Tutorspedia

Finance-QA303 Online Services

 
Caterpillar Inc. (NYSE: CAT), also known as “CAT”, designs, manufactures, markets and sells machinery and engines and sells financial products and insurance to customers via a worldwide dealer network. Caterpillar is the world’s largest manufacturer of construction and mining equipment, diesel and natural gas engines and industrial gas turbines. With more than US$70 billion in assets, Caterpillar was ranked number one in its industry and number 44 overall in the 2009 Fortune 500. Caterpillar stock is a component of the Dow Jones Industrial Average.Caterpillar Inc. traces its origins to the 1925 merger of the Holt Manufacturing Company and theC. L. Best Tractor Company, creating a new entity, Caterpillar Tractor Company. In 1986, thecompany re-organized itself as a Delaware corporation under the name, Caterpillar Inc.Caterpillar’s headquarters are located in Peoria, Illinois. Caterpillar machinery is recognizable byits trademark “Caterpillar Yellow” livery and the “CAT” logo.—Wikipedia
 
Unless noted otherwise, all dollar figures are in millions of U.S. dollars (US$000,000). Please round to millions. Assume a tax rate of 26%.
 

I. Ratios (22 points)

1. Compute return on assets for Caterpillar, using the approach we used in class, for 2010 and 2009? Use total interest expense (from both financial services and other) in your calculation. Total assets for year-end 2008 were $67,782. (4 points)
 
ROA’10=(2700+((1-26%)x(914+343)))/(60038+64020)/2 = 3630/62029 = 5.85%
ROA’9=(895+(74%x(1045+389)))/((67782+60038)/2) = 1956/63910 = 3.06%
 
2. Disaggregate return on assets for 2010 and 2009 into the two components we did in class. Use “total sales and revenues” in your calculation. Which of the two components (or both) contributed to the change in return on assets in 2010 relative to 2009? Explain in one sentence intuitively what caused the change in return on assets between 2009 and 2010 based on the two components. (4 points)
 
ROA’10 = 3630/42588 x 42588/62029 = 8.52% x 0.69 = 5.85%
ROA’9 = 1956/32396 x 32396/63910 = 6.04% x 0.51 = 3.06%
Both components increased. Both profit margin and efficiency (asset turnover)
improved.
 
3. Suppose that Caterpillar decided to exploit the current low level of interest rates to borrow money and used the money to repurchase shares. How would return on assets be affected (i.e., would it likely go up or down)? Which of the two terms in the disaggregation would be affected and why? (4 points)
 
ROA would be unaffected by debt. Neither term would change.
 
4. Disaggregate return on equity for 2010 and 2009 into the three components as we did in class. What contributed to the change in ROE in 2010 relative to 2009 based on the components of ROE? Assume that the Stockholders’ Equity for year-end 2008 is $12,000. (6 points)
 
ROE (2010) = 2700/42588 * 42588/62029 * 62029/0.5(11325+9300)
= 6.34% * 0.69 * 6.02
= 26.33
ROE (2009) = 895/32396 * 32396/63910 * 63910/10650
= 2.76% * 0.51 * 6
= 8.45
 
5. Suppose Caterpillar’s CEO is compensated, in part, using Economic Value Added
 
(EVA) based on a cost of capital of 9%. Compute EVA based on equity for 2010. Explain what the number is telling you. (4 points)
EVA = Earning – (Cost of Capital * Resources)
= 2700 – (0.09 X 10312.5)
= 1771.88
It is positive so they are adding value and covering the cost of capital.
 

II. Valuation (15 points)

Your analysis of Caterpillar suggests the following. Other than those amounts noted below, there are expected to be no further changes to the balance sheet in 2011 and 2012 and all other asset and liability values on the balance sheet (other than those mentioned below) approximate fair value.
 
