Exam 13: Using Financial Statements for Valuation

Following are financial statement numbers and select ratios for American Eagle Outfitters for 2016, the year ended January 28, 2017. Forecast assumptions and other financial information for AE Outfitters are as follows: Required: a. Use the discounted free cash flow (DCFF) model to estimate the value of AE Outfitters' equity, per share at January 28, 2017. b. AE Outfitters' shares closed at $14.28 per share on March 10, 2017, the date the 10-K was filed with the SEC. How does your valuation compare with this closing price?

The residual operating income (ROPI) model focuses on net income which is a more accurate measure of future profitability than expected cash flows.

Given the horizon period from 2018 to 2021, with the terminal year 2022, calculate the present value at December 31, 2017 of the terminal value of ROPI given the following additional information:

One advantage of the DCF model is that it only recognizes value evidenced by cash flow, which is less easily manipulated by accrual accounting practices.

You are trying to value Madison Inc. and have forecasted free cash flows to the firm (FCFF) for the terminal period of $513.8 million. You want to perform some sensitivity analysis. In particular, you want to determine the effect that terminal growth rates will have on the present value of the terminal period FCFF. Assume that the horizon period is four years long and that the terminal period begins in year five. The company's WACC is 7%. a. Calculate the present value of the FCFF for the terminal period using an expected growth rate of 1%. b. Now assume that the growth rate went up to 2%. Calculate the new present value of the FCFF for the terminal period. c. Using these two figures, make a general observation about the relation between the effect of differing growth rates on the present value of FCFF for a terminal period. Is the growth rate an important assumption? Explain.

Following is information from Skechers USA, Inc. for fiscal 2016 (in thousands). Projected 2017 total revenue would be:

Following are financial statement numbers and select ratios for Darden Restaurants Inc. for the year ended May 28, 2017 (dollars in millions). Use the information to determine the free cash flow to the firm (FCFF) in 2018.

Calculate the per share value of Rizzo Company if the cumulative present value of horizon period FCFF is $8,000, the present value of terminal period FCFF is $6,200, and the book value of net nonoperating obligations (NNO) is $2,400. The company has 200 shares outstanding.

One definition of free cash flows to the firm is net cash flows from operations+/- net cash flows from investing activities.

Assume that Bank of America Corp. reported a net loss of $584 million for the fiscal quarter. That day, Bank of America's stock price climbed from $16.23 per share to $16.37. This demonstrates that:

In a recent quarterly earnings announcement, Meridian Inc. announced that its earnings had markedly increased (up 20 cents per share over the prior year). Meridian's stock price dropped nearly 5% on the earnings report. Why do you believe that Meridian's stock reacted as it did?

Is it a good idea to rate the performance of managers based solely on the DCF model, and what should you watch for if you do such an evaluation?

The weighted average cost is computed as: WACC=(r_d × % of debt) + (r_e × % of net income)

The advantage of the dividend discount model is that:

The Discounted Cash Flow model of valuation is superior to ROPI in that it addresses investors' increasing concern with perceived earnings management by companies.

A company wants to assess the performance of its management using the ROPI-based analysis. At the beginning of the period, the company has net operating assets of $150 million, and its weighted cost of capital (WACC) for this period is 6%. a. What is the minimum level of NOPAT the company will need in this year for management to report it has achieved an acceptable level of profit under the ROPI analysis? b. Why is it often advantageous for a company to use ROPI analysis to evaluate managers?

You have recently taken a position as CFO of Elwood Electronics Inc., a leading manufacturer of consumer electronics. The industry is widely regarded as one of the more stable across the economic spectrum and offers good long-term growth prospects. In addition to Elwood Electronics Inc., there are several other well-capitalized competitors, and each company commands roughly identical market shares. Each competitor has highly efficient manufacturing processes and operates at virtually identical margins. In your new position as CFO, your incentive compensation plan is primarily driven by ROPI. Elwood Electronics Inc. has historically been ROPI neutral while its peers in have been ROPI positive. Looking at the information below, what would be your immediate objectives for Elwood Electronics Inc. in order to drive positive ROPI. Explain your actions.

Following are financial statement numbers and select ratios for Target Corp. for the fiscal year 2016. Forecast assumptions and other financial information for Target are as follows: Required: a. Use the discounted free cash flow (DCFF) model to estimate the value of Target's equity, per share at fiscal year-end 2016. b. Target Corp. shares closed at $53.82 per share on March 8, 2017, the date the 10-K was filed with the SEC. How does your valuation compare with this closing price?

The DCF valuation of a firm's equity involves the following three steps: a. Forecast free cash flows to the firm (FCFF) for the horizon period. b. Forecast discount FCFF for the terminal period. c. Sum the horizon and terminal periods to yield firm value.

Which of the following items should not be included in net operating profit after tax (NOPAT)?