Chapter 3Ross, Westerfield, and Jordan's Excel MasterEssentials of Corporate Finance, 9th editionby Brad Jordan and Joe SmoliraVersion 9.0Chapter 3In these spreadsheets, you will learn how to use the following Excel functions:The following conventions are used in these spreadsheets:1) Given data in blue2) Calculations in redNOTE: Some functions used in these spreadsheets may require that the "Analysis ToolPak" or "Solver Add-In" be installed in Excel.To install these, click on the File button then "Options," "Add-Ins" and select"Go." Check "Analysis ToolPak" and "Solver Add-In," then click "OK." SUMIF/xl/drawings/drawing1.xml#'Section%203.1'!A57 Absolute references/xl/drawings/drawing1.xml#'Section%203.1'!A26 Text boxes/xl/drawings/drawing1.xml#'Section%203.3'!A65 Shapes and lines/xl/drawings/drawing1.xml#'Section%203.3'!A65 Conditional formatting/xl/drawings/drawing1.xml#'Section%203.5'!A10 IF/xl/drawings/drawing1.xml#'Section%203.2'!A51 Section 3.1Chapter 3 - Section 1Standardized Financial StatementsThe balance sheets for Prufrock Corporation are:Prufrock Corporation2015 and 2016 Balance Sheets ($ millions)2015201620152016Current assetsCurrent liabilities Cash$ 84$ 98 Accounts payable$ 312$ 344 Accounts receivable165188 Notes payable231196 Inventory393422 Total$ 543$ 540 Total$ 642$ 708Long-term debt$ 531$ 457Owners' equityFixed assets Common stock and Net plant and equipment$ 2,731$ 2,880 paid-in surplus$ 500$ 550 Retained earnings1,799$ 2,041 Total$ 2,299$ 2,591Total assets$ 3,373$ 3,588Total liabilities and equity$ 3,373$ 3,588To construct the common-size balance sheet, we need to divide each asset account by the total assets and each liabilities and equity account by the total liabilities and equity. Once we enter the formula, we can copy and paste the formula instead of inserting in an equation in each cell. One problem with copying and pasting is that Excel keeps the formula in relation to the previous cells. For example, if you copy and paste a formula in cell B5 that references cell B2, wherever you paste the equation, it will always reference 3 cells above where you pasted it. For example, if you paste a formula from cell B5 that references cell B2 into cell D12, in the new position it will reference cell D9. A solution is to use absolute references in your formula.RWJ Excel TipTo use an absolute reference, use the $ before the column letter and row number. For example, to reference cell E21 when you copy and paste a formula, you would enter it as $E$21. A quick way to do this is just enter E21, then hit the F4 key. Wherever copied and pasted, this equation will always reference cell E21. If you want to reference the column and not the row, you would enter $E21, or if you want to reference the row and not the column, you would enter it as E$21.Using absolute references and the balance sheet from the previous worksheet, the common-sized balance sheet is:Prufrock Corp.

1. Chapter 3Ross, Westerfield, and Jordan's Excel
MasterEssentials of Corporate Finance, 9th editionby Brad
Jordan and Joe SmoliraVersion 9.0Chapter 3In these
spreadsheets, you will learn how to use the following Excel
functions:The following conventions are used in these
spreadsheets:1) Given data in blue2) Calculations in redNOTE:
Some functions used in these spreadsheets may require that the
"Analysis ToolPak" or "Solver Add-In" be installed in Excel.To
install these, click on the File button then "Options," "Add-Ins"
and select"Go." Check "Analysis ToolPak" and "Solver Add-
In," then click "OK."
SUMIF/xl/drawings/drawing1.xml#'Section%203.1'!A57
Absolute
references/xl/drawings/drawing1.xml#'Section%203.1'!A26
Text boxes/xl/drawings/drawing1.xml#'Section%203.3'!A65
Shapes and
lines/xl/drawings/drawing1.xml#'Section%203.3'!A65
Conditional
formatting/xl/drawings/drawing1.xml#'Section%203.5'!A10
IF/xl/drawings/drawing1.xml#'Section%203.2'!A51
Section 3.1Chapter 3 - Section 1Standardized Financial
StatementsThe balance sheets for Prufrock Corporation
are:Prufrock Corporation2015 and 2016 Balance Sheets
($ millions)2015201620152016Current assetsCurrent liabilities
Cash$ 84$ 98 Accounts payable$ 312$ 344 Accounts
receivable165188 Notes payable231196 Inventory393422
Total$ 543$ 540 Total$ 642$ 708Long-term debt$ 531$
457Owners' equityFixed assets Common stock and Net plant
and equipment$ 2,731$ 2,880 paid-in surplus$ 500$ 550
Retained earnings1,799$ 2,041 Total$ 2,299$ 2,591Total
assets$ 3,373$ 3,588Total liabilities and equity$ 3,373$
3,588To construct the common-size balance sheet, we need to
divide each asset account by the total assets and each liabilities
and equity account by the total liabilities and equity. Once we

