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Class Business

Class Business. Debate Proforma Assignment. Business Cycles. Business Cycle Peak Trough Industry relationship to business cycles Cyclical Defensive. NBER Cyclical Indicators:. Leading Indicators - tend to rise and fall in advance of the economy Avg. weekly hours of production workers

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Class Business

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  1. Class Business • Debate • Proforma Assignment

  2. Business Cycles • Business Cycle • Peak • Trough • Industry relationship to business cycles • Cyclical • Defensive

  3. NBER Cyclical Indicators: • Leading Indicators - tend to rise and fall in advance of the economy • Avg. weekly hours of production workers • Stock Prices • Yield Curve • Coincident Indicators - indicators that tend to change directly with the economy • Industrial production • Manufacturing and trade sales • Lagging Indicators - indicators that tend to follow the lag economic performance • Ratio of trade inventories to sales • Ratio of consumer installment credit outstanding to personal income

  4. Industry Analysis • Sensitivity to business cycles • Factors affecting sensitivity of earnings to business cycles • Sensitivity of sales of the firm’s product to the business cycles • Operating leverage • Financial leverage • Industry life cycles

  5. Financial Statements • Income Statement • Profitability over a given time period • Balance Sheet • “Stock” measure of firm’s financial position • Statement of Cash Flows • Actual Flow of Funds

  6. Example First and Second Link Old Image of 10-k Links

  7. New Image of 10-k Links Example First and Second Link

  8. Overview of Proforma Analysis

  9. Forecasting Income Statement Accounts

  10. Forecasting Balance Sheet Accounts

  11. More on Forecasting • Forecasting • Economic Plausibility • use ratios • Accounting Consistency • Plug Figures • Base much of forecasts on sales forecasts

  12. Ratio Analysis • Purpose of Ratio Analysis • Uses • Trend analysis • Comparative analysis • Forecasting • Use by External Analysts • Important information for investment community and ratings agencies

  13. Dividend Discount Models:General Model ¥ D å t = V o + t ( 1 k ) = 1 t • V0= Value of Stock • Dt= Dividend • k = required return

  14. Constant Growth Model + D ( 1 g ) o = Vo - k g • g = constant perpetual growth rate

  15. Estimating Dividend Growth Rates = ´ g ROE b • g = growth rate in dividends • ROE = Return on Equity for the firm • b = plowback or retention percentage rate = (1- dividend payout percentage rate)

  16. Return on Equity • Financial Leverage and ROE • ROA = EBIT/Total Assets • ROE = Net Profit/Equity

  17. ROE Example • Company A and B have same ROA or same assets in total of $500 million, but B has financed 30% of their assets while A has no debt. Assume they both pay 40% corporate tax rates, interest on company B’s debt is 7%. • What is A and B’s ROE if their ROA is 12%? • ROEA = .6*[.12 + (.12 - .07)*0] = .072 or 7.2% • ROEB = .6*[.12 + (.12 - .07)*(150/350)] = .084 or 8.4% • What is A and B’s ROE if their ROA is 6%? • ROEA = .6*[.06 + (.06 - .07)*0] = .036 or 3.6% • ROEB = .6*[.06 + (.06 - .07)*(150/350)] = .033 or 3.3%

  18. Du Pont Decomposition of ROE EBIT Sales Sales Assets Assets Equity Net Profit Pretax Profit Pretax Profit EBIT x ROE = x x x (1) x (2) x (3) x (4) x (5) InterestBurden Profit Margin = Tax Burden x x Turnover x Leverage x = Tax Burden x ROA x Compound Leverage Factor Walmart versus Neiman-Marcus?

  19. Quality of Earnings:Areas of Accounting Choices • Allowance for bad debts • Non-securing items • Reserves management • Stock options • Revenue recognition • Off-balance sheet assets and liabilities

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