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Accounting 523 – Spring 2001

Advanced Financial Analysis

Professor Terry Shevlin

Tuesday & Thursday 10.30-12.20pm, Balmer 211.

Office: Mackenzie 262 shevlin@u.washington.edu

Office Phone: 206-543-7223

Office Hours: Tuesday and Thursday 3.30-5.00pm

and by appointment or drop by.

I. Course Description

This course is an introduction to financial statement analysis (FSA) that will provide you with:

Financial statement analysis skills and techniques for deriving inferences from financial statements and related information. These skills include fundamental analysis, forecasting, preparation of pro-forma financial statements, and estimation of future cash flows.

A framework for business valuation using financial statement data and other information.

Insights into the usefulness, and the limitations of Financial Statement Analysis as applied in different decision contexts (e.g., investment decisions, lending decisions, performance evaluation, etc.).

An understanding of how incentives facing the producers and users of financial statement disclosures affect the content of these disclosures and the inferences they convey.

An understanding of the financial statements, accounting issues, and valuation problems facing the analyst interested in high tech and E-Businesses.

This course is intended for students with little or no background in security analysis. Students with work experience in security analysis or related fields will probably find this course redundant.

These objectives are ambitious, requiring a synthesis of: (1) traditional financial analysis techniques (ratio analysis, common size statements, forecasting, etc.), (2) knowledge of generally accepted accounting principles and their applications, and (3) the application of valuation frameworks from economics and finance.

A mastery of financial statement analysis skills also requires “hands-on” experience. To provide that experience, we will be using a number of example companies throughout the quarter; however, this course is not intended to be a “case course.” Material from the cases will be used to illustrate and practice application of the techniques being learned. Each student is expected to read and prepare the materials for each case so that they can participate in the discussion.

Each student working as a member of a group of up to 4 students will prepare an analysis of a firm in “real time.” The results of each group’s analysis will be presented by the group to the class and posted on the web available for all students in the class to review. If you include proprietary information, contact the instructor to make appropriate arrangements.

For all students to obtain the maximum benefit from this class it is essential that each student participate. In order participate you will need to adequately prepare for each and every class. During class I want you to ask questions, offer examples, and contribute to discussions. Your grade will reflect your class participation.

II. Course Materials

Required Texts

1. Palepu, Healy, & Bernard (PHB), Business Analysis & Valuation: Using Financial Statements, 2nd Edition, Text only, South-Western, 2000.

Recommended

1. Popular business publications (WSJ, BW, Forbes, Fortune, Barrons, etc.). Renew your subscriptions at student rates while you can. If you don't have subscriptions to The Wall Street Journal, start it.

2. An intermediate financial accounting text.

Other Financial Statement Analysis Texts (for future references)

1. White, Sondhi, & Fried, The Analysis and Use of Financial Statements, 2nd Edition, Wiley 1997.

2. Penman, Financial Statement Analysis & Security Valuation, McGraw-Hill Irwin, 2001.

III. Grading

Your grade will be based on a midterm exam, your project, a final exam, and class participation:

|Class Participation |20% |

|Student Group Project |30% |

|Midterm Exam |20% |

|Final Exam |30% |

The midterm and final exams will concentrate on your knowledge of technical financial analysis skills (ratios, forecasting, valuation models, etc.). A sample midterm and final will be available on the course web site. You may prepare and use a one page handwritten note sheet for both the midterm and final exam.

If you disagree with the grading of an exam, state the disagreement in writing and submit the entire test for re-grading.

IV. Student Group Projects

Each student must organize with a group of three other students. Each group is to select a unique firm to analyze. Firms are reserved on a first come first serve basis. Firm selection is due no later than April 5, 2001, and as students select a firm they should e-mail me and I will post them on the course website to avoid duplications. A first preliminary ratio analysis with comparison to industry norms is due on Tuesday, April 17. A second preliminary report is due on Tuesday, May 8 and should include an economic analysis, strategy analysis, and preliminary forecasts. These preliminary analyses will be handed back with a +/- grading. A final executive report is due on Tuesday, March 6. Your final report should have 3 sections: (1) a 1-page executive summary, (2) analysis, and (3) supporting exhibits and tables. The report should be double spaced and approximately 8-10 pages long, excluding exhibits. For this report you should take one of the following user perspectives: Investor, Creditor, Stock Analyst, Competitor, Acquirer, Venture Capitalist, Stockholder, Other (be imaginative).

Student group projects will be graded on the quality of analysis presented and the quality of the writing. Past experience has shown that many students focus on the quantitative aspects of the project while ignoring the importance of effective organization and communication of their analysis.

Students must also submit their reports in electronic format (either Office compatible, Adobe Acrobat pdf file, or html document). The electronic reports will be posted on my website so that other students in the class may download them and gain from their peers' efforts.

V. Overview of Types of Issues/Questions to be Addressed in the Class

What is the incremental profit per dollar of sales for ? When will break-even (if ever)?

What are cash burn rates? Why are they important?

What is traditional financial statement analysis? Can it be applied to high-tech and E-business stocks?

What are important accounting issues that the analyst must consider? What issues are there specific to high technology and E-business stocks? ESOs, revenue recognition (gross or net revenue, barter revenue, expense classification, etc.

What are the similarities and differences in dividend discount models, discounted cash flows models, and residual income valuation models? How does residual income relate to EVA models?

Why do analysts forecast earnings and not cash flows?

How does one value a firm with no profits? Revenues? Non-financial performance measures?

What are tracking stocks? Who uses them? Why? How do we value them?

Issues in mergers and acquisitions? Valuing the target. Purchase versus pooling – what is it and why might it matter?

Is it possible to predict financial distress?

V. Tentative Class Schedule:

This schedule is tentative and I will adjust the time spent on topics depending on actual progress. Additional supplemental assignments will be distributed during the quarter.

PHB = Palepu, Healy & Bernard.

|Class # |Date |Topic |Reading |Assignments |

|1 |March 27 |Course Overview and Introduction |PHB Ch. 1 |Browse Cisco AR |

|2 |March 29 |Framework for Business Analysis |PHB Ch. 2 |Strategy analysis for Amazon, Dell, or Cisco |

|3 |April 3 |Financial Analysis |PHB Ch. 9; |Prepare ROE decomposition for Cisco |

| | |- Profitability analysis |pp 9-1 to 9-10 | |

|4 |April 5 |Financial Analysis |PHB Ch. 9 |Prepare for Cisco |

| | |- Turnover ratios, liquidity and leverage |pp 9-11 to 9-22 |Group Project company selected |

|5 |April 10 |Financial Analysis |PHB Ch. 9 |Prepare for Cisco |

| | |- Cash flow analysis |pp 9-22 to 9-29 | |

|6 |April 12 |Forecasting: |PHB Ch. 10 |Prepare for Cisco |

| | |Sales and earnings, annual and quarterly |pp 10-1 to 10-8 | |

| | | |and 10-13 to 10-16 | |

|7 |April 17 |Forecasting: |PHB Ch. 10 |Prepare for Cisco |

| | |- Income statement and balance sheet |pp 10-8 to 10-13 |Group Project – Ratio Analysis Due |

|8 |April 19 |Forecasting |PHB Ch. 10 |Prepare for Cisco |

| | |- Statement of cash flows |pp. 10-11 to 10-12 | |

|9 |April 24 |Valuation |PHB Ch. 11 |Handout problems |

| | |- The basic models | | |

|10 |April 26 |Valuation |PHB Ch. 11 | |

| | |- The basic models | | |

|11 |May 1 |Midterm | | |

|12 |May 3 |Valuation |PHB Ch. 12 |Prepare spreadsheet for Sigma valn. |

| | |- Terminal value calculation | | |

|Class # |Date |Topic |Reading |Assignments |

|13 |May 8 |Valuation |PHB Ch. 12 |Prepare Cisco valn |

| | |- Application | |Group Project –Analysis and Forecasts Due |

|14 |May 10 |Valuation |Handouts | |

| | |- Nonfinancial information | | |

|15 |May 15 |Equity Security Analysis |Ch. 13 | |

|16 |May 17 |Credit analysis and distress prediction |Ch. 14 |Calculate Cisco scores |

|17 |May 22 |Mergers and acquisitions |Ch. 15 | |

|18 |May 24 |Some Acctg Adjustments: Leases | | |

|19 |May 29 |Wrap-up and | |Group Projects Due |

| | |Group Project Presentations | | |

|20 |May 31 |Group Project Presentations & Wrap-Up | | |

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