Balance Sheet: Assets, Liabilities, Equity

Week 1: Financial Statements, Time Value of Money

Lecture 1: The Balance Sheet

• A snapshot of a firm's financial position at a specific time, balance sheets must be disclosed by all publicly traded companies.
• Assets = Liabilities + Stockholders' Equity
• Assets and liabilities are the two main sections

Components of Assets

• Current Assets: These include items expected to convert to cash within a year, such as cash, accounts receivable (short-term debts owed to the company), and inventories (inputs/unsold products).
• Long-Term Assets: Non-cash convertible assets include net property, plant, and equipment (land, buildings, equipment valued at purchase cost with accumulated depreciation adjustment.)

Liabilities and Stockholders' Equity

• Current Liabilities: Obligations due within a year, including accounts payable (money owed to suppliers), notes payable/short-term debt, current maturities of long-term debt, taxes payable, and wages payable.
• Long-Term Liabilities: Obligations due after a year, like long-term debt, capital lease obligations, and deferred taxes.
• Stockholders' Equity: Represents the owners' stake in the company, consists of money invested by owners and retained earnings (earnings minus dividends).

Balance Sheet

• Net Working Capital: Short-term capital available to run the business, calculated as current assets minus current liabilities.
• Ensures the accounting equation (assets = liabilities + equity) always balances
• Sustained/Increasing Asset Value: Assets should maintain or increase in value, considering depreciation.
• Liquidation firms bankrupt and liquidate to repay debts.

Market Value and Book Value

• Market value of equity = market price per share * number of shares outstanding .
• Market values differ from book values
• Book value of equity = book value of assets - book value of liabilities
• Book value might not capture intangible assets, also market determines value by possible future benefits

Market-to-Book Ratio

• Market-to-Book Ratio = Market Value of Equity / Book Value of Equity Value stocks have a low ratio, while growth stocks have a high ratio.

Enterprise Value

• How much to acquire the firm
• Enterprise value = market value of equity + debt – cash.
• Invested capital = book value equity + debt - cash.

Income Statement

• Sales: Generated revenue when product is delivered
• Cost of Goods Sold: How much for inputs, production etc. Recognised when revenue is recognised.
• The recognition of revenues and expenses does not equal cash flows. Recognition triggers accounting earnings.
• Financial statement analysis to compare firms

Ratios

• Profitability Ratios to measure profitability.
• Gross Margin: Calculated as (Total Sales - Cost of Sales) / Total Sales.
• Operating Margin: Operating Profit over sales.
• EBIT and Net Profit Margins: Calculated as EBIT or Net Income / Total Sales, indicating profitability.
• Liquidity Ratios to measure liquidity Current Ratio: Calculated as Current Assets / Current Liabilities to assess short-term solvency.
• Quick Ratio: (Cash + Short-Term Investments + Accounts Receivable) / Current Liabilities.
• Cash Ratio: Cash / Current Liabilities.
• Interest Coverage Ratios:Calculated as EBIT/Interest or EBITDA/Interest. EBITDA = EBIT + Depreciation.

Cash Flow Statement

• Tracks the movement of cash both in and out
• Operating Activities: Cash flow from raising the product in the market. Depreciation (a non-cash expense) is added back.
• Accounts receivable (recorded as revenue but not cash) are removed, and accounts payable are added back to get an accurate view of cash flow.

Lecture 2: Value Today vs Value Tomorrow

• Money loses value over time
• The higher the discount rate, the value declines faster
• Compounding is interest on interest, future value is investing growing over time

Future Value

• FV = 100 × (1 + 0.10)^t
• Calculating PV
• Present value is discounted for market value to the present day or future cash flow in the future
• PV = CF / (1+r)
• CF - cashflow in t years

Annuities

• A constant cash flow for a number of periods

Annuity formula

• PV = C/r (1 - (1/1+r)^t)
• Applications are interest only loans
• Interest Only Loans: setup is mortgage 400k EUR with 3% interest paid monthly for 30 years
• Timeline is to pay off the loan,
• Application with annuity loans is where constant amount is paid
• Effective interest rate: The actual amount paid where interest rate takes compounding into account with the formula

Effective interest Rate Formula

• (1 + 5%/12)^12 – 1 = 5.12% p.a.

