Solutions Chapter 019 - Financial Statement Analysis PDF

Preview

Summary

All the solutions to this chapter., All the solutions to this chapter....

Description

Chapter 19 - Financial Statement Analysis

CHAPTER1 9 :FI NANCI ALSTATEMENTANALYSI S PROBLEM SETS 1. Thema j ordi ffe r e nc ei na ppr o a c hofi nt e r na t i on a lfina nc i a lr e p or t i n gs t a n da r d sa ndU. S. GAAPa c c ou nt i n gs t e msf r o mt hed i ffe r e n c eb e t we e n‘ pr i nc i pl e s ’a nd‘ r ul e s . ’U. S. GAAPa c c ou nt i n gi sr ul e s b a s e d,wi t he xt e n s i v ed e t a i l e dr ul e st obef ol l o we di nt he p r e pa r a t i o no ffina nc i a ls t a t e me nt s ;ma n yi nt e r n a t i o na ls t a n da r d s ,i n c l udi n gt ho s e f ol l o we di nEur o p e a nUni onc o un t r i e s ,a l l o wmu c hgr e a t e rfle xi bi l i t y ,a sl on ga s c on f o r mi t ywi t hg e ne r a lp r i n c i pl e si sd e mon s t r a t e d.Ev e nt ho u g hU. S.GAAPi s g e n e r a l l ymo r ed e t a i l e da n ds pe c i fic ,i s s u e sofc o mp a r a b i l i t ys t i l la r i s ea mo n gU. S. c omp a n i e s .Co mpa r a b i l i t yp r o bl e msa r es t i l lg r e a t e ra mo n gc o mpa ni e si nf o r e i g n c ou nt r i e s . 2 . Ea r n i n g sma n a g e me nts h o ul dn otma t t e ri nat r ul ye ffic i e ntma r k e t ,whe r ea l lp u bl i c l y a v a i l a bl ei nf o r ma t i o ni sr e fle c t e di nt h ep r i c eo fas h a r eo fs t o c k .I n v e s t o r sc a ns e e t hr o u g ha t t e mp t st oma n a g ee a r ni n g ss ot ha tt he yc a nde t e r mi neac o mp a n y ’ st r ue p r o fit a bi l i t ya n d,h e nc e ,t h ei n t r i ns i cv a l u eo fas ha r eo fs t oc k.Ho we v e r ,i ffir msd o e n g a g ei ne a r ni n g sma n a g e me nt ,t he nt h ec l e a ri mp l i c a t i o ni st ha tma na g e r sdono tvi e w fina n c i a lma r k e t sa se ffic i e n t . 3 . Bot hc r e d i tr a t i n ga g e n c i e sa n ds t oc kma r k e ta na l y s t sa r el i k e l yt ob emo r eorl e s s i nt e r e s t e di na l lo ft h er a t i osd i s c us s e di nt hi sc h a p t e r( a swe l la sma n yo t he rr a t i osa n d f or mso fa n a l y s i s ) .Si n c et h eMo o d y ’ sa n dSt a nd a r da n dPoo r ’ sr a t i n g sa s s e s sb on d d e f a u l tr i s k,t he s ea g e nc i e sa r emo s ti nt e r e s t e di nl e v e r a g er a t i o s .As t o c kma r k e ta n a l y s t wou l db emos ti n t e r e s t e di np r ofit a b i l i t ya ndma r k e tpr i c er a t i os . 4 . ROA=ROS ATO Th eo nl ywa yt ha tCr us t yPi ec a nh a v ea nROSh i g he rt h a nt h ei n du s t r ya v e r a g ea nda n ROAe q ua lt ot h ei n du s t r ya v e r a g ei sf ori t sATOt ob el o we rt ha nt h ei nd us t r ya v e r a g e . 5 . ABC’ sAs s e tt u r no v e rmu s tbea bo v et h ei n du s t r ya v e r a g e .

