04 Nov Assume that you are living in 2016 and analyze Teslas financial performance
Answer all questions on two pages (excluding the cover page) of a MS Word document (font type: Times New Roman, font size: 10, line spacing: single). A template of the answers is attached. The areas of the answer boxes are the indicative lengths of the answers to the respective questions.
AF5115 – Template to the Answers to Individual Assignment
AF5115 – Individual Assignment
Due date:
November 16, 2023
(A MS Word document should be submitted via a submission link provided on Blackboard. No hard-copy submission is required.)
Requirement:
Answer all questions on two pages (excluding the cover page) of a MS Word document (font type: Times New Roman, font size: 10, line spacing: single). A template of the answers is attached. The areas of the answer boxes are the indicative lengths of the answers to the respective questions.
Description:
Assume that you are living in 2016 and analyze Tesla’s financial performance (This means that it is important that you do not know what would happen after 2016).
By the fall of 2015, Tesla was well on its way to executing the biggest game change in the auto industry since Ford introduced the Model T. The ascendancy of the Model T in 1908 initially gave rise to the dominance of the internal combustion engine. Before that, electric vehicles (EVs) shared the road in similar numbers to gas-powered vehicles. The next century saw numerous attempts to introduce EVs, but all met with failure. Perhaps the best known was GMs EV1, the first mass-produced electric car from a major automaker. Over 1,000 EV1s were produced between 1996 and 1999. But in 2002, GM declared it an unprofitable niche, repossessing and destroying the EV1s. Critics argued that GM was concerned with cannibalizing its traditional gas-powered vehicle sales, and particularly the lucrative spare-parts market, since EVs require less maintenance and replacement parts.
Interest in electric vehicles was rekindled in 2004 when a dynamic young entrepreneur called Elon Musk took control of a fledgling EV company called Tesla and set out on a mission to create affordable mass-market EVs. Tesla’s first vehicle, the Roadster, hit the market in 2008. Employing lithium-ion battery technology, it was the first mass-produced EV to have a range in excess of 200 miles on a single charge. The Roadster was a small two-seat sports car based on a Group Lotus body. Musk’s next project was a four-door electric sedan designed and produced by Tesla from the bottom-up. To help with its burgeoning financing needs, Tesla went public in 2010. The Model S hit the auto market in 2012 to wide critical claim. A family-style four-door sedan with sleek looks and high performance, Tesla was selling over 20,000 units per year by 2013. Tesla’s next project was the Model X, an electric SUV with gull-wing doors and a high sticker price. Hitting the market late in 2015, initial deliveries failed to meet expectations due to production problems. These initial models laid the groundwork for Musk’s grand vision of an affordable mass-produced electric car. A tweet on July 16 2015 confirmed that this car would be called the Model 3, with first deliveries subsequently slated for late 2017.
Despite Tesla’s remarkable accomplishments, the company also faced a number of challenges in its quest to revolutionize the auto industry. First, Tesla was making large losses and requiring huge inflows of cash to fund its ever-increasing investment expenditures. Analysts questioned many aspects of Tesla’s business model, including Tesla’s vertically integrated distribution network, generous resale value guarantees and lengthy warranties. Tesla also faced growing competition, particularly in its target Model 3 market. The Nissan Leaf had long been available in this segment and the Toyota Prius had long provided an attractive hybrid alternative for energy-conscious drivers. In the luxury market, Mercedes, BMW and Volvo all had plans to compete in the EV segment. Despite these challenges, Tesla’s stock price was soaring. After initially pricing at around $20 in 2010, Tesla’s stock price was in the mid $200s by late 2015. The huge run-up led many commentators to argue that Tesla was overpriced. For example, in an article published in the Journal of Portfolio Management, two respected finance academics concluded that Tesla’s stock price was two and one-half times an aggressively optimistic value estimate.
QUESTIONS
Business Strategy Analysis
1. Tesla has a distribution model that is not common in the automobile industry. Briefly describe Tesla’s distribution model.
2. List the key success factor and key risks associated with Tesla’s distribution model.
Accounting Analysis
3. Tesla uses lease accounting for automotive sales under its resale value guarantee program. Assume that instead of using lease accounting for automotive sales under its resale value guarantee program, Tesla instead recognized these sales and the associated cost of sales at the inception of the sale. Estimate the Income (Loss) from operations that Tesla would have reported for 2014.
4. Summarize the accounting policy that Tesla uses for warranties.
5. Assume that instead of using its current accounting policy for warranties, Tesla instead expensed all warranty costs as costs were incurred. Estimate the Income (Loss) from operations that Tesla would have reported for 2014.
6. Which of the above two accounting methods for warranties do you think best reflects the underlying economics of the warranty obligations? Briefly explain your answer.
