SEATTLE PACIFIC UNIVERSITY
School of Business and Economics
BUS 6220 CRN 43797
Financial Analysis
Dr. Herbert Kierulff
hkierulf@spu.edu
Office: McKenna Hall 205
Phone: 281-3523
Hours: Th. 1-6 and by appt.
Classroom: McKenna 111
"…value reflects only our opinions and not the true worth of the things
themselves."
Francisco de Osuna, Third Spiritual Alphabet
COURSE OBJECTIVES: By the end of this course you should be able to demonstrate
greater competence in:

Doing short and long term financial planning and budgeting, strategic analysis
and decision making under conditions of rapid change and uncertainty.

Applying the fundamental and practical principles of valuation to pricing and to
real investment opportunities.

Gathering information, separating relevant from irrelevant factors, selecting and
evaluating relevant options with regard to their consequences, and selecting and
defending a course of action.

Conceptualizing complex issues and reducing them to coherent written and oral
statements.

Integrating valuation and investment analysis with the other functional areas of
business administration including business processes and information technology.

Working effectively in group settings; demonstrating friendship, civility, respect,
servant leadership, and community.

Integrating as appropriate the practical lessons of Christian spirituality, including
ethics, faith, values, and personal integrity.
The course builds upon and applies tools, concepts and methodologies learned in the
prerequisites for this class, but we will stick to the fundamentals of theory. The course
is first and foremost a course in evaluation and application of theory rather than the
introduction and examination of theory. And learning to critique and apply theory is
very different from learning the theory itself. Evaluation and application involves
further development of your abilities to separate relevant information from irrelevant,
and to use (not develop or learn) theoretical models and problem solving skills in
decision-making. Recognition of these facts is the key to understanding the course
and getting the most from it.
The emphasis on financial analysis and evaluation of investment opportunities—as
opposed to financial institutions, liability and equity management, derivatives or other
finance areas—is deliberate. This course is oriented to the practicing manager, not the
specialist. As a professional manager you will need to know and be able to critically
evaluate and apply the relevant concepts of finance at the generalist level. In addition,
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evaluation of investment opportunities is often viewed as the most challenging of the
finance subjects. It is here that an instructor can be of most help.
REQUIRED READINGS/RESOURCES:
The required readings are listed in the Assignments section below.
You may obtain the Harvard cases and other material for this course at a 50%
discount or free by following this course link:
The course link is to Financial Analysis Spring 2012. You must register to gain
access. You are expected to purchase the cases. To copy cases from others is a
violation of copyright law and is unethical and illegal. Harvard sends faculty lists
of those who have purchased its cases. Those who have violated copyright may be
subject to correction including but not limited to grade reduction and legal action
by Harvard.
If you need a quick review of accounting principles, go to
www.AccountingCoach.com
A good way to review cases is found at
http://college.hmco.com/business/resources/casestudies/students/analyzing.htm
PREREQUISITES: It is assumed that you have had the appropriate prerequisites
for this course or their authorized equivalents, and retain an understanding of the
fundamentals of finance. However, we will review the theory underlying all of the
applications in this course.
OUTLINE OF COURSE TOOLS, CONCEPTS AND METHODOLOGIES
We will review and discuss the following tools, concepts and methodologies helpful in
the task of financial analysis and valuation and ask you to apply them to cases. By the
end of this course you should understand what they are (if you don’t already know), how
and when they are applied, and their major strengths and weaknesses. What I really want
to help you improve is your ability to (1) apply them appropriately in practical valuation
and investment situations given their strengths and weaknesses, and (2) critique their
application by specialists working for you. Here are the concepts and methods:
1. The tools of analysis
A. Financial statements and ratios - what they mean and how they interrelate
B. Concepts: required, expected, actual, cost-benefit, risk-reward
C. Analysis: trends, comparables (benchmarking), and rules of thumb
D. Analyzing risk: the 5C’s of credit, specific risk factors and fatal flaws,
simulation (sensitivity and scenario analysis including the less-than-expected
case).
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E.
