Accounting and Financial Management Decisions Semester Of Notes
Accounting and Financial Management Decisions Semester Of Notes ACCTG 215
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ACCTG44O Notes 110 Al Dunlap at Sunbeam Al Dunlap coming off a highly successful turnaround at Scott Peter Radical restructuring and downsizing Dunlap fired Many believed Sunbeam was a dying brand failed to keep up the pace with competitors like Black amp Decker High turnover among factory workers well over 50 Al Dunlap eamed a reputation for attacking corporate culture as the source of a company s problems trademark of ring from the top down Tumaround was executed in rapid fashion Layoff should only be done once There is only one constituency I am concemed about and that is the shareholders I m probably a much nicer guy than most people think but who s going to hire a nice guy to tum around a filing conglomerate Compensation directly tied to the stock performance of the company in the form of options and grants Sunbeam Took no bonus but received a substantial package of stock options and awards Had Charles Elson a law professor to join the Board Despite some criticisms the first months of Dunlap s tumaround of Sunbeam were quite successful Dunlap s plan called for a lead time of 6 months 13 of usual l6l8 months and severely reduced RampD staff Chainsaw Al gets the Chop l acquisition of 3 new troubled companies 2 institution of a mktg strategy called early buy or bill and hold program for gas grills and other seasonal products Paine Webber s Andrew Shore sales are up but also inventory Dunlap ready to leave WHY Elson felt there was a disconnect between the lessons of Dunlap s book and what was happening at Sunbeam To Our Shareholders 1 An outstanding new management team is in place 2 We Ve attacked excessive costs 3 We have focused on our core businesses 4 Execute an aggressive growth plan making Sunbeam a global leader once again Sunbeam Board of Directors Roger W Schipke has 2nd most shares extreme of 479337 shares Albert J Dunlap has most shares 1324898 shares Russel A Kersh 3rd most shares 140817 shares ACCTG44O Notes 12 Information Collection eVal public companies in US f1lings W SEC most important source of company speci c information Company Data 23 of variation in a typical stock price is company specific and unrelated to market or industrywide movements spend at least 23 of your time on the analysis of company specific data SEC Filings 10K most useful Most important parts 1 Description of business in Item 1 2 MDampA must read a requires mgmt to identify any factors that might cause the company s liquidity to change b requires a description of the company s material capital expenditure commitments the purpose of such commitments and the anticipated sources of funding for the commitments c required to discuss any pending changes in the company s capital structure 3 Financial statements in Item 8 Main drawback of 10K only made available once a year Our main interest in the other SEC filings is to access more timely information lOQ you should plan on reviewing all 10Qs led since the most recently available Form 10K Also make sure that you are familiar w information the 10K provides before reading 10Qs Company Website One must read press release section Financial Press Analyst Research Reports Investext One strategy zero in on the research report of the analyst issuing the least favorable recommendation on a stock Macroeconomic and Industry Data a Global and Domestic Economy b Domestic economy a Bureau of Economic Analysis i GDP data and their components by industry and by state ii Inputoutput statistics which document the ow of goods between industries iiiNew investment net holdings and avg age of major classes of assets Sectors and Industries Economic sector consists of a group of industries that engage in related activities Ex consumer goods Industries de ned by the nature of the good or service that is provided by the business Firms in the same industry provide similar goods and service and will typically use similar input sand production technologies Understanding the Business Top down approach macroeconomic enviromnent ea industries ea detailed analysis of operations and strategies of the business Macroeconomic Factors Should be aware of the expected economic growth rates political risks and currency risks in each of the domestic economies in which the rm operates a GDP measures the market value of nal goods amp services produced domestically a Common leading indicators include unemployment insurance claims consumer spending consumer con dence business orders business productivity and housing and construction activity b Interest Rates affect business in 2 important ways a Determine the price that rm must pay for its own capital changes in interest rates cause changes in consumer spending b Re ect expected in ation and credit risk i Can abstract from the credit risk portion of interest