INSTANT DOWNLOAD COMPLETE TEST BANK WITH ANSWERS
Financial Statement Analysis And Security Valuation 5th Edition by Stephen H Penman – Test Bank
This exam comes in two parts. Part I involves an analysis of a set of financial statements and Part II involves forecasting and valuation based on those financial statements.
Part I: Analysis (20 Points)
The following is a comparative balance sheet for a firm for fiscal year 2002 (in millions of dollars):
|Operating cash||60||50||Accounts payable||1,200||1,040|
|Short-term investments (at market)||550||500||Accrued liabilities||390||450|
|Accounts receivable||940||790||Long-term debt||1,840||1,970|
|Property and plant||2,840||2,710||Common equity||1,870||1,430|
The following is the statement of common shareholders’ equity for 2002 (in millions of dollars):
|Balance, end of fiscal year 2001||1,430|
|Share issues from exercised employee stock options||810|
|Repurchase of 24 million shares||(720)|
|Tax benefit from exercise of employee stock options||12|
|Unrealized gain on investments||50|
|Balance, end of fiscal year 2002||1,870|
The firm’s income tax rate is 35%. The firm reported $15 million in interest income and $98 million in interest expense for 2002. Sales revenue was $3,726 million.
- Calculate the loss to shareholders from the exercise of employee stock options during 2002.
Compensation expense = = 34
Tax Benefit 12
Compensation, after tax 22
- The shares repurchased were in settlement of a forward purchase agreement. The market price of the shares at the time of the repurchase was $25 each. What was the effect of this transaction on the income for the shareholders?
Market price of shares repurchased 25
Amount paid for shares 720/24 million 30
Loss per share 5
No. of shares 24 million
[These losses are not tax deductible]
- Prepare a comprehensive income statement that distinguishes after-tax operating income from financing income and expense. Include gains or losses from the transactions in questions (a) and (b) above.
Comprehensive income = 468 + 50 – 22 – 120 = 376
All other items are unknown, except operating expense that can be plugged
- Prepare a reformulated comparative balance sheet that distinguishes assets and liabilities employed in operations from those employed in financing activities. Calculate the firms’ financial leverage and operating liability leverage at the end of 2002.
NOA 3,160 2,900
NFO 1,290 1,470
CSE 1,870 1,430
FLEV = NFO / CSE = 1,290/1,870 = 0.690
OLLEV = OL / NOA = 1,590/3,160 = 0.503
[OL = 1,200 + 390 = 1,590]
- Calculate free cash flow for 2002.
FCF = OI – DNOA
= 500 – (3,160 – 2,900)
Part II: Forecasting and Valuation (20 Points)
Use a cost of capital for operations of 9%.
Sales revenue is forecasted to grow at a 6% rate per year in the future, on a constant asset turnover of 1.25. Operating profit margins of 14% are expected to be earned each year.
- Forecast return on net operating assets (RNOA) for 2003.
RNOA = PM × ATO
= 14% ×1.25
- Forecast residual operating income for 2003.
ReOI 2003 = (0.175 – 0.09) × NOA2002
= (0.175 – 0.09) × 3,160
- Value the shareholders’ equity at the end of the 2002 fiscal year using residual income methods.
VE = NOA2002 + – NFO
= 3,160 + – 1,290
[Growth in ReOI is growth in sales because ATO is constant]
- Forecast abnormal growth in operating income for 2004.
- OI2004 586.18 2. AOIG = Growth in ReOI
FCF2003 reinvested 32.71 AOIG2004 = 268.6 × 0.06
618.89 = 16.12
(553 × 1.09) 602.77
[OI and NOA all grow at 6%]
- Value the shareholders’ equity at the end of 2002 using abnormal earnings growth methods.
- After reading the stock compensation footnote for this firm, you note that there are employee stock options on 28 million shares outstanding at the end of 2002. A modified Black-Scholes valuation of these options is $15 each. How does this information change your valuation?
before option overhang 10,825
Value of outstanding options
28 mill. × 15 = 420
Tax benefit (@35%) 147 273
Adjusted valuation 10,552
TEST NUMBER 4
Question 1 (12 points)
At the time that of its 10-Q filing of financial statements for the first half of its January 2002 fiscal year, Home Depot’s shares traded at $50 per share. The following are summaries from those financial statements.
|Balance Sheet, July 29, 2001
(in millions of dollars)
|Operating assets||23, 457||Operating liabilities||6,709|
|Financial assets||1,221||Common equity
(on 2,336 million outstanding shares)
|Statement of Earnings, Six Months Ended, July 29, 2001
(in millions of dollars)
|Cost of Merchandise Sold||18,795|
|Selling and Store Operating||4,963|
|General and Administrative||436|
|Total Operating Expenses||5,458|
|Interest Income (Expense):|
|Interest and Investment Income||22|
|Earnings Before Income Taxes||2,534|
According to financial statement footnotes, Home Depot’s statutory tax rate (combined Federal and State rates) is 39%. Other comprehensive income (not in net earnings above) is negligible. Use a required six-month return for operations of 4% in calculations below.
