3. (http://webpage.pace.edu/pviswanath/class/647/exam/fal08exa.html) 3. Looking through various 10Ks, it is possible to collect the following information (in millions of dollars):


3 mths ended 7/31

9 mths ended 7/31

Yr ended 10/31

Sales and revenues






Sales of manufactured products, net






Finance revenues






Sales and revenues, net






Costs and expenses


Costs of products sold






Selling, general and administrative expenses






Engineering and product development costs






Interest expense






Other income, net






Total costs and expenses






Equity in income of non-consolidated affiliates






Income before income tax






Income tax expense






Net income (loss)






Basic earnings (loss) per share






Diluted earnings (loss) per share






Net Capital for Navistar, as of 7/31/2008 and 10/31/2007 were $1603m. and $1633m. The latest data for 2008 that are available are as of July 31. (Net Capital was computed from available 10K data as the sum of Net Debt and Shareholder's Equity.)

  1. (10 points) Compute Net Operating Profit After Taxes (NOPAT) for Navistar for the 3 months ended 7/31/2008 and for the year ended 10/31/2007.
  2. (15 points) Has Navistar's operating performance improved in 2008 compared to 2007? Is this due to higher operating profit margins or due to better utilization of operating assets?

(http://webpage.pace.edu/pviswanath/class/648/exam/spr06exa.html) Here are three articles from the BBC website. The first one is from April 13, the second from April 28, and the third from May 4, 2006. Read the articles carefully and answer the questions that follow:

Mitchells & Butlers spurns offer
13 April 2006

The pub group behind the All Bar One and Harvester chains has rejected an informal £2.7bn takeover approach from a private equity consortium.
Mitchells & Butlers (M&B) said it would not consider a takeover until it got a formal written offer from the R20 group, led by tycoon Robert Tchenguiz. The consortium said that M&B had refused to discuss any deal. News of the 550p per share approach sent M&B shares up 7.3% to 497.5p by the close of Thursday trading.

Formal offer
The pub chain emerged as a potential takeover target for Mr Tchenguiz in March, and the Takeover Panel had given him until 8 May to make a formal bid or walk away. R20 said that its offer for M&B would be funded through a mix of equity and debt, and said it could fully fund the pub group's pension deficit. It said it would make the bid formal if it was allowed to undertake further due diligence work and get approval from its financing banks and consortium members. It also needed the M&B board to recommend its offer to shareholders.
According to the Financial Times, R20 has been told to come back with an offer of at least 600p a share, valuing the pub group at £2.94bn. M&B operates more than 2,000 sites and was created when former Bass company Six Continents demerged its hotels and retail divisions in 2002.

M&B confirms Beefeater interest
28th April 2006

Pub and restaurant chain Mitchells & Butlers has confirmed reports it is considering buying 250 Beefeater and Brewers Fayre outlets from Whitbread.
Mitchells & Butlers (M&B) made the announcement as it unveiled a 4.3% rise in quarterly sales, and said it could return up to £500m to investors. Whitbread said on Tuesday that it was selling the under-performing sites. M&B owns the Harvester and All Bar One chains. Earlier this month it rejected a private equity takeover approach. The £2.7bn offer on 13 April came from the R20 group, led by tycoon Robert Tchenguiz.

Debt increase?
M&B chief executive Tim Clark said on Friday morning that the planned £500m return of capital to investors could be scaled back if it buys the Whitbread assets, which are valued at £450m. Investment bank Morgan Stanley said that M&B might choose to buy the Beefeater and Brewers Fayre outlets by raising its debts, thereby still allowing it to return between £250m to £300m to shareholders.
M&B's like-for-like second quarter sales rose 4.3% in the 13 weeks to 22 April, an increase on the 4% rise seen in the first quarter, it said in a trading update. The company operates more than 2,000 sites and was created when former Bass company Six Continents demerged its hotels and retail divisions in 2002.

Pub group M&B snubs bid approach
Thursday, 4 May 2006

Pub and restaurant group Mitchells & Butlers has rejected a £2.7bn ($4.97bn) takeover approach from a consortium led by tycoon Robert Tchenguiz. M&B, which owns the Harvester and All Bar One chains, said the offer undervalued the business. The group operates about 2,000 outlets across the UK. M&B emerged as a potential bid target for Mr Tchenguiz in March, and the Takeover Panel had given him until 8 May to make a formal bid or walk away.

Bid defence
M&B's board met to consider the 550-pence-per-share offer from Mr Tchenguiz's R2O consortium on Wednesday night. The R2O offer proposed combining M&B's pub estate with that of the Laurel Pub Company, which is owned by Mr Tchenguiz and includes the Yates's chain of wine bars.

However, setting out its reasons for rejecting the approach, M&B said its like-for-like sales - a measure which strips out the impact of new outlets - had grown at the fastest rate in the sector over the past two years. It added that sales had risen by 4.1% in the first 29 weeks of the current financial year.

"The board believes that the company has excellent prospects for organic growth and is well placed to take advantage of further consolidation opportunities," the company said.

1. (15 points) What connections can you make between the different articles? Focus on strategies that can be employed by targets in a hostile takeover; use theories/analyses developed in class and in the text.
2. (15 points) Comment on the structure of the offer made by R2O for M&B.
3. Here are the closing prices (see below) for M&B stock (from Reuters):

a. (10 points) You need to perform a bargaining range analysis. What date would you use to compute the bargaining range?

R2O is a consortium and is not traded on any exchange. However, treat column 3 as the price per share of R2O, also quoted in pence on the London Stock Exchange, for the purpose of this question (100 pence make a pound(£)). MAB had 490.57 million shares outstanding. Assume that R2O had 540m. shares outstanding. For the purpose of this question, use the closing prices for April 3, 2006. You are told that the parties have estimated the value of the combined firm to be £4.492b.

b. (10 points) What is the amount of the estimated synergy?
c. (10 points) What is the minimum exchange ratio that would be acceptable to MAB shareholders, assuming that they do not have any alternative to R2O’s offer (other than going it alone)?
d. (10 points) What is the maximum exchange ratio that R2O would be willing to offer?

Trade Date
















































































4. (20 points) Suppose MAB believes that demand for beer worldwide will be rising over the next year, and, as such, it demands a higher price for its shares. R2O does not believe that this is so. If this is the main source of disagreement between MAB’s management and R2O, how can they come to an agreement?

