🙋 Student Q&A (Lecture 3)

Click here to learn about timestamps and my process for answering questions. Section agendas can be found here. Email office hour questions to robmgmte2700@gmail.com. PS1Q2=“Question 2 of Problem Set 1”

📅 Questions covered Saturday, Feb 14

🕣 2:21
❔ I had a question about the assignment. When we click to start the assignment, is it timed? Do we need to complete it in one sitting? Or can we start the assignment and come back to it? Thanks.

✔ You don’t need to complete it in one sitting. You have all the time until the due date. On the due date, it won’t submit, but I will submit it the following morning. Certainly, you can’t work on it after the due date has passed. You can find the due dates in the syllabus.

🕣
❔  I was recently thinking about an EV scenario where say company ABC has no debt and quite a bit of cash, and is going to be acquired. In this instance, I view the entity as having two options:

• Pay the cash out prior to sale; or
• The purchaser pays for the operating assets and non-operating assets (i.e., the cash) or, in essence, the left side of the B/S (market cap. > EV). I’m thinking the acquiring company may want to do this if they have an immediate use for the cash and don’t want to do any additional equity raises at the moment.

Is my line of thinking here sound?

✔ Typically in an acquisition, the acquirer will raise enough money so that they can purchase the company, including all of the company’s cash assets. As a result, they’ll have to raise more money. If a company has $2 billion of cash, then they’ll have to raise $2 billion more.

At the same time, the lenders won’t mind because they’ll know that they are lending the money specifically for this cash acquisition. They are essentially using the cash of the acquired firm as collateral for the lending, because they’re only going to get the money if they make the acquisition. In this sense, enterprise value is a good indication of how much money they actually have to raise when purchasing the company. They will have to raise enough money to purchase the cash of the firm, but because that cash is collateral for that fundraising, it will be hard to raise that money.

Don’t worry about this too much. I mean, this isn’t a class on leveraged buyout, but a student asked, so I’m just gonna answer the question.

🕣 2:26pm
❔ Costco

✔ I can’t verify specific answers, but I can always answer specific interpretation questions. There’s a lot of vagueness in this, so I think I can give you the help that you want. I just need a specific question. If you give me a specific question, we’re good to go.

📅 Questions covered Monday, Feb 16

🕣 7:44pm
❔ I am writing to see if we could meet to go over each of the financial statements and ratios. Specifically, I would like to discuss what each of these helps to solve for or indicate in a real-life business context.

✔

🕣 8:47pm
❔ Do I have to submit the assignment? Do I have to save?

✔ You don’t have to submit the assignment. If you don’t submit the assignment, I will submit it for you the following morning. Don’t worry about it. You don’t have to submit the assignment. Not submitting the assignment means that you always have the option to update your answers later, because once you submit it, you can’t do that any more. Of course, if you want to see what grade you got, you can submit it early. Lots of people want to do that, and it’s a personal choice.

My lab will say, “Well, it has an autosave functionality, and it’ll save your answers to the server every, I think, 10 seconds.” It’ll also save your answers to the server whenever you go to another problem in the same problem set. If you put an answer in extremely quickly and then immediately close it, there is a small chance that you could lose some data.

It’s never going to hurt to go to a previous question and go back to the question that you just entered the data in. Check to make sure that your answer is there, and you’ll see that your answer is there, and you’re good to go. It also saves the data when you go to another problem, so you don’t have to save essentially.

🕣
❔ This is a lot of ratios to remember and I know you are building out the formula sheet for us. Will this be something we have to memorize, or will the formula sheet be available on the tests?

✔ The exam is open book, so any formula sheets are completely fine. You just need to make sure you understand the formulas so that you can apply them and think with them.

🕣
❔ When calculating ratios like turnover (efficiency) or conducting a Dupont analysis, should sales represent total sales? For example, suppose you’re dealing with a car dealership and they have sales from selling vehicles and receive warranty revenue, would the figure we use be total sales (i.e., vehicle sales plus warranty revenue)?

✔ You’d want to use all revenues. You’d include both the revenue from selling vehicles and the warranty revenue because both generate revenue. A buck is a buck, and whether you get it from one program or from another, it’s still revenue.

🕣
❔ When calculating turnover ratios, should the denominator be an average figure since we’re comparing an income statement item to a balance sheet item or for this class are we just assuming total amounts for the latter for simplicity purposes?

✔ Unless the formula specifically has the word “average” in it, you just want to use the quantity from that year.

Since the formula doesn’t mention average, you don’t apply the average. The great thing about Bruce’s courses is that they’re completely self-contained. If you watch the lectures and get what he says in the lectures, you’re good to go.

🕣 8:58pm
❔ If we have a decrease in assets (e.g., an uninsured theft of inventory, or a failure in collecting accounts receivable), how would this impact equity? My guess is that it has to impact equity, since the balance sheet needs to be balanced. But the impact is indirect, because losing inventory doesn’t automatically reduce equity. I believe it decreases the net income earned after a few months (because you can’t sell the stolen inventory), which will then decrease net income, so the firm is less able to accumulate retained earnings, which will then in turn decrease equity and even out the balance sheet. Is this thinking correct? But what if my inventory is stolen on December 30 and the balance sheet is drafted on December 31. In this case, one day wouldn’t be enough to impact net income and retained earnings, so the balance sheet would be unbalanced. This feels weird to me. But is this so?

✔ So the real question here is, have the accounting statements been updated to reflect the change? You can assume the accounting statements have been updated to reflect the change. Because that has happened, your logic is absolutely correct. That equity would decrease along with the decrease in the corresponding assets.

The balance sheet is designed to reflect the state of the firm at a given point in time. If the inventory is stolen on December 30, then when they create the balance sheet as of December 31, it should balance. The assets should be written down without any other corresponding change except for a decrease in shareholder equity. Indeed, your logic is correct, as you originally stated it.

🕣
❔ If we decrease cost of sales for a product (e.g., by reducing COGS) by a certain percentage, can we say that inventory is decreased by the same percentage? This goes back to my question on Saturday, where I stated that inventory is complex as it is heterogeneous (raw materials, partially finished goods, finished goods).

✔ The answer to this comes down to how accountants calculate value. Accountants practice historical cost accounting, which means that the value of all of the goods on the balance sheet is based on the price that was paid when they were originally purchased.

If the firm’s engineers make a new discovery, which allows them to produce their new product at a lower cost, that doesn’t change the historical cost of the goods that have already been purchased. Therefore, inventory will not be decreased by the same percentage, so raw materials will still be booked at their original cost because of historical cost accounting. Final products will still be booked at their final cost because the price of the good hasn’t changed, only the cost of the good has changed. Thus, we aren’t going to have to worry about changing anything. There should be no effect on inventory.

🕣 9:06pm
❔ Also, if we decrease inventory by a certain percentage, my assumption is that we even that out on the left side by having to use less cash, or on the right side by having to use less liabilities or retained earnings to build up the inventory. So this decrease in inventory can have an impact on the book value of equity (by using retained earnings), but this is not necessarily so. Is this correct?

✔ If a warehouse burns down and you have to decrease the value of inventory by a certain percentage, then that is a decrease in a specific asset without any other corresponding category on the balance sheet, or any other corresponding account on the balance sheet that needs to change. Therefore, to balance the balance sheet, you’re going to have to write down stockholder equity. When inventory decreases in value, I’m not saying that it has; I’m just saying that if inventory decreases by a certain value because of, for example, a fire, then stockholder equity would go down by the same amount.

This makes a lot of sense because if you own something and it burns down, you will have gotten poorer, and stockholder equity represents your net worth. You just got poorer; your stockholder equity declines.