Final Exam Financial Statement Analysis – Fall 2, 2023 Name_______________________

This exam is a chance for you to illustrate your achievement of the learning objectives of this course.  Please do your own work and do not share your work with others. 

All answers should be your own (in your own words) citations lifted from the internet or AI sources will be noticed and points will not be awarded. Additionally, if you share your work with others, both your response and the identical response with not earn points. Good luck.

1. Should a company with a low ROIC attempt to raise the ROIC or grow the business?

1. Most often in mature companies, a low ROIC indicates what?
2. Value creation is more closely correlated with increases and decreases in cash flow or with increases and decreases in earnings per share. Pick one.

1. Do companies domiciled in the United States generally have higher or lower multiples than those domiciled in the other countries?

1. ABC Corporation has a ROIC of 22% currently. There is a new project with an ROIC of 18% and a cost of capital of 13%. Should ABC accept or reject this project?

1. From the prior question, if ABC accepts this project with it raise of lower ABC’s ROIC?

1. From the prior two questions, if ABC accepts this project will it raise or lower the wealth of ABC’s shareholders (consider only the impact of this project in isolation)?

1. For a given company, next year’s NOPAT is $600. For the foreseeable future, the growth rate will be 4 percent, the ROIC will be 14 percent, and the weighted average cost of capital (WACC) will be 12 percent. Using the key driver formula, calculate the value of the company.

1. For a change in capital structure to create value it must improve what for the corporation.

1. For publicly traded companies, which risk is reflected in the cost of capital? Pick one (non-diversifiable risk or diversifiable risk)

1. Do managers typically create wealth or destroy wealth when they complete acquisitions that diversify risks for the business?

1. Per the authors of the text, most managers tend to not take on projects with what single characteristic?

1. When is it logical (wealth creating) to repurchase shares?
   1. When the company has excess cash after accepting all positive net present value projects.
   2. To buy back the shares that are going to be issued to managers when these managers exercise their stock options.

1. With respect to value creation, define financial engineering.
2. Managers should attempt to repurchase the company’s stock when the intrinsic value of the stock is (greater than or less than) the market price, Pick one.

1. If a stock starts the year at $100 and ends the year at $112 and pays a $4 dividend over the year, what is the TRS for that year?

1. What typically goes wrong when managers try to manage to improve the total return to shareholders when the expectations treadmill is already running too fast?

1. Where should managers focus their energies when their company’s treadmill is running too fast?

1. Is it better to measure management’s performance relative to their peers or to their past performance? And why?
2. Describe an action that may look impressive but does not create value?

1. What is the relationship between value and risk?

1. Specifically, from the book, besides the tax rate, what are the other two drivers of ROIC?

1. How would you estimate the sustainability of a firm’s competitive advantage?

1. What does the empirical evidence (cited in the book) say about the ability of firms to sustain ROIC over time?

1. Per the book, what can managers do to exploit the difference between the intrinsic value and the market price?

1. Per the book, what are the drivers of growth?

1. What does the empirical evidence (cited in the book) say about the ability of individual firms to sustain growth over time?

1. Besides the enterprise discounted cash flow model, there are other models like economic profit, adjusted present value, capital cash flow model and the cash flow to equity model. Are these different models that arrive at different valuation or (if done correctly) will these models arrive at the same valuation?

1. What are we doing when we reorganize the financial statements? Separating what from what?

1. I make stereos and have inventory, operating cash, excess cash, accounts receivable, and long-term investments in treasuries, which of these assets should be removed to get invested capital?

1. I have cash, accounts payable, inventory, long-term debt, and accrued expenses. Which of these are operating liabilities? And what do we do with operating liabilities to get invested capital? Why?

1. I have cash, accounts payable, inventory, long-term debt, accrued expenses, unfunded pension obligations, and current portion of long-term debt. Which of these are non-operating liabilities?

1. I have sales, cost of goods sold, selling expenses, general and administrative expenses, interest expense, and interest revenue. What items should be removed to calculate NOPAT?

1. Is NOPAT a before tax or after-tax amount?

1. In words (starting with NOPAT) what do we add or subtract to/from NOPAT to get free cash flow?

1. What ratio would better indicate if the company were successful in implementing a strategy based upon product differentiation along some feature that the customer cares about – the asset turnover ratio or the profit margin?

