Ahold vs. Tesco: Analyzing Performance 1) Reformulate the balance sheets. Recall that the key is to separate out the few financial items. The rest are operating related. You can treat the long-term investment, notes receivable, other assets and liabilities as operating items. They are either long-term equity investment or have no interestbearing. 2) Derive the "other comprehensive income" of the two companies from their balance sheets. Then obtain their comprehensive incomes. 3) Suppose "other comprehensive income" is related to operations only. Identify the financing incomes and obtain the net financial expense (after tax) using 24% marginal tax rate for both firms. Then calculate the operating incomes (after tax) using the comprehensive incomes obtained in 2). Note that the "operating income" in the case is actually "operating income from sales" in our textbook definition; and the "other non-operating income" reported in the case exhibits is actually operating related. 4) Calculate the operating profit margin and asset turnover for the two firms. Then derive the return on net operating assets (RNOA). Based on the calculation, which firm performs better in operation? what drives the difference? What happens to your analysis if you drop the "other unusual items" in operating incomes? 5) Calculate the return on equity (ROE), the financial leverage, and the net borrowing cost (NBC). Then decompose ROE to separate out the financial leverage effect. 6) Which company is less impacted by financial leverage? Compare their leverage and NBC to find out what drives the difference. (hint: consider cash holding relative to debt and the interest expense). 7) Suppose you were a LBO investor and plan to buy one of them. Which company would you target? Why? After you bought one of them and used it for acquisition, how would its leverage effect change? 8) What will happen to the profitability analysis if Ahold uses its cash holding to pay out dividends? What if it uses its cash holding to reduce debt instead? Which strategy might get a better equity market response (more favored by equity investors)? Give your explanations