FIN 448 Formula Summary

April 22, 2025

IMPORTANT: On the exam, you are only allowed one 8.5 by 11 sheet of paper with your handwritten-
only notes on front and back. You will not be allowed to use this file. Any formula you want from
this file, you must handwrite on your sheet. These are just my suggestions as a starting point for your sheet.
You also are probably better o! not wasting space with writing all my notes and explanations. Just writing
the formulas probably is enough to jog your memory.

Contents
1 Valuation 2
1.1 Annuities and Perpetuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
1.2 Fixed Assets and Related Items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
1.3 Net Working Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
1.4 Free Cash Flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.5 CAPM, WACC, and Enterprise Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1.6 Discounted Cash Flow Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1.7 Multiples . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

2 Capital Structure 6
2.1 M&M Proposition I (Value Irrelevance) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
2.2 M&M Proposition II (Cost of Capital) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
2.3 Leverage, EPS, and P/E Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

3 Capital Structure Decisions and Taxes 6

3.1 Present Value of Tax Shields (PVTS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
3.2 Firm Value and WACC with Corporate Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
3.3 Personal Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
3.4 Cost of Equity under Di!erent Tax Shield Assumptions . . . . . . . . . . . . . . . . . . . . . 8

4 Capital Structure Decisions and Bankruptcy Costs 8

4.1 M&M I under Di!erent Assumptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
4.2 Measuring Distress Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

5 Information Asymmetry and Security Issuance 9

6 Convertible Debt 9

7 Payout Policy 9
7.1 Share Repurchase Mechanics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
7.2 Payout vs. Retention with Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
7.3 Payout Form and Personal Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

8 Supporting Formulas & Definitions 10

8.1 Basic Financial Calculations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
8.2 Valuation Models (CAPM) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

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1 Valuation
1.1 Annuities and Perpetuities
Remember that if you have any cash flow at time 0, you must add it on to the formulas below, which assume
0 cash flow at time 0.

Level Perpetuity
(or just “Perpetuity”) that pays CF at time 1

CF
P V0 =
r

Growing Perpetuity
that pays CF1 at time 1 and then payments grow at rate g forever.
CF1
P V0 =
r→g

Level Annuity
(or just “Annuity”) that pays CF for N periods starting at time 1.
! "
CF 1
P V0 = · 1→
r (1 + r)N

Growing Annuity
that pays CF1 at time 1, and then the payments grow at rate g for N periods.
# ! "N $
CF1 1+g
P V0 = · 1→
r→g 1+r

1.2 Fixed Assets and Related Items

After Tax Proceeds from Sale of Fixed Assets
After Tax Proceeds = Sale Price → ω · (Sale Price → Book Value)
where ω is the corporate tax rate, and

Book Value = Purchase Price → Accumulated Depreciation

1.3 Net Working Capital

Net Working Capital = Current Assets (minus Excess Cash) → Current Liabilities (minus Debt Items)
where the debt items are any kind of interest-bearing debt, like current portion of long-term debt, short-term
borrowing, etc.

Forecasting Net Working Capital With “Days” Ratios

(Using a 360 Day Year Convention)

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Days Sales Outstanding (DSO): Rearrange to Calculate Accounts Receivable

Accounts Receivable
DSO = ↑ 360
Revenue
DSO
Accounts Receivable = Revenue ↑
360

Days Sales Inventory (DSI): Rearrange to Calculate Inventory

Inventory
DSI = ↑ 360
Revenue
DSI
Inventory = Revenue ↑
360

Days Payable Outstanding (DPO): Rearrange to Calculate Accounts Payable

Accounts Payable
DPO = ↑ 360
Cash Operating Costs
DPO
Accounts Payable = Cash Operating Costs ↑
360

1.4 Free Cash Flow

Method 1: Change in Net Fixed Assets
(takes care of two steps at once) Note: in the Change in NFA formulas below, I’m assuming no fixed assets
were sold.
”NFA = Capital Expenditures → Depreciation
→”NFA = →Capital Expenditures + Depreciation
So, by subtracting change in NFA, you are (1) subtracting Capex and (2) adding depreciation

