© 2001 prentice hall business publishing financial accounting, 4/e harrison and horngren 13-1...

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren

13-1

CHAPTER 13

Financial Statement Analysis


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FINANCIAL STATEMENT ANALYSIS

• The way to compare companies of different sizes is to use standard measures

• Financial ratios are standard measures that enable analysts to compare companies of different sizes


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• In addition to the financial statements, annual reports contain the following:– Notes to the financial statements, including

a summary of the accounting methods used– Management’s discussion and analysis

(MD&A) of the financial results– The auditor’s report– Comparative financial data for a series of

years



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For example, the graphs in the next exhibit show Bristol-Myers Squibb’s three-year trend of net sales, market value of the company’s stock, and cumulative return to the company’s stockholders


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$20,000

15,000

10,000

5,000

096 97 98

$140,000

105,000

70,000

35,000

096 97 98

250%

200

150

100

50

096 97 98

Net Sales

$ Millions

Market Value

$ MillionsCumulative Return

to Shareholders

Representative Financial Data of Bristol-Myers Squibb CompanyRepresentative Financial Data of Bristol-Myers Squibb Company


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• The objectives of financial statement analysis are to help investors– Predict their expected returns (see the

previous graph)– Assess the risks associated with those

returns



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HORIZONTAL ANALYSIS

• The study of percentage changes in comparative statements is called horizontal analysis

• Computing a percentage change in comparative statements requires two steps:– Computing the dollar amount of the change

from the base period to the later period– Dividing the dollar amount of change by the

base-period amount


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Horizontal analysis is illustrated for Bristol-Myers Squibb as follows (dollar amounts in millions):

Sales $18,284 $16,701 $1,583 9.5%

Net income 3,141 3,205 (64) (2.0%)

1998 1997 Amount Percent

Increase (Decrease)


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The percentage change in Bristol-Myers Squibb’s sales during 1998 is 9.5%, computed as follows:

Step 1. Compute the dollar amount of change in sales from 1997 to 1998:

19981998 19971997 IncreaseIncrease

$18,284$18,284 $16,701$16,701 $1,583$1,583- =

Step 2. Divide the dollar amount of change by the base-period amount to compute the percentage change during the later period:

Percentage ChangePercentage Change

Dollar amount of changeDollar amount of change

Base-year amountBase-year amount

$1,583$1,583$16,701$16,701

9.5%9.5%

==

====


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• Trend percentages– Are a form of horizontal analysis that

examine more than a two- or three-year period

– Use a selected base year whose amounts are set equal to 100 percent

HORIZONTAL ANALYSIS


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• To compute trend percentages, each item for following years is divided by the corresponding amount during the base year

HORIZONTAL ANALYSIS

Trend % = Trend % = Any year $Any year $

Base year $Base year $


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Bristol-Myers Squibb Company showed sales, cost of goods sold, and gross profit for the past six years as follows:

(in millions) 1998 1997 1996 1995 1994 1993

Net Sales $18,284 $16,701 $15,065 $13,767 $11,984 $11,413Cost of products sold 4,856 4,464 3,965 3,637 3,122 3,029Gross profit 13,428 12,237 11,100 10,130 8,862 8,384

HORIZONTAL ANALYSIS


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• The base year is 1993

• Trend percentages for Net sales are computed by dividing each net sales amount by the 1993 amount of $11,413

• Trend percentages for Cost of products sold is computed by dividing by each cost of products sold amount by $3,029

• Trend percentages for Gross profit use the base gross profit of $8,383

HORIZONTAL ANALYSIS


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1998 1997 1996 1995 1994 1993

Net sales 160% 146% 132% 121% 105% 100%Cost of products sold 160 147 131 120 103 100Gross profit 160 146 132 121 106 100

Sales, cost of products sold, and gross profit have trended upward at almost identical rates throughout

the five-year period

Sales, cost of products sold, and gross profit have trended upward at almost identical rates throughout

the five-year period

The resulting trend percentages follow:

HORIZONTAL ANALYSIS


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VERTICAL ANALYSIS

• Vertical analysis of a financial statement reveals the relationship of each statement item to a specified base, which is the 100% figure

