Which of the following statements is correct when inventory prices are falling?
| ||
| ||
|
Remember, prices are falling.
MKF Consolidated reports $500 million in goodwill on its balance sheet. The market consensus indicates that the value of MKF’s intangible assets is $300 million. How should an analyst adjust MKF’s balance sheet? Reduce goodwill and:
| ||
| ||
|
If goodwill has no economic value apart from the firm, it should be eliminated from the balance sheet. If the value of the intangibles can be reliably estimated they can be substituted for accounting goodwill.
A firm has reported net income of $136 million, but the notes to financial statements includes a statement that the results “include a $27 million charge for non-insured earthquake damage” and a “gain on the sale of certain assets during restructuring of $16 million.” If we assume that both of these items are given on a pre-tax basis and the effective tax rate is 36%, what would be the “normal operating income?”
| ||
| ||
|
To normalize earnings you would increase it by the non-recurring charge of $27 million and decrease it by the non-recurring gain, both tax adjusted. $136 + (27 - 16)(1 - 0.36) = $143.04.
An analyst finds return-on-equity (ROE) a good measure of management performance and wants to compare two firms: Firm A and Firm B. Firm A reports net income of $3.2 million and has a ROE of 18. Firm B reports income of $16 million and has an ROE of 16. A review of the notes to the financial statements for Firm A, shows that the earnings include a loss from smelting operations of $400,000 and that the firm has exited this business. In addition, the firm sold the smelting equipment and had a gain on the sale of $300,000. A similar review of the notes for Firm B discloses that the $16 million in net income includes $2.6 million gain on the sale of no longer needed office property. Assume that the tax rate for both firms is 36%, and that the notes describe pre-tax amounts. What would be the “normalized” ROE for Firm A and for Firm B, respectively?
| ||
| ||
|
The ROE for Firm A is adjusted for the $400,000 loss on discontinued operations and the $300,000 non-recurring gain. The ROE for Firm B is adjusted to remove the effects of the $2.6 million one-time gain.
ABC Tie Company reports income for the year 2009 as $450,000. The notes to its financial statements state that the firm uses the last in, first out (LIFO) convention to value its inventories, and that had it used first in, first out (FIFO) instead, inventories would have been $62,000 greater for the year 2008 and $78,000 greater for the year 2009. If earnings were restated using FIFO to determine the cost of goods sold (COGS), what would the net income be for the year 2009? Assume a tax rate of 36%. Net income would have been:
| ||
| ||
|
The reduction in COGS would result in an increase in net income (62,000 ? 78,000) × (1 ? 0.36).
Endrun Company reported net income of $4.7 million in 1999, and $4.3 million in 2000. In reviewing the annual report an analyst notices that the Endrun took a charge of $2.4 million in 1999 for the costs of relocating its main office, and in 2000 booked a gain of $900,000 on the sale of its previous office building. What would “normalized earnings” be for 1999 and 2000 if we assume a tax rate of 36% for both years?
| ||
| ||
|
You will increase 1999 earnings by the tax-adjusted value of the 2.4 million one-time charge (2.4 × (1 - 0.36) = +1.536), and you would decrease Y2000 earnings by the tax-adjusted amount of the $0.9 million one-time gain (0.9 × (1 - 0.36) = -0.576).
An investor relations spokesperson for the Square Door Corporation was quoted as saying that Square Door shares were a bargain, selling at a price-to-earnings (P/E) ratio of 12, relative to the S&
500 average P/E of 15.3. The financial statements reported net earnings of $126 million, or $4.00 per share. The notes to the financial statements included a statement that income for the year included a $31.5 million (after-tax) gain from the reclassification of certain assets from its investment portfolio to its trading portfolio. What would be the normalized P/E?
| ||
| ||
|
Since the P/E ratio was 12 and EPS was $4, the price of the stock was $48 (12 × 4). After removing the nonrecurring gain, earnings will be $94.5 million (126 ? 31.5). We know the number of shares is 31.5 million (126 Million ÷ 4). So the new EPS number is 3 (94.5 million ÷ 31.5 million) and new P/E ratio is 16 (48 ÷ 3).
National Chemical Corp. (NCC) reports 2003 net earnings of $354.2 million. NCC’s financial statements and disclosures also indicate pretax impairment charges of $78.1 million and pretax amortization of $24.9 million. NCC also reports an after-tax loss of $23.4 million on the early retirement of debt and receipt of $118 million after-tax from an insurance claim. NCC effective tax rate is 36%. What are the normal operating earnings of NCC?
| ||
| ||
|
NCC’s normal operating earnings are calculated as: Net income 354.20 + After-tax impairment charge 78.1 × (1 - 0.36) = 49.98 + After-tax amortization charge 24.9 × (1 - 0.36) = 15.94 + After-tax loss on debt retirement 23.40 ? After-tax insurance settlement 118.00 Normal operating earnings 325.52 Recall that all adjustments are made on an after-tax basis.
Melinda McKay, CFA, an analyst at Integrity Equity, is considering an investment in Earthmovers Inc., whose most recent financial data is provided below.
Earthmovers Inc.
Income Statement
Year ended Dec 31, 2006
($U.S. thousands)
Revenues
20,152
Gross profit
10,022
Operating income
4,819
Depreciation
823
Interest expense
1,040
Income before taxes
2,956
Taxes
887
Net Income
2,069
Earthmovers Inc.
