Ch03 Tool Kit

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Bloomsburg University *

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535

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Finance

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Feb 20, 2024

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Uploaded by heidimutschler

Tool Kit Chapter 3 Analysis of Financial Statements Financial statements are analyzed by calculating certain key ratios and then comparing them with the ratios of other ?irms and by examining the trends in ratios over time. We can also combine ratios to make the analysis more revealing, one below are exceptionally useful for this type of analysis. 3-1 Financial Analysis Input Data: 2021 2020 Year-end common stock price $27.00 $40.00 Year-end shares outstanding (in millions) 50 50 Tax rate 40% 40% After-tax cost of capital 11.0% 10.5% Lease payments $28 $28 Required sinking fund payments $20 $20 Figure 3-1 MicroDrive Inc. Balance Sheets and Income Statements for Years Ending December 31 (Millions of Dollars, Except for Per Share Data) Balance Sheets 2021 2020 Assets Cash and equivalents $ 50 $ 60 Short-term investments - 0 40 Accounts receivable 500 380 Inventories 1,000 820 Total current asse $ 1,550 $1,300 Net plant and equipment 2,000 1,700 Total assets $ 3,550 $3,000 Liabilities and Equity Accounts payable $ 200 $ 190 Notes payable 280 130 Accruals 300 280 Total current liabilities $ 780 $ 600 Long-term bonds 1,200 1,000 Total liabilities $ 1,980 $1,600 Preferred stock (400,000 shares) 100 100 Common stock (50,000,000 shares) 500 500 Retained earnings 970 800 Total common equity $ 1,470 $1,300 Total liabilities and equity $ 3,550 $3,000 Income Statements 2021 2020 Net sales $ 5,000 $4,760 Costs of goods sold except depreciation 3,800 3,560 Depreciation 200 170 Other operating expenses 500 480 Earnings before interest and taxes (EBIT $ 500 $ 550 Less interest 120 100 Pre-tax earnings $ 380 $ 450 Taxes (40%) 152 180 Net income before preferred dividends $ 228 $ 270 Preferred dividends 8 8 Net income available to common stockholders $ 220 $ 262 Other Data Common dividends $50 $48 Addition to retained earnings $170 $214 Lease payments $28 $28 Bonds' required sinking fund payments $20 $20 Common stock price per share $27 $40 Calculated Data: Operating Performance and Cash Flows 2021 2020 Net operating working capital (NOWC) = $1,050 $790 Total net operating capital = $3,050 $2,490 Net operating pro?it after taxes (NOPAT) = $300 $330 Operating pro?itability (OP) ratio = NOPAT/Sales = 6.00% 6.93% Capital requirement(CR) ratio = (Total net operating capital/Sales) = 61.00% 52.31% Return on invested capital (ROIC) = NOPAT/Total net operating capital = 9.8% 13.3% Free cash ?low (FCF) = NOPAT − Net investment in operating capital = -$260 N/A Net cash ?low = Net income + Depreciation = $ 420 $432 Earnings before interest, taxes, depreciation & amortization (EBITDA) = EBIT + Depreciation & amortization = $700 $720 Market capitalization (# shares x price per share) $1,350 $2,000 Calculated Data: Per-share Information 2021 2020 Earnings per share (EPS) $4.40 $5.24 Dividends per share (DPS) $1.00 $0.96 Book value per share (BVPS) $29.40 $26.00 Cash ?low per share (CFPS) $8.40 $8.64 EDITDA per share $14.00 $14.40 Free cash ?low per share (FCFPS) -$5.20 N/A 3-2 Liquidity Ratios Industry 2021 2020 Average Liquidity ratios Current Ratio = CA/CL 2.0 2.2 2.2 Quick Ratio = (CA - Inventories)/CL 0.7 0.8 0.8 3-3 Asset Management Ratios Industry 2021 2020 Average Asset Management ratios Total Asset Turnover = Sales/TA 1.4 1.6 1.8 Fixed Asset Turnover = Sales/Fixed assets 2.5 2.8 3.0 Days Sales Outstanding = Accounts receivable/Daily sales 36.5 29.1 30.0 Inventory Turnover = COGS/Inventories 4.0 4.5 5.0 3-4 Debt Management Ratios Industry 2021 2020 Average Debt Management ratios Debt Ratio = Debt-to-Assets Ratio = Total debt/TA 41.7% 37.7% 25.0% Debt-to-Equity Ratio = Total debt/Total common equity 1.01 0.87 0.46 Market Debt Ratio = Total debt/(Total debt + Market Cap) 52.3% 36.1% 20.0% Liabilities-to-Assets Ratio = TL/TA 55.8% 53.3% 45.0% Times Interest Earned = EBIT/Interest expense 4.2 5.5 10.0 EBITDA Coverage Ratio = (EBIT + Depreciation + Lease pmt) (Interest + Principal pmt + Lease pmt) 4.3 5.1 12.0 3-5 Pro?itability Ratios Industry 2021 2020 Average Pro>itability ratios