• Every other item on the financial statement is then reported as a percentage of that base

• When an income statement is analyzed vertically, net sales is usually the base


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VERTICAL ANALYSIS

Vertical analysis %Vertical analysis %Each income statement itemEach income statement item

Net SalesNet Sales==

• Vertical analysis of balance sheet amounts are shown as a percentage of total assets

• The next exhibit shows the vertical analysis of Bristol-Myers Squibb’s income statement as a percentage of net sales


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BRISTOL-MYERS SQUIBB COMPANYStatement of Earnings (Adapted)

Years Ended December 31, 1998 and 1997

Dollar amounts in millions

Net sales $18,284 100.0% $16,701 100.0%Cost of products sold 4,856 26.6 4,464 26.7Gross profit 13,428 73.4 12,237 73.3Operating expenses: Marketing, selling, and administrative 4,418 24.2 4,173 25.0 Advertising and products promotion 2,312 12.6 2,241 13.4 Research and development 1,577 8.6 1,385 8.3 Special charge 800 4.4 Provision for restructuring 201 1.1 225 1.3 Other (148) (0.8) (269) (1.5)Earnings before income taxes 4,268 23.3 4,482 26.8Provision for income taxes 1,127 6.1 1,277 7.6Net earnings $ 3,141 17.2% $ 3,205 19.2%

BRISTOL-MYERS SQUIBB COMPANYStatement of Earnings (Adapted)

Years Ended December 31, 1998 and 1997

Dollar amounts in millions

Net sales $18,284 100.0% $16,701 100.0%Cost of products sold 4,856 26.6 4,464 26.7Gross profit 13,428 73.4 12,237 73.3Operating expenses: Marketing, selling, and administrative 4,418 24.2 4,173 25.0 Advertising and products promotion 2,312 12.6 2,241 13.4 Research and development 1,577 8.6 1,385 8.3 Special charge 800 4.4 Provision for restructuring 201 1.1 225 1.3 Other (148) (0.8) (269) (1.5)Earnings before income taxes 4,268 23.3 4,482 26.8Provision for income taxes 1,127 6.1 1,277 7.6Net earnings $ 3,141 17.2% $ 3,205 19.2%


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COMMON-SIZE STATEMENTS• A common-size statement simplifies the

comparison of different companies because their amounts are stated in percentages

• On a common-size income statement, each item is expressed as a percentage of the net sales amount

• In the balance sheet, the common size is total assets or the sum of total liabilities and stockholders’ equity


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Current Assets:

Cash and cash equivalents

Time deposits and marketable securities

Receivables, net

Inventories

Prepaid expenses

Total current assets

Long-Term Assets

Total Assets

13.8%

1.8

19.6

11.5

7.3

54.0

46.0

100.0%

9.7%

2.3

19.9

12.0

7.8

51.7

48.3

100.0%

Percent of Total Assets

1998 1997

BRISTOL-MYERS SQUIBB COMPANY Analysis of Current Assets

December 31,1998 and 1997


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BENCHMARKING

• Benchmarking is the practice of comparing a company to a standard set by other companies, with a view toward improvement

• Benchmarking against the industry average– Managers, investors, and creditors need to

know how one company compares with similar companies


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– The next exhibit gives the common-size income statement of Bristol-Myers Squibb Company compared with the average for the pharmaceuticals industry

– Its gross profit percentage is much higher than the industry average

– Its percentage of net income is significantly higher that the industry average

BENCHMARKING


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Net sales

Cost of products sold

Gross profit

Operating expenses

Earnings from continuing operation before income tax

Income tax expense

Earnings from continuing operations

Special items (discontinued operations, extraordinary gains and losses, and effect of accounting changes)

Net earnings

100.0%

26.6

73.4

50.1

23.3

6.1

17.2

17.2%

100.0%

54.7

45.3

36.5

8.8

2.3

6.5

1.4 5.1%

Bristol-Myers Squibb

Industry Average

BRISTOL-MYERS SQUIBB COMPANY Common-Size Income Statement for Comparison with Industry Average

