Chapter 2

Introduction to Financial Statement

Analysis

2-1. What four financial statements can be found in a firm’s 10-K filing? What checks are there on
the accuracy of these statements?
In a firm’s 10-K filing, four financial statements can be found: the balance sheet, income statement,
statement of cash flows, and statement of stockholders’ equity. Financial statements in form 10-K are
required to be audited by a neutral third party, who checks and ensures that the financial statements are
prepared according to GAAP and that the information contained is reliable.

2-3. Find the most recent financial statements for Starbucks’ corporation (SBUX) using the following
sources:
a. From the company’s Web site www.starbucks.com (Hint: Search for “investor relations.”)
b. From the SEC Web site www.sec.gov. (Hint: Search for company filings in the EDGAR
database.)
c. From the Yahoo! Finance Web site http://finance.yahoo.com.
d. From at least one other source. (Hint: Enter “SBUX 10K” at www.google.com.)
Each method will help find the same SEC filings. Yahoo! Finance also provides some analysis such as
charts and key statistics.

5
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6 Berk/DeMarzo, Corporate Finance, Fourth Edition

2-4. Consider the following potential events that might have taken place at Global Conglomerate on
December 30, 2018. For each one, indicate which line items in Global’s balance sheet would be
affected and by how much. Also indicate the change to Global’s book value of equity. (In all
cases, ignore any tax consequences for simplicity.)
a. Global used $20 million of its available cash to repay $20 million of its long-term debt.
b. A warehouse fire destroyed $5 million worth of uninsured inventory.
c. Global used $5 million in cash and $5 million in new long-term debt to purchase a $10
million building.
d. A large customer owing $3 million for products it already received declared bankruptcy,
leaving no possibility that Global would ever receive payment.
e. Global’s engineers discover a new manufacturing process that will cut the cost of its flagship
product by over 50%.
f. A key competitor announces a radical new pricing policy that will drastically undercut
Global’s prices.
a. Long-term liabilities would decrease by $20 million, and cash would decrease by the same amount.
The book value of equity would be unchanged.
b. Inventory would decrease by $5 million, as would the book value of equity.
c. Long-term assets would increase by $10 million, cash would decrease by $5 million, and long-
term liabilities would increase by $5 million. There would be no change to the book value of
equity.
d. Accounts receivable would decrease by $3 million, as would the book value of equity.
e. This event would not affect the balance sheet.
f. This event would not affect the balance sheet.

2-8. In early 2015, Ford Motor (F) had a book value of equity of $24.8 billion, 4.0 billion shares
outstanding, and a market price of $16 per share. Ford also had cash of $21.7 billion, and total
debt of $119.2 billion. Three years later, in early 2018, Ford had a book value of equity of $35.0
billion, 4.0 billion shares outstanding with a market price of $11 per share, cash of $26.5 billion,
and total debt of $154.3 billion. Over this period, what was the change in Ford's:
a. market capitalization?
b. market-to-book ratio?
c. enterprise value?
a. 2015 Market Capitalization: 4 billion shares  $16/share = $64. 2015 Market Capitalization: 4
billion shares  $11/share = $44. The change over the period is $44 – $64 = -$20 billion.
b. 2015 Market-to-Book = 64/24.8 = 2.58. 2018 Market-to-Book = 44/35 = 1.26. The change over
the period is: 1.26 – 2.58 = -1.32.
e. 2015 Enterprise Value = $64 – 21.7 + 119.2 = $161.5 billion. 2018 Enterprise Value = $44 – 26.5
+ 154.3 = $171.8 billion. The change over the period is: $171.8 – $161.5 = $10.3 billion.

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 Chapter 2/Introduction to Financial Statement Analysis 7

2-12. Find online the annual 10-K report for Costco Wholesale Corporation (COST) for fiscal year
2017 (filed in October 2017). Answer the following questions from their income statement:
a. What were Costco's revenues for fiscal year 2017? By what percentage did revenues grow
from the prior year?
b. What was Costco's operating income for the fiscal year?
c. What was Costco's average tax rate for the year?
d. What were Costco's diluted earnings per share in fiscal year 2017? What number of shares
is this EPS based on?
a. Revenues = $126,172 million. Revenue growth = (126,172/116,073) – 1 = 8.70%.
b. Operating Income = $4,111 million.
c. Average tax rate = 1,325/4,039 = 32.81%.
d. The diluted earnings per share in 2018 was $6.08. The number of shares used in this calculation of
diluted EPS was 440.94 million.

