Alcatraz Corp.

Balance Sheets ($ in millions) 2011 Assets Cash Accounts receivable Inventory Total current assets Property, plant, and equipment Total assets Liabilities and Stockholders' Equity Accounts payable Notes payable Total current liabilities Long-term debt Owners' equity Common stock and APIC Retained earnings Total equity Total liabilities and owners' equity 98 188 422 708 2,880 3,588 2010 84 165 393 642 2,731 3,373

344 196 540 457 550 2,041 2,591 3,588

312 231 543 531 500 1,799 2,299 3,373

Notes: An average of 33 million shares were outstanding during 2011. The stock price at December 31st was $88.

Alcatraz Corp. Income Statements ($ in millions) 2011 2,500 1,500 400 600 300 300 105 195 50 2010 2,000 1,200 250 550 120 430 151 280 80 2009 1,900 1,000 200 700 100 600 210 390 200

Sales Cost of goods sold Depreciation Earnings before interest and taxes (EBIT) Interest expense Taxable income Taxes (35%) Net income Dividends paid

Alcatraz Corp. 2011 and 2010 Balance Sheet (Horizontal Analysis) 2011 Assets Cash Accounts receivable Inventory Total current assets Property, plant, and equipment Total assets Liabilities and Stockholders' Equity Accounts payable Notes payable Total current liabilities Long-term debt Owners' equity Common stock and APIC Retained earnings Total equity Total liabilities and owners' equity 98 188 422 708 2,880 3,588 2010 84 165 393 642 2,731 3,373 $ Chg. 14 23 29 66 149 215 % Chg. 16.7% 13.9% 7.4% 10.3% 5.5% 6.4%

344 196 540 457 550 2,041 2,591 3,588

312 231 543 531 500 1,799 2,299 3,373

32 (35) (3) (74) 50 242 292 215

10.3% -15.2% -0.6% -13.9% 10.0% 13.5% 12.7% 6.4%

Notes: An average of 33 million shares were outstanding during 2011. The stock price at December 31st was $88.

Alcatraz Corp. Income Statements (Horizontal Analysis) 2011 2,500 1,500 400 600 300 300 105 195 50 2010 2,000 1,200 250 550 120 430 151 280 80 $ Chg. 500 300 150 50 180 (130) (46) (85) (30) % Chg. 25.0% 25.0% 60.0% 9.1% 150.0% -30.2% -30.2% -30.2% -37.5%

Sales Cost of goods sold Depreciation Earnings before interest and taxes (EBIT) Interest expense Taxable income Taxes (35%) Net income Dividends paid

Alcatraz Corp. 2011 and 2010 Balance Sheet (Common Size) 2011 Assets Cash Accounts receivable Inventory Total current assets Property, plant, and equipment Total assets Liabilities and Stockholders' Equity Accounts payable Notes payable Total current liabilities Long-term debt Owners' equity Common stock and APIC Retained earnings Total equity Total liabilities and owners' equity 2.7% 5.2% 11.8% 19.7% 80.3% 100.0% 2010 2.5% 4.9% 11.7% 19.0% 81.0% 100.0% Change 0.2% 0.3% 0.1% 0.7% -0.7% 0.0%

9.6% 5.5% 15.1% 12.7% 15.3% 56.9% 72.2% 100.0%

9.2% 6.8% 16.1% 15.7% 14.8% 53.3% 68.2% 100.0%

0.3% -1.4% -1.0% -3.0% 0.5% 3.5% 4.1% 0.0%

Significant changes: 1) Notes payble declined. 2) Long-term debt declined. 3) Retained earnings increased. The company is obtaining more of its capital from equity rather than debt.

Alcatraz Corp. Income Statements (Common Size) 2011 100.0% 60.0% 16.0% 24.0% 12.0% 12.0% 4.2% 7.8% 2010 100.0% 60.0% 12.5% 27.5% 6.0% 21.5% 7.5% 14.0% 2009 100.0% 52.6% 10.5% 36.8% 5.3% 31.6% 11.1% 20.5%

Sales Cost of goods sold Depreciation Earnings before interest and taxes (EBIT) Interest expense Taxable income Taxes (34%) Net income

Significant changes: 1) Profit margin is dropping significantly. Bad newswhy is it dropping? 2) Cost of goods sold has gone up since 2009. 3) Depreciation continues to increase. 4) Interest expense continues to go up. The company's income statement is getting significantly weaker year over year.

