is the inverse, right? If our dividend payout ratio is 30%. The plowback rate or the plowback ratio is going to be 70%.

That's how much we are plowing back into the company. So, that's B. B is the plowback. So uh.175 * b so it's.175 * 0.7 divided by 1 minus uh.175 time 0.7. Okay. So let's let's crunch all the numbers. So.175 times our plow back which is 7. It's.1225. That's my numerator 1225. My denominator is 1us.1225. So 1us.1225.8775. So 0.1225 divided by 0.8775. And it's going to give us a percentage.225 /8775 equals Whoa, I messed that up.

I missed the decimal.225 divided by.8775. There it is. 13.96% 0.1396 or 13.96%. Okay, so that is our uh internal growth rate and that just means no more debt. How quickly can I grow? Uh what's the maximum this company can grow without taking on new debt, without taking on leverage? That's the answer. That's the internal growth rate and it's about 14% for this company. Now I'm going to prove that but I'll prove it a little later.

So uh let's compute the sustainable growth rate. then we'll come back to that uh concept. So the sustainable growth rate almost the exact same formula we just change one letter we change the a and roa to e so we use return on equity exact same formula otherwise so the formula is ro e * b / 1us roe * b. So what's our return on equity? Well, it's our net income divided by our equity. So, net income divided by equity. 350 divided by a,000 is.35.

So, 0.35 time B. Same B as before which was 0.5 35 * 0.7 divided by 1 minus oops 1us 0.35 * 0.7 okay so now let's crunch the numbers uh 35 * 7 it's245 / 1 - 0.245 1us.245 is 755. So 0.245 over 0.755. And let's at long last get a number.245 divided by.755 we get 32.45%. So remember what this ratio was. The first ratio I think is very clear at least in my mind. The internal growth rate tells us how quickly can this company grow without taking on a single dollar of debt.

So the company can grow about 14% per year. Uh the sustainable growth rate is how quickly can the company grow while maintaining the same debt to equity ratio. That means it takes on more debt but the debt grows into proportion in proportion with the equity. So the fastest it can grow there is 32%. So it can grow faster. Uh the sustainable growth rate is always going to be higher than the internal growth rate. Okay. If you want to stop there, I think this is a great place to drop out.

I'm going to keep going though. So but if you want to stop there, no hard feelings as long as you smash one of those buttons. No hard feelings. But if you want to keep going, I just kind of want to prove this one. We won't go through both. You you definitely could do both. I just want to prove this one. So if we grow at 14% 13.96% what does our company look like? And the answer is it looks like it grew by 14% but we don't take on new debt.

Let's do some math here. So again we'll recast our income statement plus 13.96%. Right? Assume we grow by about 14%. So 3,00* 1.1396 3418.8 2500 times uh 1.1396 2849 uh 3418.8 sales minus our costs 2849 569.8 eight. Uh taxes will be 30% of that 170.9 say and profits 569.8 minus 170.9 and we get 398.9. Okay. So there our income statement has now grown by uh about 14%. Um let's contemplate what that looks like for our balance sheet now.

So our income statement's grown by 14%. What about when our balance sheet grows by 14%. But we again want to maintain the same level of um debt. That's the whole idea here. So, our current assets are going to grow by 14%. 200 * 1.1396 13.96% 227.9 1,800 times uh [Music] 1.1396. Our fixed assets grow 2051.3. Totaling up here two two uh oh sorry 227.9 plus 2051.3 gives us total assets of 2279.2 that's going to be our total liabilities and equity 2279.2 let's figure out what our equity is going to be after having this happen.

Okay. So, uh, our old equity was 1,000. We're going to add the net income, add the profit. 398.9. We're going to take out a dividend. Now, dividends are 398.9 times uh.3 uh 119.7 and that's going to give us our new equity. So a,000 plus 3 our net income 398.9 minus our dividend of [Music] 119.7. This gives us our uh new equity next year of 1279.2. Okay, so there's our new equity 12 oops 79.2. Okay, so now we know our liabilities.

