FIN 601: Financial Management and Markets Instructor: Dr. Jinsuk Yang Case Study #4
Instructions:
•Case Study 4 is due by 11:00 pm CST, November 30, 2020.
•What you see in the Lecture videos is the example. I have updated all the data. So, use this instruction and CS4 format in the “Module 5 Assignments” folder.
•To complete the Case Study 4, download the Excel file: Case Study 4 format. (Module 5 > Module 5 Assignments)
•Total scores for Case Study 4 are 30 points.
•You must submit the Case Study 4 through Blackboard to earn credits.
•Any late submission will not be accepted.
•With Case Study 4, you will learn how to value a business by applying the Market Approach. We will use Northrop Grumman and two comparable companies. This is a very simplified version of the Market Approach. The professionals use more sophisticated methods when applying the market approach. However, this Case Study will help you understand the basic components of the Market Approach.
Step1: Download the file listed below from “Module 5 Assignments” folder.
•Excel file: “Case_Study_4_format”
Step 2: Go to www.sec.gov and find “Consolidated statements of earnings (or income)”, “Consolidated statements of financial position (a.k.a. Balance sheet)”, and “Consolidated statements of cash flows” of the following companies.
(All information for Step 2 is given in the spreadsheet of “Case_Study_4_format” file)
•We are going to use the following companies as “Guideline Public Companies”.
Raytheon Company (Ticker: RTN) & General Dynamics Corporation (Ticker: GD)
•The subject company is:
Northrop Grumman (Ticker: NOC)
Step 3: Fill the empty boxes in the “Debts” spreadsheet. (This is the same one as you did for the Module 4 CoD Example) (10 points)
1.Use the following tables to complete the tables in the “Debts” spreadsheet.
RTN (Raytheon Company):
We are not using this bond because the maturity date passed and we are not able to obtain detailed information.
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FIN 601: Financial Management and Markets Instructor: Dr. Jinsuk Yang Case Study #4
GD(General Dynamics Corporation):
We are not using these two bonds because they are missing “last yield.” CS4 format excludes these two bonds.
2. Compute “MV” and “Total MV”
• MV (Market value) is computed by the following formula:
• ∗
= 100
•Total MV is the sum of all the MV of each bond
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FIN 601: Financial Management and Markets Instructor: Dr. Jinsuk Yang Case Study #4
Step 4: Fill the empty boxes in the “Multiples” spreadsheet.
•Table 1 (10 points):
oWe are using the 2019 year from the financial statements.
oMost of the empty boxes can be easily filled up by using the spreadsheets of financial statements. o The definition and equation for accounting items are provided below:
Revenue
Some companies use different terms for “revenue.”
Total net sales = Total sales = Revenue (which is total revenue)
If you take a look at “income statement”, you might be able to figure out which one you need to use.
Gross margin (or Gross profit)
It is the difference between the total net sales (or revenue) and the COGS, Cost of Goods Sold (or Cost of sales). There are two costs of sales: costs of sales – products & cost of sales – services. The total COGS is the sum of these costs. The income statements provided by the instructor has “Gross Margin.” So, use the value of “Gross Margin” for your CS4.
General and administrative expenses & Operating expenses
After subtracting the COGS from revenue, we get “gross margin.” Then, we subtract additional expenses related to all the operating. These expenses are called “General and administrative expenses” and “Operating expenses.” Then, we subtract these expenses from “gross margin” to derive “operating income.”
The information can be found in the Income Statement.
Operating income is also given in the Income Statement. But, for your benefit, try to find the operating income by subtracting the “General and administrative expenses” from the “Gross margin”.
Total operating expenses
Total operating expenses can be found by adding values: COGS + General and administrative expenses.
Operating income
Operating income is equal to “Total net sales – Total operating expenses.”
EBIT (Earnings before interest and taxes)
To be accurate, EBIT is different from “Operating income.” But, in this CS4, we are using “Operating income” as EBIT.
EBT (Earnings from continuing operations before taxes)
Some companies may have non-operating income or expenses. If so, we must consider these items to get the income from continuing operations before taxes.
Net Earnings
It is also known as “Net Income, Earnings, or Income.”
Depreciation and Amortization
This information can be found in the “Cash flow statement.”
Some companies report one item including both “depreciation” and “amortization.”
Other companies report “depreciation” and “amortization” separately. In this case, you need to add two items to compute the total “Depreciation and Amortization.”
EBITDA
It stands for “Earnings before interest, taxes, depreciation, and amortization.” It can be found by summing “EBIT” and “Depreciation and amortization.”
MV per share
The information is given: Cell “B22” and Cell “C22” in the “Multiples” spreadsheet.
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FIN 601: Financial Management and Markets Instructor: Dr. Jinsuk Yang Case Study #4
Number of shares outstanding
The information is given: Cell “B23” and Cell “C23” in the “Multiples” spreadsheet. It is from the financial statements (10-K).
MV of equity
It is widely known as “market capitalization”, which can be found by multiplying the “MV per share” with “Number of shares outstanding.”
MV of debts
You already found this, and it is in the “Debts” spreadsheet.
