Seminar 4 N1591

Valuation of Companies and Cash Flow Generating Assets (N1591)

Autumn Term 2019/20

Seminar 4: Reorganising the Financial Statements (McK Chap 9) and

Analysing Performance (McK Chap 10)

Calculation Questions

1. During Lecture 4, we computed the NOPLAT and IC of Microsoft. Review those calculations,
could you have done more, what difficulties did you encounter?

2. Using the Microsoft’s 2019 10K in the Case Study folder on Canvas and NOPLAT from Q1:

 How did Microsoft’s working capital evolve between 2018 and 2019, with and without
cash? How do your computations compare with what you find in the cash flow
statement?
 Work out inventory, trade debtors and trade creditor days (Lecture 4b). Was there any
change between 2018 and 2019?
 What was Microsoft’s FCF in 2019?

3. (McK Q1 and Q2) Exhibit 10.13 presents historical data for ShipCo, a manufacturer of ships.
Based on the data below:

 How has ShipCo performed over the past five years?

 What is its ROIC for years 2 to 5?
 What is its operating margin?
 What is its capital turnover?
 Is it creating more or less value over time?
 Explain your answers.

Assume an operating tax rate of 30% and a WACC of 9%.

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Exhibit 10.13 ShipCo: Income Statement and Balance Sheet

$ million

Income statement Year 1 Year 2 Year 3 Year 4 Year 5

Revenues 530.0 556.5 601.0 661.1 674.3
Cost of sales (344.5) (364.5) (396.7) (439.6) (451.8)
Selling, general, and administrative (79.5) (86.3) (87.1) (92.6) (107.9)
Depreciation (15.9) (16.7) (18.0) (19.8) (20.2)
EBIT 90.1 89.0 99.2 109.1 94.4
Interest expense (7.5) (7.5) (7.5) (7.5) (7.5)
Gain/(loss) on sale of assets - (10.0) - - -
Earnings before taxes 82.6 71.5 91.7 101.6 86.9
Taxes (24.8) (21.5) (27.5) (30.5) (26.1)
Net income 57.8 50.1 64.2 71.1 60.8

Dividends 17.3 17.0 18.0 17.8 18.3

Balance sheet Year 1 Year 2 Year 3 Year 4 Year 5

Operating cash 10.6 11.1 12.0 13.2 13.5
Excess cash and marketable securities 102.8 108.9 111.2 118.2 139.8
Accounts receivable 79.5 80.7 93.2 99.2 97.8
Inventory 169.6 183.6 204.3 231.4 242.8
Current assets 362.5 384.3 420.7 462.0 493.8

Property, plant, and equipment 206.7 219.8 240.4 267.8 276.5

Equity investments 180.0 180.0 180.0 180.0 180.0

Total assets 749.2 784.2 841.1 909.8 950.3

Accounts payable 116.6 119.6 126.2 135.5 134.9

Short-term debt 45.0 45.0 45.0 45.0 45.0
Accrued expenses 90.1 89.0 93.2 99.2 97.8
Current liabilities 251.7 253.7 264.4 279.7 277.6

Long-term debt 105.0 105.0 105.0 105.0 105.0

Common stock 100.0 100.0 100.0 100.0 100.0
Retained earnings 292.5 325.5 371.7 425.1 467.6

Total liabilities and equity 749.2 784.2 841.1 909.8 950.3

4. Using the company’s annual report on Canvas, decompose EnQuest’s revenues

(www.enquest.com). (See Lecture 4b.)

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Multiple Choice Questions

5. Which of the following are included in operating current assets?

I. Inventory.
II. Prepaid expenses.
III. Marketable securities.
IV. Accounts receivable.

A. I, II, and III only.

B. I, II, and IV only.
C. II, III, and IV only.
D. I, II, III, and IV.

6. Which of the following are operating liabilities?

I. Accounts payable.
II. Accrued salaries.
III. Deferred revenue.
IV. Income taxes payable.

A. I and II only.
B. II and III only.
C. I, III, and IV only.
D. I, II, III, and IV.

7. How will an increase in invested capital (IC) in a given year affect free cash flow (FCF) and
ROIC if all other things are kept equal?

A. It will decrease both FCF and ROIC.

B. It will increase both FCF and ROIC.
C. It will increase FCF but decrease ROIC.
D. It will decrease FCF but increase ROIC.

8. With respect to the performance measures return on invested capital (ROIC), return on
equity (ROE), and return on assets (ROA), which of the following is most accurate concerning
the relative superiority of the three as analytical tools for understanding a company’s
performance?

A. ROE is better than ROA, which is better than ROIC.

B. ROA is better than ROIC, which is better than ROE.
C. ROIC is better than ROA, which is better than ROE.
D. ROE is better than ROIC, which is better than ROA.

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9. You are an equity analyst and have computed the following figures for two cement
companies. The first, CementCo, has NOPLAT of $ 1,550m, invested capital without goodwill
of $ 15,000m, and goodwill of $ 1,950m.

The second, CementExports, has NOPLAT of $ 1,750m, invested capital without goodwill of
$ 16,000m, and no goodwill.

If the cost of capital for both firms is 10%, what is the ROIC for each company? Which company
is creating value in this year?

A. ROIC excluding goodwill is 10.3% for CementCo and 10.9% for CementExports; both
companies are creating value.
B. ROIC including goodwill is 9.1% for CementCo and 10.9% for CementExports; both
companies are creating value.
C. ROIC including goodwill is 9.1% for CementCo and 10.9% for CementExports; only
CementExports is creating value.
D. ROIC including goodwill is 9.1% for CementCo and 10.9% for CementExports; neither of
the companies is creating value.