BIWS - 400 Questions; Basic Flashcards
Walk me through the 3 Financial Statements
Income Statement: revenues/expenses and taxes over a period of time. Starts w/ Revenues & expenses, ends w/ Net Income.
Cash Flow Statement: cash inflows/outflows over a period of time. Starts w/ Net Income, adjusts for non-cash expenses & working capital changes, lists CFs from investing & financing activities, ends w/ net change in cash.
Balance Sheet: company’s resources (Assets) and how it paid for those resources/what it owes (Liabilities, Equity). Assets = L + SE.
Examples of major line items from each financial statement?
Income statement: Revenues, COGS, SG&A, Operating Income, Pre-Tax Income, Net Income
CFS: Net Income, Depreciation & Amortization, Stock-Based Compensation, Changes in Operating Assets & Liabilities, CF from Operations, CapEx, CF from Investing Activities, Sale/Purchase of Securities, Dividends Issued, CF from Financing
BS: Cash, Inventory, Accounts Receivables, PP&E, Accounts Payable, Accrued Expenses, Debt, Shareholders’ Equity
How do the 3 financial statements link together?
Net Income (to common) from the IS flows into the top line of the CFS and into the CSE of the BS.
CFS: Changes to BS items appear as Working Capital changes on the CFS and investing and financing activities affect BS items such as PPE, Debt, SE.
Bottom of CFS - Net change in Cash - flows into top line of BS (Cash) & SH.
If you were stranded on an island & only had 1 statement to review overall health of a company - which financial statement to use?
Cash Flow Statement - shows actual cash inflows/outflows of the company; how much cash the co is ACTUALLY generating, independent of non-cash expenses. Cash flow is the most impt thing you care about when analyzing financial health of a co.
If you can only look at 2 financial statements of a co - which would you use?
The IS & BS. Can construct the CFS from these 2 states. Make adjustments from bottom of IS based on non-cash expenses, make adjustments for WC changes based on the BS items. (Assuming you have before/after BS that corresponds to same period as IS).
How would Depreciation going up by $10 affect the statements?
IS: Increase in depreciation (non-cash expense) –> decreases Operating Income –> decreases pre-tax income. –> assuming tax rate of X, decreases net income by 10 * (1-tax rate)
CFS: Net income decreases (from bottom of IS #) –> add back $10 depreciation to net income –> overall CF from Operations increases ==> net change in Cash increases
BS: would decrease PPE (asset) by $10 (b/c of Depreciation); Cash is up by $X - from changes on CFS. SE (equity side) is also down by difference from Assets side –> both sides balance
Depreciation - why does it affect cash balance, if it is non-cash expense?
Depreciation is tax-deductible. Increase in depreciation = decrease in pre-tax net income => affects cash balance b/c decreases amount of taxes paid & taxes ARE a cash expense
Depreciation - where does it usually show up on an IS?
Can be separate line item or imbedded w/in COGS or Operating Expenses. Each co does it diff, but regardless: depreciation always decreases pre-tax income
Accrued Compensation - what happens if it goes up by $10?
Step 1: Confirm Accrued comp is now being recognized as an expense.
IS: Operating Expense increases by $10. Assuming Tax Rate if 40%, Net Income decreases by $6.
CFS: Net Income decreases by $6. Accrued Comp will increase CF: add back $10. Overall CF from operations is up $4 –> Net change in cash = increase by $4.
BS: Accrued Compensation increases -> Liability increases by $10, CSE decreased by $6. Cash (asset) increased by $4, so it balances.
Inventory - what happens if it goes up by $10, assuming you pay for it w/ cash?
Assuming it hasn’t been delivered yet to customer:
IS: NO CHANGE!
CFS: Inventory (asset) decreases CF from Operations by $10 –> Net Change in cash decreases by $10
BS: Inventory increases by $10, Cash decreases by $10. Both sides balance bc charges cancel on Asset side.
Why is IS not affected by changes in Inventory?
Expenses are only recorded when the goods associated with it are sold. (B/c of criteria 1 to show up on the IS: has to 100% match the same period)
Inventory does not show up on IS (not recorded as a COGS or Operating Expense), until it is used by the company in manufacturing a product and sold.
(INITIAL DEBT ISSUANCE) PART 1: Apple is buying $100 of new iPod factories with DEBT. How are all 3 statements affected at the start of Year 1, BEFORE anything else happens?
