1FINANCIAL ANALYSIS

1. Financial Statement Analysis

2. Common Size Statement Analysis

3. Ratio Analysis

4. Sources/ Uses of Funds

5. Statement of Cash Flow

6. Free Cash Flow, MVA, EVA

2Table 3-1 Allied Food Products: December 31 Balance Sheets ($ Millions)

ASSETS 2005 2004 LIABILITIES & EQUITY 2005 2004

Cash & equivalents $ 10 $ 80 Accounts payable $ 60 $ 30

Notes payable 110 60

Accounts receivable 375 315 Accruals 140 130

Inventories 615 415 Total current liabilities $ 310 $ 220

Total current assets $1,000 810 Long-term bonds 750 580

Net plant & Total debt $1,060 $ 800

equipment 1,000 870

Common stock

(50,000,000 shares) 130 130

Retained earnings 810 750

Total common equity $ 940 $ 880

Total assets $2,000 $1,680 Total liabilities & equity $2,000 $1,680

3Table 3-2 Allied Food Products: Income Statements for Years Ending December

31 ($ Millions, except for per-share data) 2005 2004

Net sales $ 3,000.0 $ 2,850.0Operating costs except depreciation 2,616.2 2,497.0Earnings before interest, taxes, and depreciation(EBITDA) $ 383.8 $ 353.0Depreciation 100.0 90.0Earnings before interest & taxes (EBIT) $ 283.8 $ 263.0

Less interest 88.0 60.0Earnings before taxes (EBT) $ 195.8 $ 203.0

Taxes (40%) 78.3 81.2Net income $ 117.5 $ 121.8Common dividends $ 57.5 $ 53.0Addition to retained earnings $ 60.0 $ 68.8Per-share data:

Common stock price $ 23.00 $ 26.00Earnings per share (EPS)a $ 2.35 $ 2.44Dividends per share (DPS)a $ 1.15 $ 1.06Book value per share (BVPS)a $ 18.80 $ 17.60

Cash flow per share (CFPS)a $ 4.35 $ 4.24

4Table 3-2 Allied Food Products: Income Statements for years ending December

31 ($ Millions, except for per-share data)

a There are 50,000,000 shares of common stock outstanding. Note that EPS is based on earnings after preferred dividends - that is, on net income available to common stockholders. Calculations of EPS, DPS, and BVPS for 2004 are as follows:

EPS = Net income

= $117,500,000

= $2.35

Common shares outstanding 50,000,000

DPS = Dividends paid to common stockholders

= $57,500,000

= $1.15

Common shares outstanding 50,000,000

BVPS = Total common equity

= $940,000,000

= $18.80

Common shares outstanding 50,000,000

CFPS = Net income + Depreciation + Amortization

= $217,500,000

= $4.35

Common shares outstanding 50,000,000

=

5Table 3-4 Allied Food Products: Statement of Retained

Earnings for year ending December 31, 2005($ Millions)

Balance of retained earnings, Dec 31, 2004 $ 750.0

Add: Net income, 2005 117.5

Less: Dividends to common stockholders (57.5)a

Balance of retained earnings, Dec 31, 2005 $ 810.0

a Here, and throughout the book, parentheses are used to denote negative numbers.

