Outlineoftoday’slectureValueofafirmtoinvestorsandcreditorsAnalysisofprofitability:ROAAnalysisofprofitability:ROCEAnalysisofprofitability:EPSThevalueofafirmtoequityinvestorsV=D1/(1+r)+D2/(1+r)2+D3/(1+r)3…….profitabilityriskThevalueofafirmtocreditorsV=I1/(1+r)+I2/(1+r)2+I3/(1+r)3+P/(1+r)3

Ii:interestrevenuesinperiodiP:returnofprincipalprofitabilityriskFinancialStatementAnalysis1.Understandtherelationbetweentheexpectedreturnandriskofinvestmentalternatives,andtheroleofanalysisinprovidingriskandreturninformation.2.Understandtheusefulnessoftherateofreturnonassets(ROA)asameasureofafirm’soperatingprofitability.3.Understandtheusefulnessoftherateofreturnoncommonshareholders’equity(ROCE)asameasureofprofitability.4.Understandthestrengthsandweaknessesofearningspercommonshareasameasureofprofitability.Whattocompare?1. Theplannedratiofortheperiod2. Thecorrespondingratiofromapriorperiod(time-seriesanalysis)3. Thecorrespondingratioforanotherfirminthesameindustry(cross-sectionanalysis)4. Theaverageratioforotherfirmsinthesameindustry(cross-sectionanalysis)AnalysisofProfitabilityReturnonassets(ROA):returntothefirmasawholeReturnoncommonequity(ROCE):returntocommonshareholdersonlyEarningspercommonshareAnalysisofProfitabilityROA:returntothefirmROCE:returntocommonShareholdersonlyReturnonAssets(ROA)ROApresentsprofitabilityindependentofthesourceoffinancingDoesnotconsiderleverageMeasureofhowwellthefirmusesitsassetstogenerateincomeAsifthefirmisfinancedbyequityaloneHorriganCorporationYear4SalesRevenue$475Lessexpense:

COGS280Selling53Administrative22Depreciation18Interest16Total

389Nextincomebeforetax

86Incometaxexpense26NextIncome

60HorriganCorporation-assumingnodebtsYear4SalesRevenue$475Lessexpense:

COGS280Selling53Administrative22Depreciation18Interest16-16Total389-16=373Nextincomebeforetax86+16=102LessIncometaxexpense26+4.8=30.8NextIncome

