Problems P5-39, P5-42
Analyzing and Interpreting Restructuring Costs and Effects
Hewlett-Packard, Inc. reports the following footnote disclosure (excerpted) in its 2012 10-K relating to its 2012 restructuring program.
• Fiscal 2012 Restructuring Plan On May 23, 2012, HP adopted a multi-year restructuring plan (the "2012 Plan") designed to simplify business processes, accelerate innovation and deliver better results for customers, employees and stockholders. HP estimates that it will eliminate approximately 29,000 positions in connection with the 2012 Plan through fiscal year 2014, with a portion of those employees exiting the company as part of voluntary enhanced early retirement ("EER") programs. HP expects to record aggregate charges of approximately $3.7 billion through the end of HP's 2014 fiscal year as accounting recognition criteria are met. Of that amount, HP expects approximately $3.1 billion to relate to the workforce reductions and the EER programs and approximately $0.6 billion to relate to other items, including data center and real estate consolidation. Due to uncertainties associated with attrition and the acceptance rates of future international EER programs, the total expected headcount reductions could vary as much as 15% from our estimates. We could also experience similar variations in the total expense of the 2012 Plan.
• HP recorded a charge of approximately $2.1 billion in the fiscal year of 2012 relating to the 2012 Plan. This amount included costs for EER plans in the United States and Canada of $41 million of stock-based compensation expense for accelerated vesting of stock-based awards held by participating EER employees and a special termination benefit ("STB") expense of $126 million. As of October 31, 2012, HP had eliminated approximately 11,700 positions as part of the 2012 Plan. The $2.1 billion charge also includes $105 million for data center and real estate consolidation, of which $56 million related to asset impairments. The cash payments associated with the 2012 Plan are expected to be paid out through fiscal 2015.
• Fiscal 2010 Acquisitions In connection with the acquisitions of Palm, Inc. ("Palm") and 3Com Corporation ("3Com") in fiscal 2010, HP's management approved and initiated plans to restructure the operations of the acquired companies, including severance for employees, contract cancellation costs, costs to vacate duplicative facilities and other items. The total expected combined cost of the plans is $101 million, which includes $33 million of additional restructuring costs recorded in the fourth quarter of fiscal 2011 in connection with HP's decision to wind down the webOS device business. The Palm and 3Com plans are now closed with no further restructuring charges anticipated. The unused accrual in the amount of $13 million was credited to restructuring expense in fiscal year 2012.
• Fiscal 2010 Enterprise Services Business Restructuring Plan On June 1, 2010, HP's management announced a plan to restructure its ES business, which includes the ITO and ABS business units. The multi-year restructuring program includes plans to consolidate commercial data centers, tools and applications. The total expected cost of the plan that will be recorded as restructuring charges is approximately $1.0 billion, and includes severance costs to eliminate approximately 8,200 positions and infrastructure charges. During the first quarter of fiscal 2012, HP reduced the severance accrual by $100 million and recognized additional infrastructure related charges of $104 million. The majority of the infrastructure charges were paid out during fiscal 2012 with the remaining charges expected to be paid out through the first half of fiscal 2015.
(a) Which of the following in NOT an example of a common non-cash charge associated with corporate restructuring activities?
Inventory revaluations
Severance paid to employees
Fixed-asset write-downs
Impairment charges on intangible assets
(b) Using the financial statement effects template, show the effects on financial statements of the (1) 2012 restructuring charge of $2,266 million, and (2) 2012 cash payment of $840 million.
(c) Assume that instead of accurately estimating the anticipated restructuring charge in 2012, the company overestimated them by $30 million. How would this overestimation affect financial statements in (1) 2012, and (2) 2013 when severance costs are paid in cash?
Overstates the expense and understates pretax income by $30 million. The restructuring liability on the 2012 balance sheet will be overstated by $30 million.
Understates the expense and overstates pretax income by $30 million. The restructuring liability on the 2012 balance sheet will be overstated by $30 million.
Overstates the expense and understates pretax income by $30 million. The restructuring liability on the 2012 balance sheet will be understated by $30 million.
Understates the expense and understates pretax income by $30 million. The restructuring liability on the 2012 balance sheet will be overstated by $30 million.
(2) How would this overestimation affect financial statements in 2013 when severance costs are paid in cash?
The cash paid out in 2013 will be more than the 2012 accrual. Any excess (the $30 million) would increase expense (decrease profit) in 2013.
The overestimation from 2012 will have no effect on the 2013 balance sheet or income statement.
The cash paid out in 2013 will be less than the 2012 accrual. Any excess (the $30 million) would increase expense (decrease profit) in 2013.
The cash paid out in 2013 will be less than the 2012 accrual and the payment would not completely eliminate the liability. Any excess (the $30 million) would reduce expense (increase profit) in 2013.
QUESTION 4
Analyzing Unearned Revenue Disclosures
The following disclosures are from the September 1, 2013, annual report of Costco Wholesale Corporation.
Revenue Recognition: Membership fee revenue represents annual membership fees paid by substantially all of the Company's members. The Company accounts for membership fee revenue, net of estimated refunds, on a deferred basis, whereby revenue is recognized ratably over the one-year membership period.
(a) Which of the following statements best explains in layman terms how Costco accounts for the cash received for its membership fees?