Operating and capital budgeting
2. Methods of valuing
A. Asset: what you can do it for (buy the components or build yourself)
B. Market (comparables): what somebody else is selling / buying it for
C. Income (intrinsic value): expected future net benefits
1. In terms of time: payback period, discounted payback
2. In percentage terms: ROE, ROA, ROTC, IRR, MIRR.
3. In currency: present value, net present value
3. Discounting to present value
A. Certainty equivalents
B. Best estimate free cash flows
COURSE ASSIGNMENTS:
You can only learn to apply theory by actually doing it yourself and then reviewing the
results. The analysis of real business situations (cases) is one of the best ways to apply
theory to practice in the classroom. The best way to prepare for the classroom
discussion is to study the case and then discuss your ideas with a small group. The first
night of class, I will ask you to form study groups of not more than 4 people. You
choose the participants in your team unless the team has fewer than 3 people. Each
study group will prepare responses to the case questions in this syllabus during class
(and afterward, if necessary) and will email each question set to me on or before the
following Sunday at 9:00 PM. That way, I will have an idea of how well the class
understands the case prior to the next time we meet. I will be available during class as
your consultant while you work on the cases. After class, I can be reached by phone,
email, or special appointment.
Two or three paragraphs are generally sufficient to answer each question. Often a
spreadsheet or number will do it, but you should show your calculations and defend
them by enumerating your assumptions. Your team’s case analysis will be given a grade
and the lowest grade during the quarter will be dropped. However, you must do and
turn in the last case in the class.
My write-up of each case will be available on blackboard on the following Sunday at
9:00 PM so that you can review it. Also, some cases will be available on Camtasia at
that time. I will email you the appropriate Camtasia links. You learn a significant
amount by studying the case on blackboard and listening to the Camtasia presentations
because: (1) you understand what you did right, (2) you understand where your
assumptions differed from mine and why (were your assumptions reasonable?), and (3)
you understand where mistakes were made.
Team case analyses will count for 10 percent of your grade. Some students in past
classes have urged me to give greater weight to the analyses because much of your time
will be taken doing cases and revising them. I resonate to that, but at the end of the
quarter I have to give out individual grades. I cannot do so on the basis of group
performance. I need to grade what you have learned, not what your group learned.
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Besides, what you learn in doing the cases will be directly reflected in the exams. I
have noticed that there can be significant differences in final grades among team
members.
Individual Participation grade is determined by team members. At the end of the
course, you will have points to give to each of your other team members on the basis of
the quality of participation in the case analysis. With four members on a team, for
example, each team member will have up to 300 points to give out to the other team
members. You may give more or less than 100 points to another team member, but the
total points you give cannot exceed 300 for a four-person team or 200 for a three-person
team. The numbers for each of your team member’s participation should be included
on your final exam. If you elect not to put individual participation numbers on the final,
I will assume that you awarded each of your other team members 100 points. I will
average the scores for each team member and multiply the result by their final exam
grade to get the individual participation grade. For example, if a person scores 95 on
the final and averages 100% on the individual participation, the participation grade will
be 95.
If a team member is not participating in the work of the team, the other team members
may choose to dismiss the person. The dismissed person will then be responsible to
work on the cases alone and turn them in.
EXAMINATION AND GRADING/EVALUATION CRITERIA:
Case Analysis Questions: I grade the case analysis questions very leniently. I don’t
expect you to have all the “right” answers, if there are such answers. I do expect a good
effort which clearly indicates that the team members have (1) studied—not just read—
the case; (2) discussed it; (3) recommended decisions where appropriate; (4) backed up
recommendations with reasoned arguments; and (5) made a fair attempt to run the
numbers if appropriate (i.e., applied the quantitative tools of financial analysis and
valuation). This latter point (5) is very important. Again, please keep in mind the
objectives of the course. My reasons for assigning the questions at the end of this
syllabus and grading them are to give you some guidance in approaching each case. A
team’s lowest case grade, except for the last case, will be dropped.
Exams The exams will consist of relatively short answer essay questions, problems,
and/or a brief case. The exams will be emailed to you and done in class. You may
expect to perform some quantitative analysis in answering some questions. At least 75
percent of each exam is case related, so be sure that you understand each case after
class discussion and before the final. All exams will be comprehensive because the
class builds on itself. However, the weekly exams will emphasize material covered in
the previous week, including the previous week’s exam and case. Your lowest grade in
the weekly exams will be dropped. If you must miss a class and cannot take it over the
net at the time it is given, that exam will count as your missed exam. No make-ups.
