Final Assessment

Answer 1(a):
When equity value is calculated using discounted cashflow method, first we need to
calculate weighted average cost of capital by using formula which is given below:
WACC= (weight of debt x cost of debt + weight of equity x cost of equity)
= (0.577 x 0.15 + 0.423 x 0.25)
= (0.087 + 0.106)
= 0.193
Therefore, the weighted average cost of capital is 19.3%
Free cash Flow Adjustments:
2020E 2021E 2022E 2023E 2024E
Net Profit 27,872.5 32,695.6 34,217.8 34,425.8 33,835.5
Increase in -5895.7 -11,696.5 -13,291.2 -15,948.2 -14,884.9
non-current
assets
Increase in -2,650 -974.5 -1,077.1 -1,198.9 -1,119
investment
assets
Change in -1,059.1 -1,621.9 -1,939.9 -2,620.9 -2,446.1
operating
working
capital
Add Net 1,712.8 2,091.1 2,661.4 3,278.9 3,794.1
interest
expense
after tax
Free Cash 19,979.8 20,494.3 20,571.4 17,937.6 19,179.9
flows
WACC @ 0.838 0.703 0.588 0.494 0.415
19.30%
Present 16,743.1 14,407.5 12,095.9 8,861.2 7,959.6
Value of
future cash
flows
As no growth rate is given in this question, so to find the terminal value we need to
look at additional information point 04. Assuming that at the end of 2024, the
company owners will sell the total business assets with their book value and will pay
all debt, the terminal value will be the cash on hand which will be KWD85,848,000
(202,950,400 – 117,102,400). The present value of terminal value will be
KWD71,940,624 (85,8448,000 X 0.838).
Enterprise value = Present values of future cash flows + Present value of terminal
value
Enterprise value= 60,067,300 + 71,940,624
Enterprise value= 132,007,924
Finally, we can calculate the equity value after deducting debt value from enterprise
value.
Equity value= Enterprise value – Value of debt
Equity value= 132,007,924 – 117,102,400
Equity value= 14,905,524
b) The equity value of ABC company represents the share price of KWD0.149
(14,905,524/100,000,000) per share which equals 149 fils per share. The Boursa price
per share is 720 fils on June 1, 2020. So, I would suggest the investors should sell the
shares on hand. As forecast shows their worth will be declined so it is better to sell
the shares on hand and invest somewhere else to earn more in the future.

Answer 02:
When asset depreciation estimates are changes, the depreciable amount and the
accumulated depreciation will be changed. These changes will lead to change to a
change in the value of total assets and deferred tax in the financial statements. In this
question, the required adjustments that we need to calculate are the yearly depreciation
rate by using a 5% salvage value. To calculate the depreciable amount, salvage value
will be deducted and the depreciable amount will be divided by the useful life of 25
years,
=95(100-5)/25
=3.8
The yearly depreciation rate will therefore be 0.038 or 3.8%.
(€ millions unless stated otherwise)
Aircraft Cost €17,917.9 Reported
Depreciable Amount €17,021.9 Cost x (1 - .05)
Acc. Depreciation: €5,651
Depreciable life 25
Acc. Depreciation / Depreciable cost 33.19% 5651 / 17021.9
Average age of aircraft (in years). 8.3 25 x 0.3319 years

1. When Lufthansa computed depreciation using a salvage value of 5% and an

average life of 25 years instead of the previous useful life of 12 years and a
salvage value of 15%, the depreciable amount will be €17,022.1(€17,917.9*(1 – .
05).
2. When depreciation will be charged to profit or loss and deducted from asset
value, the new carrying amount will be €12266.9 (€17,918 - €5651.1)
3. The average depreciable age of the airplanes is 8.3 years, the yearly depreciation
rate will be 3.8%. To compute the accumulated depreciation €5,651.1
(€17,022.1*8.3*3.8%) as an alternative to the previous value of €10,547.
4. If we talk about the non-current assets, their value is increased by $4896. When
this increased value is used and a tax rate of 35% is applied, the net deferred tax
liability entails adjustments of €1,713.6(€4986*.35), along with
€3,240.9(€4,896*.65) to shareholder’s equity.

(€ millions unless stated otherwise).

Balance Sheet Adjustments year end 2011
Assets Liabilities
Non-current assets +4,896
Deferred tax liability +1,713.6
Shareholder Equity +3,240.9
By changing these estimates, the expense and asset values in financial statements will
also be changed. The change in deferred tax liability will have effect on tax expense in
year ended 2012 and ongoing years.

Answer 03:
 Using financial statements of a company is the best way to assess the financial
health of that company. When assessing financial health, we need to look at
red flags. Red flags are signs or indicators that may suggest that there are any
potential threats or issues in financial statements or company reports. These
are signs or indicators that stand out undesirable to the analyst of financial
reports. These may vary for each analyst of the same financial report. Using
the annual financial report of Integrated Holding Company for 2019, the
following are red flags that may stand out undesirable to the analyst of
financial report.