IS: No change. Debt will last many years, so does not correspond 100% to that period.
CFS: Additional investment in factories would show up under CF from Investing –> reduces CF by $100. But, debt raised would show up under CF from Financing –> increases CF by $100. So, no change to net change in CF.
BS: Assets increase by $100 (PP&E), but Liabilities also increase by $100 (Debt). So it balances.
(INTEREST EXPENSE & DEPRECIATION ex): Apple is buying $100 of new iPod factories with DEBT –> go out 1 year to the start of YEAR 2. Assume the debt is high-yield, so no principal is paid off, and assume an interest rate of 10%. Also assume the factories depreciate at a rate of 10% per year. What happens?
IS: $10 Depreciation Expense recorded. $10 Interest expense also recorded under Non-Operating Expenses. –> Leads to a $20 decrease in Pre-Tax Income. Presuming a tax rate of 20%, Net Income would be decreased by $16.
CFS: Net Income decreased by $16. But, add back depreciation expense of $10 (b/c it is a non-cash expense). Overall, net change in cash = decreased by $6.
BS: Cash decreases by $6. PP&E decreases by $10. So overall, assets side decreased by $16. On L&E side, CSE decreased by $16 (flows in from Net Income). So, BS balances.
(WRITE DOWN & DEBT PRINCIPAL REPAYMENT ex): Apple bought $100 of new iPod factories w/ Debt. assume an interest rate of 10%. Also assume the factories depreciate at a rate of 10% per year. At the end of year 3, the factories all break down and the value of the equipment is written down to $0. The loan must also be paid back now. Walk me through the 3 statements.
- come back
Why do we look at both Enterprise Value and Equity Value?
Enterprise Value = value of core business operations of a co (net operating assets) to ALL investors
Equity Value = value of EVERYTHING in co to only the EQUITY investors
Look at both b/c: Equity Value = # the public at large sees, while Enterprise Value = “true” value of a co.
When looking at an acquisition of a co, do you pay more attention to the Enterprise or Equity Value?
Enterprise Value: b/c that’s how much an investor “really” pays & includes often mandatory debt repayment
Enterprise Value Formula?
Enterprise Value = Equity Value + Debt + Preferred Stock + Non-Controlling (Minority) Interests - Cash
Why do you need to add Minority Interest to Enterprise Value?
When a Co A owns majority (more than 50%) of another company B –> reports 100% of subsidiary (Co-B) financial performance as part of Co A’s financial performance, even though it doesn’t own 100% of subsidiary.
So, have to add Minority Interest to TEV so that numerator (TEV) and denominator (financial performance metric) both reflect 100% of majority-owned subsidiary.
How do you calculate fully diluted shares?
1) Take basic share count, and 2) add in dilutive effective of stock options and any other dilutive securities (ex: warrants, convertible debt, convertible preferred stock)
To calculate dilutive effect of options: use Treasury Stock Method (TSM)
Ex: Say a Co has 100 shares outstanding at a share price of $10 each. It also has 10 options outstanding at an exercise price of $5 each - what is its fully diluted equity value?
The options are “in the money” (exercise price is less than current share price).
When these options are exercised –> 10 new shares will be created.
To exercise the options, will pay the co $5 per option (exercise price) ==> Co will have $50 in additional cash. –> uses proceeds to buy back 5 new shares (50/10 = 5) ==> so fully diluted share count is 105 & fully diluted equity value is 1050 (= 105 * 10)
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Fully Diluted EqV = (Basic Share Count + Dilutive Effect of Options (and other dilutive securities)) * Current Share Price
Dilutive Effect of Options:
- $5 (exercise price) < $10 (share price)
- proceeds = 5 * 10 = $50
- proceeds/current price = shares repurchased by co –> 50/10 = 5 shares
- net dilution = 10 - 5 = 5 shares
Fully Diluted Share Count = 100 + 5 = 105 shares
Fully Diluted EqV = (100 + 5) * 10 = $1,050
Ex: A co has 100 shares outstanding, at a share price of $10 each. It also has 10 options outstanding at an exercise price of $15 each - what is its fully diluted equity value?
Fully diluted equity value is $1,000.
Since the strike price is above the share price, will assume the options will not be exercised ==> options have no dilutive effect.