Year Ended December 31, 1998


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• Benchmarking against a key competitor– Common-size statements are also used to

compare the company to another specific company

– The next exhibit presents the common-size income statements of Bristol-Myers Squibb and Procter & Gamble• Bristol-Myers Squibb has higher percentages of

gross profit, earnings from continuing operations, and net earnings

BENCHMARKING


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Net sales

Cost of products sold

Gross profit

Operating expenses

Earnings from continuing operation before income tax

Income tax expense

Earnings from continuing operations

Special items (discontinued operations, extraordinary gains and losses, and effect of accounting changes)

Net earnings

100.0%

26.6

73.4

50.1

23.3

6.1

17.2

17.2%

100.0%

56.7

43.3

27.9

15.4

5.2

10.2

10.2%

Bristol-Myers Squibb

Proctor & Gamble

BRISTOL-MYERS SQUIBB COMPANY Common-Size Income Statement for Comparison with Key Competitor

Year Ended December 31, 1998


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• The cash-flow statement summarizes sources and uses of the entity’s cash flows

• Internal and external decision makers want to see the majority of cash inflows coming from operating activities

• WHY?

STATEMENT OF CASH FLOWS IN DECISION MAKING


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• A company cannot stay in business for long if it cannot generate enough cash from operations to cover operating expenses

• While borrowing and investing activities provide cash for business use, long-term reliance on these activities for sources of cash is not advised

STATEMENT OF CASH FLOWS IN DECISION MAKING


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USING RATIOS TO MAKE BUSINESS DECISIONS

• A ratio expresses the relationship of one number to another

• The ratios used to make business decisions may be classified as follows:– Ratios that measure the company’s ability

to pay current liabilities– Ratios that measure the company’s ability

to sell inventory and collect receivables


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– Ratios that measure the company’s ability to pay long-term debt

– Ratios that measure the company’s profitability

– Ratios used to analyze the company’s stock as an investment

USING RATIOS TO MAKE BUSINESS DECISIONS


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MEASURING A COMPANY’S ABILITY TO PAY CURRENT

LIABILITIES

Working capital is defined as follows:

Working capital = Current assets - Current liabilitiesWorking capital = Current assets - Current liabilities


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• Working capital is widely used to measure a business’s ability to meet its short-term obligations with its current assets

• The larger the working capital, the better able is the business to pay its debts

MEASURING A COMPANY’S ABILITY TO PAY CURRENT

LIABILITIES


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CURRENT RATIO

• The current ratio– Is current assets divided by current

liabilities– Measures the ability of the company to pay

current liabilities with current assets

• The following slides give the comparative income statement and balance sheet of Palisades Furniture, Inc.


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PALISADES FURNITURE, INC.Comparative Income Statement

Year Ended December 31, 20X3 and 20X2

20X3 20X2

Net sales $858,000 $803,000Cost of goods sold 513,000 509,000Gross profit 345,000 294,000Operating expenses: Selling expenses 126,000 114,000 General expenses 118,000 123,000 Total operating expenses 244,000 237,000Income from operations 101,000 57,000Interest revenue 4,000 -0-Interest expense 24,000 14,000Income before income taxes 81,000 43,000Income tax expense 33,000 17,000Net income $ 48,000 $ 26,000

PALISADES FURNITURE, INC.Comparative Income Statement

Year Ended December 31, 20X3 and 20X2

20X3 20X2

Net sales $858,000 $803,000Cost of goods sold 513,000 509,000Gross profit 345,000 294,000Operating expenses: Selling expenses 126,000 114,000 General expenses 118,000 123,000 Total operating expenses 244,000 237,000Income from operations 101,000 57,000Interest revenue 4,000 -0-Interest expense 24,000 14,000Income before income taxes 81,000 43,000Income tax expense 33,000 17,000Net income $ 48,000 $ 26,000


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PALISADES FURNITURE, INC.Comparative Balance Sheet

December 31, 20x3 and 20X2

20X3 20X2AssetsCurrent assets: Cash $ 29,000 $ 32,000 Accounts receivable, net 114,000 85,000 Inventories 113,000 111,000 Prepaid expenses 6,000 8,000 Total current assets 262,000 236,000Long-term investments 18,000 9,000Plant, property and equipment, net 507,000 399,000Total assets $787,000 $644,000

