wk 3 - Measuring Earnings 2011s2

wk 3 - Measuring Earnings 2011s2 - FINS3641 SECURITY...

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Prepared by Henry Yip 1 FINS3641 SECURITY ANALYSIS AND VALUATION PART 2 - DISCOUNT CASH FLOW VALUATION MODELS Week 3: Measuring Earnings and Estimating Free Cash Flows Topics: Free Cash Flows to Equity (FCFE) and Free Cash Flows to the Firm (FCFF) Learning Outcomes: Learn the techniques to translate accounting earnings into free cash flows for the DCF valuation models Resources: Financial Information on companies listed on the ASX from Aspect Huntley http://www.library.unsw.edu.au/ > Login > Sirius > Find Resources > Finanalysis Reading: Damodaran Chapters 9-10
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FINS3641 SAV Week 3: Estimating Cash Flows 2 A Brief Overview of a Typical Income Statement – Damodaran Figure 3.2, p27 Revenue - Operating Expenses = Operating Income (commonly known as EBIT; accounting earnings “ to the firm ” = After-tax OI = EBIT×(1–t)) - Financial Expenses - Taxes = Net Income before Extraordinary Items -(+) Extraordinary Losses (Profits) - Income changes Associated with Accounting Changes - Preferred Dividends = Net Income (or EAIT, which is accounting earnings to the common stockholders) Both operating income and net income are described as accounting earnings. We need to: i) convert these accounting earnings into free cash flows to the firm and to the stockholders ii) estimate the growth rate in these earnings to project future cash flows.
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FINS3641 SAV Week 3: Estimating Cash Flows 3 A. From EBIT to Cash Flow to the Firm, then to Cash Flow to Equity 1. How to Get the Latest Set of Accounting Figures? i) Get the trailing 12-month financial data by adding the figures from either the last two half-yearly reports or the last 4 quarterly reports. http://www.asxgroup.com.au/asx-listing-rules-guidance-notes-and-waivers.htm http://www.library.unsw.edu.au/ > Login > Sirius > Find Resources > Finanalysis company web pages ii) Watch out the news wire (e.g., Bloomberg) or monitor the reports filed to the ASX due to the continuous disclosure listing requirement.
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Week 3: Estimating Cash Flows 4 2. Uncover Inappropriate Accounting Classifications of Operating Expenses i) Operating leases expenses treated by accountants as operating expenses, hence deducted from revenue instead of operating income from the accounting point of view are indeed financial expenses, i.e., expenses that are tax deductible and must be paid irrespective of operating results to avoid loss of control over business should appear on the balance sheet as a lease asset & a lease liability , and be deducted as a financial expense from the valuation point of view ii) R&D expenses treated by accountants as operating expenses and deducted from revenue are indeed capital expenditures, i.e., expenses that are expected to generate benefits over multiple periods, should first be capitalised into an asset before applying the depreciation schedule to spread out the expenses rather than being deducted from revenue as a lump sum in a single year from the valuation point of view
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This note was uploaded on 03/01/2012 for the course FINS 3641 taught by Professor Hyip during the Three '11 term at University of New South Wales.

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wk 3 - Measuring Earnings 2011s2 - FINS3641 SECURITY...

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