ACG
"exam question" If the coupon rate is 10%, whats the coupon payment?
$100 Coupon rate (int) x face = coupon payment. we assume FV of bond $1,000
The beginning balance in a company common stock account is $100,000. It issues 75,000 shares of $2 par common stock for $60 per share. Determine the ending balance in the common stock account.
$250,000 Common Stock = Beg balance + Par Value of issued stock =$100,000 + $2/share (75,000 shares) = $250,000
"exam question" 1,500 bonds with coupon rate of 10% paid semiannually. How much are coupon payments?
$50 because rates are always quoted annually.
Effects of Bonds on the Balance Sheet: Your company has issued 500 bonds at par -----------------last year-----------this year total assets 900,000 1,400,000 total liabilities 100,000 total equity 800,000 Net Income 100,000
$500,000 of bonds cash coming in affects assets Liability: add 500,000 = 600,000 total equity: doesn't change Net income isn't going too change Effect on ratios: original (without bonds) ROA=NI/Avg Assets = 100k/900k=11.11% with bonds = NI/Avg Assets =100,000/1,150,000=8.7% (since denominator goes up, overall equation goes down) Effects on ROE (NI/AVG EQUITY) equity doesn't change therefore ROE = 12.5% Debt to equity= total liabilities/total equity without = 100k/800k = .13 with = 600k/800k = .75 Debt Ratio= Liabilities/Assets Without = 100k/900k =.11 with = 600k/1,400,000 = .43
If inventory goes up then...
COGS goes down and income goes Up
Selling Price =
COGS/1-Gross Margin
Sales =
COGS/1-gross margin
Your company has issued 500 bonds at par Journal Entry:
Cash 500,000 ---Bonds payable 500,000
Statement of cash flows
Cash in vs cash out "provided by" vs "used" calculate: -operating cash flows -investing cash flows -financing cash flows
Stockholders Equity Section 3 basic accounts
Common Stock Additional Paid-in capital Retained Earnings
A company decides to issue 20,000 share of stock at $35 per share and repurchases 10,000 shares at $10 per share. What is the net effect on the company debt-to-equity ratio?
Decreased. Debt-To-Equity ratio = debt / equity 20,000 share ($35) =$700,000 repurchased 10,000 share ($10) = $100,000 as this amount goes into the treasury stock account (a contra-equity account)the net effect equity was an increase of $600,000. Because equity increased and debt remain constant, the debt-to-equity ratio decreased
A companys primary activities revolve around selling toothbrushes to consumers. What would be included above its operating income in its income statement
Depreciation on a machine used to mold plastic for the tooth brush Operating income = gross profit - operating expenses
Premium vs Discount your company has issued 30, 10-year bonds at 5%. The current market rate is 8% What are these bonds trading at?
Discount. Cash xxx Discount on bonds xxxx ----bonds payable
A company had 530,000 common shares outstanding for 10 months of its fiscal year. For the remaining two months, there were 573,000 shares outstanding. The company net income available to common stock shareholders was $2.52 million over the year. If the ocmpanys investors can potentially convert all of their securities to 32,000 shares of common stock, determine its EPS and dilutes EPS
EPS = NI/Outstanding Shares weighted avg # of shares = 530,000 (10) + 573,000 (2) / 12 = 537,167 EPS = 2,520,000 / 537,167 = 4.69 Diluted EPS = 537,167 + 32,000 =569,167 2,520,000 / 569,167 =4.43
Earnings per Share your company has net income of $1,000,000 at the beginning of the year you had 400,000 share outstanding. you then issued 80,000 additional shares May 1st and repurchased 45,000 shares October 1st. What is your earnings per share for the year?
EPS= NI/share outstanding 400,000 x 4/12 (don't count may jan-aril) add 80,000 to stocks = 480,000 480,000 x 5/12 (don't count october may-sept) repurchased (45,000) 480,000 - 35,000 = 435,000 435,000 x 3/12 (the rest of the months) 133,333 +200,000 +108,750 = 442,083 outstanding shares 1,000,000/442,083 = 2.6
Kelly is analyzing a companies financial statements and wants to determine if the companies increase in net income will continue into next year or if it was the result of aggressive accounting practices. Which values from the company would she be MOST interested in?