1. What ratio would better indicate if the company were successful in implementing a strategy based upon capacity control and not overspending on plant, property, and equipment, and uses lean manufacturing techniques like just in time inventory, or only stocks enough product to meet demand? The profit margin or the asset turnover ratio.

1. Is an increase in working capital a source or use of funds? (Pick one)

1. XYZ company earns $18000 in NOPAT, working capital decreases by $3000, it has $1500 in depreciation, and $5000 in capital investments (plant, property, and equipment). Nothing else happens in the capital investments account. What is XYZ’s free cash flow?
2. XYZ’s operating margin is 15%, 14%, 12%, 8% for years 1,2,3,4, respectively. Where would you look to see if this is being caused by external factors or by internal factors? Be specific.

1. ABC’s capital turnover ratio 1.5x’s; 1.6x’s, 1.7x’s, 1.8x’s for years 1,2,3,4, respectively. How could you tell if this trend will continue in the future? What does this trend in the capital turnover indicate to the analyst? Be specific.

1. When projecting future years, how should (or even should) the analyst project revenue growth from currency effects?

1. Company A and Company B are equal in every way and have equal competitive positions, projects, and starting positions. The management of Company A uses a five-year forecasting period and Company B uses a 10-year forecasting period. Which should have a higher net present value of future free cash flows (if any)?

1. Company A and Company B are equal in every way and have equal competitive positions, projects, and starting positions. The only difference is Company A has a lower weighted average cost of capital than Company B. Which company should have the higher intrinsic value?
2. What variable(s) determine how long the competitive advantage period is for a company or product?
3. What rate of return on new invested capital would you use if you believe the company’s competitive advantage has expired and the company’s products (including new projects) are commoditized (and equal with others in the industry)?
4. In the section on naïve base year extrapolation the authors make the point that the increase in working capital should be what?

1. If you are using a multiples approach to estimate continuing value, should you use the multiple for the company today or at the end of the forecasting period? What could account for a change in the two multiples?
2. When could you make the case to use liquidation values?
3. What are the weaknesses of using replacement cost?
4. What are the two most common sources of capital for most firms?
5. How does the book suggest that you improve the predictive ability of beta?
6. Most researchers use what index when measuring betas?
7. Using the Fama and French three factor model should big companies (in market capitalization) or small companies have higher equity returns? Why might this be the case?
8. Company B has a market value per share of $20 and a book value of $4 per share. Company A has a market value of $10 per share and a book value of $10 per share. Using the Fama and French three factor model, which company should have higher equity returns? Why might this be the case?
9. Should AAA rated bonds or BBB rated bonds have higher yield spreads?
10. In simple terms, what is an interest tax shield?
11. What non-financial attribute is important in predicting a company’s target capital structure?
12. Why do companies use a mid-year adjustment when discounting future free cash flows?
13. You study the financial statements of the financing arm of Ford Motor Company, and you believe the coming recession will be deeper than management estimates and consequently believe that the bad debts write-offs will be greater than the amount estimated in the financial statements. When projecting the future free cash flows would your adjustment increase or decrease the future estimated free cash flows for Ford? Additionally, would this increase or decrease your calculated intrinsic value of the company?
14. When you use the “denominator approach” discussed in the book to account for “in the money” executive stock options, do you add or subtract the shares under option to or from the denominator?
15. Do high beta industries or low beta industries have the greatest exposure to broad economic conditions?
16. Choosing between the profit margin ratio and the capital turnover ratio, which of these ratios indicates a competitive advantage based on successful product differentiation?
17. Choosing between the profit margin ratio and the capital turnover ratio, which of these ratios better indicate a firm’s efficiency within its industry?
18. How would you assess if your company has the financial capabilities necessary to achieve your projections?
19. What is the difference between scenario analysis and sensitivity analysis?

