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Corporate Finance
University of Connecticut School of Law
Kwak, James Y.

Corporate Finance Kwak
Ch. 2 Financial Statements & Cash Flow
Balance Sheet
Assets = Liabilities + Equity
Can rearrange the equation to find the missing one
Assets – Liabilities = Equity
Equity =
Common stock at par value (par value x number of shares sold)
+  additional paid-in surplus
+ accumulated retained earnings
Net working capital = Currents Assets – Current Liabilities 
How much cash is tied up in the business to keep it running
Income Statement
EBIT = (profits before interest and taxes)
(Net) Sales
– Depreciation
– SG&A Expenses
Taxable income = EBIT – Interest paid
Net income = taxable income – taxes            
Net income notionally owned by shareholders
Addition to Retained Earnings = NI – dividends
Accumulated profits – dividends
Cash Flow
CF from Assets = CF to creditors + CF to stockholders
Negative if the company is investing at a very high rate
CF from Assets = OCF – net capital spending – increase in NWC
Think of OCF as the amount if company never had to invest in fixed assets
Net capital spending = amount you spend on new fixed assets
Operating cash flow = EBIT + Depreciation – Taxes
Net capital spending = depreciation + increase in net fixed assets
Ex. building new stores or factories
CF to Creditors = interest paid – net debt issuance
Net debt issuance = borrowing or paying back money to creditors
CF to Stockholders = dividends – net equity issuance
Ordinary activities (buying and selling) generate a  lot of cash à OCF
Some cash is invested in fixed assets (“expensive stuff”) à net capital spending
Company grows, more money needed in cash register  à increase in NWC
Review Ch. 2 Problems
14.       CF to creditors à “redeem” debt means paying it back
CF to stockholders à sold stock means new equity raised
Ch. 3 Financial Statement Analysis
Why evaluate financial statements?
Internal uses
Performance evaluation – compensation and comparison between divisions
Planning for future – guide in estimating future cash flows
External uses
Common-size income statement (Totals 100%)
Income statement expressed in percentages
Useful in comparing companies across an industry
Profit margin = net income on common-size income statement
Categories of Financial Ratios
Liquidity ratios – how quickly it can be transformed into cash
Current ratio
Current assets / current liabilities
Quick ratio
(Current assets – current liabilities) / current liabilities
Financial leverage ratios – how much debt a company ha

thing company invested in
NI / total assets
ROE – return on equity. From viewpoint of shareholders, return on amount invested
NI / equity
ROE always greater than or equal or ROA
Market Value Measures
Share price = $88
Shares outstanding = 33 million
Earnings per share (EPS)
NI / shares outstanding
Note: number of shares outstanding is arbitrary
Price/earnings ratio (P/E)
Share price / EPS
Essentially: amount you pay upfront / flow from the investment
You're buying a stream
How much investors are willing to pay for a company's earnings
How quickly profits company will grow relative to other companies
Ex. Apple P/E ratio = 18        vs.       Altira (cigs) P/E ratio = 8
Apple better future growth potential
P/E ratio – can be used to estimate how optimistic (or not) entire market is but, can never really know if stock market is overvalued or undervalued
Price/sales ratio
Share price / sales per share
Share price / (sales / shares outstanding)
Ex. start-up company who has a negative P/E