5623 Ch8

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Feb 20, 2024

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Chapter 8 8-1. True or False? Acquisition premiums the last few years have averaged 25 to 40 percent, but sometimes exceed 100 percent; prior research suggests that high premiums generally have negative impacts on acquisition performance. Explain. True, sometimes the potential synergy between two firms can excite the acquiring firm to want to pay such a hefty premium, but often it sets you up for failure. Such a high premium makes it hard to get the return back from the start, but increased pressures for the acquired firm to produce output to meet new goals often hinder the overall operation. 8-2. Explain why increasing treasury stock will increase EPS in any corporation. EPS or earnings per share is total net income / shares outstanding, which shares outstanding includes treasury stock or stocks the firm has repurchased. If the firm increases treasury stock, that means they increase the number of shares they purchase of their own stock, thus reducing the total number of outstanding shares. Since the shares outstanding (denominator of EPS) is reduced, the overall EPS goes up. 8-3. Some analysts say that huge New York Stock Exchange IPOs from companies such as Alibaba, headquartered in China, should be illegal in the United States because under communist governments there are not sufficient safeguards in place for financial transactions. Do you agree or disagree? Why? I disagree, as there are many internationally based companies that have had IPOs within the New York Stock Exchange. Since the IPO occurred in the NYSE, these securities will be regulated by the U.S. law and not the Chinese government. Prohibiting IPOs from Chinese companies only opens the door for other foreign companies to not want to pursue IPOs in America. 8-4. True or False? In the United States, no federal laws prevent businesses from using GPS devices to monitor employees, nor does federal law require businesses to disclose to employees whether they are using such techniques. What are the implications for employees and companies? True, and most states also do not have any laws prohibiting this either. Employers are not required but should disclose any GPS tracking or monitoring in any employee/company agreements to allow full transparency. For employees it is important to understand this with your own regard to privacy. 8-5. To raise capital, what are the pros and cons of selling bonds compared to issuing stock or borrowing money from a bank? Corporate bond prices less sensitive to daily or quarterly firm operations compared to stocks, and can be used, however they often carry higher rates for a smaller firm which is a more expensive alternative to issuing stocks. 8-6. Many companies are aggressively buying their own stock. What are situations when this practice is recommended or especially beneficial? What are the pros and cons of increasing treasury stock on the balance sheet? A company pay purchase their own stock when they are not selling well, and risk being sold for lower than desired since it is better to buy and retain these stocks to prevent an undervaluation. Increasing treasury stock will lower outstanding stock and therefore increase earnings per share (EPS), but also reduces the amount of shareholder equity. 8-7. Hewlett-Packard has more goodwill ($) than the book value ($) of the firm. Explain what this means, how it could occur, and what can be done about this situation. Goodwill is the premium or amount over market value (book value) paid when acquiring another firm. In HP’s case, with the firms they have acquired, they have paid more in premiums than the companies have been actually valued at. Perhaps HP was ambitious to buy a supplier before a competitor could and paid much higher than the book value

Week 5 Assignment Page 2 of 4 to do so, resulting in a very high goodwill amount. HP can write off some of this goodwill as a loss as an impairment expense. 8-8. Give a hypothetical example where Company A buys Company B for a 15 percent premium. Tesla buys Amazon stock for $115 per share today when the price was $100 yesterday. 8-9. Give a hypothetical example where Company A buys Company B for a 15 percent discount. Tesla buys Amazon stock for $85 per share today when the price was $100 yesterday. 8-10. What is treasury stock? When should a company purchase treasury stock? Treasury stock is company stock that is repurchased by the company themselves. This is done when they think the stock is undervalued and want to retain ownership to be able to sell later at a more valuable price. 8-11. What is an IPO? When is an IPO good for a company? Why did Dropbox in 2018 use an IPO? Was that a wise strategic move? Why? An IPO is an initial public offering, which a company goes from private to public and shares can be bought to partially own the company, which helps the firm raise capital. An IPO is good for firms with at least $10M in sales that require more capital to expand its business. While Dropbox used an IPO for these similar reasons, they’ve struggled to grow with a lack of innovation to compete with Google and Amazon who operate similar cloud applications. 8-12. Generally speaking, how large should a firm be to justify having an IPO? Explain the IPO process. A firm should generally be large enough in which they’ve exceeded $10M in sales, as the IPO process is quite costly, and a good cash flow will be needed to remain afloat. Typically, the process involves growing your business to the point an IPO is suitable, and then hiring a bank to underwrite the IPO. A roadshow is typically done to generate interest in the upcoming IPO, meanwhile the initial offer price and date finalization is set once all the paperwork and approvals are complete. 8-13. How could or would dividends affect an EPS/EBIT analysis? Would it be correct to refer to “earnings after taxes, interest, and dividends” as retained earnings for a given year? Dividends paid out would reduce net income and therefore reduce EPS, and they would reduce cash which would reduce EBIT. Overall including dividends would make EPS/EBIT analysis stronger. “Earnings after taxes, interest, and dividends” could be correct as retained earnings represent net income that are not paid out to dividends. However, you would need to introduce a line to reflect dividends being paid out after “earnings after tax”, and another to reflect earnings after tax and dividends. 8-14. In performing an EPS/EBIT analysis, where do the first row (EBIT) numbers come from? The EBIT row comes from the most recent EBIT figure plus and minus the impact of strategy recommendations to determine a range of EBIT figures. Use a low, medium, and high across the board for pessimistic, realistic, and optimistic figures. 8-15. In performing an EPS/EBIT analysis, where does the tax rate percentage come from? The tax rate percentage comes from the income statement, whether simply stated as tax rate or calculated by taxes paid divided by EBT. 8-16. Show algebraically that the price-earnings ratio formula is identical to the number of shares outstanding multiplied by the stock price formula. Why are the values obtained from these two methods sometimes different?