by examining the interest rate on low credit risk borrowings such as federal funds rate or the yields on the bills notes and bonds of US treasury c In ation general rise in price levels CPI d Foreign Exchange Rates driven by a complex variety of factors including the relative productivity of capital and labor relative productivity of capital and labor relative in ation rates and relative real interest rates e Oil prices and other key commodity prices commodity price affect the costs of all businesses a Most important commodity price at the macro level is the price of oil f Hedging you wont know its net exposure to interest rates forex rates or commodity prices until you understand its hedging activities g Business Cycle a Historically domestic economies have exhibited systematic periods of expansion characterized by high GDP growth low unemployment and higher consumer con dence and contraction low GDP growth high unemployment and low consumer con dence Industry Factors Industry analysis has 3 primary objectives 1 to understand the sensitivity of the industry to key macroeconomic factors 2 to understand how the industry operates and the key performance metrics for evaluating these operations 3 to understand the competitive structure of the industry Sensitivity to Macroeconomic factors Industry operation and key industry ratios and statistics a Particular metrics vary widely based on the nature of the industry s operations Competition Structure of Industry a when studying the industry you should look for characteristics that might allow firms to generate abnormal pro ts over a prolonged period of time b Porter s ve forces Firm s Strategy a Firm pro tability is not solely a function of industry pro tability a Cost leadership b Product differentiation c Focus b Best source of info conceming a rm s strategy for achieving competitive advantage is the 1 section of 10K Synergy Analysis a synergies are created by leveraging proprietary assets eliminating transaction costs eliminating redundant overhead increasing market power or any number of other activities Interim Reporting Interim reports nancial statements covering periods of less than a year One of the objectives of interim reports to enhance the timeliness of nancial information Also provide additional insight on the seasonality of business operations that might otherwise get lost in annual reports Downside unreliability of interim reporting Should each interim period be viewed as a discrete reporting period or as an integral part of the annual period Reporting Revenues and Expenses a with only a few exceptions the same accounting principles applicable to annual reporting are used for interim reporting Reporting Unusual Items a major events such as discontinued operations or extraordinary items should be reported separately in the interim period in which they occur amount should not be allocated among individual quarters within the scal year Eamings per Share a discrete b based on conditions actually existing during the particular interim period rather than on conditions estimated to exist at the end of the scal year Reporting Accounting Changes a Accounting changes made in an interim period are reported by retrospectively applying the changes to prior nancial statements Minimum Disclosures a complete nancial statements not required for interim period reporting but certain minimum disclosures are required as follows Oakley Eyewear 5 5405 Avoids mass merchandisers and most dept stores Vigorously litigate unauthorized distribution of patent infringements ACCTG44O Notes 14 Freakonomics School Teachers Highstakes testing Manage a minimum score on standardized test Added reason to cheat for teachers Block of identical answers pattems E 5th grade score a 6 grade score 7th grade score A cheating teacher may tell herself that she is helping her students but the fact is that she would appear far more concemed with helping herself It was teachers in the lowestscoring classrooms who were most likely to cheat Algorithm could also identify the best teachers in the school system a students got easy problems previously missed right and carried over their gains into the next grade Duncan retest with cheating class rooms and mix of excellent teachers and mediocre scores and no suspicious answers Result very evident class with no cheating suspected scores stayed or even rose but cheating teacher class fell by an average of more than a full grade level Result some got red rest wamed E2 following year cheating teachers fell more than 30 Stamford International Case Focus Questions 39 What EPS gure do you believe best re ects the company s rstquarter operating results 47cents per share What EPS gure do you think Stamford s CEO will report to investors as the company s rstquarter operating result 52cents per share How do you believe the various accounting and disclosure issues raised in the case should be resolved in any case be conservative and correct