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FINAL EXAMINATION – SEMESTER 1, 2020

Subject Code: ACCT90002

Subject Name: FINANCIAL STATEMENT ANALYSIS

Exam duration: 15 minutes + 3 hours

This paper has 10 pages (not including this page)

QUESTION 1 (34 marks):

(a) James Broker, an analyst with an established brokerage organisation, comments: ‘The critical number I look at for any company is operating cash flow. If cash flows are less than earnings, I consider a company to be a poor performer and a poor investment prospect. ’ Do you agree with

him? Explain. (8 marks)

(b) Consider the following scenario and answer the question posed:

In early 2018, Landslide Ltd. announced that it would have to restate its financial statements as a result of sending as much as $4.55 billion worth of products into clients’ warehouses in 2016 despite no orders having been received. The company’s cost of sales percentage for 2016 was 25 per cent. The company’s marginal tax rate for 2016 was 30 per cent.

What adjustments would you, as a financial analyst, undertake to amend Landslide Ltd.’s balance sheet and income statement for December 31, 2016? Also indicate the effects on assets, liabilities, and shareholders’ equity. Note: ignore possible impacts on bad debt allowance. Ensure you clearly specify any assumptions underlying your proposed adjustments. (8 marks)

(c) Bolton Ltd. recently purchased an internet site selling books to the academic market. 75% of the revenues of this division come from direct sales of books. Fulfilment costs such as shipping, handling and warehouse expenses, which are a significant cost of doing business, are charged as marketing expenses as they are incurred. In the past two years a further 15% of revenues from this division have come from selling airline tickets online on behalf of several major airlines. When Bolton Ltd. sells a $400 airline ticket the company records all $400 as revenue and deducts the cost of the ticket in cost of goods sold given they temporarily hold the plane seat in inventory and therefore take on some inventory risk. Bolton Ltd. also swap advertising space on other internet companies’ websites. They record the value of their benefit from this bartering transaction as if it was a sale and record an expense for the value of the advertising space they

provide to the other internet company. This contributes 10% of sales revenue every year. Critically comment on the accounting for the transactions detailed above. Please indicate:

(i) whether you agree or disagree with the accounting, and

(ii) why you agree (or disagree) (12 marks)

(d) Explain why terminal values (TVs) in abnormal earnings valuation models are in general significantly less than those for discounted cash flow valuation models. (6 marks)

QUESTION 2 (24 marks):

(a) Which of the following types of businesses do you expect to show very little degree of seasonality in sub-period earnings? Explain why earnings might be constant throughout the year

for those selected? (8 marks)

i. a car mechanic

ii. a juice manufacturer

iii. a university

iv. a property valuer

v. a dentist

(b) Which of the following types of businesses do you expect to show a high degree of seasonality

in quarterly earnings? Explain why. (8 marks)

i. a supermarket

ii. a pharmaceutical company

iii. a software company

iv. a car manufacturer

v. a clothing retailer

(c) How would the following events (reported this year) affect your forecasts of a firm’s future net income? (8 marks)

i. an asset write-down

ii. a merger or acquisition

iii. the sale of a major division

iv. the initiation of dividend payments

QUESTIONS 3 AND 4:

Vodafone Group is a mobile telecommunications service provider that operates a number of networks worldwide. The company invests heavily in mobile networks and has been involved in a large number of network acquisitions since 2010. The group also operates an extensive 14,000 store network. In 2012, Vodafone Group was ranked as the number nine brand globally with an attributed worth of US$30 billion and the most valuable telecoms brand in the world.Vodafone Group describe their business as follows:

We buy licenses that give us rights to spectrum bands and we build networks over which we provide calls, SMS and mobile internet services to customers. Customers pay for the services and we use the cashflow generated to reinvest in the business andprovide a good return to our shareholders. Our reinvestment in the business allows us to make continuous improvements to our network, strengthen our brand, and develop our stores and websites to attract new customers and retain existing ones.

Vodafone Group generate their service revenue through the supply of calls, text messaging, data, and other services over their networks. Consumers pay for these services either via contracts (typically up to two years in length) or through buying their airtime in advance (prepaid or pay as you go).

Exhibits 1 to 6 should be used when answering Questions 3 and 4 below, both of which relate to the Vodafone Group information contained in these Exhibits.

QUESTION 3 (12 marks):

Use information provided in Exhibit 2 to outline three relevant questions you would ask the CFO of Vodafone Group regarding Vodafone’s future recurring profitability. Clearly and briefly indicate

why you would ask each question you propose. (12 marks)

QUESTION 4 (30 marks):

(a) One of the key assumptions underpinning the use of the abnormal earnings (residual income) valuation model is that the ‘clean-surplus relation’ holds. Does Vodafone Group’s accounting violate the ‘clean-surplus relation’? If it does, indicate the total amount by which clean surplus

is violated for the year ending on March 31, 2012. (3 marks)

(b) Prepare a condensed balance sheet for Vodafone Group as at March 31, 2012.

Use the following assumptions:

1. The only interest bearing non-current liabilities are “Long-term borrowings”.

2. “Other investments” included under “Current assets” are marketable securities. (6 marks)

(c) Using the Abnormal Earnings Valuation model, calculate the value per equity share for Vodafone Group as at March 31, 2012. Keep three decimal places in your answer. Use:

- A forecast horizon of three years (2013, 2014, 2015).

- The forecasts and assumptions provided in Exhibit 1.

Note: It is optional to use a continuity correction in your calculations. (21 marks)

Assumptions for QUESTIONS 3&4:

Total shares outstanding as at 31 March, 2012: 56,815 million