LiabilitiesCurrent liabilities: Notes payable $ 42,000 $ 27,000 Accounts payable 73.000 68,000 Accrued liabilities 27,000 31,000 Total current liabilities 142,000 126,000Long term debt 289,000 198,000 Total liabilities 431,000 324,000

Stockholders’ EquityCommon stock, no par 186,000 186,000Retained earnings 170,000 134,000 Total stockholders’ equity 356,000 320,000 Total liabilities and stockholders’ equity $787,000 $644,000

PALISADES FURNITURE, INC.Comparative Balance Sheet

December 31, 20x3 and 20X2

20X3 20X2AssetsCurrent assets: Cash $ 29,000 $ 32,000 Accounts receivable, net 114,000 85,000 Inventories 113,000 111,000 Prepaid expenses 6,000 8,000 Total current assets 262,000 236,000Long-term investments 18,000 9,000Plant, property and equipment, net 507,000 399,000Total assets $787,000 $644,000

LiabilitiesCurrent liabilities: Notes payable $ 42,000 $ 27,000 Accounts payable 73.000 68,000 Accrued liabilities 27,000 31,000 Total current liabilities 142,000 126,000Long term debt 289,000 198,000 Total liabilities 431,000 324,000

Stockholders’ EquityCommon stock, no par 186,000 186,000Retained earnings 170,000 134,000 Total stockholders’ equity 356,000 320,000 Total liabilities and stockholders’ equity $787,000 $644,000


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The current ratio of Palisades Furniture, Inc., at December 31, 20X3 and 20X2, follow, along with the average for the retail furniture industry:

Current ratio =Current ratio = Current assetsCurrent assetsCurrent liabilitiesCurrent liabilities

$262,000$142,000

= 1.85 $236,000$126,000

= 1.87

Palisades’ Current Ratio

Industry Average = 1.70Industry Average = 1.70

20X3 20X2Formula

In general, a higher current ratio indicates a stronger financial positionIn general, a higher current ratio indicates a stronger financial position

In most industries a current ratio of 2.0 is

considered good


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• The acid-test (or quick) ratio – Indicates whether the entity could pay all

its current liabilities if they came due immediately

– Is computed by dividing cash, short-term investments, and net current receivables (accounts and notes receivable, net of allowances) by current liabilities

ACID TEST RATIO


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Palisades Furniture’s acid-test ratios for 20X3 and 20X2 are:

Acid-Test ratio =Acid-Test ratio =Cash + short-term Cash + short-term investments + net investments + net current receivablescurrent receivablesCurrent liabilitiesCurrent liabilities

$29,000 + $0 + $114,000

$142,000=1.01

$32,000 + $0 + $85,000

$126,000= 0.93

Palisades’ Acid-Test Ratio

20X3 20X2Formula

Industry Average = 0.40Industry Average = 0.40An acid-test ratio of 0.90to 1.00 is acceptable in

most industries


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MEASURING ABILITY TO SELL INVENTORY AND

COLLECT RECEIVABLES• Three ratios are presented that

measure the company’s ability to sell inventory and collect receivables– Inventory turnover– Accounts receivable turnover– Days’ sales in receivables


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INVENTORY TURNOVER

• Inventory turnover is – A measure of the number of times a

company sells its average level of inventory during a year

– Computed by dividing the cost of goods sold by the average inventory for the period


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• A high rate of turnover indicates relative ease in selling inventory; a low turnover indicates difficulty in selling

• In general, companies prefer a high inventory turnover

• Inventory turnover varies widely with the nature of the business

INVENTORY TURNOVER


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Palisades Furniture’s inventory turnover for 20X3 is:

Inventory turnover =Inventory turnover =Cost of goods soldCost of goods sold

Average inventoryAverage inventory

$513,000

$112,000 4.58=


FormulaPalisades’ Inventory

Turnover

Palisades Furniture’s turnover of 4.58 times a year is high for its industry, which has an average turnover of 3.00

Palisades Furniture’s turnover of 4.58 times a year is high for its industry, which has an average turnover of 3.00


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ACCOUNTS RECEIVABLE TURNOVER

