March 30, 2018
Colorado Christian University
Analysis of Financial Statements
Time value of money is useful in making informed business decisions. For example, the “net present value method” can be used to help decide the best alternative among multiple alternative uses of a firm or personal financial resource. By discounting various alternatives to their “present value” one can compare the alternatives. Time value of money can also answer such questions as what one’s investment will be worth at a certain point of time in the future, assuming a certain interest rate. Time value of money can also be used to compute such useful information as car, mortgage and other loan payments. Another use of time value of money in accounting is reporting of certain long-term assets and liabilities. Time value of money is based on the principle of compound interest. Each time there is a compounding period the new principal is increased by the interest from the previous period.
Analysis of Financial Statements
Questions and Problems
INTRODUCTION TO VALUATION: THE TIME VALUE OF MONEY
Chapter 1: The key considerations would be: (1) Is the rate of return implicit in the offer attractive relative to other, similar risk investments? and (2) How risky is the investment; i.e., how certain are we that we will get the $10,000? Thus, our answer does depend on who is making the promise to repay. (Ross, S., Westerfield, R., ; Jordan, B. 2017).
Answer 1: The simple interest per year is: $6,000 × 0.08 = $480 So, after 10 years, I will have: $480 × 10 = $4,800 in interest. The total balance will be $6,000 + 4,800 = $10,800. With compound interest, we use the future value formula: FV = PV (1 +r) t FV = $6,000(1.08)10 = $12,953.55 The difference is: $12,953.55 – 10,800 = $2,153.55 (Kapoor, J., Hughes, R., ; Hoyt, 2001)
Answer 2: Calculating Future Values: Assume I deposit $10,000 today in an account that pays 6% interest. How much will you have in five years = $10,000 (FVIF of 6%, 5years) = $10,000 * 1.3382 = $13,382
Converting Before Using the Tables
When using the tables, I may need to convert if, for example, in a lump sum situation there are more than one compounding periods in a year. Or I may need to convert (to monthly compounding) if, for example, you are working with an annuity situation involving a car loan that involves monthly rather than annual periodic payments. (Marcus, B. 2014, pg.8-12). When using the tables, I may need to convert if, for example, in a lump sum situation there are more than one compounding periods in a year. Or I may need to convert (to monthly compounding) if, for example, you are working with an annuity situation involving a car loan that involves monthly rather than annual periodic payments. (Jackson, H. 2004)
4.2. A single amount cash flow refers to an individual, stand alone, value occurring at one point in time. An annuity consists of an unbroken series of cash flows of equal dollar amount occurring over more than one period. A mixed stream is a pattern of cash flows over more than one period. A mixed stream is a pattern of cash flows over more than one-time period and the amount of cash associated with each period will vary. (Schaeffer, M., 2004 Chapter 4 pg. 7.)
4.3 Compounding of interest occurs when an amount is deposited into a savings account and the interest paid after the specific time remains in the account, thereby becoming part of the principal for the following period. The general equation for future value in year n (FVn) can be expressed using the specified notation as follows: FVn’ PV × (1 + i) n (Ittelson, T. 2009)
4. 4. A decrease in the interest rate lowers the future amount of a deposit for a given holding period, since the deposit earns less at the lower rate. An increase in the holding period for a given interest rate would increase the future value. The increased holding period increases the FV since the deposit earns interest over a longer period. (Cornett, M., Adair, T. & Holsinger, J. 2016)
Discounted Cash Flow Valuation
5.1 What is Basic Structure of Statement of Cash Flows?
The indirect method (or reconciliation method) depicts net income as starting entry. It converts the net cash flow from operating activities. In other words, the indirect method adjusts net income for items that affected reported net income but did not affect cash. To compute net cash flow from operating activities, non-cash charges in the income statement are added back to net income and non-cash credits are deducted. (Brigham, E. 2016)
5.2 What is Discounted Cash Flow?
The cost of capital is a term used in the field of financial investment to refer to the cost of a company’s funds, both debt and equity, or from an investors’ point of view, the shareholders required return on a portfolio of a company’s existing securities. It is used to evaluate new projects of a company as it is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project must meet. (Melicher, R. 2013)
5.3 What is Cash Flow Financial?
The income statement for each year will look like this:
Cost of Goods Sold 96,952122,418
Selling ; Administrative 19,067 24,886
Depreciation 27,370 30,936
EBIT $46,730 $53,600
Interest 5,950 6,820
Net income $32,624 $37,424
Addition to retained earnings 16,31218,712 (Brealey, R., Myers, S., Marcus, A. 2017, Chapter 4, pg.20)
5.5 What is Balance Sheet and Free Cash Flows?
1. Assess the current financial health and recent financial performance of the company. 2. Forecast the firm’s financial statements for 2002 and 2003. What will be the external financing requirements of the firm in those years? Can the firm repay its loan within a reasonable period? 3. What are the key driver assumptions of the firm’s future financial performance?
The financial health or strength of a company is measured by its ability to service its financial obligations senior to the common shareholders. These obligations include debt payments, preferred stock payments, the funding of any pension plans and rental and lease expenses. (Steven, R. 2014, Chapter 4 p. 23)
Write a short answer to 6.1, 6.2 and 6.6 Critical Thinking and Concepts Review.
As a rule, critical thinking involves developing some emotional and intellectual distance between yourself and ideas whether you’re own or others to better evaluate their truth, validity, and reasonableness. (Strauss, S. 2009)
Questions and Problems.
Answer 1, 3, 5, and 23 In reading Chapter 1, Liquidity problems exist in thinly traded bonds making some bonds difficult to sell at their actual value. Default risk is the likelihood the corporation will default on its bond obligations. Taxability risk reflects the fact that some bonds are taxed disadvantageously compared to others. (Roden, P., & Cooley, P., 1997). In Chapter 3 I also learned inventors can outperform the market if they have access to information which has been performing strongly over the past several months, stock prices are more likely to decline than increase over the next several months. (Houston, J., & Brigham, E. Chapter 3, pg. 9-12).
In Chapter 5, A spin-off is a situation in which a company sells stock in a wholly-owned subsidiary or dependent division, so the subsidiary or division becomes an independent company. The parent company may or may not maintain ownership in the new company and may have many reasons for spinning it off. For example, it may wish to exit one industry to expand in another, or it may simply wish to profit from the sale. (Pysh, P. & Brodersen, Stig (2014). In Chapter 5, pg. 235-240).
In Chapter 23, Intrinsic value based on the discounted value of the expected stream of cash flows, capitalization of expected income, and Stream of dividends or other cash payouts over the life of the investment. (Tage, T., & Tracy, J. 2009). Lastly, in Chapter 6, pg. 30-40) Securities issued by corporations are classified as equity securities and debt securities. A debt in very simple terms represents something that must be paid because of borrowing money, when corporations borrow money they make regular interest payments as well as paying the principal amount at the end of the period. (Ross, S., Westerfield, R., & Jordan, B. (2017).
When it comes to Discounted Cash Flow Valuation I learned that bond values and why they fluctuate, the bond contract between the firm and the trustee representing the bondholders and observed value of an asset in the marketplace; determined by supply and demand. Intrinsic value: economic or fair value of an asset; the present value of the asset’s expected future cash flows.
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