ACC421E Valuation with financial statement analysis

• Topics

  This course aims to provide students who aspire to become future business leaders, such as entrepreneurs and professional investors, with the knowledge of how to effectively communicate business value creation using financial statements.

  The primary objective of any business is to create value for its stakeholders, and financial statements are a vital source of information about business performance and status. Accordingly, this course is designed to develop a framework for linking firms' value creation to their financial statements.

  We cover the following three topics:

  1. Review of financial statement analysis

  We review (1) how financial statements reflect firms' underlying economic value and value creation; (2) how to construct a financial statement-based value indicator, return-on-investment-capital (ROIC), and its components, and (3) how to link ROIC to value creation.

  1. Theory of accounting-based valuation models and applications

  We learn the theoretical motivation of two accounting-based valuation models: (1) Residual Income Model (RIM) and (2) Abnormal Earnings Growth Model (AEGM). We start with a comparison to the Discount Cash Flow Model (DCF) and discuss the relative advantages of the accounting-based models.

  Then, we apply the accounting-based valuation models to cases. We actively discuss how business value creation processes are reflected in the different components and the assumptions of the accounting-based valuation models.

  1. Issues in Valuations

  Suppose the accounting measurement does not reflect the underlying economics. In that case, accounting-based value indicators are poor indicators of value creation, and calculations based on the accounting-based model will give us a biased and inaccurate valuation.

  In these sessions, we study business cases for identifying the challenges in accounting measurements of the underlying economic nature of business transactions and evaluating different measurements.

  Then, we address (1) forecasting future earnings, (2) terminal value assumption, and (3) sensitivity analysis.

• Learning outcome

  General Competence

  By completing this course, students are (1) equipped with a solid theoretical background in accounting-based valuation models and (2) able to effectively communicate the value creation of any business with strong analytical and communication skills.

   

  Knowledge

  1. Review of financial statement analysis

  Upon completing the sessions, students are expected

  1. (1) to be familiar with how to use financial statements to calculate return-on-investment capital (ROIC) and its components
  2. (2) to understand the relative advantages and disadvantages of ROIC and other indicators such as cash-based performance indicators (e.g., cash flow return on investment or EBITDA on investment)
  3.  

  2. Theory of accounting-based valuation models and the applications

  Upon completing the sessions, students are expected

  1. (1) to understand the theoretical motivations, assumptions, strengths, and limitations of accounting-based valuation models, including the Residual Income Model (RIM) and Abnormal Earnings Growth Model (AEGM)
  2. (2) to link RIM and AEGM with the valuation ratios, PB, PB, and PEG

  3. Issues in Valuations

  Upon completing the sessions, students are expected

  1. (1) to understand the significant accounting measurement issues reflected in the economic substance of business transactions.
  2. (2) to understand the techniques for forecasting and the sensitivities of valuation to terminal value assumptions.

   

  Skills

  1. Review of financial statement analysis

  Upon the completion of the sessions, students are expected to be able

  1. (1) to calculate ROIC using firms' financial statements
  2. (2) to explain how ROIC is related to the underlying economic substance of business transactions
  3.  

  2. Theory of accounting-based valuation models and the applications

  Upon the completion of the sessions, students are expected to be able

  1. (1) to apply the accounting-based valuation models for real company cases
  2. (2) to effectively comminute business value creation using the accounting-based valuation models

   

  3. Issues in Valuations

  Upon the completion of the sessions, students are expected to be able

  1. (1) to identify accounting measurement issues and critically evaluate alternative accounting methods for business models
  2. (2) to forecast earnings and calculate the continuation value
  3. (3) to conduct sensitivity analysis

• Teaching

  The first half of this course mainly comprises of lectures to give students a strong understanding of accounting-based valuation models. In the meantime, students are expected to actively engage in the class by asking questions for clarification and better understanding.

  In the second half of this course, we will employ several case studies to apply accounting-based models. Throughout the discussion, we will focus on developing and then communicating the intuition for how accounting measures reflect the economic substance of business.

• Recommended prerequisites

  No prerequisites are necessary. Yet, the knowledge of financial accounting (strongly recommended) and investment would be helpful.

• Required prerequisites

  No prerequisites are necessary. Yet students with background knowledge in financial accounting and corporate finance will find it easier to follow the lectures.

• Credit reduction due to overlap

  ACC421E is a continuation of BUS440E, and cannot be combined with BUS440A, BUS440B, BUS440E, BUS440, FIE437, BUS425, BUS457, MRR413A and MRR413B.

• Compulsory Activity

  More than or equal to 60% of class attendance is required.  

• Assessment

  1. Assignments (20%)
  2. Group project: based on slides and the presentation (30%)
  3. Three-hour final school exam (50%)

• Grading Scale

  Grading scale A - F.

• Computer tools

  MS Excel, calculators

• Literature

  For sessions in 3. Inssues in Valuations, we will use the following two HBR cases:

  • 'Accounting for Virtual Goods at Zynga', Paul M. Healy; Gwen Yu; Aldo Sesia, Harvard Business Publishing, case #115005-PDF-ENG

  You can refer to the following text books for your reference (i.e., recommended but not required). Related chapters will be noted for each section if needed. 

  • Palepu, Healy, and Peek, 2022. Business Analysis and Valuation: IFRS Standards , Cengage, 6th edition. [ISBN: 9781473779075]
  • Koller / Goedhart / Wessels ("The McKinsey Book"), Valuation, 7th Edition, McKinsey & Co (2020)