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FIMA-3033 Financial-Analysis-and-Reporting

Financial Accounting and Reporting 2 (Polytechnic University of the Philippines)

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management

INSTRUCTIONAL MATERIALS FOR

FIMA 3033
FINANCIAL ANALYSIS AND REPORTING

Compiled by:

MICHAEL BRYAN G. DE CASTRO

MARIA IMELDA S. UNTAL-DE CASTRO

THE COUNTRY’S 1st POLYTECHNICU

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Republic of the Philippines

POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
Compiled by:
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management MICHAEL BRYAN DE CASTRO
MARIA IMELDA UNTAL-DE CASTRO

TABLE OF CONTENTS
I. Introduction to the course contents, activities, and requirements……………………………………..3
II. Course Syllabus…………………………………………………………………………………………4-14
III. Integration of Accounting Concepts. Review of the different financial statements nature and
significance……………………………….…………………………………………………………….15-27
IV. Analysis of Past and Present Performance……………………………………………..…….……28-31
V. Financial Analysis…………………………………………………………………………………...........32
VI. Break Even Point Analysis……………………………………………………………………….………42
VII. Forecasting Techniques……...………………………………………………………………….……….43
VIII. Computing project NPV………………………………………………………………………….……….52
IX. Financing Operations and Expansion………………………………………………………….……53-62
X. Review and Understanding of Financial Markets………………………………………………..…63-65
XI. Business Valuation and Corporate Restructuring…………………………………………….……66-68
XII. Asset Valuation Models for Mergers and Acquisitions……………………………………….……….69
XIII. Bond Yield plus Risk Premium……………………………………………………………………….….73
XIV. Capital Raising for Corporations………………………………………………………………….……..74
XV. Debt Financing vs Equity Financing……………………………………………………….……………78
XVI. Capital Structure – stock valuation.………………………………………………………….………….79
XVII. Capital Structure – bond valuation………………………………………………………………….…...82
XVIII. Activities from Week 1 to Week 17………………………………………………………………...85-103
XIX. MIDTERM EXAM………………………………………………………………………………………...104
XX. FINAL EXAM…………………………………………………………………...……………………105-112
XXI. References……………………………………………………………………………...………………...113

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
Compiled by:
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management MICHAEL BRYAN DE CASTRO
MARIA IMELDA UNTAL-DE CASTRO

INTRODUCTION
This course revolves around analyzing and coming up with solutions to common financial problems. The emphasis is on common finance reporting
tools, financial statement analysis also known as Fundamental Analysis and interpretation of financial disclosures, including qualitative information, to
help improve risk assessment, forecasting and decision making. The methods of fundamental analysis will be examined in detail and applied in cases.
Topics include models of shareholder value, methods of financial statement analysis, testing the quality of financial reports, forecasting earnings and
cash flows and pro forma analysis for strategy and planning. At the end of this course, it is expected that the student will be able to conduct financial
analysis and reporting with understanding on the micro and macroeconomic performance of a firm.
COURSE OUTCOME
Graduates of this Program should be able to (based on existing CMO 17, s. 2017) perform the basic functions of management, apply the basic
concepts that underlie each of the functional areas of business and employ these concepts in various business situations, analyze the business
environment for strategic direction, plan and implement business related activities, select the proper decision making tools to critically, analytically and
creatively solve problems and drive results, manage a strategic business unit for economic sustainability, express oneself clearly and communicate
effectively with stakeholders both in oral and written forms, demonstrate corporate citizenship and social responsibility, apply information and
communication technology skills as required by the business environment, generate new knowledge using research and development projects, innovate
business ideas based on emerging industry, work effectively with other stakeholders and manage conflict in the workplace, exercise high personal moral
and ethical standards and acquire the competencies to support national, regional and local development plans

LEARNING OUTCOME
At the end of the course, the learner should be able to discuss the basic concepts and principles of credit risk management, analyze the risks
associated with the company’s credit policy, discuss the internal credit environment of a lender, analyze the risks associated with the company’s credit
policy, discuss the internal credit environment of a lender, evaluate the credit and collection management process in a firm, analyze business and
consumer credit profiles to determine credit risk, evaluate factors that affect the decision in credit and collection operation, formulate control measures
in credit and collection management activities and discuss social responsibility and ethics as related to credit and collections.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
Compiled by:
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management MICHAEL BRYAN DE CASTRO
MARIA IMELDA UNTAL-DE CASTRO

COURSE SYLLABUS
COURSE TITLE FINANCIAL ANALYSIS AND REPORTING

COURSE CODE FIMA 30033

CREDIT UNITS 3 units

COURSE FIMA 30013 – Financial Management

PREREQUISITE

COURSE This course deals with solving common financial problems. The emphasis is on financial statement analysis and
DESCRIPTION interpretation of financial disclosures, including qualitative information, to help improve risk assessment, forecasting and
decision making. The methods of fundamental analysis will be examined in detail and applied in cases. Topics include
models of shareholder value, methods of financial statement analysis, testing the quality of financial reports, forecasting
earnings and cash flows and pro forma analysis for strategy and planning.

Institutional Learning Outcomes Program Outcomes Course Outcomes

Graduates of this Program should be able to At the end of the course, the learner should
1. Creative and Critical Thinking (based on existing CMO 17, s. 2017): be able to:
Graduates use their imaginative as well as a
rational thinking abilities to life situations in order  Perform the basic functions of management  Discuss the basic concepts and principles
push boundaries, realize possibilities, and of credit risk management
deepen their interdisciplinary and general  Apply the basic concepts that underlie each of
understanding of the world. the functional areas of business and employ  Analyze the risks associated with the
these concepts in various business situations company’s credit policy
2. Effective Communication  Analyze the business environment for strategic  Discuss the internal credit environment of
Graduates are proficient in the four macro skills direction
in communication (reading, writing, listening, and a lender
speaking) and are able to use these skills in

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
Compiled by:
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management MICHAEL BRYAN DE CASTRO
MARIA IMELDA UNTAL-DE CASTRO

solving problems. Making decisions, and  Evaluate the credit and collection
articulating thoughts when engaging with people  Plan and implement business related activities management process in a firm
in various circumstances.
 Select the proper decision making tools to  Analyze business and consumer credit
critically, analytically and creatively solve profiles to determine credit risk
3. Strong Service Orientation
problems and drive results
Graduates exemplify the potentialities of an
 Evaluate factors that affect the decision in
efficient, well-rounded and responsible  Manage a strategic business unit for economic credit and collection operation
professional deeply committed to service sustainability
excellence.  Formulate control measures in credit and
 Express oneself clearly and communicate collection management activities
4. Community Engagement effectively with stakeholders both in oral and
Graduates take an active role in the promotion written forms  Discuss social responsibility and ethics as
and fulfillment of various advocacies related to credit and collections
(educational, social and environmental) for the  Demonstrate corporate citizenship and social
responsibility
advancement of community welfare.
 Apply information and communication
5. Adeptness in the Responsible Use of technology skills as required by the business
Technology environment
Graduates demonstrate optimized use of digital
learning abilities, including technical and  Generate new knowledge using research and
numerical skills. development projects

6. Passion to Lifelong Learning  Innovate business ideas based on emerging

Graduates are enabled to perform and function industry
in the society by taking responsibility in their
 Work effectively with other stakeholders and
quest to know more about the world through
manage conflict in the workplace
lifelong learning.
 Exercise high personal moral and ethical
7. High Level of Leadership and standards
Organizational Skills

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Republic of the Philippines

POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
Compiled by:
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management MICHAEL BRYAN DE CASTRO
MARIA IMELDA UNTAL-DE CASTRO

Graduates are developed to become the best  Acquire the competencies to support national,
professionals in their respective disciplines by regional and local development plans
manifesting the appropriate skills and
leaderships qualities.

8. Sense of Personal and Professional

Ethics
Graduates show desirable attitudes and
behavior either in their personal and professional
circumstances.

9. Sense of National and Global

Responsiveness
Graduates’ deep sense of national compliments
the need to live in a global village where one’s
culture and other people culture are respected.

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Republic of the Philippines

POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
Compiled by:
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management MICHAEL BRYAN DE CASTRO
MARIA IMELDA UNTAL-DE CASTRO

COURSE PLAN
Week Topic Learning Outcomes Methodology Resources Assessment

Orientation
Introduction to the course Demonstrate interest and
Week 1 contents, activities, and appreciation of the importance of
Review of the Course Syllabus None
requirements. knowing the course.
syllabus, learning
activities and
assessment
O’Regan, P.
2016.Financial
Integration of Accounting Information Analysis:
The Role of
Concepts
Accounting
Information in
Review of the different
Modern Society 3rd
financial statements
Recognize the importance of edition Assignment
nature and significance Lecture
accurate financial statements
Week 2
Routledge, Taylor & Presentation of output in
 Income Statement Assignments
Identify various sources of Francis Group group dynamics
 Balance Sheet financial information
 Cash Flow Group dynamics
Schroeder, R. 2011. Written examination
Statement Financial Accounting
Theory and Analysis:

Text And Cases

10th Edition

Week 3 Analysis of Past and Problem solving Gibson, C. Assignment

Differentiate the types of financial
Present Performance 2013.Financial
analysis techniques
Seatwork/ Board Statement Analysis, Presentation of output in
 Vertical Analysis work Gibson, Charles H., group dynamics

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
Compiled by:
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management MICHAEL BRYAN DE CASTRO
MARIA IMELDA UNTAL-DE CASTRO

 Horizontal Analysis Identify the proper situations to 13th edition. South-

 Trend Analysis use specific analysis techniques Group dynamics Western Written examination

Prepare sample financial Assignment Gibson,C. 2009.

analyses for existing companies Financial Reporting
& Analysis : Using
Financial Accounting
Information.Cengage
Learning

O’Regan, P.
2016.Financial
Information Analysis:
The Role of
Accounting
Information in
Modern Society 3rd
edition
Routledge, Taylor &
Francis Group

Higgins, R. 2016.
Analysis for
Financial
Management 11th
ed.
McGraw-Hill

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
Compiled by:
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management MICHAEL BRYAN DE CASTRO
MARIA IMELDA UNTAL-DE CASTRO

Gibson, C.
2013.Financial
Statement Analysis,
Financial Analysis Gibson, Charles H.,
13th edition. South-
 Liquidity Ratios Western
 Solvency and
Capital Structure O’Regan, P.
ratios 2016.Financial
Information Analysis:
 Asset Utilization The Role of
and Efficiency Accounting Information
Ratios Lecture/discussion in Modern Society 3rd
 Profitability Ratios Differentiate the types of financial edition
Week 4 –  Measures of analysis techniques Seatwork/ Routledge, Taylor & Assignment
5 Returns board work Francis Group
 Cost Volume Profit Identify the proper situations to Presentation of output in
Analysis use specific analysis techniques Problem solving Higgins, R. 2014. group dynamics
 Financial Leverage Analysis for
 Break-even Point Prepare sample financial Group dynamics Financial Written examination
Analysis analyses for existing companies Management ,11th
 Variance Analysis Assignment edition. McGraw-HIll

Gitman, L.J. 2015.

Principles of
Managerial Finance
14th edition. Pearson
Education

Brigham,E. 2014
Fundamentals of
Financial Management
13th edition. Cengage
Learning

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Republic of the Philippines

POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
Compiled by:
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management MICHAEL BRYAN DE CASTRO
MARIA IMELDA UNTAL-DE CASTRO

Forecasting Techniques
Recognize the importance of
 Strategic Planning developing proper assumptions Silvia, J. 2014.
Lecture/discussion
and the Budget for forecasting financial Economic and Assignment
Week 6 –  Economic and statements Business
Seatwork/board
7 Industry Evaluation Forecasting: Presentation of output in
work
 Cash Flow Differentiate the types of financial Analyzing and group dynamics
Forecasting Interpreting
forecasting Problem solving
 Statistical Econometric Written examination
Prepare forecasted financial Results, John Wiley
Forecasting statements Group dynamics & Sons
 Pro-Forma
Forecasting

O’Regan, P.
Financing Operations and 2016.Financial
Expansion Information Analysis: The
Role of Accounting
Information in Modern
 Concept of Risk Explain the basics of financial Society 3rd edition
 Asset and Liability risk management Lecture/discussion
Management Routledge, Taylor &
Week 8 Francis Group Assignment
 Cost of Capital Use cost of capital computations Seatwork/board
Gitman, L.J. 2015. Presentation of output in
in valuation models work Principles of Managerial group dynamics
Finance
Analyze the performance of Problem solving 14th edition. Pearson
Education Written examination
financial institutions using
financial risk analysis tools Group dynamics
Brigham,E. 2014
Fundamentals of
Financial Management
13th edition. Cengage
Learning

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
Compiled by:
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management MICHAEL BRYAN DE CASTRO
MARIA IMELDA UNTAL-DE CASTRO

Week 9 MIDTERM EXAMINATION

Gitman, L.J. 2015.

