Ch02 Tool Kit

8/8/2019 Ch02 Tool Kit

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4/11/2010

Chapter 2. Tool Kit for Financial Statements, Cash Flows, and Taxes

FINANCIAL STATEMENTS AND REPORTS (Section 2.1)

THE BALANCE SHEET (Section 2.2)

The annual report contains a verbal section plus four key statements: the balance sheet, incomestatement, statement of retained earnings, and statement of cash flows. Spreadsheets can beused both to create and to analyze these statements, as we demonstrate in this model.

In addition, note that in cells which summarize data in other cells, such as sums or differences,the spreadsheet uses formulas rather than fixed numbers. For example, the cell for Total assetscontains the Sum formula rather than just $2,000. (The cell itself shows $2,000, but if you put thepointer on the cell, then the formula line will show that the cell actually contains a formula.) Thatway, if the data for any input (cash, for instance) changes, the spreadsheet will automaticallyrecalculate and provide the correct net value for Total assets. As you will see as you go throughour models, this automatic recalculation feature is one of the most useful and powerful aspectsof Excel and other spreadsheets.

Finally, note that there is a section for inputs immediately before we begin the analysis. Infinancial modeling, it is helpful to users when input data is grouped together, so you shouldfollow this practice in your own models, too.

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INPUT DATA SECTION: Historical Data Used in the Analysis

2010 2009

Year-end common stock price $23.00 $26.00

Year-end shares outstanding (in millions) 50 50

Tax rate 40% 40%

Weighted average cost of captal (WACC) 11.0% 10.8%

Table 2-1

MicroDrive Inc. December 31 Balance Sheets

(in millions of dollars)

2010 2009

Assets

Cash and equivalents $10 $15

Short-term investments $0 $65

Accounts receivable $375 $315

Inventories $615 $415

Total current assets $1,000 $810

Net plant and equipment $1,000 $870

Total assets $2,000 $1,680

Liabilities and equity

Accounts payable $60 $30

Notes payable $110 $60

Accruals $140 $130

Total current liabilities $310 $220

Long-term bonds $754 $580

Total liabilities $1,064 $800

Preferred stock (400,000 shares) $40 $40

Common stock (50,000,000 shares) $130 $130

Retained earnings $766 $710

Total common equity $896 $840

Total liabilities and equity $2,000 $1,680

THE INCOME STATEMENT (Section 2.3)

Table 2-2

MicroDrive Income Statements for Years Ending December 31

(in millions of dollars)

2010 2009

INCOME STATEMENT

Net sales $3,000.0 $2,850.0

Operating costs except depreciation $2,616.2 $2,497.0

Earnings before interest, taxes, deprn., and amortization (EBIT $383.8 $353.0

Depreciation $100.0 $90.0Amortization $0.0 $0.0

Depreciation and amortization $100.0 $90.0

Earnings before interest and taxes (EBIT) $283.8 $263.0

Less interest $88.0 $60.0

Earnings before taxes (EBT) $195.8 $203.0

Taxes $78.3 $81.2

Net Income before preferred dividends $117.5 $121.8

Preferred dividends $4.0 $4.0

Net Income available to common stockholders $113.5 $117.8

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Common dividends $57.5 $53.0

Addition to retained earnings $56.0 $64.8

*MicroDrive has no amortization charges.

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Per-share DataEarnings per share (EPS) $2.27 $2.36

Dividends per share (DPS) $1.15 $1.06

Book value per share (BVPS) $17.92 $16.80

Cash flow per share (CFPS) $4.27 $4.16

The per share data gives managers and investors a quick look at some items that affect the price

STATEMENT OF STOCKHOLDERS' EQUITY (Section 2.4)

Table 2-3 MicroDrive, Inc.: Statement of Stockholders' Equity

ommon Stock (Millions Retained

Shares Amount Earnings Total Equity

Balances, Dec. 31, 2009 50 $130.0 $710.0 $840.0

Net income $113.5 $113.5

Cash dividends (57.5) (57.5)

Issuance of common stock 0 $0.0

Balances, Dec. 31, 2010 50 $130.0 $766.0 $896.0

NET CASH FLOW (Section 2.5)

2010 2009Net income $113.5 $117.8

Depreciation $100.0 $90.0

Net cash flow $213.5 $207.8

STATEMENT OF CASH FLOWS (Section 2.6)

Table 2-4

MicroDrive Statement of Cash Flows for Years Ending Dec. 31(in millions of dollars)

Operating Activities

Net Income before preferred dividends $117.5

Noncash adjustments

Depreciation and amortization $100.0

Due to changes in working capital

Increase in accounts receivable ($60.0

Increase in inventories ($200.0

We can now use the above information to calculate three specific per-share data measures:earnings per share '(EPS), dividends per share (DPS), and book value per share (BVPS). Simplydivide the totals by the appropriate number of shares outstanding. Note that BVPS is calculatedby dividing total common equity (common stock plus retained earning) by shares outstanding.

