...On Accounting Flows and Systematic Risk Neil Garrod University of Glasgow Dusan Mramor University of Ljubljana Address for correspondence: Neil Garrod, Department of Accounting and Finance, University of Glasgow, 65-71, Southpark Avenue, Glasgow G12 8LE, Scotland, U.K. Tel: 00-44-141-330-5426 e-mail: n.garrod@accfin.gla.ac.uk On Accounting Flows and Systematic Risk Abstract The body of work that relates accounting numbers to market measures of systematic equity risk was largely undertaken in the 1970s and early 1980s. More recent proposals on changes in accounting disclosure of risk mean that a rigorous theoretical model of the relationship between accounting measures and market measures of risk is timely. In this paper such a model is developed. In addition, the assumptions required to develop the model are explicitly identified. By so doing it becomes possible to identify the potential cross-sectional differences which drive the empirical relationship between accounting and market based measures of risk. The model developed highlights a clear relationship between accounting and market measures of risk which can be exploited in situations where accounting data alone is available. It also provides a framework within which the environmental factors leading to cross-sectional differences between companies can be further explored. On Accounting Flows and Systematic...
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...that reason financial managers base their investment decisions based off of the current assets and current liabilities is because they need to see the financial position that the company is in before they choose to invest their money. If a company has a large amount of current liabilities in comparison to their current assets, this means they have more money they owe than they own. The current assets give value to the companys bottom line and the current liabilities take away from the companys bottom line. Current asset and liability balances can be viewed as a result of an investment decision because if the current assets are less than its liabilities, the company may have a negative net worth (Block, Hirt, & Danielson, 2010). The degree of operating leverage or DOL is defined as the percentage change in the operating income that occurs as a result of a percentage change in the units sold (Block, Hirt, & Danielson, 2010). When a company is highly leveraged, they will have an increase in income as their volume expands. When the DOL is computed close to the break-even point it will result in a higher number because of the increase in the operating income (Block, Hirt, & Danielson, 2010). There are leveraged firms and conservative firms. The DOL for a leveraged firm is higher than of a conservative firm. This means that in this example, the Hi Tech Manufacturing Company would be considered to be more leveraged than that the Old School. Financial leverage is the amount...
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...Financial Analysis Project Throughout the last decade, Amazon has become one of the most sustainable companies within its industry. One of the major reasons that Amazon has been able to achieve a long term competitive advantage is by offering superior pricing power, capitalizing on a large market share and creating a well-known brand name. Through these achievements Amazon has been able to produce long term advantages that have made it difficult for other companies to duplicate. Amazon has an elite status within itself, throughout out the past decade it has both surpassed bench marks and created new ones. Amazon has set the bar so high that it would be extremely difficult for a company to reproduce their success. Amazon was first developed when e-commerce was in an infancy stage. This gave Amazon the opportunity to create and expand on the platform that we know today. It would prove to be very difficult if a similar firm were to try and duplicate the same success as Amazon. A similar firm would need to develop the credibility and reputation that Amazon has taken years to develop. Then it would need to establish a large client base that can bring together both buyers and sellers. One of the second major tools that a new firm would need to be competitive with Amazon is large amounts of capital. If a firm was to borrow capital the result would cause the company to become highly leveraged, which would mean that the margin of error would...
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...marketed to consumers within 100 miles of the park. Firms like Disney and Universal have both domestic and international tourists, the majority of which come from more than 100 miles away. This leaves Six Flags with limited same-park growth because they are limited to the population within driving distance to the park. Furthermore, an unfortunate sequence of events hit the company in 2009. The outbreak of the H1N1 (swine flu virus) caused the Mexico City park to shut down and negatively impacted two of the parks in Texas. The public’s view was negatively affected because of the bankruptcy news and weather deterred park-goers. Finally, Six Flags is a luxury some people couldn’t afford throughout the financial crisis and recession that hit the economy during this time. The financial crisis proved that Six Flags’ business model was not recession-proof. While barely managing to...
