Tutorial 1

BUSI97318
Corporate Finance
Tutorial 1
MSc Finance and Accounting
Adrian Lam
y.lam16@imperial.ac.uk
Imperial College London
October 16, 2019

Logistics Reading 10-K Ratios Conclusion
About Me
Profile
Adrian Lam (3rd year PhD)
Office Hour: Thursdays 10:00-11:00
(Location: See Calendar)
Research interests: Empirical corporate
finance, particularly in environmental, social
and governance issues, corporate social
responsibility and socially responsible
investing
2nd time Graduate Teaching Assistant for
this course, feedback needed!
Know the struggle: Form C+ to A+
Attended all lectures last term
Created detailed solutions for
coursework
(Also TAed for the Applied Projects
last term)
Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 1 / 29
Go to Class (Please)!

About the Tutorials
Goal
Help you master the tools
Help you prepare for coursework and the exam
NOT a recap of lectures
Structure
First week: Reading a 10-K filing
Sandwich weeks (2-7): Giving out hints for problem sets before
submission; going through solutions after submission
Last week: Exam prep and Q&A!

Coursework and Questions
Coursework
3 problem sets, will be available on the Hub
Submit one clean, concise, to the point and typed-up PDF per group.
Show what you have learned!
Type out the formulae you used
Highlight your final answers
Submit Excel spreadsheets as a supplement if you want to (and I will
try to troubleshoot if you have arrived at a different answer)
Submit via the Hub
Questions
1 Discuss with your coursemates
2 Come to my office hours

Anchoring Expectations: Imperial College Mark Scale
Figure 1: Imperial College Mark Scale
College regulations do not allow us to give out Distinctions for free:

you have to earn your Distinction
70% is a very high mark here
That said, we try to be as lenient as possible subject to college
guidelines
Plan for Today
Plan for the day

1 Logistics
2 How to read a 10-K Filing

Key Accounting Standards: GAAP and IFRS
Two Predominant Accounting Standards

Generally Accepted Accounting Principles
Used in the United States
Refers to a common set of accepted accounting principles, standards,
and procedures that accountants must follow when they compile
financial statements
“Rules-based”, with more detailed financial information
International Financial Reporting Standards
Used in 100+ countries, including the UK and EU
Refers to a set of international accounting standards outlining the
particular types of transactions and other events to be reported in
financial statements
“Principles-based”, with more flexibility in financial reporting

Reading a 10-K
Goal
Highlight what a 10-K is
Highlight some of the more important concepts
Highlight where to look for financial information

Inputs from the Real World: SEC 10-K Filing
What is a SEC 10-K filing?

An annual report that summarises financial performance
comprehensively
Filed by listed companies in the United States
Required by the Securities Exchange Act of 1934
Contains company history, organisational structure, corporate strategy,
audited financial information, executive profiles and compensation, etc
Can be downloaded at SEC EDGAR Database
Other useful SEC filings
Form 10-Q: Quarterly financial statements
Form 8-K: Events or Changes Between Quarterly Reports

Balance Sheet and Accounting Equation
The Accounting Equation

Assets = Liabilities + Equity
Based on the system of bookkeeping known as “double-entry

bookkeeping”
A truly revolutionary idea that properly tracks what you have on the
left and how you financed them
Error detection is in-built
Earliest known accounting records in the modern double-entry
bookkeeping system
Amatino Manucci, a Florentine merchant
Employed by Giovannino Farolfi & Company a money lender, with the
Archbishop of Aries as the most important client
Late 13th century Italy

Consolidated Balance Sheet
Figure 2: Consolidated Balance Sheet: Total Assets (P. 40)

Noteworthy items in Assets

Current assets
Cash and other assets that are expected be converted into cash in a
year
Commercial papers here refer to those issued by other companies
Long-term marketable securities
Liquid financial instruments (e.g. corporate bonds and common shares)
that can be converted into cash at reasonable prices but recorded at
historical cost
Goodwill
Portion of premium paid in an acquisition, has to be tested for
amortisation

Figure 3: Consolidated Balance Sheet: Liability and Equity (P. 40)

Noteworthy items in Liabilities and Shareholders’ Equity

Current liabilities
Amount to be paid to creditors within a year
Commercial paper here refers to those issued by Apple
Some items (e.g. term debt operating leases) detailed elsewhere

Consolidated Statement of Operations
Figure 4: Consolidated Statement of Operations (P. 38)

Consolidated Statement of Operations

Noteworthy items in the Consolidated Statement of Operations
Net sales
Total revenues less returns, allowances and discount (Negative market reaction to
BlackRock and IBM’s revenue miss)
Operating income
Profit/loss incurred in usual business operations
Net income
(Residual) earnings attributable to common shareholders (Positive market reaction
to Netflix crushing EPS forecasts)
Shares used in computing earnings per share
Weighted average number of common shares outstanding held by company officers,
retail and institutional investors
Earnings per share (EPS)
Net income divided by shares outstanding
Diluted earnings per share
Net income divided by shares outstanding if all convertible instruments (e.g.
convertible preferred shares and bonds, stock options, etc) were exercised

Statement of Shareholders’ Equity
Figure 5: Consolidated Statement of Shareholders’ Equity (P. 41)

Statement of Shareholders’ Equity
Is the book value of equity the same as market value of equity?

