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Financial statements 5th Edition Stephen Barrad - Solutions
This is the final installment in a series of cases on Procter & Gamble Co. that began in Minicase 9.1 with the reformulation of financial statements and continued with a financial statement analysis in Minicases 11.1 and 12.1 Minicase 14.1 carried out a valuation of the firm, using only
Dell's 2008 annual 10-A report begins with the following introduction to the company that explains the main features of it business model.Dell listens to customers and delivers innovative technology and services they trust and value. As a leading technology company, we offer abroad range of product
On May19, 2005, Maytag Corporation (MYG), the home appliance manufacturer, agreed to be acquired by Ripple wood Holdings for $1.13 billion in cash or $14 per share, a 21 percent premium over the closing price of $11.56 the day before.Maytag is a manufacturer of washing machines, dryers,
Firms with a return on net operating assets (RNOA) that is higher than the required return on operations are adding value with their investments and so should trade at a premium over their book value. Is this statement correct?
Why are LIFO accounting and the expensing of R&D expenditures referred to as conservative accounting policies?
Explain how intrinsic price-to-book (P/B) ratios are affected by conservative accounting (such as expensing R&D expenditures).
Does conservative accounting result in higher or lower accounting rates of return?
Explain how intrinsic P/E ratios are affected by conservative accounting (such as expensing R&D expenditures).
Consultants talk of “economic profit,” or “economic value added.” What is it? Can it be observed?
How is it that accounting policies affect the measurement of residual income but the value calculated using residual income methods may not be affected by accounting policies?
A firm that uses LIFO accounting for inventory in times of rising inventory costs will always report lower profit margins than if it used FIFO. Is this correct?
A firm using LIFO accounting for inventory is likely to have a lower inventory turnover ratio than one using FIFO. Is this correct?
Firms with anticipated earnings-per-share growth are worth more. Is this statement always correct?
What is a “hidden reserve”? What does it mean to “release hidden reserves”?
What is meant by “steady state”?
In the United Kingdom, firms revalue tangible assets upward and recognize the value of brands on the balance sheet. In the United States, this accounting is not permitted. In which country would you expect the average return on common equity for firms to be higher?
On January 29, 1999, the Wall Street Journal reported: “Sears, Roebuck & Co. is moving toward more conservative accounting methods used by competing credit card issuers, which will boost its loan losses by about $200 million during the next 5 quarters.” What effect should this new policy have
Expensing research and development costs raises accounting quality issues similar to those raised in cash accounting. Explain.
You invest $100 (at time 0) and expect to receive $115 in cash in one year. Your required return is 9 percent.a. Calculate the value of your investment at time 0 using discounted cash flow techniques.b. Calculate the value of your investment using residual earnings techniques.c. Suppose that your
Here are some details of an investment in a project with a two-year life and a required return of 9 percent per year. Dollar amounts are in millions.Initial investment in equipment...........$1,500Initial investment in advertising........... 700Total investment................$2,200Expected
An entrepreneur develops a business plan that requires an initial investment of $2,200 million with a further investment of $2,200 million each year on an ongoing basis. Investment is expected to yield sales revenue equal to 70 percent of the investment in each of the two years following the
Ford Motor Company uses the last in, first out (LIFO) method for most of its inventories in its Automotive Division. The amounts of the LIFO reserve reported in footnotes for 1999 wereFord reported total shareholders' equity of $27.537 billion at the end of 1999 and $23.409 billion at the end of
Many consultants recognize that expensing R&D investments gives a poor indication of the performance of a firm or its managers because investing in R&D results in lower income. So they adjust GAAP accounting by capitalizing R&D expenditures and amortizing the capitalized amount over the estimated
A start-up firm embarks on an investment program in 2009 to manufacture and market a new switching device to be used in communications. The program requires an initial investment of $600 million in plant and equipment, increasing by $100 million each year for four years up to 2013, and then
At one time, the Coca-Cola Company reported a number called" economic profit" that is very similar to residual operating income. It also reported free cash flow in its annual summary of selected financial data. The respective numbers for 1992-1999 are given below (in millions of dollars), along
A new pharmaceutical firm has patented a technology and has committed to spending $350 million annually for the next five years to develop further products from the technology. The program is currently spending $350 million on R&D, yielding $1.000 million in sales and a loss of $150 million after
A start-up begins operations in 2009 by investing $400 million in plant and equipment. It expects to increase investment by $40 million each year, indefinitely, depreciating it straight-line over two years. The investment program is expected to generate sales for the next five years, as follows (in
New businesses take time to get established, and the new Internet firms of the late 1990s were no exception. Internet portal firms and e-commerce firms traded at high multiples of sales on the promise of large profits, but most of them were generating losses from their sales.In statements to the
A firm can create future income by temporarily increasing its bad debt allowance. Is this correct?
Low depreciation charges forecast losses in future income statements. Is this correct?
A decrease in warranty liabilities increases net sales. Is this correct?
Increasing profit margins by underestimating expenses creates net operating assets. Is this correct?
Why is a change in the asset turnover an indicator of future profitability?
Why do analysts compare cash flow from operations with earnings to assess the quality of the earnings?