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...ACCT 7340 Fall 2013 Professor Lin Solution to Individual Assignment 8 (1) The cost of equity is calculated as follows. Whirlpool: ........................... IBM: ..................................... Target Stores: ...................... 3.5% + (2.27 x 5.0%) = 14.85% 3.5% + (0.78 x 5.0%) = 7.40% 3.5% + (1.20 x 5.0%) = 9.50% (2) We use the book value of the debt and the market value of the equity as the proxies for the intrinsic values of debt and equity, respectively. Whirlpool 2,597 46.7% 2,959 53.3% 5,556 100% IBM 23,925 17.7% 110,984 82.3% 134,909 100% Target Stores 21,752 49.1% 22,521 50.9% 44,273 100% IVd IVe IVf Weighted Average Cost of Capital: Whirlpool: ........................ IBM: .................................. Target Stores: ................... (.467 x .65 x 6.1%) + (.533 x 14.85%) = 9.76% (.177 x .65 x 4.3%) + (.823 x 7.40%) = 6.58% (.491 x .65 x 4.9%) + (.509 x 9.50%) = 6.40% Note that Whirlpool has the highest weighted average costs of capital because it has the highest cost of both debt and equity. However, this does not mean firms with higher cost of debt and higher cost of equity will always have higher WACC. Look at the comparison between IBM and Target. IBM has the lower cost of debt and equity than Target. However, IBM has least leveraged capital structure (Debt-to-Equity ratio= .177/.823 = 0.216) while Target has the most leveraged capital structure with Debt-to-Equity ratio = 0.966. The extremely high portion of equity capital in IBM...
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...Unit 6 Assignment GB550: Financial Management Alberto Silveira Kaplan University Prof: Ana Machuca April 11, 2011 Chapter 13: Problem 13-5: How is it possible for an employee stock option to be valuable even if the firm's stock price fails to meet shareholders' expectations? Solution: Employees are given the option of buying stocks at a specified time at a specified price without investing any money. For example, if the price of stock is $10 today and the employee is given the option to buy 1000 shares at the price of $10 per share two years from now. If the stock price increases to $12 per share in two years, then the employee will gain $2,000 ($2 x 1000) from these stock options. Let’s say that the expected capital appreciation was 20%, the value of the stock would have increased to $14.4 per stock. Even though the stock price fell short of the expected value, it still created additional income of $2,000 for the employee. The options pay off if, at the time of option expiration, the stock price is higher than the option’s strike price, even if the company failed to meet shareholders’ expectations. Chapter 15: Problem 15-8: The Rivoli Company has no outstanding debt and its financial position is given with the following data: Assets (book=market) $3,000,000 EBIT $500,000 Cost of equity, rs 10% Stock price, P0 $15 Shares outstanding n0 200,000 Tax rate, T (federal plus...
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...Introduction This report is to analyse the capital structure of Sainsbury and Morrison. They are the top food retailer and grocery brand in UK market. These two companies use similar debt-equity structure both but with different leverage. Several measurements and methods are used to evaluate companies’ structure and financial decision, including D/E ratio, WACC, CAPM, M&M, Pecking order theory, trade-off, and free cash flow hypothesis. D/E Ratio Debt/Equity Ratio is a debt ratio used to measure a company's financial leverage level. (Investopedia, online) The ratio for these two companies for 2012-2015 is: Debt/Equity ratio | industry | 2015 | 2014 | 2013 | 2012 | Sainsbury | 0.47 | 0.5 | 0.46 | 0.48 | 0.48 | Morrison | 0.47 | 0.70 | 0.65 | 0.47 | 0.32 | The industry median is 0.47, which indicates that food retailing industry relies on debts to finance its assets. This capital structure is commonly used in food retailing industry. The benefit using debts will be referred in detail in this report. This chart indicates that Sainsbury’s D/E ratio does not change a lot in the past four years, whereas Morrison’s increase constantly from 0.32 to 0.70. Sainsbury maintained the level of leverage around the industry median level; however, Morrison went above that in 2014 and 2015. This ratio also reflects the company’s risk level. Sainsbury is in a moderate level, but the risk of Morrison rises as they finance the firm more and more based on debts. Weighted...
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...According to the static trade-off theory firms with higher profits tend to have higher leverage ratio. But this statement contradicts with empirical evidence: more profitable companies have lower leverage ratio. Such findings lead to rejection of the static trade-off theory and more attention to other theories such as dynamic trade-off theory, pecking order theory and other. In the given article, Frank and Goyal pursue the aim to prove that the literature has misinterpreted the evidence as a result of applying irrelevant empirical methods (leverage ratios). For example, leverage ratios do not distinguish variations that operate through an effect on E and D. The static theory gives results for financial decisions at the margin, while leverage ratios are an evaerage of totals. The difference in cost structure of large and small firms is also omitted and leads to wrong results. So the authors argue that such ratios have undesirable properties for examining the static trade-off theory. Conducting the research, the authors obtained the data from Compustat and CRSP. Frank and Goyal also state that using leverage ratios is not right, because it omits several features. They investigated the static trade-off model of capital structure using 2 regressions that explain debt and equity respectively. The authors describe how to deal with the exogeneity of profits. Frank and Goyal research led to several results: highly profitable firms issue debt and buyback shares while less profitable...
