03 Chapter model

10/6/2013 4:28

2/13/2006

Chapter 3. Financial Statements, Cash Flows, and Taxes

THE ANNUAL REPORT The annual report contains a verbal section plus four key statements: the balance sheet, income statement, statement of retained earnings, and statement of cash flows. These statements contain a wealth of information that is used by bankers, stock and bond analysts, and managers. Hence, they are quite important. Spreadsheets are used both to create and to analyze these statements, as we demonstrate in this model. In this model, we start with the same balance sheet and income statement that was used in the chapter, but in an Excel format, and then we show how spreadsheets can be used to analyze the data. The analysis continues to cover the statement of retained earnings, statement of cash flows, and shows how accounting data may be modified to evaluate managerial performance. INPUT DATA SECTION: Historical Data Used in the Analysis 2005 $23.00 50 40% 10.0% 2004 $26.00 50 40% 10.3%

Year-end stock price Shares outstanding (in millions) Tax rate After-tax cost of capital

BALANCE SHEET (Section 3.3)

The balance sheet can be thought of as a snapshot in time of a firm's financial position. You can observe the firm's level of assets and the manner in which they have used debt and equity to fund those assets. BALANCE SHEETS - Allied Food Products - December 31 (in millions of dollars) 2005 Assets Cash and equivalents Accounts receivable Inventories Total current assets Net plant and equipment Total assets Liabilities and Equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50M shares) Retained earnings Total common equity Total liabilities and equity $ 10 375 615 1,000 1,000 2,000 $ 2004 80 315 415 810 870 1,680

$ $

$ $

$ $

$ $

60 110 140 310 750 1,060 130 810 940 2,000

$ $

$ $

30 60 130 220 580 800 130 750 880 1,680

INCOME STATEMENT (Section 3.4)

The income statement summarizes a firm's revenues and expenses over an accounting period, usually a year. The "bottom line" of an income statement is the firm's net income. Collectively, the income statement gives an indication of a firm's operating ability. INCOME STATEMENTS - Allied Food Products - Years Ending December 31 (in millions of dollars) 2005 2004 Net sales $3,000.0 $2,850.0 Operating costs except depreciation 2,616.2 2,497.0 Earnings before interest, taxes, and depreciation (EBITDA)* $383.8 $353.0 Depreciation 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 $117.5 $121.8 Common dividends Addition to retained earnings *Allied has no amortization charges. $57.5 $60.0 $53.0 $68.8

PER-SHARE DATA 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). Simply divide the totals by the appropriate number of shares outstanding. Note that BVPS is calculated by dividing total common equity (common stock plus retained earnings) by shares outstanding. Common stock price Earnings per share (EPS) Dividends per share (DPS) Book value per share (BVPS) Cash flow per share (CFPS) 2005 $23.00 $2.35 $1.15 $18.80 $4.35 2004 $26.00 $2.44 $1.06 $17.60 $4.24

The per share data give managers and investors a quick look at some items that affect the price of the stock.

STATEMENT OF CASH FLOWS (Section 3.6)

Information from the balance sheet and income statement can be used to construct the Statement of Cash Flows, which is shown below for Allied, in millions of dollars. STATEMENT OF CASH FLOWS - Allied Food Products (2005) 2005 I. Operating Activities Net Income before dividends Additions (Sources of Cash) Depreciation and amortization Increase in accounts payable Increase in accruals Subtractions (Uses of Cash) Increase in accounts receivable Increase in inventories Net cash provided by operating activities II. Long-Term Investing Activities Cash used to acquire fixed assets III. Financing Activities Increase in notes payable Increase in bonds Payment of dividends Net cash provided by financing activities Net decrease in cash and equivalents Cash and equivalents at beginning of the year IV. Cash and Equivalents at End of the Year $117.5 100.0 30.0 10.0 (60.0) (200.0) ($2.5)

($230.0)

$50.0 170.0 (57.5) $162.5 ($70.0) 80.0 $10.0

STATEMENT OF RETAINED EARNINGS (Section 3.7)

The statement of retained earnings takes the previous year's balance of retained earnings, adds the current year's net income, and then subtracts dividends paid to common stockholders. The end result is the new balance of retained earnings. Allied's statement is shown below, in millions: STATEMENT OF RETAINED EARNINGS - Allied Food Products (2005) Balance of Retained Earnings, Dec. 31, 2004 Add: Net Income, 2005 Less: Dividends to common stockholders Balance of Retained Earnings, Dec. 31, 2005 2005 $750.0 117.5 (57.5) $810.0

MODIFYING ACCOUNTING DATA (Section 3.9)