Because Costco does not know how many of its members will continue to the end of the year, cash received from members is recorded as a liability and recognized as revenue only at year-end.
When it receives cash, the company records it as a current liability. Then, it recognizes revenue evenly over the year.
The company records revenue when the cash is received.
Because Costco has a refund policy, the company records revenue when the cash is received, less an allowance for expected membership terminations.
(b) Use the balance sheet information on Costco's Deferred Membership Fees liability account and its income statement revenues related to Membership Fees earned during 2013 to compute the cash that Costco received during 2013 for membership fees.
(c) Use the financial statement effects template to show the effect of the cash Costco received during 2013 for membership fees and the recognition of membership fees revenue for 2013.
(d) Costco reports a deferred tax asset related to deferred income/membership fees. Explain in layman terms how this asset arises. When will Costco receive the benefit associated with this asset?
For financial reporting purposes, Costco recognizes revenue from membership fees on an accrual basis. The deferred tax asset implies that the company pays tax in cash after it reports the tax expense. This means that Costco must report GAAP revenue more quickly (in earlier periods) than for tax purposes. From this we can infer that the tax authorities use a cash basis for taxing membership fees.
For tax purposes, Costco recognizes revenue from membership fees on an accrual basis. The deferred tax asset implies that the company pays tax in cash before it reports the tax expense. This means that Costco must report GAAP revenue more slowly (in later periods) than for tax purposes. From this we can infer that Costco recognizes revenue from membership fees on a cash basis for book purposes.
For tax purposes, Costco recognizes revenue from membership fees on an accrual basis. The deferred tax asset implies that the company pays tax in cash after it reports the tax expense. This means that Costco must report GAAP revenue more quickly (in later periods) than for tax purposes. From this we can infer that Costco recognizes revenue from membership fees on a cash basis for book purposes.
For financial reporting purposes, Costco recognizes revenue from membership fees on an accrual basis. The deferred tax asset implies that the company pays tax in cash before it reports the tax expense. This means that Costco must report GAAP revenue more slowly (in later periods) than for tax purposes. From this we can infer that the tax authorities use a cash basis for taxing membership fees.
Problems E6-27, P6-39
QUESTION 1
Applying and Analyzing Inventory Costing Methods
At the beginning of the current period, Chen carried 1,000 units of its product with a unit cost of $21. A summary of purchases during the current period follows. During the period, Chen sold 2,800 units.
(a) Assume that Chen uses the first-in, first-out method. Compute both cost of good sold for the current period and the ending inventory balance. Use the financial statement effects template to record cost of goods sold for the period.
(b) Assume that Chen uses the last-in, first-out method. Compute both cost of good sold for the current period and the ending inventory balance.
(c) Assume that Chen uses the average cost method. Compute both cost of good sold for the current period and the ending inventory balance.
(d) Which of these three inventory costing methods would you choose to:
QUESTION 2
Interpreting Accounts Receivable and Its Footnote Disclosure
Following is the current asset section from the W.W. Grainger, Inc., balance sheet.
Grainger reports the following footnote relating to its receivables.
Allowance for Doubtful Accounts: The following table shows the activity in the allowance for doubtful accounts.
(a) What amount do customers owe Grainger at each of the year-ends 2010 through 2012?
(b) What percentage of its total accounts receivable does Grainger deem uncollectible? Hint: Percentage of uncollectible accounts = Allowance for uncollectible accounts/Gross accounts receivable. Round your answers to two decimal places.
(c) What amount of bad debts expense did Grainger report in its income statement for each of the years 2010 through 2012?
(d) Which of the following statements most closely describes what we observe in our answer to part (b)?
The allowance for uncollectible accounts has decreased as a percentage of gross accounts receivable in 2012. The allowance decreased because the gross accounts receivable has increased and the allowance account has decreased.
The allowance for uncollectible accounts has decreased as a percentage of gross accounts receivable in 2012. This means that Grainger is over-stating its bad debt expense in the current year.
The allowance for uncollectible accounts has increased as a percentage of gross accounts receivable in 2012. The allowance is increasing appropriately because write-offs of uncollectible accounts are also increasing.
The allowance for uncollectible accounts has increased as a percentage of gross accounts receivable in 2012. This means that the allowance was too low in prior years.
(e) If Grainger had kept its 2012 allowance for uncollectible accounts at the same percentage of gross accounts receivable as it was in 2010, by what amount would its profit have changed (ignore taxes)? HINT: Use rounded answer from part b. to calculate. Round answer to the nearest thousands.
(f) Which of the following statements about Grainger's allowance for uncollectible accounts and the related bad debts expense is false?
Since 2010, Grainger has decreased its allowance for uncollectible accounts as a percentage of gross receivables.
Grainger's current allowance account appears adequate since it is two times the level of current-year write-offs.
Since 2010 Grainger has decreased it allowance for uncollectible accounts by increasing its write-offs.
Grainger's bad debt expense decreased from 2010 to 2011, but then increased again in 2012.
QUESTION 3
Interpreting and Applying Disclosures on Property and Equipment
Following are selected disclosures from theRohm and Haas Company (a specialty chemical company) 2007 10-K.
