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Case 5: Analysis of Inventories and Accounting for Obsolete Inventory 26 1. Raw materials inventory includes direct material costs associated with purchasing raw materials in order to manufacture the product as well as freight-in costs related to acquiring the materials. Materials could include things such as wood or plastic that are directly involved in production of the product. The work-in-process inventory also includes direct materials costs, and also includes direct labor costs and overhead incurred during the period. Direct labor costs include not only wages accrued by workers, but also employee benefits; overhead includes overtime and supervisor salaries earned during the period. The finished goods inventory includes all costs from the work-in-process inventory that have been completed during the period. 2. Inventories are recorded net of unmarketable or obsolete inventory. This allowance is based on current inventory levels, past sales trends, and historical data in addition to management's estimates on market conditions and predictions for future market conditions and product demand. All of these things are subject to change, and therefore management must make proper and conservative estimates in order to have a correct estimate of inventory, which should be approximately equal to the fair value of the inventory. 3. a. This amount for unmarketable or obsolete inventory does not appear as a line item within the financial statements. This amount may be disclosed in the notes to the financial statements, but without such a note, it does not appear on the financial statements. b. Gross inventories 2011 - $243,870 Inventory amount on the balance sheet for 2011 - $233,070 Balance in allowance account at year-end 2011 - $10,800 27 Gross inventories 2012 - $199,214 Inventory amount on the balance sheet for 2012 - $211,734 Balance in allowance account at year-end 2012 - $12,520 c. The allowance for obsolete and unmarketable inventory would be attributed to the finished goods and raw materials inventories. The portions attributable to each type of inventory would be based on the proportion of total inventory that each type makes up. Obsolete inventory, by nature, could not be attributed to work-in-process inventory because the units would have to be finished or not yet begun to be considered unmarketable; for example, a portion of raw materials could be considered obsolete if some amount of raw materials was unused at the end of the period. 4. 2012 Cost of goods sold 13,348 Allowance for obsolete and unmarketable inventory 13,348 Allowance for obsolete and unmarketable inventory 11,628 Finished goods inventory 11,628

81. Our company (A) is going to buy another company (B). We want to value the shares of

B and, therefore, we will use three alternatives of the structure Debt/Shareholders'

Equity so as to obtain the WACC: 1) present structure of A; 2) present structure of B,

and 3) structure used by A to finance the acquisition of B's shares. We will value the

company B by applying these three alternatives and then take as a reference the

average of the results. Is this correct?

82. When valuing the shares of my company, I calculate the present value of the expected

cash flows to shareholders and I add to the result obtained cash holdings and liquid

investments. Is that correct?

83. I think the Free Cash Flow (FCF) can be obtained from the Equity Cash Flow (CFac) by

using the relation: FCF = CFac + Interests - D. Is this true?

84. Is the relation between capitalization and book value of shares a good guide to

investments?

85. Does it make any sense to form a portfolio comprised of companies with a higher

return per dividend?

86. A financial consultant is valuing the company I set as an objective (an entertainment

centre) by discounting the cash flows until the end of the dealership at 7.26% (interest

rate on 30-year-bonds = 5.1%; market premium = 5%, and Beta = 0.47%). 0.47 is a

beta provided by Bloomberg for Kinepolis (the company whose activity is the

management of several cinemas in the EU), in function of the Dax Index. Is it correct

to use the beta of Kinepolis in this valuation?

87. I am confused because I see different formulae to lever and unlever betas in different

books (Damodaran, McKinsey, Brealey & Myers ...). Which is the correct one?

IESE Business School-University of Navarra - 7

88. An investment bank affirms that the VTS (Value of Tax Shields) of my company is

equal to each year's VTS using the WACC as a discount rate. I told them that I have

never seen such a calculation of the VTS but they answered that it was a habitual

practice. Is that true?

89. I have two valuations of the company we set as an objective. In one of them, the

present value of tax shields (D Kd T) was calculated using Ku (required return to

unlevered equity) and, in the other one, using Kd (required return to debt). The second

valuation is a lot higher than the first one, but which of the two is better?

90. My investment bank told me that the beta provided by Bloomberg incorporates the

illiquidity risk and the small cap premium because Bloomberg does the so-called

Bloomberg adjustment formula. Is that true?