Financial Statements and Corporate Managers

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Business Analysis and Valuation: IFRS Edition

Instructor’s Manual – Discussion Questions

Palepu – Healy – Bernard – Peek

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Instructor's Manual

Dot-Com Crash-3

Instructor’s Manual – Discussion Questions
Table of Contents Table of Contents...........................................................................................................3 Chapter 1 A Framework for Business Analysis Using Financial Statements................4 Chapter 2 Strategy Analysis...........................................................................................7 Chapter 3 Overview of Accounting Analysis ..............................................................16 Chapter 4 Implementing Accounting Analysis............................................................21 Chapter 5 Financial Analysis .......................................................................................29 Chapter 6 Prospective Analysis: Forecasting ..............................................................36 Chapter 7 Prospective Analysis: Valuation Theory and Concepts ..............................40 Chapter 8 Prospective Analysis: Value Implementation .............................................44 Chapter 9 Equity Security Analysis.............................................................................50 Chapter 10 Credit Analysis and Distress Prediction....................................................56 Chapter 11 Mergers and Acquisitions..........................................................................60 Chapter 12 Corporate Financing Policies ....................................................................65 Chapter 13 Communication and Governance ..............................................................70

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Chapter 1 A Framework for Business Analysis Using Financial Statements Question 1. Matti, who has just completed his first finance course, is unsure whether he should take a course in business analysis and valuation using financial statements since he believes that financial analysis adds little value, given the efficiency of capital markets. Explain to Matti when financial analysis can add value, even if capital markets are efficient.

The efficient market hypothesis states that security prices reflect all available information, as if such information could be costlessly digested and translated immediately into demands for buys or sells. The efficient market hypothesis implies that there is no further need for analysis involving a search for mispriced securities. However, if all investors adopted this attitude, no equity analysis would be conducted, mispricing would go uncorrected, and markets would no longer be efficient. This is why there must be just enough mispricing to provide incentives for the investment of resources in security analysis. Even in an extremely efficient market, where information is fully impounded in prices within minutes of its revelation (i.e., where mispricing exists only for minutes), Matti can get rewards with strong financial analysis skills: 1. Matti can interpret the newly-announced financial data faster than others and trade on it within minutes; and 2. financial analysis helps Matti to understand the firm better, placing him in a better position to interpret other news more accurately as it arrives. Markets may be not efficient under certain circumstances. Mispricing of securities may exist even days or months after the public revelation of a financial statement when the following three conditions are satisfied: 1. relative to investors, managers have superior information on their firms’ business strategies and operation; 2. managers’ incentives are not perfectly aligned with all shareholders’ interests; and 3. accounting rules and auditing are imperfect. When these conditions are met in reality, Matti could get profit by using trading strategies designed to exploit any systematic ways in which the publicly available data are ignored or discounted in the...
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