44 Questions
What is the total liabilities and equity of the company?
$1,468,800
What is the definition of equity according to concept (1)?
Total assets minus total liabilities
Why may the market value of equity exceed the book value?
Due to intangible assets not reflected in goodwill
What is the average price-to-book (P/B) ratio of the companies in the S&P 500?
1.93
What is concept (3) equivalent to?
Market capitalization of the firm
What may contribute to a company's market capitalization exceeding its book value?
Key personnel, innovations, or corporate culture
What is the primary purpose of the income statement?
To report revenues and expenses over a specific period of time
What is the total operating cost for 2022?
5,816,960
What is the purpose of depreciation?
To account for the ordinary wearing out of buildings and equipment
How is the annual depreciation charge calculated?
Based on the expected life of the asset and its salvage value
What is the net income for 2021?
87,960
Why may a charge for obsolescence be added to depreciation?
Because of the rapid innovation in the industry
What is the purpose of the balance sheet?
To report a company's financial position at a specific point in time
What is the EBIT for 2022?
17,440
What is the main concern of analysts regarding depreciation?
It is subject to manipulation by management
What is goodwill in the context of a company's acquisition?
The difference between the purchase price and the target's book value
How is goodwill typically valued on a company's books?
At $1 or not shown at all
What is the purpose of depreciation in accounting?
To reflect the decrease in value of an asset over time
What is the total value of a company's current assets in 2022?
$1,946,802
What is the net value of the company's fixed assets in 2022, after depreciation?
$939,790
What is an example of an intangible asset?
Patent
What is the total value of the company's liabilities and equity in 2022?
$2,886,592
What is the primary reason for charging depreciation expense?
To account for the gradual loss of value of fixed assets
What is the total operating cost for 2021?
$3,222,900
What is the purpose of the free cash flow statement?
To analyze the cash inflows and outflows of the company
What is the expected life of the equipment in the example?
6 years
What is the net income for 2022?
($95,136)
Why is depreciation charged as an expense even though it is not a cash expenditure?
To match the cost with the revenue generated
What is the salvage value of the equipment in the example?
$100,000
What is the effect of depreciation on the income statement?
Decreases net income
What is the primary reason analysts are wary of depreciation?
It is subject to manipulation by management
What is goodwill in the context of a company's acquisition?
The difference between the purchase price and the target's book value
What is an example of an intangible asset?
Patent
How is goodwill typically valued on a company's books?
At $1
What type of asset is goodwill?
Intangible asset
What is the purpose of depreciation in accounting?
To record the decrease in asset value over time
What is the net value of the company's fixed assets in 2022, after depreciation?
$939,790
What is the total value of the company's current assets in 2022?
$1,946,802
What is the relationship between book value and market value of equity?
Market value may exceed book value due to intangible assets.
What is the purpose of distinguishing between book value and market value of equity?
To understand the difference between a firm's intrinsic value and market perception.
What is a 'moat' in the context of a company's competitive advantage?
A barrier to entry for new competitors.
What is the implication of a high price-to-book (P/B) ratio?
The market perceives the company to be overvalued.
What is an example of an intangible asset that may contribute to a company's market value exceeding its book value?
Brand recognition.
What can be inferred about a company with a high market capitalization?
It has intangible assets or competitive advantages.
Study Notes
Financial Statements
- Income Statement:
- Sales: $3,432,000 (2021) and $5,834,400 (2022)
- Cost of goods sold: $2,864,000 (2021) and $4,980,000 (2022)
- Depreciation: $18,900 (2021) and $116,960 (2022)
- EBIT: $209,100 (2021) and $17,440 (2022)
- Interest expense: $62,500 (2021) and $176,000 (2022)
- EBT: $146,600 (2021) and -$158,560 (2022)
- Taxes: $58,640 (2021) and -$63,424 (2022)
- Net income: $87,960 (2021) and -$95,136 (2022)
Depreciation
- Fixed assets (except land) depreciate over time due to wear and tear
- Depreciation accounts for the ordinary wearing out of buildings and equipment
- Depreciation is calculated based on the asset's cost, expected life, and salvage value
- Example: Equipment installed at a cost of $1 million, with an expected life of 6 years and a salvage value of $100,000, would have an annual depreciation charge of $150,000
- In industries with rapid innovation, a charge for obsolescence may be added to depreciation
- Depreciation is a non-cash expenditure, but it's a true economic cost
Intangible Assets
- Intangible assets are non-physical, such as goodwill, brands, and patents
