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valuation measuring and managing

Business Analysis And Valuation Using Financial Statements Text And Cases 3rd Edition Krishna G. Palepu, Paul M. Healy, Victor L Bernard - Solutions

On April 22, 1999, MediaOne Group and AT&T agreed to merge. Under the merger, MediaOne Group’s shareowners will receive .95 of a share of AT&T common stock and $30.85 in cash for each share of MediaOne Group. The total package of cash and stock was valued at $85 per share. MediaOne has
The Coca-Cola Company owns 42 percent of Coca-Cola Enterprises, the largest softdrink bottler in the world. On December 31, 1998, The Coca-Cola Company reported the following information in its financial statement footnotes:“The excess of our equity in the underlying net assets of Coca-Cola
(3) What learning and development methods could the company use to address the problems? How would it resource these methods?
(2) Is the company adequately aware of the blend of technical, commercial and leadership skills that are needed for the new organization?
(1) To what extent is the company aware of the skills and knowledge that are being retained and those that are being lost?
* establish the application of learning and development practices as part of change management.
* illustrate the application of these methods in a mini-case study of the Boston Consulting Group; and
* explain alternative methods of learning and development;
* develop a model of learning for technique and insight;
* show how the nature of learning includes different preferred styles;
Many consultants are advising diversified companies in emerging markets, such as India, Korea, Mexico, and Turkey, to adopt corporate strategies proven to be of value in advanced economies, like the U.S. and the U.K. What are the pros and cons of this advice?AppendixLO1
There are very few companies that are able to be both cost leaders and differentiators.Why? Can you think of a company that has been successful at both?AppendixLO1
Explain why you agree or disagree with each of the following statements:a. It’s better to be a differentiator than a cost leader, since you can then charge premium prices.b. It’s more profitable to be in a high technology than a low technology industry.c. The reason why industries with large
What are the ways that a firm can use to create barriers to entry to deter competition in its business? What factors determine whether these barriers are likely to be enduring?AppendixLO1
In the early 1980s, United, Delta, and American Airlines each started frequent flier programs as a way to differentiate themselves in response to excess capacity in the industry. Many industry analysts, however, believe that this move had only mixed success. Use the competitive advantage concepts
Coca-Cola and Pepsi are both very profitable soft drinks. Inputs for these products include sugar, bottles/cans, and soft drink syrup. Coca-Cola and Pepsi produce the syrup themselves and purchase the other inputs. They then enter into exclusive contracts with independent bottlers to produce their
Joe Smith argues, “Your analysis of the five forces that affect industry profitability is incomplete. For example, in the banking industry, I can think of at least three other factors that are also important; namely, government regulation, demographic trends, and cultural factors.” His
Rate the pharmaceutical and lumber industries as high, medium, or low on the following dimensions of industry structure:Pharmaceutical Industry Lumber Industry Rivalry Threat of new entrants Threat of substitute products Bargaining power of buyers Bargaining power of suppliers.Given your ratings,
One of the fastest growing industries in the last twenty years is the memory chip industry, which supplies memory chips for personal computers and other electronic devices. Yet the average profitability for this industry has been very low. Using the industry analysis framework, list all the
What are the critical drivers of industry profitability?AppendixLO1
Judith, an accounting major, states, “Strategy analysis seems to be an unnecessary detour in doing financial statement analysis. Why can’t we just get straight to the accounting issues?” Explain to Judith why she might be wrong?AppendixLO1
(1) Are we inclined to think of this specific change situation as episodic/continuous and controllable/emergent (complexity scholars)?
5. Describe how different types of organic growth might create differentamounts of value. Why does organic growth often create more value thangrowth from acquisitions?
4. Which type of business, a pharmaceutical firm or an electric utility, wouldbenefit more from improving ROIC than from increasing growth? Why?
3. Under what circumstances does growth destroy value?
2. If value is based on discounted cash flows, why should a company orinvestor analyze growth and ROIC?
1. How does return on invested capital (ROIC) affect a company’s cash flow?Explain the relationship between ROIC, growth, and cash flow.