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...Chapter 12 Leverage and Capital Structure Solution to Problems P12-1. LG 1: Breakeven Point–Algebraic Basic FC (P − VC) $12, 350 Q= = 1, 300 ($24.95 − $15.45) Q= P12-2. LG 1: Breakeven Comparisons–Algebraic Basic (a) Q = FC (P − VC) Q= Q= Q= $45, 000 = 4, 000 units ( $18.00 − $6.75) $30, 000 = 4, 000 units ( $21.00 − $13.50 ) $90, 000 = 5, 000 units $30.00 − $12.00 ) ( Firm F: Firm G: Firm H: (b) From least risky to most risky: F and G are of equal risk, then H. It is important to recognize that operating leverage is only one measure of risk. P12-3. LG 1: Breakeven Point–Algebraic and Graphic Intermediate (a) Q = FC ÷ (P − VC) Q = $473,000 ÷ ($129 − $86) Q = 11,000 units 302 Part 4 Long-Term Financial Decisions (b) Graphic Operating Breakeven Analysis 3000 Profits Breakeven Point Sales Revenue Total Operating Cost 2500 2000 Cost/Revenue ($000) Losses 1500 1000 500 Fixed Cost 0 0 4000 8000 12000 16000 20000 24000 Sales (Units) P12-4. LG 1: Breakeven Analysis Intermediate (a) Q = $73, 500 = 21, 000 CDs ( $13.98 − $10.48) (b) Total operating costs = FC + (Q × VC) Total operating costs = $73,500 + (21,000 × $10.48) Total operating costs = $293,580 (c) 2,000 × 12 = 24,000 CDs per year. 2,000 records per month exceeds the operating breakeven by 3,000 records per year. Barry should go into the CD business. (d) EBIT = (P × Q) − FC − (VC × Q) EBIT = ($13.98 × 24,000) − $73,500 − ($10.48 × 24,000) EBIT = $335,520 − $73,500...
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...activity, and is directly related to the systematic risk of the firm’s assets. Financial risk is the equity risk that is due entirely to the firm’s chosen capital structure. As financial leverage, or the use of debt increases, so does financial risk and, hence, the overall risk of the equity. Business risk depends on a number of factors, including competition, liability exposure, and operating leverage. b.) In the total risk sense, one common measure of business and financial risk is the variability of ROE, also known as the standard deviation. c.) An unlevered firm's beta depends on the firm's business risk, but the use of financial leverage causes the firm's beta to increase. Thus, within a market risk framework: Total market risk = Business market risk - Financial market risk d.) Business risk is the single most important determinant of a firm's capital structure. The greater the risk inherent in a firm's assets, then, at any debt level, the greater the probability of financial distress for the firm. 2. a.) ( In the table) b.) (In the table) c.) . From the calculations, changing capital structure of the firm increases the risk of the firm so that leveraged firm has a wider range of ROE and a higher standard deviation of ROE .Thus, in the expected(base) case and in the expansion case, leveraged firm has higher returns(ROE) which implies higher profitability. 3.a.) Financial leverage adds risk to the firm’s equity. As compensation, the cost of equity rises with...
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...Rebeka Ramos Panther ID - 1948265 ACG – 6175 Case 3: United Parcel Service’s IPO 1. How is UPS performing? Back up your assessment with your financial analysis. What factors are driving this performance? Since it first opened for business 1907, UPS has proven to be a worthy competitor and more importantly a threat to be taken seriously. By 1999, after almost a century in business, UPS had captured 51% market share of the $43 billion dollar US package delivery industry. That same year they were named “Company of the Year” by Forbes and the “World’s Most Admirable Global Mail, Package, and Freight Delivery Company” by Fortune. They reported over $25 billion in revenue, which they attributed to their loyal employees, extensive geographical reach, and strong customer relations. They had become the largest parcel delivery company in the world, daily having contact with over 1.8 million customers, picking up 13 million packages, and making delivers to over 6 million business and residential addresses worldwide. Several key factors played a considerable role in UPS’ exceptional performance and industry success. For starters, UPS has always been committed to innovation, beginning as early as 1920 with its invention of the first ever-mechanical sorter and conveyor built system. UPS is also been credited with breaking new ground in delivery logistics, after creating the model for and implementing the practice of consolidating deliveries based on neighborhood groupings. However...