Direct Method
F CF = EBIT · (1 → ω ) → ”NFA → ”NWC

Indirect Method

F CF = Net Income + After Tax Interest Expense → ”NFA → ”NWC

Method 2: Capital Expenditures and Depreciation Shown Separately

Indirect Method

F CF = Net Income + After Tax Interest Expense + Depreciation → Capital Expenditures → ”NWC

Direct Method

F CF = EBIT · (1 → ω ) + Depreciation → Capital Expenditures → ”NWC

In this method 2, if there are any sales of fixed assets or recovery of net working capital, you need to add
those e!ects on to free cash flow, making sure to include the e!ects of any taxes (capital gains tax on fixed
asset sales or tax losses lost NWC).

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1.5 CAPM, WACC, and Enterprise Value
Note that in all formulas in this section D is Net Debt:

Net Debt = Total Debt → Excess Cash

Enterprise Value = Net Debt + Equity = Total Debt + Equity → Excess Cash
E[ri ] = rf + εi · Market Risk Premium = rf + εi · (E[rM ] → rf )
ϑAsset i
εi = Corr(Asset i, Market) ·
ϑMarket
D E
W ACC = · rD · (1 → ω ) + · rE
D+E D+E
D Net Debt
Net Debt to Value = =
D+E Enterprise Value
E Equity
Equity to Value = =
D+E Enterprise Value
D Net Debt to Value
=
E Equity to Value
D D/E D Net Debt to Value
= and =
D+E 1 + D/E E Equity to Value
With probability of default p and loss in the case of default of L per dollar of debt, the expected return on
debt is:
rD = Y T M → p · L

Unlevering betas (constant debt-to-value policy):

D E
εA = · εD + · εE
D+E D+E

Unlevering betas (permanent debt policy):

D(1 → ω ) E
εA = · εD + · εE
D(1 → ω ) + E D(1 → ω ) + E

Relevering Beta (constant debt-to-value policy)

D
εE = εA + · (εA → εD )
E

Relevering Beta (permanent debt policy)

D(1 → ω )
εE = εA + · (εA → εD )
E

1.6 Discounted Cash Flow Valuation

Dividend Discount Model for Stocks
D1
P0 = D 0 +
rE → g
where Dt is the dividend per share at time t, and rE is the expected return on equity.

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WACC Method for Free Cash Flow Valuation
Finite T Periods:
F CF1 F CF2 F CFT
Enterprise Value0 = F CF0 + + + ··· +
1 + W ACC (1 + W ACC)2 (1 + W ACC)T

Growing Perpetuity
F CF1
Enterprise Value0 = F CF0 +
W ACC → g
where g is the growth rate of free cash flow.

Two-Stage (T periods and then a terminal value)

T
% F CFt Terminal ValueT
Enterprise Value0 = F CF0 + t
+
t=1
(1 + W ACC) (1 + W ACC)T

Multiple Approach to Terminal Value

Terminal ValueT = Characteristic at time T ↑ Multiple

where the characteristic at time T could be something like EBIT, EBITDA, or Net Income

Growing Perpetuity Approach to Terminal Value (assumes growth rate g forever)

F CFT · (1 + g)
Terminal ValueT =
W ACC → g

1.7 Multiples
Dividend per Share Dt
b = Payout Ratiot = =
Earnings per Share EP St
In the four equations below, you don’t need to know how to derive the expressions, I just put that in for your
information. You only need the right-most expressions (with the b in them for the P/E ratios or with the
FCF/EBIT in them for the EV to EBIT ratios).

Forward Price-to-Earnings
D1
P0 r →g D1 /EP S1 b
= E = =
EP S1 EP S1 rE → g rE → g

Trailing Price-to-Earnings
(assuming that D1 = D0 · (1 + g))
P0 D1 /(rE → g) D0 · (1 + g) D0 /EP S0 b · (1 + g)
= = = · (1 + g) =
EP S0 EP S0 (rE → g)EP S0 rE → g rE → g

Forward EV to EBIT (or EBITDA)

EV0 F CF1 /(W ACC → g) F CF1 /EBIT1
= =
EBIT1 EBIT1 W ACC → g

Trailing EV to EBIT (or EBITDA)

EV0 F CF1 /(W ACC → g) F CF0 · (1 + g) F CF0 /EBIT0
= = = · (1 + g)
EBIT0 EBIT0 (W ACC → g)EBIT0 W ACC → g

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2 Capital Structure
Key Assumptions: Perfect capital markets, no taxes.