Evaluate the quality of Comdisco’s disclosure in its annual report regarding the company’s lease accounting policies. Do you think the disclosure is adequate to evaluate the company’s performance?AppendixLO1
Analyze the relative contribution of rentals, sales of computer equipment, and financial services to Comdisco’s reported profits during fiscal years 1981 and 1982 and the first nine months of fiscal year 1983. What are the reasons for the differences in the profit margins of these three
Using the information in Comdisco’s financial statements and footnotes, fill in the following to the extent possible (use plug figures if necessary):Account Balance as of 9/30/81 Increases during fiscal ‘82 Decreases during fiscal ‘82 Balance as of 9/30/82 Obligations under capital leases
Evaluate Comdisco’s business activities and the company’s strategy.AppendixLO1
German firms are traditionally financed by banks, which have representatives on the companies’ boards. How would communication challenges differ for these firms relative to U.S. firms, which rely more on public financing?AppendixLO1
When companies decide to shift from private to public financing by making an initial public offering for their stock, they are likely to face increased costs of investor communications. Given this additional cost, why would firms opt to go public?AppendixLO1
Why might the CEO of the bio-technology firm discussed in Question 7 be concerned about the firm being undervalued? Would the CEO be equally concerned if the stock is overvalued? Do you believe that the CEO would attempt to correct the market’s perception in this overvaluation case?AppendixLO1
Two years after a successful public offering, the CEO of a bio-technology company is concerned about stock market uncertainty surrounding the potential of new drugs in the development pipeline. In his discussion with you, the CEO notes that even though they have recently made significant progress
You are approached by the management of a small start-up company that is planning to go public. The founders are unsure about how aggressive they should be in their accounting decisions as they come to the market. John Smith, the CEO, asserts:“We might as well take full advantage of any
Under a management buyout, the top management of a firm offers to buy the company from its stockholders, usually at a premium over its current stock price. The management team puts up its own capital to finance the acquisition, with additional financing typically coming from a private buyout firm
Financial reporting rules in many countries outside the U.S. (e.g., the U.K., Australia, New Zealand, and France) permit management to revalue fixed assets (and in some cases even intangible assets) which have increased in value. Revaluations are typically based on estimates of realizable value
Management frequently objects to disclosing additional information on the grounds that it is proprietary. Consider the recent FASB proposals on expanding disclosures on (a) executive stock compensation and (b) business segment performance. Many corporate managers expressed strong opposition to both
a. What are likely to be the long-term critical success factors for the following types of firms?• a high technology company, such as Microsoft• a large low-cost retailer, such as Kmartb. How useful is financial accounting data for evaluating how well these two companies are managing their
Apple’s inventory increased from $1 billion on December 29, 1994, to $1.95 billion one year later. In contrast, sales for the fourth quarter in each of these years increased from $2 billion to $2.6 billion. What is the implied annualized inventory turnover for Apple for these years? What
In 1990 U.S. tax law increased capital gains rates from 20 percent to the same level as ordinary income rates, between 28 and 34 percent. What implications does this change have for corporate dividend policy and capital structure?AppendixLO1
It is frequently argued that Japanese and German companies can afford to have more financial leverage and to follow lower dividend payout policies than U.S.companies because they are largely owned by financial institutions that have longterm horizons. Does this argument make economic sense? If so,
U.S. public companies with “low” dividend payouts have payout ratios of 0 percent or less, firms with “medium” payouts have ratios between 1 and 48 percent, and“high” payout firms have a ratio of 49 percent or more. Given these data, how would you classify the following firms in terms
The following table reports (in millions) earnings, dividends, capital expenditures, and R&D for Intel for the period 1990–95:Year Net Income Dividends Capital Expenditures R&D 1990 $650 $0 $680 $517 1991 819 0 948 618 1992 1,067 43 1,228 780 1993 2,295 88 1,933 970 1994 2,288 100 2,441 1,111
A rapidly growing Internet company, recently listed on NASDAQ, needs to raise additional capital to finance new research and development. What financing options are available, and what are the trade-offs between each?AppendixLO1
U.S. public companies with “low” leverage have an interest-bearing net debt-to-equity ratio of 0 percent or less, firms with “medium” leverage have a ratio between 1 and 62 percent, and “high” leverage firms have a ratio of 63 percent or more. Given these data, how would you classify
One important driver of a firm’s capital structure and dividend policy decisions is its business risk. What ratios would you look at to assess business risk? Name two industries with very high business risk and two industries with very low business risk.AppendixLO1
Finance theory implies that the debt-to-equity ratio should be computed using the market values of debt and equity. However, most financial analysts use book values of debt and equity to compute a firm’s financial leverage. What are the limitations of using book values rather than market values
Until 1987 Master Limited Partnerships (MLPs) were treated as partnerships for tax purposes. This meant that no corporate taxes were paid by the entity. Instead, taxes were paid by partners (at their individual tax rates) on entity profits (both distributed and undistributed). The marginal tax rate
Financial analysts typically measure financial leverage as the ratio of debt to equity.However, there is less agreement on how to measure debt, or even equity. How would you treat the following items in computing this ratio? Justify your answers.• Revolving credit agreement with bank• Cash and
a. How would the following ratios differ for a company that used the purchase method to account for an acquisition versus the pooling-of-interests method in the year following the acquisition?• Return on sales• Return on assets• Asset turnoverb. Two years after the acquisition, the company
A leading oil exploration company decides to acquire an Internet company at a 50 percent premium. The acquirer argues that this move creates value for its own stockholders because it can use its excess cash flows from the oil business to help finance growth in the new Internet segment. Evaluate the