The final exam and grade will be emailed back to you before grades are due if 100% of
the class completes the course evaluation forms and emails the confirmations back to
me.
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Grades. All assigned work will receive letter grades corresponding to grade points as
follows: A, 94-100; A-, 90-93; B+, 87-89; B, 83-86; B-, 80-82; and so on. Specific
assignments weights are as follows:
Case questions (with lowest case dropped)
10 percent
Team participation grade
10
Weekly exams (8 @ 6% each, lowest dropped)*
42
Final exam
38
Extra credit for evaluating the course: two points added to your final
exam.
*The Cartwright case counts as two cases.
OTHER IMPORTANT INFORMATION: PLEASE REVIEW CAREFULLY
Disability Statement. In accordance with Section 504 of the Rehabilitation Act
of 1973 and the Americans with Disabilities Act of 1990, students with specific
disabilities that qualify for academic accommodations should contact Disabled Student
Services (DSS) in the Center for Learning. DSS in turn will send a Disability
Verification Letter to the course instructor indicating what accommodations have been
approved.
Academic Integrity. The current edition of the SPU Catalog describes the
University’s commitment to academic integrity, which is breached by academic
dishonesty of various kinds. Among these: “copying another’s work on an exam;
preparing for an exam by using test questions from a stolen exam; bringing concealed
answers to an exam; turning in another person’s work as one’s own; or committing
plagiarism (i.e., copying portions of another’s words from a published or electronic
source without acknowledging that source.”
Emergency Procedure: Note the emergency procedures posted in the classroom
and note the emergency exits. In case of an emergency (fire, earthquake, hazardous
material spillage, bomb threat, etc.), the class will evacuate the building and gather in
the Nickerson parking lot. If conditions make it impossible to meet there, meet at the
Ross parking lot at the corner of 3rd Avenue W. and W. Cremona Street just north of
First Free Methodist Church. Please try to stay together so that we can check that
everyone has made it safely out of the building. Set up a “buddy” system in case we
have a campus emergency. Your buddies will be the members of your case study team.
A reminder that when we do have a lockdown drill we are expected to lock the room
doors, close the blinds, turn off the lights, get down on the floor and remain quiet.
Inclement Weather: The University maintains an Emergency Closure Hotline
(206-281-2800). In the event of inclement weather or an emergency that might close
the university, please call the Hotline for the most up-to-date closure information or
check the SPU website. Both will be updated before 6:00 a.m. Information on evening
classes, events, and athletic games will also be updated.
Make-ups on Final Exam: A make-up exam will be given only in the case of a
documented emergency. Please provide me with sufficient documentation prepared by
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others (employer, doctor, etc.). Make-up exams create an extra burden in this course
since each exam must be newly custom-made, a new answer sheet prepared, and the
new exam graded. Since each exam is different, I cannot guarantee the new exam will
not be more (or less) challenging than the regularly scheduled one. I will do my best. It
is not possible to prepare different exams during the rush of finals, so you will need to
take an incomplete and take the exam during the following quarter. University
regulations require that the exam be taken during SBE business hours under the
monitoring of Elizabeth Gordon. Contact her and me to arrange a time.
Course Evaluation: It is my expectation that you will participate in an online
evaluation of this course in a thoughtful and constructive manner. I use the evaluation
data to make improvements in the course, and your feedback is very important when
selecting textbooks, designing teaching methods, and preparing assignments. Courses
are evaluated using the Banner Course Evaluation System. All answers are completely
confidential - your name is not stored with your answers in any way. In addition, I will
not see any results of the evaluation until after final grades are submitted to the
University. Thanks for your assistance in making this system work. An extra 2 points
will be added to your final exam grade if you complete the evaluation and email
me the Banner receipt you receive showing that you have completed the
evaluation. It will be most helpful to me if you will fill out the comments section of
the evaluation because I use those comments in making changes to the course.
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PRELIMINARY COURSE OUTLINE
Topics Discussed in
Class
Assignments
3-29
Introduction
Income Statements and Balance
Sheets (a review)
Valuation—Factors and Methods
Financial Statement Example 1
Financial Statement Example 2
Newco Case (in Blackboard)
4-5
Case Analysis
Cartwright Lumber Company (Questions 1 and
2 only). Do in class. Obtain case aid in
blackboard.