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...sole source of financing is equity. With a return on equity of 10.1% in 2006, CPK earned a return greater than its cost of capital, but did not benefit from financial leverage. Below we will illustrate how levered cost of capital may be a cheaper alternative for CPK. Increases of debts in the capital structure of the company will impact different key variables that the company leverage status would change from unlevered company to the levered company, because before these new issuance of debts, CPK had no debts in the capital structure of the company. In assessing the effect of leverage on the cost of capital, we estimated the Weighted Average Cost of Capital for a leverage of 10% debt to be: 9.26% = (1-32.50%)*6%*22,589+(4.2%+.82*6.4%)*628,516/(22,589+628,516) A leverage of 10% debt would change the unlevered beta 0.85 of CPK to levered beta of 0.82. The decrease in beta would reduce the cost of equity for CPK to 9.45%, because an increase of 10% debt in the capital structure of the company would reduce the risk of the equity investors. A leverage of 20% debt would decrease the Weighted Average Cost of Capital to: 8.91% = (1-32.50%)*6%*45,178+(4.2%+.79*6.4%)*613,259/(45,178+613,259) This would change beta to 0.79 and would reduce the cost of equity for CPK to 9.27%. A leverage of 30% debt would decrease the Weighted Average Cost of Capital to: 8.58% = (1-32.50%)*6.16%*67,766+(4.2%+.76*6.4%)*598,002/(67,766+598,002) This...
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...memorandum to: Tucker Hansson, chief executive officer from: date: September 29, 2009 ------------------------------------------------- subject: INVESTMENT IN GOLIATH FACILITY ------------------------------------------------- Mr. Hansson, After reviewing the Goliath proposal and accompanying financial statements, it is our recommendation that HPL pursue the $170 million expansion of manufacturing capacity. Although the project involves some risks and opportunity costs, our analysis suggests that the project has a very high positive NPV that more than outweighs any such concerns. In addition to increasing market share and reducing costs, the Goliath project will have a positive effect on employee morale and productivity. The remainder of this memo will present the arguments for/against expansion, as well as the associated business risks. I. Arguments Supporting Expansion * Based on our assumptions in the financial model, the Goliath project has an NPV= $105,060,315 even with a conservative weighted average cost of capital of 10%. * The sensitivity analysis tables in the financial model clearly show that the project has a positive NPV even when the assumptions are modified. * The project increases HPL’s market share and profits. * Additional capacity will reduce costs. * HPL can capitalize on the first mover’s advantage, as private label growth is too modest to support multiple producers. * The growth will substantially boost employee...
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... 1.56 3. Earnings per share: Sales…………………………………45,500,000 Less Fixed Costs…………………….12,900,000 Less: Variable Costs (58% of sales)…26,390,000 (45,500,000 x .58) Operating Income……………………6,210,000 Less: Interest…………………………2,400,000 (10,000,000 x .1125) + 1,275,000 Earnings before taxes………………...3,810,000 Less: Taxes (34%)……………………1,295,400 (3,810,000x .34) Earnings after taxes…………………..2,514,600 Shares…………………………………1,375,000 Earnings per share…………………….$1.83 4. 1.83 = 117.31% Earnings per share increased by 17.31% from 2007 to 2008. 1.56 5. Degree of financial leverage = % Change in EPS % Change in EBIT 4,935,000 = 104.44% or 4.45% 4.48% = DFL: 1.0 for question 1 4,725,000 4.45% 3,810,000 = .81 or 19% change 17.31% = DFL: .91 for question 3 4,725,000 19% 6. Degree of Combined Leverage = Sales – Total Variable Costs Sales- Total Variable Costs – Fixed Costs- Interest DCL = 45,500,000 - 26,390,000 45,500,000-26,390,000-12,900,000-1,275,000 = 19,110,000 = 3.87 for question 1 4,935,000 DCL = 45,500,000 – 26,390,000 45,500,000 – 26,930,000 - 12,900,000- 2,400,000 = 19,110,000 = 5.02 for question 3...
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...questions about the content of the test, please feel free to contact us at bat@bloomberginstitute.com. Table of Contents Introduction Test Overview Sample Questions Scoring Test Overview The BAT aids employers in identifying and screening students who wish to pursue a career in business and finance. Test takers should have a general understanding of and familiarity with current events in business, finance, and economics. However, we are not assessing knowledge: we are assessing a person’s aptitude to be successful in these fields, regardless of background. 2 Hours 8 Sections 100 Questions Chart and Graph Analysis 12% News Analysis 12% Global Markets 14% Economics 12% Investment Banking 12% Math 14% Financial Statements Analysis 12% Analytical Reasoning 12% The following pages outline the different sections of the BAT and the types of questions you can expect to see. Test Overview Exam Sections News Analysis (12 questions) This section of the BAT is designed to assess your ability to use information from news...
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