We know our equity rather. We know our liabilities plus equity. We're just going to solve for liabilities. And you can see the answer here. What's the missing number? Well, it's something plus 1279 equals 2279. It's a,000. The whole point of this exercise was to say if we grew by 14%, we're not going to need to take on any new debt. And guess what? I crunched the numbers. It's true. If we grow by 14% exact, well 13.96%, we don't need to take on any new debt.

That last part of the video, there's a reason I said goodbye to uh a lot of the students because generally speaking, you're not going to be asked to prove that. You're just going to be asked to like crunch the number, right? And so crunching the number is a lot shorter. But I just wanted to prove to you that this does in fact work. So it worked for me. If it worked for you, hit one of those buttons. Have a great day.

Thanks for watching. Bye-bye. Let's run through problem 24A. We're calculating a sustainable growth rate. This is a funny problem. I have to be honest with you. The reason it's a funny problem is because it's not super realistic. We're given just scattershot information and we have to play puzzle solver here. So, normally you just look at financial statements and be able to get the information off financial statements.

Here we're given just like bits and pieces, the odd ratio. And the idea is, are you clever enough to solve the puzzle that's been put in front of us? So, let's see if we're clever enough to solve this puzzle. It requires some algebra. And algebra is not my strong suit, I've got to be honest with you, but I think we're going to get through it together. I hope so. Calculate the sustainable growth rate given the following information.

And there's a bunch of ratios and information they've given us. Now, let's remember what a sustainable growth rate is. It starts with R OE return on equity uh times B which is our plowback ratio uh divided by 1 minus R O E * B that is our sustainable growth rate. Okay, so we've done that in previous problems, right? We've solved for the sustainable growth rate. That's the formula to do it. We're given bits and pieces.

We're basically given enough information to figure out B because we're given the dividends and the net income. So, all right, if we're paying 20,000 out of $30,000 in dividends, our dividend payout ratio is 66.67%. And that's the payout ratio. So, how much are we plowing back into the company? Remember, B is the plow back, right? It's the amount of money that we're not paying out of dividends. Well, it's 33.33%. So, that's our B in this formula.

So, all right, we're already most of the way there. We got the B. The ROE is not easy. That's the problem in this question. If it's just finding out the B, okay, yeah, you kind of got to solve for it. But, so B is 33.33%. We'll kind of keep that. You know what? I'm going to put that uh up here somewhere. B equ= 33.33%. Okay. Well, that'll come in handy much later. We now have to solve for return on equity. And and return on equity is net income, which we have divided by equity.

So, we just have to figure out what is our equity. That is the million-doll question here. And it's not so easy to get. Um to get there you have to know these formulas. So our profit margin profit margin is net income divided by sales. This goes back to stuff we learned in chapter one when we did ratios. We looked at this ratio and you have a ratio sheet you can refer back to. Uh capital intensity ratio is uh uh assets divided by sales and debt to equity ratio is debt divided by equity.

Okay. So we're just going to try to figure out the raw numbers here and we'll work our way down from profit margin and try to figure out um uh missing numbers. So let's start with profit margin. We know net income divided by sales equals uh 10% 0.1. We also know our net income is 30 grand because it was given. So we can solve for sales, right? We know this is $30,000. So $30,000 divided by sales equals 0.1. If you rearrange, you go, okay, 30,000 divided by 0.1 equals sales.

What you find is sales equals 300,000. It's just 30,000 divided by 0.1 300,000. Okay, so maybe useful information, maybe not. We'll see. Well, in fact, it is useful information. I wouldn't have solved if it wasn't. Uh, we can use that in this next ratio where we know assets divided by sales is 0.85. So assets divided by now we know ourselves 300,000 / 300,000 = 0.85. So assets is 300,000*.85. 300,000*.85 means our total assets are 255,000.

