Sample Paper 3

SP Jain Center of Management, Dubai/Singapore

Advanced Financial Statement Analysis

Q1(A) Based on the financial data of SAIL provided to you, you are required to carry out the Dupont analysis (ROE and its components) of this company for the financial years 2004, 2005, 2006.--- (6 marks)

Q1(B) For the year 2005-06 , carry out a fund flow analysis and comment on the financial

Flexibility of the firm.—(7 marks)

Analysts estimate that the financial leverage of SAIL for the financial year 2007 will increase by 10% and its return on total assets (ROTA) will increase by 20%. Based on this vital piece of information, you are also required to estimate the ROE for the year 2007.--- 2 marks

(15 Marks)

Q2.

Complete the balance sheet and sales data (fill in the blanks) using the following financial data:

Debt/Equity ratio = 0.6

Acid-test ratio = 1.2

Total assets turnover ratio = 1.5

Days’ sales outstanding in accounts receivable = 40 days

Gross profit margin = 20%

Inventory turnover ratio = 5

Balance Sheet

Equity capital: 50,000 Plant & Equip: ---------

Retained Earnings: 60,000 Inventory: ---------

Debt: -------- Accounts Receivable: ---------

Cash: ---------

Sales: --------

Cost of goods sold: --------

(5 Marks)

Q3. Answer in brief:

(a) Briefly explain the concept of EVA. And establish the relationship between EVA and Price to Book Value Ratio.-- 2 marks

(b) In a world of no taxes, discuss the impact of increased leverage on the overall cost of capital of a company. (Hint: ke= ko+ [ko-kd]*D/E) -- 2 marks

c) Derive the relationship beween ROE and ROC and Ke and Ko in a world of taxes and looking at these two relationships comment on the optimal debt to capital at which the firm value is maximized.-- 7 marks

(d) You are provided with the following information:

	Trailing PE	Expected growth	Std. deviation	PEG
Powerpact Corp.	8.96	3.5%	24.7%	2.56
Industry average	22.66	12.6%	33.3%	2.00

An analyst concludes that Powerpact is undervalued on a relative basis. Do you agree with his conclusion? Also state why you agree/disagree.

Calculate the adjusted PE for Powerpact. (Hint: Adjusted PE = Expected growth of Powerpact x Industry average PEG). Based on this adjusted PE, does Powerpact look undervalued/overvalued? --- 4 marks

(e) State whether you agree/disagree with the following statements with reasons to support your conviction: ( 2x7= 14 marks)

i. Price to earnings ratio is a function of growth alone.

ii. Firms with lower growth, higher risk and lower payout ratios, other things remaining equal, should trade at much higher earnings multiples than other firms.

iii. Firms with higher PE but lower price to book value ratios are said to be overvalued.

iv. If ROE > ke, then price will exceed the book value of equity.

v. The P/BV ratio is a decreasing function of ROE, the payout ratio and growth rate and an increasing function of the riskiness of the firm.

vi. Low price to earnings stocks, on average, earn returns in excess of expectations, while high price to earnings stocks earn less than expected. This is primarily because lower PE stocks have lower risk.

vii. Cost of equity is a decreasing function of beta.

Q4. In 1997, Boeing announced that it was acquiring McDonnell Douglas, another company involved in aerospace and defence business. At the time of the acquisition, the two firms had the following market values and betas:

	Beta	Debt	Equity	Firm value
Boeing	0.95	$3,980	$32,438	$36,418
McDonnell Douglas	0.90	$2,143	$12,555	$14,698

Evaluate the effects of the acquisition on Boeing’s beta.

(Hint: β_L = β_UL[1 + (1 – T)D/E]

The tax rate may be assumed at 35%

The Unlevered Beta of a portfolio is equal to weighted average unlevered beta of different securities.

(5marks)

Q5. The financial statements of Horizon Ltd. are as shown in Exhibits 4.1 and 4.2. You are a newly recruited financial analyst at a leading brokerage firm and for financial year 2006, you have been asked to compute the following ratios for Horizon Ltd. that will aid you in your analysis: -----(16MARKS)

1. Current ratio

2. Acid-test ratio

3. Cash ratio

4. Debt-equity ratio

5. Debt-asset ratio

6. Interest coverage ratio

7. Inventory turnover

8. Debtors turnover

9. Average Collection Period

10. Fixed assets turnover

11. Total assets turnover

12. Gross Profit Margin ratio

13. Net Profit Margin ratio

14. Return on assets

15. Return on capital employed

16. Return on equity

17. Price-earnings ratio

18. Dividend yield

19. Dividend payout

20. Market value to book value ratio (16 Marks)

EXHIBIT 4.1

HORIZON LTD. PROFIT & LOSS A/C

PARTICULARS	2006	2005
NET SALES	701	623
LESS COST OF GOODS SOLD:	552	475
STOCKS	421	370
WAGES AND SALARIES	68	55
OTHER MANUFACTURING EXPENSES	63	50
GROSS PROFIT	149	148
OPERATING EXPENSES:	60	49
DEPRECIATION	30	26
GENERAL ADMINISTRATION	12	11
SELLING	18	12
OPERATING PROFIT	89	99
NON-OPERATING SURPLUS/DEFICIT	-	6
PBIT	89	105
INTEREST	21	22
PBT	68	83
TAX	34	41
PAT	34	42
DIVIDENDS	28	27
RETAINED EARNINGS	6	15
PER SHARE DATA:
EARNING PER SHARE	2.27	2.8
DIVIDEND PER SHARE	1.8	1.8
MARKET PRICE PER SHARE	21	20
BOOK VALUE PER SHARE	17.47	17.07

HORIZON LTD. BALANCE SHEET

PARTICULARS	2006		2005
SOURCES OF FUNDS
1. SHAREHOLDERS FUNDS	262		256
(A) SHARE CAPITAL	150		150
(B) RESERVES AND SURPLUS	112		106
2. LOAN FUNDS
(A) SECURED LOANS	143		131
(i) DUE AFTER 1 YEAR	108		91
(ii) DUE WITHIN 1 YEAR	35		40
(B) UNSECURED LOANS	69		25
(i) DUE AFTER 1 YEAR	29		10
(ii) DUE WITHIN 1 YEAR	40		15
TOTAL	474		412
APPLICATION OF FUNDS
1. FIXED ASSETS	330		322
2. INVESTMENTS	15		15
(A) LONG TERM INVESTMENTS	12		12
(B) CURRENT INVESTMENTS	3		3
3. CURRENT ASSETS, LOANS AND ADVANCES	234		156
(A) INVENTORIES	105		72
(B) SUNDRY DEBTORS	114		68
(C) CASH AND BANK BALANCE	10		6
(D) LOANS AND ADVANCES	5		10
LESS: CURRENT LIABILITIES AND PROVISIONS	105		81
NET CURRENT ASSETS	129		75
TOTAL	474		412