Week 5 Assignment Page 3 of 4 Price-earnings ratio: (Share price * (Net Income or (Share price * (Net Income or (Stock price * shares outstanding). EPS) 1) NI /Shares out) 1) There may be a difference between the two as the time at which you calculate these figures may use different outstanding share values depending on the data available at that time. 8-17. In accounting terms, distinguish between intangibles and goodwill on a balance sheet. Why do these two items generally stay the same on projected financial statements? While goodwill is technically an intangible asset, it is only comprised of premiums paid when acquiring another firm. Other intangible assets include patents or trademarks, but as a whole intangibles stay the same on projected statements as strategies that are implemented rarely utilize or impact them. 8-18. Explain four methods often used to calculate the total worth of a business. 1. The Net Worth method (shareholder equity – (goodwill + intangibles)): includes items in the total equity section such as retained earnings, sum of common stock, etc. and removes all intangibles. Essentially pits how much equity a firm has against their intangible assets, which if its mostly goodwill may not be a good thing. 2. The Net Income Method ( NI * 5 ): Simply takes the net income and multiplies it by 5. Used occasionally due to a general rule of thumb being a business is worth 5 times their annual net income. 3. Price-Earnings ratio ((Share price / EPS) * Net Income): takes the share price divided by the earnings per share (net income / shares outstanding) and multiplies it by the respective net income. 4. Outstanding shares (# shares outstanding * share price): very similar and often equal to price- earnings, but depends on when shares figure is pulled. 8-19. Explain how and why top executives can and do, on occasion, legally manipulate financial statements to inflate or deflate expected results. An executive may artificially inflate revenues or deflate expenses to produce better performing end results such as net income. Doing so would affect the stock price of the company, which is directly tied to their compensation, so they are incentivized to do legal manipulations to make the books look best whenever possible. 8-20. Explain why EPS/EBIT analysis is a central strategy-implementation technique. Part of strategy implementation is resource allocation, and EPS/EBIT analysis is key in determining if and how a firm needs to raise additional capital to be able to allocate the necessary resources. Whether stock is issued, funds are borrowed, or a combination should be considered if needed. 8-21. Identify and discuss the limitations of EPS/EBIT analysis. The following are limitations of EPS/EBIT analysis: 1. Flexibility – firms require flexible options, of which EPS/EBIT are poor in this regard. Using all debt or all stock today may be an issue tomorrow. 2. Dilution of Ownership – additional stock dilutes ownership, which can make the firm a target for a hostile takeover, merger, or acquisition.

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Week 5 Assignment Page 4 of 4 3. Timing – Depending on the interest rates at the time, debt may be a better option than stock regardless of EPS. Just ensure you have a fixed rate that is locked in. 4. Leveraged Situation - If the firm is currently too highly leveraged versus industry average ratios, then financing through stock may be more attractive than debt, even if EPS values are higher for debt. 5. Continuity – EPS/EBIT analysis assumes continuity of prices and rates across various conditions. 6. EBIT Ranges - The EBIT values are estimated based on the prior year, plus the impact of strategies to be implemented. 7. Dividends - If EPS values are highest for all stock, and if the firm pays dividends, then more funds will leave the firm as per dividends if all-stock financing is selected. 8-22. True or False? Retained earnings on the balance sheet are not monies available to finance strategy implementation. Explain. True, retained earnings are earnings that are to be reinvested internally on inventory, equipment, and similar items to promote existing operations. 8-23. Explain why projected financial statement analysis is considered both a strategy-formulation and a strategy-implementation tool. Projected financial statements allows you to determine the impact of strategies and alternatives in the formulation stage to determine which are most viable from a financial standpoint. This same analysis is key in the implementation stage in to forecast impacts of the implemented strategies.