- Calculate the following from these statements:
- Financial leverage
NFO = FL – FA = 1,320 – 1,221 = 99
- Operating liability leverage
- After-tax profit margin
- Home Depot earned a return on beginning net operating assets (RNOA) of 9.3% for the six months ending July 29, 2001.
- What was the asset turnover during these six months?
RNOA = PM × ATO
9.3 % = 5.79% × ?
? = 1.606
- What was the residual operating income over the six months?
- Calculate the free cash flow generated by operations during the six months.
C – I = OI – DNOA
= 1,549 – (16,748 – 16,656)
- At the current market price of $50 per share, what growth rate for residual operating income does the market forecast for the future?
- Calculate Home Depot’s price-to-sales ratio for trailing six-month sales.
- If both profit margin and asset turnover are expected to continue at their current levels in the future, what is the sales growth rate forecast implied in the price-to-sales ratio?
Same as growth in ReoI = 3.09%
[with constant RNOA, growth in ReoI is driven by growth in sales]
Question 2 (5 points)
Below is a summary of part of IBM’s Statement of Cash Flows for the year ended December 31, 2001 (in millions of dollars). The firm faces a 37% statutory tax rate.
|Net cash provided from operating activities||9,274|
|Cash flow from investing activities:|
|Payments for plant, rental machines and other property||(5,616)|
|Proceeds from disposition of plant, rental machines and other property||1,619|
|Investment in software||(565)|
|Purchases of marketable securities||(1,079)|
|Proceeds from marketable securities||1,393|
|Net cash used in investing activities||(4,248)|
|Cash paid during the year for:|
- From this information, calculate free cash flow for 2001.
CFO reported 9,274
Net interest (1,447 – 617) 830
Tax (3.9%) 307 523
Investment minus securities transactions (4,248 +314) 4,562
Free cash flow 5,235
- What was the net amount of cash paid out of the firm in financing activities during 2001?
The same: 5,235
[C-I = d + F]
Question 3 (7 points)
The following is from the statement of shareholders’ equity for Intel Corporation for 2000 (in millions of dollars). Intel faces a 38% tax rate.
|Balance, December 25, 1999||32,535|
|Unrealized loss on available-for-sale securities||(3,596)|
|Issuance of shares through employee stock plans, net of tax benefit of $887 million||1,684|
|Reclassification of put warrant obligation||130|
|Amortization of unearned compensation||26|
|Conversion of subordinated notes to common stock (market value of stock was $350 million)||207|
|Repurchase of common stock||(4,007)|
|Issuance of shares for acquisitions||278|
Calculate comprehensive income to Intel’s shareholders for 2000, being sure to include any hidden dirty surplus expenses.
Net income 10,535
Unrealized loss (3,596)
Loss on share issue to employees
Cost before tax
Tax 887 (1,447)
Put warrant gain 130
Loss on conversion of notes (350-207) (143)
Comprehensive income 5,479
Question 4 (10 points)
A firm with a return on common equity (ROCE) of 30% has financial leverage of 37.5% and a net after-tax borrowing cost of 5% on $240 million of net debt.
- What rate of return does this firm earn on its operations?
ROCE = RNOA + FLEV [RNOA – NBC]
30.0% = ? + 0.375 [? – 5.0%]
? = 23.18%
- The firm is considering repurchasing $150 million of its stock and financing the repurchase with further borrowing at a 5% after-tax borrowing cost. What effect will this transaction have on the firm’s return on common equity if the same level of operating profitability is maintained?
- Will this repurchase change the per share intrinsic value of the equity? Why?
No effect. Share buys and borrowing are zero NPV transactions: they don’t add value.
Proviso: if shares are mis-priced, share repurchases will affect value.
- Will the normal P/E ratio for this firm change because of this transaction? Why?Leverage changes the cost of capital for equity, and so changes the normal P/E ratio:
- The firm had an unlevered price-to-book ratio (P/B) of 1.8 prior to the transaction. What will be the effect of the repurchase on the levered price-to-book ratio?
Levered P/B = Unlevered P/B + FLEV [Unlevered P/B – 1.0]
Before: = 1.8 + 0.375 × 0.8 = 2.10
After: Levered P/B = 1.8 + 0.796 × 0.8 = 2.44
- Would you expect the earnings-per-share growth rate to change after the repurchase transaction? Why?
Yes. Leverage creates eps growth.
[Normal growth is at the cost of capital and the cost of capital increases]
Question 5 (6 points)
Cisco Systems traded at $20 per share on December 3, 2001. Analysts are forecasting earnings per share of 0.22 for 2002 and 0.39 for 2003. The firm does not pay dividends.
Value Cisco on the assumption that abnormal earnings growth forecasted for 2003 will continue at the same level into the future. Use a cost of equity capital of 10%.