Balance Sheet
Year ended Dec 31, 2006
($U.S. thousands)
Assets
Liabilities & Owner’s Equity
Cash
600
Accounts payable
5,500
Marketable Securities
200
Notes payable
3,500
Accounts Receivable
8,500
Total current liabilities
9,000
Inventories
3,500
Total current assets
12,800
Long-term debt
13,000
Net P,P&E
17,000
Preferred stock (100,000 shares)
1,000
Pension Asset
1,500
Common Stock (500,000 shares)
2,000
Intangible Assets
1,000
Retained earnings
8,300
Goodwill
1,000
Total stockholder’s equity
11,300
Total Assets
33,300
Total liabilities & Equity
33,300
The footnotes to Earthmovers Inc. include the following information:
Inventories are valued at cost under the last in, first out (LIFO) method, the LIFO reserve is $1.2 million, up $120,000 from the previous year.
Capitalized interest for 2006 is $550,000.
Earthmovers recently sold $400,000 worth of accounts receivable with recourse. To date only $100,000 has been collected.
The funded status of the pension fund is a pension liability of $1,000,000.
Due to an increase in yields on corporate debt, the market value of the long-term debt is $12.35 million.
The preferred stock is redeemable at the option of the preferred stockholder.
The market value of the preferred stock is $9.50.
Management viewed the potential liability of $5 million associated with a pending lawsuit as an improbable event. There is no insurance in place to cover any potential loss.
Following the release of the financial statements, Earthmovers publicly acknowledged that the loss related to the lawsuit was a probable event and was working out a settlement for $3 million.
What is the value of the times interest earned ratio (earnings before interest, tax, depreciation and amortization (EBITDA) / interest expense) using the adjusted data?
| ||
| ||
|
The income statement needs the following adjustments:
Capitalized interest should be included on the income statement. Inclusion will not affect EBITDA but will increase interest expense to 1,590,000 (1,040,000 + 550,000).
EBITDA should be reduced by $300,000 ($400,000 ? $100,000) to $4,519,000 due to the sale of accounts receivable that are yet to be collected.
Therefore, EBITDA / interest expense is 2.8 (= 4,519,000 / 1,590,000).
| ||
| ||
|
Current assets need the following adjustments:
Increase accounts receivable by $300,000 for the uncollected receivables sold with recourse.
Increase inventories by the amount of the LIFO reserve or $1.2 million to reflect first in, first out (FIFO) accounting.
Current liabilities should increase by $300,000 to reflect the “borrowing” related to the sale of the receivables.
The adjusted current ratio is 1.54 [(12,800,000 + 300,000 + 1,200,000) / (9,000,000 + 300,000)]
| ||
| ||
|
The following balance sheet adjustments are indicated in the footnotes:
Adjustment
Long-term Assets
Long-term Liabilities
Equity
Pre-adjustment value
20,500,000
13,000,000
11,300,000
FIFO adjustment (1)
1,200,000
Capitalized interest (2)
(550,000)
(550,000)
Funded status of pension fund (3)
(1,500,000)
1,000,000
(2,500,000)
Market value of debt (4)
(650,000)
650,000
Redeemable preferred stock (5)
950,000
(950,000)
Lawsuit liability (6)
3,000,000
(3,000,000)
Goodwill (7)
(1,000,000)
(1,000,000)
Post-adjustment values
17,450,000
17,300,000
5,150,000
Notes:
(1) FIFO accounting gives the best estimate of the economic value of the inventory. Therefore, inventory and equity will increase by the LIFO reserve amount of $1.2 million.
(2) Capitalized interest should be removed from the balance sheet by reducing long-term assets and equity.
(3) The underfunded pension plan requires a compound adjustment. First, reduce assets and equity by the amount shown on the asset side of the balance sheet. Next, increase liabilities and decrease equity to reflect the amount of underfunding.
(4) The reduction in the value of the debt (650,000) is offset by an increase to equity.
(5) Because the preferred stock is redeemable it should be treated as a liability. Therefore, a liability of 950,000 (100,000 × 9.50) will reflect the market value of the preferred shares. The equity account is adjusted by 1) reducing equity by 1,000,000 to reflect the reclassification of the preferred stock to a liability and 2) increase equity by 50,000 to reflect the reduction in the value of the preferred shares (1,000,000 – 950,000). Therefore, the total adjustment is a reduction of 950,000.
(6) Because the settlement associated with the lawsuit is a probable event, that is measurable, it must be included in liabilities. The settlement amount of $3 million is used for the adjustment. A more aggressive stance would be to recognize the potential loss of $5 million if the analyst believed the settlement would not be accepted.
(7) Goodwill is eliminated and equity is reduced as an offset to the elimination.
The adjusted (liabilities / equity) ratio is 3.36 (= 17,300,000 / 5,150,000).
The Baker Company has an accrued postretirement benefit cost of $3 million on its balance sheet. Examining the notes to Baker's financial statements you find that the accumulated postretirement benefit obligation is $2.5 million. The adjustment you would make to Baker's reported balance sheet in analysis of these statements would be:
| ||
| ||
|
The excess of the accrued cost over the obligation is the excess accrual (i.e., $3 million - 2.5 million), which reduces the firm's liability.
| 欢迎光临 CFA论坛 (http://forum.theanalystspace.com/) | Powered by Discuz! 7.2 |