them by following the GAAP Why might the Technology Products Division have the type of accounting irregularities documented by the intemal audit report pressure to reach certain target from the management management compensation could be tied to profit performance of the division etc Based on the case data how comfortable would you be as the CFO signing the rst quarter s SOX certi cation Very uncomfortable The changes made have significant impact on the nal EPS Stamford growth stock First time SOX certi cation of the nancial statements by the company s CEO and CFO CFO 1 Q not great but could legitimately push them over CEO Gotta pay the price Morris can t afford to lose the stock price momentum Costs Maintenance 2 centsshare 2 centsshare Relocation of Southem Paper Sioux Springs of ce 3centsshare Overseas operations down a inventories and AR overstated b all amounts to 6 cents per share writeoff c will le lawsuit in Italian courts to recover the amounts Advertising 2 cents share above average monthly budget a bene ts come in April May and June but rules say this type of advertising cost should be expensed as incurred Unrealized exchange gain of 4 cents share on hedging of anticipated 2nd quarter foreign currency denominated transactions a feel we should defer this unrealized gain against possible future hedging losses restructuring reserve equivalent to 2 cents share left over form a 2 year old restructuring charge and program that was successfully completed last year security analysts predicting we will make 60 cents for 1 Q If we fail E PE drops ea acquisition negotiations W Apex in Cleveland and Contrelli in Italy may collapse or fail to produce the positive EPS impact we expected We need eamings of both of these companies and at least 1 more acquisition to meet the analysts consensus pro t forecast for this year 2 acquisitions will be for stock PVT Conversation Lawrence SEC taking a harder line than our auditors Look at the intemal audit team s report Auditors rate our intemal control as adequate ACCTG44O Notes 124 GROUPON Case Aggressively invest in growth Care about customers and merchants Track Gross Pro t FCF Adjusted Consolidated Segment Operating Income consolidated segment operating income before new subscriber acquisition costs and certain noncash charges operating pro tability before marketing costs incurred for longterm growth 1 Business model a Pros you get more customers Cons you are selling at a cost b Pros you wont have much inventory so less effect on costs Groupon might be effective for repeat customers Cons 2 Revenue Recognition a 594 532 b Gross version 391 Net version 887 c growth in revenue from scal 2009 to scal 2010 using growth method 224ll3 using net method 205227 d net method would be more informative because that is the actual economic pro t Groupon is making from its operations Including merchant s sales seems like double counting 3 Yes Net income is same in both methods When you deduct expenses from the revenue you get same number ACCTG44O Notes 112 CUC Intemational Focus Questions Analyze the competitive environment that CUC faces The key acctg issue in the CUC case is the capitalization of membership acquisition costs and the related 3 year amortization period Can these costs be considered economic assets What factors determine the economic values and useful lives of these assets How should appropriate accounting for membership acquisition costs depend on the factors that determine economic values of these assets Sure if they are generating economic pro ts and have some amount of certainty If you believe that membership acquisition costs are assets ie they will produce future economic benefits over what useful life should they be amortized What factors should be considered in determining values and useful lives Average length of renewal period and rates Analyze CUC s cash ows Any concems Large amounts of cash out ow based on Membership acquisition costs and prepaid solicitation costs As well as investing activities acquisitions net of cash acquired Is CUC s policy for accounting for membership acquisition costs re ective of eamings management behavior or the underlying economic values of these costs What disclosure policies could CUC adopt to accompany its policy of capitalizing membership acquisition costs Yes but needs historical track of membership period What advise would you give your client Stuart Bell NOTES Stuart Bell Executive VP and CFO of CUC lntemational Inc Concem stock was seriously undervalued Business History and Operations Membershipbased consumer services company Clients Chase Manhattan Citibank Sears J C Penny and Amoco Most popular product Shoppers Advantage 12 negotiation possible subscribers the lowest prices available on goods it sold Company carry no inventory Incurred large onetime cost for new member solicitations Membership acquisition cost gt memberships fees in the rst year Membership renewal rate key determinant of