B8110 – Fall 2012
EXERCISE SET 2
Due in class November 19 (Section 1) or November 14 (Section 2)
You may leave your work at the assistants’ station in Uris 6W (6th Floor) before class time.
This exercise set must be worked independently—without consultation with fellow students or the TA.
There are five exercises
Exercise 1.
Review of Accounting Relations
Here are some accounting numbers for a firm for fiscal years 2012 and 2011 (in millions of
dollars):
Total assets
Shareholders’ equity
Revenues
Unrealized gain (loss) on debt securities
Common share issues
Common dividends
Common stock repurchases
2012
2011
19,042
6,216
13,652
456
1,133
530
1,385
18,184
5,319
12,442
( 102)
504
505
1,385
The firm has no preferred stock. Unrealized gains and losses is the only item in other
comprehensive income.
a. Calculate the following for fiscal year 2012:
(i) Total liabilities at the end of 2012
(ii) Comprehensive income
(iii) Net income reported in the income statement
(Hint: construct the financial statements and plug for the missing numbers.)
b. The company also reported the following in the shareholders’ equity section of its
2012 balance sheet:
Common shares issued
Common shares in Treasury
377.3 million
39.8 million
What was book value per share at the end of 2012?
1
Exercise 2. Working with Accounting Relations
Below are some numbers from a firm’s financial reports for fiscal year, 2012.
Common shareholders’ equity, beginning of 2012
Common shareholders’ equity, end of 2012
Net operating assets, beginning of 2012
Net financial obligations, end of 2012
Net financial expense, 2012 (after tax)
Comprehensive income, 2012 (after tax)
Share issues
$250
307
450
170
10
40
25
Calculate the following for the year. For measures with balance sheet numbers in the
denominator, use beginning-of-period balance sheet numbers.
a.
b.
c.
d.
e.
f.
g.
h.
Return on common equity (ROCE)
Return on Net Operating assets (RNOA)
Net borrowing cost, after tax (NBC)
Net payout to shareholders
There were no share repurchases. What were the cash dividends paid?
Free cash flow
Cash flow to net debtholders
Apply the financing leverage equation to explain the difference between ROCE and
RNOA.
Exercise 3. Conversion of Stock Warrants: Warren Buffett and Goldman Sachs
In September 2008, in the midst of the credit crisis, Goldman Sachs invited Warren Buffett to
contribute much needed equity capital to the firm. Buffett seemingly got a very good deal. For a
$5 billion cash infusion, he received perpetual preferred equity shares carrying a 10 percent
dividend (redeemable by Goldman Sachs) plus warrants to buy 43.5 million common shares at
$115 per share. The $115 conversion price was set at the then current share price, a 3-year low
for Goldman.
a. If Buffet exercised the warrants at the share price of $125 on October 18, 2012, what
would be the loss to Goldman’s shareholders?
b. What would GAAP accounting report as the cost of the warrant arrangement to
shareholders?
2
Exercise 4. Reformulation of Financial Statements for a Property and Casualty Insurer
A property and casualty insurance company reports the following balance sheet at year end for
2011 (all amounts in millions of dollars):
ASSETS
LIABILITIES AND EQUITY
Investments
$1,500
Insurance assets
300
Insurance claims
Unearned premiums
700
140
Long-term debt
150
____
$1,800
Equity
810
$1,800
Investments are available-for-sale securities marked to market.
The company reports the following income statement for 2012:
Premium revenue
Investment income
Realized gains on investments
Total revenue
Insurance losses and expenses
Net income
$365
60
80
505
405
100
In addition, the company reported $65 million in unrealized losses on investments as part of
other comprehensive income.
Ignore taxes in answering the following questions:
a. What was the rate of return earned on investments for 2012?
b. Calculate net operating assets in the insurance underwriting part of the business at the end
of 2011.
Calculate the earnings and residual earnings from the insurance underwriting part of the business
for 2012. Use a required return of 9% for this calculation.
3
Exercise 5. An Analysis of Starbucks Corporation
Financial statements for Starbucks Corporation for fiscal year 2011 are provided at the end of
this exercise. Refer to the 10-K footnotes if you have any questions on these statements (or
cannot see the numbers clearly). See http://www.sec.gov/edgar/searchedgar/companysearch.html
As always, the notes to the financial statements in the 10-K contain detail that you may need to
answer the questions that follow.
Starbuck’s combined federal and state statutory income tax rate is 37.5%. See the tax footnote,
Note 13.
1. Prepare a reformulated statement of shareholders’ equity for 2011 that clearly identifies
comprehensive income for the year. Be sure to include the cost to Starbuck’s
shareholders from the exercise of stock options during the year.
2. Calculate operating income that comes from sales, after tax, for 2011.
3. Calculate total operating income on a comprehensive income basis.
4. Identify the part of operating income that is core operating income.
5. Calculate net operating assets and net financial assets at the end of fiscal years 2011 and
2010. Treat all but $50 million of cash and cash equivalents as interest-bearing debt
investments.
6. Calculate return on common equity (ROCE), return on net operating assets (RNOA), core
RNOA, and the financial leverage ratio for fiscal year 2011. Use average balance sheet
amounts.
7. Show that ROCE reconciles to RNOA according to the financial leverage equation. One
form of the equation is:
ROCE = RNOA + [FLEV × (RNOA – NBC)]
8. Calculate the core profit margin from sales and the asset turnover for 2011.
9. Calculate free cash flow for 2011 based on information in the balance sheet and income
statement (without referring to the cash flow statement).
10. If, in fiscal year 2012, Starbucks maintains the same core RNOA and return on its net
financial assets that it reported in 2011, what do you forecast will be its ROCE for 2012?
If the required equity return is 9%, what do you forecast will be its residual earnings for
2012?
4
Financial statements follow…..
5
6
7
8
9