• Accounts receivable turnover– Measures a company’s ability to collect

cash from credit customers– Is computed by dividing net sales by

average net accounts receivable• The resulting ratio indicates how many times

during the year the average level of receivables was turned into cash


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• In general, the higher the ratio, the more successfully the business collects cash and the better off its operations

• A receivable turnover that is too high may indicate that credit is too tight, causing the loss of sales to good customers

ACCOUNTS RECEIVABLE TURNOVER


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Palisades’ Furniture’s accounts receivable turnover ratio for 20X3 is computed as follows:

Accounts Accounts receivable = receivable =

turnover turnover

Net credit salesNet credit sales

Average net Average net accounts receivableaccounts receivable

$858,000

$99,0008.62=


FormulaPalisades’ Accounts Receivable Turnover

Palisades’ receivable turnover of 8.62 is much lower than the industry average, possibly because larger stores sell their receivables

Palisades’ receivable turnover of 8.62 is much lower than the industry average, possibly because larger stores sell their receivables


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DAYS’ SALES IN RECEIVABLES

• The days’-sales-in-receivables ratio tells– How many days’ sales remain in Accounts

Receivable– Is computed by a two-step process

• First, divide net sales by 365 days to figure the average sales amount for one day

• Second, divide this average day’s sales amount into the average net accounts receivable


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1. One day’s sales =1. One day’s sales =Net salesNet sales

365 days365 days

$858,000

365 days $2,351=

Industry Average = 2 daysIndustry Average = 2 days

FormulaPalisades’ Days’ Sales in

Accounts Receivable

The day’s sales in receivables for Palisades is higher (worse) than the industry average because the company collects its own receivables

The day’s sales in receivables for Palisades is higher (worse) than the industry average because the company collects its own receivables

Average net Average net accounts receivableaccounts receivable

Days’ sales in Days’ sales in average accounts = average accounts =

receivable receivable

2.2.

One days’ salesOne days’ sales$99,500$2,351

= 42 days


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MEASURING A COMPANY’S ABILITY TO PAY

LONG-TERM DEBT• Two indicators of a business’s ability to

pay long-term liabilities are the– Debt ratio– Times-interest-earned ratio


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DEBT RATIO

• The debt ratio tells the proportion of the company’s assets that it has financed with debt

• The higher the debt ratio, the higher the strain of paying interest each year and the principal amount at maturity

• The lower the ratio, the lower the business’s future obligations


13-48

Calculation of the debt ratios for Palisades Furniture at the end of 20X3 and 20X2 is as follows:

Debt ratio =Debt ratio = Total liabilitiesTotal liabilitiesTotal assetsTotal assets

$431,000$787,000

= 0.55 $324,000$644,000

= 0.50

Palisades’ Debt Ratio


20X3 20X2Formula

The company’s debt ratio indicates a fairly low-risk debt compared to the retail furniture industry average

The company’s debt ratio indicates a fairly low-risk debt compared to the retail furniture industry average

The average debt ratio for most companies

ranges from 0.57- 0.67


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TIMES-INTEREST-EARNED RATIO

• The times-interest-earned ratio measures the number of times that operating income can cover interest expense– A high times-interest-earned ratio indicates

ease in paying interest expense– A low value suggests difficulty


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Calculation of Palisades’ times-interest-earned ratio is as follows:

Times-interest-Times-interest-earned ratio =earned ratio =

Income from Income from operationsoperations

Interest expenseInterest expense$101,000

$24,000= 4.21 $57,000

$14,000= 4.07

Palisades’ Times-Interest-Earned Ratio


20X3 20X2Formula

The company’s times-interest-earned ratio of around 4.00 is significantly better than the industry average for furniture retailers

The company’s times-interest-earned ratio of around 4.00 is significantly better than the industry average for furniture retailers

The norm for U.S. business ranges from

2.0 - 3.0 formost companies


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MEASURING A COMPANY’S PROFITABILITY

• There are four rate-of-return measurements that help evaluate a company’s profitability:– Rate of return on net sales– Rate of return on total assets– Rate of return on common stockholders’

equity– Earnings per share of common stock


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RATE OF RETURN ON NET SALES

• The rate of return on net sales shows the percentage of each sales dollar earned as net income