Pro?it Margin = Net income/Sales 4.4% 5.5% 6.2% Basic Earning Power = EBIT/TA 14.1% 18.3% 20.2% Return on Assets = Net income/TA 6.2% 8.7% 11.0% Return on Equity = Net income/Total common equity 15.0% 20.2% 19.0% 3-6 Market Value Ratios Industry 2021 2020 Average Market Value ratios Price-to Earnings Ratio = Price/(Net income/# shares) 6.1 7.6 10.5 Price-to-Cash Flow Ratio = Price (Net income + Depreciation)/# shares 3.2 4.6 6.3 Price-to-EBITDA Ratio = Price (EBIT + Depreciation)/# shares 1.9 2.8 4.0 Market-to-Book Ratio = Price/(Total common equity/#sha 0.9 1.5 1.8 Market-to-Book Ratio = (Price x #shares)/(Total common e 0.9 1.5 1.8 3-7 Trend Analysis, Common Size Analysis, and Percentage Change Analysis TREND ANALYSIS Trend analysis allows you to see how a ?irm's results are changing over time. For instance, a ?irm's ROE may be slightly below the benchmark, but if it has been steadily rising over the past four years, that should be seen as a good sign. A trend analysis and graph have been constructed on this data regarding MicroDrive's ROE over the past 5 years. (MicroDrive and indusry average data for earlier years has been provided.) ROE MicroDrive Industry 2017 15.0% 14.0% 2018 18.0% 15.0% 2019 21.0% 18.0% 2020 20.2% 17.0% 2021 15.0% 19.0% Figure 3-2 MicroDrive, Inc.: Return on Common Equity COMMON SIZE ANALYSIS In common size income statements, all items for a year are divided by the sales for that year. Figure 3-3 MicroDrive Inc.: Common Size Income Statements Industry Composite MicroDrive 2021 2021 2020 Net sales 100.0% 100.0% 100.0% Costs of goods sold except depreciation 75.5% 76.0% 74.8% Depreciation 3.0% 4.0% 3.6% Other operating expenses 10.0% 10.0% 10.1% Earnings before interest and taxes (EBIT 11.5% 10.0% 11.6% Less interest 1.2% 2.4% 2.1% Pre-tax earnings 10.4% 7.6% 9.5% Taxes (40%) 4.1% 3.0% 3.8% Net income before preferred dividends 6.2% 4.6% 5.7% Preferred dividends 0.0% 0.2% 0.2% Net income available to common stockholders 6.2% 4.4% 5.5% In common sheets, all items for a year are divided by the total assets for that year. Figure 3-4 MicroDrive Inc.: Common Size Balance Sheets Industry Composite MicroDrive 2021 2021 2020 Assets Cash and equivalents 1.8% 1.4% 2.0% Short-term investments 0.0% 0.0% 1.3% Accounts receivable 14.0% 14.1% 12.7% Inventories 26.3% 28.2% 27.3% Total current asse 42.1% 43.7% 43.3% Net plant and equipment 57.9% 56.3% 56.7% Total assets 100.0% 100.0% 100.0% Liabilities and Equity Accounts payable 7.0% 5.6% 6.3% Notes payable 0.0% 7.9% 4.3% Accruals 12.3% 8.5% 9.3% Total current liabilities 19.3% 22.0% 20.0% Long-term bonds 25.4% 33.8% 33.3% Total liabilities 44.7% 55.8% 53.3% Preferred stock 0.0% 2.8% 3.3% Total common equity 55.3% 41.4% 43.3% Total liabilities and equity 100.0% 100.0% 100.0% PERCENT CHANGE ANALYSIS In percent change analysis, all items are divided by the that item's value in the beginning, or base, year. Figure 3-5 MicroDrive Inc.: Income Statement Percent Change Analysis Base year = 2020 Percent Change in 2021 Net sales 5.0% Costs of goods sold except depreciation 6.7% Depreciation 17.6% Other operating expenses 4.2% Earnings before interest and taxes (EBIT (9.1%) Less interest 20.0% Pre-tax earnings (15.6%) Taxes (40%) (15.6%) Net income before preferred dividends (15.6%) Preferred dividends 0.0% Net income available to common stockholders (16.0%) MicroDrive, Inc.: Balance Sheet Percent Change Analysis (not in textbook) Base year = 2020 Percent Change in 2021 Assets Cash and equivalents (16.7%) Short-term investments (100.0%) Accounts receivable 31.6% Inventories 22.0% Total current asse 19.2% Net plant and equipment 17.6% Total assets 18.3% Liabilities and Equity Accounts payable 5.3% Notes payable 115.4% Accruals 7.1% Total current liabilities 30.0% Long-term bonds 20.0% Total liabilities 23.8% Preferred stock (400,000 shares) 0.0% Common stock (50,000,000 shares) 0.0% Retained earnings 21.3% Total common equity 13.1% Total liabilities and equity 18.3% 3-8 DuPont Analysis ROE = Pro?it margin x TA turnover Equity multiplier MicroDrive 2021 15.0% 4.40% 1.41 2.415 MicroDrive 2020 20.2% 5.50% 1.59 2.308 Industry Average 20.3% 6.20% 1.80 1.818 Suppose MicroDrive can improve its total asset turnover ratio. Improved TA turover ratio = 1.8 ROE = Pro?it margin x TA turnover Equity multiplier 19.1% 4.40% 1.80 2.415 ROE (%) 0.0% 22.0% 2017 2018 2019 2020 2021 1

