A B C D E F G H

1 4/11/2010
2
3 Chapter 2. Tool Kit for Financial Statements, Cash Flows, and Taxes
4
5 FINANCIAL STATEMENTS AND REPORTS (Section 2.1)
6
7 The annual report contains a verbal section plus four key statements: the balance sheet, income
8 statement, statement of retained earnings, and statement of cash flows. Spreadsheets can be
9 used both to create and to analyze these statements, as we demonstrate in this model.
10
11 In addition, note that in cells which summarize data in other cells, such as sums or differences,
12 the spreadsheet uses formulas rather than fixed numbers. For example, the cell for Total assets
contains the Sum formula rather than just $2,000. (The cell itself shows $2,000, but if you put the
13
pointer on the cell, then the formula line will show that the cell actually contains a formula.) That
14 way, if the data for any input (cash, for instance) changes, the spreadsheet will automatically
15 recalculate and provide the correct net value for Total assets. As you will see as you go through
16 our models, this automatic recalculation feature is one of the most useful and powerful aspects
17 of Excel and other spreadsheets.
18
19 Finally, note that there is a section for inputs immediately before we begin the analysis. In
20 financial modeling, it is helpful to users when input data is grouped together, so you should
21 follow this practice in your own models, too.
22
23 THE BALANCE SHEET (Section 2.2)
24
 A B C D E F G H
25 INPUT DATA SECTION: Historical Data Used in the Analysis
26 2010 2009
27 Year-end common stock price $23.00 $26.00
28 Year-end shares outstanding (in millions) 50 50
29 Tax rate 40% 40%
30 Weighted average cost of captal (WACC) 11.0% 10.8%
31
32 Table 2-1
33 MicroDrive Inc. December 31 Balance Sheets
34 (in millions of dollars)
35 2010 2009
36 Assets
37 Cash and equivalents $10 $15
38 Short-term investments $0 $65
39 Accounts receivable $375 $315
40 Inventories $615 $415
41 Total current assets $1,000 $810
42 Net plant and equipment $1,000 $870
43 Total assets $2,000 $1,680
44
45 Liabilities and equity
46 Accounts payable $60 $30
47 Notes payable $110 $60
48 Accruals $140 $130
49 Total current liabilities $310 $220
50 Long-term bonds $754 $580
51 Total liabilities $1,064 $800
52 Preferred stock (400,000 shares) $40 $40
53 Common stock (50,000,000 shares) $130 $130
54 Retained earnings $766 $710
55 Total common equity $896 $840
56 Total liabilities and equity $2,000 $1,680
57
58 THE INCOME STATEMENT (Section 2.3)
59
60 Table 2-2
61 MicroDrive Income Statements for Years Ending December 31
62 (in millions of dollars)
63 2010 2009
64 INCOME STATEMENT
65 Net sales $3,000.0 $2,850.0
66 Operating costs except depreciation $2,616.2 $2,497.0
67 Earnings before interest, taxes, deprn., and amortization (EBITDA)* $383.8 $353.0
68 Depreciation $100.0 $90.0
69 Amortization $0.0 $0.0
70 Depreciation and amortization $100.0 $90.0
71 Earnings before interest and taxes (EBIT) $283.8 $263.0
72 Less interest $88.0 $60.0
73 Earnings before taxes (EBT) $195.8 $203.0
74 Taxes $78.3 $81.2
75 Net Income before preferred dividends $117.5 $121.8
76 Preferred dividends $4.0 $4.0
77 Net Income available to common stockholders $113.5 $117.8
 A B C D E F G H
78
79 Common dividends $57.5 $53.0
80 Addition to retained earnings $56.0 $64.8
81
82 *MicroDrive has no amortization charges.
 A B C D E F G H
83
84 We can now use the above information to calculate three specific per-share data measures:
85 earnings per share '(EPS), dividends per share (DPS), and book value per share (BVPS). Simply
86 divide the totals by the appropriate number of shares outstanding. Note that BVPS is calculated
87 by dividing total common equity (common stock plus retained earning) by shares outstanding.