2. (http://webpage.pace.edu/pviswanath/class/649/exam/exasum06.html)

2. At 10:09 p.m. on June 14, 2006, the following rates were shown on http://www.ozforex.com.au.










The EUR/USD forward rate for 3 months was

3 Months



The GBP/USD forward rate for 3 months was

3 Months



According to Bloomberg, on the same date, the yield on 3-month US T-bills was 4.88%, on 3-month German bills was 2.86% and that on British 3-month bills was 4.5%. 

  1. If you had $100 on June 14th, and wanted to invest it in British 3-month bills, but at the same time, hedge yourself against adverse changes in the pound-dollar rate, what rate of return would you get? How does this compare with you return from investing in US T-bills? Comment on the similarity or difference between the two numbers.
  2. Assuming you can borrow and lend at the given rates, can you make money, without bearing any risk? Prove your answer with computations (i.e. show exactly what you would do to generate the arbitrage profits, if any).
  3. What is your estimate of what the EUR/USD rate will be on September 14, 2006?
  4. The (annualized) inflation rate in the US is currently 4.17% (computed for May 2006 by http://inflationdata.com.  Suppose you believe that inflation will be about the same in the US for the next three months.  What is your estimate of the inflation rate in the euro-currency area for the next three months?
  5. The EUR/USD rate on 30/04/2006 was 1.2635, while on 31/05/2006, it was 1.2858.  If you believe that the PPP held over the month of May, estimate the actual rate of inflation in the euro-currency area over the month of May. You can use the 4.17% US inflation estimate from inflationdata.com.

2. (http://webpage.pace.edu/pviswanath/class/649/exam/exafal05.html)

2. Read the following article and answer these questions:

    1. (5 points) Make an argument that the reason for the US current account deficit is not excessive spending by US citizens, but rather excessive saving by other countries.
    2. (5 points) Rebut the argument that other countries are saving excessively.
    3. (5 points) Why would developing countries be saving more than the US?
    4. (10 points) What are the long run implications for the dollar, if the savings glut is not a cyclical phenomenon?
    5. (10 points) The figure below (Moneyline) shows that the euro has actually dropped during 2005, against the dollar. Similarly, at the end of May, the Hong Kong dollar was 7.7965 against the US dollar; on Oct. 21, 2005, it closed at 7.7586. Which of the two theories does this support -- the one that explains the US current account deficit as a result of excess foreign saving; or the one that says that the US is saving too little and importing too much? If you wanted to investigate this further, what further information would you look for?

Exchange Rates

Economist, Sep 22nd 2005

America is spending while the rest of the world is saving. But for how long? Zanny Minton Beddoes investigates

ON MARCH 10th 2005, Ben Bernanke—a former Princeton professor who at the time was a governor of America's central bank—addressed a gathering of economists in Richmond, Virginia, on America's gaping current-account deficit. Its causes, he argued, were to be found abroad rather than in American profligacy. In particular, Mr Bernanke mused, the world might be suffering from a “global saving glut”. The phrase immediately caught on. Like the famous remark about “irrational exuberance” by Alan Greenspan, the chairman of the Federal Reserve, it has since helped to shape the global economic debate.

The idea's appeal lies in the way it ties together two of the most vexing questions about today's economic landscape: why are interest rates so low? And why can America borrow eye-popping amounts from foreigners with seeming impunity? According to the IMF's latest World Economic Outlook, the global economy will grow by 4.3% this year, slower than in 2004 but still a healthy clip. Strong economic growth is normally accompanied by higher interest rates, but long-term interest rates are at their lowest levels since the 1960s.

At the same time Americans are spending over $700 billion a year more than their economy produces, the equivalent of more than 6% of annual output. As a share of America's economy, this external deficit has more than doubled since 1999. Yet it has had none of the dire consequences for the dollar that Cassandras have been predicting. For the first six months of 2005, the greenback was rising. Although it has slid in recent weeks, the drop has hardly been dramatic.

A “global saving glut” could explain both oddities. If savings are somehow super-abundant, the usual relationship between a strong economy and higher interest rates may no longer hold. And if the spare cash is mainly abroad, that should allow America to finance its deficit with ease. Rather than signalling American profligacy, the current-account deficit might simply be the counterpart to foreign thrift.

This idea turns much conventional economic wisdom on its head. Policymakers usually worry about too little rather than too much thrift. With populations ageing, the broad consensus has been that people need to build up nest eggs to finance their retirement. Economists reckoned that globalisation would lead to a shortage of capital and hence higher interest rates as millions of Indian and Chinese workers were absorbed into the world economy. If Mr Bernanke is right, all this will need re-examining.

Global Saving and InvestmentHis suggestion that the causes of global imbalances lie elsewhere conveniently deflects attention from monetary and fiscal decisions made by American policymakers. It suggests that Mr Greenspan's loose monetary policy and George Bush's tax cuts are not responsible for the imbalances in the world economy. That may seem a little self-serving, coming from a man who has subsequently moved from the Federal Reserve to become chairman of Mr Bush's Council of Economic Advisers.

Taken at face value, the notion of a global saving glut is not borne out by the facts. “Glut” suggests an unusually large amount, as in a summer glut of strawberries. In fact, figures published in the IMF's latest World Economic Outlook show that the rate of global saving as a proportion of global output, measured at market exchange rates, has mostly been heading downhill over the past 30 years, with a particularly steep plunge between 2000 and 2002 (see chart 1). Although it has since risen slightly, the global saving rate is now close to its average for the past two decades, rather than unusually high.

In search of a glut
G7 Net Savings But Mr Bernanke's argument is more subtle. He is saying that low interest rates imply too much saving relative to the amount people want to invest, and that the rising imbalance between America and the rest of the world suggests the discrepancy is concentrated outside America. A falling global saving rate could mask substantial divergence between regions. And even with the saving rate falling, there could be a glut of thrift if the demand for the use of those savings, ie, the demand for investment, was falling even faster. The important factors in the equation, therefore, are shifts in the appetite for investment as well as in the geography of thrift.