Comments Chapter 1. Christopher Buzzard February 7, 2024 at 12:28:28 PM To calculate the DSO ratio, a 365-day accounting year was used.

SECTION 3-2 SOLUTIONS TO SELF-TEST Morris Corporation has the following information on its balance sheets: Cash = $40, accounts receivable = $30, inventories = $100, net ?ixed asset = $500, accounts payable = $20, accruals = $10, short-term debt (matures in less than a year) = $25, long-term debt = $200, and total common equity = $415. What is its current ratio? Its quick ratio? Cash $40 Accounts receivable $30 Inventories $100 Net ?ixed assets $500 Total $670 Accounts payable $20 Accruals $10 ST debt $25 LT debt $200 Total common equity $415 $670 Current assets $170 Current liabilities $55 Current ratio 3.1 Current assets − Inventories $70 Current liabilities $55 Quick ratio 1.3 A company has current liabilities of $800 million, and its current ratio is 2.5. What is its level of current assets? If this ?irm’s quick ratio is 2, how much inventory does it have? Current liabilities ($M) $800 Current ratio 2.5 Current assets ($M) $2,000 Current liabilities ($M) $800 Current ratio 2.5 Quick ratio 2 Current assets - Inventories ($M) $1,600 Inventories ($M) $400

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SECTION 3-3 SOLUTIONS TO SELF-TEST Morris Corporation has the following information on its balance sheets: Cash = $40, accounts receivable = $30, inventories = $100, net ?ixed asset = $500, accounts payable = $20, accruals = $10, short-term debt (matures in less than a year) = $25, long-term debt = $200, and total common equity = $415. Its income statement reports: Sales = $820, costs of goods sold (excluding depreciation) = $450, depreciation = $50, other operating expenses = $100, interest expense = $20, and tax rate = 40%. Calculate the following ratios: total assets turnover, ?ixed assets turnover, days sales outstanding (based on a 365 day year), inventory turnover. Hint: This is the same company used in the previous Self-Test. Cash $40 Accounts receivable $30 Inventories $100 Net ?ixed assets $500 Total assets $670 Accounts payable $20 Accruals $10 ST debt $25 LT debt $200 Total common equity $415 $670 Sales $820 COGS (excluding depreciation) $450 Depreciation $50 Other operating expenses $100 EBIT $220 Interest expense $20 Pre-tax earnings $200 Tax rate 40% Tax expense $80 Net income $120 Days in year 365 Sales $820 Total assets $670 Total assets turnover 1.2 Sales $820 Fixed assets $500 Fixed assets turnover 1.6 Daily average sales $2.25 Accounts receivable $30 Days sales outstanding 13.4 COGS including depreciation $500 Inventories $100 Fixed assets turnover 5.0 A ?irm has $200 million annual sales, $180 million costs of goods sold, $40 million of inventory, and $60 million of accounts receivable. What is its inventory turnover ratio? Annual Sales ($M) $200 Costs of good sold ($M) $180 Inventory ($M) $40 Accounts receivable ($M) $60 Inventory turnover 4.5 Annual Sales ($M) $200 Inventory ($M) $40 Accounts receivable ($M) $60 Days sales outstanding 109.5