2-17. Suppose a firm’s tax rate is 35%.

a. What effect would a $10 million operating expense have on this year’s earnings? What effect
would it have on next year’s earnings?
b. What effect would a $10 million capital expense have on this year’s earnings if the capital is
depreciated at a rate of $2 million per year for five years? What effect would it have on next
year’s earnings?
a. A $10 million operating expense would be immediately expensed, increasing operating expenses
by $10 million. This would lead to a reduction in taxes of 35% × $10 million = $3.5 million. Thus,
earnings would decline by 10 – 3.5 = $6.5 million. There would be no effect on next year’s
earnings.
b. Capital expenses do not affect earnings directly. However, the depreciation of $2 million would
appear each year as an operating expense. With a reduction in taxes of 2 × 35% = $0.7 million,
earnings would be lower by 2 – 0.7 = $1.3 million for each of the next 5 years.

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8 Berk/DeMarzo, Corporate Finance, Fourth Edition

2-36. You are analyzing the leverage of two firms and you note the following (all values in millions of
dollars):
Market Interest
Debt Book Equity Equity EBIT Expense
Firm A 499.4 304.1 401.9 105.4 53.1
Firm B 83.1 32.7 41.9 7.8 7.3

a. What is the market debt-to-equity ratio of each firm?

b. What is the book debt-to-equity ratio of each firm?
c. What is the EBIT/interest coverage ratio of each firm?
d. Which firm may have more difficulty meeting its debt obligations? Explain.

499.4
a. Firm A: 𝑀𝑎𝑟𝑘𝑒𝑡 𝑑𝑒𝑏𝑡 𝑒𝑞𝑢𝑖𝑡𝑦 𝑟𝑎𝑡𝑖𝑜 = = 1.24
401.9

83.1
Firm B: 𝑀𝑎𝑟𝑘𝑒𝑡 𝑑𝑒𝑏𝑡 𝑒𝑞𝑢𝑖𝑡𝑦 𝑟𝑎𝑡𝑖𝑜 = = 1.98
41.9

499.4
b. Firm A: 𝐵𝑜𝑜𝑘 𝑑𝑒𝑏𝑡 𝑒𝑞𝑢𝑖𝑡𝑦 𝑟𝑎𝑡𝑖𝑜 = = 1.64
304.1

83.1
Firm B: 𝐵𝑜𝑜𝑘 𝑑𝑒𝑏𝑡 𝑒𝑞𝑢𝑖𝑡𝑦 𝑟𝑎𝑡𝑖𝑜 = = 2.54
32.7

105.4
c. Firm A: 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑐𝑜𝑣𝑒𝑟𝑎𝑔𝑒 𝑟𝑎𝑡𝑖𝑜 = = 1.98
53.1

7.8
Firm B: 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑐𝑜𝑣𝑒𝑟𝑎𝑔𝑒 𝑟𝑎𝑡𝑖𝑜 = = 1.07
7.3

d. Firm B has a lower coverage ratio and will have slightly more difficulty meeting its debt
obligations than Firm A.

2-43. Consider a retailing firm with a net profit margin of 3.5%, a total asset turnover of 1.8, total
assets of $44 million, and a book value of equity of $18 million.
a. What is the firm’s current ROE?
b. If the firm increased its net profit margin to 4%, what would be its ROE?
c. If, in addition, the firm increased its revenues by 20% (while maintaining this higher profit
margin and without changing its assets or liabilities), what would be its ROE?
a. 3.5 × 1.8 × 44/18 = 15.4%.
b. 4 × 1.8 × 44/18 = 17.6%.
c. 4 × (1.8*1.2) × 44/18 = 21.1%.

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