asset analysis

8/8/2019 Asset Analysis

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Asset Analysis

Vishwanath


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Assets are resources owned by a firm that are likely to producefuture economic benefits and that are measurable with areasonable degree of certainty.

Cash, marketable securities, receivables from customers,inventory, fixed assets, long-term investments in othercompanies, and intangibles.

Key principles used to identify and value assets are historicalcost and conservatism.


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Historical cost and

conservatism Historical costs are easily verifiable than

replacement or fair values or value in use

Distorts the true value as well as constrainsmanagers from presenting a favorable view Conservatism requires that assets be written

down when they are impaired Some financial instruments are required to be

reported at fair value in the US; other classesof tangible and intangible assets arepermitted to be reported at fair value in theUK, Australia


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Asset reporting challenges1) Resources are owned by the company

2) Resources are expected to provide future

economic benefits sufficient to cover costs3) Future benefits are measurable with a

reasonable degree of certainty

Challenges arise when ownership is

uncertain, future benefits from outlays areuncertain or difficult to measure, resourcevalues have changed


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1) Ownership of resources is

uncertain Leased resources, training programs

American Airlines leases 42% of itsfleet; pays $14b p.a. in lease rentals;theres a provision that Americanairlines can purchase the aircraft at or

near the lease period at market values Who is the effective owner? Is it a

purchase or a rental arrangement?


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A lease transaction is equal to purchase if:

Ownership of the asset is transferred to the

lessee at the end

Lessee has the option to purchase

Lease term is 75% or more of the useful life

of the asset PV of lease payments is 90% or more of the

fair value


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Such leases are treated as capital leases andrecorded at PV of lease payments

The same amount is shown as liability

The leased equipment is depreciated over thelife of the lease; lease payments are treated

as interest and principal payments Other leases are operating leases

Reports only rental expense


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The value of training programs

US spends close to $150b p.a. Owned by the firm or the employee?

Can be substantial for professional

service firms


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2) Economic benefits are uncertain or are

difficult to measure

E.g. does the change in price of oil make the drilling equipmentless valuable?

Good will:

In 1996, Disney acquired Capital Cities (ABC TV Network,newspapers etc) for $19b; majority is intangible- revenue fromadvertising

Value of tangible assets is only $4b Should the difference be written off? Capitalized? Prior to the acquisition, the market had valued Cap Cities at

$9b; Disney paid more than 100% premium The remaining is treated as goodwill based on the premise that

Disney has not overpaid; destroyed value of its stockholders Amortized over a maximum of 40 years in the US


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Brands:

Coca Cola had a book value of equity of

8.4b and a market value of 165b Brands create value by:

a) Permitting lower levels of marketing thancompetition

b) Creating leverage with distributors andretailers

c) Enabling higher pricing


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No limits like patents

Acquired brands are recorded as part ofintangible assets

Brands can be recorded as assets in theUK and Australia


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Valuing Brands Cost Based the value of a brand is the present value of all

expenditure incurred on the brand till date; difficult to trace allbrand related costs throughout the life of the brand

Market Based The amount for which a brand can be soldwhich is simply the present value of the benefits from owningthe brand.

Income Based This involves determining future revenuesdirectly attributable to the brand and then discounting them tothe present at a suitable rate. In order to estimate net revenuesthe brands price premium and volume are compared to those

of generic product Interbrand Approach


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Interbrand methodologyA brands value is the product of:

1) Average annual after-tax profits of thebrand adjusted for earnings of anequivalent unbranded product and

2) A multiple reflecting the brandsstrength


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Leadership A brand which has the ability influence the marketin setting price points and commanding distribution gets ahigher score (Max 25)

Stability Those brands which enjoy a strong consumerfranchise are considered stable and awarded a higher score(Max 15)

Market Brands in markets such as foods and soft drinks areless vulnerable to shifts in fashion and technology (max 15)

GeographicSpread Brands that have an international appealare stronger then regional brands ( Max : 25 )

Trend The long term appeal to consumers (Max 10) Support Consistency in investment and strength of

communication (Max 10) ProtectionLegal protection available to the brand owner


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Collect most recent profit data (3 years) Restate the prior period (year 2, year-1) profits to present day

values by inflating at a suitable rate

Attach a weighting factor to the restated profit figures. Usually,a simple weighting of three times the current year, twice theprevious year and once before is used. These aggregateearnings are divided by the sum of the weighting factors(3+2+1 = 6)

Deduct operating income of an equivalent unbranded product Deduct taxes at the medium term effective tax rate Apply a suitable multiple depending on the brand strength


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Dr Reddys Brand name in

2000 TN-1


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Deferred tax assets Tax laws permit loss carry forwards

In 1998 Amazon had losses of 207m, equivalent to

73.1m of future tax savings since inception These begin to expire in 2011

Firms are required to show deferred tax asset for thevalue of operating loss carry forwards, net of avaluation allowance for the portion of the asset that

is unlikely to be realized Deferred tax assets with more than a 50 percent

probability of being unrealized should be included inthe valuation allowance.


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Can also arise due to temporarydifferences between tax and financialreporting methods of recognizingincome.


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3) Changes in Future

economic benefits What types of assets, if any, should be

marked up or down to their fair values?

Accounts receivables, loan portfolios haveloss provisions; nothing is marked up in theUS

U.K. and Australian standards, for example,permit managers to revalue fixed assets andintangibles if they have appreciated in value


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Changes in the value of financialinstruments:

Not recorded at fair values if held forcontrol reasons; Equity method is usedif owns 20-50% i.e. initial investment +accumulated earnings is the value ofthe stake

Consolidate if more than 50%


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Changes in Values of Foreign

Subsidiaries Many companies have foreign subsidiaries that

subject their assets to exchange rate fluctuations.

How are these fluctuations recognized? Are assets offoreign subsidiaries translated into local currency atthe historical rates when the assets were acquired?

Alternatively, are they translated at current rates?

Accounting Standards for translation, transactionexposure


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Misconceptions about asset

accounting If a firm paid for a resource, it must be an

asset (e.g. acquisitions)

If you cant kick a resource, it really isnt anasset (e.g. Mercks research capabilities andsales force)

If you bought a resource, it must be an asset;if you developed it, it must not be (e.g. R&D)

Market values are only relevant if you intendto sell an asset (e.g. marketable securities)

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