Flashcards in Int. Reporting and Control Deck (37):
What does Beta measure? What does it tell us?
Investors diversify their risks efficiently along the market portfolio (portfolio risk); thus only risks that investors cannot diversify have to be priced in (undiversified risk)
A stock with a beta of 2 will move 2% if the market moves by 1%. Larger beta means larger risk. Beta = 1 = market. Beta >1 --> aggressive asset. Beta defensive asset
Pitfall: Beta is based on historical figures
How do you calculate the expected return on equity capital?
Expected return = Risk free rate of return + ß * equity risk premium
Extra return = Expected return of the market portfolio - risk free rate of return
How do you calculate the Weighted Average Cost of Capital (WACC)?
E/(E+D) * rE + D/(E+D) * rD
No matter the debt:equity ratio, the pre-tax WACC stays the same.
With tax WACC:
E% * rE + (1-t) * D% * rD
There is a sweet spot.
Why does the capital structure matter?
Free Cash Flow is affected by:
- danger of bankruptcy
- tax (debt)
- agency problems (manager)
Why does tax matter?
Interest on debt is usually tax deductible --> tax shield (up to 9,6% company's value)
Trade-off: Control v risk of bankruptcy
Cost of bankruptcy:
- Fire sale of assets
- Legal fees, lawyers, consulting costs
- Increased risk taking by managers
- Loss of customers
What is the terminal value?
= The value existing after the definite time of cash flows.
E.g. A remaining business after the last year of the Discount Cash Flow (IRR, NPV) calculation
Rule of thumb: 10 years as individual years, then just terminal value.
Important when looking at start-up businesses, e.g. Zalando; high terminal value.
How do you calculate the Terminal Value?
Last year's free cash flow * (1 + growth rate)
Discount rate - growth rate
But don't take a growth rate above GDP growth!
Discount rate can be WACC
How do you calculate the value of perpetuity?
Terminal Value / Enterprise value
= value of the perpetual period
Relevant, because the later the cash flow, the more uncertain it is.
NB: for Zalando, it's 80-90% of the company!
How do you determine the enterprise value?
a) Calculate directly:
EV = Market value of equity + debt - cash and marketable securities.
= Market capital + debt - cash (equiv.)
= costs to take over a company.
b) Multiples: EBIT multiples, turnover multiples, "user multiples", "page impression multiples"
Market-to-book ratio =
Market Value of Equity / Book value of equity
Usually value of project A/EBIT project A = multiple.
Project B value = EBIT * multiple.
How can you include inflation in your calculations?
Separate rates for staff costs
OPEX (operative expenditure)
CAPEX (capital expenditure)
How do you calculate Free Cash Flow from EBIT?
FCF = EBIT - tax + depreciation - capital expenditure - change in working capital
FCF = EBIT * (1-t) + depreciation - capital expenditure - change in net working capital
How do you derive EBIT?
Turnover (net sales)
- Cost of sales
= Gross profit
- Selling, general and admin expenses
+ Other income
= Operating income
+ share of associated companies
What is net working capital?
NWC = Current assets - current liabilities
= the money that is needed to run the business and so finance the cash cycle.
Cash cycle = time between cash out and cash in.
What is the operating cycle?
The time between purchase and payment
What are some definitions of Net Working Capital?
Accounts receiveables days = Accounts receivable/Average daily sales
Inventory days = Inventory/ Average daily cost of goods sold
Accounts payable days = Accounts payable / Average daily CoGS
What are current assets?
Cash + money due in less than 1 year + inventory
What are current liabilities?
Obligation to pay within 1 year --> delay payment = good (unless interest)
What does your networking capital depend on?
Depends on bargaining power (Porter's Five Forces)
Leverage on liabilities:
- optimise contracts with suppliers (pay late)
- Optimise internal invoice management (claims/reclamations, management payment targets)
Leverage on assets:
- manage contracts with customers (payment earlier)
- select customers (creditworthiness)
- Manage accounts receivable (dunning)
- Minimise stock (value, valume, e.g. ABC analysis, slowmover minimisation)
How do you adjust NPV for risk?
Sensitivity analysis: calculate a best case, worst case and base case scenario.
What is the Internal Rate of Return (IRR)?
IRR = expected rate of return when NPV = 0
What is the cash payback period?
The time required for the net after-tax cash inflows to recover the initial investment. The shorter the better.
Payback period = net initial investment / annual net cash inflows after tax.
Dynamic payback period method: take discounted net cash inflows after tax.
Static payback period method: take undiscounted ent cash inflows after tax.
What is break-even?
Total expenses = total revenue
Is Earnings per share a good measure?
Earnings per share = net earnings / number of shares
Not good: can dilute it very easily, doesn't have much to do with free cash flow.
What is realisation?
When the entity obtain the right to receive cash. Must deliver the product/service first. Advanced payment is not realisation.
What is recognition?
The actual recording of transactions and events in the financial statements, putting the € on the P and L statement and balance sheet.
If customer doesn't pay, write down the receivable accounts. Report positive things like sales as late as possible, and negative things as soon as possible (e.g. customer is going bankrupt) (Vorsichtsprinzip)
What is matching?
Expenses must be recognised in the same period in which the revenue is recognised. Income statement reflects performance of the period according to the matching principle
What is accrual?
It is required by GAAP.
- It records the transactions and events as they occur, not when the cash is received or expended.
What is defferal?
Deferral of revenues or expenses will occur when cash is received or expended but is not recognisable (i.e. prepaid expenses).
What are the methods for representing projects not yet completed?
1. Percentage of completion method (IFRS): recognise income according to construction progress. Methods: cost to cost, or progress of work performed
2. Completed contract method (HGB): recognise income only on completion.
How can you represent R and D expenses?
1. Expense them in the income statement (HGB)
2. Capitalise them (IFRS) (amortisation)
How do you create transparency by reporting segments?
Quantitative thresholds for reportable segments (10% size test):
- Revenue (to customers and inter-segment)
- Reported profit or loss
- Assets (but not general corporate assets or loans)
NB: Only one criteria must meet the 10% threshold!
How do you create transparency and manage performance of managers?
- This year/last year
- You/your competitors
If you want to reward managers on their performance, take out the exchange rate risk, which they can't control.
Total performance formula
Total performance (Total variance) = price (DTP - due to price) + volume (DTV - due to volume) + FX rate (DTE - due to exchange)
What is the price formula?
Price (DTP) = (Actual price - plan price) * actual units * plan FX rate
What is the formula for volume?
Volume (DTV - due to variance) =
(actual units - plan units) * plan price * plan FX rate
FX rate (DTE - due to exchange)
FX rate (due to exchange) =
Actual sales Local Currency * FX rate
- actual sales local currency * FX plan rate