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Ch. 10 slides


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