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SECTION 3-4 SOLUTIONS TO SELF-TEST Morris Corporation has the following information on its balance sheets: Cash = $40, accounts receivable = $30, inventories = $100, net ?ixed asset = $500, accounts payable = $20, accruals = $10, short-term debt (matures in less than a year) = $25, long-term debt = $200, and total common equity = $415. Its income statement reports: Sales = $820, costs of goods sold (excluding depreciation) = $450, depreciation = $50, other operating expenses = $100, interest expense = $20, and tax rate = 40%. Calculate the following ratios: total assets turnover, ?ixed assets turnover, days sales outstanding (based on a 365 day year), inventory turnover. Hint: This is the same company used in the previous Self-Test. Cash $40 Accounts receivable $30 Inventories $100 Net ?ixed assets $500 Total assets $670 Accounts payable $20 Accruals $10 ST debt $25 LT debt $200 Total common equity $415 $670 Sales $820 COGS (excluding depreciation) $450 Depreciation $50 Other operating expenses $100 EBIT $220 Interest expense $20 Pre-tax earnings $200 Tax rate 40% Tax expense $80 Net income $120 Days in year 365 Lease payments $0 Required principal payments $0 Total debt $225 Total assets $670 Debt-to-assets ratio 33.6% Total debt $225 Total common equity $415 Debt-to-equity ratio 54.2% Total liabilities $255 Total assets $670 Liabilities-to-assets ratio 38.1% EBIT $220 Interest expense $20 Times-interest-earned ratio 11.0 Suppose the previous company has 100 shares of stock with a price of $15 per share. What is its market debt ratio (assume the market value of debt is close to the book value)? How does this compare with the previously calculated debt-to-assets ratio? Does the market debt ratio imply that the company is more or less risky than the debt-to-assets ratio indicated? Number of shares 100 Price per share $15 Total debt $225 Market value of equity $1,500 Market debt ratio 13.0% Notice that the market debt ratio is much less than the debt ratio based on book values, implying that the ?irm is less risky than indicated by the ratio based on book values. A company has EBITDA of $600 million, interest payments of $60 million, lease payments of $40 million, and required principal payments (due this year) of $30 million. What is its EBITDA coverage ratio? EBITDA ($M) $600 Interest payments $60 Lease payments $40 Principal payments $30 EBITDA coverage 4.9

Comments 3-4

SECTION 3-5 SOLUTIONS TO SELF-TEST Morris Corporation has the following information on its balance sheets: Cash = $40, accounts receivable = $30, inventories = $100, net ?ixed asset = $500, accounts payable = $20, accruals = $10, short-term debt (matures in less than a year) = $25, long-term debt = $200, and total common equity = $415. Its income statement reports: Sales = $820, costs of goods sold (excluding depreciation) = $450, depreciation = $50, other operating expenses = $100, interest expense = $20, and tax rate = 40%. Calculate the following ratios: total assets turnover, ?ixed assets turnover, days sales outstanding (based on a 365 day year), inventory turnover. Hint: This is the same company used in the previous Self- Test. Cash $40 Accounts receivable $30 Inventories $100 Net ?ixed assets $500 Total assets $670 Accounts payable $20 Accruals $10 ST debt $25 LT debt $200 Total common equity $415 $670 Sales $820 COGS (excluding depreciation) $450 Depreciation $50 Other operating expenses $100 EBIT $220 Interest expense $20 Pre-tax earnings $200 Tax rate 40% Tax expense $80 Net income $120 Net income $120 Sales $820 Net pro?it margin 14.6% EBIT $220 Sales $820 Operating pro?it margin 26.8% EBIT $220 Total assets $670 Basic earnings power ratio 32.8% Net income $120 Total assets $670 Return on total assets 17.9% Net income $120 Total common equity $415 Return on common equity 28.9% A company has $200 billion of sales and $10 billion of net income. Its total assets are $100 billion, ?inanced half by debt and half by common equity. What is its pro?it margin? What is its ROA? What is its ROE? Sales ($B) $200 Net income ($B) $10 Total assets ($B) $100 Debt ratio 50% Pro?it margin 5.00% Sales ($B) $200 Net income ($B) $10 Total assets ($B) $100 Debt ratio 50% ROA 10.00% Sales ($B) $200 Net income ($B) $10 Total assets ($B) $100 Debt ratio 50% ROE 20.00%

