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financial statement analysis
Financial Statement Analysis And Security Valuation 4th Edition Stephen H Penman - Solutions
Is a Normal Forward P/E Ratio Appropriate? Maytag Corporation (Easy)A share of Maytag Corp., another appliance manufacturer, traded at $28.80 in January 2003. Analysts were forecasting earnings per share of $2.94 for 2003 and $3.03 for 2004, with dividends per share of 72 cents indicated for 2003.
In the pro forma there, an analyst forecasted earnings of $388 million for 2010. The forecast was made at the end of 2009 based on preliminary reports from the firm.When the final report was published, however, the analyst discovered that the firm had decided to write down its inventory at the end
Abnormal Earnings Growth Valuation and Accounting Methods (Hard)Refer back to the valuation in Exercise
Using Earnings Growth Forecasts to Challenge a Stock Price:Toro Company (Medium)Toro Company, a lawn products maker based in Minnesota, traded at $55 per share in October 2002. The firm had maintained a 20 percent annual EPS growth rate over the previous five years, and analysts were forecasting
Inferring Implied EPS Growth Rates: Kimberly-Clark Corporation (Medium)In March 2005, analysts were forecasting consensus earnings per share for Kimberly Clark(KMB) of $3.81 for fiscal year ending December 31, 2005, and $4.14 for 2006, up from$3.64 for 2004. KMB traded at $64.81 per share at the
Valuation of Microsoft Corporation (Medium)In 2006, some fundamental investors believed that Microsoft, after being overpriced in the stock market for many years, was now a firm to buy. Microsoft’s shares traded at $27.20 on September 26, 2006, down from a peak of $60 (split-adjusted) in January
Challenging the Level of the S&P 500 Index with Analysts’ Forecasts(Medium)The S&P 500 index stood at 1271 in early 2006. Based on analysts’ consensus EPS forecasts for calendar year 2006, the forward P/E ratio for the index was 15.0 at the time. Those same analysts were giving the S&P 500 a
Plotting Earnings Implied Growth Rates for the S&P 500 (Medium)This exercise extends the reverse engineering example for the S&P 500 in this chapter. At the end of 2003, the S&P 500 index stood at 1000. The chief economist of a leading Wall Street investment bank was forecasting 2004 earnings for
A Normal P/E for General Electric? (Easy)In early 2008, General Electric (GE) shares were trading at $26.75 each. Analysts were forecasting $2.21 in EPS for 2008 and $2.30 for 2009. A dividend of $1.24 was indicated for 2008. Use a required return of 9 percent for the questions below.a. What is
Residual Earnings and Abnormal Earnings Growth: IBM (Medium)Consider the following pro forma for International Business Machines (IBM) based on analysts’ forecasts in early 2003.The book value of IBM’s common equity at the end of 2002 was $23.4 billion, or $13.85 per share. Use a required
Calculating Cum-Dividend Earnings: General Mills (Easy)General Mills reported earnings and paid dividends from 2004 to 2008 as follows:Calculate cum-dividend earnings for General Mills for each year, 2005–2008. Also calculate abnormal earnings growth for each of these years. Assume a reinvestment
Calculating Cum-Dividend Earnings Growth Rates Nike (Easy)In early fiscal year 2009, analysts were forecasting $3.90 for Nike’s earnings per share for the fiscal year ending May 2009 and $4.45 for 2010, with a dividend per share of 92 cents expected for 2009. Compare the cum-dividend earnings
Normal P/E Ratios (Easy)Prepare a schedule that gives the normal trailing and forward P/E ratios for the following levels of the cost of equity capital: 8, 9, 10, 11, 12, 13, 14, 15, and 16 percent.Applications
Dividend Displacement and Value (Medium)Two firms, A and B, which have very similar operations, have the same book value of 100 at the end of 2009 and their cost of capital is 11 percent. Both are forecast to have earnings of $16.60 in 2010. Firm A, which has 60 percent dividend payout, is forecast
Abnormal Earnings Growth Valuation and Target Prices (Medium)The following forecasts of earnings per share (EPS) and dividend per share (DPS) were made at the end of 2009:The firm has an equity cost of capital of 12 percent per annum. (This is the same pro forma used in the residual earnings
Valuation From Forecasting Abnormal Earnings Growth (Easy)An analyst presents you with the following pro forma (in millions of dollars). The pro forma gives her forecasts of earnings and dividends for 2010–2014. She asks you to value the 1,380 million shares outstanding at the end of 2009. Use a
P/E Ratios for a Savings Account (Easy)Suppose you own a savings account that earned $10 over the past year. Your only transaction in the account has been to withdraw $3 on the last day of this 12-month period. The account bears an interest rate of 4 percent per year.a. What is the value of the
Forecasting Earnings Growth and Abnormal Earnings Growth (Easy)The following are earnings and dividend forecasts made at the end of 2008. The firm has a required equity return of 10 percent per year.a. Forecast the ex-dividend earnings growth rate and the cum-dividend earnings growth rate for 2010
Can a firm increase its earnings growth yet not affect the value of its equity?
