Ch. 10 slides


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Ch. 10 slides

  1. 1. DES Chapter 10 The Condensed Financial Statements and Financial Analysis
  2. 2. Using the Corporate Valuation Spreadsheet <ul><li>Look at the file: Home Depot (for Ch 9-11, WACC, default inputs).xls . </li></ul><ul><li>This file will be called Home Depot.xls for short. </li></ul>
  3. 3. Steps to Estimate Value Using the Corporate Valuation Spreadsheet <ul><li>The valuation spreadsheet has seven interrelated worksheets: </li></ul><ul><ul><ul><li>(1) Proj & Va l </li></ul></ul></ul><ul><ul><ul><li>(2) Inputs </li></ul></ul></ul><ul><ul><ul><li>(3) WACC </li></ul></ul></ul><ul><ul><ul><li>(4) Hist Analys </li></ul></ul></ul><ul><ul><ul><li>(5) Condensed </li></ul></ul></ul><ul><ul><ul><li>(6) Comprehensive </li></ul></ul></ul><ul><ul><ul><li>(7) Actual </li></ul></ul></ul>
  4. 5. The Condensed Sheet <ul><li>You don’t need to do your analysis on a financial statements as complicated as those in the Comprehensive or Actual sheets. </li></ul><ul><li>The spreadsheet automatically condenses the Comprehensive sheet into a format called the Condensed sheet. </li></ul><ul><ul><li>See DES Chapter 10 and its Appendix </li></ul></ul>(continued)
  5. 6. The Condensed Sheet (continued) <ul><li>Rationale for including additional items in the condensed financial statements: </li></ul><ul><ul><li>(1) provide more detail and accuracy in reporting operating performance </li></ul></ul><ul><ul><li>(2) account for nonoperating performance </li></ul></ul><ul><ul><li>(3) allow us to convert GAAP-based statements into free cash flows </li></ul></ul>(continued)
  6. 7. The Condensed Sheet (continued) <ul><li>Relative to Van Leer’s financials, the condensed statements provide details on: </li></ul><ul><ul><li>Operating performance </li></ul></ul><ul><ul><li>Nonoperating performance </li></ul></ul><ul><ul><li>Adjustments due to GAAP </li></ul></ul>
  7. 8. Additional Detail - Operating Performance <ul><li>Other Short- and Long-Term Operating Assets/Liabilities </li></ul><ul><ul><li>Short-term operating assets/liabilities – example: </li></ul></ul><ul><ul><ul><li>payroll advances to their employees </li></ul></ul></ul><ul><ul><li>Other short-term operating assets/liabilities are catch-alls for such items. </li></ul></ul><ul><ul><li>Long-term operating assets – example: </li></ul></ul><ul><ul><ul><li>goodwill and intangibles, deposits held by suppliers, deferred charges </li></ul></ul></ul><ul><ul><li>Other long-term operating assets is a catch-all line item for assets of these types. </li></ul></ul>
  8. 10. Additional Detail - Nonoperating Performance <ul><li>Long-Term Investments and Nonoperating Income </li></ul><ul><ul><li>activities that are not operating activities </li></ul></ul><ul><ul><ul><li>noncontrolling investments in other firms </li></ul></ul></ul><ul><ul><ul><li>investments in real estate or other stocks and bonds </li></ul></ul></ul><ul><ul><li>These investments are accounted for in long-term investments; income from these investments is reported in the nonoperating income account. </li></ul></ul>
  9. 11. Additional Detail - Nonoperating Performance <ul><li>After-Tax Extraordinary Income not related to the firm’s continuing operations </li></ul><ul><ul><li>one-time events classified as extraordinary items- examples: </li></ul></ul><ul><ul><ul><li>settlement of a lawsuit, casualty losses due to flood, fire, or tornado, and gains or losses on the extinguishment of debt) </li></ul></ul></ul><ul><ul><ul><li>items that relate to a firm’s decision to discontinue a segment of its operations (sale or closure of a subsidiary, division, or major segment of its business) </li></ul></ul></ul>
  10. 12. Additional Detail - Nonoperating Performance <ul><ul><li>All Short-Term Debt </li></ul></ul><ul><ul><li>levels vary based on short-term cash needs, and are not targeted </li></ul></ul><ul><ul><ul><li>used to meet any excess or unanticipated cash needs </li></ul></ul></ul><ul><ul><ul><li>firms have many different types of short-term debt, but only the total is relevant to valuation </li></ul></ul></ul><ul><ul><ul><li>includes the portion of the long-term debt that will come due within a year. </li></ul></ul></ul>
  11. 13. Additional Detail - Nonoperating Performance <ul><li>Other Long-Term Liabilities </li></ul><ul><ul><li>Claims by investors other than shareholders - example: </li></ul></ul><ul><ul><ul><li>minority interest (e.g., the company being valued owns a majority, but less than 100%, of a subsidiary firm; minority interest is reported as a liability of the parent representing that portion of the subsidiary’s assets that belong to the minority shareholders in the subsidiary) </li></ul></ul></ul><ul><ul><li>A single line item called other long-term liabilities is the catch-all. </li></ul></ul>