Okay. So again little bit of algebra and just like puzzle solving in this problem. Uh next debt to equity ratio. Now again, if you're doing this for the first time, you wouldn't know where to begin, I believe. But that's why we do these together. And so if you're faced with something like this, okay, you've got at least a prayer, right? Uh debt to equity ratio is 3.2. So, okay, we know we're trying to get down to equity, right?

Because that's what we're looking for. We're looking for ROE, and we need the E to get to ROE. So, we got to solve here for equity. Now, we know debt plus equity equals the total assets. Assets equals liabilities or debt plus equity. So, we know debt plus equity equals 255 because we just solved for assets. We also know debt divided by equity equals 3.2. Debt to equity ratio equals 3.2. I'm going to move this out a little bit just to sort of focus in on this part of the puzzle.

And so we just got a little algebra puzzle to be solved here. Debt plus equity equals 255,000. Debt divided by equity equals 3.2. I'm going to isolate equity as a variable. So I'm going to say actually I'm going to isolate debt as a variable. Debt equals 3.2 time equity. Right? I just moved the equity up. I'm going to plug this in and replace debt up there. So I'm going to say 3.2 because if debt equals 3.2 2 equity.

I can just plug it into the formula. 3.2E plus E = 255. 4.2E. So 3.2E + 1E is 4.2E = 255. Equity = 255 / 4.2. Our equity equals 60714. Okay. Now we can solve. We know our net income. Our net income was 30,000 bucks. Net income divided by equity equals roe. So 30 was it 30? Yeah. $30,000 divided by 60714 goes 494 49.4 4% or 494. Okay, so now we have everything. We have our ROE494. We have our B.33. Let's solve. I'll do this in different color ink because it's getting uh too much of the same ink.

So, let me actually move this over here. So, our equity or our ROE was 49.4% 4% 0.494 time B which was 0.333 divided by 1us 0.494 * 0.333 and let's crunch the numbers.494 *.33333 is.1647 0.1647 / 1us.1647 so divide by8353 / 0.8353 8353. And here is our answer after all that effort. 1647 divided by8353 equals 19.72%. So a long journey there. But we have calculated our sustainable growth rate. Our sustainable growth rate is 19.72%. really more of an algebra problem, really more of a puzzle that we've solved.

But congratulations to us, we've solved it. That's it for this video. Thanks for watching. I'll see you in the next one. Bye-bye. Let's jump into module three of our course. This is, I think, the most important module of the whole course. I don't think it's the hardest, but it's so fundamental to everything we do in finance that if you don't understand annuities and the time value of money, well, you'll be in trouble in your course.

Um, so let's just sort of jump into it. Uh, I brought this slide up in lots of my videos so far. The value of anything is the present value of the future cash flows. Well, again, that word future uh that makes me think, okay, there's time involved, right? This time value of money. A dollar a year from now is not the worth worth the same thing as a dollar today, right? You would rather have the dollar today than a dollar uh promised to you in a year.

Money uh changes value over time. And that's where the math of finance comes in. So, a simple example to kind of get us started and get us thinking about this. I buy a $1,000 investment that offers 5% annual interest. Whenever you're quoted interest, it doesn't say annual or when when you assume annual. Uh question, how much is it worth in a year? Okay. So, your intuition and my intuition here should be pretty much right.

Right? It's a $1,000 investment. It offers 5% interest. That means it's $50 in interest. 1,000 * 5% is 50. And so if I don't lose that original investment, I'll have a,000 + 50. I'll have 1050 in a year. And we of course are right now. Yes, we can solve I would call this a future value of a lumpsum question, right? And is only one year away. We can solve this just in our head just with our own intuition. But what if I said, "Oh, we left it in and let it roll over for 10 years." Oh, it's a little bit more complicated.

