Solutions to exam Financial Statement Analysis June 23, 2011

Question 1

(25 points)

Number of points for this question is calculated as follows:

#points = 5 max(#correct answers 5, 0).
This takes into account that, by guessing, 50% of the statements would have been answered
correctly on average.
A
False, the present value of all future residual operating income is equal to the present
value of all future residual income
B

False, such firms are likely to be overvalued.

True, all you need for an SF2 forecast is residual operating income for the current
year.

True, investments reduce the free cash flow.

True. See lecture 7.

False, whether the market to book ratio is less than one depends on the markets
beliefs about the firms future performance and not on the value of the firms retained
earnings.

True, SF3 forecasts assume that the current RNOA persists in the future. Hence,
to forecast residual operating income one needs to know how NOA changes in the
future.

True, the hidden dirty surplus loss is part of comprehensive income that is reported
on both the reformulated equity statement and reformulated income statement.

True. See lecture 6.

True. See lecture 1.

Question 2

(25 points)

A maximum of 4, 4, 6, 6, and 5 points can be earned for parts A, B, C, D, and E respectively.

2 points have been subtracted for each calculation error.
A The normal trailing P/E ratio is defined as (1 + r)/r. Hence, it equals 1.104/0.104 =
10.62.
B It holds that forward P/E ratio is equal to market value divided by forecasted earnings
for 2011, that is, 10.47 = 838.2/E2011 . Rearranging terms yields E2011 = 838.2/10.47 =
80.06 million.

Alternative solution: forward P/E ratio equals share price divided by forecasted earnings per share for 2011, that is, 10.47 = 35.90/EP S2011 . Rearranging terms yields
EP S2011 = 35.90/10.47 = 3.43. This corresponds to E2011 = 3.43 23.3 = 79.92
million. Differences with the solution above are due to rounding errors.
C
2010

2011

2012

2013

2014

2015

718.3

776.3

836.9

900.1

966.0

1,034.7

Et

74.2

76.6

79.2

81.8

84.5

87.3

dt

18.6

18.6

18.6

18.6

18.6

18.6

1.9

-1.5

-5.2

-9.1

-13.2

BVt

RIt
PV of RIt

-17.5

CV

-162.4

PV of CV

-99.0

Observe that RIt = Et 10.4% BVt1 , BVt = BVt1 + Et dt and that CV =

RI2015 (1+g)
rg

13.21.021
.104.021

= 162.4. Firm value then equals VE = 718.3 17.5 99.0 =

601.8 million.
D Reverse engineering is applied to the valuation formula: VE = BV2010 +

RI2010 (1+g)
.
rg

Hence, one first needs to calculate RI2010 . It holds that RI2010 = E2010 r BV2009 .
Using that BV2009 = BV2010 + d2010 E2010 = 662.7 it follows that RI2010 = 74.2
0.104 662.7 = 5.3. Substituting VE = 838.2, BV2010 , RI2010 , and r in the valuation
equation, one obtains
838.2 = 718.3 +

5.3 (1 + g)
.
0.104 g

Rearranging terms yields g =

0.104(838.2718.3)5.3
838.2718.3+5.3

= 0.0573 = 5.73%.

E
2010

2011

2012

718.3

779.9

848.0

Et

74.2

80.2

86.7

dt

18.6

18.6

18.6

5.3

5.5

5.6

BVt

RIt

Observe that RIt+1 = 1.03 RIt , Et = RIt + r BVt1 and BVt+1 = BVt + Et dt .
Hence, growth in earnings equals

80.274.2
74.2

2012 respectively.

= 8.1% and

86.780.2
80.2

= 8.1% for 2011 and

Question 3

(25 points)

A maximum of 9, 8, and 8 points can be earned for parts A, B, and C, respectively. 2 points
have been subtracted for each misclassification or forgotten item.
A
Reformulated income statement
Revenue

5,912

Operating expenses

(5,085)

Operating income from sales (pre-tax)

Reported income tax

827
(295)

Tax on other OI

116

Tax benefit on NFE

(20)

Tax on operating income from sales

(199)

Operating income from sales (after tax)

