Beruflich Dokumente
Kultur Dokumente
Accounting
Chapter 4
Learning Objectives:
Income Statement
Balance Sheet
Statement of Cash Flows
Accompanying Notes
Income Statement
ACME CORPORATION
Current Assets:
Cash
Inventory
A/R
Fixed Assets:
Land
Liabilities +
Owners Equity
Current Liabilities:
A/P
Accruals
S-T Debt
Plant
Equipment
Less: Ac. Dep.
Owners Equity:
Common Stock
Capital in Excess
of Par
Retained Earnings
Balance Sheet
ACME CORPORATION
Balance Sheet
ACME CORPORATION
December 31
Balance Sheet
ACME CORPORATION
Assets = Liabilities + Owners Equity
Sales
Investment Income
Gains
Interest Received
Dividends Received
COGS
Salaries
Depreciation Exp.
Taxes
Other Expenses
Interest Paid
Dividends
Retained
Earnings
Cash Sales +
Payments to Suppliers Depreciation Exp. + Salaries Collection of A/R + Increase A/R Decrease inventory +
Decrease Payables Decrease Accruals -
From Investing:
14
Statement of
Flows
Cash Cash
Inflow - Cash
Outflow = Change in Cash
From Financing:
Sale of stock +
Buy back stock Issue of LT debt +
Repay LT debt or notes payable +
Pay dividends Pay interest 15
DEPRECIATION
Accounting depreciation is the
allocation of an assets initial
cost over time.
Allowable depreciation
expense is determined by
established accounting rules.
CALCULATION OF
DEPRECIATION
Depreciable basis
The ten men drank COFFEE every day and seemed quite happy with the arrangement, until
one day, the owner threw them a curve ball. "Since you are all such good customers," he
said, "I'm going to reduce the cost of your daily coffee bill by $20". Unlimited coffee for the
ten men would now cost just $80.
The group still wanted to pay their bill the way we pay our taxes. So the first four men
were unaffected. They would still drink for free. But what about the other six men? How
could they divide the $20 windfall so that everyone would get his fair share?
They realized that $20 divided by six is $3.33. But if they subtracted that from
everybody's share, then the fifth man and the sixth man would each end up being paid to
drink THEIR COFFEE.
Now, the first four men along with the fifth would pay nothing.
The sixth now paid $2 instead of $3 (33% saving).
The seventh now paid $5 instead of $7 (28% saving).
The eighth now paid $9 instead of $12 (25% saving).
The ninth now paid $14 instead of $18 (22% saving).
The tenth now paid $49 instead of $59 (16% saving).
Income
Top 1%
40%
Top 10%
71%
Top 50%
97%
From 2009 IRS Data
'politicians!'
Dividend
Income
Corp A
Corp B
Corp A pays a
$2/share dividend
to shareholders.
$200
forget
Who
pays
the
bills.
Analysis of Financial
Statements
Chapter 5
37
Learning Objectives
How financial ratio analysis
helps managers assess the
firms health.
Compute profitability, liquidity,
debt, asset activity, and market
value ratios.
Compare financial information
over time and among
companies.
38
Ratio Analysis
Financial managers use ratios to
interpret the raw numbers on
financial statements.
Relative measures allow comparison
over time and to other firms.
Ratios are used by financial
managers, other business
managers, creditors, and investors.
39
Ratio Analysis
Five Categories of Ratios
Profitability ratios
Liquidity ratios
Debt ratios
Asset activity ratios
Market value ratios
40
Ratio Analysis
Profitability Ratios
41
Ratio Analysis
Profitability Ratios
Gross Profit Margin =
Gross Profit
Sales
Balance Sheet
Excalibur Corporation
Cash
$175
Accounts Receivable 430
Inventories
625
Current Assets
$1,230
Plant & Equipment $2,500
Less:Acc. Depr.
(1,200)
Net Fixed Assets
$1,300
Total Assets
$2,530
Income Statement
Excalibur Corporation
Sales
$1,450
Cost of Goods Sold
875
Gross Profit
$575
Operating Expenses
45
Depreciation
200
Net Operating Income
$330
Interest Expense
60
Income Before Taxes
$270
Taxes (40%)
108
Net Income
$162
Common Dividends Paid
100
Addition to Retained Earnings $62
Gross
Profit
Margin
Accounts Payable
$115
S-T Notes Payable
115
Current Liabilities
$230
Bonds
$600
Owners Equity
Common Stock
$300
Capital in Excess of Par 600
Retained Earnings
800
Total Owners Equity $1,700
Total Liabilities and
Owners Equity
$2,530
Gross Profit
Sales
$575
$1,450
= 39.7%
43
Ratio Analysis
Profitability Ratios
Operating Profit Margin =
Operating Income
Sales
44
Balance Sheet
Excalibur Corporation
Cash
$175 Accounts Payable
$115
Accounts Receivable 430 S-T Notes Payable
115
Inventories625 Current Liabilities
$230
Current Assets
$1,230 Long-term Debt
$600
Plant & Equipment $2,500 Owners Equity
Less:Acc. Depr.