The principal lives (in years) used in determining depreciation rates of various assets are: buildings and improvement (10-50); machinery and equipment (5-20); automobiles, trucks and tank cars (3-10); furniture and fixtures, laboratory equipment and other assets (5-10); capitalized software (5-7). The principal life used in determining the depreciation rate for leasehold improvements is the years remaining in the lease term or the useful life (in years) of the asset, whichever is shorter.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets, other than investments, goodwill and indefinite-lived intangible assets, are depreciated over their estimated useful lives, and are reviewed for impairment whenever changes in circumstances indicate the carrying value of the asset may not be recoverable. Such circumstances would include items such as a significant decrease in the market price of a long-lived asset, a significant adverse change in the manner the asset is being used or planned to be used or in its physical condition or a history of operating or cash flow losses associated with the use of the asset ... When such events or changes occur, we assess the recoverability of the asset by comparing the carrying value of the asset to the expected future cash flows associated with the asset's planned future use and eventual disposition of the asset, if applicable ... We utilize marketplace assumptions to calculate the discounted cash flows used in determining the asset's fair value ... For the year ended December 31, 2007, we recognized approximately $24 million of fixed asset impairment charges.
(a) Compute the PPE (land, buildings and equipment) turnover for 2007 (Sales in 2007 are $8,897 million). (Round your answer to two decimal places.)
If the median PPE turnover rate for all publicly traded companies is approximately 5.03 in 2007, what does Rohm and Haas' turnover rate tell us about the company?
Rohm and Haas' is less capital intensive than the median publicly traded company.
Rohm and Haas' is the same capital intensive as the median publicly traded company.
Rohm and Haas is more capital intensive than the median publicly traded company.
The PPE turnover rate does not tell us anything about how capital intensive Rohm and Haas is.
(b) Rohm and Haas reported depreciation expense of $412 million in 2007. Estimate the useful life, on average, for its depreciable PPE assets. (Round your answer to two decimal places.)
(c) By what percentage are Rohm and Haas' assets "used up" at year-end 2007? (Round your answer to two decimal places.)
Which of the following statements best captures the implication that the assets "used up" computation has for forecasting cash flows?
Rohm and Haas' assets are not particularly "used up" according to this computation. We, therefore, do not expect adverse implication for future cash flow.
A percentage "used up" substantially above 50% indicates that the assets are closer to the end of their useful lives and will require replacement. Such a situation would negatively impact future cash flows.
A percentage "used up" substantially above 50% indicates that the assets are closer to the end of their useful lives. This means that the depreciation expense will decrease and this in turn will have a positive impact on future cash flows.
The assets "used up" computation can not tell us anything about future cash flows.
(d) Rohm and Haas reports an asset impairment charge in 2007. Which of the following statements best captures the implications of asset impairment charges (write-offs)?
Plant assets are deemed to be impaired if the undiscounted expected future cash flows from those assets are not sufficient to recover their net book value. Because assets impairment charges are arguably nonrecurring, one might use this to justify treating them as transitory items for analysis purposes.
Plant assets are deemed to be impaired if their market value is less than their book value, even if temporary. We should treat these write-downs as recurring (operating) items because future write-downs are inevitable.
Plant assets are deemed to be impaired if the undiscounted expected future cash flows from those assets are not sufficient to recover their net book value. We should treat these write-downs as recurring (operating) items because future write-downs are inevitable.
Plant assets are deemed to be impaired if their market value is less than their book value, even if temporary. We should treat these write-downs as transitory.
Problems E7-33, P7-39
QUESTION 2
Determining Bond Prices, Interest Rates, and Financial Statement Effects
Deere & Company's 2012 10-K reports the following footnote relating to long-term debt for its equipment operations subsidiary. Deere's borrowings include $300 million, 7.125% notes, due in 2031 (bolded below).
This price quote indicates that Deere's 7.125% notes have a market price of 131.47 (131.47% of face value), resulting in a yield to maturity of 4.488%.
(a) Assuming that these notes were originally issued at par value, what does the market price reveal about interest rate changes since Deere issued its notes? (Assume that Deere's credit rating has remained the same.)
Interest rates have remained the same.
There is not enough information.
Interest rates have increased.
Interest rates have declined.
(b) Does the change in interest rates since the issuance of these notes affect the amount of interest expense that Deere reports in its income statement? Explain.
Yes, the decline in interest rates results in a decline in interest expense.
Because accounting is inherently conservative, declines in interest rates are not reflected in a reduction of interest expense. However, the increase in interest expense resulting from an increase in rates is recognized.
No, the change in interest rates since Deere issued the notes does not affect interest expense.
The change in interest rates only affects the required payment on the liability and, thus, cash flow.
(c) How much cash would Deere have to pay to repurchase the 7.125% notes at the quoted market price of 131.47? (Assume no interest is owed when Deere repurchases the notes.) (Round your answer to two decimal places.)
How would the repurchase affect Deere's current income?
The repurchase would result in a loss on repurchase of debentures, which would lower current pre-tax income.
Cash and bonds payable both decrease by the same amount. No gain or loss is recognized.
The repurchase only affects cash flow, not income.
Income is not affected because the liability has been reported at fair value since inception. As a result, the repurchase price is equal to the book value and no gain or loss is recognized.
(d) Assuming that the notes remain outstanding until their maturity, at what market price will the notes sell on their due date in 2031?