88
89 Per-share Data
90 Earnings per share (EPS) $2.27 $2.36
91 Dividends per share (DPS) $1.15 $1.06
92 Book value per share (BVPS) $17.92 $16.80
93 Cash flow per share (CFPS) $4.27 $4.16
94 The per share data gives managers and investors a quick look at some items that affect the price of the stock.
95
96 STATEMENT OF STOCKHOLDERS' EQUITY (Section 2.4)
97
98 The statement of stockholders' equity takes the previous year's balance of common stock,
99 retained earnings, and stockholders' equity and then adds the current year's net income and
100 subtracts dividends paid to common stockholders. The end result is the new balance of
101 common stock, retained earnings, and stockholders' equity.
102
103 Table 2-3 MicroDrive, Inc.: Statement of Stockholders' Equity
104
105 Common Stock (Millions) Retained
106 Shares Amount Earnings Total Equity
107 Balances, Dec. 31, 2009 50 $130.0 $710.0 $840.0
108 Net income $113.5 $113.5
109 Cash dividends (57.5) (57.5)
110 Issuance of common stock 0 $0.0
111 Balances, Dec. 31, 2010 50 $130.0 $766.0 $896.0
112
113 NET CASH FLOW (Section 2.5)
114 2010 2009
115 Net income $113.5 $117.8
116 Depreciation $100.0 $90.0
117
118 Net cash flow $213.5 $207.8
119
120 STATEMENT OF CASH FLOWS (Section 2.6)
121 Information from the balance sheet and income statement can be used to construct
122 the Statement of Cash Flows, which is shown below for MicroDrive, in millions of
123 dollars.
124
125 Table 2-4
126 MicroDrive Statement of Cash Flows for Years Ending Dec. 31
127 (in millions of dollars)
128
129 Operating Activities
130 Net Income before preferred dividends $117.5
131 Noncash adjustments
132 Depreciation and amortization $100.0
133 Due to changes in working capital
134 Increase in accounts receivable ($60.0
135 Increase in inventories ($200.0
 A B C D E F G H
136 Increase in accounts payable $30.0
137 Increase in accruals $10.0
138 Net cash provided (used) by operating activities ($2.5
139
140 Investing activities
141 Cash used to acquire fixed assets ($230.0
142 Sale of short-term investments $65.0
143 Net cash provided (used) by investing activities ($165.0
144
145 Financing Activities
146 Increase in notes payable $50.0
147 Increase in bonds $174.0
148 Payment of common and preferred dividends ($61.5
149 Net cash provided (used) by financing activities $162.5
150
151 Net change in cash and equivilents ($5.0
152 Cash and securities at beginning of the year $15.0
153
154 Cash and securities at end of the year $10.0
155
 A B C D E F G H
156
157 MODIFYING ACCOUNTING DATA FOR MANAGERIAL DECISIONS (Section 2.7)
158
159 Net Operating Working Capital
160
161 Those current assets used in operations are called operating working capital, and operating
162 working capital less operating current liabilities is called Net Operating Working Capital.
163
Operating Operating
164 2010 NOWC = current - current
assets liabilities
165 = $1,000 - $200
166 2010 NOWC = $800
167
Operating Operating
168 2009 NOWC = current - current
assets liabilities
169 = $745 - $160
170 2009 NOWC = $585
171
172 Total Net Operating Capital (also just called Operating Capital)
173
174 The Total Net Operating Capital is Net Operating Working Capital plus any fixed assets.
175
176 2010 TOC = NOWC + Fixed assets
177 = $800 + $1,000
178 2010 TOC = $1,800
179
180 2009 TOC = NOWC + Fixed assets
181 = $585 + $870
182 2009 TOC = $1,455
183
184 Net Operating Profit After Taxes
185
186 NOPAT is the amount of profit MicroDrive would generate if it had no debt and held no financial assets.
187
188 2010 NOPAT = EBIT x (1-T)
189 = $284 x 60%
190 2010 NOPAT = $170.3
191
192 2009 NOPAT = EBIT x (1-T)
193 = $263 x 60%
194 2009 NOPAT = $157.8
195
196 Free Cash Flow
197
198 MicroDrive's Free Cash Flow caluclation is the cash flow actually availabe for distribution to
199 investors after the company has made all necessary investments in fixed assets and working
200 capital to sustain ongoing operations.
