Accounting Question - Record an equity injection?
Questions for those who are gracious enough to answer:
1) How do you record an equity injection into a firm given that the par value of the stock is trivial (e.g. 1c compared to 100 dollar issue price).
2) On a related note, how do you account for the exercise of options. Let's say your stock is worth $100, and a major investor just exercised 100 call options with a $50 strike price.
3) In calculating FCF, what's the logic behind using EBIT(1-t)... Why do you keep use this depreciated and amortized EBIT figure, as opposed to using EBITDA(1-t)...
Your input is much appreciated!
The only one I'm confident in answering is #3.. im going to take a stab at the other two just for fun
3 You CAN use <abbr title="earnings before interest tax depreciation and amortization">EBITDA
(1-t), since you will be adding D&A back to EBIT(1-t) anyway. It's just easier to start with EBIT since that is the same as operating income off the income statement, and then you can add D&A from statement of cash flows. 1 is something like (assume 100k shares issues), 1c * 100,000 shares issued = $1000 cost of issuing stock (i forget the term for this) which goes into Shareholders Equity. if it is issued at $100, you then do 99.99 * 100,000 = 9,999,000 of paid-in capital, also under Shareholders Equity. Then increase "Cash" (i think?) under Assets by 10,000,000 to make it balance. you also increase cash from financing in statement of cash flows. i dont think net income is affected, but if you issue 100,000 shares it will be dilutive to EPS 2 involves treasury stock method which I don't know too much about.. but i think the process is similar to question #1. i assume its soemthing like... since each call option = 100 shares, you increase paid in capital (shareholders equity) and cash by 50 * 100,000 = 5,000,000, increase cash from financing by 5,000,000 as well, and dilute EPS by 100,000 shares (net income is not affected)im definitely missing something important from #1 and #2, interested to know what
Thanks! Any more input would be appreciated
and how about:
4) How do you derive cost of equity from a P/E ratio? My friend got this question on an interview on Friday, and he told me he used Re = 1/PE. So, if PE = 20 --> Re = 5%. Is that right?
Cost of equity is the inverse of P/E. So it's correct.
gotcha. any more input on accounting for equity injection and/or option exercises?
For option exercises, I'm not totally sure what you are looking for, but shares outstanding would increase by [(Stock Price - Strike Price)/Stock Price] * 100 * Shares per Option. That's the Treasury Stock Method at least. How C/S Par Value and C/S APIC will increase depend on the par value of the stock, and the cash can be used to buy back shares (in this case, buy back 50% of the shares issued through the options).
im pretty sure EBITDA(1-t) is not the same as EBIT(1-t)+DA, unless you add back the depreciation tax shield to EBITA(1-t), then they will be the same.
from my understanding, you use EBIT(1-t) to calculate in the effect of depreciation tax shield, then adding back depreciation and amortization because they are non cash expense.
ok i guess i really dont get this, hope someone can help
I thought EBIT(1-t) is to take away the affect of taxes, since those are paid out to the government and not holders of capital. i guess i was wrong about this.
can anyone explain how the (1-t) in EBIT serves as an adjustment for depreciation tax shield?
well, in the case of EBIT, you already substract out the depreciation.
then by taking the 1 -t of it , you are only deducting 1-t of the depreciation from the net income. Then you add back depreciation because of the non-cash charge. By doing so, you actually increase your free cash flow because of this weird accounting rule saying that you have to take account of depreciation.
ohh.. okay i get it now. i do understand that depreciation increases cash flow because depreciation is pre-tax charge
so by taking EBIT(1-t) you are getting rid of the effect of taxes AFTER depreciation is subtracted, which is essentially a tax benefit since the cost of taxes on EBIT are less that of EBITDA
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