the pro tability of the shoppers advantage program annual renewal rate 71 E guaranteed its Financial reporting controversy CUC s management decided that because current marketing outlays provided signi cant future bene ts the company should capitalize membership solicitation costs in its nancial statements amortize them over 3 yrs at rate of 40 30 and 30 Choice was endorsed by Emst amp Whinney and SEC when the company went public Rationale membership renewal rates are so high and steady 12 future bene ts As rm grew and sought more investors some analysts concemed that capitalized mktg costs would subsequently have to be writtenoff as losses bc of high uncertainty about future renewal rates Safeguard was doing it but controversy and it had to writeoff Target of shortsellers 1988 1989 stock price declined by 50 relative to the market Firm s performance in line with analyst expectations Firm able to fund its substantial marketing outlay solely from operating CF during this period Possible mgmt responses At least 3 options available 1 adopt more conservative policy to account for membership acquisition costs 2 provide expanded disclosure to justify the rm s capitalization of membership acquisition costs 3 Use corporate nance policies to enhance it stock price Cash payouts in the form of dividends and share repurchases Exhibit 1 Short selling increased from around Dec 1 yr later Exhibit 2 High AP Increase in Deferred membership charges Prepaid solicitation costs quite a jump from 19871988 1 S Operating amp Marketing highest expenses CF Net increasedecrease in members deposits AP and accrued expenses and federal and state income taxes biggest factor Deferred membership Charges Net Deferred membership income Unamortized membership acquisition costs Amortization of membership acquisition costs high ACCTG44O Notes 131 Reporting segment information Uses management approach in determining which segments of a company are reportable Operating segment Is a component of an enterprise 39 That engages in business activities from which it may eam revenues and incur expenses including revenues and expenses relating to transactions with other components of the same enterprise Whose operating results are regularly reviewed by the enterprise s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance For which discrete financial information is available What amounts are reported by an operating segment a general info about the operating segment b info about reported segment PL including certain revenues and expenses included in reported segment profit or loss segments assets and the basis of measurement c Reconciliations of the totals of segment revenues reported PL assets and other significant items to corresponding enterprise amounts d Interim period information Reporting by geographic area Info includes a reveneus from extemal customers 1 attributed to the enterprise s country of domicile and 2 attributed to all foreign countries in total from which the enterprise derives revenues and b Longlived assets other than nancial instruments longterm customer relationships of a nancial institution mortgage and other servicing rights deferred policy acquisition costs and deferred tax assets 1 located in the enterprise s country of domicile and 2 located in all foreign countries in total in which the enterprise holds assets Information about major customers If 10 or more of the revenue of an enterprise is derived from transactions with a single customer M must disclose the fact the total amount of revenue from each customer and the identity of the operating segment or segments eaming the revenue ACCTG44O Notes 213 Lehman Brothers and Repo 105 On the last day of each month the books and records of the Firm contain approximately 5 billion dollars of net assets in excess of what is managed on the last day of the month Historical strengths was in underwriting and trading xed income securities Switched from low risk brokerage model to higher risk banking model B S transformed from transferring assets to 3rd parties to holding them on their own B S Leveraged up to gain retum on small equity No access to stable base of retail deposits E2 relied on constantly re nanced shortterm loans E2 vital for the company to maintain investor con dence Concem arise as Bear Steams collapsed First ever quarterly loss Deleveraging but David Einhom a hedge fund manager had started to short Lehman s shares in July 2007 Particularly critical of Lehman s leverage and mistrusted its publicly stated ratios Problem is the overall leverage and loan portfolio 40 times levered on tangible equity Lehman led for bankruptcy signi cant liquidity problems with over 600 billion in assets largest bankruptcy ling in American history Repo Repurchase agreements used to provide liquidity and to nance its shortterm borrowings 2 steps 1 borrow cash using assets on its own BS as collaterial value of collateralized assets original borrowed amt haircut 2 as