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EXERCISE n.

1 (14 points)
At the end of year 2008 the balance sheet of Access Co. is the following:
ASSETS
Cash and Cash Equivalents
Account Receivables
Inventories
Short-term investments
Pre-paid Expenses
Total current assets
Note Receivables
Intangible assets
Fixture and Equipment
Land
Buildings
Total long-term assets
Total assets

$
723,000
137,000
311,000
121,000
30,745
1,322,745
7,960
16,823
89,820
220,000
315,000
649,603
1,972,348

LIABILITIES AND STOCKHOLDERS EQUITY


Accounts Payable
Commercial Paper
Accrued Salaries
Other accrued liabilities
Total current liabilities

243,500
15,700
70,500
112,700
442,400

Long-term note payable


Other long-term debt
Bonds Payable
Total long-term debt

218,200
29,172
256,783
504,155

Contributed Capital
Retained Earnings
Accumulated other comprehensive income (loss)
Total stockholder's equity

476,993
561,560
(12,760)
1,025,793

Total liabilities+ stockholder's equity

1,972,348

The following transactions occurred in 2009:


1. The company leases a fixture from Adrian Co. The lease is written for 22 years, with the
first payment coming at the end of the first year. The annual payment on the lease is of
46,000$. The lease discount rate is 6%. The lease agreement specifies that the company gets
to keep the fixture at the end of the lease. The fixture has an expected useful life of 25 years
with no salvage value (use the straight line method).
2. The company sold electronic devices to customers for 350,000$ on account (the cost of the
electronic devises was 250,000$)

3. On January 1, 2009 the company issued bonds for 200,000$, coupon rate 8%. The market
rate was 9%. The bonds were dated January,1 2009, pay interest each December 31, and
mature 10 years from January 1, 2009.
4. In the first half of July, the company sold 10 identical items of merchandise to 10
customers. Each of them bought one item. The 50,000$ total sale price of the 10 items was
charged on the customers Visa Credit cards. Visa charges Access.Co a 3% credit card fee.
On July 27th one customer returned the item purchased because it was defective and was
reimbursed.
5. The company earned additional sales revenues for 450,000$, of which 123,000$ was on
credit.
6. The company estimated bad debt expense for the year to be 50,000$
7. The company issued 800 shares of common stock (par value 8$ per share) for a piece of
land to be used for a facility site. The stock was selling at 25$ per share at the date of
issuance.
8. On January 1 the company paid 5,040 for a 3-year insurance policy. On Dec 31 the company
must adjust the pre-paid expenses account to reflect that one year of the policy has expired
9. On Dec. 20th, 2009 the company receives 8,000$ rent in advance for January and February
2010 from Self-Stand Co. This amount will be earned in 2010 for financial accounting
purposes but is taxed in 2009. The company is subject to a 32% income tax rate.
Create the T-accounts and prepare the classified balance sheet and the income statement for year
end 2009.
SOLUTION
T-accounts: balance sheet
Beg.
(3)
(4)
(5)
(9)

Cash
723,000
46,000 (1)
187,165
16,000 (3)
43,500
327,000
8,000
5,040
(8)

1,221,625

Accounts Receivable
Beg. 137,000

Inventory
Beg. 311,000

(2) 350,000
(5) 123,000

610,000

250,000 (2)

61,000

Fixture and Equipment


Beg. 89,820

Land
Beg. 220,000

Lease Liability
553,912.8 (1)

(1)

553,912.8

(7) 20,000
(1) 12,765.23

643,732.8

240,000

Unearned rent (L)

541,147.57

Bonds Payable
Beg. 256,783

Discount on bonds
payable (XL)
(3) 12,835

8,000 (9)
(3) 200,000
8,000

Allowance for doubtful


accounts (XA)
50,000 (6)

456,783

11,551

Pre-Paid Expense

Paid-in capital

34,105
Common Stock
6,400 (7)

Income Tax Payable

6,400
Deferred Tax Asset

152,686.31 (9)
(9) 2,560
152,686.31

22,156.51 (1)

22,156.51

13,600 (7)

13,600

Accumulated Depreciaiton

Beg. 30,745
(8) 5,040
1,680 (8)

50,000

1,284 (3)

