Download Ch 10 - Finance

DES Chapter 10
The Condensed Financial
Statements and Financial
Analysis
DES Chapter 10
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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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Steps to Estimate Value Using the
Corporate Valuation Spreadsheet
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)
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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

Adjustments due to GAAP
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Additional Detail - Operating
Performance
Other Short- and Long-Term Operating
Assets/Liabilities

Short-term operating assets/liabilities – example:
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Other short-term operating assets/liabilities are
catch-alls for such items.
Long-term operating assets – example:
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payroll advances to their employees
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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Additional Detail Nonoperating Performance
Long-Term Investments and Nonoperating
Income

activities that are not operating activities

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noncontrolling investments in other firms
investments in real estate or other stocks and bonds
These investments are accounted for in longterm investments; income from these
investments is reported in the nonoperating
income account.
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Additional Detail Nonoperating Performance
After-Tax Extraordinary Income not related
to the firm’s continuing operations

one-time events classified as extraordinary
items- examples:

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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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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.

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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.
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Additional Detail Nonoperating Performance
Par Plus PIC Less Treasury

Firms are using stock repurchases to distribute
cash to shareholders
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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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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
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Adjustments Due to GAAP
Deferred taxes

Most firms one sets of books for stockholders,
another for the IRS
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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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Adjustments Due to GAAP

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)
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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)
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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 . . .
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(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)
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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/
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(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/
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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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(continued)
Source: http://finance.yahoo.com/DES Chapter 10
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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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