Lecture 6 Flashcards
What does analysis establish
Analysis establishes where the firm is now.
What is the formula for residual earning model, given you are anchoring to CSE and the formula for RE
Look at the notes
What is the ROCE a weighted return of
What is the formula for ROCE given that it is a weighted return. (there are three returns)
ROCE is a weighted return to operating activities and financing activities
Answers in notes
How can firms grow earnings, but not create value
What is value added growth
What are growth firms, but what are the dangers when investing in a growth firm
- Firms can grow earnings, but not create value
- Earnings growth could be generated by investment (earn a return above its required return)
- Earning growth could be generated by the accounting - Value added growth is the ability to earn abnormal earnings growth (AEG), or earnings above its residual earnings, growth above its required earnings
3, A growth firm is one that grows its residual earnings.
- growth is difficult to sustain
- Growth is risky if it represents a significant portion of the stock price
therefore you should not pay to much for growth
- What are sustainable earnings, what are the other names it can be referred to as
- Why is identifying core earnings sometimes referred to as normalizing earning.
- What are unsustainable earning also referred to as
1.Sustainable earning are earnings that can repeated or sustained in the future and which can grow.
Also called
Core Earnings
Persistent Earnings
Underlying Earnings
- Identifying core earning is sometimes referred to as normalizing earnings because it establishes “normal’ ongoing earnings unaffected by one-time components
- Unsustainable earnings are earning that do not occur on a yearly basis and are hard to predict.
Unusual items
Transitory earnings
Extraordinary
What is the formula for distinguishing core operating income from unusual transitory income:
What is the formula for distinguishing core income from sales from other core operating income
What could you do to distinguish unusual items.
Operating income = Core OI + Unusual items
Operating Income = Core OI from sales + Core other OI + unusual items
Unusual items are those that con not be easily forecasted even if they appear each year. These items are hard to predict as they may result in a loss or gain, the expected value is zero.
If
ROCE = RNOA + [ FlEV x SPREAD ]
Then the change in ROCE is driven by what?
Effect of change in operating profitability
Effect of change in spread
Effect of change in leverage
This is all in the formula
What can cause a change in the spread
Spread = RNOA - NBC
Changes in Spread = ( Change in RNOA - Change in NBC ) ( Change in RNOA - Change in NBC {period before} )
Changes in NBC need to be distinguished core and unusual borrowing costs
NBC = ( Core net financing expense ) / NFO + ( unusual financing expense ) / NFO
What can core financing expense and unusual financing expense may include
Core financing:
Changes in interest rates (risk free and risk premium)
Changes in tax rates (and Shield)
Substitution of preferred for debt financing
Unusual Financing expense:
Tax effect from unusally high or low taxes (operating losses)
Interest income from tax refunds of prior years
Gains and losses on financial items.
- What causes changes in common shareholder equity
What is the formula
- Change in common shareholder equity = Changes in NOA - Changes in NFO
- Check the solutions
What are the three components of change in common equity.
What is the primary driver
- Growth of sales
- Changes in net operating assets that support each dollar of sales
- Changes in the amount of net debt that is used to finance the change in net operating assets rather than equity
Sales growth is the primary driver or least it should be
