Homework Assignments Questions and Answers:

Financial Statement Analysis: Questions on All Parts (A through D)

Question-1

Question: (Q.1 on page 127 of Course Pack of PGPMAX Co23)

Please confirm what should be the depreciation value for 2005? I believe it should be 100
because for year 2004 depreciation is mentioned as 100 in D1 document (in most of our
assignments we kept depreciation straight line), however, the pdf document says it should be 0
for 2005 (that is possible only when 2005 is the last year of depreciation, but I couldn't find any
reference to this point). 

Answer: (all page numbers are from course pack): 

1. Please note that no separate figures for depreciation were given either for 2004 or for 2005
(page 127). Therefore, we can safely assume that, if there was any depreciation expense,  it was
deducted before arriving at the EBIT figure given for both years on page 127 (line 2). 
. 
2. For 2004, I assumed that depreciation was $100 to show that, if a figure was given, it would
affect "Operating CF-- Line 20 and also investment CF on Line 26, page 127. Correspondingly,
Capital Expenditures (line 25 on page 127) is $200 which includes $100 depreciation (line 24)
and $100 of change in net fixed assets (line 23). This implies that changes in gross fixed assets
were $200. Alternatively, I could have assumed that depreciation for 2004 was zero. It would
cause Operating CF (line 20) to be equal to NOPAT ($538), and would also result in Capital
expenditures of only $100 (vs, 200). Also, the investment CF (Line 26, page 127) would be $360
rather than $460.  Under either assumption (Depreciation equal to $100 vs. 0) , therefore, there
won't be any change in Free CF (line 27, page 127). It would still be $178. 

3. This is the reason I suggested that depreciation for 2005 is zero (page 139). Alternatively, you
can assume a figure for depreciation, but you must treat its effect on operating and investment
CFs in a consistent manner as outlined above.  

Question-1:

I would like to seek a clarification regarding the Homework Assignment-Fin Analysis Part D.

As per my understanding, In the cash flow statement (Highlighted in below snapshot), dividend
and interest paid should be negative not the positive sign. Otherwise we wouldn't be able to get
opposite sign of FCF in row 5 & row 9.

Answer:
It will be easier to think of individual items, as I mentioned in class, in terms of cash inflows and
outflows. Also, FCFs from lines 1 through 4 and total in line 5 of CF statement in part D are
inflows while the FCF in lines 6 through 8 and total in line 9 are outflows. Line 5 must equal lin
9. Therefore, both dividends and interest After Taxes (lines 6 and 7) are cash outflows.
Question-2
a. Do I assume that depreciation is also zero for 2005?

Answer: Yes, depreciation for 2005 is zero.

b. Is dividend 200 for 2005 as well? (It I noted accordingly in Part D. With dividend at 200 there
is a delta of 100 between investment/operating cash flow and equity/debt cash flow if the cash
amount is held to 300. Can I note that the 100 delta has to be raised by new equity?

Answer: Yes, dividends in Part A in 2005 are also 200; however, in part D I state that
dividends are 328. This assumption is made to ensure that FCFs (lines 5 and 9) in part D are
equal.

Question 3:

With the updated parameters the savings in WCR (Old Parameter WCR is 6100 in 2005 and the
New Parameters WCR is 3215 with savings of 2885. This is more than the total short term loan
of 1900. Should I note Short Term Loan negative? Or should the saving be compared to the 2004
WCR (4440-3225) = 1225?

Answer:

As I mention in the problem in part D (second half of last sentence... "short term debt will be
fully paid by using cash saved from improving working capital") implies that S T Debt will be
zero. Any surplus will be added to cash. Key is that similar to Cash flow statement, balance sheet
must balance.

Question 4:

Just wanted to clarify the position on Homework problem – D1. Financial Analysis – Q1 Part D.
 
I have reproduced below the table provided for Part D of question 1.
 
Item Accounts Inventories Acct. Payables
Receivable
Formula Sales/365 x 30 days COGS/8 (COGS + D Inventory)/365x
33
New 31600/365 x 30 25100/8 25100+(3200-4300)/365 x 33
AMT =2,597 = 3,138 = 2170
Old 4,200 4,300 2,050
AMT.
 
  If COGS is 25,100 and inventory turnover is 8, isn’t 3,138 actually the average inventory
rather than ending inventory? Are we to assume ending inventory in the formula?
[ Inventory turnover = COGS / Ave. Inventory]
 If we do assume that 3,138 is ending inventory, then working backwards, I get purchases
in the year of 25,038. If we consider days payable at 33 for purchases, I get AP = (33 *
25038) / 365 = 2263 rather than the 2170 given in the case. [ days payable = (AP /
COGS)/365]. Again assuming here that the AP in the formula is just ending AP.
  
Answer:

Please take the revised data for A/R, Inventory and A/P as given in part D. The problem
identified by you is a common problem whenever we compute a ratio when one number is from
the income statement, and the other, from balance sheet. Also, the focus of the problem is to
investigate effect of revisions in WCR on ROIC, Margin and Turnover. Even if we compute
these ratios as suggested by you, there would not be much change in the conclusions.

Question 5:

In this case, we are mentioning that the inventory turnover has gone up to 8 there by changing
the inventory value to 3138. However, for calculating the account payables, we are still using the
4300 value (old value). Can you please clarify if there is an issue here or is it correct? Thanks.
 
Acct. Payables
(COGS +  Inventory)/365x 33
{25100+(3200-4300)}/365 x 33 = 2170 New Amount
2,050 Old Amount

Answer: We are using  Inventory (change between new inventory, 3,200 and old inventory,
4,300) to determine revised Accounts Payables.

Relevant Cash Flows: Questions on Part 2

Question 1:

I have a query re Question 2A accounts payable calculation.

I have used Raw Material Costs Plus Direct costs = Cost of Goods Sold (COGS) for this
calculation. Till now I was believing that direct costs to be included as part of COGS as they are
incurred in producing final goods from raw materials.

Your answer in the posted solutions used only raw materials cost as COGS. Please clarify.
Answer:

I think you may be reading too much into the question. Just as A/R are based on sales, A/P are
usually based on purchases (in this case Raw Material Costs). Such definitions are rather
standard and given in most accounting texts. In this question as raw material costs are given, we
can compute A/P directly as is shown in suggested answers.

Question 2:  

For Q2 & Q3, when you say incremental effect on NPV for each of the 6 scenarios you have
provided, do we undo the effect is scenario 1 when responding to scenario 2 or do we build on
scenario 1 when responding to scenario 2? For e.g. When trying to see impact of cannibalization,
do we keep the impact of including AP & AR?

Answer: You can compute incremental NPV of each item and, finally, add them all to the initial
NPV to provide a final NPV. However, I am only asking for incremental NPV of each item and
not the final NPV