Using the GAAP balance sheet, for each item, determine where it should be classified in the economic balance sheet (i.e., core operations, nonoperating net assets, debt claims, other capital claims, or equity claims). Create a two-column table in Word to show the corresponding accounts.
Determine whether any other items should appear on the economic balance sheet that is not on the GAAP balance sheet.
Determine if information exists in the annual report or elsewhere that can assist in valuing the nonoperating net assets, debt, and other capital claims.
Find the beta for your company http://finance.yahoo.com/q/ks?s=AIG
Estimate your company's cost of equity.
Estimate your company's weighted-average cost of capital.
Estimate your company's unlevered cost of equity.
Show your calculations in an Excel document. Be sure to label each calculation clearly.
A NOTE ON ECONOMIC BALANCE SHEET
A balance sheet is a statement of the book value of a business or other organization or person at a particular date, usually at the end of its "fiscal year,"
Limitations of GAAP BALANCE SHEET
GAAP is an acronym for Generally Accepted Accounting Principles. Generally accepted accounting principles (GAAP) are the accounting rules used to prepare financial statements for publicly traded companies and many private companies in the United States.
Financial reporting should provide information that is:
* Useful to present and potential investors and creditors and other users in making rational investment, credit, and other financial decisions.
* Helpful to present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts.
* About economic resources, the claims to those resources, and the changes in them.
A conventional balance sheet is primarily based on the historical cost of tangible assets, which may not describe a business well:
1. Asset market values much different than book
2. Various classes of assets and liabilities excluded that could be large and risky:
- Off-balance sheet debt
- Contingent liabilities
- Intangible assets
- Contingent assets
These "gaps in GAAP" may be particularly significant for companies in volatile commodity markets, High tech/R&D, Service industries.
Economic Balance Sheet
It gives the total enterprise value. An economic balance sheet (EBS) restates and consolidates your assets and liabilities, whether on or off-GAAP books, to give a structural explanation of the market value of your equity:
A firm can be thought of having two basic components of value:
1) Value-in-use of existing assets and, 2) value of growth options to opportunistically expand (or contract) to capture value as market conditions change.
These growth options stem from strategic advantages such as scale economies, product complementarities, first-mover advantages, etc.
Typically, they are not reflected on the GAAP balance sheet
In GAAP, intangibles only show up as "Goodwill" valued at historical cost*
- Only reflects intangible value of acquisitions, not own businesses
- Probably ...
This solution discusses the economic balance sheet of Harley Davidson in the attached Word document and provides financial calculations in the attached Excel file.