Why should an analyst view a large merger charge suspiciously?
Why should an analyst view an increase in deferred taxes from bad debt allowances suspiciously?
IBM reported a 3 percent increase in income for its first quarter of 2000, beating analysts' estimates. But it also reported a decline in revenue. Its stock price dropped in response to the report. What explanations would you give for the drop in stock price on an earnings increase?What is your
Excite signed a pact with Netscape in 1999 under which it paid $86.1 million to share revenues from co-branded search-and-directory services. It wrote off two thirds of the cost-or $56.8 million-against income immediately. Analysts objected. Why should they?
Shares of Pitney Bowes dropped 10 percent after it announced earnings per share from continuing operations of $0.70 for its September quarter of 1999, up from $0.49 in the same quarter in the year before. Revenues also increased 8 percent.Analysts raised concerns about the quality of the earnings,
If you saw a deferred tax liability from depreciation increase significantly over a year, what might you conclude?
A firm has a capital expenditure-to-depreciation ratio of 1.6 over three years. What might you infer from this ratio?
Some firms suggest that investors focus on" pro forma" earnings rather than reported earnings. Their pro forma earnings usually exclude amortizations of goodwill and shares of losses in subsidiaries. Is this good advice?
In July 1999, Federal Reserve Chairman Alan Greenspan stated that corporate profits in the United States were understated, particularly in the technology sector. To what do you think he was referring?
The realization principle, which recognizes revenues at point of sale, is said to be an accounting principle that improves the quality of reporting. Companies cannot estimate their future revenues; rather they must have a firm customer before they can recognize revenue. Do you see the realization
Matching costs to revenue-the matching principle-is seen as producing "good quality" earnings numbers. Why?
A firm reported after-tax operating income of $1,298 million. Free cash flow of $234 million was calculated from the cash flow statement.a. Identify the" hard" and" soft" components of the income.b. The free cash flow is after $687million in cash investments. What were the operating accruals
The chief financial officer of a firm presented the CEO with a set of financial statements showing $2,234 million in after-tax operating income. This number yielded a return on beginning-of-period net operating assets of 9 percent. The CEO complained that this number was below the 12 percent RNOA
Indicate which items in the balance sheet can be altered to implement the following earnings management:a. Increase gross revenues (before allowances).b. Reduce bad debt expense.c. Reduce depreciation.d. Lower selling expenses.e. Reduce software expenses.
The following lists a number of ratios against the average for the ratio over the prior three years. For each, indicate whether the ratio suggests that return on net operating assets will be higher or lower in the followingyear.
A firm reported after-tax operating income of $136 million, up from $120 million the year before, on a sales increase from $5,106 million to $5,751 million. Net operating assets increased from $2,321 million to $2,614 million. The firm's average asset turnover during the prior three years had been
An analyst finds that, for a firm reporting a return on net operating assets of 19 percent, the asset turnover had declined from 2.2 to 1.9.a. Calculate the profit margin for the year.b. What does the decrease in the asset turnover tell you about the likelihood of the19 percent RNOA being
Identify the quality red flags for 2009 in the following portion of a cash flow statement. Revenues for2009 declined from $456million in 2008 to $401million.
Bausch and Lomb, Inc., the optical products company, reported the following sales and receivables from 1990 to 1993 (in millions of dollars):Subsequently it was discovered that the firm had booked revenues incorrectly, and the SEC investigated. Do the numbers here raise concerns about the quality
Vitesse Semiconductor reported the following revenues and cost of goods sold for 2001-2003 (in thousands):Calculate the gross margin ratio (gross margin/sales) for each year. In 2001 the firm took a charge for obsolete inventory of $46.5 million and, in 2002, another $30.5 million. Explain how
a. In 1999, Microsoft Corporation announced that the Securities and Exchange Commission (SEC) was investigating some of its accounting practices. Exhibit 17.1 presents the current liability section of Microsoft's comparative balance sheet at the end of the first quarter of its 2000 fiscal year. Can
Below are portions of the cash flow statements for Electronic Data Systems (EDS) and Cerner Corporation. Spot the redflags.
The Regina Company once marketed a successful line of vacuum cleaners, but then ran into trouble and failed. As you can see from the income statements below, the firm had dramatic sales growth during the 1980s.Using the income statements and balance sheets below, track operating income (after tax),
Gateway, the computer manufacturer, was a fast-growing company during the 1990s, with continual revenue and earnings growth, bringing admiration from analysts. However, in 2000 revenue growth slowed, from $8,965 million in 1999 to only $9,601 million, despite the opening of over 800 new retail
By the mid-1990s, Sunbeam Corporation, the once celebrated household appliance manufacturer, was reporting lackluster sales and losses. New management, engaged in 1996 to turn the company around, implemented a major restructuring and trumpeted higher sales and profitability. The firm's stock price
For its September quarter of 1998, Eastman Kodak, the imaging products manufacturer, reported a net profit of $398 million, up 72 percent from one year earlier and in line with analysts' expectations. However, when it was also revealed that its sales had fallen 10 percent to $3.4 billion, its stock
Xerox Corporation is a long-established company whose very name has been lent to the process of copying documents. The firm develops copying technology through an extensive research program and manufactures and markets a large range of document processing products. Many of its sales are made with
Lucent Technologies, Inc., was formed from AT&T's Bell Laboratories research organization after the breakup of AT&T in to the Baby Bells. Lucent designs, develops, and manufactures communication systems, supplying these systems to most of the world's telecom operators for both wired and wireless
Why might the normal distribution of returns not characterize the risk of investing in a business?
