2 Cfa l1 2023 Fsa Corporate Issuers Fintree Juice Notes
2 Cfa l1 2023 Fsa Corporate Issuers Fintree Juice Notes
2 Cfa l1 2023 Fsa Corporate Issuers Fintree Juice Notes
JuiceNotes 2023
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INDEX
Financial Statement Analysis
Name of Reading
15 Financial Statement Analysis:Introduction 6
16 Financial Reporting Standards 8
17 Understanding Income Statement 11
18 Understanding Balance Sheet 20
19 Understanding Cash Flow Statement 26
20 Financial Analysis Techniques 29
21 Inventories 33
e
22 Long-Lived Assets 39
23 Income Taxes 44
24 Long Term Liabilities 47
re
25 Financial Reporting Quality 53
26 Financial Statement Analysis:Applications 56
Corporate Issuers
nT
78
32 Cost of Capital - Foundational Topics 81
33 Capital Structure 84
34 Measures of Leverage 87
Financial Statement
Analysis
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= Gross Profit
= EBITDA
COGS = EBIT
= EBT
Interest = EAT
Depreciation
(+) Unrealised Losses/
Salaries
Total
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Note : Sales is recorded after revenue earning activity (delivery of goods) is complete.
Note : Since goods are delivered now the liability is settled.
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During the first year of construction, the builder incurs $60 million of costs.
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also called
Stock split and Bonus Shares examples as stock dividend
18
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Debt Securities
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+
+
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inf low
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Corporate Issuers
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The unauthorized duplication of these notes is a violation of global copyright laws and the CFA Institute
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We have concealed a user specific code within this material to identify the original user. In case of
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indetification will also be reported to CFA Institute.
FinTree
CommuterNotes TM
US LLC US
Corporation
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Business Liability
· Limited Liability: maximum loss is the amount invested
· Unlimited Liability: in case of insolvency, personal assets are also at stake
Public For-Profit
- Listed on
stock exchange
For-Profit
Private For-Profit
- not listed on
stock exchange
Types of
Corporations
Capital
Ownership Capital Equity
· Shareholders
· Earn Dividends (Non tax deductible)
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LOS b
Private Public
LBO, MBO
IPO DL
Underwriting Yes No
ŸSpecial Purpose Acquisition Company (SPACs) is a means of acquiring a company. A SPAC is a shell
company (or blank check company), because it exists solely for the purpose of acquiring an unspecified
private company sometime in the future. SPACs raise money through IPOs, which is then kept in a
Trust A/c. SPACs have 18 months to complete the acquisition or else the money has to be returned to
the investors
Leveraged Buyout (LBO): Investors are not affiliated with the company
Management Buyout (MBO): Investors are members of the company (usually the management of the
company)
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Financial Claims:
Debt Vs Equity Claim Difference
Contractual Lender
obligation
Claim priority
Lender
Corporation
Debt Vs Equity
Debt Equity
Cheaper Costlier
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Shareholder Stakeholder
theory theory
e
Maximization of MV (not BV) of
Ÿ Ongoing interest in profitability and growth, both increasing the value of their shares
BOD Ÿ Responsibility to protect the interest of shareholders
Ÿ To hire, fire and set the compensation of the firm’s senior managers
Ÿ Monitor financial performance and other ongoing activities.
Ÿ Firm’s executives (most-senior managers) serve on BOD along with directors who are
not otherwise employed by the firm.
Ÿ One-tier - Both executive and non-executive board members serve on a single BOD
Ÿ Two-tier - Non-executive board members serve on a supervisory board that oversees a
Fi
their rights are of company and the including its which companies
violated stakeholders internal systems are subject
One-tier Two-tier
board board
2 Board responsibilities
system.
ª Ensuring the quality of the firm’s financial reporting and internal audit.