On both counts the world has seen big changes. Traditionally, most of the saving in an economy is done by households, whereas most of the investing tends to be done by firms. But in the past few years firms have become net savers as their profits have exceeded their investments. That change has been most pronounced and long-lasting in Japan, where corporate saving soared after the bubble economy collapsed in the early 1990s. Burdened with bad debts after a period of massive overinvestment, Japanese firms have been net savers for a decade.

The late 1990s saw a similar shift in many emerging Asian economies, where corporate investment plunged after the Asian financial crisis. After the stockmarket bubble burst in 2000, American and European firms' investment also fell. Although American firms began investing again a couple of years ago, the level of corporate investment is still relatively low, given how strongly the economy—and profits—have been growing. Firms in industrial countries as a whole are still saving more than they invest, despite record profits (see chart 2). The only significant country bucking the trend is China, where investment has been rising sharply. But saving has been growing faster still.

A weak appetite for investment might help explain low interest rates, but not the rising imbalances between America and the rest of the world. To understand those, two other factors have to be considered: differences in countries' economic structures, and differences in policymakers' reactions to the investment bust.

America is at one extreme. Its corporate thrift shift was smaller than that of Japan or other Asian economies, but policymakers in Washington reacted far more dramatically. Between 2001 and 2003, America enjoyed its biggest fiscal stimulus of the post-war period, and short-term interest rates were slashed. Declining interest rates fuelled a boom in house prices, encouraging people to borrow against their properties. Economic growth remained strong and the current-account deficit soared.

Current Account BalancesAsia's emerging markets faced a much bigger bust, and had fewer policy tools to deal with it. After the 1997-98 financial crisis, investment fell by ten percentage points of GDP. Unable to slash interest rates for fear of further capital flight, they suffered serious recessions. That left exports as their main source of growth. To protect exports and to build up vast war chests of reserves, many East Asian governments kept their currencies cheap for years after the financial crises. Firms stayed reluctant to invest, the saving surpluses remained large and the foreign-exchange reserves piled up.

Japan and Europe lie between those two extremes. Politicians in Tokyo tried stimulative policies and talked of structural reform, but proved notoriously ineffective at dealing with their investment bust. The economy fell into deflation and Japan, already the world's biggest exporter of savings, became an even bigger one. Its current-account surplus rose from 1.4% of GDP in 1996 to 3.7% last year.

In Europe, the record has been mixed. Some countries, such as Germany, resemble Japan, with rising saving surpluses and weak domestic demand. Others look more like America. In Britain, fiscal and monetary policy became looser. Spain's current-account deficit is almost as big as America's. Broadly, the countries that saw the biggest rises in house prices also saw the biggest drops in saving.

In short, a good part of the rising imbalances of the past few years can be explained by a series of investment busts—after periods of overinvestment—and sharp differences in the way policymakers responded to them. But particularly since 2000, two other factors have also become important: more saving in China, and the soaring price of oil.

China's investment rate, at 46% of GDP, is the world's highest by far and has been rising fast, but its saving rate has been rising even faster. Between 2000 and 2004, China's national saving rate rose by an extraordinary 12 percentage points of GDP to 50% of GDP. The country has kept its currency cheap and exported ever more capital to the rest of the world.

At the same time, high oil prices have brought a financial windfall to the world's oil exporters which so far they seem to have chosen to save rather than spend. As a group, the oil-exporting countries are now the biggest counterparts to America's current-account deficit (see chart 3).

These shifts have been large and complicated, and they have had important and unusual consequences. The first is that capital now flows primarily from poor countries to rich countries. In 2004, emerging economies, including the newly industrialised economies of East Asia, sent almost $350 billion to rich countries. Yet according to the economic textbooks, capital seeking the highest returns should flow from rich (and capital-intensive) countries to poorer ones that have less of it.

The second consequence is that outside China, less saving by households rather than investment by firms has become the engine of global economic growth. The world economy continues to hum because consumers, particularly American ones, are content to become ever more indebted. That willingness appears closely related to the rapid rise in house prices across much of the globe.

These patterns are a long way from historical norms. Can they last? In the long term, the answer is clearly no. Household saving cannot keep on falling, and America's foreign borrowing cannot keep on rising. The question is when and how the tide might turn.

One camp argues that the saving glut Mr Bernanke has identified is a temporary and largely cyclical phenomenon. As investment recovers in Japan and Europe and strengthens further in America, interest rates will rise. If the investment recovery is concentrated outside America, the surplus savings sloshing in its direction may quickly dwindle. If foreign investors then start fretting about America's dependence on foreign funds, those savings could drain away even more rapidly, sending the dollar down sharply and interest rates up. That would be the classic “hard landing” commentators worry about.

But a growing group of analysts now suggests that the “saving glut” is the result of long-term structural shifts and is likely to last for years, perhaps decades. Some argue that ageing populations in rich countries will mean lower interest rates, because older economies with mature workforces will need less capital and their citizens will save more in preparation for retirement. Others reckon that the Asian economies will continue to export their savings for many years, for mercantilist reasons (keeping their currencies cheap to create jobs in export industries) as well as demographic ones (China, for instance, is ageing faster than America).

If the “saving glut” really is here to stay, there are two main possibilities. The first is that America's consumers will continue to barrel along and the imbalances between America and the rest of the world will increase further. The second is that Americans themselves will start saving again, perhaps because the housing market falters or because high petrol prices begin to bite. With the rest of the world still determined to save too, that would send the global economy into a tailspin.


2. (http://webpage.pace.edu/pviswanath/class/649/exam/exasum05.html) 2. (20 points) Shown below is the balance sheet of MMM Corporation's subsidiary in Poznan, Poland, on December 31, 1996, denominated in thousands of Polish zloty.

MMM Corporation of Poznan, Poland
December 31, 1996
(In thousands of Polish zloty)

Accounts Payable
Accounts Receivable
Short-term Debt
Long-Term Debt
Real Estate
Prepaid Deliverables
Common Stock
Retained Earnings

The subsidiary was created in January 1, 1996, so it had been in operation for only one year, and all earnings from 1996 were retained as cash. The exchange rate on January 1, 1996, was $0.35/zloty. The exchange rate on December 31, 1996, was $0.40/zloty. The average exchange rate for the period was $0.36/zloty. The inventory is shown at historical cost. The firm also had one unusual nonmonetary liability: MMM had already collected 150 thousand zloty from a Polish firm that ordered a large amount of supplies, and MMM promised to deliver the supplies within the next year.

