Unless noted otherwise, all dollar figures are in millions of U.S. dollars. Please round to millions of U.S. dollars (SXX million). Assume a 20% tax rate (it bounces around a little, but assume 20%). Don't worry about account titles as long as the type of account is clear (asset, liability, contra asset, revenue, etc.). 1. Valuation (26 points) This problem is self-contained. Do not refer to the financial statements or footnotes in other sections of the exam. The following are the 2021 and forecasted 2022 and 2023 balance sheets and income statements for SBD. Assume a tax rate of 20%, a discount rate of 8% and that interest-bearing debt on the balance sheet and interest expense will remain constant going forward. For purposes of this problem only, assume that there is no depreciation included in Cost of Sales. SBD had 155 million shares outstanding on December 31, 2021. Assume that all of the assets and liabilities on SBD's 2021 balance sheet are carried at approximate fair value, except that the original Stanley brand which was internally developed is worth $4,500, total Property, Plant and Equipment is worth only $1,200, a lawsuit that is not included in the liabilities on the balance sheet is expected to cost $500 to resolve and a Superfund environmental obligation which is included in "Other liabilities" at S100 is expected to cost $300 to remediate. INCOME STATEMENT Net sales 2021 2022 2023 $ 11,001 $ 11,402 $ 11,797 Cost of sales 6,928 7,100 7,250 Selling, general and admin. 2,601 2,690 2,775 Depreciation expense 240 250 260 Other-net 452 452 452 Interest expense 160 160 160 Earnings from before income taxes 620 750 900 Income taxes 124 150 180 Net income 496 600 720 BALANCE SHEET Cash 2021 2022 2023 496 506 486 Accounts receivable 1,633 1,783 1,713 Inventories 1,486 1,386 1,406 Prepaid expenses 170 190 200 Property, plant and equipment, net 1,485 1,495 1,535 Goodwill 7,565 7,565 7,565 Trade names 1,703 1,803 1,853 Other assets 1,996 1,996 1,996 Total assets $16,534 $16,724 $16,754 Accounts payable 1,576 1,526 1,606 Accrued expenses 1,243 1,303 1,393 Interest-bearing debt 4,202 4,202 4,202 Other liabilities 2,634 2,634 2,634 Contributed capital 5,321 5,321 5,321 Retained earnings 3,485 3,725 4,035 Accumulated other comprehensive loss -473 -473 -473 Less: common stock in treasury -1,454 -1,514 -1,964 Total shareowners equity 6,879 7,059 6,919 Total liabilities and shareowners equity $16,534 $16,724 $16,754 1. Estimate the fair value of a share of SBD's stock as of December 31, 2021 using the discounted cash flow approach we applied in class. Assume that the sum of all cash flow terms 2024 and beyond total $16,000 when present valued to December 31, 2021. You may ignore any "excess cash" (if you don't know what that means, ignore it). (15 points) 3 2. Estimate the fair value of a share of SBD's stock as of December 31, 2021 using the discounted dividend approach we applied in class. Assume that the sum of all terms 2024 and beyond total S12,000 when present valued to December 31, 2021. (5 points) 3. Estimate the fair value of a share of SBD's stock as of December 31, 2021 using the balance sheet approach we applied in class. (5 points) 4. Given your computations and the fact that SBD is trading at about $90 per share, would you advise buying or selling SBD shares? (1 point) II. Accounts Receivable (23 points) 1. What journal entries did SBD record during 2021 that explain the change in Accounts Receivable, net. (i.e., your answer should explain why "Accounts receivable, net" increased from $1,526 to $1,633)? You may assume that all sales are on credit and there are no recoveries. Note that the footnotes reference a sale of accounts receivable which should be taken into account. (14 points) 5 2. During 2020, SBD closed facilities which were made redundant by the acquisition of Niscayah. Assume that they recognized a charge of S125 associated with closures during 2020 of which S50 was for severance and other benefits to be paid to employees during 2021 and 2022 (the employees were terminated in 2020) and $75 million was for impairment of the property, plant and equipment. $40 of the severance was paid in 2021, with the remainder to be paid in 2022. What journal entries would SBD have recorded in 2020 and 2021? This question is self-contained. (5 points) 2020 2021 6 3. What would be the effect on pretax income and total assets of the following. Assume that SBD is good at estimating bad debts and warranties (except in part d). Please provide