Topic 6: Financial Statement Analysis & Equity Valuation Flashcards

1
Q

What are economic earnings?

A
  • sustainable cash flow that can be paid out to stock holders without impairing the productive capacity of the firm
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2
Q

What are accounting earnings?

A
  • affected by some conventions (inventories, depreciation); business cycles
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3
Q

What does total asset turnover measure?

A
  • measures how efficient a firm uses its assets (for every dollar of assets, how many sales the firm generates)
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4
Q

What does a high interest coverage ratio indicate?

A
  • shows the likelihood of bankruptcy is low because annual earnings are significantly greater than annual interest obligations
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5
Q

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

A
  • Expectations of future dividends and earnings
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6
Q

What happens if ROA is greater than borrowing rate?

A
  • 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
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7
Q

What happens if ROA is less than borrowing rate?

A
  • ROE will decline

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

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8
Q

What is the compound leverage factor made of?

A

= Interest burden * Leverage

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9
Q

What does a low P/B ratio mean?

A
  • A low P/B ratio stock can be a safer investment, since the book value can be a floor supporting the market price
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10
Q

What does a high P/B ratio indicate?

A
  • 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)
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11
Q

What does a low P/E ratio indicate?

A
  • 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
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12
Q

What does a high P/E ratio indicate?

A
  • 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
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13
Q

What is the difference between LIFO & FIFO?

A
  • LIFO- assumes goods are valued at todays cost

- FIFO- assumes goods are valued at original cost

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14
Q
  • 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?
A
  • 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
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15
Q

Trading Signal

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

A
  • Buy or long
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16
Q

Trading Signal

IV < MP

A
  • Sell or short
17
Q

Trading Signal

IV = MP

A
  • Hold or fairly priced
18
Q

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

A
  • Underpriced and we should buy
19
Q

Constant dividend model is only valid if?

A

g < k