The market price is the current price of a stock, which is determined by the supply and demand of the stock in the market. Stock market in equilibrium: when all stocks in the market are in equilibrium (ie for each stock in the market, the market price is equal to its intrinsic value), then the market is in equilibrium. When the intrinsic value of a stock is higher than the market price of the stock, we say that the stock is undervalued (underpriced).
For example, if the intrinsic value for a stock is $26 and the market price is $25, then the stock is undervalued. When the intrinsic value of a stock is lower than the market price of the stock, we say that the stock is overvalued (overpriced). For example, if the intrinsic value for a stock is $30 and the market price is $32, then the stock is overvalued.
When the intrinsic value of a stock is equal to the market price of the stock, the stock is said to have a fair price in the market (the stock is in equilibrium). Semi-strong efficiency – stock prices already reflect all publicly available information in the market (only previous publicly available information). Which of the following would you expect to happen if the market is semi-powerful and efficient.
The stock price will stay the same because earnings announcements have no effect if the market is semi-strong by efficiency.
Financial Statements, Cash Flow, and Taxes
Book value = (common equity) / (# of shares outstanding) Table 3.1: Balance sheet of allied food products. 2) Income statement: a report summarizing a firm's income, expenses, and profits over a reporting period. Dividend per share (DPS) = cash dividend / number of shares outstanding Dividend payout ratio = cash dividend / NI. Retention ratio = retained earnings / NI. Table 3.2: Statements of Income from Allied Food Products. 3) Cash flow statement: a report that shows how things on the balance sheet and income statement will affect the firm's cash flows. The cash flow statement has four sections: operating, long-term investing, financing activities, and a summary of cash flows during an accounting period.
Free Cash Flow: An amount of cash available for payments to all investors, including shareholders and debt holders, after investments are made to support ongoing operations. MVA stands for added market value, which is the excess of the market value of equity over the book value. EVA stands for economic value added, which is the excess of net operating profit after tax (NOPAT) over the cost of capital.
Taxable income: gross income minus exceptions and allowable deductions as determined in the Tax Code or the income subject to taxes. Marginal Tax Rate: The tax rate that applies to the last dollar earned. Average tax rate: taxes paid divided by total taxable income. Dividend income: was taxed as ordinary income (currently taxed at up to 15%, will increase after 2012).
You should prefer 6% taxable return because you get a higher return after tax, ignore the risk. Capital losses can only offset capital gains (carried back for 3 years or carried forward for 5 years). Business losses can offset taxable income (carry back for 2 years or carried forward for 20 years).
Depreciation: plays an important role in the income tax calculation - the greater the depreciation, the lower the taxable income, the lower the tax expense.
Financial Statement Analysis
Times Earned Interest (TIE) = Operating Income (EBIT) / Interest Expense The higher the TIE, the better. 4) Profitability ratios: show how profitably the company operates and uses its assets (shows combined effects). Return on Assets (ROA) = Net Profit / Total Assets Basic Earning Power (BEP) = EBIT / Total Assets Return on Equity (ROE) = Net Profit / Common Equity The higher the returns, the better the performance. 5) Market Value Ratios: Relate share price to earnings and book value and show what investors think about the company and its future prospects. Price-to-earnings ratio (P/E ratio) = price per share / earnings per share Market-to-book value ratio = market price / book value.
ROA = net income / total assets = (net income / sales) * (sales / total assets) = profit margin* total asset turnover. To increase ROA, firms may try to improve profit margin and/or total asset turnover. ROE = net income / common equity. net income / sales)* (sales / total assets) * (total assets / common equity) = profit margin * total asset turnover * equity multiplier. In order to increase ROE, firms may try to improve profit margin and/or total asset turnover and/or equity multiplier. By decomposing ROE into a product of three independent ratios, we can see why Allied Food has a low ROE and how the firm can improve it.
By comparing Allied Food's ratios to industry averages, we can see areas where Allied Food falls short relative to the industry.
Time Value of Money
Discounting: a process of finding the present value of a cash flow or series of future cash flows. Annuity: a series of equal payments over a specified number of periods Ordinary Annuity: an annuity with payments made at the end of each period AUV: the future value of an annuity over a specified number of periods Example: if PV = 0, PMT = -$100, I/YR = 5%, N = 3 years, AUV = $315.25. Note: Your calculator has two ways (FUND for ordinary annuities and BGN for annuity liabilities) to deal with different types of annuities.
PMT In the question above, what should your annual payment be if it is the first payment. A naïve way to deal with uneven cash flows: deal with one cash flow at a time. Annual calculation: interest is calculated once a year. Half-yearly calculation: interest is calculated twice a year.
Note: If all three banks offer the same annual interest rate, which bank to choose. How much would you need to save each year (in the same amount) for the next four years (each deposit will be made at the end of the year) to buy a car in 4 years. How much would you need to save each month for the next four years to buy a car, assuming each deposit is paid at the end of each month.