(1,200) Common Stock
$300
Net Fixed Assets
$1,300 Capital in Excess of Par 600
Total Assets
$2,530 Retained Earnings
800
Total Owners Equity $1,700
Income Statement
Total Liabilities and
Excalibur Corporation
Owners Equity
$2,530
Sales
$1,450
Cost of Goods Sold
875
Gross Profit
$575
Operating Expenses
45
Depreciation
200
Operating
Operating Income
$330
Operating Income
Profit
=
Interest Expense
60
Sales
Income Before Taxes
$270
Margin
Taxes (40%)
108
Net Income
$162
$330
Oper. Profit Margin =
= 22.8%
Common Dividends Paid
100
$1,450
Addition to Retained Earnings $62
45
Ratio Analysis
Profitability Ratios
Note: Net Income equals Earnings Available to CS
when there is no preferred stock.
Net Income
Net Profit Margin =
Sales
Balance Sheet
Excalibur Corporation
Assets
Liabilities
Cash
$175 Accounts Payable
$115
Accounts Receivable 430 S-T Notes Payable
115
Inventories625 Current Liabilities
$230
Current Assets
$1,230 Long-term Debt
$600
Plant & Equipment $2,500 Owners Equity
Less:Acc. Depr.
(1,200) Common Stock
$300
Net Fixed Assets
$1,300 Capital in Excess of Par 600
Total Assets
$2,530 Retained Earnings
800
Total Owners Equity $1,700
Income Statement
Total Liabilities and
Excalibur Corporation
Owners Equity
$2,530
Sales
$1,450
Cost of Goods Sold
875
Gross Profit
$575
Operating Expenses
45
Depreciation
200
Net
Operating Income
$330
Net Income
Profit
=
Interest Expense
60
Sales
Margin
Income Before Taxes
$270
Taxes (40%)
108
$162
Net Income
$162
Net
Profit
Margin
=
= 11.2%
Common Dividends Paid
100
$1,450
Addition to Retained Earnings $62
47
Ratio Analysis
Profitability Ratios
Return on Assets =
Net Income
Total Assets
48
Balance Sheet
Excalibur Corporation
Assets
Liabilities
Cash
$175 Accounts Payable
$115
Accounts Receivable 430 S-T Notes Payable
115
Inventories
625 Current Liabilities
$230
Current Assets
$1,230 Long-term debt
$600
Plant & Equipment $2,500 Owners Equity
Less:Acc. Depr.
(1,200) Common Stock
$300
Net Fixed Assets
$1,300 Capital in Excess of Par 600
Total Assets
$2,530 Retained Earnings
800
Total Owners Equity $1,700
Total Liabilities and
Income Statement
Owners Equity
$2,530
Excalibur Corporation
Sales
$1,450
Cost of Goods Sold
875
Gross Profit
$575
Operating Expenses
45
Net Income
Return on
Depreciation
200
=
Operating Income
$330
Total Assets
Assets
Interest Expense
60
Income Before Taxes
$270
Taxes (40)
108
$162 = 6.4%
Net Income%
$162
ROA = $2,530
Common Dividends Paid
100
49
Addition to Retained Earnings $62
Ratio Analysis
Profitability Ratios
Net Income
Return on Equity =
Common Equity
How well is the firm generating return to
its equity providers?
50
Balance Sheet
Excalibur Corporation
Assets
Liabilities
Cash
$175 Accounts Payable
$115
Accounts Receivable 430 S-T Notes Payable
115
Inventories
625 Current Liabilities
$230
Current Assets
$1,230 Long-term Debt
$600
Plant & Equipment $2,500 Owners Equity
Less:Acc. Depr.
(1,200) Common Stock
$300
Net Fixed Assets
$1,300 Capital in Excess of Par 600
Total Assets
$2,530 Retained Earnings
800
Total Owners Equity $1,700
Income Statement
Total Liabilities and
Excalibur Corporation
Owners Equity
$2,530
Sales
$1,450
Cost of Goods Sold
Gross Profit
Operating Expenses
Depreciation
Operating Income
Interest Expense
Income Before Taxes
Taxes (40%)
Net Income
Common Dividends Paid
Addition to Retained Earnings
875
$575
45
200
$330
60
$270
108
$162
100
$62
Return on Equity =
ROE =
$162
$1,700
Net Income
Common Equity
= 9.53%
51
Ratio Analysis
Liquidity Ratios
Measure the ability of the firm to
meet its short-term financial obligations.
Current Assets
Current Ratio =
Current Liabilities
Are there sufficient current assets to pay off
current liabilities? What is the cushion of
safety?
52
Balance Sheet
Excalibur Corporation
Assets
Liabilities
Cash
$175 Accounts Payable
$115
Accounts Receivable 430 S-T Notes Payable
115
Inventories
625 Current Liabilities
$230
Current Assets
$1,230 Long-term Debt
$600
Plant & Equipment $2,500 Owners Equity
Less:Acc. Depr.
(1,200) Common Stock
$300
Net Fixed Assets
$1,300 Capital in Excess of Par 600
Total Assets
$2,530 Retained Earnings
800
Total Owners Equity $1,700
Total Liabilities and
Owners Equity
$2,530
Current Ratio =
Current Assets
Current Liabilities
Ratio Analysis
Liquidity Ratios
Measure the ability of the firm to meet
its short-term financial obligations.