My intuition doesn't quite get there because year one, I have a th000. Year two, I have 1050 for another year. Year three, I roll that over. And if it keeps rolling, the math gets like, you know, it's it's not so easy. Uh, and so because of that, we're going to use I'll show you how to solve things by hand using formulas this chapter, but also show you how to use a financial calculator. Let's solve this very basic one just by hand and with our financial calculator the more proper way.

And as we jump into the chapter, you're going to do tons of examples. This chapter has more examples than any other chapter I've ever written. But let's solve this one using a formula. And this is a formula. It's again future value of a lump sum. So it says let's keep the question on screen. Um future value that's what we're solving for. That's our like X, our unknown equals PV. Well, what's the value of the investment today on time zero?

The value of investment is a,000 bucks, right? This is what I'm putting in today. Times 1 + R to the T. R is the uh interest rate. In this case, it's it's often called a discount rate or required rate of return. R is sort of a standin. You might have I as your notation in your textbook and T is the number of years or the number of compounding interest periods. In this case, it's 1. So, uh 1 + R to the T 1 + 5% which of course we're going to put in as 05 to the power of t.

So, it's a,000 uh times and then again uh raise something to the power of one. It's just that number. So it's 1.05 to the first power. It's a,000 * 1.05. It's 1050. Big surprise. We kind of knew that already. Again, we wouldn't likely use a formula like this for a one-year annuity. But if I wanted to do 10 years, real easy, right? You just put the exponent to 10. In fact, why don't we just for fun do go out to 10 years.

All right. So x = a,000 * 1.05 005 to the 10th power. Let me get my calculator out. I wasn't planning on doing this, but why not? It's fun. Um, so it's 1.05. This little button is to the power of the y to the x. You'll see it on even your non-financial calculators. Y to the x 10 1.62. I multiply that by a th00and. So this this number in brackets is worth or this uh right here is worth 1.62 1.63 I should say 1.62889. I multiply this by a,000 and I get the value in 10 years. 8.89.

Okay. So there we have it. we've solved for 10 years, which I couldn't do just with my intuition and my cunning and my guile to solve that. I needed a formula. I needed some support, right? Doing it in one year, no problem. Doing it out 10 years, I I need something a little bit more than just my intuition uh to help me solve that one. Um now, I think that formula is good and I I think that's how I would solve it. But there are many things that even get more complicated that have bigger, more detailed formulas that we'll learn this chapter.

And I'll show you the formula way for pretty much everything. But it's also useful if you have uh the ability to use a financial calculator in your class. I highly recommend it. And if I had this problem in a financial calculator, it's actually a little slower to solve in financial calculators. As problems get more complicated, it's actually easier. But let's let's do the 10-year one. The one-year one is too easy. Well, let's do them both.

Okay. So, I'll do the one-year one first. So, here's what I input in my calculator. N is the number of periods. So, we called it T in our formula, but same thing. It's one. IY is 5%. Now, here we don't put in 005 into our calculator. We just put in five. PV is how much it's worth today. I'm going to put this in as a negative. Generally, if I'm making an investment, I'm giving you a,000 today and I'm going to get back positive money later.

PMT is if there's recurring payments. That's useful for annuities. Another concept we learned this chapter. But here, there's no internal like ongoing payments between either us or the the uh person we're investing in. And FV is what we're solving for. So, let's put those numbers into our calculator. So I put one in I put five IY I put a,000 negative PV PMT I put in as zero and then I uh forget how to do this. I think I go compute FV.

Yeah, compute FV and you can see it's 1050. So CPT FV. It's been a while since I've used my financial calculator. Uh, and you can see it's 1050. Well, let's quickly do this for 10 and see if we match. So, this is the number we're looking for. 1628.89. That's what we got with our formula. Let's see. Now, the good thing about a financial calculator is we've already got all the inputs in. All I have to do is put 10 in for N.

