# Expected EPS formula in Schweser notes

in Schweser notes book4 P212,the formula: Expected EPS= [(sales)(EBITDA%)-depreciation-interest](1-tax rate)…why not also -Amortization?

Since EBITDA% is used – D and A both should figure in the formula. However, most companies (manufacturing) would typically not have the A component in their income statement. CP

Interest expense occurs as there was some cash borrowing. So, beginning of year Borrowed cash = Increase in asset (an asset was bought with borrowed cash) End of year 1. Interest expense corresponding to borrowed cash 2. Payment of prinicpal (amortization) 3. Depreciation (wear and tear of asset) 4. Other operating expenses Two cases: 1. Now if purchase of an asset was expensed at start of year, then prinicpal amount will never be counted again as an expense (matching principle) 2. If purchase was capitalized then total non-cash expense=depreciation and amortization In first case prinicpal amount will never appear again on income tax reports of subsequent years —> no amortization Am I correct ??

amortization is for intangable asset, e.g. patent. , not for tangable asset, e.g. machines. and I checked CFAi book, don’t see this formula. do you have other reason?

annexguy Wrote: ------------------------------------------------------- > amortization is for intangable asset, e.g. patent. > , not for tangable asset, e.g. machines. > and I checked CFAi book, don’t see this formula. > do you have other reason? what about car loans and mortgages, they amortize too. This means part of the payment you make goes towards reducing principal amount and remaining to interest.

yes, pay back principle of loan and mortgage is amortization. and it use cash, and defineitely reduce the earning of the year. so I’d like to minus it from EBITDA. but the formula doesn’t…why?

Nope - reducing debt is just one of those things you can do with earnings. Would you say that a company that has great earnings and then decides to use all of it to call their bonds has no earnings? The A in EBITDA is talking about the intangible stuff going away.

Thanks Joey. I have another question. I know this might have been covered many times on this forum but I am gonna go ahead and ask-- where in the income statement does the payment of principal amount go (in year of borrowing and in subsequent years) ? Thanks

remember that principal payments are CFF and not an income statement expense so don’t confuse the items on an income statement with cash flows… with that said EBITDA is used to “estimate” cash flows available for debt service and commonly used for an estimate of debt service coverage ratios. DSCR = EBITDA/ (principal + interest payment) So since the principal payment is not an expense on the income statement there is no need to add it back like the “ITDA” items. make sense? it takes a second or two to wrap your mind around it.

thunderanalyst Wrote: ------------------------------------------------------- > Thanks Joey. I have another question. I know this > might have been covered many times on this forum > but I am gonna go ahead and ask-- > > where in the income statement does the payment of > principal amount go (in year of borrowing and in > subsequent years) ? > > Thanks ------------------------------------------------------- I agree on what you wrote. However,amortization also refer to the process of allocating cost of intangible long-term assets with a finite useful life to accounting periods, e.g. paten, trade mark. this is same Depreciation, just for intangible long-term assets . From this point, the formula should add Amortization of intangible assets.

Char-Lee Wrote: ------------------------------------------------------- > remember that principal payments are CFF and not > an income statement expense … > So since the principal payment is not an expense > on the income statement there is no need to add it > back like the “ITDA” items. > make sense? it takes a second or two to wrap your > mind around it. ------------------------------------------------------------------- Char-lee, you are right , the amortization of loan won’t be in income statement, but the Amortization of intangible assets is. pls see CFAi book3, P142, Exhibit2 “Kraft foods Statements of earnings 2002~2004”, there is the element of Amortization of intangibles. so I still think should minus Amortization of intangibles to estimate the EPS in this formula: Expected EPS= [(sales)(EBITDA%)-depreciation-interest](1-tax rate)

Amortization also refers to the recovery of a loss resulting from selling a bond at a discount or with a zero coupon. But is not an intangible asset, is a liability (bond discount - a liability counter account). And definitely it has nothing to do with the income statement that presents the financial result of a company’s activity over a period of time (year or operating cycle, whichever is longer). The same is with a loan repayment: like Joey said, it is one of the things that you can do with your earnings (other being paying dividends, buying assets or investing). Repayment of a loan is not a result of operations. If the company has intangible assets, like patents, or trademarks, than yes amortization on these intangible assets should be deducted too.

Thanks annexguy… I think finally I get it now… thankyou map1

thunderanalyst Wrote: ------------------------------------------------------- > Thanks annexguy… I think finally I get it now… > thankyou map1 ---------------------------------------------------------- you are welcome. I asked Schweser on-line professor . They said Amortization should be there, don’t know why? and I didn’t see this formula in CFAi book.

Thunder, and annexguy EBITDA means Earnings before Interest, Taxes, Depreciation and Amortization. So to get to EBIT - you need to remove both Depr and Amort amounts. As regards finding it on an income statement - Depreciation you would typically find in most Income statements. However, Amortization of Intangibles would be found in only a few income statements. So that might account for the fact that the formula does not state Amortization. However, if you find it on the exam, and you are using the Sales * EBITDA% --> you would need to remove the Amortization to get to EBIT. EBIT * (1-T) = NI NI / # of Shares = EPS. (Assuming no dividends). CP

CP I’m confused by your formula for NI. Isn’t it EBT * (1-T) = NI. As far as the discussion on amortization goes, I think most companies do have amortization, including manufacturing co’s for intangibles as well as financing charges. Will the cash flow statement not break out what the A is as it does for the D ?

Sorry – it is EBT * (1-t). If the problem does break out and give you Amortization amount, remember to use it, that is all I am saying. CP