Sample Paper 1

S. P. Jain Dubai/Singapore

Advanced Finance Statement Analysis – Sample Questions

Q1. Zif Software is a firm with significant research and development expenses. In the most recent year, the firm had $100 million in R&D expenses. R&D expenses are amortizable over 5 years, and over the past 5 years they are:

Year	R&D expenses
-5	$50 million
-4	$60 million
-3	$70 million
-2	$80 million
-1	$90 million
Current year	$100 million

Assuming a linear amortization schedule (over five years), estimate:

(a) The value of the research asset

(b) The amount of R&D amortization this year.

(c) The adjustment to operating income.

(5 marks)

Q2.Volvo had earnings per share of 11.04 Swedish kroner (Sk) in 2000, and paid out a dividend of 7 Sk per share, which represented 63.41% of its earnings. The growth rate in earnings and dividends, in the long term is expected to be 13.66%. The beta for Volvo is 0.80, and the risk free rate in Swedish kroner is 6.1%. (Market risk premium is 4%). Estimate the price to book value ratio based on these fundamentals.

(5 marks)

Q3. Stereo City is a retailer of stereos and televisions. The firm has operating income of $150 million, after operating lease expenses of $50 million. The firm has operating lease commitments for the next five years and beyond:

Year	Operating Lease Expense
1	$55 million
2	$60 million
3	$60 million
4	$55 million
5	$50 million
6-15	$40 million annually

The book value of equity is $1 billion, and the firm has no debt outstanding. The firm has a cost of equity of 11% and a pretax cost of borrowing of 6%. The tax rate is 40%.

(a) Estimate the capital invested in the firm, before and after adjusting for operating leases.

(b) Estimate the return on capital, before and after adjusting for operating leases.

(c) Estimate the economic value added, before and after adjusting for operating leases. (The market value of equity is $2 billion).

(10 marks)

Q4.Superior Ltd. has a 51% stake in Subordinate-I Ltd. and a 15% stake in Subordinate-II Ltd. The first holding is categorized as a majority active holding (resulting in consolidation) and the second as a minority passive holding. Estimate the enterprise value to EBITDA multiple for Superior Ltd. firstly on a consolidated basis and secondly, assuming Superior Ltd. is without any of its holdings, using the following information:

ü The market value of equity at Superior Ltd. is $1529 million and the consolidated debt outstanding at the firm is $500 million. The firm reported $500 million in EBITDA on its consolidated income statement. A portion of the EBITDA ($180 million) and debt outstanding ($150 million) represent Superior Ltd.’s holdings in Subordinate-I Ltd.

ü Subordinate-I Ltd. is a publicly traded firm with a market value of equity of $459 million.

ü Subordinate-II Ltd. is a private firm with an EBITDA of $120 million on capital invested of $250 million in the current year; the firm has $100 million in debt outstanding. Value of equity at Subordinate-II Ltd. = 370.25 million.

ü None of the firms have significant cash balances.

(5 marks)

Q4. Conceptual questions:

1. How is a deferred tax liability created?
2. What is the difference between FCFF and FCFE?
3. How do you calculate current, trailing and forward PE multiples?
4. What is the difference between basic and diluted EPS?
5. How is weighted average cost of capital calculated?

(10 marks)

Q.5 For Maurti Udyog Ltd., for the financial year ended 2004, 2005 and 2006 carry out

the

(i) Dupont Analysis (ROE and its components)

(ii) Inventory, Receivables Turnover Analysis.

(iii) During 2004-2006, Find out the CARG for Net Sales and EBDIT.

Why growth in EBDIT is greater than growth in sales?

(10 Marks)

Q.6 a) For the last year 2005-2006, do the fund flow analysis, clearly highlighting the

(i) Funds from Operations

(ii) Funds from Investing

(iii) Funds from Financing

b) For the year 2005-2006 find the Free cash flows to firm (FCFF). For the purpose

of FCFF, you may consider only operating / core profits and Investment only in

operating assets and operating working capital.

(10 Marks

Q.7 Briefly discuss the following:

i) PE Multiple and its determinants

ii) P/BV multiple and its determinants

iii) EBITDA multiple and why EBITDA multiple is preferred over PE multiple in relative valuation

iv) Impact of capitalizing R&D expenses on Net profits, Free cash flows, Reinvestment ratio and ROE.

v) Relationship between ROE and ROC.

(2 x 5 = 10 Marks)

Q.8 The Balance Sheet of two companies A and T for Financial year ended 2006 is given

below:

Figures in Millions $

Company A

Particulars		Particulars
Shareholders Funds	500	Net Fixed Assets	700
Long term loans	250	Current Assets	300
Current Liablities	250
	1000		1000

Company T

Particulars		Particulars
Shareholders Funds	100	Net Fixed Assets	200
Long term loans	150	Current Assets	100
Current Liablities	50
	300		300

Company A acquires 100% of Company T at the current market capitalization of

200 Million dollars against a book value of 100 million dollars. Company A

borrows 200 million dollars to pay for the acquisition. Company A also revalues the

NFA of T at a face value of 240 Million dollars against the book value of 200 million

dollars.

1) You are required to show the consolidated balance sheet of 2006

2) Make the consolidated balance sheet assuming Company A had acquired 70% stake in Company T

3) What does the Minority interest appearing in the Liability of consolidated Balance sheet indicate?

(5 Marks)