3 Board committees
Ÿ Implementation Ÿ CG code Ÿ Proposes qualified Ÿ Recommends to Ÿ Informs the board Ÿ Reviews and
of accounting Ÿ Implementing code of candidates for the board the about appropriate reports to the
policies ethics and policies election to the amounts of risk policy and board on
Ÿ Effectiveness of regarding conflict of board compensation to risk tolerance of management
internal controls interest be paid to the organization proposals for
Ÿ Recommending Ÿ Monitoring changes in directors and Ÿ Oversees large
external auditor laws and regulations senior managers. enterprise-wide acquisitions, sale
Ÿ Proposing Ÿ Ensuring company is risk management or disposal of
remedies based complying with all process company assets
on audits. laws and regulations or segments
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LOS g Factors that affect stakeholder relationships and CG
A threat of hostile takeover (the one not supported by management) can act as
an incentive thus influencing management and board to pursue policies more in
alignment with the interests of shareholders
2 Legal
environment
of other shareholders
Poor compliance procedures with respect to regulation and reporting can
easily lead to legal and reputational risks
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Dual class One class of shares may be entitled to several votes per share, while another
2
structure - class of shares is entitled to one vote per share
On average, companies with a dual class share structure have traded at a
discount to comparable companies with a single class of shares
Negative Certain companies and certain sectors are excluded from portfolios.
screening - Eg. mining and oil production sector.
Positive No specific sectors are excluded from portfolios but investors identify
screening - best practices across environmental sustainability.
2
Impact
investing
ee
Investing in order to promote specific social or environmental goals.
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Business Models
Business model types
Business Model : Helps analysts understand businesses
Channels :
Wholeseller Retailer
Manufacturer End-Customer
Direct Sales
Drop Shipping : Goods delivered directly from manufacturer to consumer without taking goods
into inventory
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Alternatives to Ownership
Recurring revenue/
Fractionalization Leasing Licensing Franchising
Subscription Pricing
Customers can rent selling assets in Shifting ownership Access to Franchiser gives
a product/ service smaller units of an asset from intangible assets franchisee right to
for as long as they Eg. Co-working the firm using it to sell or distribute
want the one that has its product or
lower costs for service
capital and
maintenance
Value Proposition : Product / service attributes valued by the firm’s target customers
Licensing : Produce goods using other’s brand name in return for a royalty
Value added resellers : Distribute and handle complex aspects of product installation,
customization
Franchise models : Retailers have tightly defined and exclusive relationship with the parent
company
Marketplace businesses : Creating network of buyers and sellers without taking ownership
of goods. Eg. Alibaba
Network effects : Increase in value of a network to its users due to which more users join.
Eg. LinkedIn
Explain and Classify types of Business and Financial Risks for a Company
Macro Risk :
Risk from political, economic, legal and other institutional factors. These affect all businesses
Business risk :
Risk that the firm’s operating results will be different from the expectations. It includes both industry
risk and company-specific risk
Financial risk :
Risk arising from company’s capital structure
Company-specific risk :
Ÿ Competitive risk: risk of a loss of market share or pricing power to competitors. Also arises from
potential disruption
ŸProduct market risk: risk that the market for a new product will fall short of expectations
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Components of Leverage
Contribution
Operating
Leverage
EBIT
Total
Leverage
EBIT
Financial
Leverage
EBIT
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Capital Investments
LOS a Describe the capital allocation process and basic principles of capital allocation
Other projects
Mandatory Projects such as R&D
Monitoring decisions and
conducting a post-audit
e Without detailed
analysis
2 Externalities
re
1 Basic principles of capital
budgeting
3 Conventional Unconventional
cash flow cash flow
pattern pattern
Sign on the cash flows Sign on the cash flows Problem of no IRR
changes only once changes more than once or multiple IRR
0 1 2 3 0 1 2 3
Unlimited Capital
funds rationing
Independent Mutually exclusive
Project sequencing - Investment in a project today creates opportunity to invest in projects in future
Discounted
Payback Profitabilit
NPV IRR payback
period y index
period
PV of inflows −
PV of outflows
ee
Rate at which NPV
=0
Time taken to
recover initial
Time taken to
recover initial
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investment investment
PV of inflows
PV of outflows
Doesn’t
consider TVM &
CFs after PB
Fi
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LOS c Describe expected relations among a company's investments, company value, and
share price
The NPV criterion is the criterion most directly related to stock prices.
