Question 1

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Estimating Share Value Using the ROPI Model

Following are forecasts of Illinois Tool Works Inc. sales, net operating profit after tax (NOPAT), and net operating assets (NOA) as of December 31, 2018.

Note: Complete the entire question in Excel and format each answer to two decimal places. Then enter the answers into the provided spaces below with two decimal places.

ReportedForecast Horizon PeriodTerminal
$ millions20182019202020212022Period
Sales$14,768$15,654$16,593$17,589$18,644$19,017
NOPAT2,7112,8803,0533,2363,4303,499
NOA9,46210,02810,63011,26811,94412,183

Answer the following requirements with the following assumptions:

Assumptions
Terminal period growth rate2%
Discount rate (WACC)7.35%
Common shares outstanding328.1million
Net nonoperating obligations (NNO)$6,204million

(a) Estimate the value of a share of ITW’s common stock using the residual operating income model (ROPI) model as of December 31, 2018.

(b) Illinois Tool Works Inc. closed at $144.21 on February 15, 2019, the date the 10-K was filed with the SEC. How does your valuation estimate compare with this closing price?

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Question 2

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Estimating Share Value Using the ROPI Model

Following are forecasts of sales, net operating profit after tax (NOPAT), and net operating assets (NOA) as of December 31, 2018, for Humana.

Note: Complete the entire question in Excel and format each answer to two decimal places. Then enter the answers into the provided spaces below with two decimal places.

ReportedHorizon periodTerminal
$ millions20182019202020212022Period
Sales$56,912$57,766$58,632$59,512$60,404$61,008
NOPAT2,4922,5422,5802,6192,6582,684
NOA4,0324,0974,1584,2214,2844,327

Answer the following requirements with the following assumptions:

Assumptions
Terminal period growth rate1%
Discount rate (WACC)7.8%
Common shares outstanding135.6million
Net nonoperating obligations (NNO)$(6,129)million

NNO is negative because Humana’s nonoperating assets exceed its nonoperating liabilities.

(a) Estimate the value of a share of common stock using the residual operating income (ROPI) model as of December 31, 2018.

(b) Humana (HUM) stock closed at $307.56 on February 21, 2019, the date the 10-K was filed with the SEC. How does your valuation estimate compare with this closing price?

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Question 3

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Forecasting with the Parsimonious Method and Estimating Share Value Using the ROPI Model

Following are income statements and balance sheets for Cisco Systems.

Note: Complete the entire question in Excel and format each answer to two decimal places. Then enter the answers into the provided spaces below with two decimal places.

Cisco Systems
Consolidated Statements of Income
Years Ended December ($ millions)July 27, 2019July 28, 2018
Revenue
Product$39,005$36,709
Service12,89912,621
Total revenue51,90449,330
Cost of sales
Product14,86314,427
Service4,3754,297
Total cost of sales19,23818,724
Gross margin32,66630,606
Operating expenses
Research and development6,5776,332
Sales and marketing9,5719,242
General and administrative1,8272,144
Amortization of purchased intangible assets150221
Restructuring and other charges322358
Total operating expenses18,44718,297
Operating income14,21912,309
Interest income1,3081,508
Interest expense(859)(943)
Other income (loss), net(97)165
Interest and other income (loss), net352730
Income before provision for income taxes14,57113,039
Provision for income taxes2,95012,929
Net income$11,621$110
Cisco Systems Inc.
Consolidated Balance Sheets
In millions, except par valueJuly 27, 2019July 28, 2018
Assets
Current assets
Cash and cash equivalents$11,750$8,934
Investments21,66337,614
Accounts receivable, net of allowance for doubtful accounts5,4915,554
Inventories1,3831,846
Financing receivables, net5,0954,949
Other current assets2,3732,940
Total current assets47,75561,837
Property and equipment, net2,7893,006
Financing receivables, net4,9584,882
Goodwill33,52931,706
Purchased intangible assets, net2,2012,552
Deferred tax assets4,0653,219
Other assets2,4961,582
Total assets$97,793$108,784
Liabilities and equity
Current liabilities
Short-term debt$10,191$5,238
Accounts payable2,0591,904
Income taxes payable1,1491,004
Accrued compensation3,2212,986
Deferred revenue10,66811,490
Other current liabilities4,4244,413
Total current liabilities31,71227,035
Long-term debt14,47520,331
Income taxes payable8,9278,585
Deferred revenue7,7998,195
Other long-term liabilities1,3091,434
Total liabilities64,22265,580
Equity:
Cisco shareholders’ equity
Preferred stock, no par value: 5 shares authorized; none issued and outstanding00
Common stock and additional paid-in capital, $0.001 par value: 20,000 shares authorized;
4,250 and 4,614 shares issued and outstanding at July 27, 2019, and July 28, 2018, respectively40,26642,820
(Accumulated deficit) Retained earnings(5,903)1,233
Accumulated other comprehensive income (loss)(792)(849)
Total Cisco shareholders’ equity33,57143,204
Total equity33,57143,204
Total liabilities and equity$97,793$108,784
Federal and state statutory tax rate22%

(a) Compute net operating assets (NOA) for 2019.

Hint: Treat Financing receivable as operating assets.

(b) Compute net operating profit after tax (NOPAT) for 2019, assuming a federal and state statutory tax rate of 22%. Assume that all items on the 2019 income statement will persist.

(c) Use the parsimonious forecast method, as shown in Analysis Insight box on page 14-5 and in Exhibit 14.2, to forecast Cisco’s sales, NOPAT, and NOA for 2020 through 2023 and the terminal period using the following assumptions.

Note: When completing the question in Excel, refer directly to the cells containing calculated assumptions for NOPM and NOAT, i.e., don’t type the NOPM number when making a calculation, refer to the cell.

Assumptions
Sales growth 2020–20235%
Terminal growth1%
Net operating profit margin (NOPM)2019 rate
Net operating asset turnover (NOAT)2019 rate

Hint: Use 2019 NOA, not average NOA, to compute the 2019 rate for NOAT.

(d) Estimate the value of a share of Cisco common stock using the residual operating income (ROPI) model as of July 27, 2019; assume a discount rate (WACC) of 7.6%, common shares outstanding of 5,029 million, and net nonoperating obligations (NNO) of $(8,747) million (NNO is negative, which means that Cisco has net nonoperating investments).

Assumptions
Discount rate (WACC)7.60%
Common shares outstanding5,029million
Net nonoperating obligations (NNO)$(8,747)million

NNO is negative, which means that Cisco has net nonoperating investments

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