In 1995 Disney acquired ABC television at a significant premium. Disney’s management justified much of this premium by arguing that the acquisition would guarantee access for Disney’s programs on ABC’s television stations. Evaluate the economic merits of this claim.AppendixLO1
Company T is currently valued at $50 in the market. A potential acquirer, A, believes that it can add value in two ways: $15 of value can be added through better working capital management, and an additional $10 of value can be generated by making available a unique technology to expand T’s new
You have been hired by GS Investment Bank to work in the merger department. The analysis required for all potential acquisitions includes an examination of the target for any off-balance-sheet assets or liabilities that have to be factored into the valuation.Prepare a checklist for your
The Boston Tea Company plans to acquire Hi Flavor Soda Co. for $60 per share, a 50 percent premium over current market price. John E. Grey, the CFO of Boston Tea, argues that this valuation can easily be justified, using a price-earnings analysis.“Boston Tea has a price-earnings ratio of 15, and
Kim Silverman, CFO of the First Public Bank Company, notes: “We are fortunate to have a cost of capital of only 10 percent. We want to leverage this advantage by acquiring other banks that have a higher cost of funds. I believe that we can add significant value to these banks by using our lower
In the 1980s leveraged buyouts (LBOs) were a popular form of acquisition. Under a leveraged buyout, a buyout group (which frequently includes target management)makes an offer to buy the target firm at a premium over its current price. The buyout group finances much of the acquisition with debt
During the early 1990s there was a noticeable increase in mergers and acquisitions between firms in different countries (termed cross-border acquisitions). What factors could explain this increase? What special issues can arise in executing a crossborder acquisition and in ultimately meeting your
Mary Saxon, a Dutch investment banker, is advising a local client on a potential foreign acquisition in the U.S. Currently, there is a competing cash bid for the target by a U.S. competitor. However, Saxon argues that the target should be worth more to the Dutch client than to the U.S. competitor,
A leading retailer finds itself in a financial bind. It doesn’t have sufficient cash flow from operations to finance its growth, and is close to violating the maximum debt-toassets ratio allowed by its covenants. The Vice-President for Marketing suggests:“We can raise cash for our growth by
A banker argues: “I avoid lending to companies with negative cash from operations because they are too risky.” Is this a sensible lending policy?AppendixLO1
Can Cambridge improve its Z score by behaving as the analyst claims in Question 6?Is this change consistent with economic reality?AppendixLO1
Cambridge Construction Company follows the percentage-of-completion method for reporting long-term contract revenues. The percentage of completion is based on the cost of materials shipped to the project site as a percentage of total expected material costs. Cambridge’s major debt agreement
Betty Li, the CFO of a company applying for a new loan, argues: “I will never agree to a debt covenant that restricts my ability to pay dividends to my shareholders, because it reduces shareholder wealth.” Do you agree with this argument?AppendixLO1
Many debt agreements require borrowers to obtain the permission of the lender before undertaking a major acquisition or asset sale. Why would the lender want to include this type of restriction?AppendixLO1
Some have argued that the market for original-issue junk bonds developed in the late 1970s as a result of a failure in the rating process. Proponents of this argument suggest that rating agencies rated companies too harshly at the low end of the rating scale, denying investment grade status to some
Why would a company pay to have its public debt rated by a major rating agency(such as Moody’s or Standard and Poor’s)? Why might a firm decide not to have its debt rated?AppendixLO1
What are the critical performance dimensions for (a) a retailer and (b) a financial services company that should be considered in credit analysis? What ratios would you suggest looking at for each of these dimensions?AppendixLO1
Joe states: “I can see how ratio analysis and valuation help me do fundamental analysis, but I don’t see the value of doing strategy analysis.” Can you explain to him how strategy analysis could be potentially useful?AppendixLO1
Intergalactic Software Company’s stock has a market price of $20 per share and a book value of $12 per share. If its cost of equity capital is 15 percent and its book value is expected to grow at 5 percent per year indefinitely, what is the market’s assessment of its steady state return on
Joe Klein is an analyst for an investment banking firm that offers both underwriting and brokerage services. Joe sends you a highly favorable report on a stock that his firm recently helped go public and for which it currently makes the market. What are the potential advantages and disadvantages in
Many market participants believe that sell-side analysts are too optimistic in their recommendations to buy stocks, and too slow to recommend sells. What factors might explain this bias?AppendixLO1
There are two major types of financial analysts: buy-side and sell-side. Buy-side analysts work for investment firms and make stock recommendations that are available only to the management of funds within that firm. Sell-side analysts work for brokerage firms and make recommendations that are used
Three months ago, Intergalactic Software Company went public. You are a sophisticated investor who devotes time to fundamental analysis as a way of identifying mispriced stocks. Which of the following characteristics would you focus on in deciding whether to follow this stock?• The market
Investment funds follow many different types of investment strategies. Income funds focus on stocks with high dividend yields, growth funds invest in stocks that are expected to have high capital appreciation, value funds follow stocks that are considered to be undervalued, and short funds bet
What is the difference between fundamental and technical analysis? Can you think of any trading strategies that use technical analysis? What are the underlying assumptions made by these strategies?AppendixLO1
Geoffrey Henley, a professor of finance, states: “The capital market is efficient. I don’t know why anyone would bother devoting their time to following individual stocks and doing fundamental analysis. The best approach is to buy and hold a welldiversified portfolio of stocks.” Do you agree?