If inflation is higher than expected Value of the project will be lower than expected
Inflation reduces tax savings from depreciation
Inflation decreases the value of bond payment to bondholders
Inflation will affect revenues and costs differently
LOS d
ee
Describe types of real options relevant to capital investment
Real options
Give managers
Allow management choices regarding Whole investment
to abandon a the operational is an option.
project if PV of aspects of a Payoffs from the
Allow company to
incremental CFs project investment are
make additional
from abandoning a dependant on the
investment in a
Allow company to project exceeds Price-setting underlying asset,
project if doing so
delay making an the PV of options: just like financial
creates value
investment incremental CFs Demand > Supply options
Fi
from continuing a
Similar to call
project Production- Eg. Value of gold
options
flexibility options: mine is dependent
Similar to put Using different on the price of
options inputs/producing gold
different outputs
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LOS e
Using a discount rate that does not accurately reflect the project’s risk
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Sources of capital
LOS a Describe types of financing methods and considerations in their selection
Internal and external Funding Sources
Internal External
Financial Capital
Other
Intermedlarles Markets
Financing Considerations
Firm Specific Macroeconomic
► Company Size
► Taxation
► Riskiness of assets
► Inflation
► Assets for collateral
► Government policy
► Public versus private equity
► Monetary policy
► Asset liability management
► Debt maturity structure
► Currency risks
► Agency costs
► Bankruptcy cost
► Flotation costs
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LOS b Primary and secondary sources of liquidity and factors that influence a
company's liquidity position
Primary Secondary DI PO
sources sources Drag on Inflows Pull on Outflows
Used in normal day to Used in deteriorating Eg. Uncollected Eg. Paying vendors
day operations financial conditions receivables, sooner than is
obsolete inventory optimal
è Selling good è Selling assets
è Collecting from AR è Negotiating debts Delay/reduce CF Accelerating cash
è Short-term funding (restructuring) or increase outflows
è Trade credit
è Line of credit
borrowing cost
Accounts payable - 50
0 30 50 70
Inventory AR Cash
30 40
Operating cycle (70) = No. of days in Inventory (30) + No. of days in AR (40)
Cash conversion/Net operating cycle (20) = Operating cycle (70) − No. of days in AP (50)
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ee 2 Costs
LOS c Calculate and interpret the cost of debt capital using the yield-to-maturity
approach and the debt-rating approach
1. YTM of the bond is the cost of debt and not the coupon rate.
Fi
a. Kd = YTM*(1-t)
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LOS d
Cost of Preferred Stock = Annual Preferred Dividends / Market Price of Preferred stock
LOS e Calculate and interpret the cost of equity capital using the capital asset pricing
model approach and the bond yield plus risk premium approach
Cost of equity
1
Y = a + bx
r
Covariance (s,m)
Beta =
Dependant variable Variance (m)
nT
Independent variable
Intercept Slope/beta
2 Pure-play method
Fi
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Ê Beta is estimated using historical returns data. The estimate is sensitive to the length of
time used and frequency.
Ê Beta of the entire market is 1, therefore all betas have a tendency to move toward 1 and
estimate may need to be adjusted.
Ê Beta may need to be adjusted upward for small firms to reflect inherent risk in them.
The correct method to account for floatation costs is to calculate the dollar amount of cost
and increase the initial cash outflow by this amount.