The statement of stockholders' equity takes the previous year's balance of common stock,retained earnings, and stockholders' equity and then adds the current year's net income andsubtracts dividends paid to common stockholders. The end result is the new balance ofcommon stock, retained earnings, and stockholders' equity.

the Statement of Cash Flows, which is shown below for MicroDrive, in millions ofdollars.

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Increase in accounts payable $30.0

Increase in accruals $10.0

Net cash provided (used) by operating activities ($2.5

Investing activities

Cash used to acquire fixed assets ($230.0

Sale of short-term investments $65.0Net cash provided (used) by investing activities ($165.0

Financing Activities

Increase in notes payable $50.0

Increase in bonds $174.0

Payment of common and preferred dividends ($61.5

Net cash provided (used) by financing activities $162.5

Net change in cash and equivilents ($5.0

Cash and securities at beginning of the year $15.0

Cash and securities at end of the year $10.0

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MODIFYING ACCOUNTING DATA FOR MANAGERIAL DECISIONS (Section 2.7)

Net Operating Working Capital

2010 NOWC = -

= $1,000 - $200

2010 NOWC = $800

2009 NOWC = -

= $745 - $160

2009 NOWC = $585

Total Net Operating Capital (also just called Operating Capital)

The Total Net Operating Capital is Net Operating Working Capital plus any fixed assets.

2010 TOC = NOWC + Fixed assets

= $800 + $1,000

2010 TOC = $1,800

2009 TOC = NOWC + Fixed assets

= $585 + $870

2009 TOC = $1,455

Net Operating Profit After Taxes

NOPAT is the amount of profit MicroDrive would generate if it had no debt and held no financial as

2010 NOPAT = EBIT x ( 1 - T )

= $284 x 60%

2010 NOPAT = $170.3

2009 NOPAT = EBIT x ( 1 - T )

= $263 x 60%

2009 NOPAT = $157.8

Free Cash Flow

2010 FCF = OPAT + Depr - Gross investment in operating capital

= $270.3 - $445

2010 FCF = -$174.7

Those current assets used in operations are called operating working capital, and operating

working capital less operating current liabilities is called Net Operating Working Capital.

Operatingcurrentassets

Operatingcurrent

liabilities

Operatingcurrentassets

Operatingcurrent

liabilities

MicroDrive's Free Cash Flow caluclation is the cash flow actually availabe for distribution toinvestors after the company has made all necessary investments in fixed assets and workingcapital to sustain ongoing operations.

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or

2010 FCF = NOPAT - Net investment in operating capital

= $170.3 - $3452010 FCF = -$174.7

Uses of Free Cash Flow

1. After-tax interest payments

2010 fter-tax interest expense =(Pre-tax interst expense) (1-T)

= $88.0 x 60%

= $52.8

2. Net repayment of debt

2010 epayment to debtholders = All debt at beginning of year - all debt at end of year

= $640.0 - $864.0= -$224.0

3. Total dividend payments

This includes all dividends to preferred stockholders and dividends to common stockholders.

2010 Dividends = Prefered dividends + common dividends

= $4.0 + $57.5= $61.5

4. Net repurchase of stock

2010 Repurchase stock = Preferred stock and common stockat beginning of year - Pr

= $170.0 - $170.0= $0.0

5. Net purchase of short-term investments

The amount of debt that is repaid is equal to the amount at the beginning of the year minus theamount at the end of the year. This includes notes payable and long-term debt. If the amount ofending debt is less than the beginning debt, the company paid of some of its debt. But if theending debt is greater than the beginning debt, the company actually borrowed additional fundsfrom creditors. In that case, it would be a negative use of FCF.

The amount of stock that is repurchased is equal to the amount at the beginning of the yearminus the amount at the end of the year. This includes preferred stock and common stock. If theamount of ending stock is less than the beginning stock, the company made net repurchases.But if the ending stock is greater than the beginning stock, the company actually made netissuances. In that case, it would be a negative use of FCF.

