by Sertac Roni S.

Calculation of Net financial assets (NFA) or Net financial obligation (NFO)

Net financial obligation = Financial liabilities - Financial assets

Should a firm that pays higher dividends have a higher share value?

No, a dividend is not a measure of value creation but of value distribution. Think of a firm that “pays no dividends”: doesn’t it have any equity value?

Which are the main advantages of the residual earnings model?

Dirty-surplus accounting: The most common items (other comprehensive income)

Unrealized gains and losses on securities (debt and equity)
currency translation gains and losses
gains and losses on derivative instruments

Calculation of tax benefit

Tax benefit = Net interest expenses * tax rate

Allocation of taxes

• In the income statement only one tax number is reported: It must be allocated to the operating and financial components to put both on an after-tax basis

• First, calculate the tax benefit (tax shield) provided by deducting interest expense

Tax benefit = Net interest expense x Tax rate

From the operating income deduct both the total tax and the tax benefit, to capture what the operating income would have been, after tax, had there been no financing activities

• To the net financial expense add the tax benefit, because its net effect is attributable to the financing activities

What is meant by saying that debt provides a tax shield?

Interest is deductible for taxes so issuing debt shields the firm from taxes.

Calculation of Net payout to Shareholders

Calculation of dividend payout and total payout ratio

Dividend Payout = Dividends / Comprehensive Income

Total Payout ratio = Dividends + Stock Repurchases / Comprehensive Income

Calculation of Return on net financial assets (RNFA)

RNFA = NFI / 0.5(NFA+NFAt-1)

Calculating Comprehensive Income by using statement of shareholders’ equity

Comprehensive Income = Ending Equity - Beginning Equity + Net payout to Shareholders

Calculation of common shareholders’ equity (CSE)

CSE = NOA + NFA —> if NFA is positive

CSE = NOA - NFO —> if NFA is negative which is NFO

Difference between B/S and reformulated B/S

Calculation of Net operating assets (NOA)

Net operating assets = Operating assets - Operating liabilities

What means “buyer/purchase of debt”?

A firm can be a buyer of debt (of a debt issuer) if it has excess cash.

Then it holds financial assets and interest and principal repayments flow into the firm.

What means debt issuer?

A firm can be an issuer of debt (to a debtholder) if it needs cash.

Then it has financial obligations or financial liabilities, and interest and principal repayments are paid out of the firm.

Calculation of operating liability leverage ratio (OLLEV)?

Operating liability leverage ratio (OLLEV) = OL / NOA

Calculation of financial leverage ratio (FLEV)?

Financial leverage ratio (FLEV) = NFO / CSE

Calculation of return on common equity (ROCE)?

-> without any leverage

ROCE = Comprehensive Earnings / 1/2(CSE + CSEt-1)

Calculation of capitalization ratio?

Capitalization ratio = NOA / CSE

Calculation of interest expense?

NFO * interest rate on loan

Calculation of net financial expense (NFE)?

NFE = interest expense * (1-taxrate)

Calculation of return on net operating assets (RNOA)?

-> with Avg. NOA

RNOA = OI / 0.5(NOA + NOAt-1)

Calculation of net borrowing cost (NBC)?

NBC = NFE / 0.5(NFO + NFOt-1)

Calculation of return on common equity (ROCE)?

-> with operating spread and financial leverage (FLEV)

The Financial Leverage Equation

Calculation of return on net operating assets (RNOA)?

-> with ROOA, OLSPREAD and OLLEV

Calculation of operating spread?

Operating spread = RNOA - NBC

Calculation of OLSPREAD?

OLSPREAD = ROOA - Short term borrowing rate (after tax)

Calculation of required return on debt?

Required Return on Debt = Risk-free Rate + Default Premium

Calculation of Asset Turnover (ATO)

ATO = Sales / NOA

Calculation of Operating Profit Margin

Operating Profit Margin = OI / Sales

Explicit Interest:

This is the interest that is clearly stated in a financial agreement or contract.
Typically associated with loans, bonds, and credit facilities where the interest rate is specified.
Payments are usually made at regular intervals, such as monthly or annually.
It is a fixed or variable cost that is legally binding and must be paid on the principal amount borrowed.

Implicit Interest:

Refers to interest that is not directly stated or visible as a separate charge.
Often found in lease agreements or other contracts where the cost of interest is included in the periodic payments but is not separately identified.
Calculated by comparing the present value of payments or receipts to the cash price of the good or service.
It reflects the opportunity cost of funds tied up in investments, where the return is not in the form of periodic interest payments.

What would be the operating profitability without operating liabilities?