201
202 2010 FCF = NOPAT + Depr. - Gross investment in operating capital
203 = $270.3 - $445
204 2010 FCF = -$174.7
 A B C D E F G H
205 or
206
207 2010 FCF = NOPAT - Net investment in operating capital
208 = $170.3 - $345
209 2010 FCF = -$174.7
210
211 Uses of Free Cash Flow
212
213 1. After-tax interest payments
214
215 2010 After-tax interest expense = (Pre-tax interst expense) (1-T)
216 = $88.0 x 60%
217 = $52.8
218
219 2. Net repayment of debt
220
221 The amount of debt that is repaid is equal to the amount at the beginning of the year minus the
222 amount at the end of the year. This includes notes payable and long-term debt. If the amount of
223 ending debt is less than the beginning debt, the company paid of some of its debt. But if the
224 ending debt is greater than the beginning debt, the company actually borrowed additional funds
225 from creditors. In that case, it would be a negative use of FCF.
226
227 2010 Repayment to debtholders = All debt at beginning of year - all debt at end of year
228 = $640.0 - $864.0
229 = -$224.0
230
231 3. Total dividend payments
232
233 This includes all dividends to preferred stockholders and dividends to common stockholders.
234
235 2010 Dividends = Prefered dividends + common dividends
236 = $4.0 + $57.5
237 = $61.5
238
239 4. Net repurchase of stock
240
241 The amount of stock that is repurchased is equal to the amount at the beginning of the year
242 minus the amount at the end of the year. This includes preferred stock and common stock. If the
243 amount of ending stock is less than the beginning stock, the company made net repurchases.
244 But if the ending stock is greater than the beginning stock, the company actually made net
245 issuances. In that case, it would be a negative use of FCF.
246
247 2010 Repurchase stock = Preferred stock and common stockat beginning of year - Preferred stock and com
248 = $170.0 - $170.0
249 = $0.0
250
251 5. Net purchase of short-term investments
252
253 The amount of net purchases of ST investments is equal to the amount at the end of the year
minus the amount at the beginning of the year. If the amount of ending investments is greater
254
than the beginning investments, the company made net purchases. But if the ending investments
255 are less than the beginning investments, the company actually sold investments. 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 year
minus the amount at the beginning of the year. If the amount of ending investments is greater
than the beginning investments, the company made net purchases. But if the ending investments
A than the B
are less C
beginning investments, theD company actually
E soldFinvestments.
G In that case,
H it
256 would be a negative use of FCF.
257
258 2010 Purchase ST investments = ST investents at end of year - ST investments at beginning of year
259 = $0.0 - $65.0
260 = -$65.0
261
262 Summary of uses of FCF
263 2010
264 1. After-tax interest payments $52.8
265 2. Net repayment of debt -$224.0
266 3. Total dividend payments $61.5
267 4. Net repurchase of stock $0.0
268 5. Net purchase of short-term investments -$65.0
269
270 Total uses of FCF = -$174.7
271
272 Notice that the total uses of FCF equals the previously calculated value of FCF.
273
274
275 MVA AND EVA (Section 2.8)
276
277 Market Value Added is the difference between the market value of MicroDrive's stock and the
278 amount of equity capital supplied by shareholders.
279
280 2010 MVA = Stock price x # of shares - Total common equity
281 = $23.00 x 50 - $896
282 = $1,150 - $896
283 2010 MVA = $254
284
285 2009 MVA = Stock price x # of shares - Total common equity
286 = $26.00 x 50 - $840
287 = $1,300 - $840
288 2009 MVA = $460
289
290 Economic Value Added
291
292 Economic Value Added represents MicroDrive's residual income that remains after the cost of all
293 capital, including equity capital, has been deducted.
