Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Need help! How to calculate this problem, please show the steps, thank you! Question (20 marks) Suppose you are considering an investment in the common

image text in transcribedNeed help! How to calculate this problem, please show the steps, thank you!

Question (20 marks) Suppose you are considering an investment in the common shares NewTel Limited, a telecommunications company which delivered a return on common equity (ROCE) of 18.11% for the 2018 year. A sell-side analyst argues that this ROCE is a very strong result and well above the average return on Australian shares over the past 30 years (which is about 9% per annum), and therefore the company should be valued at a significant premium to book value. The analyst has also provided you with the following reformulated financial statements: Reformulated 2018 income statement ($ millions): Operating Income After Tax 36 Net Financial Income 7 Comprehensive Income 43 Reformulated balance sheet ($ millions): 2018 2017 175 131 Operating Assets Operating Liabilities 28 27 Net Operating Assets 147 104 Financial Assets 109 125 Financial Obligations 6 4 Net Financial Assets 103 121 Common Equity 250 225 Required: (a) Decompose the firm's ROCE into components representing operating profitability (RNOA), financial leverage and operating spread. Use the average of beginning and ending balance in calculations. (5 marks) (b) On the basis of your answer to part (a) and without calculations, evaluate the company's profitability and the analysts' statement regarding the company's valuation (i.e. its expected premium over book value). Specifically, discuss the drivers of the firm's ROCE, whether you agree or disagree with the analyst about the strength of the firm's profitability and why, and whether you agree or disagree with the analysts' valuation and why. (8 marks) (c) The analyst also claims that the company is likely either to pay a special dividend or to repurchase shares. Use your results from part (a) to show the effect on the firm's ROCE of a $50 million special dividend, paid out of financial assets. (4 marks) (d) Suppose that you are considering an alternative investment in the shares of Fresa Limited, a company that operates food stores. Would a decomposition of operating profitability into profit margin and asset turnover assist you in comparing NewTel with Fresa? Why or why not

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Corporate Fraud Prevention And Detection

Authors: Joseph T. Wells

5th Edition

1119351987, 9781119351986

More Books

Students also viewed these Accounting questions

Question

9.8 Describe leadership development and its impact

Answered: 1 week ago

Question

9.6 Explain what management development is and why it is important.

Answered: 1 week ago