Principles of Managerial
Differentiate the types of financial Finance
markets 14th edition. Pearson
Review and Lecture/discussion
Education
Understanding of
Explain capital adequacy
Financial Markets Seatwork/board Brigham,E. 2014
Fundamentals of Assignment Presentation
Recognize the importance of work
Week 10  Capital Market Financial Management of output in group
maintaining reserves and proper 13th edition. Cengage
 Money Market liquidity management Learning
dynamics
 Bond Market Problem solving
Written examination
 Foreign Exchange Explain domestic financial Penman, S. 2013.
Market Group dynamics Financial Statement
markets and institutions and how Analysis and Security
firms obtain funds in the financial Valuation. Mc Graw-Hill
markets and at what cost.
Penman, S. 2013.
Financial Statement
Analysis and Security
Valuation. Mc Graw-Hill
Lecture/discussion
Gitman, L.J. 2015.
Apply basic valuation concepts
Seatwork/board Principles of Managerial Assignment
Business Valuation Finance
Describe what determines the work
14th edition. Pearson Presentation of output in
Corporate Restructuring value of a firm’s securities and
Week 11 Education group dynamics
how management can influence Problem solving
these values. Brigham,E. 2014 Written examination
Group dynamics Fundamentals of
Financial Management
13th edition. Cengage
Learning

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
Compiled by:
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management MICHAEL BRYAN DE CASTRO
MARIA IMELDA UNTAL-DE CASTRO

Higgins, R. 2014.
Analysis for Financial
Asset Valuation Models Management ,11th
for Mergers and edition. McGraw-HIll
Lecture/discussion
Acquisitions
Gitman, L.J. 2015.
Seatwork/board Principles of Assignment
 Capital Asset Recognize the rationale for work Managerial Finance
Pricing Model mergers and acquisitions
Week 12- 14th edition. Pearson Presentation of output in
 Dividend Discount Problem solving
13 Education group dynamics
Model Apply the different valuation
 Gordon Growth models Group dynamics Brigham,E. 2014 Written examination
Model
 Bond Yield plus Fundamentals of
Risk Premium Financial Management
13th edition. Cengage
Learning

Higgins, R. 2014.
Week 14- Capital Raising for Identify the pros and cons of Lecture/discussion Analysis for Financial Assignment
15 Corporations equity and debt financing Management ,11th
Seatwork/board edition. McGraw-HIll Presentation of output in
 Debt Financing Discern the best capital structure work group dynamics
Gitman, L.J. 2015.
 Equity Financing for the firm.
Principles of
Problem solving Written examination
Managerial Finance
Group dynamics 14th edition. Pearson
Education

Brigham,E. 2014
Fundamentals of
Financial Management
13th edition. Cengage
Learning

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Republic of the Philippines

POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
Compiled by:
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management MICHAEL BRYAN DE CASTRO
MARIA IMELDA UNTAL-DE CASTRO

Penman, S. 2013.
Financial Statement
Analysis and
Security Valuation.
Mc Graw-Hill

Bruner, R. 2014.
Case Studies in
Finance: Managing
for Corporate Value
Creation. 7TH edition
McGraw-Hill
Lecture/discussion
Gitman, L.J. 2015.
Assignment
Capital Structure Seatwork/board Principles of
Presentation of output in
Apply valuation techniques to work Managerial Finance
group dynamics
Week 16  Stock Valuation stocks 14th edition. Pearson
Written examination
Problem solving Education

Group dynamics Brigham,E. 2014

Fundamentals of
Financial
Management
13th edition.
Cengage Learning

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
Compiled by:
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management MICHAEL BRYAN DE CASTRO
MARIA IMELDA UNTAL-DE CASTRO

Penman, S. 2013.
Financial Statement
Analysis and
Security Valuation.
Mc Graw-Hill

Gitman, L.J. 2015.

Capital Structure Lecture/discussion Principles of
Assignment
Managerial Finance
 Bond Valuation Seatwork/board 14th edition. Pearson Presentation of output in
Apply valuation techniques to work Education
Week 17 group dynamics
bonds
Problem solving
Brigham,E. 2014 Written
Fundamentals of examination
Group dynamics
Financial
Management
13th edition.
Cengage Learning

Week 18 FINAL EXAMINATION

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
COLLEGE OF ACCOUNTANCY AND FINANCE
Department of Financial Management

COURSE CONTENT

Compiled by:

MICHAEL BRYAN G. DE CASTRO

MARIA IMELDA S. UNTAL-DE CASTRO

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Republic of the Philippines

Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

WEEK 2 - INTEGRATION OF ACCOUNTING CONCEPTS

OBJECTIVES:

At the end of this lesson, the students are expected to:

1. Describe the content of the four basic financial statements and discuss the importance of financial
statement analysis to the financial manager.
2. Identify various sources of financial information
3. Evaluate firm profitability using the income statement.
4. Use the balance sheet to describe a firm’s investments in assets and the way it has financed them.
5. Identify the sources and uses of cash for a firm using the firm’s cash flow statement.

TO DO LIST:

In order to successfully complete Module 1 Week 2 lesson, students are required to do the following:
1. Join the discussion on the topic about different financial statements
2. Follow online etiquette
3. Submit the required output for this module on or before the given deadline

LECTURE

This lecture focuses on accounting and financial statements. Understanding the financial health of a business by
reviewing its financial statements is an important function of financial management.

The accounting and regulatory authorities mandate the following four types of financial statements: income
statement, balance sheet, cash flow statement, and statement of shareholders’ equity.

Financial statement analysis is important for a number of reasons.

First, the study of these accounting statements aids in assessing the financial condition of a business.

Second, financial statements are a tool for managers to use in monitoring and controlling the firm’s operations.

Third, financial planning and forecasting often is done through the medium of financial statements.

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

BASIC FINANCIAL STATEMENTS

The accounting and financial regulatory authorities mandate the following four types of financial statements:

 Income statement

 Balance sheet

 Cash flow statement

 Statement of shareholder’s equity

INCOME STATEMENT

An income statement provides the following information for a specific period of time (for example, a full
year or quarterly):

1. Revenue earned

2. Expenses incurred

3. Profit earned

An income statement (also called a profit and loss statement) measures the amount of profits generated
by a firm over a given time period (usually a year or a quarter). It can be expressed as follows:

Revenues (or Sales) – Expenses = Profits

An income statement will contain the following:

1. Revenues

2. Expenses

– Cost of goods sold, Selling expenses, General and administrative expense,

depreciation & amortization expense, Interest expense, and Income tax expense

3. Net Income

– Difference between Revenue and all expenses

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Sample Income Statement:

Annual Consolidated Income Statement of Ayala Corporation for 2019

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

How to evaluate firm’s per share earnings (EPS) and Dividends?

• Per Share earnings = company’s net income divided by the number of common shares outstanding.

• Dividends per share = total dividends paid divided by the number of common shares outstanding.

DISCUSSION POINTS:

1. What can the firm do with the net income? - Pay dividends to shareholders, and/or Reinvest in the firm?
2. How much is the net income of Ayala Corporation for 2019?
3. Recalculate the Basic Earnings Per Share of Ayala Corporation if Net Income is reduced by 1,000,000.
4. Recalculate the Diluted Earnings Per Share of Ayala Corporation if Net Income is reduced by 2,000,000.

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

BALANCE SHEET

The balance sheet provides a snapshot of the firm’s financial position on a specific date. It is defined by the
following equation:

Total Assets = Total Liabilities + Total Shareholders’ Equity

Balance sheet contains information on a specific date (for example, as of December 31, 2019) of the following:

1. Assets (sum of total shareholders’ equity and total liabilities, represents the resources
owned by the firm)

2. Liabilities (the firm’s debts, represent the total amount of money the firm owes its creditors)

3. Shareholders’ equity (the money invested by the company owners, refers to the difference
in the value of the firm’s total assets and the firm’s total liabilities)

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Sample Balance Sheet:

Annual Consolidated Balance Sheet of Ayala Corporation for 2019

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Republic of the Philippines

Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

DISCUSSION POINTS:

1. Calculate the net working capital of Ayala Corporation

2. What is the difference of current and non-current assets?
3. How do Ayala Corporation finance its assets? How much is equity financed? How much is debt financed?
4. Recreate a balance sheet of your own with the following accounts:

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

STATEMENT OF SHAREHOLDER’S EQUITY

It provides a detailed account of the firm’s activities in the following accounts: Common stock & Preferred stock
account, Retained earnings account, and Changes to owners’ equity.

Annual Consolidated Balance Sheet of Ayala Corporation for 2019

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Republic of the Philippines

Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

CASH FLOW STATEMENT

It reports cash received and cash spent by the firm over a period of time.

The Cash Flow Statement is used by firms to explain changes in their cash balances over a period of time
by identifying all of the sources and uses of cash for the period spanned by the statement.

Source and Uses of Cash

• A source of cash is any activity that brings cash into the firm. For example, sale of equipment.

• A use of cash is any activity that causes cash to leave the firm. For example, payment of taxes.

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Why did the cash balance decline by $4.50m? See table above:

An analysis of above sample reveals the following:

– The firm used more cash than it generated, resulting in a deficit of $4.5 million
– The main source of cash flow was retained earnings ($159.75m) and long-term debt ($51.75m)
– The largest use of cash was for acquiring inventory at $148.5 million.

The basic format for a cash flow statement is as follows:

Beginning Cash Balance

Plus: Cash Flow from Operating Activities

Plus: Cash Flow from Investing Activities
Plus: Cash Flow from Financing Activities

Equals: Ending Cash Balance

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Cash Flow Continuation

• Operating activities represent the company’s core business, including sales and expenses.

• Investing activities include the cash flows that arise out of the purchase and sale of long-term assets
such as plant and equipment.

• Financing activities represent changes in the firm’s use of debt and equity such as issue of new
shares, the repurchase of outstanding shares, and the payment of dividends.

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Sample Cash Flow Statement

Annual Consolidated Statement of Cash Flows of Ayala Corporation for 2019

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

The statement can be used to answer a number of important questions such as:
– How much cash did the firm generate from its operations?
– How much did the firm invest in plant and equipment?
– Did the firm raise additional funds, and if so, how much and from what sources?
– Is the firm able to generate positive cash flows?

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

WEEK 3 – ANALYSIS OF PAST AND PRESENT PERFORMANCE

OBJECTIVES:

At the end of this lesson, the students are expected to:

1. Explain what we can learn by analyzing a firm’s financial statements.
2. Be able to conduct financial analysis using Vertical Analysis, Horizontal analysis and Trend Analysis
3. Identify the proper situations to use specific analysis techniques

TO DO LIST:

In order to successfully complete Module 1 Week 3 lesson, students are required to do the following:
1. Join the discussion on the topic about different financial analysis tools
2. Follow online etiquette
3. Submit the required output for this module on or before the given deadline

LECTURE

HORIZONTAL ANALYSIS

This type of analysis is commonly used in analyzing and comparing historical data such as financial ratios
or line items (accounts) over a number of accounting period.

Horizontal analysis can be appreciated by use of absolute comparison or percentage comparison using
the previous or historical period as baseline year. This kind of analysis is also called base-year analysis.

 Horizontal analysis is used in the review of a company's financial statements over multiple periods.
 It is usually depicted as a percentage growth over the same line item in the base year.
 Horizontal analysis allows financial statement users to easily spot trends and growth patterns.
 It can be manipulated to make the current period look better if specific historical periods of poor
performance are chosen as a comparison.

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

TREND ANALYSIS

This type of analysis is commonly used in drawing/ visualizing the current and historical
performance of a company to predict the future performance. Trend analysis can either use $
change from previous year (base year) to current year or absolute amount.

Normally this analysis involves multiple period to be able to generate a sufficient trend line.

Trend Analysis Sample 1 (Inventory Turnover of Dell and HP):

Trend Analysis Sample 2:

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

VERTICAL ANALYSIS

Vertical analysis is also known as Common Size Financial Statement.

A common size financial statement is a standardized version of a financial statement in which all
entries are presented in percentages.

It helps to compare a firm’s financial statements with those of other firms, even if the other firms are
not of equal size.

How to prepare a common size financial statement?

– For a common size income statement, divide each entry in the income statement by sales.

– For a common size balance sheet, divide each entry in the balance sheet by total assets.

Sample below (Profit and Loss Common Size Statement):

– Cost of goods sold make up 75% of the firm’s sales resulting in a gross profit of 25%.

– Selling expenses account for about 3% of sales.

– Income taxes account for 4.1% of the firm’s sales.

– After all expenses, the firm generates net income of 7.6% of firm’s sales.

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Sample below (Balance Sheet Common Size Statement):

– Total current assets increased by 5.6% in 2013 while total current liabilities declined by 2%.

– Long-term debt account for 39.2% of firm’s assets, showing a decline of 1.7%.

– Retained earnings increased by 5.8%

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ACTIVITY

1. Using Ayala Corporation, prepare the following:

a. Horizontal analysis for 2019

b. Graph/ Trend analysis of:
i. Revenue or Sales from 2014 to 2019
ii. Interest Expense from 2014 to 2019
iii. Net income from 2014 to 2019
c. Vertical analysis for 2019 and 2018

2. Prepare a short narrative/ conclusion discussing the results of above analysis

3. Random selection – student to present to the whole class

WEEK 4-5 – FINANCIAL ANALYSIS

OBJECTIVES:

At the end of this lesson, the students are expected to:

1. Use various financial analysis tools to interpret financial data
2. Differentiate types of Financial Analysis Techniques
3. Identify the proper situations to use specific analysis techniques

TO DO LIST:

In order to successfully complete Module 2 Week 4-5 lesson, students are required to do the following:
1. Join the discussion on the topic about different financial statements
2. Follow online etiquette
3. Submit the required output for this module on or before the given deadline

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

LECTURE

FINANCIAL RATIOS

Financial ratios provide a second method for standardizing the financial information on the income
statement and balance sheet.

Financial ratio by itself may have no meaning. Hence, a given ratio is generally compared to: (a) ratios
from previous years; or (b) ratios of other firms in the same industry.

LIQUIDITY RATIOS:

Liquidity ratios address a basic question: How liquid is the firm?

A firm is financially liquid if it is able to pay its bills on time. We can analyze a firm’s liquidity from two
perspectives.

1. Overall liquidity - analyzed by comparing the firm’s current assets to the firm’s current liabilities.

2. Liquidity of specific assets - analyzed by examining the timeliness in which the firm’s liquid assets
(accounts receivable and inventories) are converted into cash.

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Liquidity Ratios: Current Ratio

The overall liquidity of a firm is analyzed by computing the current ratio and acid-test ratio.

