Accounting and Capital Markets: Exercise Package

Fall 2019

Accounting and Capital Markets

Fall 2019

Exercise Package

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 Accounting and Capital Markets: Exercise Package
Fall 2019

Articulation of financial statements (8 points)

Please fill in the empty cells below.

Balance Sheet 20X2 20X1 Income Statement 20X2

Property, Plant, and Equipment 100 50 Sales 500
Intangibles 200 140 - deprecation
- amortization
Inventories 40 - other costs of goods sold -30
Receivables 30 50 = gross profit
Cash 41 20 - operating expenses -100
= EBIT
Total assets interest expense -5
= EBT
Share capital 200 taxes -99
Retained earnings 0 = net income
Total equity 200

Bonds 60 30 Statement of Cash Flows

Accounts payables 30 Cash at the beginning of the year 20
net income 231
Total liabilities and equity + depreciation
+ amortization
- change in inventories -20
- change in receivables 20
+ change in payables -20
= OCF

- investments in PP&E -65

- investments in intangibles -80
= CFI -145

- dividends -10
+ changes in share capital -100
+ changes in bods 30
= CFF -80

Total cash flow 21

Cash at the end 41

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 Accounting and Capital Markets: Exercise Package
Fall 2019

Accrual accounting and valuation (5 points)

Assume you want to value a company. What are the benefits of basing your valuation on the

company’s financial statements prepared under accrual accounting, rather than cash

accounting? Which potential issues can arise when you rely on accrual figures?

Market value versus book value (5 points)

Why can there be differences between a firm’s book value of equity and its market value of

equity?

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 Accounting and Capital Markets: Exercise Package
Fall 2019

Goodwill impairment (10 points)

Fact pattern:
The following information describes CGU X of ABC AG as of 31 December 20X1 (after
depreciation, and after the acquisition of DBE AG).

Balance sheet of CGU X, as of 31 December 20X1 (in TEUR)

Goodwill 50 Equity 830
Patent 150
PPE 350
Inventories 280
Sum 830 Sum 830

Data on CGU X as of 31 December 20X1

Future cash flows (in TEUR) 200 (decreasing by 50 each year)
Useful life 4 years
Fair value (in TEUR) 1,200
Cost to sell (in TEUR) 650
Discount rate 10%

The remaining useful life of the PP&E is four years. The remaining useful life of the patent is

four years. Both are depreciated/amortized on a straight-line basis.

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 Accounting and Capital Markets: Exercise Package
Fall 2019

Questions:

a) Please test CGU for an impairment and conduct the necessary journal entries. (4

points)

b) In 20X2, you learn that the economic reasons that lead to the impairment have ceased

to exist. The recoverable amount of CGU XX has risen to 900 TEUR as by the end of

20X2. Please determine the impariment reversal for the patent. (4 points)

c) Assume a manager wants to minimize the probability of goodwill impairment in

subsequent periods after a business combination. Would she try to allocate goodwill to

a CGU with rather high or rather low hidden reserves in the other assets? Please

explain. (2 points)

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 Accounting and Capital Markets: Exercise Package
Fall 2019

Provisions (10 points)

Fact pattern:

At the beginning of 20X1, Company X buys a power plant with an expected useful life of 40

years. At the same time, Company X enters into an obligation to dismantle the site at the end of

the useful life of the plant. At the end of 20X1, Company X records a depreciation expense for

the power plant of 48,800 EUR and an interest expense for the provision relating to the

dismantling obligation of 9,100 EUR. Company X uses a discount rate of 2%.

Questions:

a) Please calculate the purchase price of the power plant, the present value of the

provision for dismantling as at the beginning of 20X1, and the expected costs of

dismantling. (5 points)

b) Please provide the journal entries to account for the transaction in 20X2. If you could

not calculate a present value for the provision in (a), assume a present value of 500,000

EUR. (3 points)

c) Please explain whether you agree or disagree with the following statement: “Due to the

provision, the carrying amount of the power plant asset is overstated.” (2 points)

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 Accounting and Capital Markets: Exercise Package
Fall 2019

Financial instruments (10 points)

Fact pattern:

At the beginning of 20X1, Company X purchased security X. At the end of 20X2, Company X

records the following journal entries, all relating to its investment in security X:

Dr. OCI 500 Cr. Security X 500

Dr. Cash 10,000 Cr. Security X 10,000

Dr. Accumulated OCI 1,000 Cr. Retained earnings 1,000

Questions:

a) Please explain the events that can have given rise to the journal entries above. In doing

so, please explain, giving reasons for your answer:

I. Whether security X is a debt or equity instrument;

II. According to which category (IFRS 9) Company X accounts for security X;

III. The price for which security X was bought by Company X.

IV. The market value of security X at the end of 20X1. (6 points)

b) Please explain whether in the situations below the contractual cash flow characteristics

tests are met. (4 points)

I. A company purchases a bond with interest payments depending on the

inflation rate.

II. A company purchases a stock.

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 Accounting and Capital Markets: Exercise Package
Fall 2019

Equity method (10 points)

Fact pattern:

At the beginning of 20X1, KAUF AG buys 30% of the shares of ZIEL AG. KAUF AG pays

3,000 TEUR. ZIEL AG’s stock capital 2,000 TEUR and its equity reserves are 2,900 TEUR. In

20X1, ZIEL AG’s net income is 100 TEUR. During the transaction, hidden reserves on land

(2,000 TEUR) and machinery (1,000 TEUR; useful life: five years) have been uncovered.

KAUF AG accounts for the investment using the equity method.

Question:

a) Please perform a purchase price allocation for the transaction, calculating the resulting

goodwill. (3 points)

b) Please provide the journal entries to account for the investment in KAUF AG’s

consolidated statements in 20X1. What is the carrying amount of the investment at the

end of 20X1? (3 points)

c) Please discuss the issues created by the equity method for financial statement analysis.

(4 points)

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 Accounting and Capital Markets: Exercise Package
Fall 2019

Financial ratio analysis (15 points)

Fact pattern

Below you find the financial statements of Blueberry AG for 20X1.

Balance Sheet 20X1 Income Statement 20X1

Assets Sales 25,000
Non-current Cost of sales -1,000
Intangibles 7,500 Gross profit 24,000
Property, Plant &
Equipment 2,500 R&D expense -3,000
Investments in associates 500 SG&A expense -2,700
Current Other operating income 200
-
Securities held for trading 1,800 Other operating expense 15,000
Trade accounts receivable 2,500 Operating profit (EBIT) 3,500
Inventories 2,000 Income from associates 100
Cash and cash equivalents 300 Interest income 150
TOTAL 17,100 Interest expense -600
Profit before tax 3,150
Equity &Liabilities Tax expense -700
Common stock 6,000 Net income 2,450
Retained earnings 2,450
Total shareholders' equity 8,450
Non-current liabilities
Provisions 670
Long-term debt 6,000
Current liabilities
Accounts payable 600
Short-term debt 1,380
TOTAL 17,100

All interest income is generated from securities held for trading. All of Blueberry’s cash

holdings are of operating nature.

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 Accounting and Capital Markets: Exercise Package
Fall 2019

Questions:

a) Please disaggregate Blueberry’s income using the Advanced DuPont model.

b) Assume that Blueberry could take on a new loan at an effective rate of 15%. Assume

that the loan would be invested into a project that earns the same rate on return as

Blueberry’s current average operations, would you recommend that Blueberry takes on

the loan? Please explain briefly.

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 Accounting and Capital Markets: Exercise Package
Fall 2019

Forecasting (10 points)

Fact pattern:

Below you find Uncertainty AG’s income statement forecasted for 20X2 as well as its

forecasted balance sheets for 20X1 and 20X2.

Simplified Income Statement, in Simplified Balance

T€ 20X2 Sheet, in T€ 20X1 20X2
revenues (sales) 104,500 Non-current Assets
- amortization on intangibles -5,450 intangible assets 20,000 21,800
- depreciation on PPE -4,944 PPE 60,000 44,500
- other cost of sales -77,606 Current Assets
= gross profit 16,500 inventories 10,000 25,200
- other operating expenses -11,000 receivables 35,000 17,250
= operating profit (EBIT) 5,500 cash 15,125 11,000
- interest expense -3,906 total assets 140,125 119,750
= profit before tax (EBT) 1,594 Equity
- income tax expense -478 shareholders’ equity 49,127 34,559
= profit after tax (net income) 1,116 retained earnings 2,078 2,636
Dividends 558 Total equity 51,205 37,195
Liabilities
debt 70,320 59,875
payables 18,600 22,680
total equity and
liabilities 140,125 119,750