Accounts payable will decrease by $50 in 2011 and increase by $125 in 2012
Capital Expenditures will be $3,500 in 2011 and $3,700 in 2012
Cash will decrease by $100 in 2011 and increase by $150 in 2012
 
Cost of capital for Caterpillar will be 10% throughout Depreciation will be $2,400 in 2011 and $2,400 in 2012 Dividends will be $1,500 in 2011 and $1,600 in 2012 “Fair value” of environmental liabilities (present value of future cash flows expected to be necessary for remediation) not recorded on the balance sheet at year-end 2010 totals $700 Interest bearing debt at year-end 2010 is $28,418 and will remain at $28,418 going forward Interest expense will be $1,257 in both 2011 and 2012Internally developed Caterpillar brand at year-end 2010 is worth $20,000Inventory will increase by $470 in 2011 and decrease by $80 in 2012Net income will be $4,200 in 2011 and $4,400 in 2012Property, plant and equipment at year-end 2010 is worth $22,539Share repurchases will be $1,180 in 2011 and $1,555 in 2012Tax rate will be 26% in 2011 and 2012 Shares outstanding at year-end 2010 are 640 million
 
Value = 3510/1.1 + 4235/1.21 + 62000 – 28418 = 40273; 40273/640 shares = $62.93

2. Estimate Caterpillar’s share price at year-end 2010 using the balance sheet model we applied in class. (4 points)
Value = 11325 + 20000 + (22539-12539) – 700 = 40625; 40625/640 = $63.48
 

III. Accounts Receivable (14 points)

Caterpillar’s Financial Products division purchases receivables from independent dealers to help them maintain liquidity, collects some of the receivables and sells others to raise cash.
 
Because finance receivables are bought and sold, they are considered part of investing activities on the statement of cash flows. What journal entries did Caterpillar record in 2010 relative to its finance receivables? Your answer should explain the change in total finance receivables as well as the allowance for credit losses on finance receivables.
Gross finance receivables ‘09: 8301+12279+ 376 = 20956
Gross finance receivables ‘10: 8298+11264+ 362 = 19924
 
2. Estimate how many days on average gross finance receivables are kept by Caterpillar before they are disposed of (either by selling, collecting or writing off) for 2010. (3 points)
 
Turnover = (288+8987+306)/ 0.5(20956+19924)
=0.46
Days Receivable = 365/0.46 = 793 days
 

Manufacturing (18 points)

Assume that the inputs to Caterpillar’s manufacturing process (i.e., into work-in-process) are 50% raw materials, 20% labor and 30% overhead. Of the 30% overhead, 50% is depreciation (15% of the total) and 50% is from supplies inventory (15% of the total). Assume all purchases of raw materials and supplies are on account through accounts payable and labor is paid in cash.
 
What journal entries did Caterpillar record during 2010 to explain the change in each of the four components of the inventory account (raw materials, work-in-process, finished goods and supplies)? There are no obsolete inventories. (13 points)
Estimate how long it takes on average from when an employee works for Caterpillar on the manufacturing plant floor until when they sell the final product. Assume the employee works on the first machine in the production process. (2 points)
WIP + FG = 12.2 + 51.5 = 63.7 days, since it skips the raw materials days
 

IV. Inter Company Investments (18 points)

1. What number appears on the balance sheet for available-for-sale securities at year-end 2010 (it is buried in “other assets” on the balance sheet so you can’t just use the total in “other assets”)? (2 points) Fair value, $1370
 
2. What number would have appeared for the available-for-sale securities in part 1.at year end 2010 if they had instead been categorized as trading securities? (2 points) Fair value, $1370
 
3. What number would have appeared for the “total debt securities” portion of the available-for-sale securities in part 1. at year-end 2010 if they had instead been classified Cost, $1170
 
4. What journal entries did Caterpillar record for available-for-sale securities during 2010? Your answer should explain the change from the beginning to ending balance in the available-for-sales accounts (hint: you need to use information from the statement of cash flows and footnotes). (9 points)

Product code: Finance-QA303

Looking for Finance-QA303,please click here