  1. What was the translation exposure of MMM Corporation of Poznan, Poland, on December 31, 1996, if the zloty was the functional currency? If there were no changes in the balance sheet over 1997, what was the translation gain (loss) if the exchange rate was $0.35/zloty on December 31, 1997, based on this exposure? Where does this gain (loss) appear on the financial statements?
  2. What was the translation exposure of MMM Corporation of Poznan, Poland, on December 31, 1996, if the dollar was the functional currency? If there were no changes in the balance sheet over 1997, what was the translation gain (loss) if the exchange rate was $0.35/zloty on December 31, 1997, based on this exposure? Where does this gain (loss) appear on the financial statements?

3. (http://webpage.pace.edu/pviswanath/class/649/exam/exafal04.html) Mexicana de Cobre had been borrowing from the Mexican government at a high rate. In order to avoid these high borrowing rates, it arranged to borrow $251 million from a consortium of 10 banks at a fixed rate of 11.48%. Here is how the deal was arranged (this case is described in more detail in Managing Financial Risk: A Guide to Derivative Products, Financial Engineering, and Value Maximization by C.W. Smithson, C.W. Smith, Jr., and D.S. Wilford (Chicago: Irwin Professional Publishing); note that the details there differ in some details from the details given here). The picture below was taken from the web at http://www.trinity.edu/rjensen/caseans/133sp.htm#Sogem :

A Belgian company, Sogem, agreed to purchase 3700 tons of copper per month (presumably for the duration of the loan) at the prevailing spot price for copper. However, the payments from Sogem went not to Mexicana de Cobre, but rather to an escrow account in New York. Funds in the escrow account were then used to service the debt, and any residual was returned to Mexicana de Cobre.

  1. (10 points) Why do you think the deal was structured in this fashion, as opposed to having Mexicana de Cobre simply agreeing to pay the banks directly?
  2. (10 points) If the price of copper drops, there is the possibility that there would not be enough money in the New York escrow account to service the debt. In other words, it looks like the banks have swapped Mexicana de Cobre credit risk for exposure to the risk of the price of copper. How might the banks eliminate this risk in the forward/futures market?

2. (http://webpage.pace.edu/pviswanath/class/649/exam/exafal04.html) 2. (30 points) Please answer the questions below based on the following excerpt from The Wall Street Journal of Nov. 9, 2004:

  1. Discuss Honda’s foreign exchange exposure. How will the plan to build this new factory in Georgia affect Honda’s exposure to foreign exchange risk? In either case, explain, in a page or so, your reasoning. Make explicit any assumptions that you may need to make.
  2. Discuss, in about a page, how Honda can use derivatives to decrease its exposure to foreign exchange risk. Compare the effectiveness of these strategies to a strategy that uses operating decisions to manage economic exposure risk.
  3. How elastic is the demand for Honda’s products, and how will this affect Honda’s exposure to foreign exchange risk?

You also have available to you, Honda's corporate profile and some information on Honda's worldwide sales

Established in 1948, Honda Motor Co., Ltd., is one of today's leading manufacturers of automobiles and the largest manufacturer of motorcycles in the world. The Company is recognized internationally for its expertise and leadership in developing and manufacturing a wide variety of products that incorporate Honda's highly efficient internal combustion engine technologies, ranging from small general-purpose engines to specialty sports cars.

Source: Annual Report, 2004, Honda Motor Co.

WSJ, Nov. 9, 2004: TOKYO (Nikkei)--Honda Motor Co. (7267.TO) will spend about Y30 billion to build a new factory in Georgia that will begin producing automatic transmission systems as early as 2006, the Nihon Keizai Shimbun reported Tuesday.

The construction plan comes as the company is expanding output of automobiles, such as its Pilot sport utility vehicle and Odyssey minivan, in the neighboring state of Alabama.
Although the new factory will initially make 100,000 transmissions annually, output will be increased gradually to between 300,000 and 400,000 units in step with the pace of automobile production in North America.

Honda's annual vehicle production capacity has reached 1.4 million units in North America. Although the company locally procures almost all of the engines needed to assemble these automobiles, local production of automated transmissions - a key component of vehicles that requires a huge investment in production due to their complicated structure - did not start until 1996. The company currently produces 1 million transmissions annually at its Ohio factory in the U.S. Midwest - in which its major automobile plants are concentrated - and imports the remainder from Japan.

(http://webpage.pace.edu/pviswanath/class/340/exam/fal08exa.html) Kroger Sales Rise 9%; Net Declines on a Charge
Wall Street Journal, December 10, 2008, By David Kesmodel

Kroger Co. said its quarterly profit fell 6.3%, largely because of a charge related to Hurricane Ike, but the supermarket giant's revenue jumped 9% as its low prices and store brands enticed shoppers battered by the U.S. recession.

The Cincinnati-based retailer also increased its earnings guidance for the full year. Its shares were off 6.7% at $25.47 in 4 p.m. New York Stock Exchange composite trading Tuesday, however, because its profit forecast for the current quarter was slightly below analysts' projections. [Kroger earnings]

Kroger said net income for its fiscal third quarter ended Nov. 8 dropped to $237.7 million, or 36 cents a share, from $253.8 million, or 37 cents a share, a year earlier. Revenue climbed to $17.6 billion from $16.1 billion.

Excluding an after-tax charge equal to three cents a share related to insurance costs for Ike, which damaged Kroger stores, the company said profit would have been $253.6 million, or 39 cents a share.

Analysts had predicted earnings of 38 cents a share and revenue of $17.4 billion, according to a Thomson Reuters survey.

David Dillon, Kroger's chief executive, told analysts in a conference call that he is "feeling pretty good about things, given the environment we're operating in." He said Kroger's strategy of lowering prices, which has reduced its gross margins, "continues to resonate well with customers."

Kroger's same-store sales, a key barometer of the health of grocery stores, rose 5.6%, one of the highest rates in the industry and an improvement from the second-quarter rate of 4.7%. The figures exclude sales of gasoline at stores with fuel pumps.

The retailer's profit partly was damped by higher food inflation, which has affected the grocery industry throughout this year. Kroger said its product-cost inflation in the latest quarter was roughly 6%.

Mr. Dillon also said Kroger "could have done a better job of managing expenses in the quarter."