  12. 14. Additional Detail - Nonoperating Performance <ul><li>Par Plus PIC Less Treasury </li></ul><ul><ul><li>Firms are using stock repurchases to distribute cash to shareholders </li></ul></ul><ul><ul><ul><li>shares repurchased are called treasury stock </li></ul></ul></ul><ul><ul><ul><li>sale of stock is recorded in two accounts, one account called Par and the other PIC </li></ul></ul></ul><ul><ul><ul><li>PIC stands for paid-in-capital (aka capital surplus) </li></ul></ul></ul><ul><ul><ul><li>dividend reinvestment plans (DRIPs) </li></ul></ul></ul><ul><ul><li>Because only the net effect of equity accounts is important for estimating intrinsic value, the model has one account called par plus PIC less treasury. </li></ul></ul>
  13. 15. Additional Detail - Nonoperating Performance <ul><li>Preferred Stock </li></ul><ul><ul><li>Preferred stock is another source of capital </li></ul></ul><ul><ul><ul><li>Preferred stockholders have priority over common </li></ul></ul></ul><ul><ul><ul><li>Preferred stockholders typically do not have the right to vote </li></ul></ul></ul>
  14. 16. Adjustments Due to GAAP <ul><li>Deferred taxes </li></ul><ul><ul><li>Most firms one sets of books for stockholders, another for the IRS </li></ul></ul><ul><ul><ul><li>for the IRS, firms make accounting choices to minimize taxable income, but for investors, they are required to follow GAAP </li></ul></ul></ul><ul><ul><ul><li>the IRS allows firms to use accelerated depreciation </li></ul></ul></ul><ul><ul><ul><li>GAAP accounting suggests that firms use straight-line depreciation </li></ul></ul></ul><ul><ul><ul><li>taxes reported on the stockholder statements may be either more or less than the taxes the company actually pays </li></ul></ul></ul>
  15. 17. Adjustments Due to GAAP <ul><ul><li>Deferred taxes is the cumulative difference between the taxes the company has reported paying and the taxes it actually paid. </li></ul></ul>
  16. 18. The Condensed Sheet <ul><ul><li>The following two slides show the condensed balance sheet and income statements for Home Depot, with the “additional” items circled: </li></ul></ul>(continued)
  17. 19. (continued)
  18. 21. Calculating Free Cash Flow <ul><li>Additional items in the reporting format have implications for: </li></ul><ul><ul><ul><li>calculation of net operating profit after taxes (NOPAT) </li></ul></ul></ul><ul><ul><ul><li>total operating capital </li></ul></ul></ul><ul><ul><ul><li>free cash flow </li></ul></ul></ul><ul><ul><li>This section describes these changes. Calculations are shown in the Hist Analys worksheet. </li></ul></ul>(continued)
  19. 22. Calculating Free Cash Flow (continued) <ul><li>FCF Calculation Step 1: Operating Profits </li></ul><ul><li>Most companies include some nonoperating income items when calculating EBIT, but using condensed financials makes it easy to calculate pre-tax operating profits </li></ul><ul><ul><li>Sales </li></ul></ul><ul><ul><li>COGS </li></ul></ul><ul><ul><li>- SGA </li></ul></ul><ul><ul><li>- Depreciation </li></ul></ul><ul><ul><li>= Operating profits </li></ul></ul><ul><li>This step is shown in the next slide . . . </li></ul>(continued)
  20. 23. (continued)
  21. 24. Calculating Free Cash Flow (continued) <ul><li>FCF Calculation Step 2: NOPAT </li></ul><ul><ul><li>Operating profit </li></ul></ul><ul><ul><li>– Tax on operating income </li></ul></ul><ul><ul><li>+ Extraordinary income(after tax) </li></ul></ul><ul><ul><li>= NOPAT </li></ul></ul><ul><li>OK, so you need to know tax on operating income . . . </li></ul>(continued)
  22. 25. Calculating Free Cash Flow (continued) <ul><li>FCF Calculation Step 3: Tax on Operating Income </li></ul><ul><ul><li>Differences in Reported Taxes and Actual Taxes </li></ul></ul><ul><ul><ul><li>Reported taxes </li></ul></ul></ul><ul><ul><ul><li>– Taxes reported but not paid </li></ul></ul></ul><ul><ul><ul><li>= Actual taxes </li></ul></ul></ul><ul><ul><li>Taxes on Nonoperating Income </li></ul></ul><ul><ul><ul><li>Actual taxes </li></ul></ul></ul><ul><ul><ul><li>+ Taxes saved due to interest deductions </li></ul></ul></ul><ul><ul><ul><li>– Taxes paid on interest income </li></ul></ul></ul><ul><ul><ul><li>– Taxes paid on nonoperating income </li></ul></ul></ul><ul><ul><ul><li>= Tax on operating income </li></ul></ul></ul><ul><ul><li>These steps are shown in the next slide . . . </li></ul></ul>(continued)
