Essentials of Investment Chapter 11

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E11.3. Reformulation and Analysis of Financial Statements a. Reformulated balance sheet 2009 Operating cash Accounts receivable Inventory PPE Operating assets Operating liabilities: Accounts payable Accrued expenses Net operating assets Net financial obligations: Short-term investments Long-term debt Common shareholders’ equity $1,200 390 $ 60 940 910 2,840 4,750 1,040 450 2008 50 790 840 2,710 4,390

1,590 3,160

1,490 2,900

$( 550) 1,840 1,290 $1,870

( 500) 1,970

1,470 1,430

Reformulated equity statement (to identify comprehensive income): Balance, end of 2008 Net transactions with shareholders: Share issues Share repurchases Common dividend Comprehensive income: Net income Unrealized gain on debt investments Balance, end of 2009 $1,430 $ 822 (720) (180) $ 468 50

(

78)

518 $1,870

Reformulated statement of comprehensive income Revenue Operating expenses, including taxes Operating income after tax Net financing expense: Interest expense $ Interest income Net interest Tax at 35% Net interest after tax Unrealized gain on debt investments Comprehensive income $3,726 3,204 522

98 15 83 29 54 50

4 $ 518

After calculating the net financial expense, the bottom-up method is used to get operating income after tax. b. Free cash flow = OI – ΔNOA = 522 – (3,160 – 2,900) = 262 c. Ratio analysis Profit Margin (PM) = 522/3,726 = 14.01% Asset turnover (ATO) = 3,726/2,900 = 1.285 RNOA = 522/2,900 = 18% d. Individual asset turnovers Operating cash turnover = 3,726/5 = 74.52 Accounts receivable turnover = 3,726/790 = 4.72 Inventory turnover = 3,726/840 = 4.44 PPE turnover = 3,726/2,710 = 1.37 Accounts payable turnover = 3,726/1,040 = 3.58 Accrued expenses turnover = 3,726/450 = 8.28 1/individual turnover aggregate to 1/ATO: 1/ATO = 1/1.285 = 0.778 = 0.013 + 0.212 + 0.225 + 0.730 – 0.279 – 0.121 (allow for rounding error)

e. ROCE = 518/1,430 = 36.22% Financial leverage (FLEV) = 1,470/1,430 = 1.028 Net borrowing cost (NBC) = 4/1,470 = 0.272% ROCE = 36.22% = 18.0% + [1.028 × (18.0% - 0.272%)] f. NBC = 4/1,470 = 0.272% (as in part e) If RNOA = 6% and FLEV = 0.8, ROCE = 6.0% + [0.8 × (6.0% - 0.272%] = 10.58% Note: it is more likely that NBC will be at the core borrowing rate (that excludes The unrealized gain of debt investments): Core NBC = 54/1,470 = 3.67%. Chapter 12 identifies core borrowing costs. g. Implicit cost of operating liabilities = 1,490 × 0.03 = 44.7 522  44.7 = 12.91% Return on operating assets (ROOA) = 4,390 Operating liability leverage (OLLEV) = 1,490/2,900 = 0.514

RNOA = 18.0% = 12.91% + [0.514 × (12.91% - 3.0%)]

E11.4 Relationship Between Rates of Return and Leverage (a) ROCE = RNOA + [FLEV  (RNOA – NBC)] 13.4% = 11.2% + [FLEV  (11.2% - 4.5%)] FLEV = 0.328 RNOA = ROOA + (OLLEV  OLSPREAD) 11.2% = 8.5% + [OLLEV  (8.5% - 4.0%)] OLLEV = 0.6 First calculate NFO and CSE using the financial leverage ratio ( NFO ) applied to CSE

(b)

(c)

the net operating assets of $405 million. NFO FLEV = CSE NOA = CSE + NFO NOA = 1 + FLEV So CSE = 1.328 As NOA = $405 million $405 million Then CSE = 1.328 = $305 million and NFO = $100 million Now distinguish operating and financing assets and liabilities OL OLLEV = = 0.6 NOA So OL = 0.6  $405 million = $243 million OA = NOA + OL = 405 + 243 = $648 million Financial assets = total assets – operating assets = 715 – 648 = $67 million Financial liabilities = NFO + financial assets = 100 + 67 = $167 million Reformulated Balance Sheet Operating assets 648 Financial liabilities Operating liabilities 243 Financial assets

Common equity 405

167 67 100 305 405

E11.5 Profit Margins, Asset Turnovers, and Return on Net Operating Assets: A What-If Question The effect would be (almost) zero. Existing RNOA = PM ATO = 3.8%  2.9 = 11.02% RNOA from new product line is RNOA = 4.8% 2.3 = 11.04% E11.8. A What-If Question: Grocery Retailers

Net operating assets for $120 million in sales and an ATO of 6.0 are $20 million. An increase in sales of...
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