Kroger is projecting full-year earnings of $1.88 to $1.91 a share, excluding the charge related to the hurricane. It had earlier projected $1.85 to $1.90 a share, while analysts were pegging earnings at $1.92 a share.

The company estimates fourth-quarter profit of 49 cents to 52 cents a share, citing in part expectations for sluggish holiday spending. Analysts had projected earnings of 53 cents a share, according to Thomson Reuters.


Here is some additional information:

The following table (from NetAdvantage) provides revenues in millions of dollars for Kroger Co. (fiscal year ending January). Second set of numbers provide growth rate over sales in same quarter, previous year (except for last line).

2008 2007 2006 2005 2004 2003 2002
 1Q 20,726 19,415 17,948 16,905 16,266 15,667 15,102
 2Q 16,139 15,138 13,865 12,980 12,351 11,927 11,485
 3Q 16,135 14,999 14,020 12,854 12,141 11,696 11,382
 4Q 17,235 16,859 14,720 13,695 13,034 12,470 12,129
 Year 70,235 66,111 60,553 56,434 53,791 51,760 50,098
  2008 2007 2006 2005 2004 2003
 1Q 6.75% 8.17% 6.17% 3.93% 3.82% 3.74%
 2Q 6.61% 9.18% 6.82% 5.09% 3.55% 3.85%
 3Q 7.57% 6.98% 9.07% 5.87% 3.80% 2.76%
 4Q 2.23% 14.53% 7.48% 5.07% 4.52% 2.81%
 Year 6.24% 9.18% 7.30% 4.91% 3.92% 3.32%

The following table from NetAdvantage provides other details from the Income Statement (in millions of dollars):

  2008 2007 2006 2005 2004 2003 2002 2001 2000 1999












Operating Income






















Interest Expense











Pretax Income











Eff Tax Rate











Net Income











The table below shows the same information, but with the numbers for each year as a percentage of revenues for that year:

2008 2007 2006 2005 2004 2003 2002 2001 2000 1999
Revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Operating Income 5.21% 5.31% 5.45% 5.32% 5.85% 7.10% 7.12% 6.93% 6.89% 5.00%
Depreciation 1.93% 1.92% 2.09% 2.23% 2.25% 2.10% 1.94% 1.85% 2.12% 1.52%
Interest Expense 0.67% 0.74% 0.84% 0.99% 1.12% 1.16% 1.29% 1.38% 1.44% 0.95%
Pretax Income 2.60% 2.64% 2.52% 0.51% 1.43% 3.81% 3.42% 3.08% 2.49% 2.53%
Net Income 1.68% 1.69% 1.58% -0.18% 0.59% 2.38% 2.08% 1.80% 1.41% 1.60%

CORPORATE OVERVIEW (from NetAdvantage): Kroger is one of the largest U.S. supermarket chains, with 2,486 supermarkets as of February 2008. The company's principal operating format is combination food and drug stores (combo stores). In addition to combo stores, KR also operates multi-department stores, marketplace stores, price-impact warehouses, convenience stores, fuel centers, jewelry stores, and food processing plants. Total food store square footage exceeded 145 million as of February 2008.

Retail food stores are operated under three formats: combo stores, multi-department stores, and price-impact warehouse stores. Combo stores are considered neighborhood stores, and include many specialty departments, such as whole health sections, pharmacies, general merchandise, pet centers, and perishables, such as fresh seafood and organic produce. Combo banners include Kroger, Ralphs, King Soopers, City Market, Dillons, Smith's, Fry's, QFC, Hilander, Owen's, Jay C, Baker's, Pay Less and Gerbes.

Multi-department stores offer one-stop shopping, are significantly larger in size than combo stores, and sell a wider selection of general merchandise items, including apparel, home fashion and furnishings, electronics, automotive, toys, and fine jewelry. Multi-department formats include Fred Meyer, Fry's Marketplace, Smith's Marketplace and Kroger Marketplace. Many combination and multi-department stores include a fuel center.

Price-impact warehouse stores offer everyday low prices, plus promotions for a wide selection of grocery and health and beauty care items. Price-impact warehouse stores include Food 4 Less and Foods Co.

KR also operates convenience stores, jewelry stores, and food processing plants. The company's 782 convenience stores offer a limited assortment of staple food items and general merchandise, and, in most cases, sell gasoline. Convenience store banners include Kwik Shop, Loaf N' Jug Mini Mart, Quik Stop markets, Tom Thumb Food Stores, and Turkey Hill Minit Markets. With 394 jewelry stores, the company is one of the largest U.S. jewelry retailers. Jewelry stores operate under banners such as Barclay Jewelers, Fred Meyer Jewelers, and Littman Jewelers. In addition, KR operates 42 manufacturing plants, consisting of 18 dairies, 11 deli or bakery plants, five grocery products plants, three beverage plants, three meat plants, and two cheese plants.

CORPORATE STRATEGY. Kroger aims to increase shareholder value through its dividend program and sustained earnings growth created by strong identical store sales, slight operating margin improvement, and continued share repurchases. At the beginning of 2008, the company held the number one or number two market share position in 39 of its 44 major markets, which consist of nine or more stores. The company strives to grow market share as this allows it to leverage fixed costs over a wider revenue base.

To generate identical store sales growth and market share gains, the company adheres to its Customer 1st strategy. This strategy focuses company efforts on improving employee communications and training; using customer research and loyalty data analysis to personalize stores on a market by market and store by store basis; improving customer loyalty by improving customers' shopping experience (improved convenience and accessibility through multiple store formats, store cleanliness and security, reducing checkout wait times, etc.); and pricing within an acceptable range of discounters' prices so that price becomes a neutral factor in customers' shopping decisions.

As an important part of its merchandising strategy, KR offers about 14,400 private label items. Products are sold in three tiers. Private Selection is a premium quality brand, designed to meet or beat the gourmet or upscale national or regional brands. The banner brand (Kroger, Ralphs, King Soopers, etc.) represents the majority of KR's private label items, and is designed to be equal to or better than the national brand. The Kroger Value brand is designed to deliver good quality at an affordable price. About 43% of corporate brand volume is manufactured in the company's plants.