Earnings quality: describes how well the copays income predicts future earnings Accrual = NI = OCI / Avg Ass
True or False *Par value being $1 means the stock i worth $1
False Par value has nothing to do with market value
Gross Profit Ratio or Gross Margin
Gross Profit/Net Sales
If accounts receivable goes UP will it be an income increasing or decreasing accrual?
If A/R goes up, revenue goes up.. therefore income goes up
Bonds Issued at a Discount Cash xxx Discount xxx Bonds Payable xxx at each coupon payment they pay cash and amortize the discount account. int exp xxx discount xxx cash xxx
If the bond is issued at discount, interest expense will be higher than the discount payment.
OPERATING cash flows
Includes current assets, current liabilities, and income statement activities because depreciation, depletion, amortization expenses do not affect cash flow, their subrtraoion on net income is reversed by adding them to net income (on income statement) ACCOUNTS RECEIVABLE Inventory A/P
What observation can lead to an overestimation of a company earnings?
It recorded revenue from a product it was unlikely that the customer would pay. companies should not record revenue they expect not to collect.
Effect of a Premium Bond Will liabilities be higher or lower than the face value? Will interest expense be higher or lower than interest paid
Liabilities wil be higher than the face value Interest expense will be lower than the interest paid.
Effect of a discount bond: Will liabilities be higher or lower than the face value? Will interest be higher or lower than interest paid?
Liabilities will be over than the face value Interest expense will be higher than the interest paid
Financing activities
Long term debt & PIC stock bonds notes
How can we use the statement of cash flow to assess earnings quality?
NI - Operating Cash Flow
EPS =
NI/Outstanding Shares
Income statement
Net Sales -COGS = Gross Profit -OP exp -Selling exp -Admin exp -Depreciation exp = OP INCOME (EBIT) other revenues and gains interest income gain on sale of asset other expenses and losses interest expense loss on sale of investments EBT -income taxes (tax liability) NI (EAT) preferred Div NI Earnings per share
Gross Profit
Net sales - COGS
which of the following activities may an executive do to boost net income?
Not recording impaired values to asset
Premium vs Discount Your company has issued 30, 10-year bonds at 8%. The current market rate is 5% Are these bonds trading at a premium or discount
Premium the stated rate is higher than the market rate. Cash xxx ---premium ob bonds xxx ---bonds payable xxx
suppose trader joes must raise $350,000 to operate. It is deciding whether to issue the total amount through stock, or raise $150,000 through debt at 9% interest and the remaining $200,000 through stock. The copays income (before interest expense) will be $115,000. By what percentage does ROE increase if the debt motion is used.
ROE = NI/Equity Option 1: Equity: 350,000 is all equity so NI will be unaffected bc theres no int exp ROE = 115,000/350,000 = 33% option 2: debt & equity: int exp: 150,000 (.09) = 13,500 NI = 115,000 - 13,500 = 101,500 ROE = 101,500/200,000 = 51% 33 to 51 is an 18% increase 18%
A firm issues long-term debt with an effective interest rate of 10%, and the proceeds of this debt issue can be invested to earn an ROI of 12%. What effect will this financial leverage have on the firm's ROE relative to having the same amount of funds invested by the owners/stockholders?
ROE will be higher using debt ROE = Net Income / Equity as the question states, if return on investment increases with the use of the loan that means Net Income is increasing. Higher numerator in ROE = higher ROE
A company wishes to reach a 35% gross margin on all sales. If the cost of each goos is $13, determine the selling price it should set.