6 Income Statement Common Size Analysis

% of Sales Ind. ave

Net sales $ 3,000 100 %

Costs excluding depreciation 2,616. 2 87. 2 62 %

Depreciation 100 3. 3 8

Total operating costs 2,716. 2 90. 5 % 70 %

Net Operating Income, or Earnings

before interest and taxes (EBIT) $ 283. 8 9. 5 % 30 %

Less interest expense 88 2. 9 5

Earnings before taxes (EBT) $ 195. 8 6. 5 22

Taxes ( 40% ) 78. 3 2. 6 4

Net Income available to C. S. 117. 5 3. 9 18

Common Dividends 57. 5 1. 9 8

Add. to Retained Earnings 60 2. 0 9

7 Balance Sheet Common Size Analysis

% of Total Assets Ind. Ave. Comment

Cash / Securities $10 0. 50 % 10% very low

Accounts Receivable 375 18. 75 15 OK

Inventories 615 30. 75 40 low

Total Current Assets $1,000 50 % 65 % low, risky

Net Plant & Equip. 1,000 50 45 OK

Total Assets $2,000 100 %

Accounts payable $ 60 3 % 7 OK

Notes payable 110 5. 5 4 slightly high

Accruals 140 7 10 slightly low

Total Current Lia. $310 15. 5 % 21 low

Long-term Bonds 750 37. 5 22 high

Total Debt 1,060 53% 43 high

Common stock 130 6. 5 15 low

Retained earnings 810 40. 5 40 OK

Total Common Equity $940 47% 65 low

Total Lia. & Equity $2,000 100%

8 Allied Food Products: Summary of Financial Ratios ($ Millions)

Ind.

Ratio Formula Calculations Ratio Avg Comment

Liquidity

Current Current assets $1,000 = 3.2x 4.2x Poor

Current liabilities $310

Quick, or Current assets - Inventories $385 = 1.2x 2.2x Poor

acid test Current liabilities $310

9 Allied Food Products: Summary of Financial Ratios ($ Millions)

Ind.

Ratio Formula Calculations Ratio Avg Comment

Asset Management

Inventory Sales $3,000 = 4.9x 10.9x Poor

turnover Inventories $615

Days sales Receivables $375 = 46 days 36 days Poor

outstanding (DSO) Annual sales/365 $8.22

Fixed assets Sales $3,000 = 3.0x 2.8x O.K.

turnover Net fixed assets $1,000

Total assets Sales $3,000 = 1.5x 1.8x Somewhat

turnover Total assets $2,000 low

10 Allied Food Products: Summary of Financial Ratios ($ Millions)

Ind.

Ratio Formula Calculations Ratio Avg Comment

Debt Management

Total debt to Total debts $1,060 = 53% 40.0% High

total assets Total assets $2,000 (risky)

Times-interest Earnings before interest & taxes (EBIT) $283.8 = 3.2x 6.0x Low

earned (TIE) Interest charges $88 (risky)

EBITDA EBITDA + Lease payments $383.8 + $28

coverage I nterest + Principal + Lease $88 + $20 + $28 charges payments payments

$411.8 = 3.0 x 4.3x Low

$136 (risky)

11 Allied Food Products: Summary of Financial Ratios ($ Millions)

Ind.

Ratio Formula Calculations Ratio Avg Comment

ProfitabilityProfit margin Net income available to common stockholders $117.5 = 3.9% 5.0% Poor

on sales Sales $3,000

Basic earning Earnings before interest & taxes (EBIT) $283.8 = 14.2% 18% Poor

power (BEP) Total assets $2,000

Return on total Net income available to common stockholders $117.5 = 5.9% 9.0% Poor

assets (ROA) Total assets $2,000

Return on Net income available to common stockholders $117.5 = 12.5% 15% Poor

common equity Common equity $940

(ROE)

12 Allied Food Products: Summary of Financial Ratios ($ Millions)

Ind.

Ratio Formula Calculations Ratio Avg Comment

Market Value

Price/earnings Price per share $23.00 = 9.8x 11.3x Low

(P/E) Earnings per share $2.35

Price/cash flow Price per share $23.00 = 5.3x 5.4x Low

Cash flow per share $4.35

Market/book Market price per share $23.00 = 1.2x 1.7x Low

(M/B) Book value per share $18.80

13Allied Food Products: Summary of Financial Ratios ($ Millions)

Ratio FormulaOther RatiosDividend payout ratio : Div. = $57.5 = 48.9% N I $117.5

Retention ratio: 1 - payout ratio = 1 – 48.9% = 51.1% or

Retained earnings = $60 = 51.1% N I $117.5

14 Du Pont Analysis (Allied Food Products)

ROE =

Profit x Total assets

x Equity

margin turnover multiplier

NI =

NI x Sales

x TA

Equity Sales TA Equity

Firm: 12.5% = 3.9% x 1.5 x 2.13

Industry: 15.0% = 5.0% x 1.8 x 1.67

15 Allied Food Products: Changes in Balance Sheet Accounts During 2005 ($

Millions)