QUESTION 3
Analyzing Debt Terms, Yields, Prices, and Credit Ratings
Reproduced below is the debt footnote from the 2013 10-K report of Dell Inc.
(a) What is the amount of long-term debt reported on Dell's February 1, 2013 balance sheet?
What are the scheduled maturities for this indebtedness?
Why is information relating to a company's scheduled maturities of debt useful in an analysis of its financial condition?
Excessive payments in any one year can create a cash flow problem, especially if the debt cannot be refinanced.
We prefer to see liabilities coming due in the near future if interest rates are expected to decline; but deferred if interest rates are expected to increase.
The information relating to a company's scheduled maturities is not important.
We are looking to see if all payments are approximately equal. If so, the expected drain on cash flow will be constant.
(b) Dell reported $270 million in interest expense in the notes to its 2013 income statement. In the note to its statement of cash flows, Dell indicates that the cash portion of this expense is $279 million. What could account for the difference between interest expense and interest paid?
The difference arises from the amortization of any discounts or premiums on the debt.
The difference arises because the amount of interest paid is based on prevailing interest rates that change frequently.
The difference arises because the amount of interest expense is based on prevailing interest rates that change frequently.
There is never any difference between interest expense and interest paid.
(c) Dell's long-term debt is rated Baa1 by Moody's, BBB+ by S&P, and BBB+ by Fitch. What factors would be important to consider in attempting to quantify the relative riskiness of Dell compared with other borrowers?
Credit rating agencies assess companies' default risk by focusing primarily on macroeconomic factors such as the projected level of interest rates.
Credit rating agencies assess companies' default risk by gauging the level of debt in relation to the companies' operating cash flow, profitability ratios, and the ratios for long-term creditworthiness.
Credit rating agencies assess companies' default risk by comparing the target company against companies that have defaulted on their debt.
Credit rating agencies assess companies' default risk by focusing primarily on non-quantitative measures such as the quality of the company's management team.
(d) Dell's $300 million 5.4% notes traded at 69.5 or 69.5% of par, as of November 2013. What is the market value of these notes on that date? (Round your answer to one decimal place.)
How is the difference between this market value and the $300 million face value reflected in Dell's financial statements?
The balance sheet is unaffected, but the income statement reflects increases (decreases) in interest rates as increases (decreases) in interest expense.
The current market value of the notes is reflected in the balance sheet as an increase (decrease) in liabilities if rates have declined (increased).
Only the statement of cash flows is affected as cash is needed to retire the liabilities when they mature.
The current market value of the notes is not reflected in Dell's balance sheet.
What effect would the repurchase of this entire note issue have on Dell's financial statements?
There would be no effect on the financial statements if Dell were to repurchase these notes because the repurchase would be made at book value.
Dell is prohibited from repurchasing the notes before maturity and, thus, no financial statements would be affected.
Only the balance sheet and statement of cash flows would be affected as they reflect the cash payment and consequent reduction of liabilities.
If Dell were to repurchase these notes, the difference would be reported as a gain in the current income statement.
What does the 69.5 price tell you about the general trend in interest rates since Dell sold this bond issue?
The price of the bonds is unrelated to the general level of interest rates, only the rate of interest on Dell's debt. Because that hasn't changed, other causes must be considered.
Because these notes have declined in value subsequent to their issuance, market interest rates must have decreased.
The market price of the debt relates only to investor's expectations about the general condition of the airline industry and is unaffected by the level of interest rates.
Because these notes have declined in value subsequent to their issuance, market interest rates must have increased.
Problems E10-20, E10-24, P10-28, P10-31
QUESTION 1
Analyzing and Interpreting Footnote on Operating and Capital Leases
Verizon Communications, Inc., provides the following footnote relating to its leasing activities in its 10-K report.
(a) Using your financial calculator or Excel Spreadsheet, confirm that Verizon capitalized its capital leases using a rate of 9.44%
(b) What effect does the failure to capitalize operating leases have on Verizon's balance sheet? Over the life of its leases, what effect does this lease classification have on net income?
• There is no effect on the balance sheet and income statement as a result of the classification of leases.
• Total assets and total liabilities are higher than if the operating lease had been classified as a capital lease. Over the lease term, total rent expense under operating leases will be equal to the interest and depreciation expense that the company would record under capital leases.
• Total assets and total liabilities are lower than if the operating lease had been classified as a capital lease. Over the lease term, total rent expense under operating leases will be equal to the interest and depreciation expense that the company would record under capital leases.
• Total assets and total liabilities are lower than if the operating lease had been classified as a capital lease. Over the lease term, total rent expense under operating leases will be greater than the interest and depreciation expense that the company would record under capital leases.
(c) Compute the present value of Verizon's operating leases, assuming an 9.44% discount rate and rounding the remaining lease term to 3 decimal places. (Use a financial calculator or Excel to compute. Do not round until your final answers. Round each answer to the nearest whole number.)
Which of the following statements best describes how we might use this additional information in our analysis of the company?
• To assess the company's financial condition and performance, we might add the present value of its operating leases to both operating assets and nonoperating liabilities. No adjustment is necessary for the income statement.
• To assess the company's financial condition and performance, we might add the present value of its operating leases to both operating assets and nonoperating liabilities, and we can replace rent expense with the depreciation of the lease assets and the interest on the lease liability.