2.1 M&M Proposition I (Value Irrelevance)

• Firm Value:
VL = V U
Explanation: In perfect capital markets with no taxes, the total value of the firm is independent of its
capital structure. Financing decisions do not create value.

2.2 M&M Proposition II (Cost of Capital)

• Weighted Average Cost of Capital (Unlevered Cost of Capital):
E D
W ACC = rU = rE + rD
E+D E+D
Explanation: The firm’s overall cost of capital (rU ) is the weighted average of the costs of its equity
(rE ) and debt (rD ). It remains constant regardless of leverage in perfect markets.
• Cost of Levered Equity:
D
rE = r U + (rU → rD )
E
Explanation: The cost of equity (rE ) increases linearly with the debt-to-equity ratio ( D
E ) because
equityholders bear more financial risk.

2.3 Leverage, EPS, and P/E Ratios

• Price/Earnings Ratio from Dividend Growth Model:
D1 EP S ↑ Payout Ratio P Payout Ratio
P = = =↓ = PE =
rE → g rE → g E rE → g
Explanation: Shows how the P/E ratio relates to payout policy, growth (g), and the cost of equity
(rE ). Changes in leverage a!ect rE , thus changing the P/E ratio, which can o!set changes in EPS.

3 Capital Structure Decisions and Taxes

Key Assumptions: Incorporates corporate taxes (ωc ). Personal taxes (ωi , ωe ) considered separately.

3.1 Present Value of Tax Shields (PVTS)

• General Definition:
%↑
E[Tax Shieldt ]
P VT S =
t=1
(1 + rT S )t
Explanation: The value added by debt due to tax savings is the present value of all expected future
interest tax shields, discounted at a rate appropriate for their risk (rT S ).
• Fixed, Perpetual Debt (Assume rT S = rD ):
E[Tax Shield] (ωc ↑ D ↑ rD )
P VT S = = = ωc D
rD rD
Explanation: If the debt level (D) is fixed forever and tax shields have the same low risk as the debt,
the PVTS is the corporate tax rate (ωc ) times the amount of debt.

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 • Target D/V Ratio with Growth (Assume rT S = rU ):
D ↑ r D ↑ ωc
P VT S =
rU → g
Explanation: If the firm maintains a target debt-to-value ratio and grows at rate g, the tax shields
grow and are assumed to have the same systematic risk as the firm’s assets (discounted at rU ). D is
the initial debt amount.

3.2 Firm Value and WACC with Corporate Taxes

• Adjusted Present Value (APV):
V L = V U + P VT S
Explanation: The value of a levered firm (VL ) equals the value if it were unlevered (VU ) plus the
present value of tax shields generated by debt.
• E!ective After-Tax Cost of Debt:
rD,after-tax = rD (1 → ωc )
Explanation: The e!ective cost of debt to the firm is reduced because interest payments are tax-
deductible at the corporate level.
• After-Tax WACC:
E D
W ACCL = rE + rD (1 → ωc )
VL VL
Explanation: The overall cost of capital for a levered firm, incorporating the tax benefit of debt directly
into the cost of the debt component. Used to value the firm by discounting expected free cash flows.

3.3 Personal Taxes

Key Assumptions: Considers personal taxes on interest (ωi ) and equity income (ωe ).
• Derivation of E!ective Tax Advantage (ω ↓ ):

Calculation Implication After Corp. Tax After Personal Tax

(1) Unit Interest Income to Debtholder $1 $1(1 → ωi )
(2) Unit Equity Income Income to Equityholder $1(1 → ωc ) $1(1 → ωc )(1 → ωe )
Di!erence [(1)-(2)] Debt vs. Equity CF Di!. ωc 1(1 → ωi ) → 1(1 → ωc )(1 → ωe )
% Di!erence E!ective Tax Advantage ωc ω↓