Current Ratio: Current Ratio compares a firm’s current (liquid) assets to its current (short-term)
liabilities.

What is the current ratio for the below sample if current assets is $477 and current liability is
$292.5?

Current Ratio = $477 ÷ $292.5 = 1.63 times

The firm had $1.63 in current assets for every $1 it owed in current liability.

Liquidity Ratios: Quick Ratio

Acid-Test (Quick) Ratio excludes the inventory from current assets as inventory may not be very
liquid.

What is the quick ratio for the below sample if current assets is $477 of which 229.5 is inventories
and current liability is $292.5?

Quick Ratio = ($477-$229.50) ÷ ($292.50) = 0.84 times

The firm has only $0.84 in current assets (less inventory) to cover $1 in current liabilities.

Liquidity Ratios: Accounts Receivable

Average Collection Period measures the number of days it takes the firm to collects its
receivables.

What will be the average collection period for the below sample if we assume that the annual credit
sales were $2,500 million and accounts receivable is 139.5?
Daily Credit Sales = $2,500 ÷ 365 days = $6.85 million
Average Collection Period = $139.5m ÷ $6.85m = 20.37 days

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Liquidity Ratios: Accounts Receivable Turnover Ratio

Accounts Receivable Turnover Ratio measures how many times receivables are “rolled over”
during a year.

What will be the accounts receivable turnover ratio for the below sample if we assume that the
annual credit sales were $2,500 million and accounts receivable is 139.5?

Accounts Receivable Turnover = $2,500 million ÷ $139.50 = 17.92 times

– The firm’s accounts receivable were turning over at 17.92 times per year.

Liquidity Ratios: Inventory Turnover Ratio

Inventory turnover ratio measures how many times the company turns over its inventory during
the year. Shorter inventory cycles lead to greater liquidity since the items in inventory are converted
to cash more quickly.

What will be the inventory turnover ratio for the below sample if we assume that the cost of goods
sold were $1,980 million and inventory is 229.5?

Inventory Turnover Ratio = $1,980 ÷ $229.50 = 8.63 times

– The firm turned over its inventory 8.63 times per year.

Liquidity Ratios: Days’ Sales in Inventory

Days’ Sales in Inventory

= 365÷ inventory turnover ratio

= 365 ÷ 8.63 = 42.29 days

The firm, on average, holds it inventory for about 42 days.

Note on Liquid Assets – Can a firm have too much liquidity?:

• A high investment in liquid assets will enable the firm to repay its current liabilities in a timely manner.

• However, an excessive investments in liquid assets can prove to be costly as liquid assets (such as
cash) generate minimal return.

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

CAPITAL STRUCTURE RATIOS:

Capital structure refers to the way a firm finances its assets. Capital structure ratios address the
important question: How has the firm financed the purchase of its assets?

Capital structure Ratios: Debt ratio

Measures the proportion of the firm’s assets that are financed by borrowing or debt financing.

What is the debt ratio for the below sample if Total Liabilities is 1,012.5M and Total Assets is
1,764M?

Debt Ratio

= $1,012.50 million ÷ $1,764 million = 57.40%

– The firm financed 57.39% of its assets with debt.

Capital structure Ratios: Times Interest Earned Ratio

Measures the ability of the firm to service its debt or repay the interest on debt.

What will be the times interest earned ratio for the below sample if we assume interest expense of
$65 million and EBIT of $350 million?

Times Interest Earned

= $350m ÷ $65m = 5.38 times

– The firm can pay its interest expense 5.38 times or interest used 1/5.38th or 18.58% of its
EBIT.

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ASSET MANAGEMENT EFFICIENCY RATIOS:

Asset management efficiency ratios measure a firm’s effectiveness in utilizing its assets to
generate sales.

They are commonly referred to as turnover ratios as they reflect the number of times a particular
asset account balance turns over during a year.

Asset Management Efficiency Ratios: Total Asset Turnover Ratio

Represents the amount of sales generated per dollar invested in firm’s assets.

What will be the total asset turnover ratio for the below sample if we assume total sales to be
$2,500 million and total asset as 1,764 million?

Total Asset Turnover = $2,500 million ÷ $1,764 million = 1.42 times

– The firm generated $1.42 in sales per dollar of assets in 2012.

Asset Management Efficiency Ratios: Fixed asset turnover ratio

Measures firm’s efficiency in utilizing its fixed assets (such as property, plant and equipment).

What will be the fixed asset turnover ratio for the below sample if we assume sales of $2,500
million and Net Plant and Equipment is 1,2877 million?

Fixed Asset Turnover = $2,500 million ÷ $1,287 million = 1.94 times

– The firm generated $1.94 in sales per dollar invested in plant and equipment.

The following grid summarizes the efficiency of Company A’s management in utilizing its assets to
generate sales.

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

PROFITABILITY RATIOS

Profitability ratios address a very fundamental question: Has the firm earned adequate returns on
its investments?

Two fundamental determinants of firm’s profitability and returns on investments:

• Cost Control – How well has the firm controlled its costs relative to each dollar of firm sales?

• Efficiency of asset utilization – How effective is the firm in using the assets to generate
sales?

Cost Control: Is the Firm Earning Reasonable Profit Margins?

Profitability Ratios: Gross profit margin

Shows how well the firm’s management controls its expenses to generate profits.

What will be the gross profit margin ratio the below samplee if we assume sales of $2,500 million
and gross profit of $650 million?

Gross Profit Margin = $650 million ÷ $2,500 million = 26%

– The firm spent $0.74 for cost of goods sold and thus $0.26 out of each dollar of sales went
towards gross profits.

Profitability Ratios: Operating Profit Margin

Measures how much profit is generated from each dollar of sales after accounting for both costs of
goods sold and operating expenses. It also indicates how well the firm is managing its income
statement.

What will be the operating profit margin ratio below sample if we assume sales of $2,500 million
and net operating income of $350 million?

Operating Profit Margin = $350 million ÷ $2,500 million = 14%

– The firm generates $0.14 in operating profit for each dollar of sales.

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Profitability Ratios: Net Profit Margin

Measures how much income is generated from each dollar of sales after adjusting for all expenses
(including income taxes).

What will be the net profit margin ratio for the below sample if we assume sales of $2,500 million
and net income of $217.75 million?

Net Profit Margin = $217.75 million ÷ $2,500 million = 8.71%

– The firm generated $0.087 for each dollar of sales after all expenses were accounted for.

Profitability Ratios: Operating Return on Assets ratio

Summary measure of operating profitability. It takes into account the management’s success in
controlling expenses and its efficient use of assets.

What will be the operating return on assets ratio for Boswell for 2012 if we assume EBIT or net
operating income of $350 million for 2012?

Operating Return on Assets = $350 million ÷$1,764 million = 19.84%

– The firm generated $0.1984 of operating profits for every $1 of its invested assets.

Is the Firm Providing a Reasonable Return on the Owner’s Investment?

Profitability Ratios: Return on Equity (ROE)

Measures the accounting return on the common stockholders’ investment.

What will be the ROE ratio for the below sample if we assume net income of $217.75 million and
common equity as 751.5 million?

ROE = $217.75m ÷ $751.50 mi = 28.98%

– Thus the shareholders earned 28.97% on their investments.

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

MARKET VALUE RATIOS:

Market value ratios address the question, how are the firm’s shares valued in the stock market?

Market value ratios: Price-Earnings (PE) Ratio

Indicates how much investors are currently willing to pay for $1 of reported earnings.

What will be the PE ratio for the below sample if we assume the firm’s stock was selling for $22 per
share at a time when the firm reported a net income of $217.75 million, and the total number of
common shares outstanding are 90 million?

Earnings per share = $217.75 million ÷ 90 million = $2.42

PE ratio = $22 ÷ $2.42 = 9.09

- The investors were willing to pay $9.09 for every dollar of earnings per share that the
firm generated.

Market value ratios: Market-to-Book Ratio

Measures the relationship between the market value and the accumulated investment in the firm’s
equity.

What will be the market-to-book ratio for the below sample if the market price of the stock is $22
and the firm has 90 million shares outstanding and common shareholders’ equity of 751.5 million?

Book Value per Share = 751.50 million ÷ 90 million = $8.35 per share

Market-to-Book Ratio = Market price per share ÷ Book value per share

= $22 ÷ $8.35

= 2.63 times

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

BREAK EVEN POINT ANALYSIS

Break even analysis in business, economics and accounting refers to the point in which total cost
and total revenue are equal. A breakeven point analysis is used to determine the number of units
or dollars of revenue needed to cover total fixed and variable cost.

Break even quantity = Fixed costs / (Sales price per unit – Variable cost per unit)

Where:

Fixed costs are costs that do not change with varying output (e.g., salary, rent, building
machinery).

Sales price per unit is the selling price (unit selling price) per unit.

Variable cost per unit is the variable costs incurred to create a unit.

It is also helpful to note that sales price per unit minus variable cost per unit is the contribution
margin per unit. For example, if a book’s selling price is $100 and its variable costs are $5 to make
the book, $95 is the contribution margin per unit and contributes to offsetting the fixed costs.

Example of Break Even Analysis

Colin is the managerial accountant in charge of Company A, which sells water bottles. He
previously determined that the fixed costs of Company A consist of property taxes, a lease, and
executive salaries, which add up to $100,000. The variable cost associated with producing one
water bottle is $2 per unit. The water bottle is sold at a premium price of $12. To determine the
break even point of Company A’s premium water bottle:

Break even quantity = $100,000 / ($12 – $2) = 10,000

Therefore, given the fixed costs, variable costs, and selling price of the water bottles, Company A
would need to sell 10,000 units of water bottles to break even.

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Graphically Representing the Break Even Point

The graphical representation of unit sales and dollar sales needed to break even is referred to as
the break even chart or Cost Volume Profit (CVP) graph. Below is the CVP graph of the example
above:

1. The number of units is on the X-axis (horizontal) and the dollar amount is on the Y-axis
(vertical).
2. The red line represents the total fixed costs of $100,000.
3. The blue line represents revenue per unit sold. For example, selling 10,000 units would
generate 10,0= $120,000 in revenue.00 x $12
4. The yellow line represents total costs (fixed and variable costs). For example, if the
company sells 0 units, then the company would incur $0 in variable costs but $100,000 in
fixed costs for total costs of $100,000. If the company sells 10,000 units, the company
would incur 10,000 x $2 = $20,000 in variable costs and $100,000 in fixed costs for total
costs of $120,000.
5. The break even point is at 10,000 units. At this point, revenue would be 10,000 x $12 =
$120,000 and costs would be 10,000 x 2 = $20,000 in variable costs and $100,000 in fixed
costs.
6. When the number of units exceeds 10,000, the company would be making a profit on the
units sold. Note that the blue revenue line is greater than the yellow total costs line after
10,000 units are produced. Likewise, if the number of units is below 10,000, the company
would be incurring a loss. From 0-9,999 units, the total costs line is above the revenue line.

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Compiled by:
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

WEEK 6-7 – FORECASTING TECHNIQUES

OBJECTIVES:

At the end of this lesson, the students are expected to:

1. Recognize the importance of developing proper assumptions for forecasting financial statements
2. Differentiate the types of financial forecasting
3. Prepare forecasted financial statements

TO DO LIST:

In order to successfully complete Module 3 Week 6-7 lesson, students are required to do the following:
1. Join the discussion on the topic about different financial forecasting tools
2. Follow online etiquette
3. Submit the required output for this module on or before the given deadline

LECTURE

The primary objective of financial planning is to estimate the future financing requirements of a firm in advance of
when the financing is needed.

Financial planning also forces management to think systematically about the future and to develop contingency
plans that allow them to respond to challenges and opportunities.

Financial planning can be either short-term or long-term in perspective.

The long-term financial planning process spans a three- to five-year planning horizon and estimates future income
statements and balance sheets for a firm.

The short-term financial plan spans a one-year period. The primary short-term planning tool is the cash budget.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

The primary objective of preparing financial plans is to estimate the future financing requirements in
advance of when the financing will be needed. Most firms engage in three types of planning:

– Strategic planning,
– Long-term financial planning, and
– Short-term financial planning

Strategic plan defines, in very general terms, how the firm plans to make money in the future. It serves as
a guide for all other plans.

The long-term financial plan generally encompasses a period of three to five years and incorporates
estimates of the firm’s income statements and balance sheets.

The short-term financial plan spans a period of one year or less and is a very detailed description of the
firm’s anticipated cash flows. The format typically used for short-term financial plan is a cash budget.

Developing a Long-term financial plan

Three basic steps:

1. Construct a Sales Forecast
2. Prepare Pro Forma Financial Statements
3. Estimate the Firm’s Financing Needs

Step 1: Construct a Sales Forecast

Sales forecast is generally based on:
1. past trend in sales; and
2. The influence of any anticipated events that might materially affect that trend.

Step 2: Prepare Pro Forma Financial Statements

– These statements help forecast a firm’s asset requirements needed to support the forecast of
revenues (step 1).
– The most common technique is percent of sales method that expresses expenses, assets, and
liabilities for a future period as a percentage of sales.

Step 3: Estimate the Firm’s Financing Needs

– Using the pro forma statements we can extract the cash flow requirements of the firm.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Sample Forecasting – 3 step approach to Financial Planning using % sales method:

Step 1: Forecast Revenues and Expenses

– Zeigen’s financial analyst estimate the firm will earn 5% on the projected sales of $12 million in
2014.
– Zeigen plans to retain half of its earnings and distribute the other half as dividends.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Discretionary Financing Needs (DFN)

= {Total Financing Needs} less {Projected Sources of Financing}

= {$7.2 m (increase in assets)} – {$2.4m in spontaneous financing + $2.5m in short and long-term debt +
$1.8 million in equity}

= $7.2 million - $6.7 million

= $500,000

Step 2: Prepare Pro Forma Financial Statements

– The firm’s need for assets to support firm sales is forecasted using percent of sales method, where
each item in the balance sheet is assumed to vary in accordance with its percent of sales for 2013.

