Financial Statement Analysis And Security Valuation 5th Edition by Stephen H Penman – Test Bank





Financial Statement Analysis And Security Valuation 5th Edition by Stephen H Penman – Test Bank


Time allowed: 90 Minutes





Total Points: 40

























Question 1 (10 points)

Below is an excerpt from the cash flow statement of a firm for fiscal year 2003:





Cash flows from operating activities:

Net income

Adjustments to reconcile net

income to net cash provided by

operating activities:

Depreciation and amortization

Amortization of software

Tax benefits of employee

stock plans

Special charges

(Gains)/losses on investments

Change in operating assets and liabilities:



Pension assets

Other assets

Accounts payable

Pension liabilities

Other liabilities


                Net cash provided by

                operating activities


Cash flows from investing activities:

Payments for plant and other


Proceeds from disposition of plant

and other property

Investment in software

Purchases of marketable securities

and other investments

Proceeds from disposition of

marketable securities and

other investments


Net cash used in investing



Fiscal Year Ended

December 31, 2003







































Additional information:


Cash interest receipts

Cash interest payments


From the reformulated equity statement:


Shareholders’ equity December 31, 2002

Shareholders’ equity December 31, 2003

Net payout to shareholders


The firm’s tax rate is 35%.














  1. Calculate free cash flow for 2003.












  1. Calculate net payments to debt holders and issuers for 2003.













  1. Calculate comprehensive income for 2003.


















Question 2 (30 points).


Part A


The following is a condensed version of the statement of shareholders’ equity for Dell Computer Corporation for fiscal year ending January 31, 2003 (in millions of dollars):


Balance at February 1, 2002

Net income

Unrealized gain on debt investments

Unrealized loss on derivative instruments

Foreign currency translation gain

Comprehensive income

Shares issued on exercise of options, including tax benefits of $260

Repurchase of 50 millions shares



Balance of January 31, 2003
















Other information:


  1. Dell’s tax rate is 35%
  2. The repurchase occurred when the stock traded at $28 per share.





Prepare a reformulated statement of shareholders’ equity for 2003 for Dell Computer Corporation.  The reformulated statement should identify comprehensive income.















(Page for answer)














































Part B


The following is extracted from Dell’s balance sheet at January 31, 2003 (in millions of dollars):


Net financial assets

Common equity (2,579 million shares outstanding)





Analysts are forecasting consensus earnings per share of $1.01 for the year ending January 31, 2004.


  1. Calculate net operating assets at January 31, 2003.











  1. Net financial assets are expected to earn an after-tax return of 4% in 2004.  What is the forecast of operating income implicit in the analysts’ eps forecast?












  1. Forecast the residual operating income for 2004 that is implicit in the analysts’ forecast.  Use a required annual return for operations of 9%.










  1. Dell’s shares are currently trading at $34 each. With the above information, value the shares under the following set of scenarios using residual income methods:


  • Sales will grow at 5% per year after 2004.
  • Operating assets and operating liabilities with both grow at 5% per year after 2003.
  • Operating profit margins (after tax) will be the same as these forecasted for 2004.























  1. Under the same scenarios, forecast free cash flow for 2004.















  1. Under the same scenarios, forecast abnormal growth in operating income for 2005.












  1. Show that, with a long term growth rate of 5%, the following formula will give the same value as that in part (d) of the question:



where G2 is the (one plus) cum-dividend growth rate in operating income two years ahead and g is (one plus) the long-term growth rate.



Time allowed: 90 minutes





Total Points: 40




























Question 1 (10 points)


The following is an incomplete statement of common shareholders’ equity (in millions of dollars).



Balance, December 31, 2004 760
Net income ?
Common dividends ?
Issue of common stock 102
Unrealized gain on available-for-sale securities 8
Foreign currency translation loss   (6)
Balance, December 31, 2005 963


The firm has no net debt (a pure equity firm) and reported an after-tax operating profit margin of 12 ½% on sales of $912 million in its income statement for 2005.  All operating expenses in the income statement are involved in generating core income.


Calculate the following for 2005:


  • Net income and comprehensive income









  • Free cash flow










  • Dividends paid to common shareholders







  • Core return on net operating assets (on beginning-of-year balance sheet)










  • Asset turnover

























Question 2 (14 points)


The following are summaries from financial statements for the warehouse retailer, Home Depot Inc. for fiscal year ending January 29, 2006:


Summary Reformulated Balance Sheet, January 29, 2006

(in millions of dollars)


  2006 2005     2006 2005
Financial assets 757 456   Financial liabilities 4,085 2,159
Operating assets 43,725 38,564   Operating liabilities 13,488 12,703
        Common equity 26,909 24,158
  44,482 39,020     44,482 39,020



Summary Reformulated Income Statement, Year Ended, January 29, 2006
(in millions of dollars)



Core operating expenses

Core operating income

Taxes allocated to core operating income





Core operating income, after tax                5,889  
Unsustainable operating income, after tax               182  
Operating income, after tax               6,071    


Where relevant, make all calculations for 2006 with beginning-of-period balance sheet numbers in the questions below.

  • Calculate the following from these statements:


  1. Financial leverage at the end of fiscal year, 2005




  1. Operating liability leverage at the end of fiscal year, 2005




  • Home Depot estimates that it pays an implicit after-tax borrowing cost on its operating liabilities of 2% after tax. Calculate the rate of return it would have earned from its operations had it not used this supplier financing.











  • Calculate the return on net operating assets (RNOA) for the 2006. Also calculate the core return on net operating assets for the year.










  • Show that Core RNOA = Core Profit Margin × Asset Turnover










  • The firm has a net borrowing cost of 3.0% after tax. Calculate the return on common equity (ROCE) for 2006.












  • Complete the income statement to report the after-tax net financial expenses for 2006 and comprehensive income.








  • In an article in the Financial Times on September 9th of this year, Mark Sellers, a hedge fund manage in Chicago, argued that Home Depot should borrow $17 billion to repurchase its stock. Suppose that core operating profitability and the net borrowing cost were forecasted to be the same for 2007 as in 2006. What return on common equity (ROCE) would you forecast for 2007 under the following conditions:


  1. Home Depot did not made the stock repurchase








  1. Home Depot made the stock repurchase on January 29, 2006




Question 3 (5 points)


Reformulate the following income statement (in millions of dollars):


Sales 2,400
Operating expenses to generate sales

Loss from real estate partnership



Interest income 40
Interest expense (160)
Income tax expense 159
Net income 371


The firm’s statutory tax rate is 35%.


What is the effective tax rate on operating income from sales?














Question 4 (11 points)


The following numbers were calculated from the financial statements of a firm for fiscal year 2006.



Net operating assets $107.5 million
Net financial obligations 22.7 million
Asset turnover, 2006 1.9
Core operating profit-margin, after tax 7.5%



  • Calculate the core return on net operating assets for 2006.








  • You forecast that the core profit margin and asset turnover in the future will be the same as in 2006. You also forecast that sales will grow at 4% per year in the future.  The firm’s required return for its operations is 9%.


  • Calculate the enterprise price-to-book ratio and enterprise value.







  • Calculate the levered price-to-book ratio.












  • The firm’s 52 million outstanding shares are trading at $4.75 each. Given your forecasts, what is your expected rate of return from buying the firm at this price?



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