2,560

T-accounts: income statement


Bad debt expense
(6) 50,000

Insurance Expense
(8)1,680

50,000

Interest Expense
(1) 33,234.77
(3) 17,284
50,518.77

1,680

Revenues
350,000 (2)
43,500 (4)
450,000 (5)

Cost of goods sold


(2) 250,000

843,500

Depreciation Expense
(1) 22,156.51

250,000

22,156.51

Income Tax Expense


(9) 150,126.31
150,126.31
Lease calculation
Debit
Fixture (+A)

Credit

553,912.8

Lease liability (+L)

553,912.8

At year end (t1):


Depreciation expense (+E,-SE)

22,156.51
22,156.51

Accumulated depreciation (XA,-A)


Interest expense (+E,-SE)

33,234.77

Lease liability (-L)

12,765.23
46,000

Cash (-A)

PV of the fixture:

1
1

22
0.06 0.06(1 0.06)

PV 46,000

=553,912.8$
The adjustments at year end (t1):
Depreciation expense=cost-residual value*1/useful life
Depreciation expense=553,912.8/25=22,156.51$
Interest expense=553,912.8*0.06=33,234.77$
Lease liability=46,000-33,234.77=12,765.23$ (the portion of the equipment that is now
owned)

Transaction 3:
Present Value of the principal:
PV

200,000
(1 0.09)10

=84,482$

Annual Interest Payments: 200,000 x 0.08=16,000$


PV Interest Payments:

1
1

10
0
.
09
0
.
09
(
1

0
.
09
)

PV 16,000
102,683$

Issue (sale) price=84,482+102,683=187,165$


Discount on bonds payable= 200,000-187,165=12,835$
12,835 $/10=1,284$ (straight-line amortization of bond discount)
Bond Interest expense=16,000+1,284=17, 284$
Transaction 4:
Sales revenues-Credit card discounts-Sales Returns and Allowances=net sales revenues
50,000-(50,000*0.03)-(1/10*50,000)=43,500$
Transaction 7:
800 shares * 25$=20,000$ (land)
Purchased land by issuing capital stock, recorded at market value of the stock
800 shares *8$=6,400$ (common stock)
Paid-in capital=20,000$-6,400$=13,600$
Transaction 8:
5,040*1/3=1,680$
Transaction 9 (to record this transaction you must compute the pre-tax income):
8,000$ are recognized as rent expenses in 2010 financial income but are taxed in 2009.
Taxable income=469,144.72 $(pre-tax income)+8,000$ (rent expense)=477,144.72$
Income Tax Payable=477,144.72$*32%=152,686.31$
Deferred Tax Asset=8,000$*32%=2,560$
Income Tax Expense=152,686.31-2,560=150,126.31$

Income statement
Revenues:
Net sales revenues

843,500

Costs and expenses:


Cost of goods sold
Depreciation expense
Insurance expense

(250,000)
(22,156.51)
(1,680)

Operating income

569,663.49

Other revenues and gains


Interest expense
Bad debt expense

(50,518.77)
(50,000)

Pre-tax income
Income tax expense

469,144.72
(150,126.31)

Net Income

319,018.41

Balance Sheet
ASSETS
Cash and Cash Equivalents
Account Receivables (net of Allowance for doubtful accounts)
Inventories
Short-term investments
Deferred Tax Asset
Pre-paid Expenses
Total current assets

1,221,625
560,000
61,000
121,000
2,560
34,105
2,000,290

Note Receivables
Intangible assets
Fixture and Equipmet (net of accumulated depreciation)
Land
Buildings
Total long-term assets

7,960
16,823
621,576
240,000
315,000
1,201,359

Total assets

3,201,649

LIABILITIES AND STOCKHOLDERS EQUITY


Accounts Payable
Commercial Paper
Accrued Salaries
Income Tax Payable
Other accrued liabilities
Total current liabilities

243,500
15,700
70,500
152,686
120,700
603,086

Long-term note payable


Other long-term debt (includes the lease liability)
Bonds
Total long-term debt

218,200
570,320
445,232
1,233,752

Contributed Capital
Retained Earnings*
Accumulated other comprehensive income (loss)
Total stockholder's equity

496,993
880,578
-12,760
1,364,811

Total liabilities+ stockholder's equity

3,201,649

*Retained Earnings=561,560$+319,018.41=880,578.41$
EXERCISE n.2 (2 points)
Give the definition of the following ratios:

1) GROSS MARGIN
2) PAYOUT RATIO
3) CURRENT RATIO
SOLUTION
GROSS MARGIN=GROSS PROFIT/NET SALES or NET SALES-COGS/NET SALES
PAYOUT RATIO= CASH DIVIDENDS/NET INCOME
CURRENT RATIO=CURRENT ASSETS/CURRENT LIABILITIES
EXERCISE n.3 (14 points)
Company DELTA operates in the household appliances sector and it is not quoted on the stock market. The following
analysis refers to January 2012. The following data on the last 2 financial statements of company DELTA are available
(mln Euros).
Revenues
EBITDA
Amortization costs
Interest Expense
Earnings before taxes
Equity (book value)
Number of shares
Net operating working capital
Corporate tax rate

Year 2010
350
87.5
6
12
59.5
45
14 mln
28
40%

Year 2011
365
91.25
7.7
12
61.55
60
14 mln
29.2
40%

At the moment of the analysis the debt of company DELTA is made of 300,000 bonds, with a face value of 1,000 Euros,
coupon rate 6%, annual interest payments, maturity 5 years and yield to maturity 7%.
The following information concerns company GAMMA, a competitor of DELTA, quoted on the stock market.
EBIT=350 mln Euros
Net Earnings=75 mln Euros
Corporate Tax rate=40%
Beta=1.3

Market value of equity=690 mln Euros (the total number of shares is of 34 million)
Market value of debt= 130 mln Euros, entirely made of bonds with a rating equal to BBB.
The following information on capital markets are also available:
Market risk premium
4.5%
Bond yields
Treasury
Corporate bonds
bonds
6 months 3.1%
AAA
4.5%
10 years 4.2%
AA
5.5%
A
5.7%
BBB
5.9%
BB
7%
B
8%
C
12%

The management of DELTA, assuming a zero growth rate of cash flows for the year 2011 (assumption of perpetuity),
wants to calculate the following parameters at market value:
1. the weighed average cost of capital for the company
2. the possible target price of the shares of the company if it was quoted on the stock
market
3. the parameters P/E and EPS of the company (on closing data for 2011)
4. What is it possible to infer on the future perspectives of company DELTA with respect to
its competitor on the basis of the information obtained from point 3?

NB= PLEASE USE IN THE CALCULATIONS MILLION OF EUROS AND 4


DECIMALS FOR INTEREST RATES.

SOLUTION
1. Calculate ru on the basis of the information of company Gamma.
re r f i (rM r f )
re 4.2% 1.3(4.5%) 10.05%

re ru (1 Tc )(ru rd )(

D
)
E

10.05% ru (1 40%)(ru 5.9%)(

130
)
690

ru 9.62%

We assume that ru is the same for Delta company that operates in the same sector but is not quoted.
2. Calculate the UCF of Delta Company (data from 2011 financial statements)
Taxes=(91.25-7.7)0.4=33.42

UCF=91.25-33.42-1.2=56.63
From 2010 to 2011 there is an increase in working capital of 1.2 that needs to be subtracted to
calculate the UCF.
3. Calculate the value of Delta Company with the APV method (assumption that cash flows are
constant in perpetuity)
5

60
1,000

959
t
(1.07) 5
t 1 (1.07 )
D=959*0.3=287.7 mln Euros
P

V=UCF/ru +Tax rate*Debt


V=56.63/0.0962 +0.4*287.7=703.74
V=D+E
703.74=287.7+E
E=416.04
4. Calculate the rWACC
rWACC

D
E
rd (1 Tc )
re
DE
DE

rWACC

287.7
416.04
7%(1 0.4)
re
703.74
703.74

D
re ru (1 Tc )( ru rd )( )
E
re 9.62% (1 40%)(9.62% 7%)(

287.7
)
416.04

10.70%

rWACC

287.7
416.04
7%(1 0.4)
10.7% 8.04%
703.74
703.74

5. Calculate the P/E and EPS ratios


DELTA Company
Target price=416.04/14=29.71
Net earnings=61.55-24.62=36.93
P/E=416.04/36.93=11.26
EPS=36.93/14=2.63
rd=7%
Company Gamma
P/E=690/75=9.2
EPS=75/34=2.20
rd=5.9%
Even if the company Delta shows a cost of debt higher than company Gamma, it has a better
relative position in terms of market expectations (P/E) and earnings per share (EPS).

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