294
295 2010 EVA = NOPAT - Operating Capital x Weighted average cost of capital
296 = $170.3 - $1,800 x 11%
297 = $170.3 - $198.0
298 2010 EVA = -$27.7
299
300 2009 EVA = NOPAT - Operating Capital x Weighted average cost of capital
301 = $157.8 - $1,455 x 11%
302 = $157.8 - $157.1
303 2009 EVA = $0.7
304
305 Return on Invested Capital
306
307 The Return on Invested Capital tells us the amount of NOPAT per dollar of operating capital.
 A B C D E F G H
308
309 2010 ROIC = NOPAT ÷ Operating Capital
310 $170.30 ÷ $1,800
311 2010 ROIC = 9.46%
312
313 2009 ROIC = NOPAT ÷ Operating Capital
314 $157.80 ÷ $1,455
315 2009 ROIC = 10.85%
316
317
318 Table 2-5
319 MVA and EVA for MicroDrive (Millions of Dollars)
320 2010 2009
321 MVA Calculation
322 Price per share $23.0 $26.0
323 Number of shares (millions) 50.0 50.0
 A B C D
45 Example
46 Find the tax, the marginal tax rate, and the average tax rate for the following situation.
47
48 Taxable Income: $35,000
49
50 Base taxable income: $33,950.00
51 Base tax: $4,675.00
52 Marginal tax rate: 25.0%
53
54 Tax: $4,937.50
55 Average tax rate: 14.1%
 A B C D E F G H
1 SECTION 2.2
2 SOLUTIONS TO SELF-TEST
3
4 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?
5
6 Total assets $8,000,000
7 Current liabilities $3,000,000
8 Long-term debt $2,000,000
9 Preferred stock $1,000,000
10
11 Common equity $2,000,000
 A B C D E F G H
1 SECTION 2.3
2 SOLUTIONS TO SELF-TEST
3
A firm has $2,000,000 million in earnings before taxes. The firm has an interest expense of
4
$300,000 and depreciation of $200,000; it has no amortization. What is its EBITDA?
5
6 Earnings before taxes $2,000,000
7 Interest $300,000
8 Depreciation $200,000
9 Amortization $0
10
11 EBITDA $2,500,000
 A B C D E F G H
1 SECTION 2.4
2 SOLUTIONS TO SELF-TEST
3
A firm had a retained earnings balance of $3 million in the previous year. In the current year, its
4 net income is $2.5 million. If it pays $1 million in common dividends in the current year, what it its
resulting retained earnings balance?
5
6 Previous retained earnings balance ###
7 Current net income ###
8 Common dividends ###
9
10
11 Current retained earnings balance ###
 A B C D E F G H
1 SECTION 2.5
2 SOLUTIONS TO SELF-TEST
3
4 A firm has net income of $5 million. Assuming that depreciation of $1 million is its only noncash
expense, what is the firm’s net cash flow?
5
6 Net income $5,000,000
7 Depreciation $1,000,000
8
9
10
11 Net cash flow $6,000,000
 A B C D E F G H
1 SECTION 2.6
2 SOLUTIONS TO SELF-TEST
3
4 A firm has inventories of $2 million for the previous year and $1.5 million for the current year. What impact
does this have on net cash provided by operations?
5
6 Previous year's inventories $2,000,000
7 Current year's inventories $1,500,000
8
9
10
11 Change in net cash provided by operations $500,000
 A B C D E F G H
1 SECTION 2.7
2 SOLUTIONS TO SELF-TEST
3
A firm’s total net operating capital for the previous year was $2 million. For the current year, its total net
4 operating capital is $2.5 million and its NOPAT is $1.2 million. What is its free cash flow for the current
year?
5
6 Previous year's total net operating capital $2,000,000
7 Current year's total net operating capital $2,500,000
8 Current year's NOPAT $1,200,000
9
10 Net investment in operating capital $500,000
11
12 Free cash flow $700,000
 A B C D E F G H
1 SECTION 2.8
2 SOLUTIONS TO SELF-TEST
3

4 A firm has $100 million in total net operating capital. Its return on invested capital is 14 percent, and its
weighted average cost of capital is 10 percent. What is its EVA?
5
6 Total net operating working capital $100,000,000
7 ROIC 14%
8 WACC 10%
9
10
11 Free cash flow $4,000,000
 A B C D E F G H
1 SECTION 2.9
2 SOLUTIONS TO SELF-TEST
3
4 If a corporation has $85,000 in taxable income, what is its tax liability?
5
6 Taxable income $85,000
7
8 Base amount of tax from Table 3-6 $13,750
9 Base of tax range $75,000
10 Taxable income above range $10,000
11 Tax rate in base 34%
12
13
14
15 Tax liability $17,150