The earnings-to-price ratio for the S&P 500 stocks declined significantly from the late 1970s to the late 1990s. As this ratio is a “return” per dollar of price, some claimed that the decline indicated that the required return for equity investing had declined, and they attributed the increase
Look at Figure 2.3 in Chapter 2, which tracks median P/E ratios from 1963 to 2003.Explain why P/E ratios were low in the 1970s and high in the 1960s and 1990s.
The normal forward P/E and the normal trailing P/E always differ by 1.0. Explain the difference.
The following formula is often used to value shares, where Earn1 is forward earnings, r is the cost of capital, and g is the expected earnings growth rate.Explain why this formula can lead to errors. Earn Value of equity r-g
The historical earnings growth rate for the S&P 500 companies has been about 8.5 percent. Yet the required growth rate for equity investors is considered to be about 12 percent. Can you explain the inconsistency?
Explain why analysts’ forecasts of earnings-per-share growth typically underestimate the growth that an investor values if a firm pays dividends.
Impairment of Goodwill (Hard)A firm made an acquisition at the end of 2008 and recorded the acquisition cost of $428 million on its balance sheet as tangible assets of $349 million and goodwill of $79 million.The firm used a required return of 10 percent as a hurdle rate when evaluating the
Residual Earnings Valuation and Accounting Methods (Hard)Refer back to the valuation in Exercise 5.3. In that pro forma, an analyst forecast $388 million of earnings for 2010 on a book value at the end of 2009 of $4,310 million, that is, a return on common equity of 9 percent. The forecasts were
Valuing Dividends or Return on Equity: General Motors Corp (Easy)In April 2005, General Motors traded at $28 per share on book value of $49 per share.Analysts were estimating that GM would earn 69 cents per share for the year ending December 2005. The firm was paying an annual dividend at the time
The Expected Return for the S&P 500 (Medium)On January 1, 2008, the S&P 500 index stood at 1468 with a price-to-book ratio of 2.6.Expected earnings for the index for calendar year 2008 were 72.56. These earnings estimates, compiled from analysts’ consensus earnings forecasts for the 500 stocks in
Building Blocks for a Valuation: General Electric Co. (Medium)General Electric Co. reported a per-share book value of $10.47 in its balance sheet on December 31, 2004. In early 2005, analysts were forecasting consensus earnings per share of $1.71 for 2005 and $1.96 for 2006.a. Calculate the value
Sellers Wants to Buy (Medium)Mark Sellers, a hedge fund manager with Sellers Capital in Chicago, wrote a piece in the Financial Times on September 9, 2006, arguing that Home Depot, the warehouse retailer, was worth $50 per share. Home Depot traded at $34 per share at the time. Analysts were
Valuing Dell, Inc. (Easy)In September 2008 the shares of Dell, Inc., the computer maker, traded at $20.50 each. Analysts were forecasting earnings per share of $1.47 for fiscal year 2009 and $1.77 for 2010.Refer to Dell’s balance sheet in Exhibit 2.1 in Chapter 2 to calculate its book value at
Residual Earnings Valuation: Black Hills Corp (Easy)Black Hills Corporation is a diversified energy corporation and a public utility holding company. The following gives the firm’s earnings per share and dividends per share for the years 2000–2004.Suppose these numbers were given to you at the
Reverse Engineering (Easy)A share traded at $26 at the end of 2009 with a price-to-book ratio of 2.0. Analysts are forecasting earnings per share of $2.60 for 2010. The required equity return is 10 percent.What is growth in residual earnings that the market expects beyond 2010?Applications
Creating Earnings and Valuing Created Earnings (Medium)The prototype one-period project at the beginning of the chapter was booked at its historical cost of $400. Suppose, instead, that the accountant wrote down the investment to $360 on the balance sheet at the beginning of the period. See the
Using Accounting-Based Techniques to Measure Value Added for a Going Concern (Medium)A new firm announces that it will invest $150 million in projects each year forever. All projects are expected to generate a 15 percent rate of return on its beginning-of-period book value each year for five years.