19-1

Chapter 19 - Financial Statement Analysis

6 . ROE=( 1–Ta xr a t e ) [ ROA+( ROA–I nt e r e s tr a t e ) De b t / Eq ui t y] ROEA >ROEB Fi r msAa n dBh a v et h es a meROA.As s u mi n gt h es a met a xr a t ea n da s s u mi n gt h a t ROA>i n t e r e s tr a t e ,t he nFi r m Amu s th a v ee i t h e ral o we ri n t e r e s tr a t eo rah i g h e rd e bt r a t i o . CFAPROBLEMS 1 . ROE=Ne tp r o fit s / Eq u i t y=Ne tp r o fit s / Sa l e s Sa l e s / As s e t s As s e t s / Eq ui t y =Ne tp r o fitma r g i n As s e tt ur n o v e r Le v e r a g er a t i o =5 . 5 % 2 . 0 2. 2=2 4. 2 % 2 . Smi l e Wh i t eh a shi gh e rq u a l i t yo fe a r n i n g sf ort h ef o l l o wi n gr e a s o ns :  Smi l e Wh i t ea mo r t i z e si t sg o o d wi l lo v e ras h o r t e rpe r i odt ha nd oe sQui c k Br us h . Smi l e Wh i t et he r e f or ep r e s e n t smor ec on s e r v a t i v ee a r ni n g sb e c a u s ei th a sg r e a t e r g o od wi l la mo r t i z a t i one xp e n s e .  Smi l e Wh i t ed e pr e c i a t e si t sp r o pe r t y ,p l a nta nde q u i pme n tu s i n ga na c c e l e r a t e d d e p r e c i a t i onme t h od .Th i sr e s ul t si nr e c o gn i t i o no fd e pr e c i a t i o ne x pe ns es oo n e r a nda l s oi mp l i e st h a ti t si nc omei smo r ec on s e r v a t i v e l ys t a t e d .  Smi l e Wh i t e ’ sba dde b ta l l o wa n c ei sgr e a t e ra sap e r c e n to fr e c e i v a b l e s . Smi l e Wh i t ei sr e c o gn i z i n ggr e a t e rb a d de bte x pe ns et h a nQu i c kBr us h .I fa c t u a l c ol l e c t i o ne xp e r i e n c ewi l lb ec o mpa r a b l e ,t he nSmi l e Wh i t eha st hemo r e c on s e r v a t i v er e c o gn i t i o np ol i c y .

3 . a . ROE 

Net profits Net profits Sales Assets    Equity Sales Assets Equity

=Ne tp r o fitma r g i n To t a la s s e tt u r no v e r As s e t s / e q ui t y Net profits 510  0.0992 9.92% Sales 5,140

Sales 5,140  1.66 Assets 3,100 Assets 3,100  1.41 Equity 2,200

19-2

Chapter 19 - Financial Statement Analysis

b . ROE 

510 5,140 3,100    9 .92%1.661.41  23.2% 5,140 3,100 2,200

c . g=ROE pl o wb a c k23.2% 1.96  0.60 16.1% 1.96

4 . a .

