Financial Management & Markets

FIN 601: Financial Management and Markets Instructor: Dr. Jinsuk Yang Case Study #4

Instructions:

• Case Study 4 is due by 11:00 pm CST, November 30, 2020.

• What you see in the Lecture videos is the example. I have updated all the data. So, use this instruction and CS4

format in the “Module 5 Assignments” folder.

• To complete the Case Study 4, download the Excel file: Case Study 4 format. (Module 5 > Module 5 Assignments)

• Total scores for Case Study 4 are 30 points.

• You must submit the Case Study 4 through Blackboard to earn credits.

• Any late submission will not be accepted.

• With Case Study 4, you will learn how to value a business by applying the Market Approach. We will use Northrop Grumman and two comparable companies. This is a very simplified version of the Market Approach. The professionals use more sophisticated methods when applying the market approach. However, this Case Study will help you understand the basic components of the Market Approach.

Step1: Download the file listed below from “Module 5 Assignments” folder.

• Excel file: “Case_Study_4_format”

Step 2: Go to www.sec.gov and find “Consolidated statements of earnings (or income)”, “Consolidated statements of financial position (a.k.a. Balance sheet)”, and “Consolidated statements of cash flows” of the following companies.

(All information for Step 2 is given in the spreadsheet of “Case_Study_4_format” file)

• We are going to use the following companies as “Guideline Public Companies”.

 Raytheon Company (Ticker: RTN) & General Dynamics Corporation (Ticker: GD)

• The subject company is:

 Northrop Grumman (Ticker: NOC)

Step 3: Fill the empty boxes in the “Debts” spreadsheet. (This is the same one as you did for the Module 4 CoD Example) (10 points)

1. Use the following tables to complete the tables in the “Debts” spreadsheet.

RTN (Raytheon Company):

          We are not using this bond because the maturity date passed and we are not able to obtain detailed information.

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FIN 601: Financial Management and Markets Instructor: Dr. Jinsuk Yang Case Study #4 GD(General Dynamics Corporation):

     We are not using these two bonds because they are missing “last yield.” CS4 format excludes these two bonds.

2. Compute “MV” and “Total MV”

• MV (Market value) is computed by the following formula: • 𝑀𝑀𝑀𝑀 𝑜𝑜𝑜𝑜 𝑏𝑏𝑜𝑜𝑏𝑏𝑏𝑏 = 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣 𝐵𝐵𝑜𝑜 𝑏𝑏𝐵𝐵𝑏𝑏𝑏𝑏∗𝐿𝐿𝑣𝑣𝐿𝐿𝐿𝐿 𝐿𝐿𝑣𝑣𝑣𝑣𝑣𝑣 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑣𝑣

100

 • Total MV is the sum of all the MV of each bond

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FIN 601: Financial Management and Markets Instructor: Dr. Jinsuk Yang Case Study #4 Step 4: Fill the empty boxes in the “Multiples” spreadsheet.

• Table 1 (10 points):

o We are using the 2019 year from the financial statements.

o Most of the empty boxes can be easily filled up by using the spreadsheets of financial statements. o The definition and equation for accounting items are provided below:

 Revenue

Some companies use different terms for “revenue.”

Total net sales = Total sales = Revenue (which is total revenue)

If you take a look at “income statement”, you might be able to figure out which one you need to use.

 Grossmargin(orGrossprofit)

It is the difference between the total net sales (or revenue) and the COGS, Cost of Goods Sold (or Cost of sales). There are two costs of sales: costs of sales – products & cost of sales – services. The total COGS is the sum of these costs. The income statements provided by the instructor has “Gross Margin.” So, use the value of “Gross Margin” for your CS4.

 General and administrative expenses & Operating expenses

After subtracting the COGS from revenue, we get “gross margin.” Then, we subtract additional expenses related to all the operating. These expenses are called “General and administrative expenses” and “Operating expenses.” Then, we subtract these expenses from “gross margin” to derive “operating income.”

The information can be found in the Income Statement.

Operating income is also given in the Income Statement. But, for your benefit, try to find the operating income by subtracting the “General and administrative expenses” from the “Gross margin”.

 Totaloperatingexpenses

Total operating expenses can be found by adding values: COGS + General and administrative expenses.

 Operatingincome

Operating income is equal to “Total net sales – Total operating expenses.”

 EBIT(Earningsbeforeinterestandtaxes)

To be accurate, EBIT is different from “Operating income.” But, in this CS4, we are using “Operating income” as EBIT.

 EBT(Earningsfromcontinuingoperationsbeforetaxes)

Some companies may have non-operating income or expenses. If so, we must consider these items to get the income from continuing operations before taxes.

 NetEarnings

It is also known as “Net Income, Earnings, or Income.”

 Depreciation and Amortization

This information can be found in the “Cash flow statement.”

Some companies report one item including both “depreciation” and “amortization.”

Other companies report “depreciation” and “amortization” separately. In this case, you need to add two items to compute the total “Depreciation and Amortization.”