• To assess the company's financial condition and performance, we might add the sum of the contractual payments under the operating leases to both assets and nonoperating liabilities, and we can replace rent expense with the depreciation of the lease assets and the interest on the lease liability.
• Verizon's balance sheet and income statement are prepared in accordance with GAAP. No adjustments are necessary to evaluate the financial condition of the company.
QUESTION 2
Analyzing and Interpreting Pension Disclosures
General Mills, Inc. reports the following pension footnote in its 10-K report.
(a) Which of the statements below best describes what is meant by service cost and interest cost?
Service cost represents the additional pension benefits earned by employees during the current year but paid to employees in the future. Interest cost is the expense we incur on funds borrowed by the pension plan.
Service cost represents the wages earned by employees managing the pension plan during the current year. Interest cost is the expense we incur on funds borrowed by the pension plan.
Service cost represents the wages earned by employees managing the pension plan during the current year. Interest cost is an expense that accrues on the pension obligation during the year.
Service cost represents the additional pension benefits earned by employees during the current year but paid to employees in the future. Interest cost is an expense that accrues on the pension obligation during the year.
(b) What is the total amount paid to retirees during fiscal 2013?
What is the source of funds to make these payments to retirees?
pension liabilities
operating cash flows
pension obligations
pension assets
(c) Compute the 2013 funded status for the company's pension plan.
(d) Which of the following statements best describes what are the plan amendment adjustments, and how they differ from actuarial gains and losses?
Actuarial gains (losses) are decreases (increases) to the PBO resulting from changes in the assumptions used to estimate the pension or health care liability, while amendment adjustments are changes to the liability arising from amendments to the plan itself.
Actuarial gains (losses) are decreases (increases) to the PBO resulting from changes in the assumptions used to estimate the pension or health care liability, while amendment adjustments are adjustments made in accounting for the plan as a result of those estimates.
Actuarial gains and losses represent charges that the pension plan incurs from actuaries that it hires to perform various estimates, while amendment adjustments are adjustments made in accounting for the plan as a result of those estimates.
Actuarial gains and losses represent charges that the pension plan incurs from actuaries that it hires to perform various estimates while amendment adjustments are changes to the liability arising from amendments to the plan itself.
(e) General Mills projects payments to retirees of over $236 million per year. Which of the following statements best describes how it is able to contribute only $223.1 million to its pension plan?
Federal law does not require companies to fund pension plans. Any contributions that General Mills makes are purely voluntary.
The funding for payments to retirees comes from the pension assets. General Mills, therefore, does not need to contribute its own funds to the pension plan.
Contributions to pension plans are made mostly by employees. Any contributions that General Mills makes are purely voluntary.
The funding for payments to retirees comes from pension assets. General Mills' plan assets yield investment returns that currently provide the cash inflow.
(f) Which of the following statements best describes the effect from a substantial decline in the financial markets on General Mills' contribution to its pension plans?
Should pension investments decline as a result of a decline in the financial markets, General Mills might be required to increase its cash contribution to the pension plan.
General Mills' contributions to its pension plans are purely voluntary. Fluctuations in the general financial markets would, therefore, have no effect.
Any shortfall in contributions is covered by contributions from the Federal Government under its various pension benefit guarantee programs. Fluctuations in the general financial markets would, therefore, have no effect.
General Mills' pension plans are not affected by fluctuations in the general financial markets. There would be no effect on General Mills.
QUESTION 3
Analyzing, Interpreting and Capitalizing Operating Leases
Assume the Aeropostale, Inc. 10-K report contains the following footnote relating to its leasing activities. This is the only information it discloses relating to its leasing activity.
We are committed under noncancelable leases for our entire store, distribution centers and office space locations... Certain leases also require contingent rent based on sales. The aggregate minimum annual real estate rent commitments as of February 2, 2013 are as follows(thousands):
(a) What lease assets and lease liabilities does Aeropostale report on its balance sheet? How do we know?
Aeropostale reports that it leases its retail locations. Because the leases represent contractual obligations, they are reported as liabilities on Aeropostale's balance sheet.
Under GAAP, Aeropostale must recognize the present value of the lease obligations as both an asset and a liability. The asset is subsequently depreciated and the liability is amortized like a mortgage obligation.
Because no capital leases are included in the Aeropostale footnote, we know that it only has operating leases. Because operating leases are not capitalized on the balance sheet, neither lease assets nor lease liabilities appear on the Aeropostale balance sheets.
Aeropostale reports that it leases its retail locations. Because the leases represent contractual obligations, they are reported as liabilities on Aeropostale's balance sheet. Aeropostale also reports assets relating to the real property it leases.
(b) What effect does the lease classification have on Aeropostale's balance sheet? Over the life of the lease, what effect does this classification have on the company's net income?
Total assets and total liabilities for Aeropostale are lower than if the operating leases had been capitalized. Total profit is lower as a result of this classification.
Total assets and total liabilities for Aeropostale are higher than if the operating leases had been capitalized. Total profit is higher as a result of this classification.
Total assets and total liabilities for Aeropostale are lower than if the operating leases had been capitalized. Total profit is higher as a result of this classification.
Total assets and total liabilities for Aeropostale are lower than if the operating leases had been capitalized. Total profit is unaffected by this classification.