Using Accounting-Based Techniques to Measure Value Added for a Project (Medium)A firm announces that it will invest $150 million in a project that is expected to generate a 15 percent rate of return on its beginning-of-period book value each year for the next five years. The required return for
Residual Earnings Valuation and Return on Common Equity (Medium)A firm with a book value of $15.60 per share and 100 percent dividend payout is expected to have a return on common equity of 15 percent per year indefinitely in the future. Its cost of equity capital is 10 percent.a. Calculate the
Residual Earnings Valuation and Target Prices (Medium)The following forecasts of earnings per share (EPS) and dividend per share (DPS) were made at the end of 2009 for a firm with a book value per share of $22.00:The firm has an equity cost of capital of 12 percent per annum.a. Calculate the
A Residual Earnings Valuation (Easy)An analyst presents you with the following pro forma (in millions of dollars) that gives her forecast of earnings and dividends for 2010–2014. She asks you to value the 1,380 million shares outstanding at the end of 2009, when common shareholders’ equity
ROCE and Valuation (Easy)The following are ROCE forecasts made for a firm at the end of 2009.ROCE is expected to continue at the same level after 2012. The firm reported book value of common equity of $3.2 billion at the end of 2009, with 500 million shares outstanding. If the required equity
Forecasting Return on Common Equity and Residual Earnings (Easy)The following are earnings and dividend forecasts made at the end of 2009 for a firm with$20.00 book value per common share at that time. The firm has a required equity return of 10 percent per year.a. Forecast return of common equity
Comment on the following: “ABC Company is generating negative free cash flow and is likely to do so for the foreseeable future. Anyone willing to pay more than book value needs their head read.”
A firm cannot maintain an ROCE less than the required return and stay in business indefinitely. True or false?
A share trades at a price-to-book ratio of 0.7. An analyst who forecasts an ROCE of 12 percent each year in the future, and sets the required equity return at 10 percent, recommends a hold position. Does his recommendation agree with his forecast?
Jetform Corporation traded at a price-to-book ratio of 1.01 in May 1999. Its most recently reported ROCE was 10.1 percent, and it is deemed to have a required equity return of 10 percent. What is your best guess as to the ROCE expected for the next fiscal year?
Information indicates that a firm will earn a return on common equity above its cost of equity capital in all years in the future, but its shares trade below book value.Those shares must be mispriced. True or false?
