Principles of
Chapter 8 Corporate Finance
Tenth Edition
Financial
Analysis
Slides by
Matthew Will
McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
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Topics Covered
➢Financial Statements
➢Lowe’s Financial Statements
➢Measuring Lowe’s Performance
➢Measuring Efficiency
➢Analyzing the ROA: The DuPont
System
➢Measuring Leverage
➢Measuring Liquidity
➢Interpreting Financial Ratios
2
Lowe’s Companies
8-3
Balance sheet ($mil)
2008 2007
Assets
Current assets
Cash and marketable securities 661 530
Accounts receivable 166 247
Inventories 8,209 7,611
Other current assets 215 298
Total current assets 9,251 8,686
Fixed assets
Tangible fixed assets
property plant and equipment 31,477 28,836
Less accumulated depreciation 8,755 7,475
Net tangible fixed assets 22,722 21,361
Long -term investments 253 509
Other long-term assets 460 313
Total assets 32,686 30,869
Lowe’s Companies
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Balance sheet ($ mil)
2008 2007
Liabilities and Shareholders’ Equity
Current liabilities
Debt due for repayment 1,021 1,104
Accounts payable 4,543 4,137
Other current liabilities 2,458 2,510
Total current liabilities 8,022 7,751
Long-term debt 5,039 5,576
Deferred income taxes 660 670
Other long-term liabilities 910 774
Total liabilities 14,631 14,771
Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Total shareholders' equity 18,055 16,098
Total liabilities and shareholders’ equity 32,686 30,869
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Lowe’s Companies
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Other Data (end of 2008)
Net working capital = current assets - current liabilities
= 9,251 – 8,022 = $1,229 million
Total revenues - costs - depreciation = EBIT
48,230 – 42,887 – 1,539 = $3,804 million
1,470 million shares outstanding
Stock price =$18.19 per share
Lowe’s Companies
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Income ($ mil)
2008
Net sales 48,230
Cost of goods sold 31,729
Selling, general, and administrative expenses 11,158
Depreciation 1,539
Earnings before interest and taxes (EBIT) 3,804
Interest expense 298
Taxable income 3,506
Tax 1,311
Net income 2,195
Dividends 491
Addition to retained earnings 1,704
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Lowe’s Companies
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Measuring Performance: Market-to-Book Ratio
Ratio of market value of equity to book value of
equity.
market value of equity
Market - to - book ratio =
book value of equity
$26,739
=
$18,055
= 1.5
Lowe’s Companies
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➢ Market Capitalization
– Total market value of equity, equal to share price
times number of shares outstanding.
Market Capitalization = (# shares) (price per share)
Market Capitalization = $18.19 × 1,470 = $26,739 mil
➢ Market Value Added
– Market capitalization minus book value of equity.
MVA = Market Capitalization - EquityBook Value
MVA = $26,739 - $18,055 = $8,684 million
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Market Values
Stock market measures of company performance, 2008 (dollar values in millions).
Companies are ranked by market value added.
Market Value Market-to- Market Value Market-to-
Added Book-Ratio Added Book-Ratio
Exxon Mobil $154,397 1.69 Fedex ($1,538) 0.96
Wal-Mart 128,159 2.02 J.C. Penney -3,777 0.69
Coca Cola 106,957 3.46 Xerox -9,981 0.37
Google 96,880 6.82 Dow Chemical -17,823 0.55
Johnson & Johnson 67,645 1.8 AT&T -49,052 0.85
Source: We are grateful to EVA Dimensions for providing these statistics.
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Measuring Performance
➢ Economic Value Added (EVA)
– Net income minus a charge for the cost of capital
employed. Also called residual income.
➢ Residual Income
– Net Dollar return after deducting the cost of capital
EVA = Residual Income
= After Tax interest + Net Income - Cost of Capital Capital
or
After Tax interest + Net Income
EVA = − Cost of Capital - Total Capital
Total Capital
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Measuring Performance
➢Economic Value Added (EVA) of Lowe’s
After Tax interest + Net Income
EVA = − Cost of Capital - Total Capital
Total Capital
(1 - .35) 298 + 2,195
EVA = − .074 - 21,674
21,674
= $785mil
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Measuring Performance
1. After-tax 2. Cost of 5. Return on
interest + net Capital 3. Total Long- 4. EVA = 1 – Capital (ROC),
income (WACC), % term Capital (2 × 3) % (1 ÷ 3)
Exxon Mobil 46,378 6 $224,051 $33,006 20.7
Wal-Mart 14,169 5.7 125,059 7,286 11.3
Johnson & Johnson 11,964 7.5 84,848 5,529 14.1
Google 5,128 12.3 16,644 3,143 30.8
Coca Cola 4,900 5.8 33,246 3,031 14.7
J.C. Penney 553 7 12,191 -302 4.5
Fedex 1,898 6.7 37,067 -583 5.1
Dow Chemical 1,420 6.1 39,458 -1,004 3.6
Xerox 583 9.9 15,876 -1,047 3.7
AT&T 15,745 8.6 321,320 -11,779 4.9
Source: We are grateful to EVA Dimensions for providing these statistics.