Perpetuities

• A cash flow that goes on forever
• PV = C/r, Important assumption: constant interets ratw

Growing Annuities and Perpetuities

• Annuites get bigger over time to ensure same sum is paid
• For growing annuitites apply, PV = C/r-g
• Growing perpetuity formula applies PV = C/r-g

Week 2: Investment

Lecture 3: Corporate Investment

• Major investments regularly face major investment decisions
• Use NPV, IRR and payback mthod to assess this

Net present value (NPV)

• Use Net present Value to assess this
• NPV = CF / (1+r) - Co, C ois initial investment Where: r is opportunity cost of capital Investment rule: accept if >0, reject if <0, mutual highest NPV

Internal Rate of Return (IRR)

• Critical discount rate where NPV =0
• If IRR >r, the PV is negatuve and should notbe aooeoted
• Provides sesntiviyt info

IRR INVESTMENT RULE

• Accept if greater than r, reject if less than r

NPV PROFILE

• Negative for anyr above 14%
• NPV can be positive for below 14%
• Pitfalls such as, delayed investments, slope is positive

Choosing IRR with projects

• Cannot give insight to projects most profitable or may not be
• Set ups may not have IRR, and so it is useless if npv = 0

Assumptions for mutually exclusive assumptions

• A higher rate of return not higher return
• Not depend on same time fremane
• Risk will be different

Incremental IRR

• IRR of incremental cash flow from one project or another at point to switch

Incremental Method Steps

• Get incremental cash flows for every time period
• IRR for casflows
• Point at which to switch

Payback Method

• When casflows come back and take investment back in pre specified time period, ignore time value of money cost of capital
• Can be easy to find small decisions
• calculate what to invest and accept of less

Selection with Resources

• Constrtaints such as, cash, productions
• Done using Profitiability index = npv of invest, choose project
• Can be fautly or NpV is correct

Lecture 4: Capital Budgeting

• Analysis, future consequences forecast for frmsi value with free cash flow

CAPITAL SETUP

• Company e.g cisco systems proejct with wireless appliancem project for 4 yerars
• Sales forecast: based on survey Data
• Wholesale Price: Sales forecast times wholesale price

Estimating costs

• Estimate Costs for feasiibility studies, like sunk costs, sellling expensew with outsourced manufacturer
• Capital expenditure depreciation is straight line

INcremental Earnings

• Look at sales and sales forecast to increase or decreasem expenses that can show in incremental forecasting, add in Taxes in periods
• EBIT earnings befor Tax
• straight line depreciations over life of asset with formula
• marginal corporate rate, what to pay for taxes
• net income unlevered-

EFFECTS of Cashflow and Unlevered incme

• Opportunity Cost or value resource
• Cannibiliztion with existing product

###Sunk cost

• Does not show up

INcremental Effects steps

• add plus depreciation and d4ecut cap ex, net working capital cahs, inventory = c+I+R-payables
• increases will affect value if have to invest will reduce fcf look at forecast

WACC

• NPV of flow has to be higher to make it worth it

Other Analysis

• Break even analysis with npv of0 and calculate IRR to maximise rate of return, find error

Sentivity and Scenarion Analysis

• which assuumptiosn matter

Wekk3, valing stock and bond

Lecture 5: Stocks

• Gives owners rights through capital, dividenfs holders get money 1ST

Stockholder Equaty Valuations

• Valuations based on: the stock if it will be sold in time

Dividing discount Model

• By stock or pafy off for total return investmens - p1/p0 + Div 1 / Po( with wavelenght os price)

Market Equillbrim

1+re

Equity Value

PV(Total dividends and repurchases) with numbers outstanding

Discount Cash Flow

• Value to present
• Forecast cashflow
• Discount method with: EQulaity = EV minus Cashdebt

steps

• forcase future

Based on multiple variables:

Enterprise = EV divided by EBITDA × EBITDA

Zvaluation compasble fims

Based on multiple variables:

• Multiple

LECTURE 6 BOND

What promises payments though sovoreign boonds through bills, motewith cprpote bonss issued

• bonds

CERTIFICATES

statinf bond certificate

• matoritu final
• trm time rmeinaing

Coupon

• Yield,
• description bond, face value ,coupon rate seime anual

Coupon rate

• Find each coupone rate
• zerp

Arbitage in Bonds

• Bond is to sell for cheap or get from broker you should beable to get
• Bionds are safer to equiloty

1. Guarentee interest pay HOLDERS PRIORITY EQUITY IN CASW

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capital structure

leverage and erutry risk