4-12
5 C’s of Credit
Ratio Analysis
What do you mean by?
Practice: Extend Newco IS and BS over the
next four quarters assuming sales of 400, 300,
200, 100, and 100 for the ninth quarter.
Answers on blackboard. Do before class but
don’t hand in.
Case Analysis
Using Solver
Cartwright Lumber Company (Questions 3, 4,
and 5.). Do in class
Taking Discounts
Note on Bank Loans (HBS Note: study before
class.)
Break-even analysis
Practice: Taking Discount (in blackboard)
http://www.zenwealth.com/BusinessFinanceOnl
ine/FF/FinancialForecasting.html
4-19
Case Analysis
Toy World: do in class
Be sure to download free supplement
Free Cash Flow
Behavioral Finance
http://www.zenwealth.com/BusinessFinanceOnl
ine/FCF/FinCashFlow.html Note that zenwealth
uses actual taxes, not tax before interest.
Valuation Methods
Valuation-Factors and Methods (in blackboard)
8
4-26
Case Analysis
Three Problems in Capital Budgeting. Do in
class (in blackboard)
PV, NPV, IRR, MIRR,
PI
http://www.zenwealth.com/BusinessFinanceOnl
ine/CB/CapitalBudgeting.html
Kierulff: "The replacement decision: Getting it
right" In blackboard. This will help you with
the Three Problems, especially problem 2.
Kierulff: MIRR: A Better Measure. In
blackboard
5-3
Case Analysis
Stryker do in class
Cost of Capital
http://www.zenwealth.com/BusinessFinanceOnl
ine/BV/BondValuation.html
Investment Analysis and Lockheed Tri-Star
(read Lockheed Case, but do not prepare
analysis; we will discuss Tri-Star in class).
Kierulff: NPV: Doing it Better (in blackboard)
5-10
Case Analysis
Sampa Video do in class
Cost of Capital
http://www.zenwealth.com/BusinessFinanceOnl
ine/SV/StockValuation.html
Market Method
5-17
Case Analysis
Monmouth do in class
Market Method
http://www.zenwealth.com/BusinessFinanceOnl
ine/RR/RiskAndReturn.html
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5-24
Course Review
Radio One
Valuation Basics (overview of the course (in
blackboard)
5-31
FINAL EXAM (Comprehensive)
BUS 622O: FINANCIAL ANALYSIS CASE QUESTIONS
CARTWRIGHT LUMBER COMPANY
1. Is this company healthy? Construct common size statements for the years
2001 through 2003 based upon sales. Do a common size balance sheet based
upon total assets. Do a horizontal analysis. Do a ratio analysis using the basic
ratios shown in the Cartwright Spreadsheet available on blackboard. Then
analyze the income statement and balance sheet from 2001 through 2003
explaining what they tell you, but not making recommendations at this time.
2. If you were the banker, how would you evaluate risk and reward for the bank in
this situation? Use the 5 C’s of credit in your analysis.
3. Do you agree with his estimate of the company's loan requirements? How
much will he need to borrow to finance his expected expansion in sales?
Assume a 2004 sales volume to be that mentioned in the case, that he does
NOT take purchase discounts for the period January 1 to December 31, 2004
and beyond, and that the relationships between sales and those income and
balance sheet line items that vary with sales will be the same in 2004 as in
2003. Ignore the data in the case for the first quarter of 2004.
4. Does it make sense for Mr. Cartwright to take the purchase discounts if he can?
How will this affect his cash requirements for 2004? What would the income
statement and balance sheet look like if he took the discounts for the entire
2004 year?
5. What would you recommend to Mr. Cartwright? To the banker?
TOY WORLD INC.
1.
What factors should Mr. McClintock consider in deciding whether to adopt the
level production plan?
2.
What savings would be involved?
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3. Estimate the amount of funds required and the timing of the needs under
level production. Prepare pro forma income statements and balance sheets on a
monthly basis to make this estimate.
4. Compare the liability patterns feasible under the alternative production plans.
What implications do their differences have for the risk assumed by the various
parties?