Acid-Test Ratio =
Balance Sheet
Excalibur Corporation
Assets
Liabilities
Cash
$175 Accounts Payable
$115
Accounts Receivable 430 S-T Notes Payable
115
Inventories
625 Current Liabilities
$230
Current Assets
$1,230 Long-term Debt
$600
Plant & Equipment $2,500 Owners Equity
Less:Acc. Depr.
(1,200) Common Stock
$300
Net Fixed Assets
$1,300 Capital in Excess of Par 600
Total Assets
$2,530 Retained Earnings
800
Total Owners Equity $1,700
Total Liabilities and
Owners Equity
$2,530
Acid-Test Ratio =
Acid-Test Ratio =
$1,230 -$625
= 2.63x
$230
55
Ratio Analysis
Debt Ratios
Measure the relative size of
the firms debt load and the
firms ability to pay off the
debt.
56
Ratio Analysis
Debt Ratios
Debt Ratio =
Total Debt
Total Assets
57
Balance Sheet
Excalibur Corporation
Assets
Liabilities
Cash
$175 Accounts Payable
$115
Accounts Receivable 430 S-T Notes Payable
115
Inventories
625 Current Liabilities
$230
Current Assets
$1,230 Long-term Debt
$600
Plant & Equipment $2,500 Owners Equity
Less:Acc. Depr.
(1,200) Common Stock
$300
Net Fixed Assets
$1,300 Capital in Excess of Par 600
Total Assets
$2,530 Retained Earnings
800
Total Owners Equity $1,700
Income Statement
Total Liabilities and
Excalibur Corporation
Owners Equity
$2,530
Sales
$1,450
Cost of Goods Sold
Gross Profit
Operating Expenses
Depreciation
Operating Income
Interest Expense
Income Before Taxes
Taxes (40%)
Net Income
Common Dividends Paid
Addition to Retained Earnings
875
$575
45
200
$330
60
$270
108
$162
100
$62
Debt Ratio =
Total Debt
Total Assets
Ratio Analysis
Debt Ratios
Total Debt
Debt to
=
Common Equity
Equity Ratio
What is the proportion of debt relative to
equity financing for the firm?
59
Balance Sheet
Excalibur Corporation
Assets
Liabilities
Cash
$175 Accounts Payable
$115
Accounts Receivable 430 S-T Notes Payable
115
Inventories
625 Current Liabilities
$230
Current Assets
$1,230 Long-term Debt
$600
Plant & Equipment $2,500 Owners Equity
Less:Acc. Depr.
(1,200) Common Stock
$300
Net Fixed Assets
$1,300 Capital in Excess of Par 600
Total Assets
$2,530 Retained Earnings
800
Total Owners Equity $1,700
Income Statement
Total Liabilities and
Excalibur Corporation
Owners Equity
$2,530
Sales
$1,450
Cost of Goods Sold
Gross Profit
Operating Expenses
Depreciation
Operating Income
Interest Expense
Income Before Taxes
Taxes (40%)
Net Income
Common Dividends Paid
Addition to Retained Earnings
875
$575
45
200
$330
60
$270
108
$162
100
$62
Debt to
Equity Ratio
Total Debt
Common Equity
Ratio Analysis
Debt Ratios
Operating Income
Interest Expense
Balance Sheet
Excalibur Corporation
Assets
Liabilities
Cash
$175 Accounts Payable
$115
Accounts Receivable 430 S-T Notes Payable
115
Inventories
625 Current Liabilities
$230
Current Assets
$1,230 Long-term Debt
$600
Plant & Equipment $2,500 Owners Equity
Less:Acc. Depr.
(1,200) Common Stock
$300
Net Fixed Assets
$1,300 Capital in Excess of Par 600
Total Assets
$2,530 Retained Earnings
800
Total Owners Equity $1,700
Income Statement
Total Liabilities and
Excalibur Corporation
Sales
$1,450
Owners Equity
$2,530
Cost of Goods Sold
875
Gross Profit
$575
Operating Expenses
45
Depreciation
200
Times
Operating Income
Operating Income
$330
Interest
=
Interest Expense
60
Interest Expense
Earned
Ratio
Income Before Taxes
$270
Taxes (40%)
108
$330
Net Income
$162
TIE Ratio =
= 5.50x
Common Dividends Paid
100
$60
Addition to Retained Earnings $62
62
Ratio Analysis
Asset Activity Ratios
63
Ratio Analysis
Asset Activity Ratios
Accounts Receivable
Avg. Daily Credit Sales
Balance Sheet
Excalibur Corporation
Assets
Liabilities
Cash
$175 Accounts Payable
$115
Accounts Receivable 430 S-T Notes Payable
115
Inventories
625 Current Liabilities
$230
Current Assets
$1,230 Bonds
$600
Plant & Equipment $2,500 Owners Equity
Less:Acc. Depr.
(1,200) Common Stock
$300
Net Fixed Assets
$1,300 Capital in Excess of Par 600
Total Assets
$2,530 Retained Earnings
800
Total Owners Equity $1,700
Income Statement
Total Liabilities and
Excalibur Corporation
Owners Equity
$2,530
Sales
$1,450
Additional Info:
We assume all
sales are credit
sales.
