FINANCIAL STATEMENT ANALYSIS

ASSIGNMENT 4

Arranged by:
Angela Mei Vani 008201700003
Intan Zanofani 008201700015
Kristina Kitty 008201700001
Yuan Rui Qian 008201500141
Reuben Raditya A.S 008201700071

President University
Jababeka Education Park, Jl. Ki Hajar Dewantara, Kota Jababeka, Cikarang Baru,
Bekasi 17550 – Indonesia
Phone (021) 8910 9762-63, Fax (021) 8910 9768
Email: [email protected], http://www.president.ac.id

2019
Question 1
a. Investors receive dividends as payoffs for investing in equity shares. Thus the value of a
share should be calculated by discounting expected dividends. True or false?
 True, dividends are the payoff to equity investing. The second sentence is true in theory
but not in practice. Equity value is the present value of the infinite stream of expected
dividends that a going concern generates. But, in practice, one can’t forecast to infinity.
Dividends paid over practical, infinite forecast horizons are not relevant to value: the
dividends firm pay up to the liquidating dividend can be any amount but that amount does
not affect its present value. This is dividend conudrum: value is based on expected
dividends, but forecasting dividends is not relevant to value as a practical matter.

b. Some analysts trumpet the saying "Cash is King." They mean that cash is the primary
fundamental that the equity analyst should focus on. Is cash king?
 Cash isn’t king appositively it should be free cash flow. Hence FCF is what an analyst
should focus upon because it the amount that is available to the shareholders once you
have paid all the debt and the interest payments. Where as cash is biased too much by
interest payments, amortization, depreciation as it doesn’t take into account any of these.
Hence we can say an analyst should primarily focus upon the FCFF/FCFE not the cash.

c. Should a firm that has higher free cash flows have a higher value?
 Not necessarily. A firm can generate higher free cash flow by liquidating its investments.
A highly profitable (and highly valuable) firm can have low (or even negative) free cash
flows because it is investing heavily to capitalize on its investment opportunities.

d. Which of the following two measures gives a better indication of the value added from
selling inventory: (a) cash receive d from customers minus cash paid for inventory, or
(b) accrual revenue minus cost of goods sold? Why?
 The answer is (b). Matching cash received from sales with cash spent on inventory does
not match value received with value given up to earn the cash, because it recognizes the
cost of unsold goods against the receipts from goods sold. Accrual accounting
accomplishes the matching because only the cost of goods sold is recognized against the
revenue from goods sold.

e. What explains the difference between cash flow from operations and earnings?
 Although both concepts are related about cash, the recognition concept of cash differs.
Cash flow from operation shows the transfer intensity of physical cash in the inflows
(earnings) and outflow (purchases) that is made. Since only physical cash that is used that
is counted, Non-physical income are not recognized as it may be not realized yet. But it
still recognized as an earning since it is resulted from the business transaction over goods
or service offered.
f. What explains the difference between free cash flow and earnings?
 Free cash flow reflects the amount of cash that is free to use after being allocated for
expenses and expenditures that must be paid. As free cash flow still refers to the generated
physical cash, any non-physical inflows is still not included in the count. In earnings, all
kind of transaction both physical non-physical is taken into account, including the free
cash flow.

g. Interest payments should not be part of cash flow from operations. Why?
 Because it is an investment to store cash that temporarily is not needed in operations. The
investment in operations only comes when the T-bill is sold and the cash from the sale is
invested in operating assets. Interest is excluded from operating cash flow because a firm’s
operating cash flow represents the cash generated from the normal operations of business,
like producing and manufacturing, selling, and distribution of its goods and services. If
interest included in operating cash flow, then the result will not reflect the correct
operating cash flow because interest expenses is not a part of operating expenses.

h. Company X has negative free cash flows but strong earnings that yield a return on equity
of 27 percent. Which of the following statements is more likely to be true?
a) The company is wasting cash on unproductive activities.
b) The company is investing heavily.
 The true statement is B, the company is investing heavily. The waves of the reinvestment
process, when firms invest large amounts of cash in some years and nothing in others, can
cause the free cash flow to be negative in the big reinvestment years and positive in others.

i. In 2010, a newspaper interviewed a money manager who claimed the mantle of a

fundamental investor. He laid out his investment philosophy: He "seeks companies that
are likely to generate strong cash flows yet are priced very cheaply." "Cash is king," he
says so he is investing in Intel, Microsoft, Macy's, DuPont, Xerox, and Radio Shack,
firms with significant amounts of cash. Critique his approach.
 Interest draws taxes; interest income incurs tax and interest expense yields a tax deduction.
So, to understand the effect of interest on earnings or cash flows, interest must be attached
to the interest to put it on an after-tax basis. A profitable company can generate a lot of
free cash flow.