An Examination of Revenues: Microsoft (Medium)Microsoft Corp. reported $36.835 billion in revenues for fiscal year 2004. Accounts receivable, net of allowances, increased from $5.196 billion in 2003 to $5.890 billion.Microsoft has been criticized for underreporting revenue. Revenue from software
Accrual Accounting Relations (Medium)a. A firm reported $405 million in revenue and an increase in net receivables of $32 million. What was the cash generated by the revenues?b. A firm reported wages expense of $335 million and cash paid for wages of $290 million. What was the change in wages
Cash Flows for Wal-Mart Stores (Easy)Wal-Mart has been the most successful retailer in history. The panel below reports cash flows and earnings for the firm from 1988 to 1996 (in millions of dollars, except per-share numbers):The cash flows are unlevered cash flows.a. Why would such a profitable
Free Cash Flow for General Motors (Medium)For the first nine months of 2005, General Motors Corporation reported the following in its cash flow statement. GM runs an automobile operation supported by a financing arm, and both activities are reflected in these statements.Net interest paid during the
A Discounted Cash Flow Valuation: General Mills, Inc. (Medium)At the beginning of its fiscal year 2006, an analyst made the following forecast for General Mills, Inc., the consumer foods company, for 2006–2009 (in millions of dollars):General Mills reported $6,192 million in short-term and
Cash Flow and Earnings: Kimberly-Clark Corporation (Easy)Kimberly-Clark Corporation (KMB) manufactures and markets consumer paper products under brand names that include Kleenex, Scott, Cottonnelle, Viva, Kotex, and WypAll. For fiscal year 2004, the firm reported the following numbers (in
Converting Forecasts of Free Cash Flow to a Valuation:Coca-Cola Company (Medium)After reviewing the discounted cash flow valuation of Coca-Cola in Exhibit 4.1, consider the free cash flows below that were reported by Coke for 2004–2007. They are based on the actual reported cash flows but are
Identifying Accruals for Coca-Cola (Easy)The Coca-Cola Company reported “Net cash provided by operating activities” of $7,150 million in its 2007 cash flow statement. Coke also reported $5,981 million in net income for the period. How much of net income was in the form of accruals?
Calculating Cash Flow from Operations and Cash Investment for Coca-Cola (Easy)The Coca-Cola Company reported “Net cash provided by operating activities” of $7,150 million in its 2007 cash flow statement. It also reported interest paid of $405 million and interest income of $236 million. Coke
Calculate Free Cash Flow from a Cash Flow Statement (Easy)The following summarizes the parts of a firm’s cash flow statement that have to do with operating and investing activities (in millions):The firm made interest payments of $1,342 million and received $876 in interest receipts from T-bills
Valuation with Negative Free Cash Flows (Medium)At the end of 2008, you forecast the following cash flows for a firm for 2009–2012(in millions of dollars):What difficulties would you have in valuing this firm based on the forecasted cash flows?What would explain the decreasing free cash flow over
A Simple DCF Valuation (Easy)At the end of 2009, you forecast that a firm’s free cash flow for 2010 will be $430 million.If you forecast that free cash flow will grow at 5% per year thereafter, what is the enterprise value? Use a required return of 10%.
A Discounted Cash Flow Valuation (Easy)At the end of 2009, you forecast the following cash flows (in millions) for a firm with net debt of $759 million:You forecast that free cash flow will grow at a rate of 4% per year after 2012. Use a required return of 10% in answering the following
Should a firm that has higher free cash flows have a higher value?
Some analysts trumpet the saying “Cash is King.” They mean that cash is the primary fundamental that the equity analyst should focus on. Is cash king?
Implying the Market Risk Premium:Procter & Gamble (Easy)Analysts give Procter & Gamble, the consumer products firm, an equity beta of 0.65. The risk-free rate is 4.0 percent. An analyst calculates an equity cost of capital for the firm of 7.9 percent using the capital asset pricing model (CAPM).
Betas, the Market Risk Premium, and the Equity Cost of Capital:Sun Microsystems (Medium)A risk analyst gives Sun Microsystems, the networking computer firm, a CAPM equity beta of 1.38. The risk-free rate is 4.0 percent.a. Prepare a table with the cost of capital that you would calculate for the
Dividends, Stock Returns, and Expected Payoffs:Weyerhaeuser Company (Medium)Weyerhaeuser, the forest products producer, traded at $42 at the beginning of 1996. Its cost of equity capital, calculated with the CAPM, is 11.5 percent. It is expected to pay dividends of $1.60 per share in 1996 and 1997.
