Chapter_13web - EXERCISES FOR CHAPTER 13 With Solutions...

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EXERCISES FOR CHAPTER 13 With Solutions Residual Income and the Required Return An analyst uses the following summary balance sheets to value a firm at the end of 1999 (in millions of dollars): 1999 1998 Net operating assets 4,57 2 3,94 1 Net financial obligations 1,24 3 1,01 4 Common shareholders’ equity 3,32 9 2,92 7 The analyst forecasts that the firm will earn a return on net operating assets (RNOA) of 12% in 2000 and a residual operating income of $91.4 million. (a) What is the required return for operations that the analyst is using in his residual operating income forecast? (b) The analyst forecasts that the residual operating income in 2000 will continue as a perpetuity. What value of the equity does this imply? (c) Using the required return for the operations calculated in part (a) and the value calculated in part (b), calculate the required return for the equity. The after- tax cost of debt is 6%.
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Residual Income and the Required Return: Solution a) Residual operating income (ReOI) forecasted = 91.4 = (12% - required return) x 4,572 So, required return = 10% b) Value of equity = CSE 1999 + 10 . 0 OI Re 2000 = 3,329 + 10 . 0 4 . 91 = $4,243 million c) Use the formula for required return for equity: Required equity return = 10.0% + ( 29 - × % 6 % 10 243 , 4 243 , 1 = 11.17% (Assuming the net financial obligations are at market value on the 1999 balance sheet) -----------------------------------------------------------------------------------------------------------
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Dell Computer Dell Computer reported after-tax operating income of $1,435 million for fiscal year, 1999, along with average operating assets over the year of $3,080 million and average operating liabilities of $3,501 million. Using a cost of capital for operations of 16%, calculate Dell’s residual operating income for the year. Describe, in words, how Dell generated value during the year.
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Dell Computer: Solution NOA = 3,080 – 3,501 = -421 ReOI = OI – (0.16 x NOA) = 1435 + 67.36 = 1502.36 Dell generated value in operations from: (1) Operating income of 1,435 (2) A negative investment in NOA: shareholders earned 16% on operating debt in excess of operating assets. (Operating creditors financed operating assets). Dell used other people’s money. ----------------------------------------------------------------------------------------------------------- - Unlevered Price-to-Book Ratios An analyst has prepared the following reformulated balance sheet (in millions of dollars). Net operating assets
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This note was uploaded on 10/07/2010 for the course ECTCS ec12947322 taught by Professor Johnathayeri during the Spring '10 term at Life.

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Chapter_13web - EXERCISES FOR CHAPTER 13 With Solutions...

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