Financial Ratios Cheat Sheet

Short-term liquidity measures Current ratio Current assets Current liabilities Current assets - inventory Current liabilities

Quick ratio

Long-term solvency measures Total debt ratio

Total liabilities Total assets Total liabilities Total equity EBITDA Interest expense

Debt to equity ratio

Times interest earned

Asset management/turnover measures Inventory turnover

COGS Avg. inventory

Days sales in inventory

365 days Inventory turnover Sales Avg. A/R 365 days A/R turnover

A/R turnover

Average collection period

Profitability measures Profit margin

Net income Sales Net income Avg. total assets Net income Avg. total equity

Return on Assets (ROA)

Return on Equity (ROE)

Market value measures Earnings per share (EPS)

Net income Avg shares outstanding Price per share Earnings per share Market value per share Book value per share

Price-Earnings (PE) ratio

Market-to-book ratio

Explanation of Key Financial Ratios

Current ratio Current assets Current liabilities 1.31 = (708/540)

The current ratio gives us an indication of our ability to pay short-term debts. Reminder: Current assets are cash and other assets that are converted to cash in one year or less. Current liabilities are those debts which have a due date of one year or less. In this example, for every one dollar of current liabilities, Alcatraz has $1.31 in current assets. A good current ratio is 2 (sometimes expressed as "2 to 1"). It's not necessarily true that higher is better though. If a company has a current ratio of 10, that means it has a significant number of current assets which could probably be invested long-term (new facilities, etc.) and have a higher return than would current assets.

Quick ratio

Current assets - inventory Current liabilities

0.53 = (98+188)/540

For some firms, inventory may be difficult to sell. Quick ratio excludes inventory from current assets and looks at only the most liquid assets (cash, receivables, marketable securities, etc.). A quick ratio of 1 is good and gives a company flexibility to pay its short-term debt. If Alcatraz cant sell its inventory, it may have trouble paying current liabilities as they come due.

Total debt ratio

Total liabilities Total assets

27.8% = (540+457)/3,588

The total debt ratio gives us a measure of how much financing is provided by debt as opposed to equity. The basic accounting equation is Assets = Liabilities + Owner's Equity. Alcatraz has total assets of $3,588. Those assets are financed part by liabilities ($997) and part through owner's equity ($2,591). In this example, the total debt ratio is 27.8%, meaning that for every $100 of assets, $27.80 is financed through debt. The other portion (72.2%) is financed through equity. Companies can choose to be more debt financed or equity financed; there are advantages and disadvantages of each. Therefore, although total debt ratio explains a company's capital structure, there's not a hard and fast rule as to what a good total debt ratio is.

Debt to equity ratio

Total liabilities Total equity

38.5% = (540+457)/2,591

Debt to equity ratio is a similar metric as total debt ratio but just slices it differently. Now we're looking at the relationship between debt financing and equity financing. If the debt to equity ratio is greater than 1, a company is financed more through debt. If the debt to equity ratio is less than 1, the company is financed more through equity. You can see the connection between the total debt ratio and debt to equity ratio: In the Alcatraz example, the total debt ratio was 27.8% meaning that debt financing accounts for 27.8% and equity financing is the other 72.2%. If you divided 27.8 by 72.2 you get 38.5%, which is the debt to equity ratio.

Times interest earned

EBITDA Interest expense

3.3 = (600+400)/300

Times interest earned is how well our operating profit (EBITDA) covers our interest obligations. In this case, Alcatraz has $300 of interest expense but has an EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization) of $1,000. So they're able to "cover" their interest 3.3 times. Bigger is better here.