Pa l omb aPi z z aSt o r e s St a t e me nto fCa s hFl o ws Fort h ey e a re n de dDe c e mbe r3 1 Ca s hFl o wsf r o m Op e r a t i n gAc t i v i t i e s Ca s hCo l l e c t i on sf r o m Cus t o me r s $ 25 0, 0 0 0 Ca s hPa yme n t st oSu pp l i e r s ( 8 5, 0 0 0) Ca s hPa yme n t sf orSa l a r i e s ( 4 5, 0 0 0) Ca s hPa yme n t sf orI n t e r e s t ( 1 0, 0 0 0) Ne tCa s hPr o vi de db yOp e r a t i n gAc t i v i t i e s $ 11 0, 0 0 0 Ca s hFl o wsf r o mI n v e s t i n gAc t i v i t i e s Sa l eo fEq u i p me nt 3 8, 0 0 0 Pur c ha s eo fEq ui p me nt ( 3 0, 0 0 0) Pur c ha s eo fLa nd ( 1 4, 0 0 0) Ne tCa s hUs e di nI n v e s t i n gAc t i v i t i e s Ca s hFl o wsf r o m Fi n a n c i n gAc t i v i t i e s ( 6 , 0 00) Re t i r e me n to fCommo nSt oc k ( 2 5, 0 0 0) Pa yme n to fDi v i de nd s ( 3 5, 0 0 0) Ne tCa s hUs e di nFi n a n c i n gAc t i v i t i e s ( 6 0, 0 0 0) Ne tI n c r e a s ei nCa s h 4 4, 0 0 0 Ca s ha tBe gi nn i n go fYe a r 5 0, 0 0 0 Ca s ha tEndofYe a r $ 94 , 0 00

b . Ca s hflo wf r o mo p e r a t i o ns( CFO)f o c us e so nme a s u r i n gt hec a s hflo wg e n e r a t e db y o pe r a t i on sa n dno tonme a s ur i n gp r o fit a bi l i t y .I fu s e da same a s ur eofp e r f o r ma n c e , CFOi sl e s ss ub j e c tt od i s t or t i o nt ha nt h en e ti nc omefig ur e .An a l y s t sus eCFOa sa c he c kont heq u a l i t yo fe a r n i n g s .CFOt he nb e c o me sac he c kont h er e p or t e dn e t e a r ni n g sfigu r e ,b u ti sno tas u bs t i t ut ef orn e te a r n i n g s .Co mpa ni e swi t hh i g hne t i nc omeb utl o wCFOma yb eu s i n gi n c o mer e c o g ni t i ont e c h ni q ue st h a ta r es u s p e c t . Th ea b i l i t yofafir mt og e ne r a t ec a s hf r o mo pe r a t i on so nac o ns i s t e n tb a s i si so ne i nd i c a t i ono ft h efin a n c i a lh e a l t ho ft h efir m.Fo rmo s tfir ms ,CFOi st h e“ l i f e b l o od ”o ft hefir m.An a l y s t ss e a r c hf o rt r e n dsi nCFOt oi nd i c a t ef u t ur ec a s h c on di t i on sa ndt h ep o t e n t i a lf o rc a s hflo wp r o bl e ms .

