Chapter 3 Flashcards
Formulae : Common Equity
= Total equity - preferred equity
Formulae : Net Dividend
= Dividends + Share repurchases - shares issues
Formulae : Comprehensive Earnings
= CSE(end) - CSE(beginning) + net dividend
Formulae : ROCE
= Comprehensive earnings/beginning CSE
Template : Reformulation of the Equity Statement
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
Provide an est. of the option overhang @ that date
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)
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.
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.
Stock Warrants@price
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
Conversion of Stock Warrants: Company A and Company B
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.
Template: Reformulated Income Statement for the Period Ended Dec 31, 2015
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
Template: Reformulated Balance Sheet/Statement of Financial Position as at 31 Dec 2015
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.
Note of Chapter 3
- 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
Note: Reformulation
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)
Financial Expense: After Tax interest expense
= Net Interest expense - tax benefit
= NIE (1-t)
Operating Expense: Tax on op. income
= reported tax expense + tax benefit
=report tax expense + net interest expense x t
What is tax rate?
- If given progressive tax regime, use marginal tax rates
- 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:
- assess whether margins are consistent with the stated competitive strategy
- evaluate how the company is managing it overheads & administrative strategy.
FS
- 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
A firm may lose the tax benefit of debt:
- 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
Net op asset (NOA)
= OA - OL
Net Fin Obligation (NFO)
= FA - FL