Now that the statements have been developed, we can use the data contained in them to calculate some items that are of interest to managers, investors, and lenders. All of these items are used more extensively in subsequent chapters, where we look in more depth at how historical financial statements are analyzed and how future financial results are predicted. Net operating working capital (NOWC) Total operating capital Net Cash Flow (NCF) Cash Flow Per Share (CFPS) Net Operating Profit After Taxes (NOPAT) Operating Cash Flow (OCF) Free Cash Flow (FCF) Economic Value Added, EVA ($M) Market Value Added, MVA ($M) 2005 $800.0 $1,800.0 $217.5 $4.35 $170.3 $270.3 ($109.7) ($9.7) $210.0 2004 $650.0 $1,520.0 $211.8 $4.24 $157.8 $247.8 N/A $1.2 $420.0

WEB APPENDIX 3A: CALCULATING CORPORATE TAX LIABILITY

This worksheet explores the calculation of corporate income taxes under the federal tax system. By using special Excel functions, we can input a corporate tax schedule into a spreadsheet and then have a cell automatically display a company's tax liability. Either of two procedures can be used, the IF function or the VLOOKUP function. Both functions are explained below, using the data shown in the following tax table. LOOKUP There are actually two lookup functions, VLOOKUP for looking up items in vertical columns, and HLOOKUP for looking up things in horizontal rows. Since our tax table is arranged in columns, we use VLOOKUP. In words, Excel first looks down Column 1 (or A) and finds the largest value that does not exceed the firm's taxable income. Next, it looks for the corresponding value in Column 3 (or C), which is the base amount of the tax. Then, it again looks down Column (1) and finds the corresponding marginal tax rate as shown in Column 4. Then it multiplies the tax rate times the difference between the firm's taxable income and the bottom tax bracket to get the incremental tax. Then it adds the base tax to the incremental tax to calculate the firm's total tax liability.

Begin by highlighting the range A32:D39, which contains the tax table. Then click on the inverted triangle at the left of the 4th row (the formula bar) and type the word "taxtable" to name the range. Then put the pointer on G42, and then click the function wizard, fx, select "Lookup & Reference," and then select VLOOKUP. You will then get a menu box like the one shown below. When you fill in the menu box, and click OK, you will get this equation on the formula bar and $3,400,000 in cell G42. =VLOOKUP(B24,taxtable,3) Next, put the pointer on F43, get the VLOOKUP menu box, and look up the marginal tax rate. The correct value is 35.0%, and here is the formula: =VLOOKUP(B24,taxtable,4) Next, put the pointer on F44 and look up the marginal tax bracket and then subtract it from the firm's income to find the incremental income. Here is the formula: =B24-VLOOKUP(B24,taxtable,1) Finish by adding the tax on the marginal income to the tax on the bracket base. Taxable Income: $12,000,000 Corporate Tax Rates, as of January 2005 If a corporation's It pays this Plus this % on taxable income amount on the excess is between: the base over the base (1) (2) (3) (4) $0 $50,000 $0 15.0% $50,000 $75,000 $7,500 25.0% $75,000 $100,000 $13,750 34.0% $100,000 $335,000 $22,250 39.0% $335,000 $10,000,000 $113,900 34.0% $10,000,000 $15,000,000 $3,400,000 35.0%

$15,000,000 $18,333,333 $5,150,000 $18,333,333 and up $6,416,667

38.0% 35.0%

1st VLOOKUP to find the base amount of tax: 2nd VLOOKUP to find the marginal tax rate: 3rd VLOOKUP to find the marginal income to be taxed:

35.0% $ 2,000,000

Total tax liability:

SECTION 3.3
SOLUTIONS TO SELF-TEST QUESTIONS 3 A company has $2 million of cash and equivalents, $2 million of inventory, $3 million of accounts receivable, $3 million of accounts payable, $1 million of accruals, and $2 million of notes payable. What is its net working capital? Cash and equivalents Inventory Accounts receivable Accounts payable Accruals Notes payable Net working capital $2,000,000 $2,000,000 $3,000,000 $3,000,000 $1,000,000 $2,000,000 $1,000,000

SECTION 3.9
SOLUTIONS TO SELF-TEST QUESTIONS 5 A company has NOPAT of $30 million, and its depreciation and amortization expense is $10 million. During the year the companys gross capital expenditures (total purchases of fixed assets) were $20 million and its net operating working capital increased by $10 million. What is the companys operating cash flow? What is its free cash flow? NOPAT Depreciation & amort. Gross capital exp Net working capital Operating cash flow Free cash flow
$30,000,000 $10,000,000 $20,000,000 $10,000,000 $40,000,000 $10,000,000