BUSINESS SCHOOL

14.

(FINA2207: Business Analysis and Valuation)

Solution to Workshop 1 Questions

Chapter 1
E1.1. Calculating Enterprise Value
This exercise tests the understanding of the basic value relation:
Enterprise Value = Value of Debt + Value of Equity
Enterprise Value = $600 + $1,200 million
= $1,800 million
(Enterprise value is also referred to as the value of the firm, and sometimes as the
value of the operations.)
E1.3

Buy or Sell?
Value = $850 + $675
= $1,525 million
Value per share = $1,525/25 = $61
Market price

= $45

Therefore, BUY!

E1.5. Enterprise Market Value: General Mills and Hewlett-Packard

(a)

General Mills

Market value of the equity = $36.50 644.8 million shares

$23,535,2 million

=
Book value of total (short-term and long-term) debt
Enterprise value

6,885.1
$30,420.3 million

Note three points:

(i)

Total market value of equity = Price per share Shares outstanding.

(ii)

The book value of debt is typically assumed to equal its market value, but
financial statement footnotes give market value of debt to confirm this.

(iii)

The book value of equity is not a good indicator of its market value. The
price-to-book ratio for the equity can be calculated from the numbers given:
$23,535.2/$6,616.2 = 3.56.

(b)

This question provokes the issue of whether debt held as assets is part of enterprise

value (a part of operations) or effectively a reduction of the net debt claim on the firm. The
issue arises in the financial statement analysis in Part II of the book: Are debt assets part of
operations or part of financing activities? Debt is part of financing activities if it is held to
absorb excess cash rather than used as a business asset. The excess cash could be applied to
buying back the firms debt rather than buying the debt of others, so the net debt claim on
enterprise value is what is important. Put another way, HP is not in the business of trading
debt, so the debt asset is not part of enterprise operations. The calculation of enterprise value
is as follows:
Market value of equity = $41 2,126 million shares = $
Book value of net debt claims:
2

87,166 million

Short-term borrowing
Long-term debt
Total debt
Debt assets

$ 8,406 million
14,512
$22,918 million
12,700

Enterprise value

10,218
97,384 million

The $10,218 million is referred to as net debt.

Chapter 2
E2.5. Classifying Accounting Items
a. Current asset
b. Net revenue in the income statement: a deduction from revenue
c. Net accounts receivable, a current asset: a deduction from gross receivables
d. An expense in the income statement. But R&D is usually not a loss to
shareholders; it is an investment in an asset.
e. An expense in the income statement, part of operating income (and rarely an
extraordinary item). If the restructuring charge is estimated, a liability is also
recorded, usually lumped with other liabilities.
f. Part of property, plan and equipment. As the lease is for the entire life of the asset,
it is a capital lease. Corresponding to the lease asset, a lease liability is recorded
to indicate the obligations under the lease.
g. In the income statement
h. Part of dirty-surplus income in other comprehensive income. The accounting
would be cleaner if these items were in the income statement.
i. A liability
3

j. Under GAAP, in the statement of owners equity. However from the shareholders
point of view, preferred stock is a liability
k. Under GAAP, an expense. However from the shareholders point of view,
preferred dividends are an expense. Preferred dividends are deducted in
calculating net income available to common and for earnings in earnings per
share.
l. As an expense in the income statement.

E2.12. Find the Missing Numbers in Financial Statements: General Motors

a.
Total Equity (end) = Total Equity (beginning) + Comprehensive
Income Net Payout to Common Shareholders

-56,990 = -37,094 + ? 283

?

= -19,613

(a loss)

b.

Comprehensive income = Net income + Other comprehensive income

-19,613 = -18,722 + ?
?

= - 891

c.
Net income = Revenue expenses and losses
-18,722 = ? 60,895
?

= 42,173

d.
June 30, 2008

Assets

December 31, 2007

136,046

148,883

Liabilities ? = 193,036
Equity
-56,990

? = 185,977
-37,094

E2.14. Calculating Stock Returns: Nike, Inc.

The stock return is the change in price plus the dividend received. So, Nikes stock
return for fiscal year 2010 is
Stock return = $73.38 - $57.83 + $1.06 = $16.61
The rate-of-return is the return divided by the beginning-of-period price: $16.61/57.83 =
28.72%.