Calculation of adjusted return on assets and after tax cost of debt
All questions relate to the Kimberly-Clark Corp. Annual Report (Form 10-K) for the year ending December 31, 2007. Kimberly-Clark (the "Company") "is a global health and hygiene company with manufacturing facilities in 36 countries and its products are sold in more than 150 countries." The Company's "products are sold under such well-known brands as Kleenex, Scott, Huggies, Pull-Ups, Kotex and Depend."
The Company operates in the Paper Mills industry. Median data relating to the Paper Mills industry are:
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ROE
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10.35%
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Beta
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0.97
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Market-to-book
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1.97
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Net profit margin (Return on sales)
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5.86%
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Total asset turnover
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1.12
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Financial leverage
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1.56
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Gross profit margin
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22.93%
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Receivable days (Average collection period/Days to collect)
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48.06
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Inventory days (Days inventory held)
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62.42
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Payable days (Days to pay)
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32.29
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Current ratio
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1.59
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Interest coverage (Times interest earned)
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1.81
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Note: Although an individual company's ROE is the product of net profit margin, total asset turnover, and financial leverage, this relationship will not hold when using the three median variables as shown above because medians distort the relationships among individual company ratios.
Please read the instructions and each question carefully.
Some aspects of Kimberly-Clark's (hereafter, the "Company") 2007 financial statements are noteworthy.
1. Two "above-the-line" special, non-recurring items were reported. The first item was a $107.2 million net charge ($61.4 million after tax (given in annual report)) for a strategic cost reduction plan allocated as follows on a pre-tax basis: $89.4 million charge included in Cost of products sold; $31.8 million charge included in Marketing, research and general expenses; and $14 million gain on dispositions of facilities included in Other (income) and expense, net (See MD&A, pp. 24-25, Note 2, pp. 49-52). The second item was an $16.4 million gain for a settlement of litigation that was included in Other (income) and expense, net (See MD&A, p.25). The after-tax amount for the first item is given; however, consider the second item a taxable gain.
2. Treat Redeemable preferred securities of subsidiary, included in the balance sheet, as interest bearing debt in problem 8(d). Do not treat this item the same way as the preferred stock adjustment that was discussed in Module 5, p.23. Assume that the preferred dividends are already included in the interest expense reported in the 2007 income statement.
Show the adjustments for each problem individually and not a cumulative adjustment unless the question directs you to do so.
(a) Compute the Company's 2007 ROE into its three multiplicative components: return on sales (or profit margin), total asset turnover, and financial leverage. Be sure to provide an algebraic expression for this decomposition and present numbers for each element of that expression. For the purpose of this question, include all the adjustments addressed in the exam-nonrecurring "above-the-line" items, operating leases, income taxes, pension adjustment, and minority interest. Also, when computing the total asset turnover and financial leverage components, use only the adjusted 2007 ending balances of total assets and total stockholders' equity. Do not use average total assets and stockholders' equity.
(Note: If you were conducting an actual financial statement analysis, you would need to make similar adjustments as you did in 2007 to the 2006 total assets and stockholders' equity in order to compute the adjusted average total assets and stockholders' equity.)
Pro-forma net income;
Net income as reported -
Pro-forma net income ____________________
Pro-forma total assets:
Total assets as reported -
Pro-forma total assets ____________________
Pro-forma stockholders' equity:
Stockholders equity as reported -
Pro-forma stockholders equity ____________________
Net profit margin ____________________
Total assets turnover ____________________
Financial leverage ____________________
Return on equity (ROE) ____________________
(b) Based on part (a), which of the three component(s) appear(s) particularly important in explaining the difference between the Company's ROE and the Paper Mills industry's median ROE? Briefly explain.
(c) Compute what the 2007 Return on Assets (ROA) would have been in the absence of debt. For the purpose of this question, include all the adjustments addressed in the exam-nonrecurring "above-the-line" items, operating leases, income taxes, pension adjustment, and minority interest. Also, when computing the ROA, use only the adjusted 2007 ending balance of total assets. Do not use average total assets.
Formula _______________________________________________________
Adjusted return on assets (ROA) ____________________
(d) Compute the 2007 after-tax cost of debt. Be sure to include the appropriate adjustments from operating leases.
Formula _____________________________________________________________
2007 After-tax cost of debt ____________________