This is an exam for a class called Accounting Based Valuation and is best done in Excel
Accounting-Based Valuation Professor Julian Yeo Mid-Term Exam Instructions: 1. The exam is out of 100 points. 2. This is a take-home mid-term exam. 3. The assessment is not timed. You must upload your answers (whether it is scanned handwritten, typed in Word or Excel) by the deadline of April 7, 3.30pm on NYU classes under “Assignments”. 4. Unless otherwise instructed, in your analysis, you may take price as given. That is, you do not need to discount or forward the current price to match the fiscal year that corresponds with the latest annual book value of equity. 5. Let’s apply what we have learned to what’s happening in the market! Enjoy and have fun! 2 Question (1) Valuing a Project (10 points) Consider the following project that terminates at the end of Year 3 with a required return of 10%: Time, t 0 1 2 3 Periodic Cash Flow $700 $700 $700 Initial Investment ($1,200) Required: 1.1 Calculate the value of the project using the Discounted Cash Flow model. 1.2 For accounting purposes, the asset is depreciated on a straight-line basis from its market value at time 0 of $1,200 to $0 at the end of year 3. Calculate the value of the project using the Residual Income valuation model. 1.3 Now suppose that the manager, Mr. I. M. Aggressive, wants to inflate the project’s immediate earnings and revalues the project asset higher than its cost in Year 0 (misleadingly “applying” IFRS) to $1,500. This, in turn, enables him to recognize an immediate miscellaneous gain (totally not legit). Show the value of the project using the Residual Income Valuation model. 1.4 The other manager, Ms. I. Conservative, wants to write down the project immediately in Year 0 to $700. Since she will not meet her bonus target in Year 0, she thinks that she is more likely to exceed her earnings target going forward with less depreciation expenses. Show the value of the project using the Residual Income Valuation model. 1.5 Despite applying different accounting treatments to valuing the project (e.g., our three scenarios: neutral accounting (part 1.2); aggressive accounting (part 1.3) and conservative accounting (part 1.4)), the residual income valuation under all three scenarios will always give us the same value estimate for the project. Explain why. 3 Question (2) Walmart (30 points) At Walmart, the Coronavirus Makes It Feel Like Black Friday No matter how ill I have been, I’ve always gone to work. By Melissa Love, NY Times, March 26, 2020 Ms. Love works for Walmart. LONG BEACH, Calif. — Over the four years I’ve worked at a Walmart, a handful of days stand out as extremely stressful, even dangerous. But right now, we retail associates are putting our health and safety at risk as people stock up for weeks (perhaps months) of isolation. It’s been a lot like Black Friday at my store. The frenzy, with customers hoarding items or acting out when they can’t find something, is incredibly stressful. Security officers hold customers back as we restock empty shelves. And as we walk through the ransacked aisles to buy dinner for our own families at the end of our shifts, there’s not much left, even though Walmart is limiting customers’ purchases of items like milk and eggs. If there were still lots of items on the shelves, I couldn’t afford to stockpile a month’s supply of toilet paper and frozen food on just about $13 an hour anyway. Under normal circumstances, I barely have enough to put food on the table for me and my father, whom I care for. I need to work. I’m young and healthy, but I’m worried I will catch the coronavirus and infect my father, some elderly customers or even my co-workers. I’m stuck in this impossible situation because Walmart’s punitive paid leave policy fails to protect me, my family, my co-workers or our customers — particularly now. I am classified as a part-time associate, which means that over the course of the year, I accrue less paid time off than my full-time colleagues. When I’m not feeling well, I have an extremely limited amount of paid leave that I can take without facing punishment from the company. Walmart doesn’t consistently accept doctors’ notes, so people can get fired for taking too many sick days even when they present evidence that they need to stay home. While the company has made some positive adjustments in response to the pandemic — like waiving its worker attendance policy through the end of April for employees who don’t feel comfortable coming into work — they’re inadequate. The company is allowing workers who test positive for the coronavirus to stay home for up to two weeks, but it will cut pay in half for any needed sick time