🏷️ LIMITED TIME OFFER: GET 20% OFF GRADE+ YEARLY SUBSCRIPTION →
Log in
HomeTextbook Notes300,000CA170,000

FINE 2000 Chapter Notes - Chapter 4: Profit (Accounting), Economic Value Added, Nopat

89 views7 pages
emeraldlouse520
3 Mar 2015
School
York University
Department
Finance
Course
FINE 2000
Professor
Hongping Tan

For unlimited access to Textbook Notes, a Class+ subscription is required.

Document Summary

Financial ratios are convenient way to analyze large quantities of financial data and to compare firms" performances. Book value of equity: measures shareholders" cumulative investment in the firm; sum of funds invested by shareholders when they purchase shares + earnings reinvested by company. Market capitalization: total market value of equity; equal to share price x number of outstanding shares. Market value added: market capitalization book value of equity; difference between market value of firm"s shares and amount of money shareholders invested. Market to book: how much value has been added for each dollar that shareholders have invested; ratio of market value to book value of equity. Market value reflects investors" expectations about future performance; they only pay attention to current profits and investment, but keenly forecast investment and growth. Market values fluctuate; noisy measures of how well company is performing. Cannot look up market value of privately owned companies or 100% owned subsidiaries.

Get access

Grade+20% off
$8 USD/m$10 USD/m
Billed $96 USD annually
Grade+
Homework Help
Study Guides
Textbook Solutions
Class Notes
Textbook Notes
Booster Class
40 Verified Answers
Class+
$8 USD/m
Billed $96 USD annually
Class+
Homework Help
Study Guides
Textbook Solutions
Class Notes
Textbook Notes
Booster Class
30 Verified Answers

Related Documents

FINE 2000 Lecture Notes - Lecture 3: Economic Value Added, Cash Flow, Market Capitalization
bluescorpion455
FINE 2000 Chapter Notes - Chapter 4: Sustainable Development, Quick Ratio, Reserve Requirement
lilacdinosaur342
FINE 2000 Lecture Notes - Lecture 4: Nopat, Asset, Profit Margin
mag0sea

Related Questions

International Research Journal of Applied Finance ISSN 2229 – 6891

Vol. VI Issue – 8 August, 2015 Case Study Series

A Stock Valuation Case: An Application of the “Method of Comparables” for Macy’s Shares

Halil D. Kaya* ,Julia S. Kwok

Abstract

The primary focus of this case is the application of the “Method of Comparables” in the estimation of the value of a security. An investment decision will be made based on the comparison of the selling price and the estimated value. A security will be good for purchase if the estimated value is higher than the market price. This method utilizes basic financial ratios that are commonly provided by financial web sites. First, using Yahoo Finance website, the pricing, sales, book value of equity and shares outstanding data are collected for both the target firm and the competitor firms. Then, the pricing multiples (i.e. price earnings ratio, price to sales ratio and price to book ratio) of the competitors are calculated. After that, those multiples along with the target firm’s earnings, sales, book value and shares outstanding data are used to estimate target firm’s share value. The case also examines the impact of treating “negatives” in the data. Students will learn that replacing negative earnings with zeros tend to induce less bias in target firm’s value estimation than excluding the “negative” data altogether.

Introduction

March 14, 2015 was a sunny day. Mary took advantage of the nice weather to have lunch at the Mall. On her way back to work, she walked by Susan’s investment office. Susan was Mary’s college roommate. They both liked shopping together to find new fashionable clothes. Looking at her watch, Mary realized she had half an hour to spend. She thought she would drop by and say hello to Susan.

The Performance of Macy’s

“Hi, Susan, how are you?” How is your business?” said Mary. Susan was a recent finance graduate. Susan replied, “I am doing fine. Thank you. After so many years, the market is still recovering from the mortgage crisis; many investors have been buying back stocks that they have sold during the crisis. What are you up to?” “I want to start my investment in securities, too. I have a couple thousand dollars, would Macy’s be a good stock to invest in now? That was our favorite store to shop among all of the department stores,” Mary exclaimed. She added, “Also, I read from Motley’s Fool’s article on Macy’s today about its earnings per share growth for the last 16 quarters” (Zahid Waheed, 2014).

In response to Mary’s questions, Susan checked the monthly adjusted returns of Macy’s in Yahoo Finance. She found that, since March 2010, Macy’s stock price had an average annual increase of 23.5% over the last 5 years. The stock rose from $19.98 to $57.38. Susan then told Mary that Macy’s was indeed a growing stock. She added that its success could be attributed to the omni-channel integration, e-commerce and magic selling strategies which allowed merging of sales channels, online shopping and better customer care. Since investment strategy 101 is to buy low, and sell high, given Macy’s stock price had been going up, Susan was not sure whether Macy’s was currently overvalued or undervalued by the market.