Explanation: This table compares the net cash flow received by investors per dollar of pre-tax earnings
distributed either as interest or as equity income (dividends/capital gains), considering both corporate
and personal taxes.
• E!ective Tax Advantage of Debt (ω ↓ ):
[1(1 → ωi )] → [1(1 → ωc )(1 → ωe )] (1 → ωc )(1 → ωe )
ω↓ = =1→
1(1 → ωi ) 1 → ωi
Explanation: The net tax advantage of $1 of interest vs. $1 of equity income after considering both
corporate and personal taxes. It represents the percentage di!erence derived in the table above.
• PVTS with Personal Taxes (Fixed, Perpetual Debt):
P VT S = D ↑ ω ↓
Explanation: The present value of tax shields adjusted for the relative personal tax rates on debt and
equity income.

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 • Adjusted Cost of Debt (for levering/unlevering):

↓ 1 → ωi
rD = rD
1 → ωe
Explanation: A hypothetical cost of debt adjusted to reflect the personal tax rate on equity income.
Used for consistent calculation of rU when personal tax rates di!er.
• Unlevered Cost of Equity (with Personal Taxes):

D ↓ E
rU = rD + rE
VL VL
↓
Explanation: Calculating the unlevered cost of capital using the personal-tax-adjusted cost of debt rD .

• Levered Cost of Equity (with Personal Taxes):

D ↓
rE = r U + (rU → rD )
E
↓
Explanation: Calculating the levered cost of equity using the personal-tax-adjusted cost of debt rD .

3.4 Cost of Equity under Di!erent Tax Shield Assumptions

• Assuming rT S = rU :
D
(rU → rD )
rE = r U +
E
Explanation: M&M II formula (no taxes) is used when tax shields are assumed to have the same
systematic risk as the firm’s assets (rU ).
• Assuming rT S = rD :
D
rE = rU + (rU → rD )(1 → ωc )
E
Explanation: Modified M&M II formula used when tax shields are assumed to have the same low risk
as the debt (rD ), incorporating the corporate tax shield e!ect.

4 Capital Structure Decisions and Bankruptcy Costs

Key Assumptions: Considers costs associated with financial distress.

4.1 M&M I under Di!erent Assumptions

• With no taxes (Perfect Markets): VL = VU
• With corporate tax benefits only: VL = VU + P VT S

• With tax benefits and distress costs (Trade-o! Theory):

VL = VU + P VT S → P V [E(Distress Cost)]

Explanation: Firm value reflects a trade-o!: leverage adds value via tax shields (P VT S ) but subtracts
value due to the expected costs of potential financial distress. This is the core equation of the trade-o!
theory.

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4.2 Measuring Distress Costs
• Present Value of Expected Distress Costs (Derived Form):
↑
% p(1 → p)t→1 c
P V [E(Distress Cost)] =
t=1
(1 + rf )t

Explanation: Conceptually, the PV is the sum of the discounted expected costs for each future year,
where p is the probability of entering distress in any given year (assuming constant probability), c is
the cost if distress occurs (as a value), and rf is the appropriate discount rate (often approximated by
the risk-free rate).
• Present Value of Expected Distress Costs (Simplified Form):
p↑c
P V [E(Distress Cost)] =
rf + p

Explanation: The simplified result of the infinite summation above, providing a practical way to
estimate the present value impact of potential distress costs.
• Variable Definitions:

– p: Annual marginal probability of default/distress.

– c: Realized financial distress cost (e.g., % of pre-distress firm value).
– rf : Discount rate (approximated by risk-free rate in examples).

5 Information Asymmetry and Security Issuance

• Internal Rate of Return (CAGR Formula):
! " T1
VT
IRR = →1
V0

Explanation: Calculates the compound annual growth rate (CAGR), which equals the IRR only for
an investment with a single initial outflow (V0 ) and a single terminal inflow (VT ) after T periods.

6 Convertible Debt
• Conversion Value:
Conversion Value = # of Shares per Bond ↑ Stock Price
Explanation: The market value of the shares a bondholder would receive upon converting one bond.