Step 3: Estimate the Firm’s Financing Requirements

– This involves comparing the projected level of assets needed to support the sales forecast to the
available sources of financing. In essence, we now forecast the liabilities and owner’s equity
section of the pro forma balance sheet.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Developing a Short-Term Financial Plan

A short-term financial plan is typically presented in the form of a cash budget that contains details
concerning the firm’s cash receipts and disbursements. It includes the following main elements:
– Cash receipts,
– Cash disbursements,
– Net change in cash, and
– New financing needed.

Uses of the Cash Budget

– It is a useful tool for predicting the amount and timing of the firm’s future financing
requirements.
– It is a useful tool to monitor and control the firm’s operations.

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MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ECONOMIC AND INDUSTRY EVALUATION

Industry Analysis or Evaluation is a common practice when analyzing the performance of a

company as compared to companies of the same industry.

This is used to create a benchmark for industry to assess the performance of companies in the
same line of business.

This macro-economic view of analysis widens the scope of the analysis and gives better insight on
what is the financial condition of a company. Economic/ market forces are also taken into account
in this analysis.

In the sample below, Liquidity Ratio of Company A is compared to the rest of the industry.

- The firm now has a current ratio that is less than half of the industry average,
suggesting a compromised liquidity.
- Inventory turnover is faster than the rest of the industry, this is a bright spot for this
company.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

CASH FLOW FORECASTING

Pro forma financial statements are forecasts of future financial statements. We can calculate free
cash flow using the following equation:

Depreciation expenses is subtracted while calculating the firm’s taxable income. However,
depreciation is a not a cash expense. Therefore, depreciation must be added back into net
operating income when calculating cash flows.

Annual Depreciation expense (using straight line method)

= (Cost of equipment
+ Shipping & Installation Expense
– Expected salvage value)
÷ (Life of the equipment)

Example Consider a firm that purchased an equipment for $500,000 and incurred an additional
$50,000 for shipping and installation. What will be the annual depreciation expense if the
equipment is expected to last 10 years and have a salvage value of $25,000?

Annual Depreciation expense

= (Cost of equipment + Shipping & Installation Expense – Expected salvage value) ÷ (Life
of the equipment)
= ($500,000 + $50,000 - $25,000) ÷ (10)
= $52,500

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MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Calculating a Project’s Working Capital Requirements

When sales increase, firm’s account receivable balance will tend to grow. In addition, new projects
may lead to an increase in the firm’s investment in inventories. Both lead to cash outflow.
If the firm is able to finance some or all of its inventories using trade credits, this will offset the cash
outflow. Thus the net increase is given by:

Calculating a Project’s Capital Expenditure Requirement

When the project is over, we add the salvage value of asset to the final year’s free cash flow along
with recovery of any operating working capital.

Sample problem:

Crockett Clothing Company is reconsidering its sewing machine investment in light of a change in
its expectations regarding project revenues. The firm’s management wants to know the impact of a
decrease in expected revenues from $360,000 to $240,000 per year. What would be the project’s
operating cash flow under the revised revenue estimate?

Step 1: Picture the Problem

OCF1-5 = Sum of additional revenues less operating expenses (cash and depreciation) less taxes
plus depreciation expense

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

This is the information given to us:

Step 2: Decide on a Solution Strategy

Calculate operating cash flow using the below equation:

Step 3: Solve

Since there is no change in revenues or other sources of cash flows from year to year, the total
operating cash flows will be the same every year.

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MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Step 4: Analyze

• This project contributes $35,700 to the firm’s net operating income (after taxes) based on
annual revenues of $240,000.This represents a significant drop from $69,300 when the
revenues were $360,000.
• Since depreciation is a non-cash expense, it is added back to determine the annual operating
cash flows.
• The project contributes $75,700 to the firm’s net operating income (before taxes). It shows that
if the revenues drop from $360,000 to $240,000, the operating cash flows will also drop.

Computing Project NPV

Once we have estimated the operating cash flow, we can compute the NPV using the below
equation

• Compute the NPV for the sample computation above based on the following additional
assumptions:
– Increase in net working capital = -$70,000 in Year 0
– Increase in net working capital = $70,000 in Year 5
– Discount Rate = 15%

• NPV =-$270,000 + {$75,700/(1.15)} + {$75,700/(1.15)2 }+ {$75,700/(1.15)3}+

{$75,700/(1.15)4}+ {$145,700/(1.15)5}
=
$18,560

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

WEEK 8 – FINANCING OPERATIONS AND EXPANSION

OBJECTIVES:

At the end of this lesson, the students are expected to:

1. Explain the basics of financial risk management
2. Use cost of capital computations in valuation models
3. Analyze the performance of financial institutions using financial risk analysis tools

TO DO LIST:

In order to successfully complete Module 3 Week 8 lesson, students are required to do the following:
1. Join the discussion on the topic about different financial forecasting tools
2. Follow online etiquette
3. Submit the required output for this module on or before the given deadline

LECTURE

CONCEPT OF RISK

Risk is defined in financial terms as the chance that an outcome or investment’s actual gains will differ
from an expected outcome or return.

Quantifiably, risk is usually assessed by considering historical behaviors and outcomes. Standard
deviation is a common metric associated with risk. Standard deviation provides a measure of the volatility
of asset prices in comparison to their historical averages in a given time frame.

Five Step Corporate Risk Management Process

1. Identify and understand the firm’s major risks.

2. Decide which types of risks to keep and which to transfer.

3. Decide how much risk to assume.

4. Incorporate risk into all the firm’s decisions and processes.

5. Monitor and manage the risk that the firm assumes.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Step1: Identify and Understand the Firm’s Major Risks

Identifying risks relates to understanding the factors that drive the firm’s cash flow volatility. For example:
Demand risk, Commodity risk, Country risk, Operational risk, Foreign Exchange risk.

Risk management generally focuses on managing external factors that cause volatility in firm’s cash flows.

Step 2: Decide Which Type of Risk to Keep and Which to Transfer

This is perhaps the most critical step. For example, oil and gas exploration and production firms have
historically chosen to assume the risk of fluctuations in the price of oil and gas. However, some firms have
chosen to actively manage the risk.

Step 3: Decide How Much Risk to Assume

Figure below illustrates the cash flow distributions for three risk management strategies.

The specific strategy chosen will depend upon the firm’s attitude to risk and the cost/benefit analysis of risk
management strategies.

Cash Flow Distributions for Alternative Risk Management Strategies

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ASSET/ LIABILITY MANAGEMENT

Asset/liability management is the process of managing the use of assets and cash flows to reduce
the firm’s risk of loss from not paying a liability on time. Well-managed assets and liabilities
increase business profits.

The asset/liability management process is typically applied to bank loan portfolios and pension
plans. It also involves the economic value of equity.

The concept of asset/liability management focuses on the timing of cash flows because company
managers must plan for the payment of liabilities.

The process must ensure that assets are available to pay debts as they come due and that assets
or earnings can be converted into cash. The asset/liability management process applies to different
categories of assets on the balance sheet.

The asset coverage ratio

This is an important ratio used in managing assets and liabilities. It computes the value of assets
available to pay a firm’s debts. The ratio is calculated as follows:

Tangible assets, such as equipment and machinery, are stated at their book value, which is the
cost of the asset less accumulated depreciation. Intangible assets, such as patents, are subtracted
from the formula because these assets are more difficult to value and sell.

Debts payable in less than 12 months are considered short-term debt, and those liabilities are also
subtracted from the formula.

The coverage ratio computes the assets available to pay debt obligations, although the liquidation
value of some assets, such as real estate, may be difficult to calculate. There is no rule of thumb as
to what constitutes a good or poor ratio since calculations vary by industry.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

COST OF CAPITAL

The Cost of Capital: An Overview

• A firm’s Weighted Average Cost of Capital, or WACC is the weighted average of the required
returns of the securities that are used to finance the firm.

• WACC incorporates the required rates of return of the firm’s lenders and investors and also
accounts for the particular mix of financing.

The riskiness of a firm affects its WACC as:

– required rate of return on securities will be higher if the firm is riskier, and
– risk will influence how the firm chooses to finance i.e. proportion of debt and equity.

WACC is useful in a number of settings:

– WACC is used to value the entire firm.

– WACC is often used for determining the discount rate for investment projects
– WACC is the appropriate rate to use when evaluating firm performance

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Three Step Procedure for Estimating Firm WACC

1. Define the firm’s capital structure by determining the weight of each source of capital.

2. Estimate the opportunity cost of each source of financing. These costs are equal to the
investor’s required rates of return.

3. Calculate a weighted average of the costs of each source of financing. This step requires
calculating the product of the after-tax cost of each capital source used by the firm and the
weight associated with each source. The sum of these products is the WACC.

Determining the Firm’s Capital Structure Weights

The weights are based on the following sources of financing: debt (short-term and long-term),
preferred stock and common equity. Liabilities such as accounts payable are not included in capital
structure.

• In theory, market value is preferred for all securities. However, not all market values may be
readily available.

• In practice, we generally use book values for debt and market values for equity securities.

Sample WACC calculation:

After completing her estimate of Templeton’s WACC, the CFO decided to explore the possibility of
adding more low-cost debt to the capital structure. With the help of the firm’s investment banker,
the CFO learned that Templeton could probably push its use of debt to 37.5% of the firm’s capital
structure by issuing more debt and retiring (purchasing) the firm’s preferred shares.

This could be done without increasing the firm’s costs of borrowing or the required rate of return
demanded by the firm’s common stockholders. What is your estimate of the WACC for Templeton
under this new capital structure proposal?

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

We need to determine the WACC based on the given information:

– Weight of debt = 37.5%; Cost of debt = 6%

– Weight of common stock = 62.5%; Cost of common stock =15%

We can compute the WACC based on the following equation:

Weights Cost Product

Debt 0.375 0.06 0.0225
Common Stock 0.625 0.15 0.09375
Preferred Stock 0 0.1 0
1 WACC 0.11625

We observe that as the level of debt increase to 37.5% and retire the preferred stock, the WACC is
equal to 11.625%.

The Cost of Debt

The cost of debt is the rate of return the firm’s lenders demand when they loan money to the firm.
We estimate the market’s required rate of return on a firm’s debt using its yield to maturity and not
the coupon rate.

After-tax cost of debt = Yield (1-tax rate)

Example: What will be the yield to maturity on a debt that has par value of $1,000, a coupon
interest rate of 5%, and time to maturity of 10 years and is currently trading at $900? What will be
the cost of debt if the tax rate is 30%?

– N = 10; PV = -900; PMT = 50; FV =1000

– I/Y = 6.38%

– After-tax cost of Debt = Yield (1-tax rate)

= 6.38 (1-.3)

= 4.47%

It is not easy to find the market price of a specific bond. It is a standard practice to estimate the
cost of debt using yield to maturity on a portfolio of bonds with similar credit rating and maturity as
the firm’s outstanding debt.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

A Guide to Corporate Bond Ratings

Corporate Bond Yields: Default Ratings and Term to Maturity

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

The Cost of Preferred Equity

The cost of preferred equity is the rate of return investors require of the firm when they purchase
its preferred stock.

Example The preferred shares of Relay Company that are trading at $25 per share. What will be
the cost of preferred equity if these stocks have a par value of $35 and pay annual dividend of 4%?

Using equation above

kps = $1.40 ÷ $25 = .056 or 5.6%

The Cost of Common Equity

The cost of common equity is the rate of return investors expect to receive from investing in
firm’s stock. This return comes in the form of dividends and proceeds from the sale of the stock).
There are two approaches to estimating the cost of equity:

1. The dividend growth model

i. Estimate the expected stream of dividends that the common stock is expected to
provide.

ii. Using these estimated dividends and the firm’s current stock price, calculate the
internal rate of return on the stock investment.

2. CAPM – Capital Asset Pricing Model

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Sample problem: Estimating the Cost of Common Equity

Prepare two additional estimates of Pearson’s cost of common equity using the dividend growth
model where you use growth rates in dividends that are 25% lower than the estimated 6.25% (i.e.,
for g equal to 4.69% and 7.81%)

We are given the following:

– Price of common stock (Pcs ) = $19.39

– Growth rate of dividends (g) = 4.69% and 7.81%

– Dividend (D0) = $0.49 per share

– Cost of equity is given by dividend yield + growth rate.

At growth rate of 4.69%

kcs = {$0.49(1.0469)/$19.39} + .0469

= .0733 or 7.33%

At growth rate of 7.81%

kcs = {$0.49(1.0781)/$19.39} + .0781

= .1053 or 10.53 %

• Pearson’s cost of equity is estimated at 7.33% and 10.53% based on the different assumptions for
growth rate.

• Thus growth rate is an important variable in determining the cost of equity. However, estimating the
growth rate is not easy.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

The Capital Asset Pricing Model

Estimating the Cost of Common Equity Using the CAPM

Prepare two additional estimates of Pearson’s cost of common equity using the CAPM where you
use the most extreme values of each of the three factors that drive the CAPM.

CAPM describes the relationship between the expected rates of return on risky assets in terms of
their systematic risk. Its value depends on:

– The risk-free rate of interest,

– The beta or systematic risk of the common stock returns, and

– The market risk premium.

However, there can be wide variation in the estimates for each one of these variables. Here we are
given the following estimates:

– The risk-free rate of interest (.01% or 2.80%)

– The beta or systematic risk of the common stock returns (.8 or 1.2)

– The market risk premium (4% or 8%)

Risk Free Rate + (Risk Premium x Beta) = Cost of Equity

• kcs = 0.01 + 0.8(4) = 3.21%

• kcs = 2.80 + 1.2(8) = 12.40%

Pearson’s cost of equity is shown to be sensitive to the estimates used for risk-free rate of
interest, beta and market risk premium.