a direction and amount for pretax income and total assets and fill in "0" if nothing happens. (4 points) a. SBD writes off $1 of accounts receivable related to a bankrupt customer; Pretax Income: Total Assets: b. SBD recovers $1 of accounts receivable previously written off: Pretax Income: Total Assets: c. SBD pays out SI of cash to satisfy a warranty on a defective drill; Pretax Income: Total Assets: d. At year-end, SBD realizes that the Allowance for Doubtful Accounts is too high by $100 and adjusts it to the new estimate: Pretax Income: Total Assets: III. Manufacturing (20 points) 1. Estimate the number of days between when SBD buys raw materials and when they sell the final product. Assume that inputs into Work-In-Process Inventory are 50% materials, 25% labor (paid in cash) and 25% overhead (all depreciation) and that there is no obsolescence. (8 points) 2. Estimate the number of days between when an employee begins working on a new batch of product on the plant floor and when the product is sold. (2 points) 3. Assume that SBD sells product on account and the customer has 30 days to pay. In addition, assume that SBD purchases raw materials on account and has 45 days to pay its suppliers. Estimate the time from when SBD pays its suppliers until it collects from customers. (3 points) 8 4. The following are hypothetical transactions (1 point each): a. Suppose a plant employee is paid $100 in January for work done in January assembling a drill that is finished in February, sold on account in March and the sales price is collected in April. In which month will the $100 be recognized as an expense on the income statement (circle one): January February March April Never b. Suppose that a scientist is paid $100 in January for research conducted in January on an early-stage experimental drill. A drill based on the invention is manufactured in February, sold on account in March and the sales price is collected in April. In which month will the $100 be recognized as an expense (circle one): January February March April Never c. Suppose SBD pays $100 in January for titanium that goes into a drill that is manufactured in February, sold on account in March and the sales price is collected in April. In which month will the $100 be recognized as an expense (circle one): January February March April Never d. Suppose SBD prepays $100 in January for gas to heat a production facility in February. The production facility manufactures a drill in February that is sold on account in March and the sales price is collected in April. In which month will the $100 be recognized as an expense (circle one): January February March April Never e. Suppose that SBD pays $100 in January for gas to heat a SBD advertising office. The resulting ads run in January. A drill of the type featured in the ads is manufactured in February, sold on account in March and the sales price is collected in April. In which month will the $100 be recognized as an expense (circle one): January February March April Never f. Suppose that SBD typically sells its product with a warranty and estimates that 2% of drills will be returned under warranty (assume that SDB is accurate in assessing likely warranty costs). All warranties are satisfied by replacing the defective drill with a new drill. SBD sells a drill in January and in March the drill is returned under warranty. The warranty is satisfied with a drill that was manufactured in February and cost $100 to produce. In which month will the $100 be recognized as an expense (circle one): January February March April g. Suppose that SBD sells its product on account and estimates that 2% of accounts receivable will ultimately be uncollectible (assume that SDB is accurate in assessing likely bad debts). SBD sells a drill for $100 in January and in March SBD learns that the customer is bankrupt and will not repay. In which month will the $100 be recognized as an expense (circle one): January February March April 10 IV. Intercompany Investments (19 points) Suppose that everything else was identical on SBD's balance sheet and income statement except that, during 2020, SBD used S100 of cash to purchase marketable debt securities. Assume that, at year-end 2020, the fair value of those securities was $120 and they received interest of $5 in cash during 2020. During 2021, they received $5 of interest in cash and sold the securities for $110 of cash. Relative to not having purchased the securities, what would the total effect of having purchased those