Dalhousie University  Financial Accounting Analytical Review U have 4 hours to finish 5 big questions for financial accounting course. You should take a lo

Dalhousie University  Financial Accounting Analytical Review U have 4 hours to finish 5 big questions for financial accounting course. You should take a look at the materials first. i will upload actual questions in another 30 hour, so u have 4 and half hours. Lesson Notes #1
March 24/2020
FCF STATEMENT FOR ACCT 3343 (FOR TEACHING)
The following is balance sheet information for TOBIN Ltd:
Assets
2015
Cash
$ 55,000
A/R
20,000
Inv
15,000
Prepaid Exp
5,000
Land
140,000
Building
160,000
Acc. Dep…Building
(11,000)
Equipment
27,000
Acc. Dep…Equipment
(3,000)
Totals
$408,000
2014
$ 33,000
30,000
10,000
1,000
30,000
40,000
(5,000)
10,000
(1,000)
$148,000
Liabilities and Equity
A/P
Tax/P
Mortgage payable
C/S
R/E
AOCI
Totals
$ 28,000
6,000
130,000
70,000
164,000
10,000
$408,000
$ 12,000
8,000
20,000
50,000
48,000
10,000
$148,000
AOCI: accumulated other comprehensive income
The income statement for TOBIN Ltd for 2015
Sales
CGS
GM
Depreciation exp
Other operating exp
Loss on disposal of equipment
$507,000
150,000
357,000
$ 9,000
141,000
3,000
153,000
Operating income
Interest exp
Income before tax
Income tax expense
Net income
204,000
12,000
192,000
47,000
$145,000
Additional information for 2015:
1
i.
ii.
iii.
iv.
v.
There was no OCI (other comprehensive income) reported in 2015.
Equipment with an original cost of $8,000 and accumulated amortization of $1,000
was sold for $4,000 cash during the year. Equipment was acquired for cash during the
year.
Depreciation expense consists of $6,000 for the building and $3,000 for equipment.
Cash dividends were declared and paid during the year.
TOBIN acquired land by obtaining a $110,000 mortgage [long term] from a bank.
Required:
a.
Prepare a statement of CFS for 2015, using both the indirect and direct methods.
b.
Compute FCF in 2 ways:
1. Construct FCF = CFO* − CFI *
[adjusted CFO – adjusted CFI]
ATTEMPTED SOLUTION
FCF = CFO* − CFI * ;
CFO
INT(1-Tax)
CFO *
CFI *
FCF
172,000
9,062
181,062
(251,000)
(69,938)
Land (110,000)
Note: tax rate = 47/192 = 0.2448
2. Compute FCF using the formula FCF = NOPAT − NOA
2
SOLUTIONS
Recall: CFS (INDIRECT) and CFS (DIRECT)
Indirect Method
Operating:
NI
+Depreciation
+Loss on Disposal/ -Gain
$145,000
9,000
3,000
$157,000
Changes in WK:
A/R
Inv
Prepaid
A/P
Taxes/payable
10,000
(5,000)
(4,000)
16,000
(2,000)
CFO
Investing:
Acquisition of a building
Acquisition of equipment
Disposal of equipment
15,000
$172,000
(120,000)
(25,000)
4,000
CFI
($141,000)
Financing:
Issue of C/S
20,000
Cash Div
NI-(ending R/E-Begin R/E) 145000-116000 (29,000)
(hint:dividend payable in here)
CFF
($9,000)
TCF = Change in Cash
$22,000
172000-141000-9000
Direct method
Sales
Increase in A/R
Cash collections from customers
Cash disbursements:
$507,000
(10,000)
$517,000
3
CGS
Increase in Inv
Increase in A/P
For Purchases
For Operating exp
For Interest
For Taxes
Total Cash disbursements
CFO
150,000
5,000
(16,000)
139,000
145,000
12,000
49,000
($345,000)
$172,000
1. Adjustment
FCF = CFO* − CFI * ;
CFO
+INT(1-Tax)
CFO *
– CFI *
FCF
172,000
9,062
181,062
(251,000)
(69,938)
Land (110,000)
Note: tax rate = 47/192 = 0.2448
Interest expense(after tax)not include in CFO* 12000*0.2448=9062
Interest payable change not include in CFO*
CFI* include Fixed Asset increase not paid by cash
2.
Using the formula
Now use the formula FCF = NOPAT − NOA
In this question, all assets are operating except cash. So TA-Cash is OA (operating assets); TA=
total assets.
OL (operating liabilities) consist of A/P and Tax/P.