The Method of Comparables

Susan remembered her class lecture on the two types of valuation of stocks, namely absolute and relative evaluation. The absolute evaluation focuses on finding the intrinsic value of the security based on fundamentals. That involves more complicated models of discounting cash flows from dividends, operations and residual income.

On the other hand, relative evaluation is quick and easy to use. It assumes two similar securities should sell for one price in an efficient market, i.e. “Law of One Price.” So an analyst can estimate its stock price by multiplying target company’s specific earnings, sales and equity value data by the earning, sales and equity “per share” financial multiples of its competitors.

Since Mary was not familiarized with financial models, Susan decided to use the easy-toperform-and-analyze “Comparables Method” to estimate the relative value of Macy’s stock.

The Financial Data

Dillards, JC Penney and Nordstrom were selected as competitors of Macy’s as they were all in retail department store business. Susan would need some financial data regarding these companies. She went to SEC’s (i.e. Securities and Exchange Commission) website and downloaded these companies’ most recent balance sheet and income statement data. Out of those statements, she knew that she would need the EPS (i.e. earnings per share), the sales number, the number of outstanding shares, and the book value of equity. She also knew that she would need the current share price for each company. After some work, she had found all the necessary information to run the analysis. Below were the data that she had gathered:

All data are in US$ except for the number of outstanding shares. The share price as of March 15, 2014 is shown in the first column. The “Earnings per share” is shown in the second column. The third column reports the book value of equity. The last column shows the number of outstanding shares.

Firm

P ($)

EPS ($)

Sales ($)

BV of equity ($)

# of shares

Macy's

58.58

3.93

27,931 mil.

6,249 mil.

378.3 mil.

Dillard's

90.61

7.10

6,532 mil.

1,992 mil.

45.6 mil.

JC Penney

8.71

-5.57

11,859 mil.

3,087 mil.

249.3 mil.

Nordstrom

61.33

3.77

12,166 mil.

2,080 mil.

194.5 mil.

The Decision

Susan thinks that the following steps would be necessary to perform the analysis:

1.Based on the data above, calculate Sales per share, BV of equity/share values of all firms. Note that EPS is directly given.

2.Calculate P/E, P/Sales, and P/B for all of Macy’s competitors based on the data obtained.

3.Find the average of the P/E, P/Sales, and P/B multiples for the three competitors.

4.Multiply those averages calculated in step 3 with Macy’s EPS, Sales per share, and BV of equity/share values, respectively to get three value estimates for Macy’s shares.

5.The average of the three estimates would then be Susan’s best estimate of Macy’s value per share.

answer # 1-5 please

Investors generally can make one vote for each share of stock they hold. TIAA-CREF is the largest institutional shareholder in the United States; therefore, it holds many shares and has more votes than any other organization. Traditionally, this fund has acted as a passive investor, just going along with management. However, in 1993, it mailed a notice to all 1,500 companies whose stocks it held that henceforth it planned to actively intervene if, in its opinion, management was not performing well. Its goal was to improve corporate boards to appoint a majority of independent (outside) directors; and it stated that it would vote against any directors of firms that " don't have an effective, independent board that can challenge the CEO."

In the past, TIAA-CREF responded to poor performance by "voting with its feet," which means selling stocks that were not doing well. However, by 1993, that position had become difficult to maintain for two reasons. First, the fund invested a large part of its assets in "index funds," which hold stocks in accordance with their percentage value in the broad stock market. Furthermore, TIAA-CREF owns such large blocks of stocks in many companies that if it tried to sell out, doing so would severely depress the prices of those stocks. Thus, TIAA-CREF is locked in to a large extent, which led to its decision to become a more active investor.

a. Is TIAA-CREF an ordinary shareholder? Explain.

b. Due to its asset size, TIAA-CREF owns many shares in a number of companies. The fund's management plans to vote those shares. However, TIAA-CREF is owned by many thousands of investors. Should the fund's managers vote its shares, or should it pass those votes, on a pro rata basis, back to its own shareholders? Explain.

Please read the article and answer these THREE questions:

1. Why are conditions currently favorable for firms to issue debt and pay out the proceeds to stockholders?

2. What are dangerous impacts of issuing additional debt mentioned in the article?

3. TransDigm used the proceeds of their debt issue to pay a one-time dividend while Intel used the proceeds to repurchase shares. How does a repurchase differ from a one-time dividend? Why do you think the two firms chose different approaches to distributing cash to shareholders?