2. enter the formula, we can copy and paste the formula instead of
inserting in an equation in each cell. One problem with copying
and pasting is that Excel keeps the formula in relation to the
previous cells. For example, if you copy and paste a formula in
cell B5 that references cell B2, wherever you paste the
equation, it will always reference 3 cells above where you
pasted it. For example, if you paste a formula from cell B5 that
references cell B2 into cell D12, in the new position it will
reference cell D9. A solution is to use absolute references in
your formula.RWJ Excel TipTo use an absolute reference, use
the $ before the column letter and row number. For example, to
reference cell E21 when you copy and paste a formula, you
would enter it as $E$21. A quick way to do this is just enter
E21, then hit the F4 key. Wherever copied and pasted, this
equation will always reference cell E21. If you want to
reference the column and not the row, you would enter $E21, or
if you want to reference the row and not the column, you would
enter it as E$21.Using absolute references and the balance sheet
from the previous worksheet, the common-sized balance sheet
is:Prufrock CorporationCommon-Size Balance Sheets 2015 and
201620152016Change20152016ChangeCurrent assetsCurrent
liabilities Cash2.49%2.73%0.24% Accounts
payable9.25%9.59%0.34% Accounts
receivable4.89%5.24%0.35% Notes payable6.85%5.46%-1.39%
Inventory11.65%11.76%0.11% Total16.10%15.05%-1.05%
Total19.03%19.73%0.70%Long-term debt15.74%12.74%-
3.01%Owners' equityFixed assets Common stock and Net
plant and equipment80.97%80.27%-0.70% paid-in
surplus14.82%15.33%0.51% Retained
earnings53.34%56.88%3.55%
Total68.16%72.21%4.05%Total
assets100.00%100.00%0.00%Total liabilities and
equity100.00%100.00%0.00%Using absolute references and the
income statement above, the common-sized income statement
is:Prufrock Corporation2016 Common-Size Income
StatementSales$ 2,311Cost of goods sold$

3. 1,344Depreciation$ 276Earnings before interest and taxes$
691Interest paid141Taxable income$ 550Taxes187Net
income$ 363Dividends$ 121Additions to retained
earnings242The common-base year balance sheet is constructed
by dividing the current year by the base year, in this case,
dividing 2016 numbers by 2015 numbers. The common-size and
base year balance sheet is found by dividing the 2016 account
values by the total assets or total liabilities and equity,
respectively. The common base year and common-size base year
balance sheet for Prufrock are:Prufrock CorporationCommon
Balance Sheets 2015 and 2016Common-
base yearCommon-
size and
base yearCommon-
base yearCommon-
size and
base year2016201620162016Current assetsCurrent liabilities
Cash1.171.10 Accounts payable1.101.04 Accounts
receivable1.141.07 Notes payable0.850.80 Inventory1.071.01
Total0.990.93 Total1.101.04Long-term debt0.860.81Owners'
equityFixed assets Common stock and Net plant and
equipment1.050.99 paid-in surplus1.101.03 Retained
earnings1.131.07 Total1.131.06Total assets1.061.00Total
liabilities and equity1.061.00
Section 3.2Chapter 3 - Section 2Ratio AnalysisTo compare the
performance of companies, rather than compare the financial
statements, financial ratios are often used. Ratios are divided
into categories based on what each ratio measures. Below, we
calculate some basic financial ratios for Prufrock for
2016:Short-Term Solvency, or Liquidity, MeasuresCurrent
ratio:1.31timesQuick ratio:0.53timesCash ratio:0.18timesLong-
Term Solvency MeasuresTotal debt ratio:0.28timesDebt-equity
ratio:0.38timesEquity multiplier:1.38timesTimes interest
earned:4.90timesCash coverage:6.86timesAsset Management, or
Turnover, MeasuresInventory turnover:3.18timesDays' sales in
inventory:114.61daysReceivables turnover:12.29timesDays'

