2020 Second midterm

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School

Mercer University *

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514

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Accounting

Date

Apr 3, 2024

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Uploaded by CaptainCaribouMaster843

1 ACT 514 Spring 2020 – Second midterm Professor Ilia D. Dichev Name: Section (write class time): U.S. address to send your graded exam to: (OR you can state that you don't need your graded exam back) Exam Instructions: Read all instructions first before proceeding! 1. Make sure you sign the Honor Pledge below by typing your name. This is a open-book, open-notes exam. However, no communication is allowed between students. All answers and supporting calculations should be on the pages containing the exam questions. The space provided for answers should be a good guide for the length of your answers, especially for discussion questions. Please type/write your answers in such a way that the answers stay within the same page as the questions when printed, e.g., last page of the exam has three questions, so type your answers in such a way that all three questions and answers stay on this same one page. When calculations are required, you must show your work to get full credit unless otherwise indicated in the question. It is possible that you may need to make certain assumptions. If this is the case, write down your assumptions and the reason for them clearly, and proceed from there. Two questions in the Cash Flow Analysis section are based on the 2019 Deere Statement of Cash Flows, already posted. In all valuation questions, you can ignore the (1 + r/2) and the (1 + p*r) adjustments. All ROEs referenced in the exam are ROE on beginning equity. 2. A summary of the points for each question is given below. Question number and topic Points Your score 1. Cash Flow Analysis 16 2. Forecasting and Valuation I 15 3. Forecasting and Valuation II 15 Total 46 Goizueta Business School Honor Pledge: I will not lie, cheat, fabricate, plagiarize or do anything to gain unfair academic advantage, and I will report anyone who does so. Signed:

2 Cash Flow Analysis (16 points total) (5 points) Assume that the hypothetical Linda Company has several types of insurance coverage, and since payment plans vary, it has both Insurance Payable and Prepaid Insurance accounts on its Balance Sheet. During fiscal 2019, Linda had Insurance Expense of $100, the Insurance Payable account went up by $20, and Prepaid Insurance went down by $30. Calculate Linda's cash paid for insurance for fiscal 2019. Clearly show your calculations. (5 points) During fiscal 2019, Deere has a $5 gain or loss on the sale of "businesses and unconsolidated affiliates". Is the $5 a gain or a loss? Answer clearly, and explain in two sentences max why this item appears in the Operating Section of the Statement of Cash Flows. (6 points total, 3 sub-questions at 2 points each) During fiscal 2019, did the following Deere asset and liability accounts go up or down? Record your answer in the table below, using only the words "up" or "down", no explanations needed. Deere Asset or Liability account Record your answer below using only the words "up" or "down" Inventories Accounts payable and accrued expenses Retirement benefits (a liability account)

3 Forecasting and Valuation I (3 questions at 5 points each) In any given year, can a company have negative free cash flows to equity holders but positive abnormal earnings? Answer clearly, yes or no. Explain your answer in two sentences max. Assume that you are trying to estimate the equity value of a firm called Anoroc as of the end of fiscal 2019. Anoroc is projected to have free cash flows to equity holders of $110 in 2020, and thereafter these free cash flows are projected to grow at a 10% rate for the next 4 years (fiscal years 2021-2024). By the end of fiscal 2024, Anoroc is predicted to be in “steady state” with a terminal growth rate of 0% for years 2025 and all the years after. Cost of equity capital is 10%. Estimate the equity value of Anoroc as of the end of fiscal 2019. Assume that you play ping-pong with Warren Buffett, and because you win, he gives you a choice of two investments under the following conditions: Both investments have initial book value of $1 million. One investment called “Swoop” has projected ROE of 11% and sales growth of 5% forever. The other investment called “Dooley” has projected ROE of 10% and sales growth of 6% forever. All margin, turnover, and leverage ratios stay the same forever for both investments. Cost of equity capital is 10% for both investments. Which one is the better investment? Answer clearly, and explain in two-three sentences max. (Hint: No calculations really are needed to answer this question)

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4 Forecasting and Valuation II (3 questions at 5 points each) Assume that company Y has the following characteristics. Cost of equity capital is 10%. As of the end of fiscal 2019, book value of equity is $100 million. All margin, turnover, and leverage ratios are predicted to stay the same forever. You also have the following forecast for sales growth and ROE: Years 2020 and all years thereafter Sales growth 4% ROE (on beginning equity) 16% Using an abnormal ROE valuation model, provide an estimate of the equity value for this company as of the end of fiscal 2019. Can an unexpected increase in current period Free Cash Flow to Equity Holders be bad news for equity investors? Answer clearly yes or no, and explain your answer in two sentences max. Assume that Delta has book value of equity of $15 billion, and equity market value of also $15 billion as of December 31, 2019. You can also assume that Delta has cost of equity capital of 10%, and is projected to have a loss of $3 billion in fiscal 2020, and ending book value of equity of $12 billion as of the end of fiscal 2020. Delta is also projected to reach "steady state" by the beginning of fiscal 2021 and for all years beyond, with sales growth of 0% for fiscal 2021 and all years beyond. Calculate the ROE (on beginning equity) that the market apparently has in mind for fiscal 2021 and all years beyond. (Hint: probably best to use the DCF model but other valuation models would work too)