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Measuring Profitability
Lowe’s Profitability Measurements
after tax interest + net income
Return on capital =
average total capital
=
(1 - .35) 298 + 2,195 = .107
(21,674 + 23,094)/2
net income 2,195
Return on equity = = = .136
equity 16,098
after tax interest + net income
Return on assets =
total assets
=
(1 - .35) 298 + 2,195 = .077
30,869
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Measuring Efficiency
Sales
Asset turnover ratio =
total assets at start of year OR
Sales
Asset turnover ratio =
Average total assets
For Lowe’s
Sales 48,230
Asset turnover ratio = = = 1.56
total assets at start of year 30,869 OR
Sales 48,230
Asset turnover ratio = = = 1.52
Average total assets (30,869 + 32,686) / 2
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Measuring Efficiency
cost of goods sold
Inventory turnover ratio =
inventory at start of year OR
inventory at start of year
Average Days in Inventory =
cost of goods sold/365
sales
Receivables Turnover = OR
receivables at start of year
receivables at start of year
Average collection period =
average daily sales
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The DuPont System
➢A breakdown of ROE and ROA into
component ratios
Net Income
Profit Margin =
sales
After tax interest + Net Income
Operating Profit Margin =
sales
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The DuPont System
Net Income + interest
ROA =
assets
sales Net Income + interest
ROA = x
assets sales
asset Operating
profit
turnover
margin
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The DuPont System
Merging with suppliers or customers generally
increases the profit margin, but this increase is offset
by a reduction in asset turnover.
Asset Profit
Sales Profits Assets ROA
Turnover Margin
Admiral Motors $20 $4 $40 0.5 20% 10%
Diana Corporation 8 2 20 0.4 25 10
Diana Motors (the merged firm) 20 6 60 0.33 30 10
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Measuring Leverage
long term debt
Long term debt ratio =
long term debt + equity
long term debt
Debt equity ratio =
equity
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Measuring Leverage
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Measuring Leverage
assets sales Net Income + interest Net Income
ROE = x x x
equity assets sales Net Income + interest
leverag asset Operating debt
e
turnover profit burden
ratio
margin
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Liquidity Ratios
Net working capital Net working capital
=
to total assets ratio Total assets
current assets
Current ratio =
current liabilities
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Liquidity Ratios
23
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Common Size Balance Sheet
For S&P Composite Index Firms during
2008
24
Common Size Income 8-25
Statement
For S&P Composite Index Firms during
2008
25
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Financial Ratios
2008 Ratios for S&P 500 firms
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Comparing Performance
Lowe’s Home Depot
Performance Measures
Market value added ($ millions) 8,684 17,856
Market to book ratio 1.5 2
EVA ($ millions) 785 1,882
Return on capital (ROC) 11 9.3
Return on equity (ROE) 13.6 13.1
Return on assets (ROA) 7.7 6.1
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Comparing Performance
Lowe’s Home Depot
Efficiency Measures
Asset turnover 1.56 1.61
Inventory turnover 4.17 4.03
Days in inventory 87.6 90.5
Receivables turnover * 195.3 56.5
Average collection period (days) * 1.9 6.5
Profit margin 4.6 3.2
Operating profit margin 5.2 4.1
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Comparing Performance
Lowe’s Home Depot
Leverage Measures
Long-term ratio 0.28 0.35
Total debt ratio 0.45 0.57
Times interest earned 12.8 6.8
Cash coverage ratio 17.9 9.6
Liquidity Measures
Net working capital to total assets 0.038 0.054
Current ratio 1.15 1.2
Quick ratio 0.103 0.134
Cash ratio 0.082 0.047
* Both companies sell most of their receivables to a third party
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Web Resources
Click to access web sites
Internet connection required
www.jaxworks.com
www.prars.com
www.census.gov/csd/qfr
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