Ratio and Cash Flow Analysis
7. Compute the net operating asset (NOA) turnover ratios for Tesla and Ford for 2014.
8. Summarize the primary reason(s) for the difference between the NOA turnover ratios that you computed above.
9. Compute the gross margin on automotive sales for Tesla and Ford for 2014.
10. Summarize the primary reason(s) for the difference between the gross margins that you computed above.
HINTS: Most of the information for answering the above questions can be found in the 10-K forms of Teals (TSLA) and Ford (F) for 2014.
COVER PAGE
AF5115 Accounting for Business Analysis
Individual Assignment
Name:_________________________________
Student ID:_____________________________
Date of Submission:______________________
1. Tesla has a distribution model that is not common in the automobile industry. Briefly describe Tesla’s distribution model.
2. List the key success factor and key risks associated with Tesla’s distribution model.
3. Tesla uses lease accounting for automotive sales under its resale value guarantee program. Assume that instead of using lease accounting for automotive sales under its resale value guarantee program, Tesla instead recognized these sales and the associated cost of sales at the inception of the sale. Estimate the Income (Loss) from operations that Tesla would have reported for 2014.
4. Summarize the accounting policy that Tesla uses for warranties.
5. Assume that instead of using its current accounting policy for warranties, Tesla instead expensed all warranty costs as costs were incurred. Estimate the Income (Loss) from operations that Tesla would have reported for 2014.
6. Which of the above two accounting methods (i.e. current policy or expense when incurred) for warranties do you think best reflects the underlying economics of the warranty obligations? Briefly explain your answer.
7. Compute the net operating asset (NOA) turnover ratios for Tesla and Ford for 2014.
8. Summarize the primary reason(s) for the difference between the NOA turnover ratios that you computed above.
9. Compute the gross margin on automotive sales for Tesla and Ford for 2014.
10. Summarize the primary reason(s) for the difference between the gross margins that you computed above.
,
AF5115
Accounting for
Business
Analysis
Lecture 7
Understanding the
Business
2
Understanding the Business
• Macroeconomic analysis
• Industry Analysis
• Firm’s Strategy Analysis
• Example – Salesforce
3
Framework for business analysis and valuation
Chapter 1 Introduction
7
changes in future business activities. The second step involves using our analysis of the past in forecasting the future. This step is structured around forecasting the future financial statements, from which we will derive our estimates of future cash distributions to equity holders. The third step comprises valuation. In this step, we convert our estimates of future distributions to equity holders into a single estimate of firm value. In the rest of this section, we summarize how the remaining chapters in this book guide you through these three steps.
FIGURE 1.1: The Three Steps of Equity Valuation
Understanding the Past The first step involves examining relevant information about the business. This step begins with the systematic collection of pertinent information, which we refer to in Figure 1.1 as information collection. If the equity security is publicly traded on a major exchange in the United States, then the usual starting point for information collection is the firm’s financial filings with the Securities and Exchange Commission (SEC). However, there are a myriad of other information sources that should be investigated, ranging from company press releases to industry and macroeconomic data. Today, much of this information is available
STEP 1 Understanding
the Past 1. Information
Collection
2. Understanding
the Business
3. Accounting
Analysis
4. Financial Ratio
Analysis
5. Cash Flow
Analysis
STEP 2
Forecasting the
Future 1. Structured
Forecasting
a. Income
Statement
Forecasts
b. Balance
Sheet
Forecasts
c. Cash Flow
Forecasts
STEP 3
Valuation
1. Cost of Capital
2. Valuation
Models
a. Residual
Income
Models
b. Discounted
Cash Flow
Models
3. Valuation
Ratios
4. Complications
4
Understanding the business: Overview
TOP-DOWN APPROACH
Macroeconomic Analysis
Industry Analysis
Firm’s strategy
Analysis
5
Macroeconomic analysis
GLOBAL ECONOMIC CONDITIONS
▪ Most domestic businesses have direct exposure to the global economy
through their product markets, input markets, or foreign operations.
▪ Even businesses without direct exposure to global markets are sensitive to
global economy conditions.
▪ Analysts need to understand the state of global economy and the consensus
among experts about where it is headed.
6
Macroeconomic analysis
DOMESTIC ECONOMIC CONDITIONS
• Besides global economic conditions, analysts also should be aware of
▪ the individual domestic economies the business is exposed to; and
▪ their individual sensitivities to the global economy.