875
$575
45
200
$330
60
$270
108
$162
100
$62
Average
Accounts Receivable
Collection =
Avg. Daily Credit Sales
Period
ACP =
$430
$1,450/365
= 108.24 days
Days in a
year
65
Ratio Analysis
Asset Activity Ratios
Sales
Inventory
Balance Sheet
Excalibur Corporation
Assets
Liabilities
Cash
$175 Accounts Payable
$115
Accounts Receivable 430 S-T Notes Payable
115
Inventories
625 Current Liabilities
$230
Current Assets
$1,230 Long-term Debt
$600
Plant & Equipment $2,500 Owners Equity
Less:Acc. Depr.
(1,200) Common Stock
$300
Net Fixed Assets
$1,300 Capital in Excess of Par 600
Total Assets
$2,530 Retained Earnings
800
Total Owners Equity $1,700
Income Statement
Total Liabilities and
Excalibur Corporation
Owners Equity
$2,530
Sales
$1,450
Cost of Goods Sold
Gross Profit
Operating Expenses
Depreciation
Operating Income
Interest Expense
Income Before Taxes
Taxes (40%)
Net Income
Common Dividends Paid
Addition to Retained Earnings
875
$575
45
200
$330
60
$270
108
$162
100
$62
Inventory
Turnover =
Ratio
Inventory Turnover =
Sales
Inventory
$1450 = 2.3x
$625
67
Ratio Analysis
Asset Activity Ratios
Sales
Fixed Asset Turnover Ratio = Net Fixed Assets
How effective is the firm in using its fixed
assets to help generate sales?
68
Balance Sheet
Excalibur Corporation
Assets
Liabilities
Cash
$175 Accounts Payable
$115
Accounts Receivable 430 S-T Notes Payable
115
Inventories
625 Current Liabilities
$230
Current Assets
$1,230 Long-term Debt
$600
Plant & Equipment $2,500 Owners Equity
Less:Acc. Depr.
(1,200) Common Stock
$300
Net Fixed Assets
$1,300 Capital in Excess of Par 600
Total Assets
$2,530 Retained Earnings
800
Total Owners Equity $1,700
Income Statement
Total Liabilities and
Excalibur Corporation
Owners Equity
$2,530
Sales
$1,450
Cost of Goods Sold
Gross Profit
Operating Expenses
Depreciation
Operating Income
Interest Expense
Income Before Taxes
Taxes (40%)
Net Income
Common Dividends Paid
Addition to Retained Earnings
875
$575
45
200
$330
60
$270
108
$162
100
$62
Fixed Asset
Turnover
Ratio
Sales
= Net Fixed Assets
$1,450
= 1.12x
$1,300
69
Ratio Analysis
Asset Activity Ratios
Sales
Total Assets
70
Balance Sheet
Excalibur Corporation
Assets
Liabilities
Cash
$175 Accounts Payable
$115
Accounts Receivable 430 S-T Notes Payable
115
Inventories
625 Current Liabilities
$230
Current Assets
$1,230 Long-term Debt
$600
Plant & Equipment $2,500 Owners Equity
Less:Acc. Depr.
(1,200) Common Stock
$300
Net Fixed Assets
$1,300 Capital in Excess of Par 600
Total Assets
$2,530 Retained Earnings
800
Total Owners Equity $1,700
Income Statement
Total Liabilities and
Excalibur Corporation
Owners Equity
$2,530
Sales
$1,450
Cost of Goods Sold
875
Gross Profit
$575
Operating Expenses
45
Total Asset
Depreciation
200
Sales
Turnover = Total Assets
Operating Income
$330
Interest Expense
60
Ratio
Income Before Taxes
$270
Taxes (40%)
108
$1,450
Total
Asset
Turnover
=
= 0.57x
Net Income
$162
$2,530
Common Dividends Paid
100
Addition to Retained Earnings $62
71
Ratio Analysis
Market Value Ratios
Price to Earnings Ratio =
Balance Sheet
Excalibur Corporation
Assets
Liabilities
Cash
$175 Accounts Payable
$115
Accounts Receivable 430 S-T Notes Payable
115
Inventories
625 Current Liabilities
$230
Current Assets
$1,230 Long-term Debt
$600
Plant & Equipment $2,500 Owners Equity
Less:Acc. Depr.
(1,200) Common Stock
$300
Net Fixed Assets
$1,300 Capital in Excess of Par 600
Total Assets
$2,530 Retained Earnings
800
Total Owners Equity $1,700
Income Statement
Total Liabilities and
Excalibur Corporation
Owners Equity
$2,530
Sales
$1,450
Additional Info:
100 shares
$20.00 per
share
875
$575
45
200
$330
60
$270
108
$162
100
$62
P/E
= Market Price/Share
Ratio
EPS
P/E ratio =
$20.00
= 12.35x
$162/100
73
Ratio Analysis
Market Value Ratios
Market to Book Ratio =
74
Balance Sheet
Excalibur Corporation
Assets
Liabilities
Cash
$175 Accounts Payable
$115
Accounts Receivable 430 S-T Notes Payable
115
Inventories
625 Current Liabilities
$230
Current Assets
$1,230 Long-term Debt
$600
Plant & Equipment $2,500 Owners Equity
Less:Acc. Depr.
