Topic 6: Financial Statement Analysis & Equity Valuation Flashcards Preview

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Flashcards in Topic 6: Financial Statement Analysis & Equity Valuation Deck (19)
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1

What are economic earnings?

- sustainable cash flow that can be paid out to stock holders without impairing the productive capacity of the firm

2

What are accounting earnings?

- affected by some conventions (inventories, depreciation); business cycles

3

What does total asset turnover measure?

- measures how efficient a firm uses its assets (for every dollar of assets, how many sales the firm generates)

4

What does a high interest coverage ratio indicate?

- shows the likelihood of bankruptcy is low because annual earnings are significantly greater than annual interest obligations

5

What determines the intrinsic value of a firm’s stock?

- Expectations of future dividends and earnings

6

What happens if ROA is greater than borrowing rate?

- a firm earns more on its money than it pays out to creditors the surplus earnings are available to the firm’s owners (shareholders), which increases ROE

7

What happens if ROA is less than borrowing rate?

- ROE will decline
by an amount that depends on the debt-to equity ratio

8

What is the compound leverage factor made of?

= Interest burden * Leverage

9

What does a low P/B ratio mean?

- A low P/B ratio stock can be a safer investment, since the book value can be a floor supporting the market price

10

What does a high P/B ratio indicate?

- A high P/B ratio is an indication that investors think a firm has chance of earning a return on investment > market capitalization rate (K)

11

What does a low P/E ratio indicate?

- Low P/E ratio stocks may be good bargains since you can acquire a claim on a dollar of earnings more cheaply if the P/E ratio is low

12

What does a high P/E ratio indicate?

- Current earnings may differ from future earnings, so high P/E stocks may still be bargain if their earnings and dividends are expected to grow faster

13

What is the difference between LIFO & FIFO?

- LIFO- assumes goods are valued at todays cost

- FIFO- assumes goods are valued at original cost

14

- LIFO: cost of goods sold (COGS) of $1.1 million,
the end-of-year balance sheet value of the 1
million units in inventory remains $1 million
- FIFO: COGS of $1 million, the end-of-year
balance sheet value of the inventory would be
$1.1 million
Which is the preferred way of presenting inventory and why?

- LIFO firm has both a lower reported profit and a lower balance sheet value of inventories than the FIFO firm

- LIFO is preferred in computing economic earnings since it uses up-to-date prices to evaluate the COGS

15

Trading Signal
- IV (Intrinsic value) > MP (Market Price)

- Buy or long

16

Trading Signal
IV < MP

- Sell or short

17

Trading Signal
IV = MP

- Hold or fairly priced

18

Intrinsic value $50 is higher than current price $48, so ABC is what?

- Underpriced and we should buy

19

Constant dividend model is only valid if?

g < k