Based on the estimates used, the cost of common equity ranges from 3.21% to 12.40%.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

WEEK 9 – MIDTERM EXAMINATION – please see appendix in the last page of the module for the Mid Term
Examination.

WEEK 10 – REVIEW AND UNDERSTANDING OF FINANCIAL MARKETS

OBJECTIVES:
At the end of this lesson, the students are expected to:
1. Differentiate the types of financial markets
2. Explain capital adequacy
3. Recognize the importance of maintaining reserves and proper liquidity management
4. Explain domestic financial markets and institutions and how firms obtain funds in the financial markets and
at what cost.

TO DO LIST:

In order to successfully complete Module 4 Week 10 lesson, students are required to do the following:
1. Join the discussion on the topic about different financial forecasting tools
2. Follow online etiquette
3. Submit the required output for this module on or before the given deadline

LECTURE

CAPITAL MARKET

Capital Markets are venues where savings and investments are traded between the suppliers who have
capital and those who are in need of capital. This is where buyers and sellers of financing meet. The
entities that have capital include retail and institutional investors while those who seek capital are
businesses, governments, and people.

Capital markets are composed of primary and secondary markets. The most common capital markets are
the stock market and the bond market.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Primary Market is also called as New Issues Market. This is where trading of new securities is
done for the first time. Newly listed companies in the stock exchange undergo “Initial Public
Offering” which is the first time that the stock is offered and sold to the general public.

Secondary Market can be described as the market for old securities. This is where the buyers and
sellers of shares conducts trade. This market is called secondary because the shares traded are
already bought originally and not the first time that it will be traded in the public.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

MONEY MARKET

Money market refers to trading in short-term debt instruments/ investments. At the

wholesale level, it involves large-volume trades between financial institutions and traders.
At the retail level, it includes money market mutual funds bought by individual investors and
money market accounts opened by bank customers. Money market involves the buy and
sell of overnight reserves/ commercial paper.

An individual may invest in the money market by purchasing a money market mutual fund,
buying a treasury bill or opening a money market account at a bank. Money market
investments are characterized by safety and liquidity.

Sample money market instruments are:

1. Commercial paper – credit worthy large companies short term unsecured

promissory notes to raise cash.
2. Repo – repurchase agreements is when a bank issues securities but promises at
the same time to repurchase them later at a higher price
3. Treasury bills – government issued financial instruments, normally with duration of
one year or less

BOND MARKET

Bond market is also called debt market, fixed-income market or credit market as this is the
collective name given to all trades and issues of debt securities.

Governments are the usual issuer of bonds in order to raise capital and pay debts and fund
infrastructural development expenses. Publicly traded companies also can issue bonds
when they need additional financing such as expansion projects or operational
maintenance.

1. Corporate Bonds – bonds issued by corporations to raise money for various

business reasons like expansion or additional capital expenditures
2. Government Bonds – issued by national government thru the Treasury Office,
normally thee proceeds of from these bond sale is used for government projects.
Investors or bond holders in return get regular interest payments.
3. Mortgage-backed bonds – bonds issued with security of pooled mortgages on real
estate properties which also serves as collateral

FOREIGN EXCHANGE MARKET

Foreign exchange market also known as forex, FX or the currency market is an over the
counter global marketplace that determines the exchange rate for currencies around the
world. Participants are able to buy, sell, exchange and speculate on currencies. Foreign
exchange markets are made up of banks, forex dealers, commercial companies, central
banks, etc.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

WEEK 11 – BUSINESS VALUATION AND CORPORATE RESTRUCTURING

OBJECTIVES:

At the end of this lesson, the students are expected to:

1. Apply basic valuation concepts
2. Describe what determines the value of a firm’s securities and how management can influence these
values.

TO DO LIST:

In order to successfully complete Module 4 Week 11 lesson, students are required to do the following:

1. Join the discussion on the topic about different financial forecasting tools
2. Follow online etiquette
3. Submit the required output for this module on or before the given deadline

LECTURE

A business valuation is a general process of determining the economic value of a whole business or
company unit.

Business valuation can be used to determine the fair value of a business for a variety of reasons, including
sale value, establishing partner ownership, taxation, and even divorce proceedings.

Owners will often turn to professional business evaluators for an objective estimate of the value of the
business.

 Business valuation determines the economic value of a business or business unit.

 Business valuation can be used to determine the fair value of a business for a variety of reasons,
including sale value, establishing partner ownership, taxation, and even divorce proceedings.
 Several methods of valuing a business exist, such as looking at its market cap, earnings
multipliers, or book value, among others.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

METHODS of VALUATION

There are numerous ways a company can be valued. You'll learn about several of these methods
below.

1. Market Capitalization

Market capitalization is the simplest method of business valuation. It is calculated by multiplying the
company’s share price by its total number of shares outstanding. For example, as of January 3,
2018, Microsoft Inc. traded at $86.35. With a total number of shares outstanding of 7.715 billion,
the company could then be valued at $86.35 x 7.715 billion = $666.19 billion.

2. Times Revenue Method

Under the times revenue business valuation method, a stream of revenues generated over a
certain period of time is applied to a multiplier which depends on the industry and economic
environment. For example, a tech company may be valued at 3x revenue, while a service firm may
be valued at 0.5x revenue.

3. Earnings Multiplier

Instead of the times revenue method, the earnings multiplier may be used to get a more accurate
picture of the real value of a company, since a company’s profits are a more reliable indicator of its
financial success than sales revenue is. The earnings multiplier adjusts future profits against cash
flow that could be invested at the current interest rate over the same period of time. In other words,
it adjusts the current P/E ratio to account for current interest rates.

4. Discounted Cash Flow (DCF) Method

The DCF method of business valuation is similar to the earnings multiplier. This method is based
on projections of future cash flows, which are adjusted to get the current market value of the
company. The main difference between the discounted cash flow method and the profit multiplier
method is that it takes inflation into consideration to calculate the present value.

5. Book Value

This is the value of shareholders’ equity of a business as shown on the balance sheet statement.
The book value is derived by subtracting the total liabilities of a company from its total assets.

6. Liquidation Value

Liquidation value is the net cash that a business will receive if its assets were liquidated and
liabilities were paid off today.

This is by no means an exhaustive list of the business valuation methods in use today. Other
methods include replacement value, breakup value, asset-based valuation and still many more.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

RESTRUCTURING

Restructuring is commonly known as reorganization of a company as a result of business decision

to achieve greater efficiency or to adapt to a recent business decision or economic reaction. This is
a significant modification in the structure of the company most often to strengthen the business
performance or to adapt based on the need to the corporation.

A company may also undergo restructuring in case of sale, buyout, merger or change in overall
goals or transfer of ownership. When a company restructures internally, the operations, processes,
departments, or ownership may change, enabling the business to become more integrated and
profitable.

Sample cases:

The Wall Street Journal

In early 2017, Dow Jones announced plans to reorganize its flagship publication, The Wall Street
Journal, saying that it would help the company shift toward a more digital strategy. Dubbed WSJ2020,
the reorganization was announced as a plan to move away from outdated editorial processes and shift
the focus from print to digital. The company also announced the creation of new job categories and
alignment of journalist positions with a more technology-driven vision.

Some employee positions have already been cut in the WSJ Asia and Europe bureaus, but in the
U.S., WSJ plans a reorganization of existing staff rather than a series of layoffs or position
eliminations. According to the Editor-in-Chief, the company plans to keep the WSJ headcount of 1,300
roughly flat. The plan is to avoid mass layoffs by reallocating employees into new roles, for which
existing employees must self-select and apply. Although such a strategy can seem like a veiled
attempt to cut jobs, having employees apply for new positions could help the publication identify
internal candidates for roles rather than having to do layoffs and subsequently recruit from the outside.

Google

In 2015, Google announced a reorganization and the creation of its Alphabet holding company to
solidify its lead as one of the world’s most successful tech innovators and expand into new industries.
The reorganization named a new CEO and also provided Google’s two cofounders more time to focus
on exploring new business opportunities.

Since reorganizing, Google has continued its growth trajectory. After two years of operating under the
new structure, the company announced some of the positive outcomes of its reorganization, including:

 The separation of its traditional business from speculative ventures has offered greater transparency
for investors.
 Each business unit has its own CEO and greater autonomy in day-to-day operations.
 Alphabet’s speculative “moonshot” business units have controlled spending and are working toward
becoming profitable.
 The company’s leadership team has become more diverse, with more women on its senior executive
team (six out of 13) than any other tech company in the Fortune 100.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

WEEK 12-13 – ASSET VALUATION MODELS FOR MERGERS AND ACQUISITONS

OBJECTIVES:

At the end of this lesson, the students are expected to:

1. Recognize the rationale for mergers and acquisitions
2. Apply the different valuation models

TO DO LIST:

In order to successfully complete Module 4 Week 12-13 lesson, students are required to do the following:
1. Join the discussion on the topic about different financial forecasting tools
2. Follow online etiquette
3. Submit the required output for this module on or before the given deadline

LECTURE

CAPITAL ASSET PRICING MODEL

The Capital Asset Pricing Model (CAPM) is a major theory in finance. This theory suggests that beta is the
appropriate measure of a stock’s non-diversifiable or systematic risk. Further, the higher the stock’s beta,
the higher rate of return will be for this security. CAPM describes how the betas relate to the expected
rates of return. Investors will require a higher rate of return on investments with higher betas.

Below figure provides the expected returns and betas for portfolios comprised of market portfolio and risk-
free asset.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Risk and Return for Portfolios Containing the Market and the Risk-Free Security

The Security Market Line and the CAPM

The straight line relationship between the betas and expected returns in above is called the security
market line (SML), and its slope is often referred to as the reward to risk ratio.
SML is a graphical representation of the CAPM.
SML can be expressed as the following equation, which is often referred to as the CAPM pricing equation:

Sample case: Estimating the Expected Rate of Return Using the CAPM
Estimate the expected rates of return for the three utility companies, using the 4.5% risk-free rate and
market risk premium of 6%.
18.0%
16.0%
14.0%
Expected Return

12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
0 0.5 1 1.5 2 2.5
BETA

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

The graph shows that as beta increases, the expected return also increases. When beta = 0, the
expected return is equal to the risk free rate of 4.5%.

We can determine the required rate of return by using CAPM equation. The betas for the three
utilities companies (Yahoo Finance estimates) are: AEP = 0.74, DUK = 0.40, CNP = 0.82

• Beta (AEP) = 4.5% + 0.74(6) = 8.94%

• Beta (DUK) = 4.5% + 0.40(6) = 6.9%
• Beta (CNP) = 4.5% + 0.82(6) = 9.42%

Expected Return for 3 Stocks

10.0%
9.4%
9.0% 8.9%
8.0%
7.0% 6.9%
Expected Return

6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9
Beta

The expected rates of return on the stocks vary depending on their beta. Higher the beta, higher is
the expected return.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

DIVIDEND DISCOUNT MODEL

This is a quantitative method used for predicting the price of a company's stock based on the
theory that its present-day price is worth the sum of all of its future dividend payments
when discounted back to their present value.

It attempts to calculate the fair value of a stock irrespective of the prevailing market conditions and
takes into consideration the dividend payout factors and the market expected returns.

If the value obtained from the DDM is higher than the current trading price of shares, then the stock
is undervalued and qualifies for a buy, and vice versa.

Based on the expected dividend per share and the net discounting factor, the formula for valuing a
stock using the dividend discount model is mathematically represented as:

This formula is best used for companies which are regularly paying regular dividends as the
dividend growth rate is based on periodic dividend distribution.

GORDON GROWTH MODEL – GGM MODEL

This valuation model is used to determine the intrinsic value of a stock based on a future series of
dividends that grow at a constant rate. It is a popular and straightforward variant of a dividend
discount mode (DDM).

Given a dividend per share that is payable in one year and the assumption the dividend grows at a
constant rate in perpetuity, the model solves for the present value of the infinite series of future
dividends. Because the model assumes a constant growth rate, it is generally only used for
companies with stable growth rates in dividends per share.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Sample case for GGM model calculation:

As a hypothetical example, consider a company whose stock is trading at $110 per share. This
company requires an 8% minimum rate of return (r) and currently pays a $3 dividend per share
(D1), which is expected to increase by 5% annually (g).

The intrinsic value (P) of the stock is calculated as follows:

According to the Gordon Growth Model, the shares are currently $10 overvalued in the market.

BOND YIELD PLUS PREMIUM

The bond yield plus risk premium (BYPRP) approach is another method we can use to determine
the value of an asset, specifically, a company's publicly traded equity.

BYPRP allows us to estimate the required return on an equity by adding the equity's risk premium
to the yield to maturity on company's long-term debt. Below equation states that the required return
on an equity equals the yield of the company’s long-term debt plus the equity’s risk premium.

The equity risk premium is essentially the return that stocks are expected to receive in excess of
the risk-free interest rate.

The normal historical equity risk premium for all equities has just been over 6% or anything
between 5% to 7%. In the below sample the projected yield is 4%.

To calculate sample required return = 6% + 4% = 10%

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

WEEK 14-15 – CAPITAL RAISING FOR CORPORATIONS

OBJECTIVES:

At the end of this lesson, the students are expected to:

1. Identify the pros and cons of equity and debt financing
2. Discern the best capital structure for the firm.

TO DO LIST:

In order to successfully complete Module 4 Week 14-15 lesson, students are required to do the following:
1. Join the discussion on the topic about different financial forecasting tools
2. Follow online etiquette
3. Submit the required output for this module on or before the given deadline

LECTURE

DEBT FINANCING

There are two main sources of borrowing for a corporation:

1. Loan from a financial institution (known as private debt since it involves only two parties)
2. Bonds (known as public debt since they can be traded in the public financial markets)

Financial Institutions provide loans to finance firm’s day-to-day operations (working capital loans) or it
might be used for the purchase of equipment or property (transaction loans). Loans may or may not be
secured by a collateral.