Question 2
At the end of 2012, you forecast the following cash flows (in millions) for a firm with net debt
of $759 million:

You forecast that free cash flow will grow at a rate of 4 percent per year after 2015. Use a
required return of 10 percent in answering the following questions.
a. Calculate the firm's enterprise value at the end of 2012.
b. Calculate the value of the equity at the end of 2012.

2012 2013 2014 2015

Cash from operations $1,450 1,576 1,718
Cash investments $1,020 1,124 1,200
Free cash flow $ 430 452 518
Discount rate (1.10)t 1.10 1.21 1.331
Present value of free cash flows 391 374 389
Total present value to 2015 $1,154
Continuing value (CV)* 8,979
Present value of CV 6,746
a. Enterprise value $7,900
Book value of net debt 759
b. Value of equity $7,141
518 x 1.04
*CV = = 8,979
1.10−1.04

Question 3
At the end of 2012, you forecast the following cash flows for a firm for 2013-2016 (in millions
of dollars):

What difficulties would you have in valuing this firm based on the forecasted cash flows?
 The difficulties occurs because these are result in negative free cash flow over the years
and it’s sign that the company need to raise and earn new equity immediately, otherwise
it will not always negative as long as the company could maintain their investing lower
than operation activities.

What would explain the decreasing free cash flow over the four years?
 Decreasing free cash flow over the years could reach the negative free cash flow which
influenced by several factors, the main factor of this case is because the amount of cash
investments exceeds the amount of cash from operations.

Question 4
The following summarizes the parts of a firm's cash flow statement that have to do with
operating and investing activities (in millions):
The firm made interest payments of $1,342 million and received $876 in interest receipts
from T-bills that it held. The tax rate is 35 percent. Calculate free cash flow.

Cash flow from operations reported $5,270

Interest payment $1,342
Interest receipts 876
Net interest payments 466
Tax on net interest (at 35%) 163 303
Cash flow from operations $5,573

Cash investments reported $6,417

Purchase of short-term investments (4,761)
Sale of short-term investment 547 2,203
Free Cash Flow $3,370

Question 5
Kimberly-Clark Corporation (KMB) manufactures and markets consumer paper products
under brand names that include Kleenex, Scott, Cottormelle, Viva, Kotex, and WypAll. For
fiscal year 2004, the firm reported the following numbers (in millions):

The cash investment section of the 2004 cash statement was reported as follows (in millions):
The firm has a combined federal and state tax rate of 35.6 percent. Calculate:
a. Free cash flow generated in 2004.

Cash flow from operations reported $2,969.6

Interest paid $175.3
Interest income (17.9)
Net interest 157.4
Tax on net interest (at 35.6%) 56.0 101.4
Cash flow from operations $3,071

Cash investments reported $(495.4)

Net investment in debt securities (38) - 11.5 (26.5)
Net investment in time deposits 22.9 (499)
Free cash flow $2,572

b. The accrual component of 2004 net income.

Accruals = Net income – Cash flow from operations
= $1,800.2 – 2,969.6
= $(1,169.4)

Question 6
Walmart has been the most successful retailer in history. The panel below reports cash flows
and earnings for the firm from 1988 to 1996 (in millions of dollars, except per-share
numbers):

The cash flows are unlevered cash flows.

a. Why would such a profitable firm have such negative free cash flows?
A profitable firm have negative free cash flows because it invest more cash in operations than it
takes in from operations, cash for investing is greater than the cash for operating, so it cause the
negative free cash.

b. What explains the difference between Walmart's cash flows and earnings?
The difference is how the company recognize the calculation while taking account to the net
interest and accruals.

c. Is this a good firm to apply discounted cash flow analysis?

No, It isn't. The discounted cash flow analysis won't be work for this firm because the free cash
flow doesn't measure value added from operations