after that. If a worker is under forced quarantine, she will receive up to two weeks’ pay. We aren’t given additional paid time off if we have possible coronavirus symptoms or to care for family members affected by the coronavirus. So if I or my co-workers develop symptoms, we could face the impossible choice of going to work sick and possibly infecting others or risking our already precarious finances. There are over 1.5 million workers at Walmart who are trying to get ahead. But they have nowhere to turn during this crisis. Hundreds of thousands of part-timers like me are feeling especially squeezed. That’s why, when I heard that giant corporations like Walmart, Amazon and McDonald’s were going to be exempt from federally mandated paid sick and family leave for workers hit by the coronavirus, it felt like a gut punch. Yet again, Walmart, one of the country’s largest private employers, and which employs more women and people of color than any other retailer, has used its wealth and power to wriggle out of doing the bare minimum for its employees’ well-being. Last year, Walmart gave $12 billion to shareholders in dividends and stock repurchases, and a lot of that went right to the Walton heirs. The family is worth an estimated $190 billion. I want to ask our chief executive, Doug McMillon, why we can afford to hand over so much money to the wealthiest family in America, but we can’t provide our associates with adequate paid sick leave and health care. These basics are vital year-round, but during this pandemic, business as usual isn’t cutting it. We make corporations like Walmart profitable — it’s time for them to ensure we have enough to live on. 4 Before the coronavirus, I joined with other retail workers and a labor advocacy group, United for Respect, to sound the alarm on the corporate practices that leave so many of my co-workers without adequate health insurance, fired for missing work because of medical issues or relying on food stamps to supplement low wages. If Walmart continues down this path, I hope that our lawmakers will step in to ensure all working people have a lifeline for support. I serve my Walmart customers and community tirelessly, day in and day out, in the middle of a pandemic. That’s a responsibility I don’t take lightly — but I need chief executives to take theirs seriously, too. Melissa Love works for Walmart and is part of the labor advocacy group United for Respect. Required: In addition to surge in store traffic at Walmart (WMT), grocery delivery apps in the United States are seeing record downloads, as people are increasingly avoiding stepping out of their homes in the wake of the coronavirus outbreak. According to the data, average daily downloads in February till Mar 15 for Walmart has increased by 160%. WMT is currently traded at its around $110 on March 30, 2020. Use a required rate of return for equity of 12% with a 40.85% dividend payout ratio. Book value per share (BPS) as at fiscal 2020 is $26.36. Below are the latest analyst EPS estimates: For fiscal year 2021 For fiscal year 2022 Latest EPS estimates $5.10 $5.43 Required: 2.1 Forecast (a) BPS (Book Value Per Share) for 2021 and 2022 2.2 Forecast ROCE (Return on Common Shareholders’ Equity) for 2021 and 2022. 2.3 Calculate Residual Earnings (RE) for 2021 and 2022. 2.4 Based on its current stock price of $110, calculate the expected market premium for fiscal 2022 (P2022-B2022). 2.5 Analysts are expecting EPS to be growing at an annualized rate of 5.71% for 2023 to 2025. Calculate Residual Earnings for 2023, 2024, and 2025. 2.6 Convert your Residual Earnings into a value estimate. Show how sensitive your value estimate is when you alter your growth rate assumption for RE after 2025. (hint: show g at 5% to 11% with 1% increment) 2.7 A better approach is reverse engineering the RE model. Using the stock price of $110, what is the implied growth rate in residual earnings after 2022 that is implicit in the stock price? 2.8 Translate the residual earnings growth rate into market’s expectations of EPS for 2023 to 2025. 2.9 What is the implied annualized earnings growth from 2023 to 2025? 2.10 Comment on the difference between your annualized implied earnings growth rates and the analyst annualized earnings growth rate. 2.11 Construct the building blocks. For block II, assume that residual earnings after 2022 will remain constant. Comment on your building blocks. 2.12 If WMT can only deliver the analyst annualized earnings growth rate for 2023 go 2025, realistically what is your expected rate of return (round it to the closest percentage)? 2.13 Based on your limited analysis, what is your buy/sell/hold recommendation for WMT at its current price.