4. sales in receivables:29.69daysTotal asset
turnover:0.64timesProfitability MeasuresProfit
margin:15.71%Return on assets (ROA):10.12%Return on equity
(ROE):14.01%Since ROA and ROE are intended to measure
performance over a prior period, often the average assets and
average equity, respectively, are used in the calculation. The
ROA and ROE using the averages in the denominator are:ROA
with average assets:10.43%ROE with average
equity:14.85%Market Value MeasuresMarket value ratios use
other numbers such as shares outstanding and share price that
are not found on the balance sheet. The other numbers we need
are:Shares outstanding:33.00(in millions)Price per share:$
88.00Earnings per share (EPS):$ 11.00Price-earnings ratio
(PE):8.00timesPrice-sales ratio:1.26timesMarket-to-book
ratio:1.12timesRWJ Excel TipWe used a "trick" in the
calculation of ROA, ROE, and the price-earnings ratio. You can
always mathematically calculate a ratio, however what happens
when the denominator is negative? While this is very unlikely
to happen with ratios such as the current ratio, it does happen in
these three ratios when the net income is negative, or if the
equity is negative. In this case, these ratios are often reported as
"NMF" for "No meaningful figure." Excel will try to calculate
the ratio, as since the denominator is negative, Excel will report
"#DIV/0" to let you know you have tried to divide by zero. We
prefer to see "NMF," so we used a simple IF statement to
display "NMF" if these ratios are negative. Do you see any of
these other ratios which could be negative?RWJ Excel TipIF
statements are used for a logical test. The IF function is located
under Logical. The basic format of an IF statement is
=IF(logical_test,[value_if_true],[value_if_false]). In an IF
statement, we determine the possible conditions first, then
determine what value we want if the test is true, or else the
value in the cell will be false. For example, in the case of the
PE ratio, our possible conditions are that earnings are positive
or negative (we will ignore the possibility earnings are exactly
zero). If earnings are positive, we want to calculate the PE as

5. the stock price divided by earnings per share. However, if
earnings are negative, we want NMF to display. To have an IF
statement return text, put the text in parentheses. The format for
the PE ratio is:
Section 3.3Chapter 3 - Section 3The Du Pont IdentityThe three-
factor Du Pont equation separates the ROE into 3 components.
For Prufrock, the three-factor Du Pont equation is:ROE = Profit
margin ´ Total asset turnover ´ Equity
multiplierROE = 15.71%´0.64´1.38ROE =14.01%This is exactly
the same as the ROE we previously calculated, but it breaks
ROE into its constant parts. Of course, ROE can be further
subdivided, which we will do next. The abbreviated financial
statements for Du Pont for the most recent year were:Du Pont
Income StatementDu Pont Balance Sheet12 months ending Dec
31, 201512 months ending Dec 31, 2015($ in millions)($ in
millions)Sales$ 35,553AssetsLiabilities and Owner's
EquityCoGS21,703Current assetsCurrent liabilitiesGross profit$
13,850 Cash$ 7,034 Accounts payable$ 11,217SG&A
expenses6,411 Accounts receivable6,594 Notes
payable1,423Depreciation2,067 Inventory8,120EBIT$ 5,372
Total$ 21,748 Total$ 12,640Interest377EBT$ 4,995Long-
term debt$ 23,916Taxes1,370Net income$ 3,625Fixed assets$
28,128Total equity$ 13,320Total liabilities andTotal assets$
49,876 owner's equity$ 49,876Now we can show an expanded
Du Pont analysis, which is:Return
on equity27.21%ROAEquity
multiplier7.27%3.74Profit
marginTotal asset
turnover10.20%0.71Net
incomeSalesSalesTotal
assets$ 3,625$ 35,553$ 35,553$ 49,876Total
costsSalesFixed
assetsCurrent
assets$31,928$ 35,553$ 28,128$21,748Cost
of goods
soldDep.Cash$21,703$2,067$ 7,034Selling, general,

