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LS Chap 2

LS Chap 3

Macroeconomic Analysis

Understand general consensus about major macroeconomic factors


and how they might influence firm performance in the future

1. GDP measures the market value of final goods and services produced domestically
Common definition of economic recession two consecutive quarters of negative real GDP growth
2. Interest rates affects firms cost of capital and consumer consumption
It is the changes in interest rates that cause changes in consumer spending
3. Inflation risk from investing in financial assets increases and the credibility of domestic currency is undermined in
global financial markets
4. FOREX rates if value of SGD rises, cost of foreign input decreases, but so does revenue from foreign sales
5. Oil and key commodity prices increase/decrease in transportation costs and energy costs
6. Hedging assess based on a firms net exposure, after understanding its real and financial hedging activities
7. Business cycle economies may expand and contract systematically over periods, thus it is good to have a sense of
the current state of the business cycle, as well as when and how it is most likely to change
Profitability of some sectors is much more sensitive to movements in the business cycle than others

Industry analysis
Objective 1: Understand the sensitivity of the industry to key macroeconomic factors
GDP growth rate is key driver of profitability for all sectors of the economy
Some sectors are highly sensitive to GDP growth due to high operating leverage (i.e. high fixed costs), so small
movements in economic activity have big impacts on profitability
Interest rates affect industrial and IT sectors in particular increased interest rates reduce capital expenditures
Financial sector is impacted by reduced borrowing activity due to high interest rates
Oil prices have the same negative impacts on all sectors, except energy sector (exploration, production, transportation,
refining and marketing of oil)

Objective 2: Understand how the industry operates and the key performance metrics for evaluating these operations
Firms in the same industry produce similar goods using similar production technologies
Identify key ratios and statistics that capture the financial health of the industry and firms within the industry
Particular metrics vary widely based on the nature of the industrys operations
Objective 3: Understand the competitive structure of the industry (Apply Porter 5 forces)
Relate to sources of direct competition Rivalry among existing firms, Threat of new entrants, Availability of
substitute products
Relate to a companys relative bargaining position with its suppliers and customer Bargaining power with
suppliers and customers

LS Chap 3

Firm Strategy

Cost leadership low production costs, thin margins,


Product differentiation higher premium, higher profits
Focus niche strategy that supplies one segment of the market with exactly what they want, be it low cost or a
differentiated product
Analysis of biz strategy should include the profitability of the business and the growth potential of the business

Synergy Analysis

Create synergy by leveraging proprietary assets, eliminating transaction costs, eliminated redundant overhead,
increasing market power
Free market is a very good disciplining mechanism, but can be lost when activities are brought inside a firm
Example: Sawmill company acquire timber company timber company no longer works efficiently since it does not
have to compete on the open market as sawmill company will buy over all the timber produced costs incurred from
coordination and control issues

LS Chap 12
If all assets and liabilities are recognized and recorded on the B/S at its fair market value, the value of equity on the B/S will
equal the fair market value of the firm
Trade-off between relevance and reliability any attempt of measurement is highly subjective, thus quite unreliable
Primary role of accounting analysis determine which benefits and obligations have been ignored in the F/S and which
have been recognized but incorrectly valued.

Components of Financial Statements


[ASSETS] Accounting does a good job at recognizing and valuing future benefits associated with financial resources (@
fair value) but does a poor job at recognizing and valuing future benefits associated with operating resources accounting
only recognizes a subset of future benefits associated with operating resources and value these benefits based on what they
cost, rather than on the value of the cash flow streams they are expected to generate.
[EQUITY] Changes in equity due to 2 main reasons owner contribute/withdraw assets from the firm and business
operations leading to changes in assets and liabilities (value creation)
Income statement only reports changes in assets and liabilities resulting from the firms business operations, and not
those resulting from investing and financing transactions
Ending Equity = Beginning Equity + Income Net Distributions to Equity Holders

Clean Surplus Relation


Income = Change in Equity (reinvested income) + Net Distributions to Equity Holders (distributed income)
[OPERATING PROFIT] Profit associated with firms ongoing operating activities primary driver of firm value
**Distinguish between operating vs non-operating, recurring vs non-recurring
[GAINS] Increase in assets that are incidental/peripheral to the firms operating activities
[Discontinued Operations] Report gain/loss from sale of a major division/segment on an after-tax basis
[Extraordinary gains and losses] Must be unusual in nature and infrequent in occurrence sufficiently infrequent natural
catastrophes

Accounting Information and Valuation

B/S measures the cumulative amount that has been invested in the past to generate future sales transactions
P/L measures the expected benefits associated with sales transactions consummated during the current period
Past FS provide the starting point for forecasting the future FS, which are then used to value the firm
BV of firms which has invested substantial amounts in R&D are understated, as R&D are expensed when incurred.