CHANGE 12/31/05 12/31/04 Sources Uses

Cash & marketable securities $ 10 $ 80 $ 70

Accounts receivable 375 315 $ 60

Inventories 615 415 200

Gross plant & equipment 1,500 1,270 230

Less Accum. Depreciation (500) (400) 100

Net plant & equipment 1,000 870

Accounts payable 60 30 30

Notes payable 110 60 50

Accruals 140 130 10

Long-term bonds 750 580 170

Common stock 130 130

Retained earnings 810 750 60

Totals $490 $490

16 Allied Food Products: Statement of Cash Flows for 2005 ($ Millions)OPERATING ACTIVITIES

Net income $117.5Additions (Sources of Cash)

Depreciationa 100.0Increase in accounts payable 30.0Increase in accruals 10.0

Subtractions (Uses of Cash)Increase in accounts receivable (60.0)Increase in inventories (200.0)

Net cash provided by operating activities ($ 2.5)LONG-TERM INVESTING ACTIVITIESCash used to acquire fixed assetsb ($230.0)FINANCING ACTIVITIES

Increase in notes payable $ 50.0Increase in bonds 170.0Payment of common dividends (57.5)

Net cash provided by financing activities $ 162.5Net decrease in cash & marketable securities ($ 70.0)Cash & securities at beginning of year 80.0Cash & securities at end of year $ 10.0

17 Allied Food Products: Statement of Cash Flows for 2005 ($ Millions)

a Depreciation is a non-cash expense that was deducted when calculating net income. It must be added back to show the correct cash flow from operations.

b The net increase in fixed assets is $130 million; however, this net amount is after a deduction for the year’s depreciation expense. Depreciation expense should be added back to show the increase in gross fixed assets. From the company’s income statement, we see that 2004 depreciation expense is $100 million; thus, the acquisition of fixed assets equals $230 million.

18

Stock Markets and Stock ReportingI. Stock markets

A. New York stock exchange (NYSE)

B. American stock exchange (AMEX)

C. Over-the-counter (OTC) markets

D. Smaller regional markets

Ii. Stock market reporting52 weeks Yld. P-E sales net

High low stock div. % Ratio 100s high low close chg.

1757/8 102 IBM 4.40 3.8 16 27989 1181/4 1151/4 1171/4 +13/4

Dividend yield = D/P

= $4.40 / $117.25 = 3.8%

19

Free Cash Flow, MVA, EVA, and Stock Valuation

20FREE CASH FLOW

2004 2005CA (Current Asset) 810 1,000

AP (Account Payable) -30 -60

Accruals -130 -140

Total Operating Working Capital (TOWC) 650 800

Net Fixed Asset 870 1,000

Total Operating Capital (TOC) 1,520 1,800

Net Investment in Oper. Cap (NIOC) 280

Depreciation (2002) 100

Gross Investment in Operating Cap (GIOC) 380

21

NET OPERATING PROFIT AFTER TAX (NOPAT):NOPAT = EBIT ( 1 – TAX ) 283.8 (1- 0.4) = 170.3

FREE CASH FLOW CALCULATION:

FCF = NOPAT – NIOC = 170.3 - 280 = - 109.7FCF = NOPAT + Depreciation – GIOC = 170.3 + 100 – 380 = - 109.7

(NOPAT + Depreciation = Operating Cash Flow)

FREE CASH FLOW

22STOCK VALUATION

Total Corporation Value =

PV (FCF1)+PV (FCF2)+....+ PV ( FCFn) + PV (Terminal Value)Where i = WACC

Terminal Value = FCF n +1 WACC - g

Value of Common Stock Equity =

Total Corp. Value – Market Value of Debt – Market Value of Preferred Stock

23MARKET VALUE ADDED (MVA)

MVA measure the effects of managerial actions since the inception of a company

MVA = Market Value – Book Value MVA = (Stock Price * No of shares) – Common Stock Equity

MVA = ( 23 * 50 mil shares) – 940

MVA = $ 210

24

ECONOMIC VALUE ADDED (EVA)

EVA measures the managerial effectiveness in a given year

EVA = Net Oper. Profit After Tax- After Tax Dollar Cost of Operating Capital

EVA = NOPAT – (Total Operating Capital * WACC)

EVA = EBIT (1–T) – (TOC * WACC)

EVA = 283.8 (1-0.4) – (1800 * 10%)

EVA = 170.3 – 180

EVA = $ - 9.7