FINANCIAL TRENDS. In the five years through FY 08, the company experienced a compound annual growth rate (CAGR) for revenues of 6.3%, reflecting increased same-store sales and square footage expansion. As of February 2008, the company was targeting EPS of $1.83 to $1.90 for FY 09, up 8% to 12% from operating EPS of $1.69 in FY 08. To achieve its EPS target, the company expects to achieve identical food store sales growth, excluding fuel sales, of 3% to 5%, and square footage growth of approximately 2.0% to 2.5%. KR expects capital expenditures for FY 09 of $2.0 billion to $2.2 billion, excluding acquisitions. The company reduced shares outstanding by 12% between 2003 and 2008. As of February 2008, $941 million remained under a $1 billion stock repurchase program that directors approved in January 2008.

Using the information above, answer the following questions. Please interpret statements by management cautiously -- do not take them as automatically true; at the same time, you don't have to ignore them, either.

  1. (5 points) Forecast revenues for fiscal year 2009 (ending Jan. 2009). Explain. (Keep in mind that this is not so much a forecast, since it's already mid-December and fiscal 2009 ends Jan. 2009 -- so it's more of an estimate than a forecast!)
  2. (10 points) Forecast revenues for fiscal years 2010 through 2012. How would the competitive environment in the retail sector that Kroger operates in affect your forecast of Kroger's revenues? Explain.
  3. (10 points) Forecast operating profit margins for 2009 through 2012. Explain.
  4. (5 points) How long would you set the forecast period at? What stable growth rate would you assume? What drivers would you use to determine the stable growth rate? Explain.
  5. (10 points) What would you infer from the pattern of behavior of depreciation as a fraction of revenue over time?
  6. (10 points) Can you make any inferences about Kroger's financial leverage? Is it too high or too low? Explain.
  7. (5 points) Quoting David Dillon, Kroger's chief executive, the article tells us that Kroger's strategy of lowering prices, which has reduced its gross margins, "continues to resonate well with customers." Interpret Dillon's statement, in the light of the information in the last table.

1. (http://webpage.pace.edu/pviswanath/class/340/exam/spr08exa.html) Read the article below and the additional information provided to answer these questions:

  1. (10 points) If you were forecasting Exxon's Capital Expenditures, what would you forecast for 2008 to 2012? Explain your answer fully; take into account as much information as possible.
  2. (5 points) Evaluate critically the article's allegation that Exxon is not spending enough on capital outlays?
  3. (7 points) Let us assume for now that you believe that Exxon is not spending enough (independent of your answer in part b.). What implications would that have for you as an analyst estimating Exxon's share price? Explain in as much detail as you can as to what quantities you would modify in your analysis and cashflow forecast.
  4. (5 points) How would you take into account the information about Chevron's capital expenditures in forecasting Exxon's capital expenditures?
  5. (6 points) What other information would you search for in coming up with a better forecast of Exxon's capital expenditures?
  6. (7 points) How would you incorporate the information in the expenditure breakdown as provided in the Capital and Exploration Expenditure section of Exxon's 10K for 2008 (item A. of the additional information) in evaluating whether Exxon is spending enough or not?

Exxon's Stingy Capital Spending May Haunt It
April 16, 2008; Page B2, WSJ

Exxon Mobil Corp. doesn't make many mistakes. In the often-chaotic petroleum business, its careful budgeting and efficient operations are widely admired.

But Exxon's stingy approach to capital spending -- amid skyrocketing oil prices -- could be a target of second-guessing for years to come. With crude oil hitting a record above $113 a barrel Tuesday, the payoff for extracting more petroleum is enormous. Until very recently, Exxon hasn't been sprinting to win that race.

Consider these numbers. In 2007, Exxon spent 5.3% of revenue on exploration and capital outlays, down from 6.5% in 2003. The actual dollar amounts did increase, to $20.9 billion from $15.3 billion. But they didn't keep pace with Exxon's overall revenue growth, let alone soaring oil prices. Crude climbed to about $92 from $34 a barrel during that period.

Meanwhile, the Irving, Texas, oil giant poured cash into stock buybacks. In 2007, Exxon repurchased $31.8 billion of its shares, up five-fold from the amount acquired in 2003. That activity helped earnings per share. It didn't increase oil output.

Wall Street analysts generally have cheered this financial conservatism, on the notion that big oil companies tend to waste money when they start drilling with too much gusto. But some now wonder if Exxon played it too safe. Benchmark Co. analyst Mark Gilman mutters about the company's "moribund" exploration program.

"Exxon has consistently been the most cost-disciplined of the big oil companies," says Morgan Stanley analyst Doug Terreson. "They most likely believe that the historic rise in oil prices isn't sustainable. Otherwise they would be spending a lot more than they have."

Exxon keeps a tight lid on its internal oil-price forecasts, but analysts say it has acted as if it wants to make sure its spending decisions still make sense in a world of $65 or even $40 per barrel oil. In moderation, such "stress testing" is an essential part of good budgeting. Taken to extremes, it can stifle almost any initiative.

Last month, Exxon finally announced a big boost in drilling efforts. Rex Tillerson, the company's chief executive, said exploration and capital spending for 2008-2012 were being raised at least 20% beyond previous forecasts. That amounts to outlays of more than $125 billion over that five-year period.

Part of the increase simply reflects higher costs for oil projects, Mr. Tillerson told analysts, as boom times send both labor and equipment rates soaring. But he also hinted at greater optimism within Exxon about what projects are worth pursuing. "Some things are moving ahead that we were not as prepared to put in the outlook last year," Mr. Tillerson said.

Exxon officials say they like their competitive position. Current or planned projects range from Greenland to New Zealand. They include a wide mix of conventional oil and gas, heavy oil, liquefied natural gas and deepwater initiatives. Spokesman Gantt Walton calls the company's resource base of 72 billion oil-equivalent barrels "the largest and highest quality in the industry."

Even with the cautious capital spending of recent years, Exxon has added reserves slightly faster than it has drawn them down. But making new projects pay off will take years.

What's more, countries such as Venezuela and Russia have become more assertive about the terms on which foreign oil companies can operate within their boundaries. That's made it harder for companies such as Exxon to roam the globe as profitably as they used to.

"So many places are off limits," says J. Bennett Johnston, a former Chevron Corp. director and senator from Louisiana who runs Johnston & Associates, a political-consulting firm in Washington. He contends that Exxon and other major oil companies are "going about as fast as they can."