Inventory turnover

COGS Avg. inventory

3.68 = 1,500/((422+393)/2)

Inventory turnover is a frequently used measure informing a business of how quickly it is moving its inventory. A good inventory turnover depends on industry (custom homes would turn slower than milk at a grocery store). In the Alcatraz case, the company turns its inventory 3.68 times per year. This means that, on average , new inventory is being purchased and old inventory is being sold 3.68 times per year. Inventory turnover could be increased by selling product at discount prices, but profit might suffer. Therefore, this metric should be kept in balance with others.

Days sales in inventory

365 days Inventory turnover

99 days = 365/3.68

Inventory turnover is sometimes difficult to grasp so a more user friendly way to say the same thing is Days sales in inventory. If you divided 365 by the Inventory turnover, you figure out how long it took to sell the inventory. In this case, on average, inventory sat on the shelves for 99 days before being sold.

A/R turnover

Sales Avg. A/R

14.16 = 2,500/((188+165)/2)

How long do we give our customers to pay? That's what A/R turnover and Average collection period tell us. A low A/R turnover tells us that customers are taking a very long time to pay off their accounts and therefore, the company is without the cash that it probably needs for other operations. In this case, Alcatraz makes a sale and then collects from the customer on average 14 times a year.

Average collection period

365 days A/R turnover

26 days = 365/14.16

Just like we did with Inventory turnover, we can convert A/R turnover to a more user friendly metric. We divide 365 by the A/R turnover from above and get Average collection period. In this case we came up with 26 days telling us that Alcatraz collects a sale on account on average 26 days from the time of the sale.

Profit margin

Net income Sales

7.8% = 195/2,500

How much of every $1 sold makes it down to the bottom line? That's what profit margin tells us. For Alcatraz, for every $100 sold, they make $7.80 in profit, or 7.8%. This number should look familiar it's the same number we found when we did vertical analysis (common-size financials) on the income statement.

Return on Assets (ROA)

Net income Avg. total assets

5.6% = 195/((3,588+3,373)/2)

How well did we use the assets invested into the business? We'd expect a company with a large amount of assets invested to return a significantly higher profit than a business with a small amount of assets invested. ROA gives a measure of this by adjusting for the scale or size of the company. In the Alcatraz case, for every $100 of assets invested, the company made $5.60 in profit, or 5.6%.

Return on Equity (ROE)

Net income Avg. total equity

8.1% = 195/((2,591+2,229)/2)

How well did we use the owner's capital invested into the business? We'd expect a company with a large amount of capital investment to return a significantly higher profit than a business with a small amount of capital invested. ROE gives a measure of this by adjusting for the scale or size of the company. In the Alcatraz case, for every $100 invested capital, the company made $8.10 in profit, or 8.1%.

Earnings per share (EPS)

Net income Avg shares outstanding

$ 5.91 = 195/33

EPS is one of the most frequently cited measures of profitability. How much (in terms of net income) did each share make in the prior period? For Alcatraz, each share was responsible for $5.91 of profit in the prior period.

Price-Earnings (PE) ratio

Price per share Earnings per share

14.9 = $88/$5.91

How expensive is a stock in relation to its earning? PE ratio gives an indication of that. Typically, company earnings drive stock prices. If other considerations are normal, the more profit a company makes the higher the stock price goes. So there should be some relationship between earnings and price. That's PE ratio. PE ratio answers the question: "How many more times than last year's earnings per share is the stock currently selling for?" A normal range is 15-20. A stock with a very high PE ratio could be a) overpriced or b) the market could expect significant growth in profitability (EPS) in future years and therefore, investors are willing to pay the premium until EPS catches up. Alcatraz has a relatively normal PE ratio of 14.9.

Market-to-book ratio

Market value per share Book value per share

1.12 = $88/(2,591/33)

Another way to measure the how "expensive" a stock is would be to use market-to-book ratio. The market price is simply what the stock is currently trading for on the stock market. This fluctuates minute to minute. The book value per share is the total owner's equity of the firm divided by the number of shares outstanding. The book value is a historical measure (looking back to the last reporting date). Book value per share asks "How much is a share of stock worth on the Balance Sheet?" In this case, the market price of a share of stock exceeds its value on the books by 12%. Just we discussed for PE ratio, if a company has a high market-to-book-ratio, they could be a) overpriced or b) have significant growth potential.