19-3

Chapter 19 - Financial Statement Analysis

Ca s hflo wf r o mi n v e s t i n ga c t i v i t i e s( CFI )i sa ni n di c a t i o no fh o wt h efir mi s i n v e s t i n gi t se x c e s sc a s h .Th ea n a l y s tmu s tc o n s i d e rt h ea bi l i t yo ft h efir mt o c on t i nu et og r o wa n dt oe x pa nda c t i v i t i e s ,a ndCFIi sag o o di nd i c a t i ono ft h e a t t i t u deo fma n a g e me nti nt hi sa r e a .An a l y s i so ft hi sc omp on e n to ft o t a lc a s hflo w i nd i c a t e st h et yp eofc a pi t a le x pe nd i t ur e sb e i n gma d eb yma n a g e me n tt oe i t he r e x pa ndorma i nt a i np r o du c t i v ea c t i v i t i e s .CFIi sa l s oa ni n di c a t oro ft h efir m’ s fina n c i a lfle xi b i l i t ya n di t sa bi l i t yt og e ne r a t es u ffic i e n tc a s ht or e s p o ndt o u na nt i c i p a t e dn e e d sa n do p po r t uni t i e s .Ad e c r e a s i n gCFIma yb eas i g nofa s l o wdo wni nt h efir m’ sgr o wt h . Ca s hflo wf r om fina nc i n ga c t i v i t i e s( CFF)i n di c a t e st hef e a s i bi l i t yo ffin a n c i n g ,t h e s o ur c e soffina nc i n g ,a ndt h et y pe sofs o ur c e sma na g e me nts up p or t s .Con t i nu e d d e btfin a n c i n gma ys i gn a laf ut u r ec a s hflo wp r o bl e m.Th ed e p e nd e n c yofafir m on e x t e r na ls ou r c e so ffin a n c i n g( e i t h e rb or r o wi n gore q u i t yfin a n c i n g )ma ypr e s e n t p r o bl e msi nt h ef ut u r e ,s u c ha sde bts e r v i c i n ga n dma i nt a i ni n gd i vi de ndpo l i c y . An a l y s t sa l s ous eCFFa sa ni n di c a t i o no ft heq ua l i t yofe a r ni n g s .I to ffe r si n s i g ht s i nt ot hefina nc i a lha bi t sofma n a g e me n ta ndpo t e n t i a lf ut u r epo l i c i e s . 5 . a . CFf r om o pe r a t i n ga c t i vi t i e s=$ 26 0–$8 5–$1 2–$3 5=$ 12 8 b . CFf r om i n v e s t i n ga c t i vi t i e s=– $8+$ 30–$ 40=– $1 8 c . CFf r om fina nc i n ga c t i v i t i e s=– $3 2–$3 7=–$ 69 6 . a . Qu i c k Br us hh a sha dhi g he rs a l e sa nde a r ni n g sgr o wt h( p e rs ha r e )t h a nSmi l e Wh i t e . Ma r g i nsa r ea l s oh i gh e r .Butt h i sdo e sno tme a nt h a tQui c k Br us hi sn e c e s s a r i l ya b e t t e ri n v e s t me nt .Smi l e Wh i t eh a sahi g he rROE,whi c hha sb e e ns t a b l e ,wh i l e Qu i c k Br us h ’ sROEh a sb e e nde c l i n i n g .Wec a ns e et h es ou r c eoft hed i ffe r e n c ei n ROEu s i n gDu Po n ta na l y s i s : Comp on e n t De fini t i on Qu i c k Br us h Smi l e Wh i t e Ta xb ur d e n( 1–t ) Ne tpr o fit s / pr e t a xpr o fit s 6 7. 4% 6 6. 0% I n t e r e s tbu r d e n Pr e t a xp r o fit s / EBI T 1 . 00 0 0 . 95 5 Pr o fitma r g i n EBI T/ Sa l e s 8 . 5% 6 . 5% As s e tt ur no v e r Sa l e s / As s e t s 1 . 42 3 . 55 Le v e r a g e As s e t s / Eq ui t y 1 . 47 1 . 4 8 ROE Ne tpr o fit s / Eq ui t y 1 2. 0% 2 1. 4% Wh i l et a xbu r d e n,i n t e r e s tbu r d e n ,a n dl e v e r a g ea r es i mi l a r ,p r o fitma r g i na nda s s e t t u r no v e rdi ffe r .Al t h o u ghSmi l e Wh i t eh a sal o we rp r ofitma r g i n,i th a saf a rhi g he r a s s e tt ur no v e r .

19-4

Chapter 19 - Financial Statement Analysis

Sus t a i n a b l egr o wt h=ROE pl o wb a c kr a t i o o wb a c k Sus t a i n a b l e ROE Pl r a t i o g r o wt hr a t e Qu i c k Br us h 1 2. 0% Smi l e Wh i t e 2 1. 4%