628

Litigation settlement income

269

Share of results of joint ventures and associates

32

Profit on disposal of available for sale investment

Tax on other

OI1

116

Exchange differences on translation of foreign operations2

Gains on cash flow

115

hedge2,5

8
51

Other operating income

359

Operating income

987

Investment income

Finance cost
Investment income on litigation

(122)
settlement3

Tax benefit on NFE4

49
20

Gain on revaluation of available for sale

investment2

Net financing expense

(48)

Comprehensive income

939

28.0% (269 + 32 + 115) = 116

Taken from equity statement

May also be classified as other operating income

28.0% (122 3 49) = 20

May also be classified as financing income

B
Reformulated balance sheet (June 30, 2010)
Operating assets:
Goodwill

852

Intangible assets

336

Property, plant and equipment

899

Investments in joint ventures and associates

149

Trade and other receivables

556

Inventories

343

Total operating assets

3,135

Operating liabilities:
Trade and other payables

1,578

Current tax liabilities

136

Provisions

38

Deferred tax liability

Total operating liabilities

1,759

Net operating assets

1,376

Financial assets:
Short-term deposits

400

Cash and cash equivalents

649

Derivative financial assets

438

Available-for-sale investments

182

Total financial assets

1,669

Financial liabilities:
Derivative financial liabilities

27

Borrowings

2,458

Total financial liabilities

2,485

Net financial obligations

816

Share capital

876

Share premium

1,437

Retained earnings

(2,243)

Reserves

490

Common shareholders equity

560

Cash flows from operating activities:

Cash generated from operations

1,634

Taxation paid

(320)

Tax benefit on net interest paid

(28)

Net cash from operating activities (C)

1,286

Cash flows from investing activities:

Dividends received from joint ventures and associates
Net funding to joint ventures and associates

(30)
1

Proceeds on disposal of an investment

(196)

Purchase of property, plant and equipment

261

Purchase of intangible assets

183

Proceeds on disposal of property, plant and equipment

Net cash used in investing activities (I)

(1)
218

Tax benefit on net interest paid is calculated as follows:

Interest paid
156
Interest received

(57)

Tax benefit: 28.0% (156 57) =

(28)

Net interest paid

71

From this it follows that C I = 1, 286 218 = 1, 068.

For completenes sake, the remainder of the reformulated cash flow statement is:
Cash flows from financing activities
(Increase) decrease in short-term deposits

310

Repayment of borrowings

495

Net interest paid

71

Decrease in cash and cash equivalents

(162)

Cash flows from financing activities (F)

714

Proceeds from disposal of shares in ESOP

Purchase of own shares for ESOP

(16)
56

Dividends paid to shareholders

314

Net transaction with shareholders (d)

354

Notice that F + d = 754 + 314 = 1, 068 = C I.

Question 4

(25 points)

A maximum of 6, 6, 6, and 7 points can be earned for parts A, B, C, and D, respectively. 2

points have been subtracted for each calculation error.
A It holds that
ROCE = 206.1/(0.5 842.5 + 0.5 1, 048.3) = 21.8%
RN OA = (234.2 2.6)/(0.5 1, 482.3 + 0.5 1, 676.1) = 14.7%
N BC = 25.5/(0.5 639.8 + 0.5 627.8) = 4.0%
F LEV

= (0.5 639.8 + 0.5 627.8)/0.5 842.5 + 0.5 1, 048.3) = 0.67%

so that
ROCE = RN OA + F LEV (RN OA N BC)
= 14.7% + 0.67 (14.7% 4.0%)
= 21.86%
3 points have been subtracted if you did not use yearly average values.
B It holds that
P M sales = 234.2/4, 472.7 = 5.24%
P M other OI = 2.6/4, 472.7 = 0.06%
AT O = 4, 472.7/(0.5 1, 482.3 + 0.5 1, 676.1) = 2.83
C For the SF3 forecast it holds that ReOI2011 = (CoreRN OA2010 rF ) N OA2010 .
So, the additional information required is the cost of operations rF (presuming that
CoreRN OA is core operating income from sales). Note that the growth rate in NOA is
not needed for the 2011 forecast. It is needed to forecast ReOI for the years 2102 and
beyond.
D Two important observations can be made:
In 2010, $ 308.0 is reported in current maturities of long term debt. This means
that Radioshack has to repay this debt in 2011.

 Even though Radioshack made a profit in 2010, retained earnings decreased considerably in 2010. It is important to know what was driving this decrease in retained
earnings. Did Radioshack pay a huge dividend or did they repurchase a lot of
shares?