Exxon isn't under any obligation to push every dollar of its sturdy profits -- $40 billion last year -- into dubious exploration efforts. But its recent strategy of focusing heavily on share repurchases can't go on forever, either. By some calculations, if Exxon sticks to its current buyback rate, its last share of publicly traded stock will disappear in 15 years.

Exxon's other big alternative could be to use some of those repurchased shares to finance a major acquisition. But at current oil prices, almost any logical target is far more expensive than it was a few years ago.

The company could just wait until oil prices stumble and acquisitions become cheaper. But the way energy markets are behaving, and the way global demand for energy keeps climbing, that could be a long, lonely vigil.


Here is some additional information from various sources:

  1. Information from Exxon's 10K for the fiscal year ended Dec. 31, 2007, issued on Feb. 28, 2008 (Capital and Exploration Expenditures section)
  2. Information from Exxon's 10K for 2007 (Liquidity and Capital Resources Section)
  3. Information on the meaning of upstream and downstream from http://www.maverickenergy.com
  4. Information from Chevron's 10K for the financial year ended Dec. 31, 2007, issued on Feb. 28, 2008.
  5. Sales and Revenue Income for several years (from Exxon's 10K for 2007)

A: From Exxon's 10-K for 2007: Capital and Exploration Expenditures







     (millions of dollars)

Upstream (1)

   $ 2,212    $ 13,512    $ 2,486    $ 13,745


     1,128      2,175      824      1,905


     360      1,422      280      476


     44      —        130      9





   $ 3,744    $ 17,109    $ 3,720    $ 16,135





(1) Exploration expenses included.

Capital and exploration expenditures in 2007 were $20.9 billion, reflecting the Corporation’s continued active investment program. The Corporation expects annual expenditures to range from $25 billion to $30 billion for the next several years. Actual spending could vary depending on the progress of individual projects.

Upstream spending of $15.7 billion in 2007 was down 3 percent from 2006, mainly due to timing of project implementation and related expenditures. During the past three years, Upstream capital and exploration expenditures averaged $15.5 billion. The majority of these expenditures are on development projects, which typically take two to four years from the time of recording proved undeveloped reserves to the start of production from those reserves. The percentage of proved developed reserves has remained relatively stable over the past five years at over 60 percent of total proved reserves, indicating that proved reserves are consistently moved from undeveloped to developed status. Capital and exploration expenditures are not tracked by the undeveloped and developed proved reserve categories. Capital investments in the Downstream totaled $3.3 billion in 2007, an increase of $0.6 billion from 2006, as a result of new investment in China and higher environmental expenditures. Chemical 2007 capital expenditures of $1.8 billion were up $1.0 billion from 2006 due to increased investment in Singapore and China to meet Asia Pacific demand growth.


B: Further, in the Liquidity and Capital Resources Section in Exxon's 10K for 2007:

To support cash flows in future periods the Corporation will need to continually find and develop new fields, and continue to develop and apply new technologies and recovery processes to existing fields, in order to maintain or increase production. After a period of production at plateau rates, it is the nature of oil and gas fields eventually to produce at declining rates for the remainder of their economic life. Averaged over all the Corporation’s existing oil and gas fields and without new projects, ExxonMobil’s production is expected to decline at approximately 6 percent per year, consistent with recent historical performance. Decline rates can vary widely by individual field due to a number of factors, including, but not limited to, the type of reservoir, fluid properties, recovery mechanisms, and age of the field. Furthermore, the Corporation’s net interest in production for individual fields can vary with price and contractual terms.

The Corporation has long been successful at offsetting the effects of natural field decline through disciplined investments and anticipates similar results in the future. Projects are in progress or planned to increase production capacity. However, these volume increases are subject to a variety of risks including project start-up timing, operational outages, reservoir performance, crude oil and natural gas prices, weather events, and regulatory changes. The Corporation’s cash flows are also highly dependent on crude oil and natural gas prices.

The Corporation’s financial strength, as evidenced by its AAA/Aaa debt rating, enables it to make large, long-term capital expenditures. Capital and exploration expenditures in 2007 were $20.9 billion, reflecting the Corporation’s continued active investment program. The Corporation expects spending in the range from $25 billion to $30 billion for the next several years. Actual spending could vary depending on the progress of individual projects. The Corporation has a large and diverse portfolio of development projects and exploration opportunities, which helps mitigate the overall political and technical risks of the Corporation’s Upstream segment and associated cash flow.


C. Extract from website (http://www.maverickenergy.com/history.htm):

All of the oil world is divided into three: 1) The "upstream" comprises exploration and production; 2) The "midstream" are the tankers and pipelines that carry crude oil to refineries, and; 3) The "downstream" which includes refining, marketing, and distribution, right down to the corner gasoline station or convenient store. A company that includes together significant upstream and downstream activities is said to be "integrated".


D. Information from Chevron's 10K for the financial year ended Dec. 31, 2007, issued on Feb. 28, 2008:

Capital expenditures for Chevron (as reported in the Consolidated Statement of Cashflows) were $16.678b, $13.813b and $8.701b in 2007, 2006 and 2005 respectively. However, including expensed exploration expenditures, assets acquired and Chevron's share of exploratory expenditures by affiliates, these same numbers worked out to $20.026b, $16.611 and $11.063b respectively for those three years. In fact, under the heading Capital and Exploratory Expenditures, this is what the firm's 10K statement had to say:

Total reported expenditures for 2007 were $20 billion, including $2.3 billion for Chevron’s share of expenditures by affiliated companies, which did not require cash outlays by the company. In 2006 and 2005, expenditures were $16.6 billion and $11.1 billion, respectively, including the company’s share of affiliates’ expenditures of $1.9 billion and $1.7 billion in the corresponding periods. The 2005 amount excludes $17.3 billion for the acquisition of Unocal.

Of the $20 billion in expenditures for 2007, 78 percent, or $15.5 billion, related to upstream activities. Approximately the same percentage was also expended for upstream operations in 2006 and 2005. International upstream accounted for about 70 percent of the worldwide upstream investment in each of the three years, reflecting the company’s continuing focus on opportunities that are available outside the United States.