Book value of equity
Equity invested in company
Less payout
Plus reinvested income (retained earnings)
Market value of equity
Stock price × Shares outstanding

Select Item (I): Term Debt
Figure 6: Term Debt (P. 56)
Term Debt
A loan with a fixed payment schedule and a fixed terminal date
Failure to pay according to payment schedule may result in
bankruptcy
Select Item (II): Operating Leases
Figure 7: Operating Leases (P. 61)

Select Item (II): Operating Leases
Operating leases
A contract that allows for use of asset(s) without conferring
ownership
Sizable lease payments: ≥ US$ 9.5B over 10 years
Contains mutiple-year renewal options
Useful in computing market value of debt
Operating leases to be reported both as an asset and a liability under
new accounting standards effective on 1st January, 2019 (See Deloitte
US and Deloitte UK for more information if you are curious)

Select Item (III): Liquidity and Capital Resource
Figure 8: Liquidity and Capital Resources (P. 30)

Select Item (III): Liquidity and Capital Resource
What is included in cash and cash equivalents?

Cash
Cheques
Highly liquid investments with ≤ 3 months maturity such as treasury
bills and commercial papers
Money market mutual funds
How much is this cash?
Average cash and cash equivalents held by Compustat firms in 2016:
US$ 1,892M
Cash and cash equivalents held by Apple: US$ 237,100M
Market value of Netflix (Early October 2019): US$ 119,440M
Why so much cash?
A large portion sits offshore would have been taxed twice if repatriated
to the US, see MarketPlace.com

Select Item (IV): Capital Return Program(me)
Figure 9: Capital Return Program(me) (P. 31)

Select Item (IV): Capital Return Program(me)
Payout policy
Retained earnings: Earnings kept as internal capital to fund projects
Return of capital: Principal payments (portion that exceeds growth of
business) to investors
Dividends
Share repurchases
Qualified dividends (i.e. stocks held long enough before ex-dividend
date) and capital gains tax are the same in the US

Select Items (V): Effective Tax Rate
Figure 10: Effective Tax Rate (P. 28)

Select Items (V): Effective Tax Rate
Effective Tax Rate

Average tax rate for corporation at which profits are taxed
Usually different from statutory income tax rate (curerntly 35%)
Geographical mix of earnings
Undistributed foreign earnings (e.g. earnings parked in Irish
subsidiaries)
Apple’s Plan to Repatriate Overseas Cash Holdings
Tax credits (e.g. R&D tax credits)
Use marginal tax rate in corporate finance
Tax rate incurred on each additional dollar of income

Profit Margins and Profitability
Profit Margins: How much profit you make out of your revenues
Gross Profit
Gross Margin =
Sales
EBIT
Operating Margin =
Sales
Net Income
Net Profit Margin =
Sales
Profitability Ratios: How efficient do you make out of your capital
Net Income
Return on Assets =
Total Assets
Net Income
Return on Equity =
Book Value of Common Equity

Wrap Up
Wrap-up
10-K contains a lot of useful information (both for your career and
coursework)
Learn how to make good use of a 10-K throughout this course!
Next Week
Coursework 1 preparation
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BUSI97318

MSc Finance and Accounting

Imperial College London

October 16, 2019

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 2 / 29

About the Tutorials

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 3 / 29

Coursework and Questions

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 4 / 29

Anchoring Expectations: Imperial College Mark Scale

Figure 1: Imperial College Mark Scale

College regulations do not allow us to give out Distinctions for free:

Plan for Today

Plan for the day

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 6 / 29

Key Accounting Standards: GAAP and IFRS

Two Predominant Accounting Standards

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 7 / 29

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 8 / 29

Inputs from the Real World: SEC 10-K Filing

What is a SEC 10-K filing?

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 9 / 29

Balance Sheet and Accounting Equation

The Accounting Equation

Based on the system of bookkeeping known as “double-entry

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 10 / 29

Consolidated Balance Sheet

Figure 2: Consolidated Balance Sheet: Total Assets (P. 40)

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 11 / 29

Consolidated Balance Sheet

Noteworthy items in Assets

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 12 / 29

Consolidated Balance Sheet

Figure 3: Consolidated Balance Sheet: Liability and Equity (P. 40)

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 13 / 29

Consolidated Balance Sheet

Noteworthy items in Liabilities and Shareholders’ Equity

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 14 / 29

Consolidated Statement of Operations

Figure 4: Consolidated Statement of Operations (P. 38)

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 15 / 29

Consolidated Statement of Operations

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 16 / 29

Statement of Shareholders’ Equity

Figure 5: Consolidated Statement of Shareholders’ Equity (P. 41)

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 17 / 29

Statement of Shareholders’ Equity

Is the book value of equity the same as market value of equity?

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 18 / 29

Select Item (I): Term Debt

Figure 6: Term Debt (P. 56)

Select Item (II): Operating Leases

Figure 7: Operating Leases (P. 61)

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 20 / 29

Select Item (II): Operating Leases

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 21 / 29

Select Item (III): Liquidity and Capital Resource

Figure 8: Liquidity and Capital Resources (P. 30)

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 22 / 29

Select Item (III): Liquidity and Capital Resource

What is included in cash and cash equivalents?

Adrian Lam (Imperial College) Tutorial 1 October 16, 2019 23 / 29

Select Item (IV): Capital Return Program(me)

Figure 9: Capital Return Program(me) (P. 31)