Learn: Financial Statement Analysis, DuPont and Growth Rates

The SEC requires public companies to report financial information:

Annually and quarterly.

GAAP Reporting, Compared to IFRS Is:

More conservative but not the global dominant standard.

Which of the following Financial Statements reports financial items for a given point in time?

Balance Sheet.

The Balance Sheet Identity is:

Assets = Liabilities + Stockholders' Equity.

Inventory Turnover is better when it is:

Higher.

Which of the following working capital ratios indicates better cash efficiency when it is higher?

Accounts Payable Days.

When utilizing the DuPont identity, which of the following will lead to a higher ROE?

Higher Profit Margin.

When calculating Free Cash Flow to value equity, _____ is added back to net income because the business is valued independent of its financing choices.

After-tax interest expense.

Name a financial statement item that could be included in changes to working capital.

Accounts receivable, accounts payable, inventory, prepaid expenses, or accrued liabilities.

List something that is commonly found in the Notes to Financial Statements.

Inventory components, future long-term debt and lease payments, stock-based compensation plans, mergers and acquisitions, or segment information.

What is the gross margin for a company with Sales of $100 million and Gross Profit of $30 million? Show your calculation.

$30 million ÷ $100 million = 30%.

Calculate the Gross Margin for a Company with Sales of $800 million and Gross Profit of $550 million. Show your answer as a percentage.

$550 million ÷ $800 million = 68.75%.

The _____ Rate is the maximum growth rate a firm can achieve without external financing.

Internal Growth Rate (IGR).

List one of the two forms of business organizations where owners have personal liability for the debts of the firm.

Sole proprietorship or partnership.

Provide an example of a situation where the goal of a corporation to increase shareholder value may come at the expense of a community or society as a whole.

A company closes a local factory to cut costs and increase profits, but community members lose their jobs.

What is the goal of a corporation?

Increase shareholder value.

What is the Balance Sheet?

A snapshot of the firm's financial position at a given point in time.

What does the Balance Sheet list?

The firm's assets and liabilities.

What is the Balance Sheet identity?

Assets = Liabilities + Stockholders' Equity.

What are liabilities?

Obligations to creditors.

What is stockholders' equity?

Assets minus liabilities; an accounting measure of a firm's net worth.

What does the Income Statement report?

Financial performance over a period of time.

How does IFRS compare with GAAP?

IFRS is more flexible and principles-based; GAAP is more conservative and rules-based.

What is the goal of working capital management?

Minimize how long cash is tied up and maximize how quickly inventory is sold.

What do Accounts Receivable Days measure?

How long it takes to collect cash from customers. Lower is generally better.

What do Accounts Payable Days measure?

How long it takes to pay suppliers. Higher is generally better for cash efficiency.

What do Inventory Days measure?

How long inventory sits before being sold. Lower is generally better.

What does Inventory Turnover measure?

How quickly inventory is sold and replaced. Higher is generally better.

What is the DuPont Identity of ROE?

Profit Margin × Asset Turnover × Leverage.

How do you calculate Profit Margin?

Net Income ÷ Sales.

How do you calculate Asset Turnover?

Sales ÷ Total Assets.

How do you calculate Leverage in the DuPont Identity?

Total Assets ÷ Total Equity.

How can a company increase ROE using the DuPont Identity?

Increase profit margin, increase asset turnover, or increase leverage. More leverage also increases risk.

Given Sales of $1,500,000, Net Income of $200,000, Assets of $1,125,000, and Equity of $845,000, how do you calculate Profit Margin?

$200,000 ÷ $1,500,000 = 13.33%.

Using the same figures, how do you calculate Asset Turnover?

$1,500,000 ÷ $1,125,000 = 1.33 times.

Using the same figures, how do you calculate Leverage?

$1,125,000 ÷ $845,000 = 1.33 times.

Using the same figures, how do you calculate ROE using DuPont?

Profit Margin × Asset Turnover × Leverage.

What is Internal Growth Rate (IGR)?

The maximum growth rate a firm can achieve without external financing.

What is Sustainable Growth Rate (SGR)?

The maximum growth rate a firm can achieve without issuing new equity or increasing the debt-to-equity ratio.

What is the Internal Growth Rate formula?

ROA × Retention Rate.

What is the Sustainable Growth Rate formula?

ROE × Retention Rate ÷ (1 − ROE × Retention Rate).

What is the retention rate?

1 − Dividend Payout Ratio.

What is a sole proprietorship?

A business owned and run by one person. The owner has unlimited personal liability.

What is a partnership?

A business with more than one owner. Partners can be personally liable for the firm's debts.

What is a corporation?

A separate legal entity from its owners. Shareholders generally have limited liability.

The greatest risk to a call writer is:

The underlying asset price rises sharply.

Two otherwise identical American call options have the same strike price, but one expires in 2 months and the other expires in 8 months. Which will generally be more valuable?

The 8-month option.

What is volatility?

How much a stock's price swings over time.

What generally happens to the value of a put option when the risk-free interest rate increases?

The value of the put option decreases.

Which statements about put writers are true?

They profit if the option expires worthless, receive a premium, and can lose money if the stock price falls dramatically.

If a stock price falls from $80 to $65, what is the likely effect on a put option?

The put value will likely increase.

An investor owns a call option on a stock currently priced at $50. Would the investor prefer high or low volatility, and why?

High volatility, because the call buyer's loss is limited to the premium while the potential gain is unlimited.

The option to expand a project is most valuable for:

Capturing upside potential.

A callable bond contains an option to:

The issuing firm.

Briefly explain how an abandonment option affects a project's risk and overall value.

It lets the company stop a poorly performing project, limiting potential losses and increasing the project's overall value.

Equity can be viewed as:

A call option on the firm's assets.

Investors typically pay more for convertible bonds because they:

Contain a valuable conversion feature.

Which of the following generally focuses more on the core profitability of a firm?

EBITDA.

The discounted cash flow (DCF) model uses which of the following as the discount rate?

Weighted average cost of capital (WACC).

List 2 examples of Qualitative Analysis for companies and briefly explain why they can be important to the value of the firm.

Management competence can improve decisions. Brand recognition can attract customers and build loyalty, increasing sales and profits.

The Price-to-Book Value ratio is considered particularly useful for firms with high levels of intangible assets. True or False?

False.

Name an industry where using Price-to-Sales might be appropriate and explain why.

Retail, because companies often have high sales volume but low profit margins.

For a profitable and growing company, its forward P/E generally _____ its trailing P/E.

Is lower than.

What is the gross margin for a company with Sales of $120 million and Gross Profit of $36 million?

$36 million ÷ $120 million = 30%.

A company has Sales of $2,000,000, Net Income of $300,000, Assets of $1,500,000, and Equity of $750,000. Calculate Profit Margin.

$300,000 ÷ $2,000,000 = 15%.

Using the same figures, calculate Asset Turnover.

$2,000,000 ÷ $1,500,000 = 1.33 times.

Using the same figures, calculate Leverage.

$1,500,000 ÷ $750,000 = 2 times.

Using the same figures, calculate ROE using the DuPont Identity.

15% × 1.3333 × 2 ≈ 40%.

A put has a strike price of $70 and a premium of $4. The stock price at expiration is $60. What is the put buyer's profit or loss?

$70 − $60 − $4 = $6 profit.

A call has a strike price of $50 and a premium of $3. The stock price at expiration is $60. What is the call buyer's profit or loss?

$60 − $50 − $3 = $7 profit.