NOPAT=NOI = EBIT(1-Tax) = 204,000(1-.2448) = 154,062 EBIT=operating income
End
Beg
OA
353,000
115,000
-OL
34,000
20,000
NOA
319,000
95,000
=
224,000
NOA = 319,000 – 95,000
OA: Total Asset-cash-market securities (short-term investment)
OL: Current liability are not related to interest and dividend ( interest payable and dividend
payable are not OL)
FCF = NOI − NOA = 154,062 – 224,000 = (69,938)
4
LEVERAGE ANALYSIS
Co. V
0
80%
$200
$100
$100
FC
VC/Sales
Total assets (TA)
Total debt (TD)
Total equity (TE)
Co. F
$40
40%
$200
$100
$100
Cost of borrowing, r = 5%
Co. V
Co. F
Year 1
Year 2
Year 1
Year 2
Sales
VC
$100
80
$150
120
$100
40
$150
60
CM
FC
20
0
30
0
60
40
90
40
EBIT
Interest
20
5
30
5
20
5
50
5
$15
$25
$15
EBT
$45
Leverage: proportion of FC in the firm’s overall cost structure
Operating leverage (OLE)
proportion of fixed operating cost
CM: contribution margin; EBIT operating income. OLE = CM/EBIT
Interpretation: %EBIT = OLE * %Sales
Financial leverage (FLE)
proportion of fixed financing. FLE = EBIT/EBT
Total leverage (TLE) = OLE*FLE
Interpretation: %EBT = TLE * %Sales
Compute OLE and FLE for both companies for year 1.
1
OLE
FLE
TLE
Co. V
20/20 =1
20/15=4/3
=4/3
Co. F
60/20 =3
20/15 =4/3
=4
Percentage change in sales from year 1 to year 2 is 50%
%EBIT
%EBT
=50%
3*50%=150%
4/3 * 50%=66.67%
4*50%=200%
Leverage is RISKY because it exacerbates the swing in demand
Question
Sales
CGS
Year 1
$100,000
60,000
Year 2
$150,000
90,000
GP
OPE
40,000
20,000
60,000
20,000
EBIT
Interest
EBT
Tax(40%)
NI
20,000
8,000
40,000
8,000
12,000
4,800
32,000
12,800
$ 7,200
$ 19,200
Let TC (total op. cost) = CGS + OPE (other op cost). Then TC = Fixed + v*Sales
Determine the parameters, fixed and v. [That is, estimate the underlying linear function]
Recast the year 1 I/S into the contribution margin [CM] format.
Suppose sales are expected to decline by 10% next year (Year 1 is the current year). What
NOPAT should the company expect next year? What about NI?
Attempted solution
High-low method: Change in TC/Change in Sales
TC = $20,000 + 0.6*Sales
(90000+20000)-(60000+20000)/(150000-100000)=0.6
Year 1 TC=Fixed+v*sales 80000=Fixed+0.6*100000 Fixed=20000
2
Sales
VC
Year 1
$100,000
60,000 0.6*100000
CM
FC
40,000
20,000
EBIT
Interest
20,000
8,000
EBT
Tax(.4)
12,000
4,800
NI
$ 7,200
OLE =40000/20000= 2;
FLE = 5/3;
TLE = OLE*FLE = 10/3
Percentage decline in EBIT = 2*10% =20%. The current level of EBIT is $20,000. The new
level expected is $20,000*.80 = $16,000. New NOPAT = new EBIT(1-tax rate) =$16,000(1-.4) =
$9,600.
EBT is expected to decline by =10/3*10%=1/3. New EBT = $12,000 * 2/3 = $8,000. Thus new
NI = $8,000(1-.4) = $4,800
3
OFF B/S FINANCING
Assets or Liabilities are not reported on the balance sheet
Operating Lease for the Lessee
The economic substance of the lease transaction requires a capital lease accounting.
Convert an operating lease into a capital for analysis
Note the following under operating lease
1. The lease asset is not reported on B/S
2. The lease liability is not reported on B/S
3. During the early years of the lease term, rent expense reported for operating lease, which
is the annual lease payments, is less than the depreciation and interest expense reported
for a capital lease.
Assets
Capital Lease
Lease asset reported
Operating Lease
Lease asset not reported
Liabilities
Lease liability reported
Lease liability not reported
Expenses
Dep and Interest expense
Rent expense
Cash Flows
Payments per lease contract
Both CFO and CFF are affected
Payments per lease contract
Only CFO is affected
The capitalization process involves 3 steps
1. Determine the discount rate
2. Compute the PV of future lease payments
3. Adjust B/S to include a lease asset and a lease liability. Adjust I/S to include depreciation
and interest in lieu of rent expense
1
Example
The lease payments of an operating lease from footnote disclosures of an operating lease
Year
Lease payments
1.
2.
3.
4.
5.
Year 6 and after
688
614
507
392
369
1823
In step 1, we choose 5.67% discount rate.