Despite many years of research, the evidence on market efficiency described in this chapter appears to be inconclusive. Some argue that this is because researchers have been unable to link company fundamentals to stock prices precisely. Comment.AppendixLO1
Nancy Smith says she is uncomfortable making the assumption that Sigma’s dividend payout will vary from year to year. If she makes a constant dividend payout assumption, what changes does she have to make in her other valuation assumptions to make them internally consistent with each
Can accounting distortions, if not recognized by an analyst, affect cash flow-based valuations? Construct a numerical example to verify your answer.AppendixLO1
Can accounting analysis improve accounting-based valuations? Explain why or why not.AppendixLO1
Calculate the proportion of terminal values to total estimated values of equity and assets under the abnormal earnings method and the discounted cash flow method.Why are these proportions different?AppendixLO1
Verify the terminal value calculations in Table 12-9. How will the terminal values in Table 12-9 change if the sales growth in years 2004 and beyond is 5 percent(keeping all the other assumptions in the table unchanged)?AppendixLO1
Verify the present value calculations in Table 12-3. How will the present values in the table change if the cost of equity changes to 15 percent?AppendixLO1
Calculate Sigma’s dividend payments in the years 1999–2003 implicitly assumed in the projections in Table 12-2. How will these payments change if the ratio of net debt to net capital is changed from 40 percent to 50 percent?AppendixLO1
Recalculate the forecasts in Table 12-2 assuming that the ratio of net operating working capital to sales is 30 percent, and the ratio of net long-term assets to sales is 50 percent. Keep all the other assumptions unchanged.AppendixLO1
Recalculate the forecasts in Table 12-2 assuming that the NOPAT profit margin declines by 1.5 percent per year (keep all the other assumptions unchanged).AppendixLO1
Verify the forecasts in Table 12-2. How will the forecasts change if the assumed growth rate in sales from 1999 to 2003 is changed to 15 percent (and all the other assumptions are kept unchanged)?AppendixLO1
Janet Stringer argues that “the DCF valuation method has increased managers’focus on short-term rather than long-term performance, since the discounting process places much heavier weight on short-term cash flows than long-term ones.”Comment.AppendixLO1
Starite Company is valued at $20 per share. Analysts expect that it will generate free cash flows to equity of $4 per share for the foreseeable future. What is the firm’s implied cost of equity capital?AppendixLO1
Free cash flows (FCF) used in DCF valuations discussed in the chapter are defined as follows:FCF to debt and equity = Earnings before interest and taxes × (1 – tax rate)+ Depreciation and deferred taxes – Capital expenditures –/+ Increase/decrease in working capital.FCF to equity = Net
What type of companies have:a. a high PE and a low market-to-book ratio?b. a high PE ratio and a high market-to-book ratio?c. a low PE and a high market-to-book ratio?d. a low PE and a low market-to-book ratio?AppendixLO1
How can a company with a high ROE have a low PE ratio?AppendixLO1
Analysts reassess Manufactured Earnings’ future performance as follows: growth in book value increases to 12 percent per year, but the ROE of the incremental book value is only 15 percent. What is the impact on the market-to-book ratio?AppendixLO1
Given the information in question (3), what will be Manufactured Earnings’ stock price if the market revises its expectations of long-term average ROE to 20 percent?AppendixLO1
Manufactured Earnings is a “darling” of Wall Street analysts. Its current market price is $15 per share, and its book value is $5 per share. Analysts forecast that the firm’s book value will grow by 10 percent per year indefinitely, and the cost of equity is 15 percent. Given these facts,
Explain why terminal values in accounting-based valuation are significantly less than those for DCF valuation.AppendixLO1
Joe Watts, an analyst at EMH Securities, states: “I don’t know why anyone would ever try to value earnings. Obviously, the market knows that earnings can be manipulated and only values cash flows.” Discuss.AppendixLO1

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