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All Textbook Solutions for Financial Reporting, Financial Statement Analysis and Valuation
25PC26PC27PC1.1AIC1.1BIC1.1CIC1.1DIC1.2AIC1.2BIC1.2CICEstimate the average total estimated useful life of depreciable property, plant, and equipment. Starbucks reports 580.6 million of depreciation and amortization in the statement of cash flows, of which 4.5 million relates to amortization of limited-life intangible assets. Does the estimate reconcile with stated accounting policy on useful lives for property, plant, and equipment? Explain.1.3BIC1.3CIC2AIC2BIC2CIC2DIC2EIC1QE2QE3QE4QE5QE6QE7QE8QE9QE10QE11QE12QE13QEDiscuss when each of the following types of businesses is likely to recognize revenues and expenses. a. A bank lends money for home mortgages. b. A travel agency books hotels, transportation, and similar services for customers and earns a commission from the providers of these services. c. A major league baseball team sells season tickets before the season begins and signs its players to multiyear contracts. These contracts typically defer the payment of a significant portion of the compensation provided by the contract until the player retires. d. A producer of fine whiskey ages the whiskey 12 years before sale. e. A timber-growing firm contracts to sell all timber in a particular tract when it reaches 20 years of age. Each year it harvests another tract. The price per board foot of timber equals the market price when the customer signs the purchase contract plus 10% for each year until harvest. f. An airline provides transportation services to customers. Each flight grants frequent-flier miles to customers. Customers earn a free flight when they accumulate sufficient frequent-flier miles.15PC16PC17PC18PC19PCA large manufacturer of truck and car tires recently changed its cost-flow assumption method for inventories at the beginning of 2014. The manufacturer has been in operation for almost 40 years, and for the last decade it has reported moderate growth in revenues. The firm changed from the LIFO method to the FIFO method and reported the following information (amounts in millions): REQUIRED Calculate the inventory turnover ratio for 2014 using the LIFO and FIFO cost-flow assumption methods. Explain why the costs assigned to inventory under LIFO at the end of 2013 and 2014 are so much less than they are under FIFO.21PC22PC23PC24PC25PC1AIC1BIC2AIC2BIC2CIC2DIC2EIC2FIC2GIC2HIC3AIC3BIC3CIC3DIC1QEThe chapter encourages analysts to develop forecasts that are realistic, objective, and unbiased. Some firms managers tend to be optimistic. Some accounting principles tend to be conservative. Describe the different risks and incentives that managers, accountants, and analysts face. Explain how these different risks and incentives lead managers, accountants, and analysts to different biases when predicting uncertain outcomes.3QESuppose you are analyzing a firm that is successfully executing a strategy that differentiates its products from those of its competitors. Because of this strategy, you project that next year the firm will generate 6.0% revenue growth from price increases and 3.0% revenue growth from sales volume increases. Assume that the firms production cost structure involves strictly variable costs. (That is, the cost to produce each unit of product remains the same.) Should you project that the firms gross profit will increase next year? If you project that the gross profit will increase, is the increase a result of volume growth, price growth, or both? Should you project that the firms gross profit margin (gross profit divided by sales) will increase next year? If you project that the gross profit margin will increase, is the increase a result of volume growth, price growth, or both?Use the following hypothetical data for Walgreens in Years 11 and 12 to project revenues, cost of goods sold, and inventory for Year +1. Assume that Walgreenss Year +1 revenue growth rate, gross profit margin, and inventory turnover will be identical to Year 12. Project the average inventory balance in Year +1 and use it to compute the implied ending inventory balance.6QE7QE8QEThe Home Depot is a leading specialty retailer of hardware and home improvement products and is the second-largest retail store chain in the United States. It operates large warehouse-style stores. Despite declining sales and difficult economic conditions in 20X1 and 20X2, The Home Depot continued to invest in new stores. The following table provides summary hypothetical data for The Home Depot. REQUIRED a. Use the preceding data for The Home Depot to compute average revenues per store, capital spending per new store, and ending inventory per store in 20X2. b. Assume that The Home Depot will add 100 new stores by the end of Year +1. Use the data from 20X2 to project Year +1 sales revenues, capital spending, and ending inventory. Assume that each new store will be open for business for an average of one-half year in Year +1. For simplicity, assume that in Year +1, Home Depots sales revenues will grow, but only because it will open new stores.10PC11PC12PC13PC14PC15PC1AIC1BIC1CIC1DIC1EIC1FICIdentify clues from the financial statements and financial statement ratios for Year 3Year 7 that might suggest that Massachusetts Stove Company is a mature business.Design a spreadsheet for the preparation of projected income statements, balance sheets, and statements of cash flows for MSC for Year 8Year 12. Also forecast the financial statements