Comment on the following statement. The challenge in measuring the required return for investing is to measure the size of the risk premium over the risk-free rate, but the capital asset pricing model largely leaves this measurement as a guessing game.
Can you explain why diversification lowers risk?
Why does operating liability leverage increase operating risk?
Why are growth stocks often seen as high risk?
Explain asset turnover risk.
Airlines are said to have high operating risk. Why?
Why might stock returns have greater risk than is justified by the fundamentals of the firm's business activities?
Should firms manage risk on behalf of their shareholders?
Suppose one calculated the intrinsic value of two firms using residual earnings techniques with the risk-free rate as a discount rate. The price-to-value (PIV) ratio of these two firms, so calculated, should be the same if they have the same risk characteristics. Is this so?
Explain the difference between Scenario A and Scenario B investing and the risks involved in each.
Below are balance sheets for two firms with similar revenues. Amounts are in millions of dollars. Which firm looks more risky for shareholders?Why?
The statements below are for two firms in the same line of business (in millions of dollars).a. Analyze the risk drivers in these income statements, Which firm looks more risky for stockholders? Why?b. On the basis of the relationships in these income statements, develop pro forma income statements
Below are income statements and balance sheets for three firms. Rank these firms on what you perceive to be the relative riskiness of their equity from these statements. What features in the statements determined your ranking? All numbers are in millions of dollars. All three firms face a statutory
Two firms, Firm A and Firm B, have $1,000 million invested in net operating assets in the same line of business. Firm A has $25 million in net financial obligations while Firm B has $600 million in net financial obligations. Both firms face a statutory tax rate of 36 percent.Below are forecasted
For fiscal year 2004, Nike reported after-tax core profit margins on.84 percent on an asset turnover of 2.759. An analyst forecasts that this margin and turnover will persist in the future on a sales growth rate of 5.1 percent per year. Nike reported $4,840 million of common equity and $4,551
Explain what a default premium is.
What is the objective in reformulating financial statements for credit analysis? How does the reformulation for credit analysis differ from that for equity analysis?
Describe off-balance-sheet financing.
What is the" moral-hazard" problem with business debt?
Distinguish a Type I error in predicting default from a Type II error.
What is a default point?
How does pro forma analysis of financial statements help in credit analysis?
Why might a deferred tax liability be considered not a liability for credit scoring?
What is a default strategy?
Explain the danger posed by special-purpose entities.
The following numbers are extracted from the financial statements for a firm for 2008 and 2009. Amounts are in millions of dollars.At the end of 2008, the firm's 80 million shares traded a $25 each, but by the end of 2009 they traded at $15. Commentators blamed the drop on an increase in the risk
A firm has the following balance sheet and income statement (in millions of dollars):The long-term debt is 8 percent coupon debt maturing in five years. The statutory tax rate is 38 percent. Prepare pro forma financial statements for the next five years under the two following scenarios. Also
After analyzing the default risk for a five-year bond with a maturity value of $1,000 and an 8 percent annual coupon, an analyst estimates the required return for the bond at 7 percent per year. The bond has just been issued at a price of $1,000.a. What is the value of the bond at a 7 percent
Below are ratios for some of the firms that have appeared in this book, for their 1998 fiscal year.a. Calculate Z-scores from these ratios.b. Explain why Nike has a different Z- score from Reebok. c. What reservations do you have about the Z-score as an indicator of credit worthiness?
Toys €œR€ Us, Inc., is the world€™s largest toy retailer, with sales of nearly $12 billion in 1999. It has been challenged in recent years, particularly in e-commerce, losing market share from 20.2 percent in 1993 to 16.8 percent in 1999. The firm€™s stock
Maytag Corporation is the established manufacturer of washing machines, dryers dish washers, and other home appliances-including the venerable Hoover vacuum cleaner. But in 2004 and 2005, the firm faced deteriorating profitability. Competitors had moved manufacturing to low-cost countries while
Fruit of the Loom Ltd. fared poorly from 1997 to 1999. Between April 1997 and October 1999, its stock price dropped from $38 to $3, a 92 percent loss in market value.Fruit of the Loom manufactures men’s and boys’ underwear. It had an estimated 32 percent share of the U.S. market in 1999, second
If assets are at fair market value in the balance sheet, the income reported from those assets in the income statement does not give any information about the value of the assets. In this correct?
If assets are measured at their fair (intrinsic) value, the analyst must forecast that residual earnings from those assets will be zero. Is this correct?
Why might the market value of the assets of a pure investment fund that holds only equity securities not be an indication of the funds’ (intrinsic) value?
What drives growth in residual operating income?
Can residual income increase while, for the same period, residual earnings decrease?
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