BKM04AC: Financial Analysis

Instructor: Jeroen Suijs (82762)

Written examination
Friday 21 December 2007, 13:30-16:30 hrs

Name
Student number

Instructions
You should answer each question in the designated space on this form. Always provide a clear
overview of any calculations in your answer. On the final page of this exam you will find an
overview of the most important formulas.
Use of a graphic calculator is allowed.
Use of a dictionary is not allowed.

Question 1

(25 points)

For each of the statements below, indicate whether the statement is true or false.
A

In an efficient capital market there is no need for an equity valuation

True

False

model.
B

The discounted free cash flow model is not a proper valuation model
because it treats investments in operating activities as value destroying.

The residual income valuation model is preferred over the abnormal

earnings growth valuation model in situations where the income statement better reflects a firms financial situation than the balance sheet.

The higher the financial leverage of a firm, the lower its price-earnings
ratio will be. The reason for this is that highly levered firms have a lower
cost of equity capital.

A firm with high future residual operating income is a more attractive

investment than a firm with low future residual operating income.

The PEG-ratio of a company increases when the markets expected long

run growth rate in earnings increases (all other things equal).

Stock option exercises can be settled with cash instead of shares; that is,
when a stock option is exercised, the firm does not issue (or sell) share
but pays the difference in market price and exercise price in cash to the
holder of the stock option. So, when stock option exercises are settled
with cash, no hidden dirty surplus flow arises.

Reformulating financial statements is necessary for equity valuation purposes because financing activities are assumed not to generate value.

Firms with high operating leverage will have a lower required rate of
return rF on the firms operating activities.

For a type SF1 forecast, the firms (re)investment policy in operating

assets is irrelevant for valuation purposes.

Question 2

(25 points)

On December 1, 2007, the shares of company XLR8R trade at e52.00 per share. Bookyear 2007
of XLR8R has ended on December 1 and has resulted in an earnings per share of e3.33. The
book value per share equals e19.36 which is net of e0.64 dividends. Analysts forecast for 2008
and 2009 an earnings per share of e3.74 and e3.42, respectively. They further forecasts dividend
payouts to grow at 10%.
For answering the questions below, you should use a cost of equity capital of 10%.
A Show that the forward price-earnings ratio implies a growth rate in earnings per share of
2.81%.
B Calculate residual income for the years 2008-2013 assuming that for the years 2010, 2011,
2012 growth in residual income is 3% and that for the year 2013 and beyond growth in
residual income is 5%.
C Calculate abnormal earnings growth for the years 2008-2013.
D Calculate the equity value of XLR8R using the residual income valuation model.
E The abnormal earnings growth valuation model results in an equity valuation that is below
the current market value of e52.00 per share. Can you explain how this is possible given
that the forward price earnings ratio implies a growth rate of 2.79% while the residual
income valuation model assumes a growth rate of at least 3%?

Anwer 2A:

Anwer 2B:

Anwer 2C:

Anwer 2D:

Anwer 2E:

Question 3

(25 points)

Shimano is a manufacturer in cycling and fishing equipment. Part of the 2006 financial statements is provided below.
A Reformulate Shimanos 2006 income statement using the information provided above. The
statutory tax rate for Shimano is 41.0%.
B Reformulate Shimanos 2006 Cash flow statement using the information provided above.

Income statement 2006

Net sales

170,303

Cost of sales

111,667

Gross profit

58,636

Selling, general & administrative expenses

37,729

Operating income

20,907

Interest and dividend income

1,719

Other non-operating income

572

Total non-operating income

2,291

Interest expense

214

Other non-operating expenses

2,021

Total non-operating expenses

2,235

Ordinary income

20,963

Gain on sales of investment securities

Total extraordinary gains

226
226

Devaluation loss on inventories

1,057

Loss on impairment

386

Total extraordinary losses

1,443

Net income before taxes

19,746

Income-tax

5,973

Net income

13,773

Statement of changes in shareholder equity (31-12-2006)

Common

Retained

Treasury

stock

earnings

stock

Other

Total
common
equity

Balance 31/12/2005

51,068

104,481

(255)

5,780

161,074

Dividends

(3,342)

(3,342)

Net income

13,773

13,773

Acquisition treasury stock

Retirement treasury stock

(9,632)

(8,500)

(20,003)

(20,003)

18,132

Unrealized gains/losses
on other securities
Foreign currency translations
Balance 31/12/2006

41,436

106,412

(2,126)