(1,200) Common Stock
$300
Net Fixed Assets
$1,300 Capital in Excess of Par 600
Total Assets
$2,530 Retained Earnings
800
Total Owners Equity $1,700
Income Statement
Total Liabilities and
Excalibur Corporation
Owners Equity
$2,530
Sales
$1,450
Cost of Goods Sold
875
Gross Profit
$575
Operating Expenses
45
Market
Depreciation
200
Price/Share
to
=
Operating Income
$330
Common Equity/ # shares
Interest Expense
60
Book
Income Before Taxes
$270
Taxes (40%)
108
$20.00
Net Income
$162
M/B
=
= 1.18x
Common Dividends Paid
100
$1,700/100
Addition to Retained Earnings $62
Additional Info:
100 shares
$20.00 per
share
75
EBITDA
EBITDA stands for Earnings Before
Interest, Taxes, Depreciation, and
Amortization.
It is often of great interest to financial
analysts although FASB does not
require that this number be reported.
It measures the amount of cash thrown
off from the operations of the company.
76
Ratio
Industry Excalibur
Profitability
Gross Profit Margin
Operating Profit Margin
Net Profit Margin
Return on Assets
Return on Equity
38%
20%
12%
9.0%
13.4%
39.7%
22.8%
11.2%
6.4%
9.5%
Industry
5.00x
3.00x
Excalibur
5.35x
2.63x
Ratio
Industry Excalibur
Debt
Debt Ratio
35%
Times Interest Earned 7.00x
Debt to Equity
49%
33%
5.50x
48%
79
Ratio
Industry Excalibur
Asset Activity
Avg. Collection Period
Inventory Turnover
Fixed Asset Turnover
Total Asset Turnover
90 days
3.00x
1.00x
0.75x
108 days
2.32x
1.12x
.57x
Ratio
Market Value
Price Earnings
Market to Book
Industry Excalibur
18.0
2.5
12.35
1.18
82
Net Inc.
Assets
Net
Profit x
Margin
= Net Inc.
Sales
Total
Asset
Turnover
Sales
Assets
83
Net Inc.
Equity
Net
Profit x
Margin
Net Inc.
Sales
Total
x
Asset
Turnover
Sales
x
Assets
Equity
Multiplier
Assets
Equity
84
Elton Corporation
Income Statement
for the year ending 12/31/XX
(in thousands of dollars)
Net sales
$ 2,700
Operating Costs
(2,350)
Depreciation
( 150)
Interest Expense
( 70)
EBT
130
Income Tax (40%)
(
52)
Net Income
$
78
85
Cash
$ 150
Accounts Payable
$100
Accounts Receivable
250
Notes Payable
250
Inventory
600
Other Current Liabilities
Total Current Assets
$1,000
Total Current Liabilities
50
$400
86
87
88
5. Fill in the missing data based on the information provided for years 2009 and 2010.
ABC CORPORATION
Balance Sheet Changes and Classification
Of Key Accounts between 2009 and 2010
Account
Long-term debt
Accounts receivable
Common stock
Cash
$640
Retained earnings
Accruals
Inventory
Accounts payable
Net fixed assets
2009
$960
$640
$200
2010 Change
$800
$500
$300
Source/Use
$500
$960
$800
$50
$200
$840
$600
$1,150
$1,800
$1,000
$2,000
89
Forecasting for
Financial Planning
Chapter 6
90
Learning Objectives:
The importance of forecasting to
business success.
The financial forecasting
process.
Preparation of pro forma
financial statements.
The importance of analyzing
forecasts.
91
Why is forecasting
important?
Mistakes are costly:
If you produce too much of a product,
or a product that no one wants to
buy, you still must pay for materials,
labor, and storage.
If you produce too little of a product,
you will lose sales and possibly
market share.
92
Forecasting Approaches
Financial managers concentrate on
three general approaches to financial
forecasting:
Experience
Probability
Correlation
93
Experience
Managers who have been in the
business for a long time have
developed a sense for the patterns
in sales, expenses, consumer
demand factors, etc.
Example: Editors who work for book
publishers regularly read submitted
manuscripts and make judgments
about whether their company should
buy the rights to publish the books.
94
Probability
Past history often tells us a lot
about what will happen in the
future.
Managers can use this
information to estimate the
future.
Example: In the past, a 7-11
manager has found that she will
lose 1% of candy inventory to
shoplifters. She can use this
information to estimate future
95
Correlation
Correlation is a measure of the relative
movement of two variables relative to
each other.
Example: If interest rates go up, a real
estate agent knows that home sales will
tend to fall (because the higher cost of
financing makes it harder for buyers to
qualify for mortgages).
Example: Sales of umbrellas are higher in
rainy seasons.