 Unsteady Cash Flows:

To assess the steadiness of cash flows, we need to pay attention to the

consolidated statement of cash flows. The statement of cashflow tells about
the quality of profits earned and the liquidity position of a company. When
looking at the statement of the cash flow of the integrated holding company,
there is a much higher positive cash balance at the start of the year. Despite
the very high profits in 2019, the cash balance at end of the year 2019 is very
low than at the end of the year 2018. The reason is that the company has used
more cash in investing activities than it has generated from operating and
financing activities. When comparing the financial reports of 2018 and 2019,
the company has steady cashflows in 2018 but there are great fluctuations in
cash flows for the year 2019. These fluctuating cash flows each year are a
matter of serious concern and needs to be investigated.

 Changes in Accounting policies:

An entity may change accounting policies when required by standards or

when changing them to provide more useful information to the investors or
analysts. The integrated holding company has changed its policies for IFRS 16
Leases. The company has restated IFRS 16 Leases retrospectively but has not
changed the comparative figures for the financial statements of the company
for 2018. The reclassification and adjustments are accounted for in the
opening balances. Previously these liabilities were remeasured at present
values of remaining lease payments discounted at incremental borrowing rate
but now these have been reclassified as operating leases which opens a gate
of manipulation of figures for the company.

 Declining Gross Profit Margin:

 The profitability of a company can be easily assessed by the profitability ratios
of that company. To assess the profitability of an integrated holding company
we need to calculate some profitability ratios. The gross profit margin for 2018
was 47.8% [(20,082,984 / 41,961,348) x 100] but gross profit margin for 2019
is 38.7% [(11,457,579 / 29,594,584) x 100]. This measure of profitability is
decreasing year on year, which is a matter of serious concern. The reason for
its decline is that profit and revenues both are decreasing. The revenues have
decreased enormously but the cost of services provided is not decreasing in
the same proportion as that of revenue. This may be a cause of alarm for the
shareholders and potential investors.

 Complex Accounting Treatment:

The entity has adopted several new IFRS standards that involve very complex
accounting treatments. These amendments include prepayment features with
negative compensation (IFRS 9), Long term interest in associates and joint
ventures (IAS 28), Annual improvements to IFRS standards 2015 and plan
amendment, curtailment and settlement (IAS 19). All these changes and
amendments involve complex accounting treatments which may be difficult to
interpret for the users of financial statements. To overcome this issue, the
entity might need to issue some details about each transaction and complex
accounting treatment.

Answer 04:
To evaluate the liquidity position of both companies, we need to compare some
liquidity ratios of both companies provided in the question. The current ratio means
how much of the total current assets are financed by current liabilities. So, a high
current ratio will normally be a sign of a good liquidity position. When we look at the
table provided below, the current ratio of ABC seems declining day by day and the
current ratio of XYZ is improving day by day. This means the liquidity position of ABC
is getting worse year on year.
The acid-test ratio is a measure that exhibits how well current liabilities are covered
by liquid assets. The quick ratio also means that the company can meet existing
liabilities if they all fall due at once. Using the provided information, the acid-test
ratio of ABC is declining each year and is less than XYZ in each respective year. The
acid-test ratio of XYZ seems to be improved year on year.
The receivable turnover ratio means that how efficiently a business collects its
receivables from its credit customers. So, high receivable turnover is an emblem of
good management and also the company converts its receivables into cash rapidly.
Using the provided information, ABC company has a much higher receivable turnover
ratio than the XYZ company.
The inventory turnover means that how efficiently a business converts its inventory
into cash. When we look at the provided ratios table, the statistics of ABC company
seem better than XYZ company because it has a high inventory turnover ratio in each
successive year.
Working capital is the capital available for day to day operations of a business. This is
normally the excess of current assets over current liabilities. When looking at the
provided information, the working capital of XYZ is higher than the working capital of
ABC company in each year. This means the XYZ company has enough current assets
to meet its short-term liabilities. Hence, when looking at all provided ratios the
liquidity position of the XYZ company seems much better than the ABC company.

Answer 05:
a)
Asset efficiency measures a business's capability to generate sales from its total
assets. To assess asset efficiency, we need to look at asset turnover and return on
the total assets of a company. As freshmen Inc. has higher asset turnover than
graduate Inc, this means that freshmen Inc. is generating more sales per dollar of the
total assets. The freshmen Inc. also has a return on assets than graduate Inc, this
implies that it has better asset efficiency than graduate Inc.
When need to calculate the profits for both companies using profit margin ratios:
Profit= Profit margin x Sales
Profit 2018 2017 2016
Freshmen Inc. 9200 8880 8492
Graduates Inc. 5400 4640 2800
To assess the profitability, we need to look at some ratios such as gross profit
margin, operating profit margin, etc instead of just profit figures. Although the profit
of freshmen Inc. is much higher than the profits of graduates Inc. but the profit
margin of graduates Inc. is better than freshmen Inc. which means the profitability of
graduates Inc. is better than the other.

(b) The debt management involves a business efficiency to reduce its unpaid,
unsecured debts over time. This involves management strategies such as making
smart decisions about assets and monitoring credit. As both company's cost of debt
is 5%, graduate Inc.'s return on assets is just above 5% but freshmen Inc.'s return on
total assets is very high which means freshmen Inc. is managing its debt efficiently
and effectively. The graduates Inc.'s performance is not well in this area and does not
seem to manage its debt effectively. As its return on total assets is not much higher
so its riskiness in comparison to freshmen Inc. is very high. The riskiness of freshmen
Inc. is very low because its return on total assets is much greater than its cost of
debt. Hence, freshmen Inc. is better than graduate Inc in the success of debt
management and riskiness.