Economics 434
Professor Burton
Fall 2015
August 27, 2015
Questions about value
• What determines value?
• How is valued traded from one person to
another?
• How should I “invest” to increase value in an
optimal way?
• Value comparisons – Balance Sheet, Income
Statement, Stock
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Balance Sheets define “Book Value” for a business
at a specific point in time
Balance Sheet for XYZ Corporation, August 28th, 2014
Assets
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Liabilities
+
Net Worth
Balance Sheet for XYZ Corporation, August 28th, 2014
Assets
Liabilities
+
Net Worth
• “Book Value” is Net Worth (can be negative)
• LHS of Balance Sheet is “operational”
• RHS of Balance Sheet is “financial”
• If there are no liabilities, value of Assets is Book Value
• Value of a business is not Net Worth
• Value of a business is Liabilities + Net Worth
August 27, 2015
What is bankruptcy?
• Bankruptcy means owners of liabilities
(creditors) take over company
• Only the RHS of the balance sheet will change
initially
Can’t pay interest on
debt (liabilities)
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Default
Owners of liabilities
(creditors) take over
company
What happens in bankruptcy?
• Net Worth is zero and the Creditors take over
• Equity holders wiped out
Next steps
Chapter 7
• Liquidation of assets
• Proceeds paid to creditors
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or
Chapter 11
• Liabilities converted to
new debt + new equity
(recapitalization)
• Emerge from bankruptcy
as Newco
After bankruptcy
Balance Sheet for XYZ Corporation, August 28th, 2014
Assets
Liabilities
With Chapter 11, becomes
Emerging from bankruptcy
Balance Sheet for Newco Corporation, August 29th, 2014
Assets
August 27, 2015
Liabilities*
+
Net Worth*
Key takeaways about bankruptcy
• Equity becomes zero
• Owners of debt/liabilities take over
• Most importantly, assets are unchanged (they
don’t disappear or become worthless)
• Two outcomes:
– Either liquidation (Chapter 7) or
– Recapitalization (Chapter 11)
August 27, 2015
Remember this about balance sheets
• LHS is “operational” side
• RHS is “corporate finance” side
Balance Sheet for XYZ Corporation, August 28th, 2014
Assets
Operational
August 27, 2015
Liabilities
Corporate
+
Finance
Net Worth
What is an Income Statement?
• Compared to Balance Sheets which show asset
positions “at a point in time”, Income Statements
show revenue “over a period of time”
• I/S connects two balance sheets together (or
“updates” a balance sheet)
• Income is a “flow”, assets are a “stock”
• Typical corporate time periods:
– for a quarter
(e.g. threeIncome
months ending
Sept
30th)
Balance Sheet
Balance
Sheet
2013
Statement st
2014
– annual (e.g.
year ending
Dec 31 )
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How does income relate to the Balance Sheet?
Balance Sheet for XYZ Corporation, August 28th, 2014
Assets
Liabilities
+
Equity
Debt Service
Income
• Income is earnings remaining after “debt service.” Debt
service is any fixed payments to liabilities (e.g. bank loans,
corporate bonds, etc.)
• Equity (net worth) owners own the income
• Income can be positive or negative
• Updating Balance Sheet affects both LHS and RHS
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What is common stock?
• Common stock owns the “Net Worth” section
of the balance sheet.
• Common stock can become more valuable
(capital gain) or less valuable (capital loss)
• Common stock can receive dividends
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Public vs Private Stock
Public Stock
Private Stock
• Public stock is what you buy
through a brokerage firm
• Never might know who the
buyer/seller on the other side of
the transaction is
• Trading is on an exchange
• Issuance and trading (buying and
selling) is regulated by the
Securities and Exchange
Commission (SEC)
• Only registered representatives of
broker-dealers can make offers to
buy and sell
• Not germane to our course; buy
through private placement
• Always know who the
buyer/seller on the other side of
the transaction is
• No wide-open exchange
• Not as heavily regulated because
not bought by or sold to public
August 27, 2015
Public Stock
• Main subject of this course
• Anonymous purchase and sale using a broker-dealer
registered with SEC
Return has two main components
Capital Gain
Dividend
• Increase in stock
value
• Pt+1 - Pt
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• Cash payments
• Usually every 3
months
• Dt
Where P is price, t is time, D is dividend at time t
August 27, 2015