|Based on weekly team and individual assignments, a final team valuation project, class participation, and an open-book final exam during the normal exam schedule. The weekly assignments are not returned, and a check is recorded for completed assignments turned in on time. The final team valuation project is graded and returned. For three of the ten classes, teams will have the opportunity to volunteer to lead the case discussion the following week. Cannot be taken pass/fail. No auditors.|
|I. (Expected time is 10 minutes)
Indicate answers with a check in the appropriate boxes below:
Increase Decrease No Effect Unclear
a. Effect of an increase in tax exempt interest revenue (from municipal bonds) on a profitable firm’s net deferred tax asset (assume no NOLs)
b. Effect of expensing stock options on total accruals
c. Effect of an increase in interest rates during the period on the difference between the carrying value and fair value of available for sale debt securities on the end-of-period balance sheet date (assume no hedging)
d. Effect on free cash flows in the subsequent year of a spin-off of 100% of the common stock of a profitable wholly-owned subsidiary
e. Effect of increasing the expected growth in the book value of equity beyond the forecast horizon on the value of equity
f. Typical effect of outsourcing production
(i.e. reducing the proportion of operating costs that are fixed) activities on the beta of a firm’s common stock (assume no change in capital structure)
g. Effect of a decline in the operating cycle on the net trade cycle.
h. Expected effect on future EPS of carving out 40% of a wholly-owned profitable subsidiary (assume cash proceeds paid out as a cash dividend to common stockholders)
i. Effect of an increase in expected inflation on a firm’s unlevered cost of equity capital
j. Effect of in financial leverage on ROE during the following year
k. Effect of consolidation (relative to
equity method) on earnings per share
II. Accounting-Based Valuation (Expected time is 40 minutes)
Below appear the 2002 income statement and balance sheet for the Johnson Company, selected notes to the 2002 financial statements, and a set of assumptions. Based on the information provided, estimate what the price earnings ratio would be as of 12/31/2002 (using the 2002 earnings in the denominator). Use the abnormal operating earnings method to generate your answer, where abnormal operating earnings = (NOPLAT – WACC x Invested capital at beginning of year). (Treat the deferred tax liability the same way as stockholders’ equity in the computation of invested capital, as suggested in Valuation: Measuring and Managing the Value of Companies.)
Income Statement ($mil) Yr Ending
- Cost of goods sold <1943>
- Selling, general, and admin. Exp <2623>
- Interest expense <108>
+ Equity in the income of uncon affil 20
- Income tax expense <360>
Net Income 600
Balance Sheet ($mil)
Accounts receivable 800
Other current assets 202
Total Current Assets 2162
Long term investments 52
Net property, plant, and equipment 940
Other assets 3706
Total Assets 6860
Liab & Stockholders' Equity
Accounts payable 700
Short-term debt 100
Other accrued expenses 398
Total Current Liabilities 1198
Long-term debt 1600
Deferred income taxes 500
Other non-current liabilities 100
Total Liabilities 3398
Stockholders' Equity 3462
Total Liab & Stockholders' Eq. 6860
Selected Notes to the 2002 financial statements of the Johnson Company
The fair value of financial obligations maturing within a year approximates their carrying value. The following table presents the value of long-term debt (excluding current portion) as of 12/31/2002 (in $ millions):
Carrying Value Fair Value
12/31/02 Long-term debt 1600 1700
The Johnson Company accounts for its long-term investments using the equity method. If valued at December 31, 2002 closing prices, the value of these investments exceeds the carrying value of $52 million by approximately $48 million.
Income Taxes (in $ millions):
Current portion 310
Deferred taxes 50
Total Income Tax Expense 360
Long-term investments are classified as non-operating assets.
The effective tax rate on equity in the income of unconsolidated affiliates during 2002 is zero.
The marginal tax rate is .40 during 2002.
The WACC in 2003 and thereafter is .10.
The long-term Treasury Bond yield is .05.
The EBIT in 2002 is expected to grow at 2% a year forever.
The effective EBIT cash tax rate in 2002 of .337 will remain the same in all future years.
Earnings are realized on the last day of each year.
The book value of total invested capital is expected to grow beyond year 2002 by 2% a year forever.
The expected rate of inflation is 2% a year.
III. Pro-Formas (Expected time is 30 minutes)
Below appear balance sheets (2001 and 2002) and an income statement (2002) for the Katrina Company and a set of assumptions. Using the assumptions provided, complete the pro-forma balance sheet, income statement, and the selected items in the pro-forma cash flow statement for the Katrina Company for 2003 on the templates provided. Please note that some items on all three pro-forma statements have been provided. Take these items as given. Please show all work clearly in the space provided. (If you get “stuck” on a specific item on the pro-formas, indicate that you are stuck and fill in an assumed value to enable you to complete the pro-formas.)
HISTORICAL INCOME STATEMENT AND BALANCE SHEETS
Income Statement ($ millions) 2002
Cost of goods sold <1,873>
Selling, general, and administrative expense <661>
Interest expense <90>
Income tax expense <129>
Net Income 211
Balance Sheet ($ millions) 12/31/01 12/31/02
Cash 192 243
Accounts receivable 8 10
Inventories 314 366
Prepayments 52 72
Property, plant, and equipment (net) 1,367 1,638
Other assets 34 38
Total Assets 1,967 2,367
Liabilities and Stockholders’ Equity
Accounts payable 158 193
Current portion of long-term debt 3 0
Other current liabilities 169 142
Long-term debt 897 1,063
Other noncurrent liabilities 62 81
Common stock 8 8
Additional paid-in capital 33 118
Retained earnings 637 762
Total Liabilities and Stockholders’ Equity 1,967 2,367
1. Purchases will be $2,309 million in 2003.
2. Property, plant, and equipment will be sold on 1/1/03 for $100 million for a gain
of $7 million. In addition, fully depreciated PPE with a gross book value of $50 million will be retired on 1/1/03. No other PPE will be sold or retired during 2003. New machinery and equipment will be purchased on 7/1/03 for $859 million.
3. The accounts payable period will be 37 days.
4. The average effective interest rate (pre-tax) will be 7.46%.
KATRINA COMPANY: PRO-FORMAS
Pro-forma Income Statement ($ millions) 2003
Cost of goods sold <2275>
Selling, general, and administrative expense <748>
Gain on sale of PPE 7
Income tax expense <167>
Pro-forma Balance Sheet ($ millions) 12/31/03
Accounts receivable 20
Property, plant, and equipment (net)
Other assets 16
Liabilities and Stockholders’ Equity
Current portion of long-term debt 20
Other current liabilities 340
Long-term debt 1000
Other noncurrent liabilities 129
Common stock 8
Additional paid-in capital 118
Total Liabilities and Stockholders’ Equity
Selected Items from Pro-Forma Cash Flow Statement
Pro-forma Statement of Cash Flows ($ millions) 2003
Net capital expenditures for PPE
IV. DCF Valuation-WACC Method (Expected time is 1 hr and 20 minutes)
Below are the liability section of the 2003 balance sheet for the Francis Pharmaceutical Company, selected notes from the 2003 financial statements, pro-forma income st|