Cash Is King Chapter 5 Review FIN 690 Steve Ruesch April 09, 2003.

Cash Is KingChapter 5 Review

FIN 690Steve Ruesch

April 09, 2003

Chapter 5 - Cash Is King

Quote from an expert in the field

“Everything we do should increase the Net Present Value of the company”

Mo Vaziri (April 02,2003)


Valuation Methods

Traditional Accounting Measurements

Balance Sheet (On and Off) Income Statement Statement of Owners Equity Statement of Cash Flows

New Paradigm

Free Cash Flow Cost of Investing Return on Invested Capital


Manner in which market functions

1) Changes in value are linked more closely to changes in expectations than to absolute performance.

In 1997 Intel reported 19% earnings growth and stock declined 6.3% because of 23% forecast.


Relationship between TRS and Expected Performance (p.75)

See Exhibit 5.1 on page 75



2) Valuation levels are linked to return on invested capital and growth.

Authors conducted a survey of 340 large companies Five year growth Five year average spread (ROIC vs Opportunity Cost of Capital) Average Market/Book Value


Relationship between Market Values, Spread, and Growth (p.76)



Market-to-Book Regressions (p.76)



More Regression Analysis for you Statisticians… (p.77)




3) The market sees through cosmetic earnings effects and focuses on underlying economic results.

Not fooled easily by creative accounting Accounting methods used in different countries. Inventory Valuation methods Mergers and Aquisitions


German Industrial Company - Hoechst

Year

German accounting(DM million)

U.S accounting(DM million)

Difference (percent)

1995 1,709 (57) NM

1996 2,114 1,324 -37%

1997 1,343 377 -72%


Inventory Valuation

Choice of accounting method affects both earnings and cash flow – in opposite directions.

In periods of rising prices: LIFO = lower earnings, lower income taxes, higher

after-tax cash flow. FIFO = just the opposite.


Inventory Valuation (cont) (p.79)



Mergers and Acquisitions

Purchase: Price Paid – Book Value = Goodwill (amortized over 40 years)

Pooling of Interests: Reported at Book Value with no amortization. Earnings are higher without amortization


Mergers and Acquisitions (cont) (p.80)




4) The market puts great weight on long-term results, not just short-term performance.

Internet Companies – valued very high even without earnings or products to sell.

Dividends as percentage of stock price. Market reacts favorably to increases in

investment Changes in Leverage


Present Value of Expected Dividends (p.82)



New R&D Projects Announced (p.83)



Long-Term Investment

Type of Investment Sample Size

Cumulative 2-day market adjusted return (percent)

Capital Expenditures 260 +0.35

Product Strategies 168 +0.84

R&D Expenditures 45 +1.20

Joint Venture Formations 161 +0.78

Total Sample 634 +0.71


Market values CASH, not earnings

Exchange and Stock Swap TransactionsEPS impact does not matterChange in Leverage matters

Decrease in Leverage = negative share price reaction


Is the Stock Market Efficient? Some managers claim that the market

behaves irrationally.

Does ‘efficient’ mean “Get it Right”?

What are the implications for investors and corporate managers?


THANK YOU!

Accounting Earnings

Cash Is King Chapter 5 Review FIN 690 Steve Ruesch April 09, 2003.

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Transcript of Cash Is King Chapter 5 Review FIN 690 Steve Ruesch April 09, 2003.