Transcript No Slide Title
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Fundamentals of Corporate Finance
Sixth Edition
Richard A. Brealey Stewart C. Myers Alan J. Marcus Slides by Matthew Will
Chapter 3
Accounting and Finance
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Topics Covered
The Balance Sheet The Income Statement The Statement of Cash Flows Accounting Practice & Malpractice Taxes
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The Balance Sheet
Definition
Financial statement that show the value of the firm’s assets and liabilities at a particular point in time
(from an accounting perspective).
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Balance Sheet
PepsiCo Balance Sheet (December 31, 2006) $Millions
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The Main Balance Sheet Items Current Assets
The Balance Sheet
Cash & Securities Receivables Inventories Fixed Assets
+
Tangible Assets Intangible Assets
=
Current Liabilities Payables Short-term Debt
+
Long-term Liabilities
+
Shareholders’ Equity
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The Balance Sheet
Common-Size Balance Sheet
All items in the balance sheet are expressed as a percentage of total assets.
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Common Size Balance Sheet
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Market Value vs. Book Value
Book Values are determined by GAAP Market Values are determined by current values
Generally Accepted Accounting Principles (GAAP)
Procedures for preparing financial statements.
Equity and Asset “Market Values” are usually higher than their “Book Values”
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Market Value vs. Book Value
Example According to GAAP, your firm has equity worth $6 billion, debt worth $4 billion, assets worth $10 billion. The market values your firm’s 100 million shares at $75 per share and the debt at $4 billion.
Q: What is the market value of your assets?
A: Since (Assets=Liabilities + Equity), your assets must have a market value of $11.5 billion.
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Market Value vs. Book Value
Example (continued)
Book Value Balance Sheet
Assets = $10 bil Debt = $4 bil Equity = $6 bil
Market Value Balance Sheet
Assets = $11.5 bil Debt = $4 bil Equity = $7.5 bil
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The Income Statement
Definition
Financial statement that shows the revenues, expenses, and net income of a firm over a period of time
(from an accounting perspective).
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The Income Statement
Earnings Before Income & Taxes (EBIT) EBIT = Total Revenues - costs – deprecation = 35,753 – 27,292 – 1,406 = $ 7,055 million
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The Income Statement
Pepsico Income Statement (year end 2006)
Net Sales COGS Selling, G&A expenses Depreciation expense EBIT Net interest expense Taxable Income Income Taxes Net Income 35,753 15,762 11,530 1,406 7,055 66 6,989 1,347 5,642
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Profits vs. Cash Flows
Differences “Profits” subtract depreciation (a non-cash expense) “Profits” ignore cash expenditures on new capital (the expense is capitalized) “Profits” record income and expenses at the time of sales, not when the cash exchanges actually occur “Profits” do not consider changes in working capital
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The Statement of Cash Flows
Definition
Financial statement that shows the firm’s cash receipts and cash payments over a period of time.
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The Statement of Cash Flows
Pepsico Statement of Cash Flows (excerpt - year end 2006)
Net Income Non-cash expenses Depreciation Other Changes in working capital A/R=(464) A/P=(86) Inv=(233) other=1,956 CL=155 Cash Flow from operations Cash Flow from investments Cash provided by financing
Net Change in Cash Position
5,642 1,406 0 1,328 8,376 (933) (7,508)
(65)
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Cash Flows
Free Cash Flow (FCF)
Cash available for distribution to investors after firm pays for new investments or additions to working capital FCF = EBIT - taxes depreciation - change in net working capital - capital expenditures
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Accounting Practice
Stock options Cookie Jar Reserves Off balance sheet assets and liabilities Revenue recognition
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Taxes
Taxes have a major impact on financial decisions Marginal Tax Rate is the tax that the individual pays on each extra dollar of income.
Average Tax Rate is the total tax bill divided by total income.
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Taxes
Example - Taxes and Cash Flows can be changed by the use of debt. Firm A pays part of its profits as debt interest. Firm B does not.
EBIT Interest Pretax Income Taxes (35%) Net Income
Firm A
100 40 60 21
39 Firm B
100 0 100 35
65
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Taxes
FOOD FOR THOUGHT - If you were both the debt and equity holders of the firm, which would generate more cash flow to you? (assume Net Income = Cash Flow)
EBIT
Firm A
100
Firm B
100 Interest Pretax Income 40 60 0 100 ?
Taxes (35%)
Net Income
21
39
35
65
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Taxes
FOOD FOR THOUGHT - If you were both the debt and equity holders of the firm, which would generate more cash flow to you? (assume Net Income = Cash Flow)
Firm A Firm B
Net Income + Interest
Net Cash Flow
39 40
79
65 0
65
?
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Corporate Tax Rates (2008)
Taxable Income ($)
0-50,000 50,001-75,000 75,001-100,000 100,001-18,333,333 over 18,333,333
Tax Rate (%)
15 25 34 34-39 35
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Personal Tax Rates (2008)
Single Taxable Income ($)
0 - 8,025 8,025–32,550 32,550–78,850 78,850–164,550 164,550–357,700 over 357,700
Married Taxable Income ($)
0–16,050 16,050–65,100 65,100–131,450 131,450–200,300 200,300–357,700 over 357,700
Tax Rate (%)
10 15 25 28 33 35
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www.irs.gov
IRS Web Site
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