Dr. M. Nusrate Aziz Senior Lecturer and DBA Coordinator
Graduate School of Management Multimedia University E-mail: firstname.lastname@example.org
Accounting Profit Vs. Cash Flow
• The Midland Company refines and trades gold. It purchased gold at the beginning of the year and paid $900,000. End of the year the company sold it for $1 million. However, money has yet to collect from customer. Accounting View Income Statement, December 31 Sales - Costs $1,000,000 - $900,000 Financial View Income Statement, December 31 Cash Inflow Cash outflow $0 -$900,000
• Value creation depends on cash flows. For Midland, value creation depends on whether and when it actually receives $1 million.
Timing of Cash Flow
• Present Value: The value of an investment made by a firm depends on the timing of the cash flows. One dollar today worth usually more than one dollar in the next year. • Suppose, the Midland Company is attempting to choose between two proposals for new products. Both proposals will provide additional cash flows over a four-year period.
Year 1 2 3 4 Total
New Product A $ 0 $ 0 $ 0 $20,000 $20,000
New Product B $ 4,000 $ 4,000 $ 4,000 $ 4,000 $16,000
• Which project would be chosen depends on whether the value of total cash from A outweigh the cash from B or vice versa.
Risk of Cash Flow
• Suppose, the Midlands company is considering expanding operations overseas. Europe is considered to be relatively safe, whereas operating in Japan is seen as risky. After doing a complete financial analysis, company has come up with the following cash flows of the alternative plans under three scenarios:
Europe Japan $75,000 0
• If we ignore the pessimistic scenario, perhaps Japan is the best alternative. When we take pessimistic scenario into account, the choice is unclear (depends whether manager is risk taker or risk averse).
The Balance Sheet
• Assets = Liabilities + Stockholders’ equity • Stockholders’ equity = Assets – Liabilities
Market Value Vs Book Value
• A corporation has fixed assets with a book value of $700 and an apprised market value of about $1,000. Net working capital is $400 on the books, but approximately $600 would be realized if all current accounts were liquidated. The corporation has $500 in long-term debt, both book value and market value. What is the book value of the equity? What is the market value?
• Shareholders’ equity is actually worth almost twice as much as what is known on the books.
The Income Statement
• The income statement measures performance over a specified period – usually one year. The accounting definition of income is – • Revenue – Expenses = Income
The Income Statement (Concepts)
• Operating Revenue: Income derived from sources related to a company's everyday business operations (e.g., sell underperforming stores and/or assets). • Shares outstanding are all the shares of a corporation that have been authorized, issued and purchased by investors and are held by them. Shares outstanding plus treasury shares together amount to the number of issued shares. • Treasury shares are shares held by the corporation itself (bought back by the issuing company to reduce the outstanding shares).
Analyzing Income Statement
• Suppose, there are 29 million shares outstanding. Earnings per share and dividends per share can be calculated by:
Corporate Tax Calculation
• Suppose, tax base and tax rates are given as follows:
• Suppose, our corporation has a taxable income of $200,000. What is the tax bill?
Average Tax Rate and Marginal Tax Rate
• Average tax rate: Average tax rate is tax bill divided by taxable income (the percentage of income that goes to pay tax). • Marginal tax rate: Marginal tax rate is the tax corporation would pay (in percent) if corporation earn one extra dollar....