(c) Using a 6% discount rate and rounding the remaining lease life to the nearest whole year, estimate the assets and liabilities that Aeropostale fails to report as a result of its off-balance-sheet lease financing. (Use a financial calculator or Excel to compute. Do not round until your final answers. Round each answer to the nearest whole number.)
(d) What adjustments would we consider to Aeropostale's income statement corresponding to the adjustments we would make to its balance sheet in part c.
We would remove rent expense from the income statement and replace it with depreciation expense relating to the leased assets.
We would make the following adjustments to Aeropostale's income statement: remove rent expense, add depreciation expense, and add interest expense.
No adjustments to the income statement are required.
We would remove rent expense from the income statement.
(e) Indicate the direction (increase or decrease) of the effect that capitalizing these leases would have on the following financial items and ratios for Aeropostale: return on equity (ROE), net operating profit after tax (NOPAT), net operating assets (NOA), net operating profit margin (NOPM), net operating asset turnover (NOAT), and measures of financial leverage.
QUESTION 4
(a) How much pension expense (revenue) does DuPont report in its 2012 income statement?
(b) What is DuPont's actual gain or loss realized on its 2012 pension plan assets?
(c) What main factors affected DuPont's pension plan assets and pension liability during 2012?
Investment gains and employer contributions increased the plan assets. Service costs, interest costs, and actuarial losses increased the pension liability, and benefit payments reduced the liability. Benefits were paid directly by the company and did not affect plan assets
Investment gains and employer contributions increased the plan assets, and benefits paid reduced plan assets. Service costs and actuarial losses increased the pension liability, and benefit payments reduced the liability. Interest reflects the amount the company paid to its lenders and did not affect the pension obligation directly.
Investment gains and employer contributions increased the plan assets, and benefits paid reduced plan assets. Service costs, interest costs and actuarial losses increased the pension liability, and benefit payments reduced the liability.
Investment gains and employer contributions increased the plan assets, and benefits paid reduced plan assets. Service costs, interest costs and actuarial losses decreased the pension liability, and benefit payments reduced the liability.
(d) What does the term funded status mean? What is the funded status of the 2012 DuPont pension plans?
"Funded status" reveals how much cash the plan has.
"Funded status" reflects the contributions that the company has made to the plan.
"Funded status" is the excess or deficiency of the pension obligation over plan assets.
"Funded status" refers to the extent to which the plan assets are invested in mutual funds.
(e) DuPont decreased its discount rate from 5.32% to 4.32% in 2012. What effect(s) does this decreasehave on its balance sheet and its income statement?
A decrease in the discount rate increases the PBO and increases pension cost.
A decrease in the discount rate increases the PBO and decreases pension cost.
A decrease in the discount rate reduces the PBO and decreases pension cost.
A decrease in the discount rate increases the PBO and has no effect on pension cost.
(f) How did DuPont's pension plan affect the company's cash flow in 2012?
The company's cash flow increased as the increase in pension assets more than offset the increase in the PBO.
There was no effect on the company's cash flow as all benefit payments are paid from plan assets.
The company contributed cash to its pension plan in 2012. This contribution directly affected the company's cash flow.
The company's cash flow increased by the gains on the plan's investment portfolio and decreased by the benefits paid to plan participants.
(g) Explain how the returns on pension assets affect the amount of cash that DuPont must contribute to fund the pension plan.
Should pension investments decline as a result of a decline in the financial markets, DuPont might be required to increase its cash contribution to the pension plan.
Asset returns have no effect on DuPont's cash flow because they are recognized in the pension plan and not on the company's financial statements.
Asset returns have no effect on DuPont's cash flow because increases in the PBO provide whatever financing the plan needs.
Asset returns have no effect on DuPont's cash flow because employee contributions make up any shortfall.
Problems E11-20, E11-21, P11-31
QUESTION 1
Analyzing, Forecasting, and Interpreting Both Income Statement and Balance Sheet
Following are the income statements and balance sheets of Macy's, Inc.
QUESTION 2
Forecasting the Statement of Cash Flows
Following are the income statements and balance sheets of Macy's, Inc.
QUESTION 3
Forecasting the Income Statement, Balance Sheet, and Statement of Cash Flows
Asume the following are the financial statements of Nike, Inc.
Instructions: Round answers to the nearest whole number. Do not enter negative signs with answers. Remember to use rounded forecasted revenues with subsequent calculations.
Problems P12-39, P12-40, P12-41, P12-43
QUESTION 1
Harley Davidson, Inc. (HOG) has $5.1 billion in total debt (which approximates its market value). Interest expense for the year was about $46.0 million. The company's market capitalization is approximately $11.0 billion, its market beta is 2.16, and its assumed tax rate is 37%. Assume that the risk-free rate equals 2.5% and the market premium equals 5%. Rounding Instructions: Do not round until your final answers. Round answers to one decimal place.
(a) Estimate Harley Davidson's cost of debt capital.
(b) What does a beta of 2.16 mean regarding the volatility of Harley-Davidson's stock price.
• Harley-Davidson's stock price decreases faster than the market index.
• Harley-Davidson's stock price follows the market index very closely.
• Harley-Davidson's stock price increases faster than the market index.
• Harley-Davidson's stock price tends to be volatile compared to the market index.
