MN5911: FINANCIAL STATEMENT ANALYSIS
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MSc ASSESSMENT 2022
MN5911: FINANCIAL STATEMENT ANALYSIS.
MN5911R: FINANCIAL STATEMENT ANALYSIS – Paper for Resit Students.
Answer the following ONE question
You have just been hired by an investment bank as an analyst. You joined the sportswear research team which is currently working on a report on adidas. One team member has recently left the investment bank and you have been asked to work through his notes in order to use them in the report. You quickly realise that the notes contain numerous errors, i.e. wrong statements and wrong results of calculations. You conclude that there could be an error anywhere in the notes.
REQUIRED:
Identify the errors in the notes and correct them.
Specifically:
- If a wrong statement is made in a sentence, provide a correct sentence.
- If there is a wrong result of a calculation, do the calculation by yourself and provide the correct result.
- List the corrections in the order the errors appear in the notes.
- Number your corrections consecutively, i.e. 1., 2., 3. etc.
Marking (total 100 marks):
- 10 marks are awarded for following the format requirements. Specifically, 5 marks for listing the corrections in the order the errors appear in the notes and 5 marks for numbering the corrections consecutively.
- 90 marks are awarded for identifying the errors and correcting them. There are between 10 and 20 errors in the notes. Each error carries the same number of marks. No mark is awarded for identifying an error without a reasonable correction. For example, if a wrong statement says “current ratio equals 2.0”, you won’t get marks for simply saying“current ratio does not equal 2.0”– you need to do the calculation and provide the correct current ratio. There is no need to write many words and there is no need to show your calculations – the only task is to identify the errors and correct them.
Notes of the former team member:
General company information
- Company: adidas AG
- Accounting period end date of the most recent financial statements: 31 December 2020
Background research
- adidas prepares its consolidated financial statements in accordance with IFRSs as adopted by the EU.
- A competitive advantage can only be achieved with a corporate strategy of differentiation.
- Managers’accounting choices may be influenced by their incentives, e.g. not to violate accounting-based debt covenants.
- An example for a conservative accounting policy is to overestimate the depreciable life of PPE.
- Turnover ratios allow to evaluate a company’s investment management.
- When forecasting the financial statements of adidas, one should assume that profitability tends to be mean-reverting.
- According to the findings of Francis, Olsson and Oswald (Journal of Accounting Research, 2000), the forward earnings multiple generates more accurate value estimates than the discounted free cash flow model.
- If we assume a competitive equilibrium after the final year of the forecast, the sum of the discounted abnormal profits in the discounted abnormal profit model is zero.
- According to Demirakos, Strong and Walker (Accounting Horizons, 2004), analysts frequently use earnings multiples to value a company but rarely use the discounted abnormal profit model.
- adidas has a long-term credit rating from Standard & Poor’s of A+, and this indicates that adidas has a low default probability.
- adidas could acquire another company in order to penetrate new markets.
Ratio analysis
Financial statements of adidas (directly copied from the annual report 2020):
Note: For calculating return on equity, liabilities-to-equity ratio and debt-to-equity ratio,‘Total equity’from the balance sheet above must be used.
Ratios:
|
Ratio |
2020 |
|
Return on equity |
6.69% |
|
Return on assets |
2. 12% |
|
Net profit margin |
2.23% |
|
Asset turnover |
94.26% |
|
Current ratio |
1.38 |
|
Quick ratio |
0.67 |
|
Liabilities-to-equity ratio |
214 6% |
|
Debt-to-equity ratio |
47.3% |
Interpretation:
- Current ratio decreased from 2019 to 2020.
- Liabilities-to-equity ratio increased from 2019 to 2020.
- Debt-to-equity ratio increased from 2019 to 2020.
- There are no major concerns regarding the company’s liquidity.
- There are no major concerns regarding the company’s solvency.
- There are no major concerns regarding the company’s profitability.
- The quick ratio is a more conservative measure of liquidity than the current ratio.
Accounting adjustment: capitalising marketing expenditure
|
2020 |
2019 |
2018 |
2017 |
2016 |
|
Marketing expenditure (€ millions) 2,573 |
3,042 |
3,001 |
2,724 |
2,410 |
Assumptions for capitalising marketing expenditure as an intangible asset:
- Marketing spending occurs evenly throughout the year.
- Only half a year’s amortisation is taken on the latest year’s spending.
- Average expected life of marketing investments is 4 years.
- Amortisation of the intangible asset using the straight-line method (with no residual value).
Note: Assume that the table and text above do not contain any errors.
Findings:
- Capitalising marketing expenditure results in a marketing asset of €2,573 million on 31 December 2020.
- Capitalising marketing expenditure results in a marketing amortisation expense of €2,573 million in 2020.
- Capitalising marketing expenditure increases total assets.
- Capitalising marketing expenditure results in a lower asset turnover.
- Capitalising marketing expenditure results in a lower debt-to-equity ratio.
- Capitalising marketing expenditure increases the gross profit margin.
Valuation
|
A=actual, E=estimate/forecast |
2020A |
2021E |
2022E |
2023E |
|
Earnings per share (€) |
2.21 |
7.33 |
9.50 |
|
|
EPS growth beyond 2022 |
|
|
|
3.0% |
|
Dividends per share (€) |
3.00 |
3.00 |
3.00 |
|
|
DPS growth beyond 2022 |
|
|
|
4.5% |
|
Free cash flow per share (€) |
7.03 |
8.00 |
10.00 |
|
|
FCF per share growth beyond 2022 |
|
|
|
1.0% |
|
Book value per share (€) |
33.07 |
37.40 |
43.90 |
|
|
Abnormal profit growth beyond 2022 |
|
|
|
2.0% |
|
Net debt per share (€) Cost of equity (estimate) WACC (estimate) |
-4.23 6.0% 5.9% |
|
|
|
Note: Assume that the table above does not contain any errors.
- Using the dividend discount model with the data above generates a value estimate on 31 December 2020 of €200.00.
- Using the discounted cash flow model with the data above generates a value estimate on 31 December 2020 of €200.00.
- Using the discounted abnormal profit model with the data above generates a value estimate on 31 December 2020 of €200.00.
- Net debt per share is negative because adidas has more cash and cash equivalents than debt.
- If a lower cost of equity is estimated, the value estimate using the dividend discount model decreases.
- If a higher terminal growth assumption is estimated, the value estimate of the discounted free cash flow model increases.
2023-05-12