• The overall state of the domestic economy and its future prospects can be
summarized by a few key economic indicators:
▪ Gross Domestic Product
▪ Interest Rates
▪ Inflation
▪ Foreign Exchange Rates
▪ Oil Prices and Other Key Commodity Prices
7
Domestic Economic Conditions
GDP GROWTH RATE
• the most widely used measure of
macroeconomic performance
• typically expressed in real (i.e. inflation-
adjusted) term as real GDP growth rate
• an important determinant of the rate at
which many businesses can grow
• the most used definition of recession is
two consecutive quarters of negative real
GDP growth
8
Domestic Economic Conditions
INTEREST RATES
• Lower interest rates mean less interest
expense and higher profit
• Low interest rates also reduce the cost
of capital, increasing the number of
viable investment opportunities
• A decline in interest rate tends to spur
consumer spending, thereby increasing
sales growth for many businesses. E,g.
you have a greater incentive to buy a
new car today if the cost of borrowing
declines.
9
Domestic Economic Conditions
INFLATION
• A general rise in price level
• create a gap between real and nominal
economic effects; real terms worse off (less
value of the currency) if high inflation
• high inflation can create uncertainty in the
economy and discourage businesses from
investing – more difficult to predict the costs
of production and future profitability;
investors will avoid investing in counties with
high inflation
• Central banks may raise interest rates to try to
combat high inflation, which can increase
borrowing costs – discourages borrowing and
slows economic growth
10
Domestic Economic Conditions
FOREIGN EXCHANGE RATES
• Describe how many units of one currency can be bought with a unit of another
currency
• The impact on a business is determined by whether the firm is net importer of
exporter in a particular currency.
• The value of Chinese RMB increases:
▪ cost of foreign inputs decreases
▪ the revenue from foreign sales decreases
11
Domestic Economic Conditions
OIL AND COMMODITY PRICES
• Affect the costs of all businesses
• Oil is the most important commodity for
successful functioning of an industrialized
economy
• Increase in oil prices → increases in
transportation and energy costs
• Increase in oil prices → decrease amount of
income that consumers have to spend on
other products
• Other important commodity: Natural gas and
various metals
• depending on industry, businesses have
different key commodity input; e.g. steel for
auto industry
12
Domestic Economic Conditions
• Aside from the economic indicators above, other
important factors to consider in macroeconomic analysis
are:
▪ Corporate Hedging Activities
▪ Business Cycle
13
Domestic Economic Conditions
Corporate Hedging Activities
• With hedging, two firms in the exact same business may have
completely different exposure to the economic indicators.
• Corporate hedging is another important part in macroeconomic
analysis
• Hedging against to interest rates: Financial institutions
• Hedging against to foreign exchange rate: Export/import firms
• Hedging against to commodity prices: Gold mining
• Natural hedging by structuring transactions: Firms expecting large
A/R in foreign currency can arrange its operations in a way that it
creates A/P in foreign currency
14
Domestic Economic Conditions
Business Cycle
• To understand the current status and future prospects of the
domestic economy, understand business cycle is necessary.
• Domestic economy experience some systematic periods of
expansion (high GDP growth, low unemployment, high
consumer confidence) and contraction (low GDP growth,
high unemployment, and low consumer confidence)
• Some industries are more sensitive to business cycles than
others
15
Domestic Economic Conditions
Realistic Goal for Macroeconomic analysis
• If you try to become an expert in global and domestic economy,
then you may never get to firm analysis
• General rule is to understand the general consensus about the major
macroeconomic factors
• No need to develop your own forecasts of future GDP or interest
rate
• However, you need to understand
• What the experts are saying about these factors
• How they might influence your firms’ performance
16
Industry Analysis
Three objectives of Industry Analysis:
• To understand the sensitivity of the industry to key
macroeconomic factors
• To understand how the industry operates and key
performance metrics for evaluating these operations
• To understand the competitive structure of the industry
17
Industry Analysis: Macroeconomic Sensitivities by sector
• Some sector/industries are more sensitive to macroeconomic
conditions.
• The following table provides an overview of the sensitivities
of each economic sector to three key macroeconomic factors:
• GDP Growth Rate: positive effect on the profitability of
all sectors
• Interest rate: negative effect on the profitability of all
sectors
• Oil Price: negative effect on the profitability of all
sectors except oil industry, which consists of companies
involved in the exploration, extraction, transportation,
refining, and marketing of oil.
18
Industry Analysis: Macroeconomic Sensitivities by sector
Key : ++ = strong positive correlation; + = positive correlation
– – = strong negative correlation; – = negative correlation
19
Where to get Macro Information?
• Historical Macroeconomic data
• https://tradingeconomics.com/
• Forecast data
• https://www.philadelphiafed.org/surveys-and-data/real-time-data-
research/survey-of-professional-forecasters
20
Industry analysis – Understand how industry operates
• Understand how industry operates
• Firms in same industry generally produce similar goods and
services using similar production technologies
• Beginning your industry analysis by figuring out how the industry
operates
1. What is the nature of the production process that takes place in the
industry?
2. What are the key inputs in the production process?
3. What is the nature of the marketing and distribution process?
4. Is after sale service a significant factor?
21
Industry analysis – identify key ratios and statistic