96
Finance
Department
Production
(capacity, schedules)
Accounting
(financial statements,
depreciation, taxes)
SALES
FORECAST
97
00 01
02 03 04
05 06 07 08
09
Time
98
Trend Line
00 01
02 03 04
05 06 07 08
09
Time
99
Sales
Growth Rate
00 01
02 03 04
05 06 07 08
09
Time
100
New Product
Introduced
00 01
02 03 04
05 06 07 08
09
Time
101
New Product
Introduced
00 01
02 03 04
05 06 07 08
09
Time
102
2009
2010
103
105
Current
Current Projected
Projected
Sales $5,000
COGS 4,133
EBIT
867
867
Int
200
EBT
667
Tax (.40) 267
NI
400
$8,000
106
Current Projected
Sales $5,000
$8,000
$5,000
COGS 4,133
6,613
EBIT
867
1,387
Int
200
200
200
EBT
667
1,187
Tax (.40) 267
475
NI
400
712
400
712
107
Assets
Current Projected
Liabilities
Current
Current Assets
$2.5
Accounts Payable $1.0
Net Fixed Assets
3.0
Accrued Expenses 0.5
Total
$5.5
Notes Payable
0.0
Current Liabilities
$1.5
Long Term Debt
$2.0
Common Stock
0.5
Retained Earnings 1.5
Common Equity
$2.0
Total Claims
$5.5
Projected
108
Assets
Current Projected
Liabilities
Current
Projected
Current Assets
$2.5
$4.0
Accounts Payable $1.0
Net Fixed Assets
3.0
Accrued Expenses 0.5
Total
$5.5
Notes Payable
0.0
Current Liabilities
$1.5
Long Term Debt
$2.0
Common Stock
0.5
$2.5(1+.60) = $4.0
Retained Earnings 1.5
Common Equity
$2.0
Total Claims
$5.5
109
Assets
Current Projected
Liabilities
Current
Projected
Current Assets
$2.5
$4.0
Accounts Payable $1.0
Net Fixed Assets
3.0
4.8
Accrued Expenses 0.5
Total
$5.5
$8.8
Notes Payable
0.0
Current Liabilities
$1.5
Long Term Debt
$2.0
+$3.30
Common Stock
0.5
Retained Earnings 1.5
Common Equity
$2.0
$3.0(1+.60) = $4.8
Total Claims
$5.5
110
Assets
Current Projected
Liabilities
Current
Projected
Current
$2.5
$4.0
Accounts Payable $1.0
$1.6
Current Assets
Assets
$2.5
$4.0
Net
3.0
4.8
Accrued Expenses 0.5
Net Fixed
Fixed Assets
Assets
3.0
0.5
Total
$5.5
$8.8
Notes Payable
0.0
Total
$5.5
$8.8
0.0
Current
$1.5
Current Liabilities
Liabilities
$1.0(1+.60)
=
$1.60
Long Term Debt
$2.0
Common Stock
0.5
0.5
Retained Earnings 1.5
1.5
Common Equity
$2.0
Total
$5.5
Total Claims
111
Assets
Current Projected
Liabilities
Current
Projected
Current Assets
$2.5
$4.0
Accounts Payable $1.0
$1.6
Net Fixed Assets
3.0
4.8
Accrued Expenses 0.5
.8
Total
$5.5
$8.8
Notes Payable
0.0
Current Liabilities
$1.5
$0.5(1+.60) = $0.80
Long Term Debt
$2.0
Common Stock
0.5
Retained Earnings 1.5
Common Equity
$2.0
Total Claims
$5.5
112
Assets
Current
Projectedearnings
Liabilities
Current
Projected
New retained
Current Assets
$2.5
$4.0
Accounts Payable $1.0
$1.6
=Old
retained
earnings
Net Fixed Assets
3.0
4.8
Accrued Expenses 0.5
.8
+ additions
earnings
Total
$5.5
$8.8to ret.Notes
Payable
0.0
Liabilitiespayout)]
$1.5
=1.5 +Current
[NI x (1-div.
Term Debt
$2.0
=1.5 + [.712 x (1-.7)]Long
= 1.7
Common Stock
0.5
Retained Earnings 1.5
1.7
Common Equity
$2.0
Total Claims
$5.5
113
Assets
Current Projected
Liabilities
Current
Projected
Current Assets
$2.5
$4.0
Accounts Payable $1.0
$1.6
Net Fixed Assets
3.0
4.8
Accrued Expenses 0.5
.8
Total
$5.5
$8.8
Notes Payable
0.0
0.0
Current Liabilities
$1.5
2.4
Long Term Debt
$2.0
2.0
Common Stock
0.5
.5
Retained Earnings 1.5
1.7
Common Equity
$2.0
2.2
Total Claims
$5.5
$6.6
114
Assets
Current Projected
Liabilities
Current
Projected
Current Assets
$2.5
$4.0
Accounts Payable $1.0
$1.6
Net Fixed Assets
3.0
4.8
Accrued Expenses 0.5
.8
Total
$5.5
$8.8
Notes Payable
0.0
0.0
Current Liabilities
$1.5
2.4
Long Term Debt
$2.0
2.0
AFN
Common Stock
0.5
.5
= $8.8 - 6.6
Retained Earnings 1.5
1.7
= $2.2 mill.
Common Equity
$2.0
2.2
Total Claims
$5.5
$6.6
115
figures in 000,000s
Assets
Current Projected
Liabilities
Current
Projected
Notes
Payable,
and/or
LT
Current Assets
$2.5
$4.0
Accounts Payable $1.0
$1.6
Debt,Expenses
and/or Common
Stock
Net Fixed Assets
3.0
4.8
Accrued
0.5
.8
Total
$5.5
$8.8
Notes Payable
0.0
0.0
Current Liabilities
$1.5
2.4
AFN
Long Term Debt
$2.0
2.0
= $8.8 - 6.6
Common Stock
0.5
.5
Retained Earnings 1.5
1.7
= $2.2 mill.
