EXAMPLE EXAM

Master of Science in
Student number : __________________________
Business Administration
Student name : __________________________
Finance & Investments

Supply Chain Management Signature : __________________________

Written Exam

General Information
Course: FINANCIAL ANALYSIS Group:

Course code: Type of exam Closed book

(open or closed book):
Date: 2010 (PRACTICE EXAM) Time: 3 hours

Lecturer(s): Total amount of pages 5

(including 1 cover
page):

Instructions

• Use of a dictionary is not permitted.

• First read the examination carefully before starting to answer the questions!
• Write your name and exam number on every page you hand in!

• You are allowed to make use of a (graphical) calculator

• Exam questions and answers should be handed in
• You are not allowed to take the exam questions home after the examination
• This exam has 90 total points.

Additional Information:

If you are caught cheating, the following penalties can be applied:

• invalidation of the examination concerned;
• exclusion from the examination concerned for at most one year;
• exclusion from one or more rounds of examinations;
• a combination of the above measures.

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 EXAMPLE EXAM

Question 1: Introduction/framework (10p.)

A. (4p.) Palepu, Healy & Peek describe that strategy analysis typically precedes the analyst’s accounting
analysis. Explain how the outcomes of the strategy analysis help the analyst in her accounting analysis (in
not more than 100 words!).
B. (6p.) Palepu, Healy & Peek indicate that financial intermediaries and information intermediaries may play
an important role in improving the functioning of capital markets. Describe how debt rating analysts can
help in reducing information problems between firms and public equity markets (in not more than 100
words!).

Question 2: Accounting analysis (16p.)

A. (4p.) Firms reporting under IFRS can choose between classifying their expenses in the income statement
by function or by nature. Explain the difference between the classification of expenses by function and the
classification of expenses by nature (in not more than 100 words!).
B. (6p.) Skyline Corp’s aircraft has originally cost €6,400 million. On December 31, 2005, accumulated
depreciation on the aircraft is €3,456 million. The airline depreciates its aircraft on a straight-line basis
over a period of 10 years. It further assumes that the residual value of the aircraft is 10 percent of its
original cost. The airline’s tax rate equals 30 percent.
An analyst wishes to make adjustments to the airline’s balance sheet on December 31, 2005, and income
statement for fiscal year 2006 that reflect the following assumptions: the depreciation period for aircraft is
12 years and the aircraft has a residual value of 5 percent of its original cost. Calculate the adjustments
that the analyst has to make.
C. (6p.) From 2002 to 2006, the XYZ Company made the following R&D expenditures:

2002 2003 2004 2005 2006

R&D outlays £3.0 £3.5 £3.0 £3.8 £4.0

Currently, the XYZ Company immediately expenses all R&D outlays. The company’s tax rate is 30%. An
analyst wishes to make adjustments to the company’s balance sheet on December 31, 2006 that reflect the
following assumptions: (1) the R&D investments are no longer immediately expensed but recognized as
an R&D asset, (2) the average expected life of R&D investments equals 4 years, and (3) R&D spending
occurs evenly throughout the year (i.e., only half a year’s amortization is taken on the latest year’s
spending). Calculate the adjustments that the analyst has to make to the balance sheet.

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 EXAMPLE EXAM

Question 3: Condensed financial statements and financial ratios (24p.)

Summaries of balance sheets and income statements for Martine & Gerard’s Inc., a manufacturer of premium
ice cream, frozen yoghurt, and novelty products, follow. M & G ’s marginal and effective tax rate is 38
percent

Balance Sheets (amounts in millions)

2006 2005
Marketable Securities € 36.6 € 35.4
Trade receivables 8.7 11.7
Inventories 22.8 21.0
Current assets 68.1 68.1

Property, Plant, and Equipment, net 65.1 59.6

Non-current Intangible Assets 3.5 3.4
Total assets 136.7 131.1

Trade payables 17.4 16.5

Current portion of non-current debt 0.6 0.5
Current liabilities 18.0 17.0

Non-current debt and lease obligations 31.1 32.0

Deferred tax liability 4.8 3.5
Total liabilities 53.9 52.5

Share capital and share premium 47.5 47.2

Retained earnings 35.3 31.4
Total equity and liabilities € 136.7 € 131.1

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 EXAMPLE EXAM

Income Statements (amounts in millions)

2006 2005
Net sales € 167.1 € 155.3
Cost of sales (115.2) (109.1)
Gross profit 51.9 46.2
Other operating income, net of operating expense 0.2 (0.6)
Selling, general, and administrative expenses (45.5) (36.4)
6.6 9.2
Other income (expense)
Interest income 1.7 1.7
Interest expense (2.0) (1.5)
Profit before tax 6.3 9.4
Tax expense (2.4) (3.6)
Net profit € 3.9 € 5.8

Dividend € 1.9 € 1.8

A. (10p.) Prepare the condensed balance sheets and income statements (showing at least sales, NOPAT, net
interest after tax and net profit) for fiscal years 2006 and 2005.
B. (6p.) Calculate free cash flow to equity and debt holders in fiscal year 2006.
C. (4p.) Did M&G’s inventory turnover increase or decrease in 2006? Explain your answer.
D. (4p.) Did M&G’s sustainable growth rate increase or decrease in 2006? Explain your answer.

Question 4: Financial and prospective analysis (32p.)

On January 1, 2009, analyst John Armstrong prepares the following estimates of ABC Company’s income
statement and balance sheet for the fiscal years ending on December 31, 2009 and 2010.

Item 2009 Expected 2010 Expected

End-of-year working capital €600 €500
End-of-year equity €3,800 €4,300
End-of-year net debt €3,000 €3,300
Net operating profit after taxes (NOPAT) €1,000 €1,200
Marginal and effective tax rate 30% 30%
Dividend pay out ratio 50% 50%
Net interest expense after taxes €200 €200
Sales €4400 €4600

A. (10p.) Calculate the analyst’s estimates of ABC’s return on equity (ROE) in 2009 and decompose ROE in
2009 into: NOPAT margin, asset turnover, financial spread, and financial leverage. (Use end-of-year
balance sheet values to calculate the ratios.)

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 EXAMPLE EXAM

B. (10p.) ABC’s cost of equity equals 12%. The analyst anticipates that ABC’s abnormal profits will grow at
a constant rate of 2% (annually) in the fiscal years after 2010. Using the abnormal earnings valuation
model and the above information, calculate the analyst’s estimate of ABC’s market value on January 1,
2009. (Note: to calculate the beginning-of-year book value of equity, assume that the clean surplus
relationship holds.)
C. (6p.) Calculate the analyst’s estimate of abnormal earnings growth in fiscal year 2010.
D. (6p.) Using the above information, calculate the terminal value of ABC (at the end of fiscal 2010) for the
abnormal earnings growth model.

Question 5: Other (8p.)

A. (4p.) Several researchers have attempted to explain debt ratings as a function of selected financial
statement ratios (e.g., Kaplan and Urwitz). Describe three of these quantitative variables that can explain
debt ratings. Clearly indicate the sign of their correlation with debt ratings and explain why these variables
and debt ratings are correlated (in not more than 100 words!).
B. (4p.) A bank extends three loans to the following companies: an Italy-based biotech firm; a France-based
car manufacturer; and a UK-based food retailer. How may these three loans differ from each other in
terms of loan maturity, required collateral, and loan amount?

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