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(Solved) During 2010, WIDGET Inc. earned a return on net operating assets (RNOA) of 14 percent from sales of $900 million and after-tax operating income of...


  • During 2010, WIDGET Inc. earned a return on net operating assets (RNOA) of 14 percent from sales of $900 million and after-tax operating income of $60 million. Its required return on operations is 10 percent. The December 31, 2010 balance sheet reports net operating assets (NOA) of $450 million, net financial obligations (NFO) of $50 million and common stock equity (CSE) of $400 million.

Management forecasts that RNOA is likely to continue at the same level in the future with organic growth in sales of 3 percent and growth in net operating assets to support sales of 3 percent per year.

As the past year was ending, Management considered introducing a new product at the start of 2011 that is expected to increase future sales growth rate from 3 percent to 4 percent while maintaining the current profit margin of 7 percent. But the plan will require additional investment of $90 million in net operating assets that will reduce ACME’s asset turnover from 2.0 to 1.67 going forward.

Calculate the impact the new product will have on the value of the firm. (Hint: Use a ReOI valuation)

1. During 2010, WIDGET Inc. earned a return on net operating assets (RNOA) of 14 percent
from sales of $900 million and after-tax operating income of $60 million. Its required
return on operations is 10 percent. The December 31, 2010 balance sheet reports net
operating assets (NOA) of $450 million, net financial obligations (NFO) of $50 million and
common stock equity (CSE) of $400 million.
Management forecasts that RNOA is likely to continue at the same level in the future with
organic growth in sales of 3 percent and growth in net operating assets to support sales
of 3 percent per year.
As the past year was ending, Management considered introducing a new product at the
start of 2011 that is expected to increase future sales growth rate from 3 percent to 4
percent while maintaining the current profit margin of 7 percent. But the plan will require
additional investment of $90 million in net operating assets that will reduce ACME’s asset
turnover from 2.0 to 1.67 going forward.
Calculate the impact the new product will have on the value of the firm. ( Hint: Use a ReOI
valuation)
2. As Widget Co.’s fiscal year-end was nearing, the CFO presented the CEO expected
financial statement results for the year. The after-tax operating income (OI) was to be
$12.6 million resulting in a return on beginning-of-period net operating assets (NOA) of
14.0 percent. “This won’t do!,” declared the CEO. “The Street is expecting a 15.0 percent
RNOA,” the CEO continued and sent the CFO back to her office to find any “accounting
tricks” to meet the target.
a. How much after-tax operating income does the CFO need to add to meet the
Street’s expectations?
b. What is the likely effect of the earnings management on NOA in the current year
and its implication for RNOA the following year?
c. Explain how, in general, a manipulation of current operating income has an
“accounting effect,” but does not have a “valuation effect.”

 


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