FIN 4504 EXAM 3 REVIEW 1 Calc holding period return ch13 Holding period return is the return on a stock investment comprises cash dividends and capital gain loss If stock is priced correctly req return should equal expected return HPR 1x return on year one percentage x 1x return on year two percentage 1 Or if return is equal for all years 1 reurn percentage n 1 The payout ratio provides an idea of how well earnings support the dividend payments 2 Dividend payout Percentage of earnings paid out as dividends DPR yearly dividends per share Earnings per share OR Dividends net income 3 Security s intrinsic value ch13 Slide 13 14 Intrinsic value is the present value of a firms expected future net cash flow discounted by a risk adjusted required rate of return Expectations of future dividends and earnings determine intrinsic value of stock The difference between strike and current price Strike current price Also calc by DDM 4 Calc expected market price per share Use Price to earning ratio P e market value per share earnings per share Market value is what the stock is currently trading at 5 Stock valuation models 13 17to20 Basic dividend discount model formula for the intrinsic value of a firm to the present value of all expected future dividends DDM asserts that stock prices are determined ultimately by cash flows dividends accruing to stock holders FIN 4504 EXAM 3 REVIEW No growth models rate Constant growth model a form of DDM that assumes dividends grow at a constant 6 Components of balance sheet income statement Income statement Balance sheet Cost of goods sold General and admin expenses Interest expense Taxes on earnings Assets current and long term Liability and stock holders equity Common size income statements Common size balance sheet Divide each account by net sales Eliminate size distortions Div each account by total assets Each account presented as a percent of the total 7 Components of DuPont model ROE Net Profit Pretax Profit Pretax Profit 1 Tax Burden EBIT 2 Interest Burden Sales EBIT Sales Assets 3 Margin Assets Equity 5 4 Turnover Leverage 1 Tax burden ratio measures the percentage of pretax profit that the firm keeps after paying taxes FIN 4504 EXAM 3 REVIEW 2 Interest burden measure percent of EBIT kept after paying interest expense EBIT interest exp pretax profit 3 Operating profit margin Measures the percentage of sales revenue that remains after subtracting cost of goods sold selling and administrative expenses and depreciation assets Note Margin x ATO ROA 4 Measures the efficiency of the firm at generating sales per dollar invested in the Leverage ratio The leverage ratio is a measure of the percentage of debt in total capitalization Leverage ratio 1 Debt Equity 8 Calc current ratio 9 Quality of earnings Current ratio current assets current liabilities Refers to the realism and sustainability of reported earnings Remember that earnings are supposed to translate into cash flow and we are always trying to identify the trend in expected future cash flows Allowance for bad debts must be realistic Extraordinary and nonrecurring items are sometimes pretty ordinary and common Earnings smoothing is persuasive Revenue and expense recognition options Engaging in contingent off balance sheet assets or liabilities that have unknowable effects on earnings Earnings management practice of using flexible accounting rules to improve the apparent profitability of the firm 10 GAAP IFRS ch14 FIN 4504 EXAM 3 REVIEW IFRS international financial reporting standards Have been adopted European union and over 100 countries In 2007 the SEC began allowing foreign firms to list their securities in U S markets if they prepared their statements using IFRS In 2008 the SEC ruled that large U S multinational firms may start using IFRS rather than GAAP in 2010 and that all firms should use IFRS by 2014 IFRS standards are principle based rather than rules based The IFRS standards will generally allow more flexibility in reporting standards GAAP fasb Generally Accepted accounting principles Fasb financial accounting standards Fair value accounting uses market values rather than book values in the firms board financial statements Market is truer picture of the current value of the firm Market value is forward looking book value is backward looking Trend is toward market value accounting FASB Rule 157 classifies assets in one of three buckets Level 1 assets that are traded in active markets and should be valued at Level 2 assets that are not actively traded but their values may be estimated market prices from market data on similar assets Level 3 assets that can only be valued with inputs that are difficult to observe Level 2 and 3 assets may be valued using pricing models and the values may be marked to model FIN 4504 EXAM 3 REVIEW 11 Interest rate sensitivity ch11 Inverse relationship between bond price and interest rate or yields Long term bonds are more price sensitive than short term bonds except deep discount bonds can have lower duration at longer maturities Sensitivity of bond prices to change in yields increases at a decreasing rate as maturity increases A bonds price sensitivity is inversely related to the bonds coupon EX If interest rates increase and I have a high coupon bond I am getting more current income to reinvest at the new higher rates so my bond s price is not affected as much as a bond with a lower coupon and vice versa Sensitivity of a bond s price to a change in its yield is inversely related to the YTM at which the bond currently is selling If interest rates increase and I have a high coupon bond I am getting more current income to reinvest at the new higher rates so my bond s price is not affected as much as a bond with a lower coupon and vice versa An increase in a bonds YTM results in a smaller price decline than the gain associated with a decrease in yield If interest rates increase and I have a high coupon bond I am getting more current income to reinvest at the new higher rates so my bond s price is not affected as much as a bond with a lower coupon and vice versa If interest rates increase and I have a high coupon bond I am getting more current income to reinvest at the new higher rates so my bond s price is not affected as much as a bond with a lower coupon and vice versa If interest rates increase and I have a high coupon bond I am getting more current income to reinvest at the new higher rates so my bond s price is not affected as much as a bond with a lower coupon