___________

"Borrowing for Dividends Raises Worries" at the Wall Street Journal on 10/06/2009

Rock-bottom interest rates and thawed credit markets are emboldening some companies to use bond-sale proceeds to go on the offensive, even if that means rewarding shareholders at the expense of bondholders.

The nascent trend is controversial because corporate borrowers are sinking themselves deeper into debt to pay out special dividends, buy back stock or finance acquisitions. While such moves were all the rage during the credit boom, most corporate-bond offerings during the recession have been used to reduce debt or stockpile cash.

Eric Felder, global head of credit trading at Barclays Capital, says the lure of low rates and companies' stables of cash increases "the risk of non-bondholder friendly events."

Last week's sale of $425 million of bonds by aircraft-parts manufacturer TransDigm Group Inc. is one of the back-to-the-past corporate-bond deals causing concern among some analysts. More than $360 million of the proceeds will be used to pay a special cash dividend to shareholders and management of the Cleveland company.

The added debt increased TransDigm's borrowings to 4.3 times its earnings before interest and taxes, compared with 3.1 times before last week's deal. The expected dividend of $7.50 to $7.70 a share is equal to nearly all of the net income that TransDigm reported since the end of fiscal 2003, according to Moody's Investors Service.

Moody's said the dividend "illustrates the company's aggressive financial policy." Moody's gave the new debt a junk rating of B3, even though the ratings firm said TransDigm's "strong operating performance will enable the company to service the increased debt level."

Sean Maroney, director of investor relations at TransDigm, says the "stability of our business, high profit margins and consistent cash flow" give the company "the ability to support this level of leverage."

Borrowing from bondholders to pay shareholder dividends is "a hallmark of an earlier credit era," Jeffrey Rosenberg, head of credit strategy at Bank of America Merrill Lynch, wrote in a report Friday. Such deals were popular in 2003 and 2004, the last time the Federal Reserve lowered its benchmark interest rate to historically low levels, keeping it at 1% for more than a year.

Companies like Dex Media Inc. DEX -0.18% took on debt to pay dividends to its private-equity owners, including Carlyle Group and Welsh, Carson, Anderson & Stowe, before taking the companies public. Dex Media filed for bankruptcy earlier this year under a mountain of debt.

With the federal-funds rate at 0% for nine months now and confidence returning to the stock and debt markets, investors have been driven to take on more risk. That is flooding the corporate-bond market with cash. Investors poured $43 billion into investment-grade corporate-bond funds in the second quarter and nearly $40 billion in the third quarter -- almost double previous peak quarters, according to Lipper AMG Data Services.

The wave of buying drove down borrowing costs for the average highly rated corporation to about 5%, according to Merrill, a level not seen since 2005. In the heat of the crisis last October, such rates averaged 9%. Through the end of September, more than 1,000 high-rated companies borrowed a record $860 billion, according to Dealogic.

In July, Intel Corp. INTC 0.33% sold $1.75 billion of convertible bonds, planning to use $1.5 billion of the proceeds to buy back shares. A spokesman for Intel declined to comment.

The computer-chip giant has a strong credit rating of single-A, so it doesn't carry a burdensome debt load. Still, the deal raised eyebrows among some analysts and investors, who say floating debt to buy back stock could become more common as companies regain confidence.

And as merger-and-acquisition activity revs up, the cheaper cost of debt compared with equity is tempting companies to use bond sales as a deal-making war chest.

Analysts are watching Kraft Foods Inc. in anticipation that the company would finance its proposed purchase of U.K. chocolate, candy and chewing gum maker Cadbury PLC by raising tons of debt. Last month's unsolicited bid by Kraft was then valued at about $16.7 billion, but it could be weeks before Kraft submits a formal offer.

Three major credit-ratings agencies have warned Kraft that they could slash the company's debt ratings if the company reaches a deal agreement with Cadbury. At the current offering price, Kraft would need to shell out at least $6 billion in cash, much of it likely from the debt markets, according to corporate-bond research firm Gimme Credit.

"Kraft is committed to maintaining an investment-grade rating," a Kraft spokesman said, declining to comment further.

So far in 2009, returns to high-grade bond investors are 19%, according to Merrill. "We've seen a feeding frenzy" because of low interest rates, says Kathleen Gaffney, portfolio manager at Loomis, Sayles & Co. She sold some bonds recently to take profits from the rally. Loomis Sayles wants to have cash on the sidelines in case the Fed raises rates soon or Treasury bonds sell off.