Chapter 3 Flashcards

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1
Q

Formulae : Common Equity

A

= Total equity - preferred equity

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2
Q

Formulae : Net Dividend

A

= Dividends + Share repurchases - shares issues

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3
Q

Formulae : Comprehensive Earnings

A

= CSE(end) - CSE(beginning) + net dividend

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4
Q

Formulae : ROCE

A

= Comprehensive earnings/beginning CSE

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5
Q

Template : Reformulation of the Equity Statement

A

Beginning balance

Net transaction with SH:
+ Share issues
- Dividends (if got dividend paid need to minus it)
+ Exercise of stock option

Comprehensive income to common:
\+ Net income
\+/- Foreign currency translation gain/loss
-/+ Unrealized holding loss/gain
\+ Translation adjustment, net of tax
\+/- unrealized gain on debt securities
\+ Unrealized change in investment
-/+ Translation loss/gain
-/+ Loss/Gain on stock option exercise, net of tax benefit
-/+ Loss/Gain on repurchase of shares
- Preferred dividends (div paid)
\+ other comprehensive income

Ending balance

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6
Q

Provide an est. of the option overhang @ that date

A

A.
Market price per share $
- In-the-money amount $
= In-the-money amount

B.
Number of the options expected to be exercised =

Option overhang (In-the-money amount x Number of the options expected to be exercised) A x B
- Tax Benefit (at income tax rate %) Option overhang x %
= Option overhang after tax (a liability)

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7
Q

Note: Option Overhang

Overhang: is a measure of the potential dilution to which common shareholders are exposed due to possible awards of stock-based compensation. Overhang is usually represented as a percentage and is calculated as stock options granted plus the remaining options to be granted divided by the total shares outstanding.

A

This is a floor estimate; it is only the in-the-money value of the options (it excludes option value)

Options number is the number that are expected to be exercised. As options cannot be exercised untill they vest ( after a service period), the appropriate number is the number expected to vest (some employees are expected to leave before vesting.

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8
Q

Stock Warrants@price

A

represent the right the purchase a company’s stock @ a specific price & @ a specific date.

issued directly by a company to an investor

represents future capital for a company

purchase a source of a capital for the company

certificate include terms of the warrant, expiry date & final days it can be exercised

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9
Q

Conversion of Stock Warrants: Company A and Company B

A

Market price of shares issued on exercise of warrants:
Warrants to buy number of common shares x shares traded price $ per share
- Exercise price: warrants to buy number of common shares x offer share price $ per share
= Loss/Gain: warrants to buy number of common shares x (shared traded per share - offer share price $)

*The loss is not tax deductible.

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10
Q

Template: Reformulated Income Statement for the Period Ended Dec 31, 2015

A

Revenues

  • Operating Expenses
    = Operating Income before tax.
  • Tax Expense:
    Tax reported
    + Tax on interest expense

= Operating Income after Tax

  • Net Financial Expense:
    Interest expense
  • Tax benefit @ % income tax rate

+ Preferred Dividend

= Net Income to Common

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11
Q

Template: Reformulated Balance Sheet/Statement of Financial Position as at 31 Dec 2015

A
Operating Assets:
\+PPE
\+Intangible Assets
\+Inventory
\+TR
\+Cash
= Operating Assets (A)
- Operating Liabilities:
\+TP
\+Accrued Liabilities
\+Taxation
= Operating Liabilities (B)
= Net Operating Assets (A-B) 1

+ Financial Assets: (C)
Cash Equivalents
Interest-bearing debt

  • Financial Obligations: (D)
  • LT Debt
  • Preferred Equity
    = Net Finance Obligations (C-D) 2

= Common Shareholders Equity (1-2)

CSE: All that attributes to SHs + Non- controlling interest (shown separately)
FO: borrowings (both ST & LT), preference shares, lease liabilities
OL: all other liabilities except 1 & 2 above
OA: all other assets except FA
FA: long term debt instruments (eg. bonds), short term interest bearing investments (eg. T-bills), cash/cash equivalent in excess of operating needs.

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12
Q

Note of Chapter 3

A
  • Preferred Equity in reformulation is a financial obligations
  • Preferred dividend becomes financial expense in IS.
  • FS prepare under GAAP do not distinguish between operating & fin. profitability
  • FS reformulated into op. & fin. activities will enable the discovery op. & fin. profitability such as RNOA= OI/NOA and NBC = NFE/NFO
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13
Q

Note: Reformulation

A

by way of distinguishing between operating & financing activities.
Revenue & expenses :
1. operating - arising from trade of goods & services and/or use of operating assets
2. financing - arising from transactions with capital or money markets

improves the effectiveness of a problem - solving process by recasting a problem into a new one that is tailored to a given task.

Note: a typical problem in the reformulation is the allocation of a single income tax expense number to 2 components of income (operating & financing)

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14
Q

Financial Expense: After Tax interest expense

A

= Net Interest expense - tax benefit

= NIE (1-t)

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15
Q

Operating Expense: Tax on op. income

A

= reported tax expense + tax benefit

=report tax expense + net interest expense x t

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16
Q

What is tax rate?

A
  1. If given progressive tax regime, use marginal tax rates
  2. otherwise, assume single (effective) flat tax rate (ETR)
    Scenario:
    (i) when there is NFI: Income -> tax is positive (expense)
    Tax on OI@ETR (X)
    Tax on NEI@ETR. (X)
    = Tax reported in P/L (XX)

(ii) when there is NFE: Expense tax is save
Tax on OI@ETR (X)
Tax saved on NFE@ETR. (Y)
= Tax reported in P/L (X+Y)

Benefits:

  1. assess whether margins are consistent with the stated competitive strategy
  2. evaluate how the company is managing it overheads & administrative strategy.
17
Q

FS

A
  • useful tools - do not provide an appropriate pic of the biz for valuation purposes.

Valuation process:
reformulate FS -> better aligns the reported “stocks & flows” with business activities that generate value.

AIM: produce stylized FS (reformulated FS) clearly highlighting operating & fin. activities

INVESTING: use cash raised from fin. activities. & generated in operations to acquire (physical & intellectual assets to be used in operations)

NATURE OF INVESTING: to refer to the operating & investing activities together as operating activities

18
Q

A firm may lose the tax benefit of debt:

A
  • when it is unable to comply with tax regulations required such as the tax benefit must be used within a specified time or change of SHs or business
  • when the firm has no foreseeable profits to absorb the tax benefits.
  • when the firm has no tax liability
19
Q

Net op asset (NOA)

A

= OA - OL

20
Q

Net Fin Obligation (NFO)

A

= FA - FL