5. Calculate accounts receivable turnover, inventory turnover, profit margin, and
ROE for each month over the year 1994. What do these tell you about the
validity of ratios in a seasonal business?
Here are some hints for doing Toy World:
Toy World will require you to create multiple formulas and use Solver each month in creating.
your proforma (forecasted) balance sheet and income statement.
You may assume that the 2004 ending inventory will be the same as the 2003 ending
inventory.
In estimating the value of a line item, like ending inventory, accounts receivable, and taxes
payable you can create a format as follows:
Jan
Feb
Mar
Etc.
Beginning item value
Additions to the value
Subtractions from the value
Equals ending value
Creating the accrued taxes presents an opportunity to use this approach.
Estimated taxes can be paid based upon last years' taxes or an estimate of 2012 taxes.
If you are growing, it makes more sense to use last year's tax for the estimated taxes
because it will be lower than the current year. If you do use the current year, you must
be within 90% or more of the actual tax to avoid a penalty bill.
Now check Table B in the Toy World case before going further.
Suppose the ending taxes owed (taxes payable) of a company as of Dec. 31, 2011 is $100.
The company is expected to sustain losses over the first three months making their
2013 pro forma taxes of 40, 50, and 45 positive on the income statement (because they
get a tax credit for the losses) and negative in the balance sheet (because the taxes are
shown as negative liabilities). In April, the company is showing a profit so the tax
of 30 becomes a positive liability.
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The tax bill for 2012 is $160 to be paid over four quarters April, June, September,
and December of 2013 . The $100 from 2012 is due in March. Here's how you can construct the
format to calculate monthly taxes payable:
Balance Sheet Taxes:
Beginning Accrued Taxes
Plus: Taxes Accrued For the Month
Minus: Taxes Paid During the Month
Equals: Ending Accrued Taxes
Dec.
2012
100
Jan,
2013
100
(40)
0
60
Feb,
2013
60
(50)
0
10
Mar,
2013
10
(45)
(100)
(135)
The Ending Accrued Taxes will show up on the proforma balance sheet for 2013 because
values are shown as of the end of the month.
Developing Accounts Receivable is done the same way:
Beginning Accounts Receivable
+ Sales on Credit
- Collections of Accounts Receivable
= Ending Accounts Receivable
STRYKER (Consider only option 3)
1. State the business case for option #3, the PCB In-Sourcing proposal.
2. Use the projections provided in the case to compute incremental cash flows
for the PCB project, as well as its NPV, IRR, profitability index, and payback
period. The hurdle rate is 15%. Calculate MIRR assuming a reinvestment
rate of 15%. Note that architectural and engineering fees are tax
deductible as expenses.
3. Suppose the cash flows came in the middle of the year. How would this
affect the NPV? The initial investment will be paid for at the end of 2003.
The terminal value will come at the end of 2009. The discount rate stays
the same at 15%.
4. Based on your analyses, would you recommend that Stryker Instruments
fund this project?
SAMPA VIDEO INC.
Apr,
2013
(135)
30
(40)
(145)
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1. What is the value of the project assuming the firm was entirely equity
financed? What are the annual projected free cash flows? What discount
rate is appropriate?
2. Value the project using the Adjusted Present Value (APV) approach assuming
the firm raises $750,000 of debt to fund the project and keeps the level of
debt constant in perpetuity.
3. Value the project using WACC approach assuming the firm maintains a
constant 25% debt-to-market value ratio in perpetuity.
4. What are the end-of-year debt balances implied by the 25 % target debt-tovalue ratio?
5. How do the values from the APV and WACC approaches compare?
6. How do the assumptions about financial policy differ between the two
approaches?
7. Given the assumptions behind APV and WACC, when is one method more
appropriate or easier to implement than the others?
MONMOUTH, INC.
1. If you were Mr. Vincent, executive vice president of Monmouth, Inc., would you
try to gain control of Robertson Tool in May 2003?
2. What is the maximum price that Monmouth should pay, based on EBIAT
multiples analysis (Exhibit 6) using the market method?
3. What is the maximum price that Monmouth should pay based upon a discounted
cash flow valuation? Assume a debt beta of 0 and then do it with a debt beta of 0.2.