- Goodwill arises when one company buys another, and is the difference between the purchase price and the target's book value
- Goodwill is not always shown on the balance sheet, or may be valued at $1
- If goodwill has been acquired at a definite cost, it's carried at cost and written down over time
Balance Sheet
- Assets:
- Cash: $9,000 (2021) and $7,282 (2022)
- Short-term investments: $48,600 (2021) and $20,000 (2022)
- Accounts receivable: $351,200 (2021) and $632,160 (2022)
- Inventories: $715,200 (2021) and $1,287,360 (2022)
- Total current assets: $1,124,000 (2021) and $1,946,802 (2022)
- Gross fixed assets: $491,000 (2021) and $1,202,950 (2022)
- Less depreciation: $146,200 (2021) and $263,160 (2022)
- Net fixed assets: $344,800 (2021) and $939,790 (2022)
- Total assets: $1,468,800 (2021) and $2,886,592 (2022)
- Liabilities and Equity:
- Accounts payable: $145,600 (2021) and $324,000 (2022)
- Notes payable: $200,000 (2021) and $720,000 (2022)
- Accruals: $136,000 (2021) and $284,960 (2022)
- Total current liabilities: $481,600 (2021) and $1,328,960 (2022)
- Long-term debt: $323,432 (2021) and $1,000,000 (2022)
- Common stock: $460,000 (2021) and $460,000 (2022)
- Retained earnings: $203,768 (2021) and $97,632 (2022)
- Total equity: $663,768 (2021) and $557,632 (2022)
Book vs. Market Values
- Book value of equity is total assets minus total liabilities
- Book value of equity is initial paid-in capital plus retained earnings
- Market capitalization is the number of shares outstanding times the price per share
- Market value of equity typically exceeds book value if the firm has intangible assets not reflected in goodwill
- Examples of intangible assets include brands, patents, key personnel, innovations, and corporate culture
- "Moats" that deter new competitors can also contribute to a market capitalization exceeding book value
- The S&P 500 companies trade at an average price-to-book (P/B) ratio of 1.93
Financial Statements
- Income Statement:
- Sales: $3,432,000 (2021) and $5,834,400 (2022)
- Cost of goods sold: $2,864,000 (2021) and $4,980,000 (2022)
- Depreciation: $18,900 (2021) and $116,960 (2022)
- EBIT: $209,100 (2021) and $17,440 (2022)
- Interest expense: $62,500 (2021) and $176,000 (2022)
- EBT: $146,600 (2021) and -$158,560 (2022)
- Taxes: $58,640 (2021) and -$63,424 (2022)
- Net income: $87,960 (2021) and -$95,136 (2022)
Depreciation
- Fixed assets (except land) depreciate over time due to wear and tear
- Depreciation accounts for the ordinary wearing out of buildings and equipment
- Depreciation is calculated based on the asset's cost, expected life, and salvage value
- Example: Equipment installed at a cost of $1 million, with an expected life of 6 years and a salvage value of $100,000, would have an annual depreciation charge of $150,000
- In industries with rapid innovation, a charge for obsolescence may be added to depreciation
- Depreciation is a non-cash expenditure, but it's a true economic cost
Intangible Assets
- Intangible assets are non-physical, such as goodwill, brands, and patents
- Goodwill arises when one company buys another, and is the difference between the purchase price and the target's book value
- Goodwill is not always shown on the balance sheet, or may be valued at $1
- If goodwill has been acquired at a definite cost, it's carried at cost and written down over time
Balance Sheet
- Assets:
- Cash: $9,000 (2021) and $7,282 (2022)
- Short-term investments: $48,600 (2021) and $20,000 (2022)
- Accounts receivable: $351,200 (2021) and $632,160 (2022)
- Inventories: $715,200 (2021) and $1,287,360 (2022)
- Total current assets: $1,124,000 (2021) and $1,946,802 (2022)
- Gross fixed assets: $491,000 (2021) and $1,202,950 (2022)
- Less depreciation: $146,200 (2021) and $263,160 (2022)
- Net fixed assets: $344,800 (2021) and $939,790 (2022)
- Total assets: $1,468,800 (2021) and $2,886,592 (2022)
- Liabilities and Equity:
- Accounts payable: $145,600 (2021) and $324,000 (2022)
- Notes payable: $200,000 (2021) and $720,000 (2022)
- Accruals: $136,000 (2021) and $284,960 (2022)
- Total current liabilities: $481,600 (2021) and $1,328,960 (2022)
- Long-term debt: $323,432 (2021) and $1,000,000 (2022)
- Common stock: $460,000 (2021) and $460,000 (2022)
- Retained earnings: $203,768 (2021) and $97,632 (2022)
- Total equity: $663,768 (2021) and $557,632 (2022)
Book vs. Market Values
- Book value of equity is total assets minus total liabilities
- Book value of equity is initial paid-in capital plus retained earnings
- Market capitalization is the number of shares outstanding times the price per share
- Market value of equity typically exceeds book value if the firm has intangible assets not reflected in goodwill
- Examples of intangible assets include brands, patents, key personnel, innovations, and corporate culture
- "Moats" that deter new competitors can also contribute to a market capitalization exceeding book value
- The S&P 500 companies trade at an average price-to-book (P/B) ratio of 1.93
Quiz on financial statements, including income statement, balance sheet, and free cash flow, based on Lecture 3 by Brian Gendreau.
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