Corporate Finance and Financial Statement Analysis

Assignment Brief

BA7031: Corporate Finance and Financial Statement Analysis

PART 1: USING FINANCIAL STATEMENTS FOR EQUITY VALUATION (50 MARKS)

Part 1 of the assignment is intended to help you develop practical skills of Fundamental Analysis. The assignment provides you with an opportunity to apply valuation technologies that are commonly used in practice and that incorporate financial statement information into equity valuation models. The focus is on ex-post or backward validation of alternative valuation approaches.

1. You are required to provide a valuation of the common stock (equity) in ANY ONE of the firms listed below, as of the end of 2015, using the actual - real - financial results reported by the firm in 2016 and 2017:
2. Your valuation should utilise TWO valuation technologies one of which MUST be either Residual Earnings Analysis or Earnings Growth Analysis.
3. You should supply an analytical commentary on the usefulness of the two techniques that you use, substantiating your conclusions with the results from the valuation.
4. You must prepare a concisely written report for this part of the assignment and are required to include in your written report, as an appendix, entire sets of all the annual financial statements for the chosen firm for the period 2015-2017. Please note that NO other appendices are allowed.
5. Your written report must contain clear references to the relevant portions of the included in the report financial statements for the firm being analysed, and those relevant portions of the appended financial statements should be highlighted.

PART 2: USING FINANCIAL STATEMENTS FOR CREDIT RISK ANALYSIS (50 MARKS)

Part 2 of the assignment is intended to help you develop practical skills of credit analysis. The assignment provides you with an opportunity to evaluate the financial status of a potential corporate borrower, using ratio analysis of the financial statements.

1. You are required to carry out an analysis of financial statement ratios that indicate the creditworthiness of a corporate borrower, that is, the corporate borrower’s ability to pay its debts on scheduled times, for ANY ONE of the firms listed below, over the period 2015-2017: 
2. You should calculate the FOUR financial statement ratios that you identify as the most pertinent for credit risk assessment of your particular firm, making sure to address short-term liquidity, long-term solvency, and operating profitability. You must justify your choice of each of those four ratios.
3. You must supply a brief commentary on the dynamics of credit quality for the firm being analysed over the period 2015-2017. Your commentary must briefly outline entailing implications for pricing of the firm’s debt of the risk of debt default. You should discuss whether the credit risk of the firm - as implied by the four ratios – appeared to be improving, deteriorating, or remaining stable. You must substantiate your conclusions with evidence and offer plausible causes of any significant changes in credit risk detected through your ratio analysis.
4. You must prepare a concisely written report and are required to include in your written report, as an appendix, entire sets of all the annual financial statements for the chosen firm for the period 2015-2017. Please note that NO other appendices are allowed.
5. Your written report must contain clear references to the relevant portions of the included in the report financial statements for the firm being analysed, and those relevant portions of the appended financial statements should be highlighted

Sample Answer

Corporate Finance and Financial Statement Analysis Report

Executive Summary

This report offers a detailed financial analysis of Apple Inc., focusing on two key dimensions: the valuation of equity using financial statements and the assessment of credit risk over the period 2015–2017. Part 1 applies the Residual Earnings and Earnings Growth models to determine the intrinsic value of the firm’s equity as of the end of 2015. Part 2 evaluates the firm’s creditworthiness by analysing four essential financial ratios, each representing a different aspect of financial health, liquidity, solvency, debt servicing, and profitability. All data references are drawn directly from the company’s financial statements for 2015–2017, appended and highlighted for ease of review.

Part 1: Equity Valuation Using Financial Statements

Accurate equity valuation is fundamental to sound investment decisions. This analysis employs two valuation models, with Residual Earnings (RE) being mandatory as per assignment requirements, and Earnings Growth (EG) as a complementary model. Both are backward-looking, using actual data from 2016 and 2017 to assess the value of equity at the end of 2015.

The Residual Earnings model evaluates value by adjusting the book value of equity to include future residual earnings, earnings that exceed the firm’s cost of equity capital. It is grounded in the clean surplus accounting principle, ensuring that all changes in equity are reflected through income or dividends. Calculations involve determining the book value at year-end 2015, estimating residual earnings for subsequent years, and discounting these back to the valuation date.

In contrast, the Earnings Growth model focuses on projected earnings increases and their effect on value creation. It relies on growth rate assumptions, which, if inaccurate, can significantly impact valuation results.

Findings indicate that RE produced a more conservative and arguably more realistic equity value compared to EG, which was highly sensitive to growth assumptions. RE’s reliance on actual performance data enhances its reliability, particularly in contexts of earnings volatility or market uncertainty.

Part 2: Credit Risk Analysis Using Financial Ratios

Assessing a firm’s credit risk involves evaluating its ability to meet financial obligations. This analysis uses four ratios deemed most pertinent to the selected firm’s financial structure: the Current Ratio (short-term liquidity), Debt-to-Equity Ratio (long-term solvency), Interest Coverage Ratio (debt servicing capacity), and Return on Assets (operating profitability).

From 2015 to 2017, the Current Ratio displayed [insert trend], suggesting [interpretation]. The Debt-to-Equity ratio revealed [insert trend], implying [interpretation]. Interest Coverage fluctuated [describe], affecting the firm’s perceived risk in meeting interest payments. Meanwhile, ROA reflected the firm’s capacity to generate earnings from its assets, with [insert analysis].

These metrics collectively suggest that the firm’s credit risk profile [improved/deteriorated/remained stable] over the period. An increase in leverage or a decline in liquidity would necessitate higher risk premiums for debt, while stable profitability may mitigate overall risk. The implications for debt pricing are significant, with any observed deterioration in key ratios potentially leading to increased borrowing costs.

Continued...