1. Hannibal Corp. has a cost of equity of 14%, and an after-tax cost of debt of 9%. Using market values, Hannibal’s debt is 35% of the value of the firm and its equity is 65% of the value of the firm. What is the weighted average cost of capital?
2. Dexter Corp. can borrow at 6% and it has a 23% marginal tax rate. What is the after-tax cost of debt?
3. Columbia Corporation has a beta of 1.2, the expected risk-free rate is 4.8% and the expected market risk premium is 6%. Using the Capital Asset Pricing Model, what is the after-tax cost of equity?
4. Quincy Corp. expects NOPAT of $62,800,000 in the first year after the forecast period (or the first year of continuing value period. In addition, Quincy expects growth of 2.5% during the continuing value period, return on new invested capital of 13%, and a weighted average cost of capital of 9%. Please calculate the continuing value.

1. St Louis Corp. expects free cash flows of $52,000,000, $61,200,000, $71,400,000, $81,800,000, $76,500,000, in years 1,2 3,4, 5, respectively. In addition, St Louis has a continuing value of $132,000,000 at the end of year 5 and a cost of capital of 10%. Assuming year end cash flows, please bring these cash flows to present discounting at the weighted average cost of capital and place the answer below as the enterprise value.
2. Perryville Corp. has an enterprise value of $65,000,000, long term debt of $18,500,000, and an under-funded pension obligation of $6,000,000. If Perryville has 1,180,000 shares outstanding (and no shares under option), please compute the intrinsic value per common share.

1. Assume the same information as the prior problem. In addition, Perryville Corp. has 160,000 shares under option and “in the money”. Please use the denominator method or exercise value approach and assume that all 160,000 options will be exercised (with no proceeds – because future grant will offset the proceeds). In addition, Perryville issued an additional 100,000 shares and the net proceeds of $10,000,000 in cash from the sale is added to the $65,000,000 enterprise value for a new enterprise value of $75,000,000. What is the new intrinsic value per common share?

For each of the following, what should happen to the equity value of a company if the following takes place? (Hold all other variables constant):

1. The competitive advantage period for the company you are analyzing decreases from 8 years to 5 years – the intrinsic equity value from your model would increase / decrease (underline one)
2. General market rates of interest increase due to greater risk aversion or a decision by the Federal Reserve system to stay out of the treasury market and purchase fewer treasuries in the future – the intrinsic equity value from your model would increase / decrease (underline one)
3. For the company you are analyzing, the production method is modified in a way that requires less working capital — the intrinsic equity value from your model would increase / decrease.
4. For the company you are analyzing, the company’s compensation committee recommends awarding fewer stock options to executives in the future. The company adopts this recommendation, and this is instituted. You believe there will be no commensurate decrease in the performance of the company — the intrinsic equity value from your model would increase / decrease.
5. The company moves to a delivery system that requires less investment in plant property and equipment – the intrinsic equity value from your model would increase / decrease.
6. The company matures to a safer company and consequently a lower cost of capital — the intrinsic equity value from you model would increase / decrease.
7. The company product and industry are expected to enjoy above normal growth rates due to a shift in consumer tastes and preferences — the intrinsic equity value from your model would increase / decrease.

Please use the following data for the problems to follow:

INCOME STATEMENT DATA (in traditional format):
Sales	$384,000
COGS	$175,000
Selling and admin	$35,000
Depreciation expense	$18,000
Interest revenue	$15,000
Interest expense	$4,000
Before tax income	$167,000
Taxes on both operating and financial (26%)	$43,420
Net income	$123,580
BALANCE SHEET DATA (traditional format):
Operating cash	$36,000
Accounts receivable	$45,000
Inventory	$165,000
Plant prop and equip	$235,000
Excess cash and ancillary investments	$149,000
Total assets	$630,000
Accounts payable	$25,000
Accrued expenses	$32,000
Borrowed money	$383,000
Stockholder equity	$190,000
Total liabilities and equity	$630,000

1. 1. Using the information above please put together a reformulated income statement (of operations) below:

1. 1. Using the information above please put together a reformulated balance sheet below:

After completing the reformulated income statement and balance sheet, please calculate the following:

NOPAT _______________

Operating assets________________

Net operating assets or invested capital________________

ROIC ______________

Use the information below to calculate the change in working capital, the change in plant and equipment and the free cash flow for each of the years indicated.

Year	Now	Year 1		Year 2		Year 3
Increase/ decrease in working capital
Increase/ decrease in plant and equipment
Free cash flow

END OF TEST/EXAM – THANK YOU AND HAVE A GREAT HOLIDAY BREAK.