MVIC: Market value of invested capital MVIC = “MV of equity” + “MV of debts”.
The capital raised by issuing bonds or equity will be recorded in the accounting book. But, the recorded values are different from the value in the market, which we referred to as “Market value.” You already found the MV of equity and MV of debts (in the “Debts” spreadsheet)
Please read the textbook to understand the difference between market value and book value. Also, please visit the following site: https://www.investopedia.com/articles/investing/110613/market-value-versus-book-value.asp
BVIC: Book value of invested capital
BVIC = “Long-term debts” + “Stockholders’ equity”
A company raises capital to invest in equipment, fixed asset, and so on. Book value implies that the raised capital recorded in the account book. There are two ways to raise capital: issue bonds or issue equity.
The value of total bonds is recorded in the book, and it is known as the “book value of debts.” If you look at the “Debts” spreadsheet, there is also “Book value of all bonds”. You might ask “why don’t we use the book value of bonds to find BVIC?” It is simply because, when the company filed the financial statements (Balance sheet), some bonds were not issued yet. So, we stick with the reported (in the financial statements) book value for debts (or bonds).
The value of equity (including all types of stocks and retained earnings) is also recorded in the book, and it is known as “stockholders’ equity.”
Gross cash flow (a.k.a. Net operating cash flow)
It is the sum of “Net earnings” and “Depreciation and amortization”
The reason we add “depreciation and amortization” back to “net earnings” is that the “depreciation and amortization” is a non-cash transaction. And, we subtract this to find the net earnings or net income. However, if you look at the income statement, you might notice that there isn’t an accounting item, “depreciation and amortization.” It is because some companies break it down to a small amount and include them into operating expenses: cost of goods sold. Since we subtract non-cash transactions to get “net income”, we add it back to “net income” to find the “gross cash flow.”
Debt/Equity ratio
We divide “MV of debts” by “MV of equity”.
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FIN 601: Financial Management and Markets Instructor: Dr. Jinsuk Yang Case Study #4
•Table 2 (10 points):
o Compute all the ratios for RTN and GD.
Price/Earnings
⁄ =
This ratio can be found by using the following equation:
An alternative way to find this ( )
⁄ = ratio is provided below:
ℎ )
= ()/(
()/( ℎ )
= ℎ
ℎ
Price/Pretax Earnings
“Price” is “MV of equity”
“Pretax earnings” is “EBT,” which is “earnings before taxes.”
Price/Gross cash flow
“Price” is “MV of equity”
“Gross cash flow” is “Net earnings + Depreciation and amortization”
Price/Operating income
“Price” is “MV of equity”
“Operating income” is “EBIT,” which is “earnings before interest and taxes.”
Price/Book value
This can be computed in two different ways.
⁄ = ℎ ′
oCompute average and median of ratios
Using the Excel function
•Average: “=average(Cell # : Cell #)”
•Median: “=median(Cell #: Cell #)”
•We have only two guideline public companies; therefore, the average will be equal to the median.
•To understand what is “median,” please visit the following link: https://www.purplemath.com/modules/meanmode.htm
oCompute “Selected Multiple” by using the following equation:
“Selected Multiple” can be considered as the “weighted average” of ratios from the guideline public companies.
Selected multiple = [(Ratio of RTN) * (0.3)] + [(Ratio of GD) * (0.7)]
We assume that “RTN” is more similar to our subject company. Therefore, we put 30% weight on the ratio of RTN and 70% weight on the ratio of GD.
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FIN 601: Financial Management and Markets Instructor: Dr. Jinsuk Yang Case Study #4
For example, let’s suppose that we select the “Price/Earnings” ratio (it becomes “selected ratio”) to compute the value of our subject company and that we have two guideline public companies (A and B). Let’s suppose that the ratio of A company is 5 and the ratio of B company is 7. And, we analyze that our subject company is more similar to A company (50% similar) than to B company (50% similar). Then, we can approximately estimate the “Price/Earnings” ratio of the subject company as “5*(50%) + 7*(50%) = 6.” Now, the value “5.6” becomes the “selected multiple.” Then we use this estimated ratio to compute the “Implied value” of our subject company.
oCompute the implied value
Implied value = (Selected multiple)*(Denominator-value of NOC)
For instance, if the selected ratio is the “Price/Earnings” ratio, then (Selected multiple)*(Earnings of NOC) is equal to the implied value of NOC.
•Requirements
1.Your report must be in Excel file format.
2.You must find the value by using the Excel function.
3.Save the file as:
•Your file name must be “CS4-first name-last name”
•You must save the file as “Save as type: Excel Workbook”, not “CSV” or any other formats.
4.Failure to comply with the instruction or requirements will result in a penalty.
FAQ:
•Selected multiple %
The lecture video shows a different % of similarity between the “subject company” and the “guideline public companies.” Please follow the percentages indicated in this instruction.
•Questions related to “Cost of Debt”
First, please watch lecture videos in Module 4, “FIN 601: Module 4 Lecture – Cost of Debt.” Then, use Forum Q&As in Module 5 if anything needs further explanation.
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