Question 7 25 points The following is extracted from Dells b

Question 7 (25 points) The following is extracted from Dell\'s balance sheet at January 31, 2003 (in millions of dollars): Net financial assets Common equity (2,579 million shares outstanding 9,167 4,873 Analysts are forecasting consensus earnings per share of S1.01 for the year ending January 31,2004. a. Calculate net operating assets at January 31, 2003. b. Net financial assets are expected to earn an after-tax return of 4%in 2004, what is the forecast of operating income implicit in the analysts\' eps forecast? c. Forecast the residual operating income for 2004 that is implicit in the analysts\' forecast. Use a required annual return for operations of9%. d. Dell\'s shares are currently trading at S34 each. With the above information, value the shares under the following set of scenarios using residual income methods: (i) Sales will grow at 5% per year after 2004. (i) Operating assets and operating liabilities with both grow at 5% per year after (ii) Operating profit margins (after tax) will be the same as these forecasted for 2004. e. Under the same scenarios, forecast free cash flow for 2004 2003.

Solution

Dell a.Calculate net operating assets at January 31, 2003. NOA = CSE - NFA            = 4873 - 9167            = -4294 b.Net financial assets are expected to earn an after-tax return of 4% in 2004. What is the forecast of operating income implicit in the analysts’ eps forecast? Earnings forecast = $ 1.01 x 2579 = 2605 Forecast of net financial income = 9,167 × 0.04 = 367 Forecast of operating income = 2605 - 367 = 2238 c.Forecast the residual operating income for 2004 that is implicit in the analysts’ forecast. Use a required annual return for operations of 9%. ReOI2004 = OI2004 - (0.09 x NOA 2003)                     = 2238 - (0.09 x (-4294))                     = 2624 d.Dell’s shares are currently trading at $34 each. With the above information, value the shares under the following set of scenarios using residual income methods: Ve 2003 = CSE 2003 + Re OI2004 / Pf - g                  = 4873 + 2624 / ( 1.09 - 1.05 )                  = 70473 (or $27.33 or 2,579 shares) If sales are to grow at 5% and profit margins are constant, OI will grow at 5%. If NOA are to grow at 5%, then ReOI will also grow at 5%. e.Under the same scenarios, forecast free cash flow for 2004. Free Cashflow = Operating Income 2004 - change in NOA 2004          = 1.05 x -4294 = 4509 NOA 2004 = 2238 - ( - 4509 - (-4294 ))                      = 2453