DES Chapter 10 The Condensed Financial Statements and Financial Analysis

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# DES Chapter 10 The Condensed Financial Statements and Financial Analysis - PowerPoint PPT Presentation

DES Chapter 10 The Condensed Financial Statements and Financial Analysis. 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.

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Presentation Transcript
• Look at the file: Home Depot (for Ch 9-11, WACC, default inputs).xls.
• This file will be called Home Depot.xls for short.

DES Chapter 10

The valuation spreadsheet has seven interrelated worksheets:

(1) Proj & Val

(2) Inputs

(3) WACC

(4) Hist Analys

(5) Condensed

(6) Comprehensive

(7) Actual

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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

(continued)

DES Chapter 10

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

(continued)

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The Condensed Sheet (continued)

Relative to Van Leer’s financials, the condensed statements provide details on:

• Operating performance
• Nonoperating performance

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• 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.

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• 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.

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• 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)

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• 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.

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• 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.

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• 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.

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• 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

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• 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

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• Deferred taxes is the cumulative difference between the taxes the company has reported paying and the taxes it actually paid.

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The Condensed Sheet
• The following two slides show the condensed balance sheet and income statements for Home Depot, with the “additional” items circled:

(continued)

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(continued)

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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.

(continued)

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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 . . .

(continued)

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(continued)

DES Chapter 10

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 . . .

(continued)

DES Chapter 10

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 . . .

(continued)

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(continued)

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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

(continued)

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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 . . .

(continued)

DES Chapter 10

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

(continued)

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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 finance.yahoo.com:

• Go to finance.yahoo.com
• Enter ticker symbol for Home Depot (HD), and select “Go” and you will see the following screen . . .

(continued)

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Source: http://finance.yahoo.com/

(continued)

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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:

(continued)

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(Continued at right)

Source: http://finance.yahoo.com/

(continued)

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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:

(continued)

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Source: http://finance.yahoo.com/

(continued)

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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.

(continued)

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Source: http://finance.yahoo.com/

(continued)

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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.

(continued)

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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?

(continued)

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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?

(continued)

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Analyze the Historical and Current Situation (Continued).

Important aspects for projections:

• Sales growth
• Profitability changes
• Asset Utilization
• Working Capital
• Debt level

(continued)

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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

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