Tasks:

a) Please provide the pro forma cash flow statement for 20X2. (7 points)

b) Please calculate the Free Cash Flow to all investors using the indirect method. (3

points)

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 Accounting and Capital Markets: Exercise Package
Fall 2019

Forecasting (10 points)

Fact pattern

On the next page, you are provided with excerpts of Company X’s cash flow

statement forecasted for 20X2, its income statement forecasted for 20X2 as well

as its balance sheet forecasted for 20X1.

Questions

a) Please derive Company X’s balance sheet of 20X2 by filling in the missing cells in the

table on the next page. (7 points)

b) Taking the cash flow statement as forecasted for 20X2, can you simply derive Free

Cash Flow to all investors by adding CFO and CFI? If not, why not? Please explain the

adjustment you would have to make so that Free Cash Flow to all investors would equal

the sum of CFO and CFI in the cash flow statement and calculate the firm’s Free Cash

Flow to all investors (3 points)

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 Accounting and Capital Markets: Exercise Package
Fall 2019

Statement of
Balance Sheet 20X1 20X2 Income Statement 20X2 Cash Flows 20X2
Property, Plant 5,000 Sales 40,000 Net income 13,325
and Equipment
Raw materials 6,700 - Cost of good sold - + Depreciation (PP&E) 1,500
inventory (COGS) 13,200
Accounts receivable 4,400 Gross profit 26,800 + Change in provisions 2,000

Cash 3,200 - R&D expenses -2,500 - Change in -6,500

accounts receivables
Total assets 19,300 - Selling expenses -7,000 - Change in 1,700
inventories
- Other operating -3,000 + Change in 5,500
expense accounts payable
Share capital 10,000 EBIT 14,300 Cash from operations 17,525

Retained earnings 4,700 - Interest expense -200 - Investment in PP&E -5,000

Total equity 14,700 EBT 14,100 Cash from investment -5,000

Accounts payable 2,300 - Income taxes -775 + Share issuance 5,000

Long-term loan 300 Net income 13,325 + Change in long-term 12,500

loan
Provision 2,000 - Dividend paid -800

Total equity and 19,300 Cash from financing 16,700

liabilites

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 Accounting and Capital Markets: Exercise Package
Fall 2019

Residual Income Model (10 points)

Fact pattern:

You are provided with the following information relating to Company X:

Book value of equity, end of 2016: 50 TEUR

Earnings expected for 2017: 2 TEUR

Earnings expected for 2018: 10 TEUR

Cost of equity capital = discount rate (constant over time): 5%

Company X, as a general policy, does not pay dividends.

Questions:

a) Please calculate Company X’s equity value under a “no growth” scenario, assuming that

the firm’s residual income in 2018 reflects its steady state and remains constant from

this point onwards. (7 points)

b) Please explain how the residual income model provides a way to think about uncertainty

in equity valuation. (3 points)

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 Accounting and Capital Markets: Exercise Package
Fall 2019

Price-to-Book Ratio (10 points)

Fact pattern

Analyst Alfred attempts to value Company X at the end of 20X0. By doing so, he applies a

constant growth rate from 20X1 onwards (perpetuity model) and assumes that Company X will

earn a constant RoE. In 20X0, Company X’s book value of equity is 15,000 TEUR. The

forecasted book value of equity for 20X1 is 15,450 TEUR. Residual income forecasted for

20X1 is 900 TEUR, and the present value of residual income forecasted for 20X1 and

discounted to 20X0 is 865.38 TEUR. Net income forecasted for 20X1 is 1,500 TEUR.

Question:

a) Please calculate Company X’s price-to-book ratio as at the end of 20X0. (8 points)

b) Alfred’s colleague Albert also performs a valuation for Company X. Albert’s valuation

yields a price-to-book ratio of 6. If Albert and Alfred agree on Company X’s risk and

forecasted profitability, does Albert assume a higher or lower growth ratio than Alfred?

(2 points)

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