60+16–4.8=71.2HorriganCorporationROAAveragetotalassetsofthiscompanyinyear4(520+650)/2=585,ThenROA=71.2/585=12.2%Whyaddbackinterestincomenetofincometaxsavingsinthenumerator?1)Ifallequity,thefirmwon’tpay$16interestexpense,whichincreasenetincomeby$16;2)at30%taxrate,governmentwillcollectanadditionalamountof$4.8(16*30%)astax,thentheactualincreaseofnetincomeis(16––4.8).DisaggregatingROAROA=ProfitMarginratio*AssetturnoverratioATOmeasuresthefirm’sAbilitytogeneratesalesAtagivenlevelofInvestmentinassetsPMmeasurestheFirm’’sabilitytoControlcostandExpensesatagivenLevelofsalesActivity.HowtoincreaseROA?Atthecurrentassetbase,increasesales?ButincreasedsalesincreasesATOwhiledecreasesPMAdilemma!Soonehastoincreasesalesandatthesametimeholddowncostsandexpenses,i.e.,holdPMatcertainlevel.HowtoincreaseROA?-2TheevolutionofROAintheU.S.thegraphsinthenextfewslidesarefromPenmanandNissimReviewofAccountingStudies,2001RNOA:ReturnonnetoperatingassetsRegressiontothemean（回歸到平平均值）ProfitmarginAssetturnoverRevenuegrowthDisaggregatePMPM=(sales––COGS–SGA––depreciation…….)/SalesCOGS-to-SalesratioSelling,Generalandadministrative(SGA)expense-to-salesratioEtc.Byobservingthetimeseriesandcross-sectionofeachexpense-to-salesration,onecanidentifyabnormalratiosandinvestigatethereasons,inordertocontrolcostsandexpensestoincreasePMDisaggregateATOATO=Sales/averagetotalassetsAveragetotalassets=(averageaccountreceivables+averageinventory+averagefixedassets+averageotherassets)AccountsreceivableturnoverMeasureshowquicklyafirmcollectscash.IfA.R.turnovertwiceayear,thentheyaverageonehalfofayearincollection.Lesstimeispreferredtomore.Ahighturnoverispreferredtoalowone.Thedaysofoutstandingforaccountreceivables:365days/accountsreceivableturnoverInventoryturnoverIndicateshowfastfirmssellmerchandise.Ifinventoryturnovertwiceayear,thentheyaverageonehalfofayearininventory.Holdinginventoryiscostlybecausethefundsinvestedininventorycouldbeusedelsewhere.Ahighturnoverispreferredtoalowone.Dayofinventoryinwarehouse:365/InventoryturnoverFixedassetturnoverMeasurestherelationbetweeninvestmentinlong-termorfixedassets(suchasproperty,plant,equipment)andsales.Efficientuseoffixedassetswouldbeassociatedwithhighsales.Iffixedassetsturnovereveryfouryears,theneachdollarinvestedinfixedassetsisgeneratingaquarterofadollarinsalesperyear.Ahighturnoverispreferredtoalowone.ReturnonCommonEquity(ROCE)Thenumeratormeasuresreturnasnetincomereducedbyanypaymentstopreferredshareholdersasthesedividendsarenotavailabletothecommonshareholderandhavenotbeendeductedfromnetincome.ThedenominatoristheaverageamountcontributedbycommonshareholderswhichincludesCommonstockatpar,Additionalpaidincapital,andRetainedearnings.RelationbetweenROAandROCEROCEistheresidualreturnwhichgoestothecommonshareholders.Sinceitmaybelowinpooryearsbuthighingoodyears,ithasarisk,thatis,theresidualreturnisnotknown.Debtischaracterizedbyadefinitescheduleofpayments,sothereislittlerisktothedebtholders.Preferredstockislikedebt,thedividendsarespecified.However,debtorsmustbepaidbeforepreferredshareholdersandifthemoneyrunsout,thentheyaren'tpaid.RelationbetweenROAandROCEROAcanbedividedintoReturntocreditorsordebtorsReturntopreferredshareholders,andReturntocommonshareholders(ROCE)Becausethereturntodebtorsandpreferredshareholdersarefixed,ingoodyearswhenthefirmhashighreturns,thereisalotofprofitleftoverforthecommonshareholders;inpooryearswhenreturnsarelow,thereislittleormaybenoprofitleftover.RelationbetweenROAandROCEThus,ifROCEandROAwerebothlinear,thenROCEwouldhaveagreaterslopethanROA,thatis,itismorehighlylevered.Aprudentfirmwillborrowfundsonlywhenthereturnonthosemarginalfundsexceedthecostofborrowinggivinganetpositivereturntothecommonshareholder.ROCEcanbedisaggregatedintothreerelatedratios1.Profitmarginratio2.Totalassetsturnover3.LeverageratioRelationbetweenROAandROCEThefirsttwohavebeenpreviouslydefined.Leverageratioindicatestherelativeproportionofcapitalprovidedbycommonshareholdersasdistinctfromthatprovidedbycreditors(debtors)orpreferredshareholders.RelationbetweenROAandROCEAhighleverageratiomeansthatthefirmhasalotofassetsatitscommand,butthattheshareholdershavelessoftheirowninvestmentsatrisk.Thisisgoodingoodyearsbecausethecommonshareholderscaptureallprofitsoverwhatisneededtoservicethedebt.Thisisbadinpooryearsbecausethedebthastobeservicedwhetherornotthecommonshareholdersmakeaprofit.Therefore,borrowingisonlybeneficialwhenROAisgreaterthanthecosttoborrowmoneyTheevolutionofROCEandnetborrowingcost(NBC)intheU.S.Debit-to-Equityratio(leverage)intheU.S.EarningsperShare(EPS)ofCommonStockThisratioistheprofitthatgoestoeachshareofcommonstock.Itwouldbesimplythenet