• Conversion Price:
Face Value of Bond
Conversion Price =
# of Shares per Bond
Explanation: The implied stock price at which the conversion value equals the bond’s face value.
Conversion is generally beneficial for the holder if the stock price is above this level.

7 Payout Policy
Key Assumptions: Considers corporate (ωc ) and personal taxes on dividends (ωd ) and capital gains (ωe ).

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7.1 Share Repurchase Mechanics
• Value Relationship:
(N → ”N ) ↑ P = E
Explanation: Post-repurchase, the total equity value (E) equals the remaining shares (N → ”N ) times
the share price (P ).
• Repurchase Value:
”N ↑ P = R
Explanation: The cash spent on repurchase (R) equals the number of shares bought back (”N ) times
the price paid per share (P ).

7.2 Payout vs. Retention with Taxes

• Payout Today (Investor’s Value Next Year):

C ↑ (1 → ωd ) ↑ [1 + r(1 → ωi )]

Explanation: The future value for an investor if cash C is paid out as a dividend today (taxed at ωd )
and invested personally at rate r (interest taxed at ωi ).
• Retain & Payout Next Year (Investor’s Value Next Year):

C ↑ [1 + r(1 → ωc )] ↑ (1 → ωd )

Explanation: The future value for an investor if cash C is retained by the firm, earns r (taxed at ωc ),
and the net amount is paid as a dividend next year (taxed at ωd ). Comparing helps determine the
tax-e#cient location for cash. Note: r here represents the investment return rate.

7.3 Payout Form and Personal Taxes

• Ex-Dividend Price Drop:
1 → ωd
Pcum → Pex = Div ↑
1 → ωe
Explanation: The expected drop in stock price from cum-dividend (Pcum ) to ex-dividend (Pex ) reflects
the after-tax value of the dividend (Div) relative to an equivalent capital gain, considering personal
tax rates ωd and ωe .
• E!ective Tax Cost of Dividends vs. Repurchases:
ωd → ωe
Tax Cost =
1 → ωe
Explanation: The percentage tax disadvantage of receiving $1 in dividends compared to $1 in capital
gains (if realized immediately).

8 Supporting Formulas & Definitions

8.1 Basic Financial Calculations
• EBIT (Earnings Before Interest and Taxes):

EBIT = EBIT DA → Depreciation & Amortization

Explanation: Operating profit before deducting interest and taxes.

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 • Net Income (Earnings):

Net Income = (EBIT → Interest Expense) ↑ (1 → ωc )

Explanation: Profit after deducting interest and corporate taxes.

• EPS (Earnings Per Share):

Net Income
EP S =
Shares Outstanding
Explanation: Net income allocated to each outstanding share of common stock.

• Market Value of Equity:

E = Shares Outstanding ↑ Price per Share
Explanation: Total market worth of the company’s common stock.
• Market Value Balance Sheet:
VL = D + E
Explanation: The total market value of a levered firm’s assets (VL ) equals the market value of its debt
(D) plus the market value of its equity (E).
• Interest Coverage Ratio (Example: EBIT Coverage):

EBIT
Coverage Ratio =
Interest Expense
Explanation: Measures a company’s ability to meet its interest obligations with its operating earnings.
Often used to help assess credit risk/rating.

8.2 Valuation Models (CAPM)

Key Assumptions: Based on the Capital Asset Pricing Model.
• Required Return / Cost of Capital (General CAPM):

r = rf + ε ↑ (rm → rf )

Explanation: The required return on an asset (r) depends on the risk-free rate (rf ), the asset’s sys-
tematic risk (ε), and the market risk premium (rm → rf ).
• Unlevered Cost of Capital (rU ):
rU = rf + εU ↑ (rm → rf )
Explanation: The required return on the firm’s assets, calculated using the asset beta (εU ).
• Cost of Debt (rD ):
rD = rf + εD ↑ (rm → rf )
Explanation: The required return on the firm’s debt, calculated using the debt beta (εD ).

• Cost of Equity (rE ):

rE = rf + εE ↑ (rm → rf )
Explanation: The required return on the firm’s equity, calculated using the equity beta (εE ).

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