(c) Estimate Harley-Davidson's cost of equity capital.
(d) Using your rounded answers from (a) and (c) above, estimate Harley-Davidson's weighted average cost of capital.
QUESTION 2
Estimating Components of both WACC and DDM
Analysts estimate the cost of debt capital for Abbott Laboratories (NYSE: ABT) is 3.0% and that its cost of equity capital is 5.0%. Assume that ABT's statutory tax rate is 37%, the risk-free rate is 2.5%, the market risk premium is 5.0%, the ABT market price is $65.60 per common share, and its dividends are $0.88 per common share.
(a) Compute ABT's average pretax borrowing rate and its market beta. (Round your answers to one decimal place.)
(b) Assume that its dividends continue at the current level in perpetuity. Use the constant perpetuity dividend discount model to infer the market's expected cost of equity capital. (Hint: Use Price per share = Dividends per share/Cost of equity capital.) (Round your answer to one decimal place.)
(c) Compare the inferred cost of equity capital from part (b) to the 5.0% estimated cost of equity capital from analysts.
The inferred cost of equity capital seems high compared to 5.0%, which suggests that the investment has a negative beta.
The inferred cost of equity capital seems low compared to 5.0%, which suggests that the investment has a negative beta.
The inferred cost of equity capital seems high compared to 5.0%, which suggests that the investment has a positive beta.
The inferred cost of equity capital seems low compared to 5.0%, which suggests that the investment has a positive beta.
QUESTION 3
Estimating Cost of Capital Measures and Applying the DDM Model
Procter and Gamble Co. (PG) has a June fiscal year-end. On June 30, 2006, analysts expected the company to pay $1.41 dividends per share in fiscal year 2007. The company's market beta is estimated to be 0.7. Assume that the risk-free rate is 4.6% and the market premium is 5%. During fiscal year 2006, the company's sales growth was 20.2%. However, analysis reveals that P&G's fiscal 2006 sales include eight months of sales from Gillette after its acquisition by P&G during 2006. Footnotes report pro forma sales that show what the income statement would have reported had Gillette's full-year sales been included in both 2005 and 2006-specifically, P&G's sales growth would have been 4.4%.
(a) Estimate P&G's cost of equity capital using the CAPM model. (Round your answer to one decimal place.)
(b) Using your rounded answer from (a), estimate P&G's intrinsic value using the DDM model assuming that dividends per share are projected at $1.41 per share after 2007. (Hint: Apply the DDM model with constant perpetuity.) (Round your answer to two decimal places.)
(c) Discuss the appropriateness of the estimate computed in part (b) in light of its assumption for no future dividend growth.
The DDM model with a constant perpetuity would correctly estimate P&G's intrinsic value
The DDM model with a constant perpetuity would likely underestimate P&G's intrinsic value
The DDM model with a constant perpetuity would likely overestimate P&G's intrinsic value
(d) If we use the Gordon growth DDM to estimate stock value per share, which sales growth rate should we use (20.2% or 4.4%)? Explain.
The 20.2% rate is appropriate. The 4.4% rate would underestimate the growth rate because the 2006 sales does not include sales from Gillette.
The 4.4% rate is appropriate. The 20.2% rate would overestimate the growth rate because the 2005 sales number does not include sales from Gillette.
Comment on the reasonableness of this inferred growth rate.
Investors seem to expect P&G to grow at the same rate as the historical number of 4.4%.
Investors seem to expect P&G to grow at a slower rate than the historical number of 4.4%.
Investors seem to expect P&G to grow at a faster rate than the historical number of 4.4%.
Estimating Market and Book Values and Cost of Capital Measures
The December 31, 2012, partial balance sheet of 3M Company follows ($ millions, except per share amounts). Ycharts.com reported that the total market capitalization of 3M was $63.80 billion an its stock price was $92.85 as of December 31, 2012. Also, Ycharts.com estimates its total enterprise value at $65.73 billion, and its market beta at 0.87. 3M's average pretax borrowing cost is 2.8%, and its statutory tax rate is 37%. Assume that the risk-free rate equals 2.5% and the market premium equals 5%.
(a) Verify Ycharts.com's computation of 3M's market capitalization using the data from its financial report excerpts above. (Round your answer to two decimal places.)
(b) Compute the book value of 3M's long-term debt as of December 31, 2012.
(c) Compute the market value of 3M's debt using the data from Ycharts.com. (Round your answer to two decimal places.)
(d) Identify reasons behind the difference between the amounts computed in parts (b) and (c). (Select all that apply.)
(e) Compute 3M's cost of debt capital. (Round your answer to one decimal place.)
(f) Compute 3M's cost of equity capital. (Round your answer to one decimal place.)
(g) Using your rounded answer from (e) and (f) above, compute 3M's weighted average cost of capital. Use the market capitalization from Ycharts.com and your rounded answer from (c) above for this calculation. (Do not round until your final answer. Round answer to one decimal place.)
Problems E13-10, P13-16
Following are forecasts of Abercrombie & Fitch's sales, net operating profit after tax (NOPAT), and net operating assets (NOA) as of February 2, 2013.
Answer the following requirements assuming a discount rate (WACC) of 10%, a terminal period growth rate of 2%, common shares outstanding of 78.4 million, and net nonoperating obligations (NNO) of $(372) million (negative NNO reflects net nonoperating assets such as investments rather than net obligations).