• The higher the rate of return, the more net sales dollars are providing income to the business and the fewer net sales dollars are absorbed by expenses


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The rate-of-return-on-sales ratios for Palisades Furniture are calculated as follows:

Rate of return Rate of return on saleson sales

Net incomeNet income

Net SalesNet Sales $48,000$858,000

= 0.056 $26,000$803,000

= 0.032

Palisades’ Rate of Return on Sales


20X3 20X2Formula

The increase in Palisades Furniture’s return on sales identifies the company as more successful than the average furniture store

The increase in Palisades Furniture’s return on sales identifies the company as more successful than the average furniture store

==


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RATE OF RETURN ON TOTAL ASSETS

• The rate of return on total assets (return on assets) measures a company’s success in using its assets to earn a profit

• The sum of interest expense and net income in the numerator is the return to creditors and shareholders who have financed the company’s operations


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Computation of the return-on-assets ratio for Palisades Furniture is as follows:

Rate of return Rate of return on assetson assets

Net Net incomeincome

Average total assetsAverage total assets $48,000 + $24,000

$715,000= 0.101

Palisades’ 20X3 Rate of Return on Total Assets


Formula

The increase in Palisades Furniture’s return on assets is higher than the industry average

The increase in Palisades Furniture’s return on assets is higher than the industry average

Interest Interest ExpenseExpense++

==


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RATE OF RETURN ON COMMON STOCKHOLDERS’

EQUITY• Rate of return on stockholders’ equity

(return on equity)– Shows the relationship between net

income and common stockholders’ investment in the company

– Is calculated by dividing net income available to common stockholders by the average stockholders’ equity during the year


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The rate of return on common stockholders’ equity for Palisades Furniture is calculated as follows:

Rate of return Rate of return on common on common

stockholders’ stockholders’ equity equity


Average common Average common stockholders’ equitystockholders’ equity

$48,000 - $0$338,000

= 0.142

Palisades’ 20X3 Rate of Return on Common

Stockholders’ Equity


Formula

Preferred Preferred DividendsDividends--

==


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• Palisades’ return on equity (0.142) is higher than its return on assets (0.101).

• This difference results from borrowing at one rate (8%) and investing the funds to earn a higher rate (14.2%)

• This practice is called trading on the equity or using financial leverage

RATE OF RETURN ON COMMON STOCKHOLDERS’

EQUITY


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EARNINGS PER SHARE OF COMMON STOCK

• Earnings per share (EPS) is– The amount of net income per share of the

company’s outstanding common stock– Computed by dividing net income available

to common stockholders by the number of common shares outstanding during the year


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Computation of the firm’s EPS for 20X3 and 20X2 follows, assuming the company had 10,000 share of common stock outstanding

Earnings Earnings per share per share of common of common stock stock

Number of shares of Number of shares of common stock common stock

outstandingoutstanding

$48,000 - $0 10,000

=

$4.80 $26,000 - $0 10,000

= $2.60

Palisades’ Earnings Per Share

20X3 20X2Formula

Palisades Furniture’s EPS increased 85 percent

Palisades Furniture’s EPS increased 85 percent


Preferred Preferred DividendsDividends--

Most companies strive to increase EPS by 10 -15%

annually

==


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ANALYZING A COMPANY’S STOCK AS AN INVESTMENT• Investors purchase stock to earn a

return on their investment, which consists of two parts:– Gains (or losses) from selling the stock at a

price that differs from the investors’ purchase price

– Dividends, the periodic distributions to stockholders


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PRICE EARNINGS RATIO

• The price earnings ratio is the ratio of the market price of a share of common stock to the company’s earnings

• The higher a stock’s P/E ratio, the higher its downside risk--the risk that the stock’s market price will fall


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Calculations for the P/E ratio of Palisades Furniture, Inc., follow. The market price of its common stock was $50 at the end of 20X3 and $35 at the end of 20X2:

P/E ratio = P/E ratio = Earnings per shareEarnings per share

$50.00

$4.80=

10.4 $35.00

$2.60= 13.5

Palisades’ Price/Earnings Ratio

20X3 20X2Formula

Palisades Furniture’s 20X3 P/E ratio indicates that the company’s stock is

selling at 10.4 times earnings

Palisades Furniture’s 20X3 P/E ratio indicates that the company’s stock is

selling at 10.4 times earnings

P/E ratios vary from industryto industry

Market price per Market price per share of common share of common

stockstock


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DIVIDEND YIELD

• Dividend yield is the ratio of dividends per share of stock to the stock’s market price per share

• This ratio measures the percentage of a stock’s market value that is returned annually as dividends


13-65

Palisades Furniture paid annual cash dividends of $1.20 per share of common stock in 20X3 and $1.00 in 20X2, and market prices of the company’s common stock were $50 in 20X3 and $35 in 20X2. Calculation of the firm’s dividend yields on common stock is as follows:

Dividend yield Dividend yield on common on common

stockstock Market price per share Market price per share of common stockof common stock

$1.20

$50.00=

0.024 $1.00

$35.00= $0.029

Dividend Yield on Palisades’ Common Stock

20X3 20X2Formula

Dividend yields vary widely, from 5% to 8% for older, established companies, down to the range of 0% to 3% for young growth-oriented companies

Dividend yields vary widely, from 5% to 8% for older, established companies, down to the range of 0% to 3% for young growth-oriented companies

Dividend per share Dividend per share of common stockof common stock

==


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BOOK VALUE PER SHARE OF COMMON STOCK

• Book value per share of common stock is common stockholders’ equity divided by the number of shares of common stock outstanding

• Some investors rank stock on the basis of the ratio of market price to book value– To these investors, the lower the ratio the

more attractive the stock


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Calculations of book-value-per-share-of-common-stock ratios follows:

Book value Book value per share of per share of common common stock stock

Number of shares of Number of shares of common stock common stock

outstandingoutstanding

$356,000 - $0

10,000=

$35.60 $320,000 - $0

10,000= $32.00

Book Value per Share of Palisades’ Common Stock

20X3 20X2Formula

Total Total stockholders’ stockholders’

equityequityPreferred Preferred

equityequity--==


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LIMITATIONS OF FINANCIAL ANALYSIS

• Ratios have their limitations

• Financial analysis may indicate that something is wrong, but it may not identify the specific problem or show how to correct it

• Managers must evaluate data on all ratios in the light of other information about the company


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• Ratios should be analyzed over a period of years

• Any one year, or even any two years, may not be representative of the company’s performance over the long term

LIMITATIONS OF FINANCIAL ANALYSIS


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ECONOMIC VALUE ADDED

• Economic value added (EVA) combines the concepts of accounting income and corporate finance to measure whether the company’s operations have increased stockholder wealth

• A positive EVA amount indicates– An increase in stockholder wealth– An attractive stock to investors


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EVA = Net income + Interest expense - Capital chargeEVA = Net income + Interest expense - Capital chargeEVA = Net income + Interest expense - Capital chargeEVA = Net income + Interest expense - Capital charge

Capital Capital charge charge

Notes Notes payablepayable

Loans Loans payablepayable

Long-term Long-term debtdebt

Stockholders’ Stockholders’ equityequity

Cost of Cost of capitalcapital== ++++ ++ xx

Where



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• The capital charge is the amount that stockholders and lenders charge a company for the use of their money

• The cost of capital is a weighted average of the returns demanded by the company’s stockholders and lenders– The cost of capital varies with the

company’s risk



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EFFICIENT MARKETS, MANAGEMENT ACTION,

AND INVESTOR DECISIONS• An efficient capital market is one in

which market prices fully reflect all information available to the public

• Because stocks are priced in full recognition of all publicly accessible data, it can be argued that the stock market is efficient


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• This means that managers cannot fool the market with accounting gimmicks

• For investors, an appropriate strategy seeks to manage risk, diversity, and minimize transaction costs

• The role of financial statement analysis consists mainly of identifying the risks of various stocks to manage the risk of the overall investment portfolio

EFFICIENT MARKETS, MANAGEMENT ACTION,

AND INVESTOR DECISIONS


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END OF CHAPTER 13

© 2001 prentice hall business publishing financial accounting, 4/e harrison and horngren 13-1...

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