for each of these years under three scenarios: (1) best case, (2) most likely, and (3) worst case. The following sections describe the assumptions you can make.2CICWhat advice would you give the management of MSC regarding its decision to enter the gas stove market? Your recommendation should consider the profitability and risks of this action as well as other factors you deem relevant.Explain the theory behind the dividends-based valuation approach. Why are dividends value-relevant to common equity shareholders?2QE3QE4QE5QE6QE7QE8QE9QEThe data in Exhibit 11.3 on industry median betas suggest that firms in the following three sets of related industries have different degrees of systematic risk. REQUIRED a. For each matched pair of industries, describe factors that characterize a typical firms business model in each industry. Describe how such factors would contribute to differences in systematic risk. b. For each matched pair of industries, use the CAPM to compute the required rate of return on equity capital for the median firm in each industry. Assume that the risk-free rate of return is 4.0% and the market risk premium is 5.0%. c. For each matched pair of industries, compute the present value of a stream of 1 dividends for the median firm in each industry. Use the perpetuity-with-growth model and assume 3.0% long-run growth for each industry. What effect does the difference in systematic risk across industries have on the per-dollar dividend valuation of the median firm in each industry?Whirlpool manufactures and sells home appliances under various brand names. IBM develops and manufactures computer hardware and offers related technology services. Target operates a chain of general merchandise discount retail stores. The data in the following table apply to these companies (dollar amounts in millions). For each firm, assume that the market value of the debt equals its book value. REQUIRED a. Assume that the intermediate-term yields on U.S. government Treasury securities are 3.5%. Assume that the market risk premium is 5.0%. Compute the cost of equity capital for each of the three companies. b. Compute the weighted-average cost of capital for each of the three companies. c. Compute the unlevered market (asset) beta for each of the three companies. d. Assume that each company is a candidate for a potential leveraged buyout. The buyers intend to implement a capital structure that has 75% debt (with a pretax borrowing cost of 8.0%) and 25% common equity. Project the weighted-average cost of capital for each company based on the new capital structure. To what extent do these revised weighted-average costs of capital differ from those computed in Requirement b?12PC13PCProblem 10.16 projected financial statements for Walmart for Years +1 through +5. The following data for Walmart include the actual amounts for 2012 and the projected amounts for Years +1 through +5 for comprehensive income and common shareholders equity, assuming it will use implied dividends as the financial flexible account to balance the balance sheet (amounts in millions). Assume that the market equity beta for Walmart at the end of 2012 was 1.00. Assume that the risk-free interest rate was 3.0% and the market risk premium was 6.0%. Also assume that Walmart had 3,314 million shares outstanding at the end of 2012, and share price was 69.09. REQUIRED a. Use the CAPM to compute the required rate of return on common equity capital for Walmart. b. Compute the weighted-average cost of capital for Walmart as of the start of Year +1. At the end of 2012, Walmart had 48,222 million in outstanding interest-bearing debt on the balance sheet and no preferred stock. Assume that the balance sheet value of Walmarts debt is approximately equal to the market value of the debt. Assume that at the start of Year +1, it will incur interest expense of 4.2% on debt capital and that its average tax rate will be 32.0%. Walmart also had 5,395 million in equity capital from noncontrolling interests. Assume that this equity capital carries a 15.0% required rate of return. (For our forecasts, we assume noncontrolling interests are similar to preferred shares and receive dividends equal to the required rate of return each year.) c. Use the clean surplus accounting approach to derive the projected dividends for common shareholders for Years +1 through +5 based on the projected comprehensive income and shareholders equity amounts. (Throughout this problem, you can ignore dividends to noncontrolling interests.) d. Use the clean surplus accounting approach to project the continuing dividend to common shareholders in Year +6. Assume that the steady-state long-run growth rate will be 3% in Years +6 and beyond. e. Using the required rate of return on common equity from Requirement a as a discount rate, compute the sum of the present value of dividends to common shareholders for Walmart for Years +1 through +5. f. Using the required rate of return on common equity from Requirement a as a discount rate and the long-run growth rate from Requirement d, compute the continuing value of Walmart as of the beginning of Year +6 based on its continuing dividends in Years +6 and beyond. After computing continuing value, bring continuing value back to present value at the start of Year +1. g. Compute the value of a share of Walmart common stock, as follows: (1) Compute the sum of the present value of dividends including the present value of continuing value. (2) Adjust the sum of the present value using the midyear