Questions, Comments MBA 648: Spring 2014 Prof. PV Viswanath.

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Questions, Comments MBA 648: Spring 2014 Prof. PV Viswanath

Questions from Feb. 11  I am still having a little trouble connecting some of the ratios to one another (especially those using equity)  I don’t understand your question.  Being able to use the appropriate ratio  Read the text and ask me again with more specific questions  Do I need to know the accounting formulas?  Yes; you need to know how the numbers are to be computed. But once you understand what their function is, it will easier to remember them.  You mentioned Warren Buffet’s investment technique, I’d like you to elaborate  The key element of Warren Buffet’s investment style was to invest for the long run. Even though at a particular point in time, a well-run company might not be a good investment value, that’s only if you’re planning to hold it for the short run. If you’re planning to hold it over a long-period of time, then the initial price is less important, especially if it’s difficult to know if the company is over- or under-valued.  How and when do we use these theories and formulas in the real business?  All these formulas are used by actual analysts. The four categories indicate how the ratios are used – to estimate short-term liquidity (if the firm has sufficient liquid assets to meet short-term payment needs), long-term profitability (if the firm is making profitable), efficiency of asset use (if firm assets are being used efficiently) and financial leverage (if the firm is in danger of going bankrupt).

Questions from Feb. 11  Still confused on some materials regarding calculations of determinants of growth  The internal rate of growth is how fast the firm can grow without additional external resources; it is equal to Retention Ratio x ROA. The sustainable growth rate is higher and assumes that leverage levels can be maintained, i.e. as the firm retains earnings and increases equity, it can obtain a corresponding amount of additional debt to keep the leverage ratio constant; this rate is equal to the Retention Ratio x ROE.  Difference between balance sheet & income statement  The income statement is a record of the activities of the firm over a period of time, usually a year; the balance sheet is a snapshot of the assets/liabilities of the firm at appoint in time.  The cash flow coverage and times interest earned  Times interest earned is EBIT/Interest. Since Interest expense has to be paid out of EBIT, the ratio indicates the size of the cushion. For example, if the ratio is < 1, the firm is clearly in trouble!  Why does depreciation added back change EBIT into cash flows?  Because to compute EBIT, we subtract out depreciation, which is not a cashflow. So if we were computing the cash profitability of the firm, we would not have subtracted out depreciation. Adding back depreciation undoes this action.  Why is Dupont Analysis is so important?  We’ll do that today. Dupont Analysis helps the firm strategize.