Week 3
mloi01
AGibson_13E_Ch09.pptx© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 9
For the Investor
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
2
The use of financing with a fixed charge is termed financial leverage
Interest as related to debt financing
A contractual obligation
Must be paid regardless of entity’s current profits
Contrast with dividends that are discretionary
Interest is tax deductible
Reduces taxable income
Reduces income tax expense
Financial Leverage
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
3
Exhibit 9-1—Dowell Company
Percentage change in net income increase [A] is greater than percentage change in EBIT [B] due to the fixed nature of interest expense
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
4
Computation of the Degree of Financial Leverage
The degree of financial leverage is the multiplication factor by which the net income changes in respect to changes in EBIT
A more simple formula for degree of financial leverage
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
5
Degree of financial leverage calculations should exclude
Noncontrolling interest
Equity income
Nonrecurring items
Computation of the Degree of Financial Leverage—Continued
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
6
The amount of income earned on a share of common stock during an accounting period
Required disclosure for corporate income statements
Pertains only to common stock
Earnings per Common Share
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
7
Per share amounts for discontinued operations and extraordinary items must be presented
In the income statement and the notes to the financial statements
Earnings per share for recurring items are significant for primary analysis
Retroactive recognition must be given to events such as stock dividend and stock split
Earnings per Common Share—Continued
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
8
Earnings pertain to an entire fiscal period
Average common shares outstanding is used for parity of information
Current guidelines require basic and diluted earnings per share presentation
Diluted earnings per share is calculated the same as basic plus the dilutive effect of potentially dilutive securities
Convertible securities, warrants, or other rights that upon conversion or exercise could in the aggregate dilute earnings per common share are potential dilutive securities
Earnings per Common Share—Continued
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
9
Weighted Average Common Outstanding Shares
| Months Shares Are Outstanding | Shares Outstanding | × | Fraction of Year Outstanding | = | Weighted Average |
| January–June | 10,000 | 6/12 | 5,000 | ||
| July–September | 12,000 | 3/12 | 3,000 | ||
| October–December | 15,000 | 3/12 | 3,750 | ||
| 11,750 |
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
10
Measures the relationship between the market price of a share of common stock and that stock’s current earnings per share
Use of diluted earnings per share gives a more conservative price/earnings ratio
Price/Earnings Ratio
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
11
Interpretation
High-growth-potential firms have higher P/E ratios
P/E ratio is a function of the market
Compare with
Competitors
Industry average
Exchange averages
Price/Earnings Ratio—Continued
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
12
Reflects the proportion of current earnings retained for internal growth
Trend analysis is improved by exclusion of nonrecurring items
Higher percentage typically found in growth firms
Percentage of Earnings Retained
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
13
Measures the portion of current earnings per common share being paid out in dividends
A stable dividend policy is developed by consideration of recurring earnings
Lower payout typically found in growth firms
Dividend Payout
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
14
Indicates the relationship between the dividends per common share and the market price per common share
The yield depends on a firm’s dividend policy and market price
Dividend Yield
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
15
Preferred equity should be measured at liquidation value, if available
Market value and book value
Book value reflects past unrecovered asset costs
Market value reflects the potential of the firm
Book Value per Share
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16
Recognize an expense for all employee services received in share-based payment transactions, using a fair-value-based method
Similar to SFAS No. 123 (R)
Allocate option fair value to the service period
Date of grant through vesting date
Noncompensatory plans
Encourage widespread ownership by employees
Slight discount from fair value
No compensation expense is recognized
Stock Options
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
17
Impact of options can be substantial
It may result in lower net income and earnings per share
Following formula is used to determine the materiality of options:
Stock Options—Continued
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
18
Sometimes offered to employees in lieu of stock option plans
Restrictions
Employee cannot sell stock for a specified period of time
Employees may forfeit their shares if they leave employer before vesting
Awards may be linked to financial goals
Restricted Stock
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19
Gives the employee right to receive compensation in cash or stock or in a combination of both
Based on the difference between option price and market price
Expense is a function of market price
Year-end spread is measured
Compensation expense is spread minus prior recognition, multiplied by number of shares of stock appreciation rights outstanding
Stock Appreciation Rights
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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
20
% Change in Net Income
Degree of Financial Leverage =
% Change in EBIT
Earnings Before Interest and Tax
Degree of Financial Leverage =
Earnings Before Tax
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Earnings Before Interest, Tax,
Noncontrolling Interest,
All-Inclusive Degree
Equity Income, and Nonrecurring Items
=
Earnings Before Tax,
of Financial Leverage
Noncontrolling Interest,
Equity Income,
and Nonrecurring Items
Net Income Preferred Dividend
Earning per Share =
Weighted Average Number of Common
Shares Outstanding
-
Market Price per Share
Price/Earings Ratio =
Diluted Earnings per Share,
Before Nonrecurring Items
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Net Income Before Nonrecurring
Percentage of
Items All Dividends
=
Net Income Before Nonrecurring Items
Earnings Retained
Dividends per Common Share
Dividend Payout ratio =
Diluted Earnings per Share
Before Nonrecurring Items
Dividends per Common Share
Dividend Yield =
Market Price per Common Share
Total Shareholders' Equity
Preferred Stock Equity
Book Value per Share =
Number of Common Shares
Outstanding
-
Net Income Before Net Income Before
Nonrecurring Items not Nonrecurring It
ems
Including Option ExpenseIncluding Option
Expense
Net Income Before Nonrecurring Items
Not Including O
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ption Expense