Advantages of Private Debt Placement

– Speed
– Reduced costs
– Financing flexibility
Disadvantages of Private Debt Placement
– Interest costs
– Restrictive covenants
– The possibility of future SEC registration

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Floating Rate Loans

In the private financial market, loans are typically floating rate loans i.e. the interest rate is adjusted
based on a specific benchmark rate. The most popular benchmark rate is the London Interbank Offered
Rate (LIBOR), rate at which banks offer to lend in the London wholesale or interbank market
For example, a corporation may get a 1-year loan with a rate of 300 basis points (or 3%) over LIBOR with
a ceiling of 11% and a floor of 4%.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Sample problem:
Calculating the Rate of Interest on a Floating-Rate Loan
Consider the same loan period as above but change the spread over LIBOR from to .75%. Is the
ceiling rate or floor rate violated during the loan period?
We have to determine the floating rate for every week and see if it exceeds the ceiling or falls
below the floor.
Floating rate on Loan = LIBOR for the previous week + spread of .75%

The floating rate on loan cannot exceed the ceiling rate of 2.5% or drop below the floor rate of
1.75%.
– If the floating rate falls below the floor, the rate will be reset at the floor rate.
– If the floating rate exceeds the ceiling, the rate will be reset at the ceiling rate.

The table shows the ceiling is violated during the first week and last two weeks of the loan period.
The floor rate is never violated.

The ceiling is the maximum rate charged on the loan while floor is the minimum rate charged on
the loan. If the ceiling or floor rates are violated, the loan rate is reset to the ceiling rate or the floor
rate.

If there were no ceiling, the loan rate would have been 2.73% during the first week of the loan, and
2.63% and 2.68% during the last two weeks of the loan.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Borrowing Money in the Public Financial Market

Corporations engage the services of an investment banker while raising long-term funds in the
public financial market. The investment banker performs three basic functions:
– Underwriting: assuming risk of selling a security issued. The client is given the money
before the securities are sold to the public.
– Distributing
– Advising

Corporate bond is a debt security issued by corporation that has promised future payments and a
maturity date.
If the firm fails to pay the promised future payments of interest and principal, the bond trustee can
classify the firm as insolvent and force the firm into bankruptcy.

The basic features of a bond include the following:

– Bond indenture
– Claims on assets and income
– Par or face value
– Coupon interest rate
– Maturity and repayment of principal
– Call provision and conversion features

Bond ratings indicate the default risk i.e. the probability that the firm will make the bond’s
promised payments. Rating agencies use borrower’s financial statements, financing mix,
profitability, variability of past profits, and make judgments about the quality of the firm’s
management in order to determine ratings.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

EQUITY FINANCING

Equity financing is the process of raising capital through the sale of shares. Companies raise
money because they might have a short-term need to pay bills or they might have a long-term goal
and require funds to invest in their growth. By selling shares, they sell ownership in their company
in return for cash, like stock financing.

Equity financing comes from many sources; for example, an entrepreneur's friends and family,
investors, or an initial public offering (IPO). Industry giants such as Google and Facebook raised
billions in capital through IPOs.
While the term equity financing refers to the financing of public companies listed on an exchange,
the term also applies to private company financing.

DEBT FINANCING vs. EQUITY FINANCING

 There are two types of financing available to a company when it needs to raise capital: equity
financing and debt financing.
 Debt financing involves the borrowing of money whereas equity financing involves selling a
portion of equity in the company.
 The main advantage of equity financing is that there is no obligation to repay the money
acquired through it.
 Equity financing places no additional financial burden on the company, however, the downside
is quite large.
 The main advantage of debt financing is that a business owner does not give up any control of
the business as they do with equity financing.
 Creditors look favourably upon a relatively low debt-to-equity ratio, which benefits the company
if it needs to access additional debt financing in the future.

Equity Financing vs. Debt Financing Example

Company ABC is looking to expand its business by building new factories and purchasing new
equipment. It determines that it needs to raise $50 million in capital to fund its growth.

To obtain this capital, Company ABC decides it will do so through a combination of equity financing
and debt financing. For the equity financing component, it sells a 15% equity stake in its business
to a private investor in return for $20 million in capital. For the debt financing component, it obtains
a business loan from a bank in the amount of $30 million, with an interest rate of 3%. The loan
must be paid back in three years. There could be many different combinations with the above
example that would result in different outcomes. For example, if Company ABC decided to raise
capital with just equity financing, the owners would have to give up more ownership, reducing their
share of future profits and decision-making power.

Conversely, if they decided to use only debt financing, their monthly expenses would be higher,
leaving less cash on hand to use for other purposes, as well as a larger debt burden that it would
have to pay back with interest. Businesses must determine which option or combination is the best
for them.
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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

WEEK 16 – CAPITAL STRUCTURE: Stock Valuation

OBJECTIVES:

At the end of this lesson, the students are expected to:

1. Apply valuation techniques to stocks

TO DO LIST:

In order to successfully complete Module 5 Week 16 lesson, students are required to do the following:
1. Join the discussion on the topic about different financial forecasting tools
2. Follow online etiquette
3. Submit the required output for this module on or before the given deadline

LECTURE

STOCK VALUATION

Common Stock

Common stockholders are the owners of the firm. They elect the firm’s board of directors who in turn
appoint the firm’s top management team. The firm’s management team then carries out the day-to-day
management of the firm.

Common Stock Characteristics

Claim on Income Common stockholders have the right to the firm’s income after bondholders and
preferred stockholders have been paid. The common stockholders either receive dividends or any
increase in value that results from the reinvested earnings.
Claim on Assets In case of liquidation, common stockholders have residual claim on assets.
Voting Rights In general, common shareholders are the only security holders given the right to vote. Most
shareholders vote by proxy.
Agency Costs and Common Stock Shareholders elect the board. In reality, board members are nominated
by the management. As a result, management effectively elects the board. This may lead to agency
problems.

Valuing Common Stock Using the Discounted Dividend Model

Like bonds, common stock’s value is equal to the present value of all future cash flows that the stockholder
expects to receive from owning the shares of stock. However, unlike bonds, the future cash flows in the
form of dividends are not fixed and there is no maturity date.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Three Step Procedure for Valuing Common Stock

Step 1: Estimate the amount and timing of the receipt of the future cash flows the common stock is
expected to provide.
Step 2: Evaluate the riskiness of the common stock’s future dividends to determine the stock’s required
rate of return.
Step 3: Calculate the present value of the expected dividends by discounting them back to the present at
the stock’s required rate of return.

The three steps show that the value of a common stock is equal to the present value of all future
dividends.

The Constant Dividend Growth Rate Model

If a firm’s cash dividend grow by a constant rate, then the common stock can be valued as follows:

Sample problem: Valuing Common Stock

What is the value of a share of common stock that paid $6 dividend at the end of last year and is expected
to pay a cash dividend every year from now to infinity, with that dividend growing at a rate of 5 percent per
year, if the investor’s required rate of return is 12% on that stock?

With a perpetuity, a timeline goes on forever with the growing cash flow occurring every period.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

• The value of a share of stock can be viewed as a present value of a growing perpetuity.
• Here we know the expected dividends, the growth rate, and investor’s required rate of return.
• We can use equation 10-2 to determine the value of a share of common stock.

• We need to first determine D1, the dividend next period.

• Since dividends at the end of last year was $6 and dividends are expected to grow at a rate of 5%,
dividends for next period will be:
• D1 = D0 (1+g) = $6 (1.05) = $6.30

• Vcs = $6.30 ÷ (0.12-0.05) = $6.30 ÷ 0.07

= $90

Above equation is based on the assumption that dividends will grow at a constant rate for ever. While not a
realistic assumption, it enables us to determine the value of common stock easily and also helps us to
identify the factors that move the stock prices.

Market Value of Equity

There’s another way of calculating the market value of equity or Market Capitalization. This measure of a
company’s value is calculated by multiplying the current stock price by the total number of outstanding
shares.

A company's market value of equity is therefore always changing as these two input variables change. It is
used to measure a company's size and helps investors diversify their investments across companies of
different sizes and different levels of risk.

Investors looking to calculate market value of equity can find the total number of shares outstanding by
looking to the equity section of a company's balance sheet.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

WEEK 17 – CAPITAL STRUCTURE: Bond Valuation

OBJECTIVES:
At the end of this lesson, the students are expected to:
1. Apply valuation techniques to bonds

TO DO LIST:
In order to successfully complete Module 6 Week 17 lesson, students are required to do the following:
1. Join the discussion on the topic about different financial forecasting tools
2. Follow online etiquette
3. Submit the required output for this module on or before the given deadline
LECTURE

BOND VALUATION

Valuing Corporate Debt

The value of corporate debt is equal to the present value of the contractually promised principal
and interest payments (the cash flows) discounted back to the present using the market’s required
yield to maturity on similar risk.
Bond Terminology

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

Valuing Bonds by Discounting Future Cash Flows

Step 1: Determine bondholder cash flows, which are the the amount and timing of the bond’s
promised interest and principal payments to the bondholders.

• Annual Interest = Par value × coupon rate

• Example 9.1: The annual interest for a 10-year bond with coupon interest rate of 7% and a par
value of $1,000 is equal to $70, (.07 × $1,000 = $70). This bond will pay $70 every year and
$1,000 at the end of 10-years.

Step 2: Estimate the appropriate discount rate on a bond of similar risk. Discount rate is the return
the bond will yield if it is held to maturity and all bond payments are made.

Step 3: Calculate the present value of the bond’s interest and principal payments from Step 1 using
the discount rate in step 2.

Calculating a Bond’s Yield to Maturity (YTM)

We can think of YTM as the discount rate that makes the present value of the bond’s promised
interest and principal equal to the bond’s observed market price.

Sample problem: Calculating the Yield to Maturity on a Corporate Bond

Calculate the YTM on the Ford bond where the bond price rises to $900 (holding all other things
equal).

• Purchase price = $900

• Interest payments = $65 per year for years 1-11
• Final payment = $1,000 in year 11 of principal.

We can use the below equation to find YTM. YTM is the rate that makes the present value of all
future expected cash flows equal to the current market price. We can also solve for YTM using a
calculator and a spreadsheet.

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MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

It is cumbersome to solve for YTM by hand using the equation. It is more practical to use the
financial calculator or the spread sheet.

The yield to maturity on the bond is 7.89%. The yield is higher than the coupon rate of interest of
6.5%. Since the coupon rate is lower than the yield to maturity, the bond is trading at a price below
$1,000. We call this a discount bond.

WEEK 18 – FINAL EXAMINATION

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MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ACTIVITY: WEEK 2 - INTEGRATION OF ACCOUNTING CONCEPTS

1. Explain briefly the following:

a. What is the importance of understanding the financial statement for:
i. Creditor
ii. Debtor
iii. Chief Financial Officer of a company
iv. Bureau of Internal Revenue
v. Independent Auditor like SGV, Ernst & Young

2. Define briefly what an income statement is and list down the key accounts that a financial analyst should
look at when analyzing this report.

3. Define briefly what balance sheet is and list down the key accounts that a financial analyst should look at
when analyzing this report.

4. Define briefly what cash flow is and list down the key accounts that a financial analyst should look at when
analyzing this report.

5. Define briefly what shareholders equity is and list down the key accounts that a financial analyst should
look at when analyzing this report.

6. Using the Ayala Corporation Financial Statement discussed in this chapter, provide a narrative on how the
company performed in year 2018 compared to year 2019, utilize all available information to back up your
analysis.

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MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ACTIVITY: WEEK 3 – ANALYSIS OF PAST AND PRESENT PERFORMANCE

1. Define briefly the use of Horizontal Analysis and when should this be used as a financial tool to analyze
the firm’s performance? Is this financial tool effective? Explain further.

2. Define briefly the use of Vertical Analysis and when should this be used as a financial tool to analyze the
firm’s performance? Is this financial tool effective? Explain further.

3. In what instance does a financial analyst should look at the Trend of financial results? When is this
analysis useful and what is the correct way to use this financial tool?

4. Using Ayala Corporation, prepare the following:

a. Horizontal analysis for 2019

b. Graph/ Trend analysis of:
i. Revenue or Sales from 2014 to 2019
ii. Interest Expense from 2014 to 2019
iii. Net income from 2014 to 2019
c. Vertical analysis for 2019 and 2018

5. Prepare a short narrative/ conclusion discussing the results of above analysis

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MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ACTIVITY: 4 – FINANCIAL ANALYSIS: PART 1

1. What is the importance of Financial Ratio is financial analysis and reporting?

2. Explain briefly the following:

a. What is the importance of understanding the financial ratios for:
i. Creditor
ii. Debtor
iii. Chief Financial Officer of a company

3. Differentiate the use and importance and identify the situation to utilize the below analysis techniques:
a. Liquidity Ratio
b. Capital Structure Ratio
c. Asset Management Efficiency Ratio
d. Profitability Ratio
e. Market Value Ratio

4. Conduct liquidity ratio analysis for Ayala Corporation using the available formula in this module. Provide a
narrative of your findings after every ratio computation.

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MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ACTIVITY: 5 – FINANCIAL ANALYSIS: PART 2

1. Conduct capital structure ratio analysis for Ayala Corporation using the available formula in this module.
Provide a narrative of your findings after every ratio computation.

2. Conduct asset management efficiency analysis for Ayala Corporation using the available formula in this
module. Provide a narrative of your findings after every ratio computation.

3. Conduct profitability ratio analysis for Ayala Corporation using the available formula in this module. Provide
a narrative of your findings after every ratio computation.