Lehman repaid the cash it would then repossess the collateralized asset and pay the lender the originally borrowed amt interest level of control sale or not 3 conditions under which a sale could be reported Lehman created a new type of Repo transaction which allowed the rm to consider the transaction as a sale Take higher haircuts of 5 or 8 E e2 established a surrender of control over the asset At inception of borrowing Lehamn record a reduction in the collateralized assets equivalent to the borrowed amount plus the haircut Difference between the cash received and the transferred asset value haircut option to repurchase an asset account Lehman then use cash proceeds from Repo to pay down other liabilities w liabilities on B S amp equity unchanged lower leverage ratios reduce total Faced only w the total value of Lehman s derivatives readers were thus unable to know that Lehman had engaged in Repo 105 transactions Also no indication in n statements that Lehman had obligation to repurchase securities worth tens of billions of dollars on a short term basis Auditors rating agencies Fed nor SEC aware of Lehman s use of Repo 105 transactions Lehman a big client for EY Lee whistle blower In the meantime EampY had issued an unqualified audit review report for Lehman s Form l0Q on July 10 2008 less than a month after the interview with lee ACCTG440 Notes 127 Kansas City Zephyrs Baseball Club Focus Questions Identify the controversial accounting issues about which the owners group and the players association disagree For each controversial accounting issue identify the underlying economic reality outline how each side in the negotiations is accounting for it and identify how each issue should be accounted for according to GAAP As the arbitrator make any adjustments that are necessary to restate the owners accounting for income in 2005 How does your accounting for net income compare with that of the owners groups and the players associations Players felt they should share in the teams pro ts Owners most of the teams were actually losing money each year and they produced nancial statements to support that position Baseball club entity not owned by another corporation and it did not own the stadium the team played in Nonroster guaranteed contract expense salaries paid to players who are no longer on our active roster EXPENSED b c they are not serving to bring in our current revenues 20062007 stadium owners plan to add 25 luxury boxes to expand seating capacity charge 250000 up front for each box plus an annual fee a recognize 250000 upfront cash pmt as revenue over 5 yrs on a straight line basis Players argument Owners used 3 techniques to hide pro ts 1 initial roster depreciation 2 overstated player salary expense 3 relatedparty transactions Roster Depreciation Depreciation expense arises only when a team is sold Maybe Don t really know the reason of doing so Most of the players actually improve their skills with experience NA UNREASONABLE Player salary expense 1 Owners expense the signing bonuses in the year they re paid M spread apart REASONABLE 2 Back out the deferred portion of the total compensation since the team is paying this money over a long period of time it is misleading to include the whole amount as a current expense UNREASONABLE 3 players think salaries due to players who are no longer on the roster should be recognized when the cash is paid out not when the players leave the roster UNREASONABLE this is cash accounting Related party transactions Players listed Stadium operations at about 80 of what the owners charged some shareholders in the team are eaming a nice gain on the stadium pricing agreement HARD TO TELL Players thinks the down payment of 250000 up front should be recognized as part of next year s revenue DEPRECIATE IT so UNREASONABLE RESULT Roster Depreciation 19000 Roster salary 12540 Owners Claims Disputed Published July 6 1985 Negotiators for major league baseball players told the owners representatives yesterday that they differed significantly with them in their assessment of the owners financial information The players association indicated a reported 36 million industry loss for 1984 actually could have been more than a 9 million profit The players association did not convince the owners negotiating team of its view of the 1984 figures but Lauren Rich the association39s assistant general counsel said there could be as much as a 75 million difference between the owners reported losses and the actual cash ow Miss Rich said that the association39s accountants reached the figure of a 93 million profit by eliminating various types of depreciations from the clubs figuring depreciation for initial roster costs deferred compensation player acquisition costs and stadium and equipment costs Lee MacPhai1 the owners chief negotiator said he might agree on the initial roster depreciation but not the other areas ACCTG44O Notes 22 Leasing Decision at Magnet Beauty Products Inc