Common Equity
$2.0
2.2
Total Claims
$5.5
$6.6
116
Financing feedback
If outside financing is required, the new
debt or equity may affect your original
projections of the amount of the addition
to retained earnings (due to increased
interest or dividends on the income
statement).
In this case, the pro forma should be
recast with the new information to make
final projections of AFN.
118
Homework Questions
1. Briefly discuss the three general
approaches to forecasting.
2. Why is forecasting important?
3. Distinguish between the cash budget
and the capital budget.
119
4.
Given the following data on the Sands Corporation, project the balance sheet for the coming year using
the percentage of sales technique:
Current Sales: $650,000
Next years sales: $925,000
After-tax profits: 6% of Sales
Dividend payout ratio: 40%
Current retained earnings: $200,000
Accounts receivable as a percent of sales: 10%
Cash as a percent of sales: 5%
Inventory as a percent of sales: 32%
Net fixed assets as a percent of sales: 38%
Accounts payable as a percent of sales: 6%
Accruals as a percent of sales: 12%
Next years common stock: $200,000
ASSETS
Cash
Accounts receivable
Inventory
Net fixed assets
(d)
Total
(e)
Sands Corporation
Balance Sheet
December 31, 2005
LIABILITIES AND EQUITIES
(a)
Accounts payable
(b)
Notes payable
(c)
Accruals
Common stock
(i )
Retained earnings
(j )
Total
(k)
(f )
(g)
(h)
120
Chapter 7
121
Learning Objectives
Define risk, risk aversion, and riskreturn tradeoff.
Measure risk.
Identify different types of risk.
Explain methods of risk reduction.
Describe how firms compensate for
risk.
Discuss the CAPM.
122
Expected Return
Expected return is the mean of the
probability distribution of possible
returns.
Future returns are not known with
certainty. The standard deviation
is a measure of this uncertainty.
123
Expected Return
Expected return is the mean of the
probability distribution of possible
returns.
Future returns are not known with
certainty
To calculate expected return,
compute thewhere
weighted average of
possible returns
= Expected return
V i x Pi)
Vi
Pi
Expected Return
Calculation
Example:
You are evaluating Zumwalt Corporations
common stock. You estimate the following
returns given different states of the economy
State of Economy Probability Return
Economic Downturn
Zero Growth
Moderate Growth
High Growth
.10
.20
.40
.30
5%
5%
10%
20%
=
=
=
=
k=
0.5%
1.0%
4.0%
6.0%
10.5%
Measurement of Investment
Risk
Example:
You evaluate two investments: Zumwalt
Corporations common stock and a one year
Gov't Bond paying a guaranteed 2%.
There is risk in owning Zumwalt
stock, no risk in owning the T-bills
Probability
of Return
Probability
of Return
T-Bill
Zumwalt Corp
100%
40%
30%
20%
10%
2%
Return
= variance
Example:
22 = .005725 = 0.5725%
Compute the standard deviation on
Zumwalt
= SQRT ofcommon
0.005725
stock. the mean () was previously computed
as 7.566%
10.5%
= .07566 =
State of Economy Probability Return
Economic Downturn
.10
(- 5% Zero Growth
.20
( 5% Moderate Growth
.40
( 10% High Growth
.30
( 20% -
10.5%)2
10.5%)2
10.5%)2
10.5%)2
128
= .24025%
= .0605%
= .001%
= .27075%
Market
related
Risk
due to overall
price will
most likely
fall -ifRisk
a major
Stock
market conditions
government
contract is discontinued unexpectedly.
Stock
Market Related
Risk
# of stocks in Portfolio
130
# of stocks in Portfolio
131
Total Risk
# of stocks in Portfolio
132
15%
10%
5%
-15%
-10%
-5%
S&P
Return
5%
10%
15%
-5%
-10%
-15%
134
15%
10%
5%
-15%
-10%
-5%
Jan 1999
PepsiCo-0.37%
S&P
-1.99%
S&P
Return
5%
10%
15%
-5%
-10%
-15%
135
15%
10%
5%
-15%
-10%
Plot
Remaining
Points
-5%
S&P
Return
5%
10%
15%
-5%
-10%
-15%
136
15%
10%
Best Fit
Regression
Line
-15%
-10%
5%
-5%
S&P
Return
5%
10%
15%
-5%
-10%
-15%
137
15%
10%
-5%
-15%
-10%
rise 5.5%
=
Slope =
= 1.1
run 5%
-5%
5%
S&P
Return
5%
10%
15%
-5%
-10%
-15%
138
139
15%
10%
5%
-15% -10%
-5%
S&P
Return
5%
10%
15%
-5%
-10%
140
Beta = 1
Market Beta = 1
Company with a beta of 1 has average risk
Beta < 1
Low Risk Company
Return on stock will be less affected by the market
than average
Beta > 1
High Market Risk Company
Stock return will be more affected by the market
than average
141
CAPM Example
Suppose that the required return on
the market is 12% and the risk free
rate is 5%.