Now step 2. We assume that every year after year 5, the annual lease payments are constant at
Year 5 level, which is 369. Remaining Life of the lease = [$1823/$369] = 4.94 years
Total year=5+4.94=9.94
PV of lease payments for the first 5 years =
688
614
507
392
369
+
+
+
+
=
2
3
4
1 + r (1 + r )
(1 + r )
(1 + r )
(1 + r ) 5
2,225 using r=5.67%
1 n
1− (
)
1
+
r
PV for year 6 and thereafter, use the annuity formula
, so that
r
1 − [1 /(1.0567)] 4.94
1
}*
PV = 369 * {
=
1,173
.0567
(1.0567) 5
The total PV we are seeking = $2,225 + $1,173 = $3,403
For the B/S and I/S effects shown below, the column Reported are the data for operating lease
and the column Adjusted are the corresponding amounts for capital lease.
Balance Sheet Effects
TA
TL
TE
Reported
Adjustment
Adjusted
$7,176
184
6,992
$3,403
3,403
$10,579
3,587
6,992
2
Calculations for I/S effects rent expense change to (interest expense+ depreciation expense)
ST-Line depreciation of the leased asset = 3,403/9.94 = 342 per year.
Interest expense = 3,403 * 5.67% = 193 for year 1.
Assume tax rate = 37% (given)
The rent expense is reported on I/S as an operating expense. Remove the rent expense of $688
and replace it with depreciation expense of $342. That is, NOI will increase by [688 – 342]*(1.37) = 346*.63=218. After tax interest expense, INT(1-tax rate), will increase by 193*(1-.37) =
122.
Income Statement Effects
NOI
INT(1-tax)
NI
Reported
Adjustment
Adjusted
$496
75
$421
$218
122
$ 96
$714
197
$517
Using year-end figures, and sales of $17,088, compute the following ratios:
NOI/Sales
Reported
2.9%
Adjusted
4.2%
ATO (Sales/TA)
2.38
1.62
ROA (NOPAT/TA)
6.9%
6.7%
FLE (TL/TE)
.03
.51
ROE (NI/TE)
6.0%
7.4%
3
SAVINGS ACCOUNTS MODEL
One year
Invest $1,000 at t=0; return on investment = 15%; discount rate = 10%.
Required:
a. Use FCF valuation model to compute V and NPV
b. Use RI valuation model to compute V and NPV RI=Residual Income,
SOLUTION
At t=0, Investment (BV) = $1,000.
At t=1, investment value = 1.15*1,000=1,150
NPV = V-BV= 1150/1.1 – 1,000
= 1045.45 – 1,000 = 45.45.
V = 1150/1.1= 1045.45;
NPV = 45.45
RI model
NI = 1,000*15% = 150; Required NI = 10%*1,000 = 100.
RI1 = 150 -100 =50
PV of RI= 50/1.1
=
45.45 = NPV = PRI.
V = BV + PRI = 1,000 + 45.45 = 1045.45
A 2 year model
At t=2, investment value = 1000 * (1.15) 2 = 1322.50
1322.50
− 1,000 = 92.98;
NPV =
V = 1322.50/1.1^2=1092.98
(1.1) 2
RI valuation model=NI-BVb*discount rate
NI=BVb*return on Investment
Construct the RI table
Time
1
2
BV b
NI
(DIV)
BVe
1,000
150
0
1,150
1,150
172.5
0
1,322.5
RI at t=1;
RI at t=2;
150 – 10%*1000 = 50
172.5 – 10%* 1150 = 57.5
1
50 57.5
+
= 92.98
1.1 (1.1) 2
V = BV + PRI = 1,000 + 92.98 = 1092.98
PRI =NPV=
Another example
At t=0, BV of equity is $44. The following forecast is made at t=0:
Time
t=1
t=2
t=3
NI
7.8
7.4
6.62
DIV
2
2
2
Discount rate = 12%
Required:
a. Compute P (at t=0), the value of equity, using FCF/DIV valuation model
b. Compute P (at t=0), the value of equity, using RI valuation model.
Hint: RI at t=3 is zero
RI Valuation Model
Construct the RI table
Time
1
2
3
BV b
+NI
-(DIV)
BVe
44
7.8
(2)
49.8
49.8
7.4
(2)
55.2
55.2
6.62
(2)
59.82
RI 1 =7.8 – 12%*44= 2.52; RI 2 = 7.4- 12%*49.8 = 1.424; RI 3 = 0
PRI
BV
V
= 2.52/1.12+1.424/1.12^2+0=3.385
= 44.00
= 44+3.385=47.385; economic value is V (or P)
FCF/DIV Valuation Model.
At t=3, RI=0…So at end of year 2, book-value = economic value = 55.2 (t=2)
P=
2
2
55.2
+
+
=
47.385.
Again, the FINANCE Model and the
2
1.12 (1.12)
(1.12) 2
ACCOUNTING Model yield the same results.
2

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