1 . 00 0. 3 4

1 2. 0% 7 . 3%

Lu dl o w’ s e s t i ma t eo f g r o wt hr a t e 30 % 1 0%

Lu dl o wha so v e r e s t i ma t e dt hes u s t a i na bl egr o wt hr a t ef orbo t hc omp a n i e s . Qu i c k Br us hh a sl i t t l ea bi l i t yt oi n c r e a s ei t ss u s t a i na bl egr o wt h–pl o wba c ka l r e a d y e q u a l s1 00 %.Smi l e Wh i t ec ou l di n c r e a s ei t ss u s t a i n a b l egr o wt hb yi n c r e a s i n gi t s p l o wb a c kr a t i o. b . Qui c k Br us h ’ sr e c e ntEPSgr o wt hha sb e e na c hi e v e db yi nc r e a s i n gbo okv a l u epe r s h a r e ,no tb ya c hi e vi n ggr e a t e rp r o fit spe rdo l l a rofe q ui t y .Afir mc a ni nc r e a s eEPS e v e ni fROEi sde c l i ni n ga si st r ueo fQu i c k Br u s h.Qui c k Br u s h ’ sbo okv a l u epe r s h a r eh a smo r et h a ndo ub l e di nt hel a s tt woy e a r s . Boo kv a l uep e rs h a r ec a ni n c r e a s ee i t he rb yr e t a i n i n ge a r ni n g so rb yi s s u i n gn e w s t o c ka tama r k e tpr i c egr e a t e rt h a nb oo kv a l ue .Qui c kBr us hh a sbe e nr e t a i n i n ga l l e a r ni n g s ,bu tt hei nc r e a s ei nt h en umbe rofo ut s t a nd i n gs h a r e si n di c a t e st ha ti tha s a l s oi s s ue das ub s t a n t i a la mou ntofs t o c k . 7 . a . ROE=o pe r a t i n gma r g i n i nt e r e s tbu r d e n a s s e tt ur no v e r l e v e r a g e t a xb ur d e n ROEf orEa s t o v e r( EO)a n df o rSo u t ha mpt o n( SHC)i n2 00 7a r ef ou nda sf ol l o ws : SHC: EO: SHC: EO: SHC: EO: Assets SHC: l e v e r a g e= EO: Equity Net profits SHC: t a xbu r d e n= Pretax profits EO: SHC: ROE EO:

EBIT Sales i nt e r e s tbu r d e n=Pretax profits EBIT Sales a s s e tt ur n o v e r= Assets

p r o fitma r g i n=

19-5

1 45 / 1 , 79 3= 8 . 1% 7 95 / 7 , 40 6= 1 0. 7% 1 37 / 1 45= 0 . 95 6 00 / 7 95= 0 . 75 1 , 79 3/ 2 , 1 04= 0 . 85 7 , 40 6/ 8 , 2 65= 0 . 90 2 , 14 0/ 1 , 1 67= 1 . 80 8 , 26 5/ 3 , 8 64= 2 . 14 9 1/ 13 7= 0 . 66 3 94 / 6 00= 0 . 66 7 . 8% 1 0. 2%

Chapter 19 - Financial Statement Analysis

b . Th edi ffe r e nc e si nt h ec ompo n e n t sofROEf orEa s t o v e ra ndSo ut ha mpt ona r e : Pr o fitma r g i n EOh a sahi g he rma r g i n I n t e r e s tbu r d e n EOha sah i gh e ri nt e r e s tb ur d e nbe c a u s ei t sp r e t a xpr o fit sa r ea l o we rpe r c e nt a g eo fEBI T As s e tt ur no v e r EOi smo r ee ffic i e nta tt ur ni n go v e ri t sa s s e t s Le v e r a g e EOha sh i gh e rfin a n c i a ll e v e r a g e Ta xBu r d e n Noma j ordi ffe r e n c eh e r eb e t we e nt h et woc o mpa ni e s ROE EOha sah i gh e rROEt ha nSHC,bu tt hi si son l yi np a r td uet o h i gh e rma r g i n sa n dabe t t e ra s s e tt ur no v e r-gr e a t e rfina n c i a l l e v e r a g ea l s op l a y sap a r t . c . Th es us t a i na bl egr o wt hr a t ec a nbec a l c ul a t e da s :ROEt i me spl o wba c kr a t i o .Th e s u s t a i na bl egr o wt hr a t e sf o rEa s t o v e ra ndSo ut ha mp t o na r ea sf o l l o ws : Pl o wb a c k Sus t a i n a b l e ROE r a t i o * g r o wt hr a t e Ea s t o v e r 1 0. 2 % 0. 36 3 . 7% So u t h a mp t o n 7. 8 % 0 . 58 4 . 5% * Pl o wba c k=( 1–pa y o u tr a t i o ) EO:

Pl o wba c k=( 1–0. 64 )=0 . 3 6

SHC:

Pl o wb a c k=( 1–0. 4 2)=0 . 5 8

Th es us t a i na bl egr o wt hr a t e sd e r i v e di nt hi sma n ne ra r eno tl i k e l yt ob e r e pr e s e n t a t i v eo ff u t ur egr o wt hbe c a u s e20 07wa spr o b a bl yno ta“ n o r ma l ”y e a r . ForEa s t o v e r ,e a r ni n g sha dno ty e tr e c o v e r e dt o2 00 420 05l e v e l s ;e a r ni n g s r e t e nt i o no fon l y0. 36s e e msl o wf o rac o mpa n yi nac a p i t a li nt e n s i v ei n du s t r y . So u t h a mp t o n ’ se a r ni n g sf e l lb yo v e r50p e r c e n ti n20 07a ndi t se a r ni n g sr e t e nt i o n wi l lp r ob a b l yb ehi g he rt h a n0. 58i nt h ef ut u r e .The r ei sada n g e r ,t h e r e f or e ,i n b a s i n gapr o j e c t i ononon ey e a r ’ sr e s u l t s ,e s p e c i a l l yf orc omp a n i e si nac y c l i c a l i nd us t r ys u c ha sf or e s tp r od uc t s . 8 . a . Th ef o r mu l af o rt h ec o n s t a ntgr o wt hdi s c ou nt e dd i vi de ndmo de li s : P0 

D0 (1  g) k g

ForEa s t o v e r : P0 

$1.20 1.08  $43.20 0 .11  0.08

Thi sc o mpa r e swi t ht hec ur r e nts t oc kp r i c eof$ 28 .Ont h i sba s i s ,i ta pp e a r st ha t Ea s t o v e ri su nd e r v a l u e d .

19-6

Chapter 19 - Financial Statement Analysis

b . Th ef o r mu l af o rt h et wo s t a g ed i s c ou nt e dd i vi de ndmo d e li s : P0 

D1 D2 D3 P3    1 2 3 (1  k ) (1 k ) (1 k ) (1 k )3

ForEa s t o v e r :g1=0. 12a n dg . 08 2=0 D0=1. 20 1 D1=D0( 1. 12 ) =$1 . 3 4 2 D2=D0( 1. 12 ) =$1 . 5 1 3 D3=D0( 1. 12 ) =$1 . 6 9 3 D4=D0( 1. 12 )( 1 . 0 8)=$1 . 8 2

P3 

D4 $1.82 $60.67  k  g 2 0.11  0.08

P0 

$1.34 $1.51 $1.69 $60.67    $48.03 1 2 3 (1 .11) (1 .11) (1 .11) (1 .11)3

Thi sa p p r oa c hma k e sEa s t o v e ra pp e a re v e nmo r eu nd e r v a l ue dt ha nwa st h ec a s e u s i n gt hec on s t a ntgr o wt ha pp r o a c h. c . Ad v a n t a g e so ft hec on s t a ntgr o wt hmo d e li nc l ud e :( 1)l o gi c a l ,t h e o r e t i c a lb a s i s ;( 2) s i mpl et oc o mpu t e ;( 3)i n pu t sc a nbee s t i ma t e d . Di s a d v a nt a g e si nc l ud e :( 1)v e r ys e n s i t i v et oe s t i ma t e so fgr o wt h;( 2)ga ndkd i ffic u l t t oe s t i ma t ea c c ur a t e l y ;( 3)on l yv a l i df org...