4. Conduct market value ratio analysis for Ayala Corporation using the available formula in this module.
Provide a narrative of your findings after every ratio computation.

5. Provide a summary of all your findings and discuss the highlights and lowlights of Ayala Corporation
financial performance.

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MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ACTIVITY: WEEK 6 - FORECASTING TECHNIQUES: PART 1

1. Discuss the objective and importance of preparing financial plans/ forecasts. Why do financial managers
see this as a vital financial analysis tool?

2. What is the purpose of strategic planning? Explain 3 scenarios when a company should have done
strategic planning in business operations.

3. What is the purpose of long-term financial plan? Explain 3 scenarios when a company should have done
strategic planning in business operations.

4. What is the purpose of short-term financial plan? Explain 3 scenarios when a company should have done
strategic planning in business operations.

5. Prepare a forecasted financial statement for Ayala Corporation for the year 2020 using the available
financial information in this module and current macro-economic trends. Provide a conclusion page or
narrative that explains the future financial performance of Ayala Corporation based on your forecast.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ACTIVITY: WEEK 7 - FORECASTING TECHNIQUES: PART 2

1. Prepare a forecasted financial statement for Jollibee Foods Corporation for the year 2020 using the
available financial information in this module and current macro-economic trends. Provide a conclusion
page or narrative that explains the future financial performance of Ayala Corporation based on your
forecast.

*Financial statements in the next page*

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MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

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MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ACTIVITY: WEEK 8 – FINANCING OPERATIONS AND EXPANSION

1. Explain the importance of Financial Risk Management.

2. As a financial manager, when should you use financial management risk tools? Explain and provide 3
scenarios on when this could be useful.

3. What are the five steps of corporate risk management process? As the CFO of a corporation, provide 3
scenarios why do you need to take this steps in making decisions? Explain your answer in detail.

4. What are the importance of Asset Liability Management? As the CFO of a corporation, provide 3 scenario
why do you need to take this steps in making decisions? Explain your answer in detail.

5. What are the importance of computing and comparing Cost of Capital? As the CFO of a corporation,
provide 3 scenario why do you need to take this steps in making decisions? Explain your answer in detail.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ACTIVITY: WEEK 10 - REVIEW AND UNDERSTANDING OF FINANCIAL MARKETS

1. Enumerate and differentiate the types of financial market – provide 3 sample scenario on the instances
that you will trade in specific markets.

2. What is capital adequacy and provide 3 scenarios when a CFO knowledge on financial markets is
necessary to satisfy capital adequacy requirements.

3. Explain domestic financial markets and institutions and how firms obtain funds in the financial markets and
at what cost.

4. What is an IPO? Explain the importance of IPO to a private company.

5. What is Philippine Stock Exchange (PSE)? Are all companies in the Philippines under PSE?

6. Do you consider a bond as a debt? Explain why.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ACTIVITY: WEEK 11 – BUSINESS VALUATION AND CORPORATE RESTRUCTURING

1. Describe what determines the value of a firm’s securities and how management can influence these
values.

2. As a CFO of a company, what are the steps that you will take to determine the value of your firm? Provide
scenarios to explain your steps further.

3. Enumerate different methods of valuation and provide 3 scenarios on when each method is applicable.
Explain in detail your answer.

4. What is restructuring? As a financial manager, what is your involvement in the restructuring process?
Provide 3 sample scenarios when a company need to do restructuring and explain the importance of this
process.

5. What is your judgment about the restructuring that the following companies undergo, do you agree about
the restructuring decision that they had? Provide your assessment about these companies as the CEO of
these companies:

a. The Wall Street Journal

b. Google

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ACTIVITY: WEEK 12-13 – ASSET VALUATION MODELS FOR MERGERS AND ACQUISITONS

1. Discuss the rationale of merger and acquisition.

2. Provide 3 scenario on when a merger and acquisition is necessary, explain your answer in detail.

3. What is the importance of Capital Asset Pricing Model and how should this be used in making business
decisions. Provide 2 sample scenarios and explain your answer briefly.

4. What is the importance of Dividend Discount Model and how should this be used in making business
decisions. Provide 2 sample scenarios and explain your answer briefly.

5. What is the importance of Gordon Growth Model and how should this be used in making business
decisions. Provide 2 sample scenarios and explain your answer briefly.

6. What is the importance of Bond Yield Plus Premium Model and how should this be used in making
business decisions. Provide 2 sample scenarios and explain your answer briefly.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ACTIVITY: WEEK 14-15 – CAPITAL RAISING FOR CORPORATIONS

1. Identify and provide 3 sample scenarios of pros and cons of equity financing.

2. Identify and provide 3 sample scenarios of pros and cons of debt financing.

3. As the CFO of the company, how do you discern the best capital structure for the firm?

4. What is debt financing? As a financial manager, would you advise your CFO to borrow money for financing
needs? Explain your answer in detail.

5. What is equity financing? As a financial manager, would you advise your CFO to borrow money for
financing needs? Explain your answer in detail.

6. Explain the pros and cons of a floating rate. Is it advisable to borrow money with floating rate? Explain your
answer in detail.

7. Explain what would you choose as financing source – equity or debt? Provide 2 scenario to explain your
answer.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ACTIVITY: WEEK 16 – CAPITAL STRUCTURE: Stock Valuation

1. What is common stock? Explain the characteristics of common stock.

2. As an investor, would you prefer to hold common stock instead of preferred stock? Explain your answer in
detail.

3. What are the steps in valuing common stock? Explain and provide sample scenarios.

4. Explain the importance of calculating the market value of equity. Provide sample scenario when an
investor should look into this. Explain your answer in detail.

5. What is constant dividend growth rate model? Is this an effective tool in valuing common stock? Explain
your answer.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ACTIVITY: WEEK 17 – CAPITAL STRUCTURE: Bond Valuation

1. What is a bond? Provide the pros and cons of issuing bonds as source of financing. Explain your answer
by providing 2 sample scenarios.

2. How do you value corporate debt? Explain your answer in detail.

3. What are the steps required to value bonds by discounting future cash flows? Explain your answer by
providing 2 sample scenarios.

4. How do you calculate a bond’s yield to maturity value? Explain the importance of this tool and provide 2
sample scenarios to discuss your answer.

5. What is “Call Provision”? Explain the importance of this feature on the part of the bond issuer.

6. What is “Conversion Feature”? Explain the importance of this feature on the part of the bond holder.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

MIDTERM EXAM – COVERAGE WEEK 1 TO WEEK 8 TOPICS

1. Explain the importance of the following financial statements. Provide at least 5 key accounts per financial
statement and explain its use to financial analysis.
a. Income Statement
b. Balance Sheet
c. Cash Flow Statement
d. Statement of Shareholders Equity

2. Differentiate horizontal analysis, vertical analysis and trend analysis and provide scenarios to explain when
these financial analysis tools should be used.

6. Using Jollibee Foods, prepare the following:

a. Horizontal analysis for 2019

b. Graph/ Trend analysis of:
i. Revenue or Sales from 2017 to 2019
ii. Interest Expense from 2017 to 2019
iii. Net income from 2017 to 2019
c. Vertical analysis for 2019 and 2019

7. Conduct liquidity ratio analysis for Jollibee Foods using the available formula in this module. Provide a
narrative of your findings after every ratio computation.

8. Conduct capital structure ratio analysis for Jollibee Foods using the available formula in this module.
Provide a narrative of your findings after every ratio computation.

9. Conduct asset management efficiency analysis for Jollibee Foods using the available formula in this
module. Provide a narrative of your findings after every ratio computation.

10. Conduct profitability ratio analysis for Jollibee Foods using the available formula in this module. Provide a
narrative of your findings after every ratio computation.
11. Conduct market value ratio analysis for Jollibee Foods using the available formula in this module. Provide
a narrative of your findings after every ratio computation.
12. Provide a summary of all your findings and discuss the highlights and lowlights of Jollibee Foods financial
performance.
13. Prepare a forecasted financial statement for Ayala Corporation for the year 2020 using the available
financial information in this module and current macro-economic trends. Provide a conclusion page or
narrative that explains the future financial performance of Ayala Corporation based on your forecast.

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

FINAL EXAM – COVERAGE WEEK 9 TO WEEK 17 TOPICS

1. Explain the different types of financial market. As a CFO of a corporation, explain the instances when you
will trade in each financial markets.
2. What is restructuring? As a CFO, what is your involvement in the restructuring process? Provide 3 sample
scenarios when a company need to do restructuring and explain the importance of this process.
3. What is your judgment about the restructuring that the following companies undergo, do you agree about
the restructuring decision that they had? Provide your assessment about these companies as CEO of
competing company:

a. The Wall Street Journal

b. Google

4. Enumerate different types of asset valuation models and explain the importance, advantages and
disadvantages of each in detail.
6. Explain the importance of calculating the market value of equity. Provide sample scenario when a CFO
should look into this. Explain your answer in detail.
7. What is a bond? Provide the pros and cons of issuing bonds as source of financing. Explain your answer
by providing 2 sample scenarios as the CEO of the company.
8. Case Study: Answer ENRON CORPORATION case study using the provided format below:

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

ENRON CORPORATION: CASE STUDY

ENRON CORPORATION

Enron was a Houston based energy company that was formed through merger of Internorth and Houston
Natural Gas. It was founded by Kenneth Lay in 1985. It ventured into other lines of business and was able to
penetrate the international market. Its executives and audit firm (Arthur Andersen) used a variety of deceptions and
fraudulent accounting processes to hide billions of losses and to maintain its credit rating at investment grade.
Extravagant spending was rampant throughout the company most especially among executives. Moreover, the
deal-makers entered into several contracts and projects without thinking of its implications to the company. As a
result, many of the business engagement of Enron failed and contributed a big loss to the corporation.

On December 2, 2001, Enron filed for bankruptcy. The Security and Exchange Commission started to
investigate and filed several civil cases to Kenneth Lay and some of its executives and audit firm (Arthur Andersen).
Some of the employees and executives were found guilty of conspiracy, fraud and money laundering.

The Enron scandal paved the way for the creation of Sarbanes-Oxley Act and reforms in the stock-exchange
regulations in order to restore public’s confidence in financial accounting system.

BACKGROUND

Former Type: Public Corporation

Industry: Energy
Founded: 1985 (Omaha, Nebreska, United States)
Headquarter: Houston, Texas, United States
Founded by: Kenneth Lay (merger of Internorth and Houston Natural Gas)
Key people: Kenneth Lay, Founder, Chairman and CEO
Jeffrey Skilling, former President and COO
Andrew Fastow, former Chief Finance Officer
Rebecca Jubasche, former Vice Chairman, Chairman and CEO
Stephen F. Cooper, Intermin CEO and CRO
Fate: Bankruptcy, December 2, 2001

Enron was founded by Kenneth Lay in 1985 after the merger of a two gas company and related products.
Northern Natural Gas Company which was formed in 1932 in Omaha, Nebraska was reorganized in 1979 as the
main subsidiary of a holding company, Internorth. Internorth was a major business for natural gas production,
transmission and marketing as well as for natural gas liquids and was an innovator in the plastic industry. In 1985,
it bought the smaller and less diversified Houston Natural Gas company which Kenneth Lay as a current Chief
Executive Officer. The company initially named itself “HNG/InterNorth Inc. After six months of merger, the Internorth
was sold to Physicians Mutual Corporation. The departure of ex-InterNorth and first CEO Samuel Segnar allowed
HNG CEO Kenneth Lay to become the next CEO of the newly merged company. Lay soon relocated the company’s
headquarter to Houston and began to change the business. Lay and his secretary, Nancy McNeil, originally selected
the name “Enteron” and were quickly abbreviated to “Enron”. After relocation to Houston, Enron began selling major
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MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

assets such as its chemicals division Northern PetroChemicals, accepted silent partners in Enron CoGeneration,
Northern Border Pipeline and Transwestern Pipeline. Early financial analyst said Enron was accumulating great
debt and the sale of major operations would not solve the problem.

During 1993, under the directives of Kenneth Lay and Jeffrey Skilling, Andrew Fastow began establishing
numerous limited liability special purpose entities that allowed Enron to transfer liability in order not to appear in its
financial accounts and maintain critical investment credit ratings and increasing stock price. Jeffrey Skilling change
and adopt Mark-to-Market accounting method that once a long-term contract was signed, income is recognized in
estimated net present value of net future cash flow. In addition to mislead the board and investors, Fastow
developed a complex accounting practice that few people could understand. They used variety of deceptions and
fraudulent accounting processes to hide billions of losses and entitle Enron to seem profitable than actually it was.
They hired several accountants and lawyers to help keep the illusion of revenues going. Also, conspiracy between
Enron and their auditor Arthur Andersen was taken place. To pressure Andersen into earnings expectation, Enron
would occasionally allow accounting companies Ernst & Young or PricewaterhouseCoopers to complete accounting
tasks to create the illusion of hiring a new company to replace Andersen.

Due to Enron’s practice of illusion, cost for executives and employees are not questioned. Extravagant
spending was rampant throughout the company most especially among executives. Employees had a large
expense account and many executives were paid twice as much as competitors. Deal-makers are continuously
accepting contracts and projects without thinking of implication to cash inflows and outflows just to create earnings
for better rating performance. This high rating performance gives the deal makers and executives received a large
cash bonuses and stock option.

Just before the discovered corporate fraud, Enron traded in more than 30 different products including
products traded on EnronOnline, petrochemicals, plastics, power, pulp and paper, steel, weather risk management,
oil and LNG transportation, broadband, principal investments, risk management for commodities, shipping/freight,
streaming media, water and wastewater. It was also an extensive futures trader, including sugar, coffee, grains,
hog and other meat futures.