Premium hair body and face care product Leased all its stores from the same lessor a large real estate company operating in Massachusetts Company considerably leveraged AP and outstanding debt had reached 20 and 52 million respectively Operating Lease shorter lease 1 net income for year 1 would remain 15 million 2 leverage would equal 46 3 lease payments would be higher in the future reducing net cash ow before debt issues Capital Lease five year lease 1 net income decrease from 15m to 08m for year 1 as a result of the accounting change 2 leverage increase from 46 to 68 ACCTG440 Notes 215 Boston Chicken Boston Chicken is about developing a marketwinning formula for picking real estate designing stores organizing a franchise operation and analyzing data Transformed what had been a momandpop business into a new national category take out home cooked food Firm s concept to combine fresh avorful and appealing meals associated w traditional home cooking w a high level of convenience and value Meals cost less than 5 Rapid growth a IPO Area Developer Organizations Instead of selling store franchises to a large of small franchisees Boston Chicken focused on franchising to large regional developers Intended to provide the entrepreneurial energy of a franchise operation with the control and economies of scale of companyowned operations Area developer fmancing revolving line of credit and possible conversion to equity with premium Communications infrastructure Company invested 8l0 million to build computer software Operating improvements Added menus drive thru technology increased quality Expected Future Performance Lehman Brothers Strong Buy Lipton Financial Services Franchisees had actually lost money a2 short Quality of eamings is very low all of Boston Chicken s income comes from fees royalties and interest pmts from franchisees most of whom were financed by the franchiser Stock closed at 3375 up more than 100 over the beginning but short positions all time high of 10 million shares more than 20 of the shares outstanding and double the short interest position at the beginning of 1995 Revenue Increase primarily due to an increase in royalties attributable to the larger base of franchise stores operating systemwide an increase in franchise fees related to the increase in the number of stores that commenced operations as franchised stores during the year and higher interest income generated on increased loans made to certain area developers Revenue from company operated stores increased higher avg number of company operated stores open during the year Cost of Products Sold Increased primarily due to an increase in the number of companyoperated stores open during the periods Newer stores tend to have higher food and paper costs Salaries and Benefits Increased due to incrase in number of employees at the Company s support center necessary to support systemwide expansion and in crease in number of employees at Companyoperated stores due to higher avg number of companyoperated stores open during the year General and Administrative Increased due to development of support center infrastructure and higher avg number of company operated stores open Provision for Relocation Consolidated its four Chicago based support center a single one in Colorado Other Expense Higher interest expense primarily to Convertible Debt and short term borrowings partially offset by higher interest income Income Tax MKTG and Advertising Funds Such amounts are not segregated from the cash resources of the Company but the National Advertising Fund is accounted for separately and not included in the financial statements of the Company Debt Credit Risk and Allowance for Loans Subsequent Events Convertible secured loan agreement providing 20 million of financing to Progressive Bagel Concepts ACCTG44O Notes 221 Introduction to Forecasting Potential to eam abnormal returns increases substantially if one correctly forecasts the sign and magnitude of the change in oneyear ahead eamings General Forecasting Principles 1 objective of forecasting is to produce reliable and realistic expectations of future eamings cash ows and dividends which determine the valuerelevant future payoffs to investment Forecasts of financial statements should be comprehensive Financials statement forecast must be intemally consistent assumptions and relations Financial statement forecasts must rely on assumptions that have intemal and extemal validity SixStep Forecasting Game Plan 1 2 3 projecting revenues from sales and other operating activities projecting operating expenses and deriving projected operating income projecting the assets that will be necessary support the level of operations projected in step 1 and 2 projecting the operating liabilities and the financial leverage and capital structure that will be necessary to finance the assets projected in step 3 determining the cost of financing the financial liabilities in the fir s capital structure