Cash Is King Bulletpoints

• 2 methods: LIFO last-in-first-out and FIFO first-in-first-out. LIFO accounting leads to a higher after-tax cash flow than FIFO accounting, despite the lower reported earnings.

• Switching from FIFO to LIFO should result in a lower share price due to lower earnings and vice versa; results in a higher share price due to an increased cash flow, which is what the DCF model predicts

• A business combination that is accounted for as a purchase requires that te difference between the price paid for the target and the book value of its assets (with some adjustment) be recorded as an asset called goodwill or amortization.

• The accounting model suggests that the market would react more favorably to pooling accounting than to purchase accounting because of the former’s higher earnings.

• Pure accounting manipulation doesn’t fool the market.

• To improve earnings at the expense of long-term cash flow: managers can reduce spending on research and development of capital goods. Reducing R&D spending will increase earnings in the short run, potentially at the expense of developing profitable new products for the long run. Similarly cutting back on value-adding capital spending will increase short-term profits because new capital projects often earn low profits in their earlier years.

• Leverage-increasing transactions could signal strong cash flows in the future.

• Even if the market is inefficient for moderate periods of time, managers should make business decisions as if the market were efficient.

• Market efficiency simply means that the market immediately incorporates all relevant, publicly available information about a company into its share price.

• What should matter to you as a manager making business decisions is the long-term behavior of your company’s share price, not whether it is 5 percent undervalued this week.

• The market behaves more like it using the DCF approach than the accounting approach.