The amount of net purchases of ST investments is equal to the amount at the end of the yearminus the amount at the beginning of the year. If the amount of ending investments is greaterthan the beginning investments, the company made net purchases. But if the ending investments

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2010 urchase ST investments = ST investents at end of year - ST investments at beginning

= $0.0 - $65.0= -$65.0

Summary of uses of FCF2010

1. After-tax interest payments $52.8

2. Net repayment of debt -$224.0

3. Total dividend payments $61.5

4. Net repurchase of stock $0.0

5. Net purchase of short-term investm -$65.0

Total uses of FCF = -$174.7

Notice that the total uses of FCF equals the previously calculated value of FCF.

MVA AND EVA (Section 2.8)

2010 MVA = Stock price x # of shares - Total common equity

= $23.00 x 50 - $896

= $1,150 - $896

2010 MVA = $254

2009 MVA = Stock price x # of shares - Total common equity

=

$26.00 x 50-

$840= $1,300 - $840

2009 MVA = $460

Economic Value Added

2010 EVA = NOPAT - Operating Capital x Weighted average cost

= $170.3 - $1,800 x 11%

= $170.3 - $198.0

2010 EVA = -$27.7

2009 EVA = NOPAT - Operating Capital x Weighted average cost

= $157.8 - $1,455 x 11%

= $157.8 - $157.1

2009 EVA = $0.7

Return on Invested Capital

The Return on Invested Capital tells us the amount of NOPAT per dollar of operating capital.

, . ,would be a ne ative use of FCF.

Market Value Added is the difference between the market value of MicroDrive's stock and theamount of equity capital supplied by shareholders.

Economic Value Added represents MicroDrive's residual income that remains after the cost of allcapital, including equity capital, has been deducted.

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2010 ROIC = NOPAT Operating Capital

$170.30 $1,800

2010 ROIC = 9.46%

2009 ROIC = NOPAT Operating Capital

$157.80 $1,4552009 ROIC = 10.85%

Table 2-5

MVA and EVA for MicroDrive (Millions of Dollars)

2010 2009

MVA Calculation

Price per share $23.0 $26.0

Number of shares (millions) 50.0 50.0

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Example

Find the tax, the marginal tax rate, and the average tax rate for the followin

Taxable Income: $35,000

Base taxable income: $33,950.00

Base tax: $4,675.00Marginal tax rate: 25.0%

Tax: $4,937.50

Average tax rate: 14.1%

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SECTION 2.2SOLUTIONS TO SELF-TEST

Total assets $8,000,000Current liabilities $3,000,000

Long-term debt $2,000,000

Preferred stock $1,000,000

Common equity $2,000,000

A firm has $8 million in total assets. It has $3 million in current liabilities, $2 million in long-term debt, and $1 million in preferred stock. What is the total value of common equity?

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Earnings before taxes $2,000,000Interest $300,000

Depreciation $200,000

Amortization $0

EBITDA $2,500,000

A firm has $2,000,000 million in earnings before taxes. The firm has an interest expense of$300,000 and depreciation of $200,000; it has no amortization. What is its EBITDA?

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Previous retained earnings balance ###

Current net income ###

Common dividends ###

Current retained earnings balance ###

A firm had a retained earnings balance of $3 million in the previous year. In the current year, itsnet income is $2.5 million. If it pays $1 million in common dividends in the current year, what it itsresulting retained earnings balance?

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Net income $5,000,000Depreciation $1,000,000

Net cash flow $6,000,000

A firm has net income of $5 million. Assuming that depreciation of $1 million is its only noncashexpense, what is the firms net cash flow?

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Previous year's inventories $2,000,000Current year's inventories $1,500,000

Change in net cash provided by operatio $500,000

A firm has inventories of $2 million for the previous year and $1.5 million for the current year. What impactdoes this have on net cash provided by operations?

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Previous year's total net operating capital $2,000,000

Current year's total net operating capital $2,500,000

Current year's NOPAT $1,200,000

Net investment in operating capital $500,000

Free cash flow $700,000

A firms total net operating capital for the previous year was $2 million. For the current year, its total netoperating capital is $2.5 million and its NOPAT is $1.2 million. What is its free cash flow for the currentyear?

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Total net operating working capital $100,000,000ROIC 14%

WACC 10%

Free cash flow $4,000,000

A firm has $100 million in total net operating capital. Its return on invested capital is 14 percent, and itsweighted average cost of capital is 10 percent. What is its EVA?

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If a corporation has $85,000 in taxable income, what is its tax liability?

Taxable income $85,000

Base amount of tax from Table 3-6 $13,750

Base of tax range $75,000

Taxable income above range $10,000

Tax rate in base 34%

Tax liability $17,150

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