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IB3960
Summer Examination 2019
FINANCIAL STATEMENT ANALYSIS AND SECURITY VALUATION
SECTION A
Question 1
The following information has been forecasted for Sage Plc, a company which is expected to undergo rapid expansion during the next two years:
After this period of expansion, sales revenue is expected to grow at constant rate of 5% per annum forever (i.e., sales revenue is expected to be £819 million in 2021) and asset turnover is expected to remain at 2. Also, net operating profit margin (after tax) will remain at 10% from 2020.The weighted average cost of capital for Sage Plc. is estimated to be 16%.
(a) Calculate expected abnormal operating profit and expected free cash flow for 2019, 2020, and 2021 and estimate the intrinsic value of Sage's operations at the beginning of 2019 using:
(i) the abnormal operating profit valuation model
(ii) the free cash flow valuation model
(iii) Comment on the figures you have calculated. [30 marks]
(b) Briefly comment on the relative usefulness of the abnormal operating profit model and the free cash flow model as a basis for company valuation. [10 marks]
[Total: 40 marks]
SECTION B
Answer one question from this section
Question 2
Analysts have forecasted the following earnings per share and dividend per share performance for Ryan Trent plc for the next three years:
The book value per share at the beginning of 2019 was £40 or 4000.00 pence. Ryan Trent plc's cost of equity is 10%.
Required:
a) Using the clean surplus relation, calculate expected ROE (based on beginning balance), expected growth in book value per share and dividend retention rate for 2019, 2020, and 2021. Briefly comment on your figures. [12 marks]
b) Assuming a growth rate of 3% per annum in dividends and residual earnings after 2021, estimate the equity value per share using:
(i) the dividend valuation model
(ii) the residual earnings model [12 marks]
(c) Briefly comment on the relative usefulness of the residual earnings model and the dividend model as a basis for equity valuation.[6 marks]
[Total 30 marks]
Question 3
The following condensed balance sheets were prepared for GM Plc. (in millions of dollars).
The income statements for 2018 and 2017 are as follows (in millions of dollars):
a) Calculate:
(i) Net operating assets (NOA) and Net financial obligations (NFO) for 2017 and 2018.
(ii) Return on beginning common equity (ROE) for 2017 and 2018
(iii) Return on beginning net operating assets (RNOA) for 2017 and 2018 [16 Marks]
b) Explain what determined the change in RNOA from 2017 to 2018. [4 Marks]
c) Calculate financial leverage for 2017 and 2018. [4 Marks]
d) Explain why the change in ROE from 2017 to 2018 is considerably greater than the changein RNOA. [6 Marks]
[Total 30 marks]
Answer one question from this section
Question 4
Discuss the relative usefulness of cash flow and accrual based valuation models. Support your arguments with findings from relevant empirical studies. [30 Marks]
Question 5
Prior literature suggests that sell-side analysts' main role in the market is not to accurately forecast earnings or recommend a stock but to provide rich contextual information on companies and industries. Evaluate this claim making use of relevant references. [30 Marks]
Question 6
Explain how past profit and loss account and balance sheet information should be analysed in order to improve prediction of future financial performance and facilitate equity valuation.Your analysis should include a discussion of the problems of using these financial statements for this purpose. [30 Marks]