Fabozzi Frank, Peterson Pamela. Financial Management and Analysis Workbook

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410 SOLUTIONS

Q1 = 1.5 million shares outstanding, Q2 = Q3 = Q4 = 1.87 mil-

lion shares, then

2. a.

c. Investors base their purchase decisions on expected future earnings,

not on past earnings. The P/E ratio indicates how much investors are

willing to pay for each dollar of current earnings per share. It does

not take future earnings into account, but investors do. It can be

shown that sometimes investors are too optimistic and have paid for

overvalued stock.

Because there is no speciﬁc method of timing, weighted measures are

not used.

EPS

$6.5 million

0.25 1.5 million shares()0.75 1.87 million()+

--------------------------------------------------------------------------------------------------------------------- -

$6.5 million

1,777,500 shares outstanding

----------------------------------------------------------------------------

$3.67 per share=

Dividend Payout Ratio

Dividends

Earnings available to common shareholders

-----------------------------------------------------------------------------------------------------------------

$0.30

$1.80

-------------- -

16.7%==

P/E ratio

Market price per share

Earnings per share

---------------------------------------------------------- -

$28.50

$1.80

------------------

15.83===

BPS

Earnings available to common shareholders Preferred dividends–

Number of shares outstanding

-------------------------------------------------------------------------------------------------------------------------------------------------------------------------

DPS

Earnings available to common shareholders Preferred dividends–

Number of shares outstanding including all dilutive securities

-------------------------------------------------------------------------------------------------------------------------------------------------------------------------

BPS

$4,355 million

1,300 million shares outstanding

------------------------------------------------------------------------------------ -

$3.35 per share==

SolCh23 Page 410 Tuesday, December 16, 2003 9:34 AM

Earnings Analysis 411

4. a.

b. The forecast error is –7.14%, meaning that the actual was 7.14%

lower than the forecasted. The market will react negatively to the

worse-than-expected earnings and the stock price should decrease

accordingly.

DPS

$4,355 million

1,300 million shares outstanding 300 million potentially dilutive shares+

-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

$2.72 per share=

Forecast error

Actual EPS Consensus EPS–

Actual EPS

-------------------------------------------------------------------------

$1.82 $1.95–

$1.82

----------------------------------- -

7.14%–==

SolCh23 Page 411 Tuesday, December 16, 2003 9:34 AM

SolCh23 Page 412 Tuesday, December 16, 2003 9:34 AM

CHAPTER

413

Cash Flow Analysis

FILL IN THE BLANKS

Answers

1. Cash, valuation, value, future; past, current, dividends, expenditure,

ﬁnancing

2. measuring, into, out; cash, size, demands, working

3. nondiscretionary, discretionary; statement, ﬂexibility, decisions, health

4. no, calculating; measure, methods, calculate

5. net free, NFCF; earnings, less; expenditures, maintenance, expansion,

working

6. Net, unconstrained; creditor’s, ability, debt; shareholder’s, reinvested

7. capital expenditures, capital expenditures; ﬂexibility, capital; larger,

greater

8. debt, debt, debt; ability, debt, credit

9. information, condition; Healthy, unhealthy, operations, declining;

unhealthy, more

SolCh24 Page 413 Tuesday, December 16, 2003 9:34 AM

414 SOLUTIONS

SHORT ANSWER QUESTIONS

Answers

1. There is no uniform deﬁnition of cash ﬂow, so it must always be dis-

cussed in context. Cash ﬂow can be the total amount of cash ﬂowing

into and out of the company during a period. It can be the net of those

cash ﬂows. Some ways to measure cash ﬂow are:

■

Add noncash expenses to net income

■

Calculate earnings before interest, taxes, depreciation, and amorti-

zation

■

Use the statement of cash ﬂows

2. The direct method of reporting cash ﬂow is reporting all cash inﬂows

and outﬂows. The indirect method begins with net income and makes

adjustments for depreciation, noncash expenses, and changes in

working capital. Of the two, the direct method is the most computa-

tionally expensive.

3. Examining the cash ﬂows from operations, investments, and ﬁnanc-

ing activities, an analyst can gauge the activities of the ﬁrm. Please

refer to Exhibit 24.1 on page 802 of Financial Management and

Analysis for more detail.

4. Michael Jensen developed the theory of free cash ﬂow which is the

cash ﬂow left over after the company funds all positive NPV projects.

In other words, free cash ﬂow is the cash ﬂow of the ﬁrm, less capital

expenditures necessary to stay in business and grow at the expected

rate. Free cash ﬂow reveals how ﬁrms actually get rid of their excess

cash. This can be done through dividend payments to shareholders,

retirement of debt, repurchase of stock, and the like. If free cash ﬂow

is not purged, the ﬁrm holding the free cash ﬂow could become a

takeover target by a ﬁrm that needs free cash ﬂow.