And all the other numbers are in. So, now I'm going to compute FV and I get FV is 1628.89. And sure enough, it matches. So the purpose of this chapter is there's these types of calculations all over finance and this was as easy as it gets, right? It gets harder and harder and harder and so you really got to grasp what's going on. So find out from your professor if you can use a financial calculator. If you can, you know, you should be zipping along with your financial calculator.

If you can't, it's totally okay. It's totally appropriate. you're going to need to learn the formulas that we introduce through the chapter. Uh, but that's, you know, I can't speak to what your professor is doing. I think it's appropriate to allow a financial calculator. I think it's appropriate if they don't allow it. So, you have to figure out what your professor is doing and work with them. In our videos, I'll do both.

All right. Thanks so much for watching and uh, practice, practice, practice. You're going to want to do lots of examples and I've got lots for you. Uh, stay tuned for the next video. Bye-bye. In this video, we're going to work on a problem you can download from tonybell.com. Go to the website, click the PDF link, and you'll notice there's no sign in, no sign up. The PDF just pops right up. You'll scroll down and find whatever problem it is that we're working on.

As you scroll through the problems, you'll notice many are free and open, like the one you're watching now, but some are memberson. I think the free and open ones are enough for most people, but if you can't get enough of me and you'd like to join and get access to those membersonly videos, click the join button underneath the YouTube play box. All right, thanks so much for watching. Let's get started. Let's take a look at problem 31A, the first in our series on time value of money.

Uh, so we deposit some money in an account. It's going to grow for a while. We got to figure out, well, what's it going to be when we go to withdraw it a year or five years from now? Uh, you deposit $5,000 into a high yield savings account that pays 4% interest. Uh, how much money do you have after a year? Okay. Well, this I don't need any fancy finance to tell me, right? I can just go, well, it's $5,000 I'm putting in.

It earns 4% interest, so that's $200 is what it's going to earn this year. So, if I start with 5,000, how much money do I have? I'll have $5,200. But of course, you probably won't be handed a question like this on your corporate finance midterm or, you know, in any test. It's it's too uh uh basic, I would say. But, you know, it could ask what's that going to grow to over five years. And it's not as simple as saying, well, it's $200 in interest every year.

So, five years from now, that'll be $1,000 in interest. Because after year one, we have 5,200 in the account. and that 5,200 grows at 4%. This is the concept of compound interest. I'll show you how to solve this in a financial calculator in a minute. Uh but I would never solve this one with a financial calculator. I would do it by hand. And here's how you would do this by hand. You go $5,000 times 1 + r being our annual interest rate in this case to the power of t. t is the number of years or the number of periods that this thing is going to compound for.

So $5,000. And and this might seem weird if you're it's probably hopefully it isn't your first time seeing it, but if it is your first time seeing it, it might feel weird. You use this little function so much in a finance class, it's going to become second nature to you. which is why I would never use the financial uh elements of my financial calculator uh to solve here just because the formula is real easy once you've used it a billion times as you will in your finance course.

So 5,000 * 1 plus r well what's 1 plus r it's 1 + 4% it's 1.04 to the t 5 years 1.04 to the^ of 5 okay so let's punch that in our calculator 1.04 04 y to the x that means to the power of and it's the power of five. So 1.2166 that's what this equals 1.2166 * 5,000. So I'll just multiply this number by 5,000 and I get 6083.2683.26. Okay. So there we've answered the question. We're done. And the idea is money grows when invested in an account that has interest.

Pretty straightforward. I hope straightforward. Um, I don't think you should use your financial calculator. And if you're not going to use your financial calculator, stop the video here. Just hit the thumbs up on your way out the door. But if you're one of those folks that wants to say, "I'd like to know how to use my financial calculator." This isn't a great question for it, but you know, just practice. So, here's what I use the BA2 Plus financial calculator in classes and in videos.

Uh, if you're using some Casio or some other brand, you know, it'll be similar. So, let's figure out what we're going to input here. The number of periods for this was, I think it was five. The interest rate per period or discount rate per period was 4%. Uh, present value is the value of