Security Market Line
kj = kRF + j ( kM kRF )
143
CAPM Example
Suppose that the required return on
the market is 12% and the risk free
rate is 5%.
kj = 5% + j (12% 5% )
15%
10%
5%
1.0
Beta
1.5
144
CAPM Example
Suppose that the required return on
the market is 12% and the risk free
rate is 5%.
kj = 5% + j (12% 5% )
Risk &
Return on
market
15%
10%
5%
1.0
Beta
1.5
145
CAPM Example
Suppose that the required return on
the market is 12% and the risk free
rate is 5%.
15%
10%
SML
Market
5%
Beta
.50
1.0
1.5
146
CAPM Example
Suppose that the required return on the
market is 12% and the risk free rate is
5%.
If beta = 1.2
k = 13.4
kj = 5% + j (12% 5% )
j
15%
13.4%
10%
Company kj
SML
Market
5%
Beta
.50
1.0 1.2
1.5
147
Homework
1. You hold a diversified portfolio of stocks and are
considering investing in the XYZ Company. The firms
prospects look good and you estimate the following
probability distribution of possible returns:
Probability
70%
20%
10%
Return
15%
9%
20%
The return on the market is 13.5% and the risk free rate
is 7%. You have calculated XYZs beta from past returns as
1.3 and you believe this will be the future beta.
a. What is the expected return for XYZ?
b. What is the required return for XYZ according to the
CAPM?
148
Homework
2. Assume your existing portfolio is valued at $9,000 and its beta is 1.0.
You plan to buy an additional $3,000 of a particular stock that has a
beta of 1.8 (without selling any other stock). What is the beta of the new
portfolio?
3. Distinguish between business risk and financial risk.
4. What is risk aversion? How does the assumption of risk aversion
affect the risk/return tradeoff?
5. Compare diversifiable and nondiversifiable risk. What are some
examples of each type of risk?
149
Learning Objectives
The time value of money
and its importance to
business.
The future value and
present value of a single
amount.
The future value and
present value of an
annuity.
earns interest.
Therefore, money that is to be
received at some time in the
future is worth less than the
same dollar amount to be
received today.
Similarly, a debt of a given
amount to be paid in the future
are less burdensome than that
$
PV
CPT
FV
2. Future Value of an
Annuity
Toda
y
PMT
CPT
FV
3. Sinking
Fund
?
Toda
y
FV
?
i
?
CPT
PMT
155
4. Present Value
Single Payment
?
FV
CPT
PV
156
?
PMT
$
i
$
N
CPT
PV
157
6. Amortized Loans
$
PV
?
i
?
N
CPT
158
PMT
Financial Calculator
Example: Solution
You invest - FV
$200 at 10%. How
much is it worth
after 5 years?
1) Calculator
Enter:
N = 5
I/YR = 10
PV
= -200
CPT FV = ?
2) Using Formula:
322.10
Annuities
An annuity is a series of equal
cash flows spaced evenly over
time.
For example, you pay your
landlord an annuity since your
rent is the same amount, paid on
the same day of the month for
the entire year.
Jan
Feb
$500
Mar
$500
$500
Dec
$500
$500
161
1
$100
2
$100
3
$100
Future Value of an
Annuity
Using the
Calculator:
Dont forget to clear
your calculator of the
previous problem!
N=3
I/Y = 2
PV = -$200
CPT FV = $212.24
$212.2
4
$100
$100
$100
FVA=?
Annuity Due:
Calculator
Solution
Example:
You receive
$100 per year for 3
years. How much is it
worth after 3 years if
you can earn 4%
N=3
annually?
I/Y = 4
PMT = -$100
CPT FV = $312.16
Calculator
Enter:
N =8
I/YR = 3
FV = 100
CPT PV78.9
=?
4
78.9
4
168
257.7
1
PV=?
$100
Enter:
N =3
I/YR = 8
PMT = 100
CPT PV = ? 257.7
1
$100
$100
-257.71
N I/ P PM F
Y V
V
169
$100
$100
$100.
$92.60
00
$85.73
$278.33 BGN
N=3
PMT = -100
I/Y = 8
CPT PV = 278.33
278.3
3
170
Amortized Loans
A loan that is paid off in
equal amounts that
include principal as well
as interest.
Solving for loan
payments.
171
Amortized Loans
You borrow $5,000 from your parents to purchase a used car.
You agree to make payments at the end of each year for the
next 5 years. If the interest rate on this loan is 6%, how much
is your annual payment?
0
$5,000 $?
$?
ENTER:
N =5
I/Y = 6
PV = 5,000
CPT PMT =
- ?
1,186.
$?
$?
$?
1,186.9
8
N I/Y P PMT FV
V
172
2. How much will you have at the end of the 6th year if you invest $5,000 annually for six years at 7% annual rate, if
you:
a. Start one year from today
b. Start today
3. A bank agrees to give you a loan of $12,000,000 and you have to pay $1,309,908 per year (end of year) for 26
years. What is your rate of interest? What would the payments be if this were a monthly payment loan?
4. You have found the perfect burial plot. Of course, you don't plan to need it for 60 years. The plot costs $12,000
today and burial plot prices are increasing at 4% per year. How much do you need to deposit at the beginning of
each of the next 60 years to pay for the plot if you can earn 11% on your deposit?