discounting adjustment factor. (3) Compute the per-share value estimate. h. Using the same set of forecast assumptions as before, recompute the value of Walmart shares under two alternative scenarios. To quantify the sensitivity of your share value estimate for Walmart to these variations in growth and discount rates, compare (in percentage terms) your value estimates under these two scenarios with your value estimate from Requirement g. Scenario 1: Assume that Walmarts long-run growth will be 2%, not 3% as before, and assume that its required rate of return on equity is 1 percentage point higher than the rate you computed using the CAPM in Requirement a. Scenario 2: Assume that Walmarts long-run growth will be 4%, not 3% as before, and assume that its required rate of return on equity is 1 percentage point lower than the rate you computed using the CAPM in Requirement a. i. What reasonable range of share values would you expect for Walmart common stock? Where is the current price for Walmart shares relative to this range? What do you recommend?1AIC1BIC1CIC1DIC1EIC1FIC1GIC1HIC1IIC1QE2QE3QE4QE5QESuppose you are valuing a healthy, growing, profitable firm and you project that the firm will generate negative free cash flows for equity shareholders in each of the next five years. Can you use a free-cash-flows-based valuation approach when cash flows are negative? If so, explain how a free-cash-flows approach can produce positive valuations of firms when they are expected to generate negative free cash flows over the next five years.7QE8QE9QE10PC11PC12PC13PC14PC15PC16PC17PC1AIC1BIC1CIC1DIC1EIC1FIC1GIC1HIC1IIC1JIC1KIC1LIC1MIC1NIC1OIC1PIC2AIC2BIC2CIC2DIC2EIC2FIC1QE2QE3QE4QE5QE6QE7QE8QE9QE10QE11QE12QE13PC14PC15PC16PC17PC18PCThe Coca-Cola Company is a global soft drink beverage company (ticker: KO) that is a primary and direct competitor with PepsiCo. The data in Chapter 12s Exhibits 12.14, 12.15, and 12.16 (pages 943946) include the actual amounts for 2010, 2011, and 2012 and projected amounts for Year +1 to Year +6 for the income statements, balance sheets, and statements of cash flows, respectively, for Coca-Cola. The market equity beta for Coca-Cola at the end of 2012 is 0.75. Assume that the risk-free interest rate is 3.0% and the market risk premium is 6.0%. Coca-Cola had 4,469 million shares outstanding at the end of 2012, when Coca-Colas share price was 35.48. REQUIRED Part IComputing Coca-Colas Share Value Using the Residual Income Valuation Approach a. Use the CAPM to compute the required rate of return on common equity capital for Coca-Cola. b. Derive the projected residual income for Coca-Cola for Years +1 through +6 based on the projected financial statements. The financial statement forecasts for Year +6 assume that Coca-Cola will experience a steady-state, long-run growth rate of 3% in Year +6 and beyond. c. Using the required rate of return on common equity from Requirement a as a discount rate, compute the sum of the present value of residual income for Coca-Cola for Years +1 through +5. d. Using the required rate of return on common equity from Requirement a as a discount rate and the long-run growth rate from Requirement b, compute the continuing value of Coca-Cola as of the start of Year +6 based on Coca-Colas continuing residual income in Year +6 and beyond. After computing continuing value as of the start of Year +6, discount it to present value at the start of Year +1. e. Compute the value of a share of Coca-Cola common stock. (1) Compute the total sum of the present value of all residual income (from Requirements c and d). (2) Add the book value of equity as of the beginning of the valuation (that is, as of the end of 2012, or the start of Year+1). (3) Adjust the total sum of the present value of residual income plus book value of common equity using the midyear discounting adjustment factor. (4) Compute the per-share value estimate. Part IISensitivity Analysis and Recommendation f. Using the residual income valuation approach, recompute the value of Coca-Cola shares under two alternative scenarios. Scenario 1: Assume that Coca-Colas long-run growth will be 2%, not 3% as above, and that Coca-Colas required rate of return on equity is 1% higher than that calculated in Requirement a. Scenario 2: Assume that Coca-Colas long-run growth will be 4%, not 3% as above, and that Coca-Colas required rate of return on equity is 1% lower than that calculated in Requirement a. To quantify the sensitivity of your share value estimate for Coca-Cola to these variations in growth and discount rates, compare (in percentage terms) your value estimates under these two scenarios with your value estimate from Requirement e. g. Using these data at the end of 2012, what reasonable range of share values would you have expected for Coca-Cola common stock? At that time, what was the market price for Coca-Cola shares relative to this range? What would you have recommended? h. If you completed Problem 12.16 in Chapter 12, compare the value estimate you obtained in Requirement e of that problem (using the free cash flows to common equity shareholders valuation approach) with the value estimate you obtain here using the residual income valuation approach. The value estimates should be the same. If you have not completed Problem 12.16, you would benefit from doing so now.20PC1AIC1BIC1CIC1DIC1EIC1FIC1GIC1HIC1IIC1QE2QE3QE4QE5QE6QE7QE8QE9QE10QE11QE12QE13QE14QE15QE16QE17QE18PC19PC20PC21PC22PC23PC24PC1AIC1BIC1CIC1DIC1EIC1FIC1GIC1HIC1IIC1JIC1KIC1LIC1MIC1NIC