securities be on total assets, total equity and pretax income assuming the securities were Equity Securities, Securities Available for Sale Debt Securities or Debt Held to Maturity? For purposes of this question only, assume no taxes. (15 points) Please read the following example carefully. If SDB purchased equipment in 2020 for $100 cash with a five year life and there was a full year of depreciation in 2020, the answer would be: 2020 Total Assets: -$20 Total Shareholders' Equity -$20 Pretax Income: -$20 2021 Total Assets: -$40 Total Shareholders' Equity -$40 Pretax Income: -$20 If the marketable securities were classified as Securities Available for Sale DEBT 2020 Total Assets: Total Shareholders' Equity: Pretax Income: 2021 Total Assets: Total Shareholders' Equity: Pretax Income: If the marketable securities were classified as Equity Securities 2020 Total Assets: Total Shareholders' Equity: Pretax Income: 2021 Total Assets: Total Shareholders' Equity: Pretax Income: If the marketable securities were classified as Held-to-Maturity Securities (2020 only) 2020 Total Assets: Total Shareholders' Equity: Prelax Income: 3. What journal entry did SBD record relative to its Infastech acquisition in 2020? (4 points) 12 STANLEY BLACK & DECKER BALANCE SHEET Assets Current Assets Cash and cash equivalents Accounts receivable, net Inventories Prepaid expenses 2021 2020 496 716 1,633 1,526 1,486 1,305 170 199 Other current assets 182 366 Total Current Assets 3,967 4,112 Property, Plant and Equipment, net 1,485 1,330 Goodwill 7,565 7,016 Trade Names 1,703 1,681 Other Intangible Assets 1,814 1,705 Total Assets $16,534 $15,844 Liabilities and Shareowners Equity Current Liabilities Short-term borrowings Accounts payable Accrued expenses Total Current Liabilities Long-Term Debt Other Liabilities 403 12 1,576 1,346 1,243 1,717 3,222 3,075 3,799 3,527 2,634 2,516 9,655 9,118 Total Liabilities Shareowners Equity Common sock, par value $2.50 442 442 Additional paid in capital 4,879 4,879 Retained earnings 3,485 3,300 Accumulated other comprehensive loss -473 -798 Less: common stock in treasury -1,454 -1,097 Total Shareowners Equity 6,879 6,726 Total Liabilities and Shareowners Equity $16,534 $15,844 13 INCOME STATEMENT Net Sales 2021 2020 $11,001 $10,148 Costs and Expenses Cost of sales 7,068 6,452 Selling, general and admin. 2,701 2,489 Provision for doubtful accounts 23 38 Other-net 442 485 Interest income -13 -10 Interest expense 160 144 Total Costs and Expenses 10,381 9,598 Earnings before income taxes 620 550 Income taxes 124 110 Net Income $496 $440 14 STANLEY BLACK & DECKER FOOTNOTES 1. Accounts Receivable and Allowance for Doubtful Accounts Allowance for Doubtful Accounts: Year Ended 2021 Year Ended 2020 Year Ended 2019 Beginning Balance Charged to Write-offs Allow. on Expense Receivables Ending Balance Sold $66 23 -12 -7 $70 $53 38 -19 -6 $66 $54 24 -21 -4 $53 The Company has an accounts receivable sale program that expires on December 11, 2022. According to the terms of that program the Company sells certain of its trade accounts receivable to a third-party financial institution for cash. The purpose of the program is to provide liquidity to the Company. Receivables, and the associated Allowance for Doubtful Accounts, are removed from the Company's Balance Sheets when the receivables are sold. During 2021 and 2020, $85 million and $80 million, respectively, of net receivables were sold. Gross receivables sold totaled $92 million for the year ended December 31, 2021 and $86 million for the year ended December 31, 2020. These sales resulted in a pre-tax loss of $2 million and $3 million for the years ended December 31, 2021 and December 31, 2020, respectively. 2. Inventories Finished products Work in process Raw materials Total 3. Acquisitions 2021 1,082 2020 957 129 122 275 $1,486 226 $1,305 On February 27, 2020, the Company acquired a 100% ownership interest in Infastech for a total purchase price of $826, paid in cash. Infastech designs and manufactures fastening applications for a diverse blue-chip customer based in a variety of markets. The following table summarizes the estimated fair values of assets acquired and liabilities assumed, as well as the original book values in Invastech's records. Fair Value Book Value Accounts Receivable 117 117 Inventories 95 95 Property, Plant and Equip. 48 20 Trade Names 222 18 Other Assets 80 80 Accounts Payable -99 -99 Accrued Expenses -38 -38 Other Liabilities -109 -89 Total Identifiable Net Assets $316 $104