Module 2 - Financial Statements

SYLLABUS PLAN
Modules Compulsory readings

1 Mishkin, Chapter 1
Introduction to Finance Cecchetti, Chapters 1,2 & 3
Cornett, Chapter 1
2
Financial Statements Bodie, Chapter 3
3 Cornett, Chapters 2 & 3
Analyzing financial statements
4 Bodie, Chapters 4 & 5,8 & 9
Time Value of Money Mishkin, Chapter 4
Cornett, Chapters 4 & 5
5
Mishkin, Chapters 1,2,3 & 8
Understanding Financial Markets Cecetti, Chapter 11
and Institutions Cornett, Chapter 6,7 & 8
Financial Statements 1
REVIEWING FINANCIAL STATEMENTS
Bodie, Chapter 3
Cornett, Chapters 2 & 3
Content
1.Balance Sheet
2.Income Statement
3.Statement of Cash Flows
4.Free Cash Flow
5.Statement of Retained Earnings
• Song wants to invest in DPH Tree
Farm Inc. Song has a set of recent
Looking financial statements from DPH Tree
Farm’s annual report but is not sure
for a perfect
how to read them or what are the
company meanings of all these numbers and
reports.
• What are the four financial statements?
• What information can she gets from
these statements?
An annual report
• Four basic financial statements:
1. The balance sheet
2. The income statement
3. The statement of cash flows
4. The statement of retained earnings
• A financial statement provides an accounting-
based picture of a firm’s financial position.
The balance sheet
• Assets = Liabilities + Equity
7
Balance
Sheet
Financial Statements
Net working capital
• Net working capital = Current assets – Current liabilities
Book vs Market Value
• Balance Sheet shows its

book (or historical cost) value
based on generally accepted
accounting principles.
• Because of inflation and
market forces, many assets
are more worth now thatn
they were worth when the
firm bought them.
• Book values can differ widely from market
values for the same assets.
Computing Book vs Market Value
• D2K Inc. lists fixed assets and current assets
of $25 million and $10 million respectively on
its balance sheet. The firm’s fixed assets and
current assets were recently appraised at $32
and $ 11 million respectively.
• The current liabilities’ book and market values
stand at $6 million and the firm’s long-term
debt is $15 million.
• What are the book value and market value of
the firm’s shareholders equity? Construct the
book value and market value balance sheet for
D2K Inc.
Income Statement
Some equations
1. EPS
2. DPS
3. BVPS
4. MVPS = Market price of the firms’ common stock
13
Statement
Income
Corporate Income Taxes
• Corporate Tax Rates as of 2012
• The U.S tax structure is progressive, meaning

that the larger the income, the higher the taxes
assessed.
Average Tax Rate
vs Marginal Tax Rate
• Average tax rate =

• Marginal tax rate is the additional
taxes a firm must pay out for every
additional dollar of taxable income it
earns.
Calulating the tax rate
• E.g: Antonio Inc. earned $17 mill taxable
income (EBT) in 2012. Use the tax schedule to
compute the firm’s 2012 tax liability, its average
tax rate and its marginal tax rate.
Effect of Debt vs Equity Financing on Returns
• Supposed you wonder between two alternative

investments (in Firm A or Firm B). Both are active
in the same industry and have identical operating
incomes of $10 million. Firm A finances its $24
million in assets with $22 million in debt (on which
it pays 10% interest) and $2 million in equity. Firm
B finances its $24 million in assets with $24 million
in equity and no debt. Both firm has pay 30% tax
on their taxable income.
• Calculate the income that each firm has available
to pay its debt and shareholders and the ROEs.
The
Statement of
Cash Flow
• Financial managers
and investors are far
more interested in
actual cash flows than
in the backward-
looking profit listed on
the income statement.
• A financial statement
that shows the firm’s
cash flows over a
given period of time.
The Statement of Cash Flow
The Statement of Cash Flow
Statement
of Cash
Flows
21
Free Cash Flow
• The cash that is actually available for
distribution to the investors in the firm after the
investments that are necessary sustain the
firm’s ongoing operations are made.
Computing FCF
• What was DPH Tree Farm’s free cash flow for
2012?
Statement of Retained Earnings
• Increases in retained earnings occur not just
because a firm has net income, but also
because the firm’s common shareholders
agree to let management reinvest net income
back into the firm rather than pay it out as
dividends.
• Reinvesting net income back into retained
earnings allows the firm to grow by providing
additional funds that can be spent on plant and
equipment, inventory, and other assets needed
to generate even more profit.
Statement
of
Retained
Earnings
25

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SYLLABUS PLAN

Modules Compulsory readings

3.Statement of Cash Flows

4.Free Cash Flow

5.Statement of Retained Earnings

• Net working capital = Current assets – Current liabilities

• Balance Sheet shows its

4. MVPS = Market price of the firms’ common stock

• The U.S tax structure is progressive, meaning

• Average tax rate =

• Supposed you wonder between two alternative

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