projected in step 4 and any income from financial assets projected in step 2 Deriving the statement of cash ows from the projected income statement and the changes in the projected balance sheet amounts ACCTG440 Notes 223 Starbucks Founded in 1971 Went public in 1992 Expanded into Japan and Singapore in 1996 Expanded into the UK in 1998 Jumpstarted its worldwide expansion in 2001 Stock price steadily decreased over 2007 Shultz back as CEO Closed approximately 800 underperforrning US companyoperated stores 61 in Australia E New growth strategy 1 expand the number of foreign stores that Starbucks has business partners to share risk With 2 introduce Via instant coffee all over the world 3 strengthen Seattle s Best Coffee Focus Questions 1 Analyze Starbucks as a business How do you characterize their industry Who are Starbucks competitors What is Starbucks competitive business strategy Does Starbucks have a sustainable competitive advantage a Coffee retail industry b Other coffee shops as Well as readytogo drinks ice creams etc c Large organization with abundant knowhow and brand reputation 2 What are Starbucks key profit drivers What accounts on Starbucks balance sheet and income statement are related to these drivers a Company operated stores 3 What intemal and extemal factors do you think will impact Starbucks net revenues over the next three years As you list each factor note whether management has any control over the factor IF you could ask CEO Howard Schultz one question that would help you forecast Starbucks 2012 revenues what would that question be a General economy and consumer spending b Marketing product development c What s the samestore sales figure like Number of opening stores 4 Compute Starbucks asset tumover ratio for scal 2011 2011 net revenues average total assets Do you expect this ratio to change over the next three years Use the bottomup approach to forecast Starbucks 2012 total assets a 2011 net revenues 117004 10 b average total assets 7360463859 2 687315 c Asset tum over ratio 170 d It may change if it can generate higher rate of sales relative to its assets IN CLASS we will analyze the nancial performance and position of Starbucks by using common size nancial statements ratios cash ow analysis etc INCLASS we will forecast Starbucks income statement and balance sheet for 2012 and note our key assumptions along the way We will then compare our forecast to management s goals in terms of store openings IN CLASS we will estimate the cost of equity capital for Starbucks IN CLASS We will extend tour forecast of eamings out to 2016 and use the valuation model to estimate Starbucks value INCLASS We will compare our estimate of value from above to the current market price range of Starbucks stock and discuss possible reasons for any differences Based on our inclass analysis would you recommend Starbucks stock to an investor ACCTG44O Notes 228 Using a Valuation Model to Estimate a Firrn s Stock Price In the absence of a clearly superior approach We emphasize a Valuation model based on discounted future accounting eamings Simple perpetuity Valuation model PV NIr N1 eamings assumed to continue in perpetuity R discount rate NItl re BE often called abnormal eamings MVE beginning BVE PV of future abnormal eamings 4 main inputs to the Valuation model Current data 1 current book Value of equity BVEt only known item in the model remaining items are forecasts Future data estimates the future Value of abnormal eamings The inputs are 2 forecasts of eamings NI or eamings per share eps 3 future book Value of equity BVEtr needed to create our benchmark for a normal expected retum 4 cost of equity capital re Again at the most simple level when a firm eams a normal economic retum on the shareholders investment re the price per share of stock Pt should be approximately equal to its accounting book Value of equity per share BVPSt ie Pt BVPSt ACCTG44O Notes 221 Google and Earnings Guidance Google has no guidance Now that it s entering new markets developing new products and making signi cant acquisitions should Google begin to offer eamings guidance Disclosing eamings forecasts by senior managers of publicly listed companies is commonly referred to as eamings guidance Regular guiders those rms provide guidance every quarter generally high pro le rms whose stock is held by a large number of institutional investors and covered by several analysts Occasional guiders those rms issue guidance only on an ad hoc basis mostly if their managers believe that analysts consensus estimate is far from what the actual eamings will tum out to be Nonguiders those rms either face little demand for guidance or have a policy not to issue guidance Why doesn t Google issue guidance What is the role of equity analysts in capital markets Should more firms follow Googe s approach to communicating with analysts and investors or should Google change its policy
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