Mini Case Assignment 6

Mini Case Assignment 6 - CEG GSB 703 Mini Case Assignment...

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CEG GSB 703 Mini Case Assignment #6 Adam Ohanesian Email: Adam.Ohanesian@nichols.edu Table of Contents I. Important factors in making projections of future ROEs for Merck a. Factors contributing to Merck continuing a high ROE performer b. Factors causing Merck to revert to industry mean II. Random walk model a. Disagree with John Right b. Why not III. Expecting to show high degree of seasonality in quarterly earnings a. Supermarket b. Pharmaceutical company c. Software company d. Auto manufacturer e. Clothing retailer IV. Factors to drive a firm’s outlays for new capital and working capital a. Ratios I would use to forecast outlays V. Events affecting forecasts of future net income a. Asset write-down b. Merger or acquisition
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c. Sale of a major division d. Initiation of dividend payments VI. Wal-Mart earnings per share FY2000 through FY2004 a. Forecast in FY2005 for each model b. Forecast in FY2006 for each model c. Why different forecasts d. Which is better VII. Pattern of return on equity is implied a. Is it reasonable? 1. Merck is one of the largest pharmaceutical firms in the world, and over an extended period of time in the recent past, it consistently earned higher ROEs than the pharmaceutical industry as a whole. As a pharmaceutical analyst, what factors would you consider to be important in making projections of future ROEs for Merck? In particular, what factors would lead you to expect Merck to continue to be a superior performer in its industry, and what factors would lead you to expect Merck’s future performance to revert to that of the industry as a whole? There are two factors contributing to Merck continuing to be a high ROE performer. First is that of barriers to competition. Merck can enjoy superior ROEs for long periods of time if it builds high entry barriers such as patents, economies of scale arising from large investments in The second factor is artifacts of accounting methods. The tendency of high ROEs may be purely an artifact of accounting methods. At Merck, major economic assets, such as the
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intangible value of research and development, are not recorded on the balance sheet and are therefore excluded from the denominator of ROE. There are two factors causing Merck to revert to the industry mean. First is the economics of competition. Abnormally high profit attracts competition. Increased competition may lower Merck’s high ROEs. The second is increase of investment base. Firms with higher ROEs expand their equity bases more quickly than others, which cause the denominator of the ROE to increase. If firms could earn returns on the new investments that match the returns on the old ones, then the level of ROE would be maintained. However, firms have difficulty pulling that off.
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Mini Case Assignment 6 - CEG GSB 703 Mini Case Assignment...

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