Selling Price = Cost per unit / 1-gross margin = $13/1-0.35 = $20
Deferred Tax Liability
The difference between tax expense and tax payable is referred to as deferred taxes. financial statement income tax expense - IRS income tax payable
Financial Leverage
The use of debt or fixed costs to maximize returns. The difference between ROI and ROE. Can also be defined as a company use of fixed costs or debt. Additionally, a firm receives ax deduction on the interest it pays ob debt.
From the perspective of the financial statements, if they are taking more depreciation on the return this year than on the financials, what will happen in the future?
They will take less depreciation in the future. Therefore in the future they will have less deductions and therefore higher taxable income and higher tax liability.
Depreciation expense had been 8,000 a year for the last 5 years, now this year it is only 5,000. Would income go up or down relative to prior years?
Up.
Par Value
an arbitrary amount selected by the company at its creation. It has no relation to the market value of stock. Some companied may set their par value as $1 or $0.01
Interest Rates are always quoted ______
annually *determines annual coupon payment... if it said semi annually it'd be $50 every 6 months
Bond Issued at a Discount Cash xxx Discount xxx ----B/P xxx During the life of the bound the discount will be amortized...
at each coupon payment they will pay some cash, amortize (reduce) the discount) and then they will have debited interest expense. Interest expense will be higher than coupon payment (coupon payment + amortization) int exp xxx ----discount xxx ----cash xxx
Bonds
borrowing money "debt"
bond issued at par entry
cash xxx ----b/p xxx
bond issued at premium entry:
cash xxx ----premium xxx ----n/p xxxx
bond indenture
contract containing terms of bonds. key features (4): *1. FACE VALUE*: amount bond holders receive at the end of a bond. Face value is paid to bond holders at maturity date. ($1,000 FV is the standard, on exam this may not be specified it should be known.) *2. MATURITY DATE*: the length of the bond, time left to maturity. *3. COUPON RATE (STATED RATE)*: to determine coupon payment. **Coupon rate (int) x face = coupon payment** *4. COUPON PAYMENT*: periodic payments on a long term bond (annually, semi annually, quarterly)
If market rate is higher than coupon rate, then bonds are issued at a ....
discount because the rate is higher, the price is lower. They will collect less cash than the face amount.
Investing Cash Flows
fixed asset & intangible assets
If the bond is issued at a discount then interest expense is _______ than coupon payment
higher
Issuance of Bonds Payable at a Discount or Premium
if stated rate is above market rate = premium *yield to maturity (market rate) will be lower equal to market rare = face (par) *market rate = coupon rate if stated rate is below market rate = discount *market rate will be higher than coupon rate
Common Stock vs Preferred Stock
in contrast to common stock, preferred stockholders have priority when it comes to company dividends and liquidations but usually do not have voting rights. Because of this priority, preferred stock is considered less risky then common stock (but still riskier than bonds). Additionally, preferred stock may have the following characteristics: CONVERIBLE: share can be exchanged for a set amount of common stock CALLABLE: the company can repurchase its preferred stock CUMULATIVE: shares receive priority for future dividends
If were approaching earnings quality to see if earning will be good in the future we will be more concerned with..
income increasing accruals. If accruals are increasing this year, next year income will go down.
in the operating section of the statement of cash flow, the accruals for purposes of assessing earning quality are going to fall into 2 categories, those that...
increase income decrease income.
If depreciation expense goes down....
it is an income increasing accrual.
If a bond is issued at a premium then interest expense will be _______ than the coupon payment
lower
If the price of bonds go up....
market rates go down
The point of the tax return is to...
raise money for the government.
The financial statements are prepared under GAAP and the point is to...
report underlying economic reality **FINAL EXAM QUESTION
Common Stock...
represents a claim to the company assets. Although it is often the case that common stockholders have voting rights within the company, this is not a requirement for common stock. The common stock account equals the number of issued shares x the par value of stock CS=Issued share x Par Value
Authorized Stock
sometimes seen listed on the balance sheet, it is the total number of share the company is ALLOWED to issue. This amount is determined when the company is created. Note that authorized stock has nothing to do with the actual amount of shares issued.