318

318

4,331

4,331

10,429

156,151

Csh flow statement 2006

Net income before taxes

19,746

Adjustments for accruals

1,224

Interest and dividend income received

1,643

Interest expense paid

(216)

Income taxes paid

(6,884)

Net cash provided by operating activities

Purchase of time deposits

15,513
(2,777)

Proceeds from maturities of time deposits

6,825

Acquisition of property, plant & equipment

(6,631)

Acquisition of intangible assets

(3,736)

Acquisition of investment securities

(10)

Proceeds from sales of investment securities

407

Proceeds from collection of loans

43

Others, net

(226)

Net cash provided (used in) investing activities

Increase (decrease) in short-term bank loans
Decrease in long-term debt

(6,105)
221
(704)

Acquisition of treasury stock

(20,003)

Gain on sales of treasury stock

Cash dividends to shareholders

(3,376)

Net cash used in financing activities

(23,862)

Net increase (decrease) in cash and cash equivalents

(14,454)

Anwer 3A:

Anwer 3B:

10

Question 4

(25 points)

Ajax N.V. main operational activities consist of running a profesisonal dutch soccer team. Revenues are generated from ticket sales, merchandise and sponsoring. The financial performance
of Ajax N.V. is even worse than their soccer performance as you can see from the reformulated
balance sheet and income statement presented below:
Reformulated balance sheet
2005

2006

2007

113,873

106,209

92,481

113,873

106,209

92,481

Operational liabilities

28,587

24,978

21,863

Financial liabilities

10,374

12,947

12,766

Total liabilities

38,961

37,925

34,629

Equity

74,912

68,284

57,852

Operational assets
Financial assets
Total assets

Reformulated income statement

2005

2006

2007

Revenues

66,625

74,430

64,891

Cost of sales

(2,927)

(2,976)

(3,439)

(32,377)

(36,234)

(35,510)

Depreciation fixed assets

(1,933)

(1,434)

(1,376)

Depreciation player rights

(15,487)

(12,238)

(13,105)

Other expenses

(24,707)

(26,786)

(25,981)

16,418

2,092

517

5,612

(3,146)

(14,003)

(3,115)

(1,010)

2,917

2,191

(4,156)

(11,086)

509

(3,529)

951

Taxes

(153)

1,059

(285)

Comprehensive income

2,853

(6,626)

(10,420)

Personnel expenses

Gain on sale of players

Operating income before taxes
Taxes
Operating income after taxes
Net financial income

11

Assume the required rate of return for the company equals 6%.
A For the year 2007, calculate the return on common equity and the return on net operating
assets
B For the year 2007, calculate residual operating income.
C Give the SF3 forecast of 2008 operating income for Ajax N.V.
D Determine the value V F of Ajax N.V. based on SF2 forecasts for the future periods. Is the
SF2 forecast a reasonable assumption for your valuation?

Anwer 4A:

Anwer 4B:

12

Anwer 4C:

Answer 4D:

13

Summary of formulas
RIt+T
RIt+2
CV
t+1
VtE = BVt + RI
+ (1+r
2 + . . . + (1+r )T + (1+r )T
1+rE
E)
E
E

AEGt+T
t+2
t+3
VtE = r1E Et+1 + AEG
+ AEG
+ . . . + (1+r
T 1 +
1+rE
(1+rE )2
E)

CV
(1+rE )T 1

RIt = Et rE BVt1
AEGt = Et + rE dt1 (1 + rE ) Et1
CV
t+1
t+2
t+T
VtF = N OAt + ReOI
+ ReOI
+ . . . + ReOI
+ (1+r
T
1+rF
(1+rF )2
(1+rF )T
F)


ROIGt+T
ROIGt+2
ROIGt+3
CV
1
F
Vt = rF OIt+1 + 1+rF + (1+rF )2 + . . . + (1+rF )T 1 + (1+rF )T 1

ReOIt = OIt rF N OAt1

ROIGt = OIt + rF F CFt1 (1 + rF ) OIt1
CSE = N OA N F O
ROCE =

E
average CSE

RN OA =

OI
average N OA

ROOA =

OI+implicit interest on OL
average OA

F LEV =

average N F O
average CSE

OLLEV =
N BC =

average OL
average OA

NF E
average N F O

ROCE = RN OA + F LEV (RN OA N BC)

RN OA = ROOA + OLLEV (ROOA implicit interest on OL)
PM =

OI
sales

AT O =

sales
N OA

RN OA = P M AT O
N OA = sales

1
AT O

14