Stock Repurchases and Value: Dell, Inc. (Easy)During fiscal year 2008, Dell repurchased 179 million shares on the market for $4,004 million. There were 2,239 million shares outstanding prior to the repurchase. What was the effect of the repurchases on the per-share price of Dell’s stock?
Share Issues and Market Prices: Is Value Generated or Lost by Share Issues? (Medium)a. XYZ Corporation had 158 million shares outstanding on January 1, 2009. On February 2, 2009, it issued an additional 30 million shares to the market at the market price of $55 per share. What was the effect of
Valuation of Bonds and the Accounting for Bonds, Borrowing Costs, and Bond Revaluations (Hard)On January 1, 2008, Debtor Corporation issued 10,000 five-year bonds with a face value of$1,000 and an annual coupon of 4 percent. Bonds of similar risk were yielding 8 percent p.a. in the market at the
Forecasting Prices in an Efficient Market:Weyerhaeuser Company (Medium)Weyerhaeuser, the forest products producer, traded at $42 at the beginning of 1996. Beta services typically place its beta at 1.0 with a market risk premium of 6 percent. The riskfree rate at the end of 1995 was 5.5 percent. The
Measuring Value Added (Medium)a. Buying a stock. A firm is expected to pay an annual dividend of $2 per share forever.Investors require a return of 12 percent per year to compensate for the risk of not receiving the expected dividends. The firm’s shares trade for $19 each. What is the value added
Pricing Multiples: General Mills, Inc. (Medium)General Mills, the consumer foods company, traded at 1.6 times sales in 2008. It was reporting a net profit margin on its sales of 9.5 percent. What was its P/E ratio?
A Stab at Valuation Using Multiples: Biotech Firms (Easy)The following table gives accounting data from the 1994 annual reports of six biotechnology firms. The market value of the equity of five of the firms is also given. All numbers are in millions of dollars. From these numbers, estimate a value
The Method of Comparables: Dell, Inc. (Easy)Here are some accounting numbers and market values (in millions) for Hewlett-Packard and Gateway for 2002. These two computer manufactures are considered to be comparables for Dell, Inc.a. Calculate price-to-sales, price-earnings (P/E), and price-to-book
Applying Present Value Calculations to Value a Building (Easy)In the year 2008, a real estate analyst forecasts that a rental apartment building will generate $5.3 million each year in rents over the five years 2009–2013. Cash expenses are expected to be $4.2 million a year. At the end of five
Valuing Bonds (Easy)a. A firm issues a zero-coupon bond with a face value of $1,000, maturing in five years. Bonds with similar risk are currently yielding 5 percent per year. What is the value of the bond?b. A firm issues a bond with a face value of $1,000 and a coupon rate of 5 percent per year,
Identifying Firms with Similar Multiples (Easy)Find a screening engine on the Web, enter a multiple you are interested in, and get a list of firms that have that multiple of a particular size. Choose a particular industry and see how the various multiples—P/E, price-to-book,
Unlevered (Enterprise) Multiples (Easy)A firm reported $250 million in total assets and $140 in debt. It had no interest-bearing securities among its assets. In the income statement it reported $560 million in sales. The firm’s 80 million shares traded at $7 each. Calculatea. The price-to-book
Stock Prices and Share Repurchases (Easy)A firm with 100 million shares outstanding repurchased 10 million shares at the market price of $20 per share. What is the total market value of the equity after the repurchase?What is the per-share value after the repurchase?
Calculating a Price from Comparables (Easy)A firm trading with a total equity market value of $100 million reported earnings of $5 million and book value of $50 million. This firm is used as a comparable to price an IPO firm with earnings per share of $2.50 and book value per share of $30 per
It is sometimes said that firms prefer to make stock repurchases rather than pay dividends because stock repurchases yield a higher eps. Do they?
The yield on a bond is independent of the coupon rate. Is this true?
If a firm is expected to have a profit margin of 8 percent but trades at a price-tosales ratio of 25, what inferences would you make?
If a firm has a P/E ratio of 12 and a profit margin on sales of 6 percent, what is its price-to-sales (P/S) ratio likely to be?