  23. 26. (continued)
  24. 27. Calculating Free Cash Flow (continued) <ul><li>FCF Calculation Step 4: Total Operating Capital </li></ul><ul><ul><li>Net operating working capital </li></ul></ul><ul><ul><li>+ Operating long-term capital </li></ul></ul><ul><ul><li>= Total operating capital </li></ul></ul><ul><ul><li>Total operating capital, year t </li></ul></ul><ul><ul><li>+ Total operating capital, year t-1 </li></ul></ul><ul><ul><li>= Investment in Operating Capital, year t </li></ul></ul>(continued)
  25. 28. Calculating Free Cash Flow (continued) <ul><li>FCF Calculation Step 5: Free Cash Flow </li></ul><ul><ul><ul><li>NOPAT </li></ul></ul></ul><ul><ul><ul><li>- Investment in Operating Capital </li></ul></ul></ul><ul><ul><ul><li>= Free Cash Flow </li></ul></ul></ul><ul><li>Steps 4 & 5 are shown in the next slide . . . </li></ul>(continued)
  26. 30. Analyze the Historical and Current Situation. <ul><li>Corporate information resources: </li></ul><ul><ul><li>Thomson ONE - Business School Edition access comes with your purchase of Corporate Valuation </li></ul></ul><ul><ul><li>Your library may have accessible online or print sources </li></ul></ul><ul><ul><li>The Internet </li></ul></ul>(continued)
  27. 31. Analyze the Historical and Current Situation (Continued). <ul><li>Using other sources -- there are many good sources of information available on the internet. Just to see one example, consider </li></ul><ul><li>Go to </li></ul><ul><ul><li>Enter ticker symbol for Home Depot (HD), and select “Go” and you will see the following screen . . . </li></ul></ul>(continued)
  28. 32. Source: (continued)
  29. 33. Analyze the Historical and Current Situation (Continued). <ul><li>Now consider the list of options in the frame on the left side of the Home Depot screen: </li></ul>(continued)
  30. 34. (continued) (Continued at right) Source:
  31. 35. Analyze the Historical and Current Situation (Continued). <ul><li>Select “Profile” (circled on the slide) for background information about the company. You will get the following screen: </li></ul>(continued)
  32. 36. Source: (continued)
  33. 37. Analyze the Historical and Current Situation (Continued). <ul><ul><li>Once in the “profile,” there is another list of linked options -- click on the one called “Ratio Comparison.” </li></ul></ul><ul><ul><ul><li>This brings up “Valuation” ratios - several other categories of useful ratios may be chosen (see circled selections). </li></ul></ul></ul><ul><ul><ul><li>Note the ratio comparisons of the individual company with both the industry and sector. You will use them soon. </li></ul></ul></ul>(continued)
  34. 38. (continued) Source:
  35. 39. Analyze the Historical and Current Situation (Continued). <ul><li>Input ratio data for competitors (but this is already done this for you in Home Depot.xls ). </li></ul><ul><li>Check “average” of historical ratios. </li></ul><ul><li>Check “trend” of historical ratios. </li></ul><ul><li>Check “most recent ratio,” compared with competitors/industry. </li></ul><ul><li>Use “graph button” to look at historical ratios. </li></ul>(continued)
  36. 40. Analyze the Historical and Current Situation (Continued). <ul><li>What can you say about the company’s past performance with respect to: </li></ul><ul><ul><li>Profitability (NOPAT/Sales and other ratios)? </li></ul></ul><ul><ul><li>Efficiency (Operating capital/sales and other ratios)? </li></ul></ul><ul><ul><li>Comparison to its industry? </li></ul></ul>(continued)
  37. 41. Analyze the Historical and Current Situation (Continued). <ul><li>What are important issues? </li></ul><ul><li>What are signs of financial strength? </li></ul><ul><li>Signs of financial weakness? </li></ul><ul><li>Signs of a growing versus a declining industry? </li></ul><ul><li>What is the life cycle of a firm? </li></ul>(continued)
  38. 42. Analyze the Historical and Current Situation (Continued). <ul><li>Important aspects for projections: </li></ul><ul><li>Sales growth </li></ul><ul><li>Profitability changes </li></ul><ul><li>Asset Utilization </li></ul><ul><li>Working Capital </li></ul><ul><li>Debt level </li></ul>(continued)
  39. 43. Analyze the Historical and Current Situation (Continued). <ul><li>More issues to examine: </li></ul><ul><li>ROIC over time—does the company have good investment opportunities? </li></ul><ul><li>Cash accumulation </li></ul><ul><li>Extraordinary items </li></ul><ul><li>Free Cash Flow </li></ul><ul><li>Dividend policy </li></ul>
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