GSBS6506: At One Point During The Internet And Telecom Bubble: Financial Statement Analysis, USA, Australia

Exercise 1.

 At one point during the internet and telecom bubble of the late 1990s, Cisco Systems, the manufacturer of routers for communications networks, traded at a market capitalization of over half a trillion dollars, the largest market capitalization for any firm ever. Its P/E was 130. Analysts said that Cisco was such a good company that investors should buy it at any price.

Comment on the analyst recommendation

Solution

Good companies can be overpriced.  A P/E of 130 has rarely been observed for a firm with large market capitalization: the historical P/E for the S&P 500 is 14. These observations suggest that Cisco’s price should be challenged with some fundamental analysis. Price is what you pay, value is what you get.

Exercise 2.

With its shares trading at $89 in September 2003, the market capitalization of IBM’s common equity was $153.97 billion. IBM listed $14 billion of debt on its most recent balance sheet.

1. How many common shares were outstanding?

2. What value was the market placing on IBM’s enterprise value (the value of the firm)?

3. IBM listed 199 million shares in treasury stock on its balance sheet. How many issues shares were there?

Solution

1. Shares outstanding = Market cap/price per share

= $153.97/89

= 1,730 million

2. Enterprise value = Value of Equity + Value of debt

= $153.97 + 14

= $167.97

This calculation assumes that the debt is carried on the balance sheet at an amount close to its value (which it usually is).

3. Shares outstanding = issues shares – shares (repurchased) in treasury

So, issued shares    = 1,730 million + 199 million

= 1,929 million

Section 1: Multiple Choice Questions 

Identify the choice that best completes the statement or answers the question.

1. are analysts who use information concerning the current and prospective profitability of firms to assess the firm’s fair market value.
A. Credit analysts
B. Fundamental analysts
C. Systems analysts
D. Technical analysts

2. An analyst produces the following set of forecasts for the company:
Year t+1 Year t+2 Year t+3
Net profit $ 100 $ 100 $ 100
Dividend payout ratio 50% 50% 50%

At the end of year t, the book value of company F’s equity is $500. Company F has no debt and its cost of equity is 10 percent. The analyst expects that in and after year t+4, company F will earn constant residual earnings. Under this assumption, the analyst’s estimate of company F’s equity value at the end of year t is:
A. $642.75
B. $885.90
D. $1012.70
C. $913.22

3. The following list shows transactions reported in the statement of
comprehensive income as part of net profits and other comprehensive
income. Select other comprehensive income items only.
(i) changes in revaluation surplus for property
(ii) value decreases that are not cash flow
(iii) the effective portion of gains and losses on hedging instruments in a cash flow hedge
(iv) adjustments to cash inflows that are not value-added
A. (i),(ii), (iii)
B. (i), (iii), (iv)
C. (i), (iii)
D. (i), (iv)

4. Consider the following information about company G’s performance and
financial position in year t and t+1:
Earnings year t = $60; Earnings year t+1 = $90
Beginning book value of equity year t = $900
Dividend year t = $30; dividend year t+1 = $50 Cost
of equity = 10 percent
Company G’s abnormal earnings in year t+1 is
A. ($3)
B. ($30)
C. ($7)
D. $0

5. Company H’s forecasted return on common equity (ROCE) for next year is 12
percent. An analyst assumes that the company’s ROCE will grow indefinitely
at a rate of 2 percent. Company H’s cost of equity is 10 percent. Under these
assumptions, the analyst’s estimate of company H’s intrinsic price-to-book
ratio is
A. 1.00
B. 1.10
C. 1.12
D. 1.25