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though the analyst concocted the forecasts used in the revised DCF model so
that the original $13 share value estimate was confirmed when the share
count was corrected.
P6–7. Determining abnormal earnings: Some simple examples
Abnormal earnings (AE) = NOPAT – (r x BVt-1).
Requirement 1:
AE = $5,000 – (0.15 x $50,000)
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NOTE: Eliminating unproductive assets that do not earn as high a rate of
return as other assets increases AE. In this case, the unproductive assets
were earning a return of only 8% ($2,000/$25,000).
Requirement 5:
P6-8. Assigning credit ratings using financial ratios
Requirement 1:
Standard & Poor’s credit analysts would probably assign a credit rating of BB
to Firm 1. The financial ratios for this firm are closest to the median values
P6–9. Calculating value creation by two companies
Requirement 1:
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Education.
differential has already been baked into the current market price of each
company’s shares.
P6–10. Making credit rating changes
Requirement 1:
The company’s credit risk has increased since the first quarter of 2013. At
that time, the company’s financial ratios were closest to the median values for
P6–11. ENRON: Fair value accounting
Requirement 1:
There are several features of the Bravehart structure that were essential to
achieving the fair value accounting profit boost. First, Enron needed to
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requires financial assets to be “marked–to–market”, meaning that fair value
accounting rules automatically applied once the Bravehart investment was
recorded in this way on Enron’s books.
The final piece required for the profit boost involved “monetizing” the Enron–
Blockbuster contract with the aid of an investment bank. The bank loan $115
$115 million loan from the bank). Once the bank loan transaction was
completed, Enron recorded a mark-to–market adjustment of $110 million to its
Investment in Bravehart shares and this adjustment flowed to profits.
Requirement 2:
There are two critical judgments required to estimate the bank guarantee’s
flows expected to arise from the Enron-Blockbuster contract. The higher
these net cash flows, the lower is Bravehart’s credit risk and the smaller is the
fair value of Enron’s loan guarantee because it is unlikely that the bank will
seek cash payments from Enron.
Requirement 3:
Requirement 4:
This would be an extraordinarily challenging audit task because the fair value
measurement occurs at Level 3, and thus relies on unobservable inputs. The
auditor could turn to independent estimates of the future net cash flows for
the Enron-Blockbuster contract, but the only third party estimates available
P6–12. Calculating sustainable earnings
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Requirement 1:
The original income statements for 2011–2014 appear on the next page
along with the calculation of sustainable earnings for each of the three years.
Except for the transitory revenue of $1 billion in 2014, which was given in the
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P6-13. Krispy Kreme Doughnuts: Valuing abnormal earnings
Requirement 1:
The following table implements the abnormal earnings valuation procedure
illustrated in Exhibit 6.8 of the appendix.
Requirement 2: