Fall 2005

Professor Bob Halsey

1) You will work in groups of five. Each group will prepare an analysis of a company of your choosing, including a review of the company’s financial statements, a discussion of any accounting issues particular to your company that are relevant for the interpretation of its annual report, forecasted financial statements, and valuation of the company's common stock. The objective of the analysis is to form an opinion about the current and expected financial health of the company and an opinion concerning the current valuation of its common stock.

2) Please utilize only the information which was available at the time your company issued its annual report. For example, if the annual report for your company is dated as of December 31, 2004, do not use any of the quarterly reports issued in 2005 nor any information in the financial press appearing in 2005 about the financial condition of the company or its industry. The objective is to put yourselves in the shoes on an analyst with only the financial statements of the company and press about the company existing as of December 31, 2004.

3) You should gather company, and industry data, as well as reports in the financial press. Feel free to access analyst reports, Compustat, Bloomberg and any other database in our library.

4) Your written analysis should be a maximum of 5 pages and should culminate with a “bottom line” conclusion about the company’s financial condition and the value of its common stock. This conclusion should be supported by your analysis and forecasts. Any charts, tables or graphs you prepare should be in tables in an appendix at the end of your analysis. Don’t merely report that this ratio went up and that went down with no context or discussion. The idea is to look past the numbers to try to understand the business reasons for changes in the company’s financial condition.

Here are the specifics:

Discuss any accounting issues that you feel are relevant to an evaluation of the company’s financial statements. This should be a major section of the paper. In this section, I expect you to read through all of the footnotes and to discuss any items that might affect your evaluation of the company’s earnings or balance sheet. For example, you might question the level of profitability for a firm that significantly reduced its allowance for uncollectible accounts receivable. Or, you might discuss the “true” level of financial leverage for a firm with significant off-balance sheet exposure.
Develop the financial footprint (ROE decomposition) for the company. The analysis should decompose ROE into profit margin, turnover and leverage for the most recent year the previous two years. Within the profit margin section, further examine gross margin and operating expenses. Within the turnover section, further examine receivable, inventory, payables, and fixed asset turnover rates. Describe the differences between the company’s financial footprint and averages for its industry or significant competitors. Do the differences result from strategic differences, or differences in markets or marketing strategy. What insights do you gain about your company from the comparison (don’t include the comparison unless it provides meaningful insights)? Discuss the company’s use of financial leverage. Is the stockholder’s equity insufficiently leveraged to maximize the investment or has the company taken on too much risk to realize its level of ROE (compare the company’s leverage against its competitor or industry averages to get a sense of its relative leverage)? What are the strengths and weaknesses within the financial footprint? Does the company have a sustainable competitive advantage that will allow it to perpetuate the strong aspects of its financial footprint? If so, what is it and why can it not be easily competed away? For the weaknesses, does the company have a viable plan to correct them?
Perform a valuation of the company using the discounted free cash flow (DCF) and residual operating income (ROPI) approaches. Discuss the difference between your valuation of the company and the stock price as of the date of its annual report. Can you pinpoint any differences in assumptions that contribute to the difference, if any, between your expectations and that of the market? For this part you may also want to examine analysts reports and/or articles in the financial press.

I suggest that you meet as a group as soon as possible to select your company, to determine the tasks which must be done, and to make assignments of those tasks to group members. Your company should be selected carefully – I will be more forgiving to those groups that select a company with difficult accounting adjustments and numerous issues to consider.

Any task assignments should also have a due date. Remember, the other members in your group are depending on you. Get your assignments done on time so that the project runs smoothly. To help you communicate with each other, I will set up your group on Babson’s E-campus. There, you will have the ability to exchange documents and communicate in a threaded discussion that will be archived for later viewing.

This project is due on November 16, 2005.

On November 30, 2005 we will discuss the projects. Your group should be prepared to present its findings to the class during the course of the discussion. You should focus particularly on any accounting or analysis issues you encountered with your company. Also, we will want to discuss your valuation conclusions. So, please prepare yourself to participate in this discussion. More details about this discussion will follow.

You will rate each other’s contribution at the end of the project. These individual ratings, in addition to my evaluation of your group paper, will provide input into my determination of your individual grade for the paper.

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