ACCT820 Chapter 5[1]

ACCT820 Chapter 5[1] - Equity investors make investment...

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Unformatted text preview: Equity investors make investment decisions based on the expected return from equity investments relative to the risks of realizing those returns Similarly, lenders make lending decisions based on the expected return in the form of interest revenue relative to the risks of the borrower defaulting on repayments The analysis of risk is central to any decision to commit economic resources to a project or an investment Disclosures Regarding Risk Management The sources & types of risk a firm faces are numerous & often interrelated; they include the following: o Firm Specific Risks : ability to attract, retain, & motivate employees; dependence on one or few customers; dependence on one or few suppliers; employee relations; litigation; environmental or political scrutiny o Industry Risks : technology; competition; regulation; availability & price of RM or other production inputs; labor wages & supply o Domestic Risks : recessions; inflation or deflation; interest rate volatility; demographic shifts; political environment o International : exchange rate changes; host govt regulations & posturing; political unrest or asset expropriation Most of these risks are inevitable, & firms most continually monitor each to ensure that appropriate actions are taken to minimize the impact of detrimental events or changes in circumstances The focus in this chapter, however, is on how to assess the financial consequences of these types of risks using disclosures & data from financial reports o Various Financial reporting standards & financial market regulations require firms to discuss in notes to the financial statements or in regulatory filings how important elements of risk affect a particular firm & the actions the firm takes to manage these risks F IRM-S PECIFIC R ISKS All companies are subject to numerous firm-specific risks that are driven by the nature of the business, competition, supplier relationships, customers, & overall firm strategy o For forms 10-K filed w/the SEC, a candid discussion of such risks is required as Item 1A o For non-US companies that list securities in the US, a required Form 20-F includes Item 3D. Risk Factors o Capital market regulators generally require companies around the world to file similar reports in their local jurisdictions The identification & discussion of firm-specific risks provides a useful bridge b/w understanding a companys industry, business strategy, & profitability & identifying specific risks that may have an impact on the ability to grow, be profitable, & ultimately create value for debt & equity stakeholders Of the firm-specific risks identified, some are quantifiable & subject to required disclosures in the footnotes to financial statements C OMMODITY P RICES Firms purchase RM to use in manufacturing products; changes in the prices of those RM affect future profitability unless the firm can pass along price increases to customers, engaged in fixed-price contractual arrangements w/suppliers, or purchase commodity futures...
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ACCT820 Chapter 5[1] - Equity investors make investment...

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