6. & admin.
expenseInterestAccounts
receivableInventory$6,411$377$6,594$8,120Taxes$1,370RWJ
Excel TipTo insert the mathematical instructions, we used text
boxes. To insert a text box, simple go to "Insert" and select
"Text Box." Text boxes allow you to enter text that is "linked"
to the position you put the box. Although we could have entered
the text in a cell, text boxes in this case allow the text to go
across multiple rows and/or columns, which can often look more
professional. Text boxes are also very useful in graphing, which
we will show later. To draw the lines between the boxes, we
went to "Insert" and selected "Shapes." We chose the straight
line, although many other choices are available.
Multiplied
by
Divided
by
Divided
by
Subtract-ted from
Plus
Multiplied
by
Section 3.5Chapter 3 - Section 5Using Financial Statement
InformationFinancial ratio analysis is very much a management
by exception tool. When you are analyzing ratios, a number by
itself tells you very little. However, whenever a ratio is above
or below some level, it tells us that something is different. It is
up to us to determine if that difference is good or bad. We can
always compare each ratio to the industry average, or some ratio
target, but looking through columns of numbers can be difficult.
Excel has a conditional formatting function which will allow
you to change the display for numbers within a specified range
or outside a specified range. In this case, we have a range in
mind, so we want to change the font color of the calculated
number, as well as the cell color if the company's ratio is

7. outside a specified range. Additionally, we used a basic IF
statement to tell us specifically if the ratio appears to be too
high, too low, or within the acceptable range.While we used
factors of 0.75 and 1.25, these factors could be higher or lower
depending on the industry. If you change these factors in the
spreadsheet, Excel will automatically change the graphics to
match the new calculations.RWJ Excel TipIn our conditional
formatting, on the Home tab, we selected Conditional
Formatting, and New Rule. This allows us to create a rule for
the conditional formatting. We selected "Format only cells that
contain" and then used the pulldown menu to choose "not
between." The next two cells allow use to enter the calculations,
so we entered a formula to multiply the industry ratio by the
lower bound and the industry ratio by the upper bound. Next,
we selected "Format.." on this window. The "Format.." option
took us to another window that allows you to specify the font
color, cell color fill, and more. We made the font color white
and the cell fill red if the company's ratio is outside the range
specified in the 3rd and 4th inputs.Lower range:0.75Upper
range:1.25Short-Term Solvency, or Liquidity,
MeasuresAverageCurrent ratio:1.311.39Looks OK.Quick
ratio:0.530.85Too low?Cash ratio:0.180.35Too low?Long-Term
Solvency MeasuresTotal debt ratio:0.280.19Too high?Debt-
equity ratio:0.380.29Too high?Equity multiplier:1.381.29Looks
OK.Times interest earned:4.903.80Too high?Cash
coverage:6.864.15Too high?Asset Management, or Turnover,
MeasuresInventory turnover:3.182.95Looks OK.Days' sales in
inventory:114.61123.73Looks OK.Receivables
turnover:12.2914.15Looks OK.Days' sales in
receivables:29.6925.80Looks OK.Total asset
turnover:0.640.71Looks OK.Profitability MeasuresProfit
margin:15.71%17.83%Looks OK.Return on assets
(ROA):10.12%12.18%Looks OK.Return on equity
(ROE):14.01%15.83%Looks OK.A quick glance indicates that
Prufrock's liquidity ratios and long-term solvency ratios are
generally outside the ranges we set, while the asset management

8. and profitability ratios appear to be similar to the industry
average for all of the ratios in these two categories. This means
we should investigate the causes of the differences in the
liquidity ratios and long-term solvency ratios.
Master it!Chapter 3 - Master it!The exTensible Business
Reporting Language (XBRL) is likely the future of financial
reporting. XBRL is a computer language that "tags" each item
and specifies what that item is. XBRL reporting has already
been adopted for use in Australia, Japan, and the United
Kingdom. As of early 2009, a Securities and Exchange
Commission advisory committee has recommended that U.S.
companies be required to submit financial reports to the SEC in
XBRL format. It has been suggested that requiring XBRL be
gradually implemented, so it could be several years before we
see all companies file XBRL financial reports. All listed U.S.
companies file electronic reports with the SEC, but the reports
are only available in html or text format. XBRL reporting will
allow investors to quickly download financial statements for
analysis.Currently, several companies voluntarily submit
financial statements in XBRL format. For this assignment, go to
the SEC website at www.sec.gov. Once there, search for a
company and click the link that says "Interactive Data" in the
report list and follow the link. Now follow the "Interactive Data
Viewers" link, then "Interactive Financial Reports." Download
the income statement and balance sheet from the annual report
for the company you chose. Using these reports, calculate the
financial ratios for the company from the data available,
typically two or three years. Do you notice any changes in these
ratios that might indicate further investigation?
Solution
Master it!