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Exercise Questions

Exercise Questions. Specialty Eateries—PNRA Yiwen Lin. Question 1a. Question 1b.

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Exercise Questions

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  1. Exercise Questions Specialty Eateries—PNRA Yiwen Lin

  2. Question 1a

  3. Question 1b

  4. The return on net enterprise assets (RNEA) is different because in the first method R&D is expensed. However, in the second scenario, R&D is capitalized and then amortized over 5 years. This resulted different net enterprise assets. Before the company reached its steady stage, which is in year 2018, the EPAT is different. Since RNEA equals EPAT divided by average NEA, both variables changed when account R&D differently under two scenarios. Therefore, RNEA is different despite the company reached steady state in 2008. Same rule applied for REI, since EPAT and NEA changed under different accounting treatments, the calculated REI value changed as well. Question 1c

  5. Question 1d

  6. The company stopped investing in R&D in 2020. In the first scenario, the EPAT increased from 60 to 160. Since average NEA remains the same at 80, the RNEA increased from 0.75 to 2 solely due to increased EPAT. The increased EPAT also resulted in the increase in REI to 152 in 2020. In the second scenario, The amortization increased to 80 in 2020, but no R&D is capitalized in 2020. Therefore, NEA dropped by 100 to 180 in 2020. Accordingly, RNEA increased to 0.3333 solely due to decreased NEA in 2020. For REI, since the EPAT and the previous year NEA remains the same, REI did not change in 2020. Question 1d Cont.

  7. Question 1e

  8. Question 1e Cont.

  9. These valuations resulted in the same enterprise value of 334 as of 2013. The REI model anchors the valuation on the current book value of NEA and future REI serves as the adjustment to counter the effect that accounting rules and procedures have on the valuation. This further demonstrated that different accounting method (expense or capitalize R&D) does not affect the valuation of enterprise value. Why?

  10. The company has not reached steady-state in 2016. Therefore, if we value the firm by forecasting only to 2016. The accounting rules and procedures would result in different enterprise values under two scenarios. Therefore, it is important to make sure that the company has already reached the steady state in order to calculate the continuing value to avoid these mistakes. Question 1f

  11. Question 1g

  12. Though sales are growing at a slower rate in 2016, 2017, and 2018 and declining in 2019, the R&D expenditures are declining at a faster rate from 2016 to 2019. The declined value compensated to the slower growth rate in sales. Therefore, the EPAT increased from 2016 to 2019. Since R&D is expensed in each period rather than capitalized and amortized, NEA remains the same. Therefore, RNEA increased solely due to increased EPAT. Why?

  13. Question 2a

  14. As shown in the previous calculation. The five-year straight-line depreciation method yields a higher EPAT (489 vs. 389) compared to the three-year straight-line depreciation method. The main reason behind this is the lower depreciation taken in the first couple years under the five-year SL method. Question 2b

  15. Question 2c

  16. Question 2c Cont.

  17. As shown in the calculation, both depreciation methods result in same enterprise value. Therefore, the depreciation method does not affect the intrinsic value of the firm at the time of the IPO. Same enterprise value

  18. Given efficient market and rational investors, despite the higher earnings reported at the time of the IPO, the investors would know the intrinsic value of the firm, which does not change under both depreciation methods. Therefore, market will not give a higher value due to higher earnings. The stock price would stay the same. Question 2d

  19. The firm had already reached steady state in 2021. Even though investors cannot exercise their stock options until 2022, given perfect market and rational investors, they would know the intrinsic value of the firm would not change after the steady-state under either depreciation method. Therefore, it would not make any difference to use both methods to calculate the enterprise value in 2022. Question 2e

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