Many of the business engagement of Enron failed and contributed a big loss to the corporation such as
Azurix Corporation in the water market utility and the very controversial contract with Maharasthra State Electricity
Board in India and with Dabhol Power Company which did not prosper because Indian government discovered a
natural gas in their own and think that the contract with Enron would be very expensive.

At the time of bankruptcy, Enron owned interest in the following major assets:

Power Plants

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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

 Teesside (United Kingdom)—at the time of commission in 1992, at 1750 MW, was the largest Natural Gas
Co-Gen plant in the world. Its on-time and under-budget completion put Enron Power on the map as an
international developer, owner and operator.

 Bahia Las Minas (Panama)—largest thermal power plant in Central America, 355 MW.
 Puerto Quetzal Power Project (Guatemala)—110 MW.
 PQP LLC (Guatemala)—holding company for 124 MW Power Barge named "Esperanza".
 Empresa Energetica Corinto (Nicaragua)—holding company for "Margarita II" 70.5 MW power barge, Enron
had 35% share.
 EcoElectrica (Puerto Rico, USA)—507 MW natural gas cogeneration plant, with adjacent LNG import
terminal- supplied 20% of island's electricity.
 Puerto Plata Power Project (Dominican Republic)—185 MW power barge named "Puerto Plata".
 Modesto Maranzana Power Plant (Argentina)—70 MW.
 Cuiaba Integrated Project (Brazil)—480 MW combined cycle power plant.
 Nowa Sarzyna Power Plant (Poland)—116 MW, first privately developed post-Communist electricity project
in Poland.
 Sarlux Power Project (Italy)—551 MW combined cycle power plant, converted residue from Italy's largest oil
refinery into synthetic gas for fuel.
 Trakya Power Project (Turkey)—478 MW.
 Chengdu Cogen Project (China)—284 MW, joint venture with Sichuan Electric Company.
 Northern Marianas Power Project (Guam, USA)—80 MW slow speed diesel oil plant.
 Batangas Power Project (Philippines)—110 MW.
 Subic Bay Power Project (Philippines)—116 MW.
 Dabhol Power Project (India)—2,184 MW combined cycle plant, generally considered one of Enron's most
controversial and least successful projects.
 Storm Lake Wind Generation Project (Iowa, USA)—193 MW wind farm.
 Lake Benton II Wind Generation Facility (Minnesota, USA)—104 MW wind farm.
 Lake Benton I Wind Generation Facility (Minnesota, USA)—107 MW wind farm.
 Cabazon Wind Generation Facility (California, USA)—40 MW wind farm.
 Green Power I Wind Generation Facility (California, USA)—16.5 MW wind farm.
 Indian Mesa I Wind Generation Facility (Texas, USA)—25.5 MW wind farm.
 Clear Sky Wind Power Generation Facility (Texas, USA)—135 MW wind farm.
 Mill Run Wind Power Generation Facility (Pennsylvania, USA)—15 MW wind farm.
 Trent Mesa Wind Generation Facility (Texas, USA)—150 MW wind farm.
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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

 Montfort Wind Generation Facility (Wisconsin, USA)—30 MW wind farm.

 8 hydroelectric plants in Oregon with a combined capacity of 509 MW, owned through Portland General
Electric.
 4 additional thermal plants in Oregon and Montana with a combined capacity of 1,464 MW, owned
through Portland General Electric.

Pipelines

 Centragas (Colombia)—357 miles, natural gas.

 Promigas (Colombia).
 Transportadora de Gas del Sur (Argentina)—largest pipeline system in South America, 5,005 km
 CEG (Brazil)—1,368 miles, natural gas.
 CEGRio (Brazil).
 Transredes (Bolivia)—3,000 km natural gas pipeline and 2,500 km oil & liquids pipeline
 Bolivia-to-Brazil Pipeline (Bolivia/Brazil)—3,000 km, natural gas.
 Northern Natural Gas (Upper Midwestern USA)—16,500 miles, included share in Trailblazer Pipeline.
 Transwestern Pipeline (Texas, Arizona, New Mexico, Colorado)—2,554 miles.
 Florida Gas Transmission (Texas, Louisiana, Alabama, Mississippi, Florida)—4,800 miles.
 Northern Border Pipeline (Indiana, Illinois, Iowa, South Dakota, North Dakota, Montana )—1,249 miles.

Electric Utilities/Distributors

 Portland General Electric Company (USA)—serving 775,000 customers in Oregon.

 Elektro Electricidade e Servicos S.A. (Brazil)—1.5 million customers.
 Compania Anonima Luz y Fuerza Electricas de Puerto Cabello (Venezuela)—50,000 customers.

Natural gas-related businesses

 ProCaribe (Puerto Rico, USA)—LPG storage terminal, only fully refrigerated LPG storage facility in
Caribbean.
 San Juan Gas Company (Puerto Rico, USA)—gas distribution, 400 industrial/commercial customers.
 Industrial Gases Ltd. (Jamaica)—8 filling plants, industrial gas manufacturing & LPG distribution, had 100%
monopoly on Jamaican industrial gas business and 40% of LPG business.
 Gaspart (Brazil)—consortium of 7 gas distribution companies.
 Vengas (Venezuela)—LPG transportation and distribution.
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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

 ACCRO III and IV Project (Venezuela) is the largest outsourcing contract offered by PDVSA. Enron's
partners in the venture were Accro Barbados Ltd., a subsidiary of TransCanada Pipelines Ltd., and private
Venezuelan company Tecnoconsult. The project included two extraction plants, each with 400 MM cubic
feet per day capacity, a fractionation plant to remove the liquids and other related infrastructure.
 SK-Enron Company Ltd. (South Korea)—joint venture with SK Corporation; included 8 city gas utilities, an
LPG distributor, and a steam and electricity cogeneration facility.

Pulp and paper

 Garden State Paper Company Inc. (New Jersey, USA)—paperboard and newsprint recycling mill.
 Papiers Stadacona Ltee. (Quebec, Canada)—wood pulp & paper mill.
 St. Aurelie Timberlands Company Ltd. (Quebec, and New Brunswick, Canada & Maine, USA)—timber
company.

Others

 Mariner Energy Inc. (Houston, Texas, USA)—oil & gas exploration, development, and production with
operations in the Gulf of Mexico.
 Interruptores Especializados Lara (Venezuela)—manufacturer of valves, thermostats, and electrical
breakers for appliances.
 Enron Wind (formerly Zond) – manufacturer of wind power turbines and related systems, with factories
in USA, Spain, Portugal, and Germany. Purchased by General Electric during 2002.

The Enron accounting scandal revealed in October 2001. It all started when some analyst try to question
Enron’s practices and could not get any answers to their curiosity. March 5, 2001 when the first issue to question
Enron’s stock price was publicized. In a conference call on April 17, 2001, Jeffrey Skilling verbally attacked Wall
Street analyst Richard Grubman who questioned Enron’s unusual accounting practice. Richard Grubman
complained that Enron was the only company that could not release a balance sheet along with its earnings
statements.

On August 2001, Jeffrey Skilling sold his 450,000 shares before he resigned in the company. He admitted
that the reason behind his resignation was the faltering market price of Enron. Kenneth Lay gave a statement of
reassurance to the public that the market price will increase as he re-assumed the position of Chief Finance Officer
on the same date. Analyst and observers continued their complaints regarding the difficulty or properly assessing
a company whose financial statements were so mysterious. But some executives defended Kenneth Lay and told

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MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

the general public to buy stocks because it will continue to increase while secretly unloading their shares in the
company.

On October 16, 2001, Enron announced that restatements to its financial statements for years 1997 to 2000
were necessary to correct accounting violations. It reduces earnings by $613 million, increased liabilities by $628
million and reduced equity by $1.2 billion. Enron’s management team claimed the losses were due to investment
losses and the money spent for restructuring the trouble in broadband trading unit.

On October 22, 2001, Andrew Fastow disclosed to Enron’s board of directors the fraudulent accounting
practice and admitted that he earned $30 million from compensation arrangements. The share price decreased
from $90.75 to $80, $80 to $40, and $40 to $20.65 down to $5.40 after the announcement by the SEC that it was
investigating several suspicious deals by Enron. Two days later, Kenneth Lay dismissed Andrew Fastow from his
position as Chief Finance Officer to restore investor confidence. Before the end of October 2001, the company
started buying back all its commercial paper to calm investor fears about Enron’s supply of cash. And as the market
price of Enron continuously falls down to $0.26, the proposed buy-out of Dynergy from $8 billion to $4 billion did not
prosper.

On December 2, 2001, Enron filed a bankruptcy. SEC started to investigate and filed several civil cases to
Kenneth Lay and some of its executives including auditor Arthur Andersen. Kenneth Lay was accused of selling
more than $90 million worth of stock in the open market. He pleaded not guilty to the eleven criminal charges and
claimed that he was misled by those around him. In the year 2006 after the trial, Kenneth Lay was convicted of all
six counts of securities and wire fraud and was subject to a maximum of total sentence of 45 years in prison.
However, Kenneth Lay died on heart attack just before the sentence was scheduled. Also, Lay’s wife Linda, was
accused of selling 500,000 shares of Enron stock totaling $1.2 million on November 28, 2001, 10 minutes before
the hidden losses of Enron became public and stock price slide to $0.26. Money earned from the sale goes to
charitable institution. Later the case was dismissed because of lack of evidence on conspiracy.

Some of the employees and executives were found guilty of conspiracy, fraud and money laundering. Jeffrey
Skilling was convicted of 19 counts of securities fraud and insider trading and was sentenced to 24 years and 4
months in prison. Andrew Fastow and his wife Lea both pleaded guilty of charges. As a of bargain to testify against
Kenneth Lay and Jeffrey Skilling, Andrew Fastow was sentenced to 10 years imprisonment with no parole. Lea
was sentenced to one year of helping her husband hide income from the government. Michael Kopper was the first
executive to plead guilty. Chief Accounting Officer Rick Causey after pleading not guilty switched to guilty and was
sentenced to 7 years imprisonment. Kenneth Rice, former Chief of Enron high-speed internet unit who cooperated
and testify against Lay and Skilling received a 27-month sentenced. Giles Darby, David Bermingham and Gary
Mulgrew were sentenced to 37-months imprisonment. Former executive Paula Rieker was charged with criminal
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MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

insider trading by selling its 18,380 shares at $49.77 which valued at $15.51, a week before the public was told
what she already knew about the millions of losses. Michael W. Krautz, a former Enron accountant was among the
accused who was acquitted of charges related to the scandal.

Enron’s auditor, Arthur Andersen, was accused of applying reckless standards in its audits because of a
conflict of interest and found guilty of obstruction of justice for shredding the thousands of documents and deleting
e-mails and company files that tied the firm to its audit. The company earned $25 million in audit fees and $27
million consulting fees. Later, major customers lost its confidence and had closed.

After emerging from bankruptcy, Enron change its name to Enron Creditors Recovery Corporation with its
goal to repay the old Enron’s remaining creditors and end its affairs. Enron’s new board of directors sued 11
financial institutions for helping Lay, Skilling, Fastow and others hide Enron’s true financial condition. Among the
defendants were Royal Bank of Scotland, Deutsche Bank and Citigroup. As of 2008, Enron has settled will all the
institutions and able to obtain nearly $20 billion to distribute to its creditors as a result of megaclaim litigation.
Remaining assets are sold and proceeds are continuously distributed to the claimants in 2009 and beyond.

Because of Enron’s scandal which attributed as a big audit failure gives the creation of Sarbanes-Oxley Act.
The first provision of this act is the establishment of the Public Company Accounting Oversight Board to develop
standards for the preparation of audit reports. Second, the restrictions for the public accounting companies from
providing any non-auditing services when auditing. Third, the provisions for the independence of audit committee
members, executives being required to sign off on financial reports and relinquishment of certain executives’
bonuses in case of financial restatements. Lastly, it requires expanded financial disclosure of companies’
relationships with unconsolidated entities. Sarbanes – Oxley act increased penalties for destroying, altering, or
fabrication records in federal investigations or for attempting to defraud shareholders. This act also increased the
accountability of auditing firms to remain unbiased and independent of their clients.

In November 2003, the proposed regulation of New York Stock Exchange approved by the SEC with final
provisions of:

 All companies must have a majority of independent directors.

 Independent directors must comply with an elaborate definition of independent directors.
 The compensation committee, nominating committee, and audit committee shall consist of independent
directors.
 All audit committee members should be financially literate. In addition, at least one member of the audit
committee is required to have accounting or related financial management expertise.
 In addition to its regular sessions, the board should hold additional sessions without management.
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MICHAEL BRYAN DE CASTRO
COLLEGE OF ACCOUNTANCY AND FINANCE MARIA IMELDA UNTAL-DE CASTRO
Department of Financial Management

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Routledge, Taylor & Francis Group

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10th Edition

Gibson, C. 2013.Financial Statement Analysis, Gibson, Charles H., 13th edition. South-Western

Gibson,C. 2009. Financial Reporting & Analysis : Using Financial Accounting Information.Cengage
Learning

Higgins, R. 2016. Analysis for Financial Management 11th ed.

McGraw-Hill

Gitman, L.J. 2015. Principles of Managerial Finance

14th edition. Pearson Education

Brigham,E. 2014 Fundamentals of Financial Management

13th edition. Cengage Learning

Silvia, J. 2014. Economic and Business Forecasting: Analyzing and Interpreting Econometric Results,
John Wiley & Sons

Penman, S. 2013. Financial Statement Analysis and Security Valuation. Mc Graw-Hill

Bruner, R. 2014. Case Studies in Finance: Managing for Corporate Value Creation. 7TH edition
McGraw-Hill

https://www.accountingformanagement.org/horizontal-analysis-of-financial-statements/

https://corporatefinanceinstitute.com/resources/knowledge/modeling/break-even-analysis/

https://www.investopedia.com/

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