It is also common to compare firms on their price-to-ebitda ratios. What are the merits of using this measure? What are the dangers? Hint: ebitda leaves something out.
It is common to compare firms on their price-to-ebit ratios. What are the merits of using this measure? What are the problems with it? Hint: ebit leaves something out.
Calculating Stock Returns: Nike, Inc. (Easy)The shares of Nike, Inc., traded at $55 per share at the beginning of fiscal year 2008 and closed at $67 per share at the end of the year. Nike paid a dividend of 87.5 cents per share during the year. What was the return to holding Nike’s shares during
Mismatching at WorldCom (Hard)During the four fiscal quarters of 2001 and the first quarter of 2002, WorldCom incorrectly capitalized access charges to local networks as assets (as explained in Box 2.3). The amount of costs capitalized were as follows:Suppose WorldCom amortized these capitalized
Find the Missing Numbers in Financial Statements: General Motors Corporation (Medium)General Motors ended its 2007 year with shareholders’ equity of $37,094 million at December 31 (yes, negative equity!). Six months later, at June 30, 2008, it reported$56,990 million in equity after paying a
Find the Missing Numbers in the Equity Statement: Cisco Systems, Inc. (Easy)At the end of its 2007 fiscal year, Cisco Systems, Inc., the producer of routers and other hardware and software for the telecommunications industry, reported shareholders’ equity of$31,931 million. At the end of the
Using Accounting Relations: Genentech Inc. (Medium)Consider the following excerpts from Genentech’s 2004 income statement and cash flow statement. From the 2004 income statement (in millions):From the 2004 cash flow statement (in thousands):For 2004, calculatea. Revenues.b. ebit (earnings before
Using Accounting Relations: General Mills, Inc. (Medium)The following numbers appeared in the annual report of General Mills, Inc., the consumer foods manufacturer, for the fiscal year ending May 2008 (in millions of dollars):The firm has no preferred stock.For fiscal 2008, calculatea. Total
Finding Financial Statement Information on the Internet (Easy)The Securities and Exchange Commission (SEC) maintains the EDGAR database of company filings with the commission. Explore the SEC’S EDGAR site:http://www.sec.gov/edgar.shtml.Look at the “Descriptions of SEC Forms” page to
Using Accounting Relations to Check Errors (Hard)A chief executive reported the following numbers for fiscal year 2009 to an annual meeting of shareholders (in millions):Show that at least one of these numbers must be wrong because it does not obey accounting relations. Revenues Total expenses,
Violations of the Matching Principle (Easy)Generally accepted accounting principles (GAAP) notionally follow the matching principle. However, there are exceptions. Explain why the following accounting rules, required under GAAP, violate the matching principle.a. Expenditures on research and
Classifying Accounting Items (Easy)Indicate where in the financial statements the following appear under GAAP:a. Investment in a certificate of deposit maturing in 120 days.b. Expenses for bad debts.c. Allowances for bad debts.d. Research and development expenditures.e. A restructuring charge.f. A
Preparing an Income Statement and Statement of Shareholders’ Equity (Medium)From the following information for the year 2009, prepare an income statement and a statement of shareholders’ equity, under GAAP rules, for a company with shareholders’ equity at the beginning of 2009 of $3,270
The Financial Statements for a Bank Savings Account (Medium)You received the following statement for 2009 for your savings account at a bank. Cash balances in the account earn interest at a 5 percent rate per annum.This statement is effectively a statement of owner’s equity for the account. It
Applying Accounting Relations: Cash Flow Statement (Easy)A firm reported $130 million increase in cash over a year. It also reported $400 million in cash flow from operations, and a net $75 million paid out to claimants in financing activities. How much did the firm invest in operations?
Applying Accounting Relations: Balance Sheet, Income Statement, and Equity Statement (Easy)The following questions pertain to the same firm.a. The balance sheet reports $400 million in total assets and $250 million in shareholders’ equity at the end of a fiscal period. What are the firm’s
Why do fundamental analysts want accountants to follow the reliability criterion when preparing financial reports?
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