It should not be incorporated directly into the cost of equity because it is not an ongoing
expense and it would lead to increase in WACC which in turn will reduce the NPV
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Capital Structure
LOS a Capital structure and company life-cycle
+
Revenue
Cash flow
0 Time
Revenue growth
ee
Start-up Growth
Financial management
Beginning Rising
Mature
Slowing
Cash flow Negative Improving Positive / Predictable
Business risk High Medium Low
Debt capital/leverage
r
Availability Very limited Limited/improving High
nT
Note: These ratios are calculated based on the market values of equity and debt
Fi
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VL = VU VL = VU + (t × d)
MM proposition II MM proposition II
Assumptions:
Œ No taxes, no transaction costs and no bankruptcy costs
Investors have same expectations with respect to CFs
Ž Borrowing and lending at RFR
No agency costs
Operating income is unaffected by changes in capital
LOS c Trade-Off Theory with Taxes and Costs of Financial Distress. Firm Value and the Debt-to-Equity
Ratio
Value of
unlevered firm
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Shareholder Stakeholder
theory theory
Primary stakeholders of a
company
Shareholders
ee
Ÿ Voting rights
Ÿ Residual interest
Ÿ Ongoing interest in profitability and growth, both increasing the value of their shares
Senior managers Ÿ Compensation - salary, bonus and perquisites
Ÿ Executive bonuses are tied to same measure of firm performance, giving them a strong
interest in financial success of the firm.
Employees Ÿ They have interest in the pay, opportunities for career advancement, training and
working conditions
r
Creditors Ÿ Providers of debt capital
Ÿ Do not have voting rights
Ÿ Do not participate in the firm’s growth beyond their promised interest and principal
nT
payment
Suppliers Ÿ Ongoing relationship with the firm
Ÿ Typically short-term creditors
Ÿ They have interest in the firm’s solvency and ongoing financial strength
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Measures of Leverage
LOS a
1 Variable
Variable cost
cost
Fixed
Fixed cost
cost
Degree of
Operating
Leverage
ee
Degree of
Financial
Leverage
Uncertainty about
firm’s sales
Additional
uncertainty
about operating
earning
LOS b
1 Degree of operating Degree of financial Degree of combined
leverage (DOL) leverage (DFL) leverage (DCL)
Fi
% ∆ EBIT
% ∆ sales
% ∆ EPS
DOL × DFL
% ∆ EBIT
Sales − VC
EBIT % ∆ EPS
EBIT
% ∆ sales
EBT
Highest at low level of
sales Sales − VC
If there’s no FFC,
EBT
DFL=1
If there’s no OFC,
DOL=1
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+10% +10%
2 Sales 1000
Variable 400
cost
Contribution 600 Contribution % ∆ EBIT
1.5 DOL = Or
EBIT % ∆ Sales
Operating
200
fixed cost
DTL = DOL × DFL 3
+15%
EBIT 400
+15%
Interest 200
EBIT % ∆ EAT
EBT 200 2 DFL = Or
% ∆ EBIT
EBT
Taxes 100
EAT 100
+30% +30%
% ∆ Sales = % ∆ Contribution
% ∆ EBT = % ∆ EAT
% ∆ Net income = % ∆ PAT = % ∆ EPS
LOS c
ee
Effect of financial leverage on ROE
ROE = Net income Use of financial leverage increases the risk of default but also
Equity increases the potential return for equity shareholders
LOS d LOS e
r
Operating Operating fixed cost
Breakeven Level of sales a
breakeven
= Contribution per unit
firm must generate
nT
Fixed cost
Breakeven point (in amount) =
Contribution ratio
Contribution
Contribution ratio =
Sales
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Eg. Operating fixed cost = 10,000 Financing fixed cost = 20,000 Tax rate = 50%
Selling price = 100 Variable cost = 60 Desired EBT = 30,000 Desired EBIT = 10,000 Desired EAT = 50,000
OFC
Operating breakeven =
Contribution per unit
10,000
=
40
= 250
OFC + FFC
Total breakeven (quantity) =
Contribution per unit
10,000 + 20,000
=
40
ee = 750
OFC + FFC
Total breakeven (in amount) =
Contribution ratio
10,000 + 20,000
=
40%
= 75,000
r
OFC + FFC + Desired EBT
Units to be sold to generate desired EBT =
Contribution per unit
nT
= 1,500
=
40
= 500
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= 3,250
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