(a) Estimate the value of a share of Abercrombie & Fitch common stock using the discounted cash flow (DCF) model as of February 2, 2013. Rounding instructions: Round answers to the nearest whole number unless noted otherwise. Use your rounded answers for subsequent calculations.
(b) Assume Abercrombie & Fitch (ANF) stock closed at $45.46 on April 2, 2013, the date the 10-K was filed with the SEC. How does your valuation estimate compare with this closing price? What do you believe are some reasons for the difference?
• Stock prices are a function of many factors. It is impossible to speculate on the reasons for the difference.
• Our stock price estimate is lower than the ANF market price, indicating that we believe that ANF stock is overvalued. Stock prices are a function of expected NOPAT and NOA, as well as the WACC discount rate. Our lower stock price estimate might be due to more pessimistic forecasts or a higher discount rate compared to other investors' and analysts' model assumptions.
• Our stock price estimate is lower than the ANF market price, indicating that we believe that ANF stock is overvalued. Stock prices are a function of expected NOPAT and NOA, as well as the WACC discount rate. Our lower stock price estimate might be due to more optimistic forecasts or a lower discount rate compared to other investors' and analysts' model assumptions.
• Our stock price estimate is lower than the ANF market price, indicating that we believe that ANF stock is undervalued. Stock prices are a function of expected NOPAT and NOA, as well as the WACC discount rate. Our lower stock price estimate might be due to more optimistic forecasts or a lower discount rate compared to other investors' and analysts' model assumptions.
QUESTION 2
Forecasting and Estimating Share Value Using the DCF Model
Assume the following are the income statement and balance sheet for CVS Caremark.
(a) Compute CVS's net operating assets (NOA) as of December 31, 2012.
(b) Compute net operating profit after tax (NOPAT) for fiscal year ended December 31, 2012, assuming a federal and state statutory tax rate of 37%.(Round your answer to the nearest whole number.)
(c) Forecast CVS's sales, NOPAT, and NOA for 2013 through 2016 using the following assumptions:
(d) Estimate the value of a share of CVS common stock using the discounted cash flow (DCF) model as of December 31, 2012; assume a discount rate (WACC) of 7%, common shares outstanding of 1,231 million, and net nonoperating obligations (NNO) of $8,448 million. Use your rounded answers for subsequent calculations.
(e) CVS's stock closed at $51.12 on February 15, 2013. How does your valuation estimate compare with this closing price?
What do you believe are some reasons for the difference? What investment decision is suggested from your results?
Problems P14-19
QUESTION 1
Assume the following are the income statement and balance sheet for CVS Caremark.
(a) Compute CVS's net operating assets (NOA) as of December 31, 2012.
(b) Compute net operating profit after tax (NOPAT) for 2012, assuming a federal and state statutory tax rate of 37%.(Round your answer to the nearest whole number.)
(c) Forecast CVS's sales, NOPAT, and NOA for 2013 through 2016 using the following assumptions:
(d) Estimate the value of a share of CVS common stock using the residual operating income (ROPI) model as of December 31, 2012; assume a discount rate (WACC) of 7%, common shares outstanding of 1,231 million, and net nonoperating obligations (NNO) of $8,448 million. Use your rounded answers for subsequent calculations.
(e) CVS's stock closed at $51.12 on February 15, 2013. How does your valuation estimate compare with this closing price?
What do you believe are some reasons for the difference? What investment decision is suggested from your results?
Problems P15-37, P15-38
QUESTION 1
(a) Compute the price to net operating assets ratio for both Kohl's and Wal-Mart. (Round your answers to one decimal place.)
(b) Use Kohl's and Wal-Mart as comparables, along with the price to NOA ratios from part (a), and then estimate for Target its company intrinsic value, its equity intrinsic value, and its equity intrinsic value per share. (Round the intrinsic value and equity intrinsic value to the nearest million and the value per share to the nearest cent.)
(c) Compute the PB ratio for both Kohl's and Wal-Mart. (Round your answers to one decimal place.)
(d) Use Kohl's and Wal-Mart as comparables, along with the PB ratios from part (c), and then estimate for Target its equity intrinsic value and its equity intrinsic value per share. (Round the equity intrinsic value to the nearest million and the value per share to the nearest cent.)
QUESTION 2
The following table provides summary data for Target and its competitors, Kohl's and Wal-Mart.
(a) Compute the price to NOPAT ratio for both Kohl's and Wal-Mart. (Round your answers to one decimal place.)
(b) Use Kohl's and Wal-Mart as comparables, along with the company value to NOPAT ratios from part (a), and then estimate for Target its company intrinsic value, its equity intrinsic value, and its equity intrinsic value per share. (Round the intrinsic value and equity intrinsic value to the nearest million and the value per share to the nearest cent.)
(c) Compute the price to net income ratio for both Kohl's and Wal-Mart. (Round your answers to one decimal place.)
(d) Use Kohl's and Wal-Mart as comparables, along with the equity to net income ratios from part (c), and then estimate for Target its equity intrinsic value and its equity intrinsic value per share. (Round the equity intrinsic value to the nearest million and the value per share to the nearest cent.)
Attachment:- Financial Statement Analysis.rar