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SECTION 3-6 SOLUTIONS TO SELF-TEST A company has $6 billion of net income, $2 billion of depreciation and amortization, $80 billion of common equity, and one billion shares of stock. If its stock price is $96 per share, what is its price/earnings ratio? Its price/cash ?low ratio? Its market/book ratio? Net income ($B) $6 Amortization and depreciation ($B) $2 Common equity $80 Number of shares ($B) 1 Stock price per share $96 Earnings per share $6 P/E ratio 16.00 Cash ?low $8.00 Cash ?low per share 8.00 Price/cash ?low 12.00 Book value per share 80.00 Market/Book 1.20

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SECTION 3-8 SOLUTIONS TO SELF-TEST A company has a pro?it margin of 6%, a total asset turnover ratio of 2, and an equity multiplier of 1.5. What is its ROE? Pro?it margin 6.0% Total asset turnover 2.0 Equity multiplier 1.5 ROE 18.0%

Comments 3-8

Mini Case Data Input Data: 2014 2015 2016 Year-end common stock price $8.50 $6.00 $12.17 Year-end shares outstanding 100,000 100,000 250,000 Tax rate 40% 40% 40% Lease payments $40,000 $40,000 $40,000 Balance Sheets Assets 2014 2015 2016 Cash and equivalents $9,000 $7,282 $14,000 Short-term investments $48,600 $20,000 $71,632 Accounts receivable $351,200 $632,160 $878,000 Inventories $715,200 $1,287,360 $1,716,480 Total current assets $1,124,000 $1,946,802 $2,680,112 Gross Fixed Assets $491,000 $1,202,950 $1,220,000 Less Accumulated Dep. $146,200 $263,160 $383,160 Net Fixed Assets $344,800 $939,790 $836,840 Total Assets $1,468,800 $2,886,592 $3,516,952 Liabilities and Equity Accounts payable $145,600 $324,000 $359,800 Notes payable $200,000 $720,000 $300,000 Accruals $136,000 $284,960 $380,000 Total current liabilities $481,600 $1,328,960 $1,039,800 Long-term bonds $323,432 $1,000,000 $500,000 Total liabilities $805,032 $2,328,960 $1,539,800 Common stock (100,000 shares) $460,000 $460,000 $1,680,936 Retained earnings $203,768 $97,632 $296,216 Total common equity $663,768 $557,632 $1,977,152 Total liabilities and equity $1,468,800 $2,886,592 $3,516,952 Income Statements 2014 2015 2016 Net sales $3,432,000 $5,834,400 $7,035,600 Costs of Goods Sold Except Depr. $2,864,000 $4,980,000 $5,800,000 Depreciation and amortization $18,900 $116,960 $120,000 Other Expenses $340,000 $720,000 $612,960 Total Operating Cost $3,222,900 $5,816,960 $6,532,960 Earnings before interest and taxes (EBIT) $209,100 $17,440 $502,640 Less interest $62,500 $176,000 $80,000 Pre-tax earnings $146,600 ($158,560) $422,640 Taxes (40%) $58,640 ($63,424) $169,056 Net Income before preferred dividends $87,960 ($95,136) $253,584 EPS $0.880 ($0.951) $1.014 DPS $0.220 $0.110 $0.220 Book Value Per Share $6.638 $5.576 $7.909 1

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