02 Chapter model

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Chapter 2. Financial Statements, Cash Flows, and Taxes

This model is STRICTLY OPTIONAL. Neither students nor instructors need to go through it. However, if someone wants to practice with Excel, then the model can be useful. Also, on the tabs we show solutions for the within-chapter self-test questions. THE ANNUAL REPORT The annual report contains a verbal section plus four key statements: the balance sheet, income statement, statement of stockholders' equity, 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 stockholders' equity, 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 2008 Year-end stock price $23.06 Shares outstanding (in millions) 50 Tax rate 40%

2007 $26.00 50 40%

BALANCE SHEET (Section 2-2)

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) 2008 Assets Cash and equivalents Accounts receivable Inventories Total current assets Net plant and equipment Total assets Liabilities and Equity Accounts payable Accruals Notes payable Total current liabilities Long-term bonds Total debt Common stock (50,000,000 shares) $ 10 375 615 1,000 1,000 2,000 $ 2007 80 315 415 810 870 1,680

$ $

$ $

$ $

60 140 110 310 750 1,060 130

$ $

30 130 60 220 580 800 130

Retained earnings Total common equity Total liabilities and equity

$ $

810 940 2,000

$ $

750 880 1,680

INCOME STATEMENT (Section 2-3)

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) 2008 2007 Net sales $ 3,000.0 $ 2,850.0 Operating costs except depreciation 2,616.2 2,497.0 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 Common dividends Addition to retained earnings 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) $ $ $ $ 2008 23.06 2.35 1.15 18.80 $ $ $ $ 2007 26.00 2.44 1.06 17.60 $ $ $ 117.5 57.5 60.0 $ $ $ 121.8 53.0 68.8

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 2-4)

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 (2008) Parentheses indicate net cash outflows, no parentheses indicates net cash inflows. I. Operating Activities Net Income before dividends Depreciation and amortization Increase in inventories Increase in accounts receivable Increase in accounts payable Increase in accruals Net cash provided by (used in) operating activities II. Long-Term Investing Activities Additions to property, plant, and equipment Net cash used in investing activities III. Financing Activities Increase in notes payable Increase in bonds outstanding Payment of dividends to stockholders Net cash provided by financing activities 2008 $ 117.5 100.0 (200.0) (60.0) 30.0 10.0 $ (2.5)

$ (230.0) $ (230.0)

50.0 170.0 (57.5) 162.5

IV. Summary Net decrease in cash and equivalents: (Net sum of I, II, $ and (70.0) III) Cash and equivalents at beginning of the year 80.0 Cash and Equivalents at end of the Year $ 10.0

STATEMENT OF STOCKHOLDERS' EQUITY (Section 2-5)

The statement of stockholders' equity 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 STOCKHOLDERS' EQUITY - Allied Food Products (2008) Total Common Stock (000) Retained Stockholders' Shares Amount Earnings Equity Balances, Dec. 31, 2007 50,000 $130.0 $750.0 $880.0 2008 Net Income $117.5 Cash dividends ($57.5) Addition to Retained Earnings $60.0 Balance of Retained Earnings, Dec. 31, 2008 $810.0

FREE CASH FLOW (Section 2-6)

FCF = EBIT(1 T) + Depr'n (Capital expenditures + Net Working Capital) FCF = FCF =
$170.3 -$109.7 + $100.0 ( $230.0 + $150.0 )

CORPORATE TAXES (Section 2-7)

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Use the Excel function VLOOKUP to find the taxes due on a given amount of corporate income. The corporate tax table is shown below, with an income statement that's missing the tax liability and net income to the right. We use VLOOKUP to find the taxes due, after which we find net income.

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 38.0% $18,333,333 and up $6,416,667 35.0%

Sales Costs Taxable Taxes Net income Tax on base Income over base Tax rate Tax on income over base Total taxes Average tax rate

$315,000 $250,000 $65,000

$315,000 1. You are to fill in the 8 yellow cells. They should end Sales up looking like the green cells. $250,000 Costs $65,000 2. Put pointer on H11. Then click fx. Find and select Taxable category Lookup & Reference, and then click VLOOKUP and $11,250 Taxes OK to get the dialog box shown to the right. Fill it in as $53,750 Net income indicated. H7 is the number you are looking up, the taxable income. Highlight A9:D16 and select it to define the Tax on base $7,500 area of the lookup table. You want to look up a number Income over base $15,000 in the 3rd column. Tax rate 25.0% 4. Excel looks down Column 1 until it finds the value that's Tax: income over base $3,750 just larger than the number in H7, then it backs up one, Total taxes $11,250 then it goes to the 3rd column, finds the right number, and Average tax rate 17.3% inserts it in H11. You now have the tax on the base income. 5. To find the income over the base, use VLOOKUP again. Put pointer on H12. Get a new dialog box and fill it in just like the first one, except the third entry is 1 rather than 3. You now subtract this amount from the firm's taxable income. Do this by editing and entering entering H7 followed by a minus sign right after the equal sign in H12. The income over base is $15,000. 6. Now look up the marginal tax rate, i.e., the rate on the income over the base. Again, get a dialog box and fill it out as before, but with a 4 for the index. See the third box to the right. 7. Now just complete the arithmetic and finish the income statement. Note that the marginal tax rate is 25%, but the average tax rate is only 17.3%. With the income statement completed, you can change sales and/or costs to see the new results. For example, change sales (H5) from $315,000 to $400,000 to see the average rate rise from 17.3% to 27.8%.

SECTION 2-2
SOLUTIONS TO SELF-TEST QUESTIONS

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3. What was Allieds net working capital on December 31, 2007? ($650 million)
Cash and equivalents Inventories Accounts receivable Accounts payable Accruals Notes payable Net working capital $80 $415 $315 -$30 -$130 -$60 Not included $650

SECTION 2-6
SOLUTIONS TO SELF-TEST QUESTIONS

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3. A company has EBIT of $30 million, depreciation of $5 million, and a 40% tax rate. It needs to spend $10 million on new fixed assets and $15 million to increase its current assets, and it expects its payables to increase by $2 million and its accruals to increase by $3 million. What is its free cash flow? ($3 million) FCF FCF FCF FCF FCF = = = = = EBIT(1 T) + Depreciation - (Cap. Expenditures + Increase in Net WC)
$30(1 0.4) $18 $23 $3 + + $5 $5 20 [10 [ 10 + + (15-2-3)] 10 ]