4. Why is Simmons eager to sell its position to Monmouth for $50 per share? What
are the concerns of and alternatives for each of the other groups of Robertson
shareholders?
5. What offer would you make in an effort to gain the support of the Robertson
family and the great majority of the stockholders, while improving the long-term
trend of Monmouth’s earnings per share over the next five years?
Assume a future debt to total capital ratio of 29%, and that the Robertson’s working
capital to sales ratio will drop to 40%. Use the Harris-Pringle beta formulas.
Assume debt cost at 5.5% pre-tax.
RADIO ONE
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1. Why does Radio One want to acquire the 21 stations? What are the
benefits and risks?
2. What price should Radio One offer for the 21 stations based upon a
transaction and trading multiples analysis?
3. Assuming that Radio One's stock price is 30 times BCF, can it offer
as much as 30 times BCF for the 21 new stations?
4. What should Radio One offer for the 21 new stations using the
market method?
5. What price should Radio One offer for the 21 new stations using the
income method?
You can make the following assumptions:
a. Corporate expenses will be 2% of BCF for the new acquisitions.
b. The tax rate is 34%.
c. Use Exh. 7 to come up with working capital. Assume that the
required cash is 3 % of Net Broadcast Revenue outlined in Exh. 6 for
1999. Apply your working capital ratio to Net Revenue (Potential New
Markets in Exh. 9) to obtain working capital for future years.
d. Depreciate capital expenditures on a straight-line basis over five
years.
e. Assume that Net Revenue and EBITDA both grow at a 10 percent rate
after 2004, but slow to 4% after 2015.
f. Assume that the local marketing arrangement fees part of BCF are
negligible.
g. Assume Rm-Rf, the market risk premium, is 5%.
Besides these assumptions, here are some hints:
1. Be very sure you know how BCF is calculated.
2. Be very careful what you include in working capital. Remember our
definition.
3. Income taxes payable in the balance sheet are very high in 1999
probably because of the rapid growth in 1999. I would replace the
$1.532 million with, say, $300,000 to get a better long-term working
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capital ratio. The deferred income taxes may have had to do with the
acquisitions, so they may disappear in the future.
HERBERT E. KIERULFF (BIO)
Seattle Pacific University
School of Business and Economics
In 1980, Dr. Herb Kierulff joined Seattle Pacific University and has been the
Snellman Professor of Entrepreneurship and Finance since 1983. During the 19982000 academic years he was Visiting Professor at the Warsaw School of Economics,
Warsaw, Poland.
Herb has consulted on a part time basis throughout his career, primarily in the fields
of start-ups, financial planning and turnaround management. His diverse clientele
has ranged from independent inventors and entrepreneurs to corporate managers
at TRW and Microsoft; the turnaround firm of Durkee, Sharlit Associates;
government agencies including the U.S Department of Energy, the U.S Federal
Laboratories’ Technology-transfer Initiatives Program, the Small Business
Administration, the Washington State Small Business Development Center; and
educational institutions here and abroad.
From 1970 to 1980, he taught at the University of Southern California. While there,
he co-founded and was Director of the first large scale graduate Entrepreneurship
Program in the world. It is now the Lloyd Greif Center for Entrepreneurial Studies
and has consistently been rated among the top entrepreneurship programs in the
U.S. He was awarded the Justin Dart Prize for this Program, and became a Director
Emeritus in 1998.
Prior to 1970, Herb spent seven years in industry in both line and staff positions. At
TRW, Inc., he did long and short term planning at the divisional level, joint venture
management, and preparation of technology commercialization plans. At Security
Pacific Bank, he managed a team responsible for GDP forecasts and specialized
industry studies. At Sears Roebuck he managed two departments.
Herb enlisted in the Army—63d Infantry Division (Reserve)—in 1960 and was
honorably discharged in 1966. From1963 to 1966 he was assigned (TDY) to the
Strategic Intelligence Unit operating from UCLA.
He is the author of a book, The Economics of Decision, and of more than 40 articles
appearing in Harvard Business Review, California Management Review, Business
Horizons, Management Science, and other U.S. and foreign publications. He holds a
B.A. in Economics from Stanford University. His MBA and Doctor of Business
Administration (Business Economics) degrees are from USC.
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Herb has three children and lives with his wife, Ginny, in Kenmore, Washington.