Treasury Stock
stock that has been repurchased by the company Treasury Stock = Shares issued - share outstanding bc TS subtracts from total equity it is a contra equity account
Retained Earnings
the amount of earning the company has retained since its inception RE=Beg RE + NI - Div
You have exchanged your favorite pair of shoes for a textbook. You bought the shows of $55 and the textbook is worth $40 in the day of the exchange. How much revenue will be recorded?
the amount of revenue is the fair market value of what you receive $40
Additional Paid-in capital
the difference between what the shareholders paid for the stock and the par value. The APIC and common stock balances sum to the total amount shareholders paid for the stock, the total paid in capital total paid-in capital = CS + APIC
the more debt a company has...
the more risky the business
COGS
the total cost of the merchandise that was sold to the customer beginning inventory + purchases =COGAFS -Ending Inventory =COGS COGS includes the cost of merchandise from the supplier plus any additional costs necessary to get the merchandise into inventory and ready for sale
if price goes down...
yield to maturity (market rate) is going up
Atom Endeavour Co. issued $35 million face amount of 6.4% bonds when market interest rates were 7.14% for bonds of similar risk and other characteristics. a. How much interest will be paid annually on these bonds? b. Were the bonds issued at a premium or discount? c. Will the annual interest expense on these bonds be more than, equal to, or less than the amount of interest paid each year?
A) Annual Interest Payment = $2,240,000 (35,000,000 x .064 = 2,240,000) *face rate has nothing to do with market rate B) Discount if stated rate is below market rate = discount *market rate will be higher than coupon rate C) Interest expense will be more than the interest paid. (If the bond is issued at discount, interest expense will be higher than the discount payment.)
Alexi Co. issued $3.70 million face amount of 5%, 10-year bonds on June 1, 2016. The bonds pay interest on an annual basis on May 31 each years A) Assume that the market interest rates were slightly higher than 5% when the bonds were sold. Would the proceeds from the bond issue have been more than, less than, or equal to the face amount? B) Independent of your answer to part a, assume that the proceeds were $3,335,000. Use the horizontal model to show the effect of issuing the bonds.
A) The bonds will sell for less than their face amount. (above market rate = premium *yield to maturity (market rate) will be lower) B) Cash 3,335,000 ---Discount on bonds payable 365,000 ---Bonds payable (3,700,000) *discount is the difference
Bonds Payable example: On july 1st of the current year, $5 million face amount of 8%, 20-year bonds were issued. The bonds pay interest on an annual basis on june 30th each year. The market interest rates were slightly lower than 8% when the bonds were sold. A) How much interest will be paid annually on theses bonds? B) Were the bonds issued at a premium or discount? C) Will the annual interest expense for these bonds be more than , equal to, or less than the amount of interest paid each year?
A) annual interest payment = par value (face amount) x stated interest rate (coupon rate) $5,000,000(.08)=$4,000,000 B) The bonds were issued at a premium because market interest rates were less than the stated rate when the bonds were issued. The lower the discount rate (the market interest rate), then higher the present value of cash flows for interest payments and principal (the higher the bonds selling price) C) Interest expense will be less than interest paid because the amortization of bond premium will decrease interest expense. The premium on bonds payable is initially shown as a credit and adds to the bonds payable liability on the balance sheet. When premium is amortized each interest payment date, the premium account is debited and thus the debit to interest expense and premium on bonds payable must be equal to the credit representing the cash interest payment. In this case int exp would be debited for an amount smaller than the credit for cash for 400,000 because the premium on bonds payable is also debited.
Equity Section Common stock 700,000 APIC 1,400,000 Retained Earnings 900,000 (treasury stock) (500,000) Total equity 2,500,000 after the payment of dividends what are the profits that have remained in the business since inception? assuming 100,000 of common stock have been issued, what is the total investors paid per share?
700,000+1,400,000 = 2,100,000 2,100,000/100,000=21 per share assuming the par value is $2 how many shares of common stock have been issued? issued x par = CS ....... x 2 = 700,000 issued = 350,000