Download Analyzing Financial Statements: Quality of Earnings and Smoothing in MSc Finance and more Study Guides, Projects, Research Finance in PDF only on Docsity!
FINANCIAL STATEMENT ANALYSIS
MSc Finance
Tutorials week commencing Monday 30 th November 2009
QUESTION 1
a) Identify four quality of earnings issues reported in the case and discuss the analysts’ concern about each.
- Nonrecurring gains
- Lower tax rate
- Currency translations
- Share buyback
Question 2
Rogan
Interest payable
Debt % In terest
De velop men t loan 6,0 00,0 00 11% 66 0,00 0
M ortgag e de bt 10,0 00,0 00 9% 90 0,00 0
De bent ures 40,0 00,0 00 10% 4,00 0,00 0
In terest p aya ble 5,56 0,00 0
Capi ta lise d intere st
De velop men t loan 6,0 00,0 00 11% 66 0,00 0
De bent ures 4,0 00,0 00 10% 40 0,00 0
Ave ra ge b alance 10,0 00,0 00
Ca pit alised int erest 1,06 0,00 0
Interest ex pense 4,50 0,00 0
Q3: Track plc.
The most important thing about this question is to demonstrate your understanding of earnings smoothing and why a company would want its profit figures to appear consistent from year to year. In an exam situation, marks would be awarded for insightful discussion rather than a “correct” answer.
Two things you should immediately note:
- Increasing an asset’s expected useful life (assuming straight line basis) will result in a reduction in the depreciation expense in any one year.
- Not charging depreciation on work-in-progress benefits companies by imparting a delay on any depreciation charged in the years of construction (obviously!).
Answers to parts i to iv:
i) No change (2002 is consistent with previous years)
ii) No change (change in depreciation policy never affects cash flows)
iii) Initial rise (lower depreciation charge) and then probably smoothing effect as new assets are recognised and push up depreciation. Under the old depreciation policy, the completion of construction plans would have meant a
corresponding large increase in the depreciation expense in any given year (and thus a fall in observed profit).
Additionally, however, it would be expected that completion of the construction around 2005 would lead to increases in profit (through attraction of new customers and a more efficient use of new assets). Together these outcomes would cause a fluctuation in profit under the old policy. The introduction of the new policy entails that there is a time delay in providing for depreciation until completion of the new assets, so the rise in profits and the rise in depreciation will offset each other because they will both occur in the same year, and, that depreciation when it does begin in 2005 will be a much smaller sum because of the extended asset lives being used. The overall effect of this policy change then, is to prevent observed profits from fluctuating. Without a reasonably detailed examination it will appear to investors that the profit figure is reliable over time and thus a safer investment.
iv) No change (see ii).