 EBITDA

It stands for “Earnings before interest, taxes, depreciation, and amortization.” It can be found by summing “EBIT” and “Depreciation and amortization.”

 MVpershare

The information is given: Cell “B22” and Cell “C22” in the “Multiples” spreadsheet.

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FIN 601: Financial Management and Markets Instructor: Dr. Jinsuk Yang Case Study #4

 Numberofsharesoutstanding

The information is given: Cell “B23” and Cell “C23” in the “Multiples” spreadsheet. It is from the financial statements (10-K).

 MVofequity

It is widely known as “market capitalization”, which can be found by multiplying the “MV per share” with “Number of shares outstanding.”

 MVofdebts

You already found this, and it is in the “Debts” spreadsheet.

 MVIC:Marketvalueofinvestedcapital

MVIC = "MV of equity" + "MV of debts".

The capital raised by issuing bonds or equity will be recorded in the accounting book. But, the recorded values are different from the value in the market, which we referred to as “Market value.” You already found the MV of equity and MV of debts (in the “Debts” spreadsheet)

Please read the textbook to understand the difference between market value and book value. Also, please visit the following site: https://www.investopedia.com/articles/investing/110613/market- value-versus-book-value.asp

 BVIC: Book value of invested capital

BVIC = "Long-term debts" + "Stockholders' equity"

A company raises capital to invest in equipment, fixed asset, and so on. Book value implies that the raised capital recorded in the account book. There are two ways to raise capital: issue bonds or issue equity.

The value of total bonds is recorded in the book, and it is known as the “book value of debts.” If you look at the “Debts” spreadsheet, there is also “Book value of all bonds”. You might ask “why don’t we use the book value of bonds to find BVIC?” It is simply because, when the company filed the financial statements (Balance sheet), some bonds were not issued yet. So, we stick with the reported (in the financial statements) book value for debts (or bonds).

The value of equity (including all types of stocks and retained earnings) is also recorded in the book, and it is known as “stockholders’ equity.”

 Grosscashflow(a.k.a.Netoperatingcashflow)

It is the sum of “Net earnings” and “Depreciation and amortization”

The reason we add “depreciation and amortization” back to “net earnings” is that the “depreciation and amortization” is a non-cash transaction. And, we subtract this to find the net earnings or net income. However, if you look at the income statement, you might notice that there isn’t an accounting item, “depreciation and amortization.” It is because some companies break it down to a small amount and include them into operating expenses: cost of goods sold. Since we subtract non-cash transactions to get “net income”, we add it back to “net income” to find the “gross cash flow.”

 Debt/Equity ratio

We divide “MV of debts” by “MV of equity”.

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FIN 601: Financial Management and Markets Instructor: Dr. Jinsuk Yang Case Study #4 • Table 2 (10 points):

o Compute all the ratios for RTN and GD.  Price/Earnings

 𝑀𝑀𝑀𝑀 𝑜𝑜𝑜𝑜 𝑃𝑃𝑒𝑒𝑒𝑒𝑃𝑃𝑟𝑟𝑒𝑒 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃⁄𝐸𝐸𝐸𝐸𝑃𝑃𝑏𝑏𝑃𝑃𝑏𝑏𝐸𝐸𝐸𝐸 𝑃𝑃𝐸𝐸𝑟𝑟𝑃𝑃𝑜𝑜 = 𝑇𝑇𝑜𝑜𝑟𝑟𝐸𝐸𝑇𝑇 𝑃𝑃𝐸𝐸𝑃𝑃𝑏𝑏𝑃𝑃𝑏𝑏𝐸𝐸𝐸𝐸 (𝑜𝑜𝑃𝑃 𝑁𝑁𝑃𝑃𝑟𝑟 𝑃𝑃𝐸𝐸𝑃𝑃𝑏𝑏𝑃𝑃𝑏𝑏𝐸𝐸𝐸𝐸)

This ratio can be found by using the following equation:

 𝑀𝑀𝑀𝑀 𝑜𝑜𝑜𝑜 𝑃𝑃𝑒𝑒𝑒𝑒𝑃𝑃𝑟𝑟𝑒𝑒 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃⁄𝐸𝐸𝐸𝐸𝑃𝑃𝑏𝑏𝑃𝑃𝑏𝑏𝐸𝐸𝐸𝐸 𝑃𝑃𝐸𝐸𝑟𝑟𝑃𝑃𝑜𝑜 = 𝑇𝑇𝑜𝑜𝑟𝑟𝐸𝐸𝑇𝑇 𝑃𝑃𝐸𝐸𝑃𝑃𝑏𝑏𝑃𝑃𝑏𝑏𝐸𝐸𝐸𝐸

An alternative way to find this ratio is provided below:

= (𝑀𝑀𝑀𝑀 𝑜𝑜𝑜𝑜 𝑃𝑃𝑒𝑒𝑒𝑒𝑃𝑃𝑟𝑟𝑒𝑒)/(𝑇𝑇𝑜𝑜𝑟𝑟𝐸𝐸𝑇𝑇 𝐸𝐸h𝐸𝐸𝑃𝑃𝑃𝑃𝐸𝐸 𝑜𝑜𝑒𝑒𝑟𝑟𝐸𝐸𝑟𝑟𝐸𝐸𝑏𝑏𝑏𝑏𝑃𝑃𝑏𝑏𝐸𝐸) (𝑇𝑇𝑜𝑜𝑟𝑟𝐸𝐸𝑇𝑇 𝑃𝑃𝐸𝐸𝑃𝑃𝑏𝑏𝑃𝑃𝑏𝑏𝐸𝐸𝐸𝐸)/(𝑇𝑇𝑜𝑜𝑟𝑟𝐸𝐸𝑇𝑇 𝐸𝐸h𝐸𝐸𝑃𝑃𝑃𝑃𝐸𝐸 𝑜𝑜𝑒𝑒𝑟𝑟𝐸𝐸𝑟𝑟𝐸𝐸𝑏𝑏𝑏𝑏𝑃𝑃𝑏𝑏𝐸𝐸)

 𝑀𝑀𝑀𝑀 𝑝𝑝𝑃𝑃𝑃𝑃 𝐸𝐸h𝐸𝐸𝑃𝑃𝑃𝑃 𝐸𝐸𝐸𝐸𝑃𝑃𝑏𝑏𝑃𝑃𝑏𝑏𝐸𝐸𝐸𝐸 𝑝𝑝𝑃𝑃𝑃𝑃 𝐸𝐸h𝐸𝐸𝑃𝑃𝑃𝑃

   Price/PretaxEarnings

“Price” is “MV of equity”

“Pretax earnings” is “EBT,” which is “earnings before taxes.”

 Price/Grosscashflow “Price” is “MV of equity”

“Gross cash flow” is “Net earnings + Depreciation and amortization”

 Price/Operatingincome

“Price” is “MV of equity”

“Operating income” is “EBIT,” which is “earnings before interest and taxes.”

    Price/Bookvalue

This can be computed in two different ways.

 𝑀𝑀𝑀𝑀 𝑜𝑜𝑜𝑜 𝑃𝑃𝑒𝑒𝑒𝑒𝑃𝑃𝑟𝑟𝑒𝑒 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃⁄𝐵𝐵𝑜𝑜𝑜𝑜𝐵𝐵 𝑃𝑃𝐸𝐸𝑟𝑟𝑃𝑃𝑜𝑜 = 𝑆𝑆𝑟𝑟𝑜𝑜𝑃𝑃𝐵𝐵h𝑜𝑜𝑇𝑇𝑏𝑏𝑃𝑃𝑃𝑃𝐸𝐸′𝑃𝑃𝑒𝑒𝑒𝑒𝑃𝑃𝑟𝑟𝑒𝑒

 o Compute average and median of ratios  Using the Excel function

• Average: “=average(Cell # : Cell #)”

• Median: “=median(Cell #: Cell #)”

• We have only two guideline public companies; therefore, the average will be equal to the

median.

• To understand what is “median,” please visit the following link:

https://www.purplemath.com/modules/meanmode.htm

o Compute “Selected Multiple” by using the following equation:

 “Selected Multiple” can be considered as the “weighted average” of ratios from the guideline

public companies.

 Selectedmultiple=[(RatioofRTN)*(0.3)]+[(RatioofGD)*(0.7)]

We assume that “RTN” is more similar to our subject company. Therefore, we put 30% weight on the ratio of RTN and 70% weight on the ratio of GD.

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FIN 601: Financial Management and Markets Instructor: Dr. Jinsuk Yang Case Study #4

For example, let’s suppose that we select the “Price/Earnings” ratio (it becomes “selected ratio”) to compute the value of our subject company and that we have two guideline public companies (A and B). Let’s suppose that the ratio of A company is 5 and the ratio of B company is 7. And, we analyze that our subject company is more similar to A company (50% similar) than to B company (50% similar). Then, we can approximately estimate the “Price/Earnings” ratio of the subject company as “5*(50%) + 7*(50%) = 6.” Now, the value “5.6” becomes the “selected multiple.” Then we use this estimated ratio to compute the “Implied value” of our subject company.

o Compute the implied value

 Impliedvalue=(Selectedmultiple)*(Denominator-valueofNOC)

For instance, if the selected ratio is the “Price/Earnings” ratio, then (Selected multiple)*(Earnings of NOC) is equal to the implied value of NOC.

• Requirements

1. Your report must be in Excel file format.

2. You must find the value by using the Excel function. 3. Save the file as:

• Your file name must be “ ”

• You must save the file as “

4. Failure to comply with the instruction or requirements will result in a penalty.

FAQ:

 CS4-first name-last name

 Save as type: Excel Workbook

  • Selected multiple %

The lecture video shows a different % of similarity between the “subject company” and the

“guideline public companies.” Please follow the percentages indicated in this instruction.

• Questions related to “Cost of Debt”

First, please watch lecture videos in Module 4, “FIN 601: Module 4 Lecture - Cost of Debt.” Then, use Forum Q&As in Module 5 if anything needs further explanation.

”, not “CSV” or any other formats.

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