5. An analysis of cash ﬂows can reveal a more accurate picture of a

ﬁrm’s health and operations. The analysis reveals:

■

The sources of ﬁnancing for the company’s capital spending

■

The company’s dependence on borrowing

■

The quality of earnings

SolCh24 Page 414 Tuesday, December 16, 2003 9:34 AM

Cash Flow Analysis 415

PROBLEMS

Answers

1. Although there are several variations on how to calculate the various

free cash ﬂows, the method that is applied to this problem can be found

on page 808 of Financial Management and Analysis. The purpose of

choosing this method is to keep the calculations simple.

Free Cash Flows In Millions

EBIT $21

Depreciation and amortization $4

Capital expenditures ($15)

Free cash ﬂow $10

Interest ($2)

Taxes ($7)

Net free cash ﬂow $1

Cash dividends ($2)

Net cash ﬂow ($1)

SolCh24 Page 415 Tuesday, December 16, 2003 9:34 AM

SolCh24 Page 416 Tuesday, December 16, 2003 9:34 AM

CHAPTER

417

International Financial

Management

FILL IN THE BLANKS

Answers

1. domestic; ﬁnancing, investment, international, domestic; ﬁnancial,

global

2. protectionism; Agreement, Tariffs, barriers; International Monetary,

IMF; European, economic; American, Trade, NAFTA, goods

3. multinational, countries; multinational, borders; domestic, markets,

production, resources, hurdles, technology

4. currencies; exchange, currency; exchange, currency, value; exchange-

rate, adversely

5. loses, depreciated, devalued; gains, appreciated, revalued

6. no, price, same; one, currencies, price; purchasing power, PPP

7. Income, indirect, central, corporate; sales, business

8. subsidiaries; intercompany, transfer; congruence, multinational;

taxes, income, import

SolCh25 Page 417 Tuesday, December 16, 2003 9:35 AM

418 SOLUTIONS

9. Globalization, integration; internal, national, external; domestic, for-

eign; domestic, domiciled, traded

10. segmented, integrated; segmented, not; integrated, no; neither, mildly,

mildly

11. bond, foreign, Euromarket; underwritten, simultaneously, outside,

unregistered; Eurobond

12. cost, international, domestic, international; foreign, repatriation,

political; restrictions, capital

SHORT ANSWER QUESTIONS

Answers

1. As the global community gets smaller and more easily accessible,

ﬁrms should participate in the international market for the sake of

survival, competition, and increasing proﬁts. Because everything

today is more global, a ﬁrm in isolation will have trouble competing.

If ﬁrms cannot compete, they do not survive. The goal of the ﬁrm is

to maximize shareholder wealth and with the advent of computers

and advanced telecommunications, this can be done through world-

wide expansion in friendly markets.

2. Free trade is the ability of countries to trade with one another with-

out being constrained. Free trade promotes specialization which

makes production more efﬁcient and increases output. This in turn

increases competition which translates into product variety and lower

prices for the consumer. Free trade beneﬁts countries that have a com-

parative or competitive advantage, however it hurts those that don’t.

3. Corporate income tax is based on a percentage of income earned. The

rate can vary within the country, such as in the United States where

there are tax brackets, and it can vary between countries. If a com-

pany has foreign branches and/or subsidiaries, it is customary for resi-

dent corporations to be taxed by the main country on the entire

worldwide income. Some countries repatriate taxes, meaning they

return some of the taxes back to the country in which the subsidiary

resides. If a company is a nonresident corporation, then that company

SolCh25 Page 418 Tuesday, December 16, 2003 9:35 AM

International Financial Management 419

only pays taxes on the income earned within the country. Some coun-

tries have tax treaties that allow for negotiation of tax treatments.

4. There is no set global deﬁnition of taxable income, therefore it varies

from country to country. Nonresident corporations and expatriates

often must obtain an accountant in the foreign country and one in their

home country in order to fully determine taxable income because there

are multiple methods in dealing with some of the accounting data. Such

items that are treated differently are depreciation, inventory, the

deductibility of interest expense, and inﬂation of expenses.

5. When a corporation issues equity outside of its domestic market and

it is traded in the foreign market, it is an international depository

receipt (IDR). Banks issue IDRs as proof of ownership and hold them

in trust for the owner. A beneﬁt to the IDR is that the issuer is

released from foreign regulatory issuing requirements.

The American depository receipt (ADR), is the U.S. version of the

IDR. Characteristics of ADRs are:

■

They are denominated in U.S. dollars.

■

They pay dividends.

■

They do not grant the holder voting rights or any rights that give

authority in the company.

PROBLEMS

Answers

1. A Venezuelan bolivar is worth $0.000626 U.S.

An Australian dollar is worth $0.64 U.S.

a. There are 0.64/$0.0006 = 1,066.67 Venezuelan bolivars per Austra-

lian dollar

b. There are $0.0006/$0.64 = 0.0009375 Australian dollars per Vene-

zuelan bolivars

2. Consider, $10,000 (35,000 ARS):

In terms of AR: Return

43,750 35,000–

35,000

------------------------------------------

25%==

SolCh25 Page 419 Tuesday, December 16, 2003 9:35 AM