In 2008, the company estimates capital and exploratory expenditures will be 15 percent higher at $22.9 billion, including $2.6 billion of spending by affiliates. About three-fourths of the total, or $17.5 billion, is budgeted for exploration and production activities, with $12.7 billion of that amount outside the United States.

E. Sales and Revenue Income for several years (obtained from the 10K statement for 2007, in millions of dollars):

2007 2006 2005 2004 2003
Sales and Other Operating Revenue 390,328 365,467 358,955 291252 237,054
Earnings 26,497 26,230 24,349 16,675 14,502
Downstream 9,573 8,454 7,992 5,706 3,516
Chemical 4,563 4,382 3,943 3,428 1,432
Corporate and Financing -23 434 -154 -479 1510
Income from Continuing Operations 40,610 39,500 36,130 25,330 20,960
Cumulative effect of accounting change, net of income tax 550
Net Income 40,610 39,500 36,130 25,330 21,510

2. Investopedia shows you how you can get P/E ratios and other comparative information for firms industry-by-industry. If you follow their procedure for the Apparel Store industry (http://www.investopedia.com/offsite.asp?URL=http://biz.yahoo.com/p/industries.html), you can get comparables data. Assume you are comparing hte price-to-book ratios of the 13 largetst banks in the United States in 2000. The following table summarizes information on all the firms for which Yahoo provides data, excluding those for which data on P/E ratios and Debt/Equity Ratios are listed as NA (not available or not applicable):

Market Cap P/E ROE % Debt to Equity Price to Book Net Profit Margin (mrq) Price To Free Cash Flow (mrq)
Citi Trends
286.82M 20.38 11.089 0.022 2.078 6.226 40.142
Abercrombie & Fitch Co.
6.26B 13.978 31.465 0.027 3.868 17.637 24.796
Wet Seal Inc.
331.94M 15.652 18.662 0.028 2.592 6.799 39.681
Gap Inc.
13.41B 17.388 18.353 0.044 3.132 5.668 17.988
Zumiez, Inc.
592.53M 23.646 19.525 0.048 3.832 9.827 19.914
Cache Inc.
169.71M 44.52 4.255 0.064 1.971 -3.032 NA
Guess? Inc.
3.86B 20.553 34.037 0.082 5.873 10.725 45.025
Foot Locker Inc.
1.98B 38.994 2.146 0.097 0.87 5.735 13.341
Men's Wearhouse Inc.
1.26B 9.011 18.735 0.113 1.551 2.769 27.683
Ross Stores Inc.
4.50B 17.763 27.764 0.155 4.673 5.719 25.014
Stage Stores Inc.
523.05M 11.014 9.719 0.193 1.004 6.691 7.817
Dress Barn Inc.
779.34M 10.419 17.235 0.284 1.534 2.145 60.211
Casual Male Retail Group, Inc.
170.11M 411 1.963 0.32 0.935 0.477 NA
Genesco Inc.
471.23M 73.552 2.054 0.368 1.169 0.695 5.632
Jones Apparel Group Inc.
1.44B 5.69 0.984 0.389 0.717 1.999 -15.339
J. Crew Group, Inc.
2.94B 31.32 133.032 0.891 20.93 6.24 42.092
Tween Brands, Inc.
466.40M 10.426 18.567 0.897 2.386 7.908 7.503
Retail Ventures Inc.
240.75M 5.464 152.795 0.913 1.392 -27.816 NA
Limited Brands Inc.
6.01B 9.328 27.754 1.312 2.748 11.874 6.751
Collective Brands, Inc.
659.07M 15.819 6.087 1.312 0.937 -5.999 35.434
Nordstrom Inc.
7.77B 12.362 43.544 2.239 7.035 8.434 30.229
Apparel Stores
77.73B 15.8 18 0.593 3.44 4.9 57.5
  1. (8 points) In a comparison across firms, what factors affect the PE ratio?
  2. (7 points) How would you rank the following industries in terms of PE ratio - i.e., which would have the highest PE ratio, which second and which third - Cigarettes, Cement, Communication Equipment? Why?
  3. (15 points) The three firms in the above table for which data was not available for Price-to-Free Cashflow were eliminated and a regression of the P/E ratio on the following variables was run for the remaining observations: Market Capitalization, ROE (in %), Debt-to-Equity Ratio, Price-to-Book Ratio, Net Profit Margin, Price-to-Free Cashflow. Consider the results of the regression, as given below, and explain the signs of the coefficients for ROE and Price-to-Book.

    Regression Statistics
    Multiple R 0.575026
    R Square 0.330654
    Adjusted R Square -0.03444
    Standard Error 16.0179
    Observations 18

    Standard Error
    t Stat
    Intercept 26.04142 9.328261 2.79167
    Market Cap (in mils.) -0.00055 0.001238 -0.44228
    ROE % -1.48137 0.893216 -1.65846
    Debt to Equity -3.26532 7.16697 -0.45561
    Price to Book 10.0126 5.448706 1.837611
    Net Profit Margin (mrq) -0.32376 0.933526 -0.34681
    Price To Free Cash Flow (mrq) -0.08211 0.242584 -0.33849

3. a. (10 points) According to Yahoo (http://finance.yahoo.com/q/ks?s=goog), Google's beta as of Dec. 10, 2007 was 1.21. Assume that the market risk premium was 6% per annum. The 10 year T-bond on that date yielded 4.15% (http://finance.yahoo.com/). What is the rate of return that investors should have required then, to invest in Yahoo, according to the CAPM?
b. ( 15 points) The Free Cash Flow to Equity for Google is $1.09b., according to Yahoo (actually, this is Levered Free Cash, as defined at http://help.yahoo.com/l/us/yahoo/finance/tools/research-12.html). This is the cashflow that Google had available to it, in 2006, after it took care of its short-term and long-term investment needs, and after adjusting for payments to and from bondholders. According to some researchers, this could be considered a measure of how much the company could afford to pay out in dividends. Google had, at that time, 312.84m. shares outstanding, and it sold for $718.42 as of the end of trading on Monday, December 10, 2007. If you believe that Google's trading price is correct, what was the implied rate of growth of dividends, assuming that Google would grow at the same rate of growth forever? (Hint: If you use the usual formula to compute the growth rate, you should get a surprising answer.)
c. (5 points) Does your answer make sense? If not, how would you change your assumptions about Google's growth?