FIN924 Workshop Topic 2 Questions

Questions
Topic 2: CH 3 & 4
Use of financial statements in valuation
Cash vs accrual accounting and discounted cash flow valuation
CHAPTER 3: Use of Financial Statements in valuation
C3.1. What explains differences between firms’ price-to-sales ratios?
C3.2. It is common to compare firms on their price-to-ebit ratios. What are the merits of
using this measure? What are the problems with it? Hint: ebit leaves something out.
C3.7. What do traders mean when they refer to stocks as “glamour stocks” and “value
stocks?”
E3.3. Unlevered (Enterprise) Multiples (Easy)

A firm reported $250 million in total assets and $140 in debt. It had no interest-bearing
securities among its assets. In the income statement it reported $560 million in sales. The
firm’s 80 million shares traded at $7 each. Calculate
a. The price-to-book ratio (P/B)
b. The unlevered price-to-sales ratio (P/S)
c. The enterprise price-to-book ratio
E3.9. Measuring Value Added (Medium)

a. Buying a stock. A firm is expected to pay an annual dividend of $2 per share forever.
Investors require a return of 12 percent per year to compensate for the risk of not receiving
the expected dividends. The firm’s shares trade for $19 each. What is the value added by
buying a share at $19?
b. An investment within a firm. The general manager of a soccer club is considering paying
$2.5 million per year for five years for a “star” player, along with a $2 million up- front
signing bonus. He expects the player to enhance gate receipts and television advertising
revenues by $3.5 million per year with no added costs. The club requires a 9 percent return
on its investments. What would be the value added from the acquisition of the player?
E3.10. Valuation of Bonds and the Accounting for Bonds, Borrowing Costs, and Bond
Revaluations (Hard)
On January 1, 2008, Debtor Corporation issued 10,000 five-year bonds with a face value of
$1,000 and an annual coupon of 4 percent. Bonds of similar risk were yielding 8 percent p.a.
in the market at the time.
a. What did the firm receive for each bond issued?
b. At the end of 2008, the market was still yielding 8 percent on the bonds.
1. What was the firm’s borrowing cost before tax for 2008?
2. How much interest expense was reported in the income statement for 2008?
c. At the end of 2009, the yield on the bonds had dropped to 6 percent. 1. What was the firm’s
borrowing cost before tax for 2009? 2. How much interest expense was reported in the
income statement for 2009?
d. Creditor Corporation purchased 2,000 of the bonds in the issue. FASB Statement No. 115
requires firms to mark these financial investments to market. 1. What were the bonds carried
at on the balance sheet at the end of 2009? 2. What was interest income in the income
statement for 2009?
E3.13.Betas, the Market Risk Premium, and the Equity Cost of Capital: Oracle
Corporation (Medium)
A risk analyst gives Oracle Corporation, the enterprise software and database management
firm, a CAPM equity beta of 1.20. The risk-free rate is 4.0 percent.
a. Prepare a table with the cost of capital that you would calculate for the equity with the
following estimates of the market risk premium:
4.5%
6.0%
7.5%
9.0%
b. Other analysts disagree on the beta, with estimates ranging from 0.90 to 1.40. Prepare a
table that gives the cost of capital for each estimate of the market risk premium and beta
estimates of 0.90 and 1.40.
c. At the end of May 2011, analysts were forecasting earnings of $2.17 per share for the fiscal
year ending May 31, 2012. They were also forecasting that the P/E ratio would be 20 on May
31, 2012. The company is expected to pay $0.24 in dividends per share for the fiscal year.
Calculate the current value of the stock in May 2011 for this P/E forecast using the lowest
and highest cost of capital estimates from part b.
CHAPTER 4: Cash vs Accrual accounting and DCF valuation
C4.1. Investors receive dividends as payoffs for investing in equity shares. Thus the value of
a share should be calculated by discounting expected dividends. True or false?
C4.7. What explains the difference between free cash flow and earnings?
C4.8. Interest payments should not be part of cash flow from operations. Why?
E4.1. A Discounted Cash Flow Valuation (Easy)
At the end of 2012, you forecast the following cash flows (in millions) for a firm with net
debt of $759 million:
You forecast that free cash flow will grow at a rate of 4 percent per year after 2015. Use a
required return of 10 percent in answering the following questions.
a. Calculate the firm’s enterprise value at the end of 2012.
b. Calculate the value of the equity at the end of 2012.
E4.4. Calculate Free Cash Flow from a Cash Flow Statement (Easy)
The following summarizes the parts of a firm’s cash flow statement that have to do with
operating and investing activities (in millions):
The firm made interest payments of $1,342 million and received $876 in interest receipts
from T-bills that it held. The tax rate is 35 percent.
Calculate free cash flow.
E4.5. Reconciling Accrual and Cash Flow Numbers (Medium)

a. A firm reports earnings of $735 million and cash flow from operations of $1,623 million.
What was the dollar amount of accruals listed in the cash flow statement?
b. A firm with no net debt reports cash flow from operations of $4,219 million in its cash
flow statement after adding $1,389 million in accruals to earnings. It reported cash
investments in operations of $2,612 million. What was the firm's free cash flow and earnings
for the period?
c. Afirmreportedrevenuesof$623milliononitsincomestatement.Accountsreceivable at the
beginning of the year were $281 million and $312 million at the end of the year. How much
cash was received from customers?
d. A firm paid $128 million in income taxes during a year. Income taxes payable at the
beginning of the year were $67 million and $23 million at the end of the year. There were no
deferred taxes. What was the income tax expense on its income statement for the year?
E4.6. Accrual Accounting and Cash (Medium)
a. A firm reported $405 million in revenue and an increase in receivables of $32 million.
What was the cash generated by the revenues?
b. A firm reported wages expense of $335 million and cash paid for wages of $290 million.
What was the change in wages payable for the period?
c. A firm reported net property, plant, and equipment (PPE) of $873 million at the beginning
of the year and $923 million at the end of the year. Depreciation on the PPE was $131 million
for the year. There were no disposals of PPE. How much new investment in PPE was there
during the year?
E4.12. Cash Flows for Walmart Stores (Easy)

Walmart has been the most successful retailer in history. The panel below reports cash flows
and earnings for the firm from 1988 to 1996 (in millions of dollars, except per-share
numbers):
The cash flows are unlevered cash flows.

a. Why would such a profitable firm have such negative free cash flows?
b. What explains the difference between Walmart’s cash flows and earnings?
c. Is this a good firm to apply discounted cash flow analysis to?

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CHAPTER 3: Use of Financial Statements in valuation

C3.1. What explains differences between firms’ price-to-sales ratios?

E3.3. Unlevered (Enterprise) Multiples (Easy)

E3.9. Measuring Value Added (Medium)

E4.5. Reconciling Accrual and Cash Flow Numbers (Medium)

E4.12. Cash Flows for Walmart Stores (Easy)

The cash flows are unlevered cash flows.

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