Financial Statement Analysis And Security Valuation 5th Edition by Stephen H Penman – Test Bank A+

Description

Total Points: 40

Question 1 (10 points)

The following is an incomplete statement of common shareholders’ equity (in millions of dollars).

Balance, December 31, 2004	760
Net income	?
Common dividends	?
Issue of common stock	102
Unrealized gain on available-for-sale securities	8
Foreign currency translation loss	(6)
Balance, December 31, 2005	963

The firm has no net debt (a pure equity firm) and reported an after-tax operating profit margin of 12 ½% on sales of ^$912 million in its income statement for 2005. All operating expenses in the income statement are involved in generating core income.

Calculate the following for 2005:

• Net income and comprehensive income

• Free cash flow

• Dividends paid to common shareholders

• Core return on net operating assets (on beginning-of-year balance sheet)

• Asset turnover

Question 2 (14 points)

The following are summaries from financial statements for the warehouse retailer, Home Depot Inc. for fiscal year ending January 29, 2006:

Summary Reformulated Balance Sheet, January 29, 2006

(in millions of dollars)

	2006	2005			2006	2005
Financial assets	757	456		Financial liabilities	4,085	2,159
Operating assets	43,725	38,564		Operating liabilities	13,488	12,703
				Common equity	26,909	24,158
	44,482	39,020			44,482	39,020

Summary Reformulated Income Statement, Year Ended, January 29, 2006 (in millions of dollars)
Sales Core operating expenses Core operating income Taxes allocated to core operating income		81,511 72,148 9,363 3,474
Core operating income, after tax		5,889
Unsustainable operating income, after tax		182
Operating income, after tax		6,071

Where relevant, make all calculations for 2006 with beginning-of-period balance sheet numbers in the questions below.

• Calculate the following from these statements:

1. Financial leverage at the end of fiscal year, 2005

1. Operating liability leverage at the end of fiscal year, 2005

• Home Depot estimates that it pays an implicit after-tax borrowing cost on its operating liabilities of 2% after tax. Calculate the rate of return it would have earned from its operations had it not used this supplier financing.

• Calculate the return on net operating assets (RNOA) for the 2006. Also calculate the core return on net operating assets for the year.

• Show that Core RNOA = Core Profit Margin × Asset Turnover

• The firm has a net borrowing cost of 3.0% after tax. Calculate the return on common equity (ROCE) for 2006.

• Complete the income statement to report the after-tax net financial expenses for 2006 and comprehensive income.

• In an article in the Financial Times on September 9^th of this year, Mark Sellers, a hedge fund manage in Chicago, argued that Home Depot should borrow $17 billion to repurchase its stock. Suppose that core operating profitability and the net borrowing cost were forecasted to be the same for 2007 as in 2006. What return on common equity (ROCE) would you forecast for 2007 under the following conditions:

1. Home Depot did not made the stock repurchase

1. Home Depot made the stock repurchase on January 29, 2006

Question 3 (5 points)

Reformulate the following income statement (in millions of dollars):

Sales	2,400
Operating expenses to generate sales Loss from real estate partnership	(1,650) (100)
Interest income	40
Interest expense	(160)
	530
Income tax expense	159
Net income	371

The firm’s statutory tax rate is 35%.

What is the effective tax rate on operating income from sales?

Question 4 (11 points)

The following numbers were calculated from the financial statements of a firm for fiscal year 2006.

Net operating assets	$107.5 million
Net financial obligations	22.7 million
Asset turnover, 2006	1.9
Core operating profit-margin, after tax	7.5%

• Calculate the core return on net operating assets for 2006.

• You forecast that the core profit margin and asset turnover in the future will be the same as in 2006. You also forecast that sales will grow at 4% per year in the future. The firm’s required return for its operations is 9%.

• Calculate the enterprise price-to-book ratio and enterprise value.

• Calculate the levered price-to-book ratio.

• The firm’s 52 million outstanding shares are trading at $4.75 each. Given your forecasts, what is your expected rate of return from buying the firm at this price?

TEST NUMBER 7

Time allowed: 90 minutes

Total Points: 40

Exercise 1 (8 points)

The following summarizes reformulated balance sheets at the end of fiscal years 2008 and 2007 (in millions of dollars):

	2008	2007
Net operating assets (NOA)	40	35
Net financial obligations (NFO)	13	12
Common shareholders’ equity (CSE)	27	23

Comprehensive income for 2008 was $7 million.

Free cash flow for 2008 was $3 million.

• What was operating income (after tax) for 2008?

• What was net financial expense (after tax) for 2008?

• What was the net payment to shareholders?

Exercise 2 (4 points)

Explain in no more than 50 words why it is common that firms with higher return on net operating assets (RNOA) also have negative free cash flow. Also explain why such firms tend to have above-average forward P/E.

Exercise 3 (8 points)

A junior colleague of yours has prepared the following pro forma to indicate his forecasts for a firm (in millions of dollars):

	Actual	Forecast
	2007A	2008E	2009E	2010E
Operating income (after tax)		22	26	28
Net interest expense		5	5	5
Comprehensive income		17	21	23
Net operating assets	240	255	270	290
Net financial obligations	100	110	115	122
Common shareholders’ equity	140	145	155	168
Cash flows:
Free cash flow		21	24	25
Net payout to shareholders		6	6	7

The interest expense relates to bonds payable with an effective interest rate of 5% equal to the coupon rate. The firm’s tax rate is 35%. There are no financial assets.

There are four things wrong with this pro forma. Can you spot them? (You are not required to re-work the pro forma).

Exercise 4 (20 points)

The following were extracted from a financial report for a 2008 fiscal year (in millions of dollars):

	2008
Operating assets	165
Operating liabilities	78
Financial assets	40
Financial liabilities	60
Interest income	3.6
Interest expense	5.8
Comprehensive income	12

The firm has a statutory tax rate of 35%.

• What was operating income (after tax) for 2008?

• What was common shareholders’ equity at the end of 2008?

• Net operating assets (NOA) grew by 5% over the year. Calculate free cash flow for 2008.

• What was the return on net operating assets (RNOA) for 2008 (on beginning-of-year NOA)?

• Net payout to shareholders for 2008 was $6 million. What was common shareholders’ equity at the beginning of 2008?

• Show that the financing leverage equation (that reconciles return on common equity, ROCE, to RNOA) holds for this firm.

• Forecast residual operating income for fiscal year 2009 based on the information you have identified. Use a required return for operations of 10%.

• Estimate the equity value at the end of 2008 based on the following forecasts:

1. RNOA will continue in the future at the same level as in 2008.

1. Net operating assets will grow at the same rate as in 2008.

• Calculate the levered P/B and unlevered (enterprise) P/B implied by your calculations. Show that the following formula holds:

Levered P/B = Unlevered P/B + [Financial leverage x (Unlevered P/B -1)]

• The (equity) market capitalization for this firm is $110 million. If you think that your forecasts of profitability and growth in part (h) of the question are appropriate, what is your expected return to buying the enterprise at the current market price?