Ch02 PPT Brighamfm1ce

PowerPoint Presentation
prepared by
Traven Reed Canadore College
chapter 2
Financial Statements, Cash Flow, and Taxes
Corporate Valuation and Financial Statements

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Copyright 2011 by Nelson Education Ltd. All rights reserved.
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Topics in Chapter
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Balance sheet Income statement Statement of retained earnings Accounting income versus cash flow Statement of cash flows MVA and EVA Personal taxes Corporate taxes
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Financial Statements and Reports

Company annual report describes the operating results from the past year and new plans for the coming year with four financial statements:
Balance sheet Income statement Statement of retained earnings Statement of cash flows
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Balance Sheet
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Provide a snapshot of the firms financial position at a particular point in time. Show assets on the left-hand size or at the top and liabilities/equity (i.e. claims against assets) on the righthand size or at the bottom. Record with book values when assets are purchased or liabilities are issued.
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Balance Sheet: Assets

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2009 Cash & equivalents S-T investment Accts receivable Inventories Total current assets Net plant and equipment Total assets 10 0 375 615 $1,000 1,000 $2,000
2008 15 65 315 415 $810 870 $1,680
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Implications on Assets
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All assets are stated in dollars Only cash represents actual money can be spent. Cash and short-term investments fell. A/R and inventory (FIFO vs. LIFO) both increased. Net fixed assets slightly expanded. Depreciation expense
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Balance Sheet: Liabilities & Equity

2009 Accts. payable Notes payable Accruals Total current liabilities Long-term bonds Total liabilities Preferred stock (400,000 shares) Common stock (50,000,000 shares) Retained earnings Total common equity Total liabilities and equity 60 110 140 $310 754 $1,064 40 130 766 $896 $2,000 2008 30 60 130 $220 580 $800 40 130 710 $840 $1,680
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Implications on Liabilities & Equity

CL increased as creditors and suppliers financed part of the expansion. Long-term debt increased to help finance the expansion. The company didnt issue any new stock. Retained earnings went up, due to no dividend payment.
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Income Statement
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Show a firms performance over a period of time such as a month, a quarter or a year Although NI (i.e. profit or earnings) is an important item, EBITDA can be a better measure of financial strength EBITDA is not as important as FCF
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Income Statement
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2009 Net sales Op. costs excluding depre. & amort. EBITDA Depre. & amort. EBIT (operating income) Int. expense EBT Taxes (40%) NI before pre. Dividends Preferred div. NI 3,000.0 2,616.2 $383.8 100.0 $283.8 88.0 $195.8 78.3 $117.5 4.0 $113.5
2008 2,850.0 2,497.0 $353.0 90.0 $263.0 60.0 $203.0 81.2 $121.8 4.0 $117.8
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Stock Price and Other Data

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2009 Common stock price # of shares EPS DPS BVPS CFPS $23.00 50,000,000 $2.27 $1.15 $17.92 $4.27 $26.00
2008 50,000,000 $2.36 $1.06 $16.80 $4.16
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What happened to sales and net income?

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Sales increased by over $150 million. Total operating costs shot up. Interest expenses also went up. Net income was down. The firm paid less tax as a result.
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Statement of Retained Earnings, 2009

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Balance of retained earnings, 12/31/2008 Add: Net income, 2009 Less: Dividends paid, 2009 Balance of retained earnings, 12/31/2009
$710.0 113.5 (57.5) $766.0

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Net Cash Flow

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Net cash flow accounting profit since some revenues and expenses are not received or paid in cash NCF = NI noncash revenues + noncash charges NCF = NI + Depreciation and amortization
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Statement of Cash Flows: 2009

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Operating Activities Net Income Adjustments: Depreciation Change in A/R Change in inventories Change in A/P Change in accruals Net cash provided by op. act.
$117.5 100.0 (60.0) (200.0) 30.0 10.0 ($2.5)

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Statement of Cash Flows: 2009 (contd)

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Investing Activities Cash used to acquire FA Change in S-T investment Net cash provided by inv. act.
(230.0) 65.0 ($165.0)
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Statement of Cash Flows: 2009 (contd)

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Financing Activities Change in notes payable Change in long-term debt Payment of cash dividends Net cash provided by fin. act.
50.0 174.0 (61.5) $162.5
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Summary of Statement of CF
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Net cash provided by op. act. Net cash provided by inv. act. Net cash provided by fin. act. Net change in cash Cash at beginning of year Cash at end of year
(2.5) (165.5) 162.5 ($5.0) 15.0 $10.0

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What can you conclude from the statement of cash flows?

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Net CF from operations = -$2.5 million, because of reduction net income and big increases in working capital. The firm spent $230 million on fixed assets. The firm borrowed heavily and sold bonds to meet its cash requirements. Even after borrowing, the cash account fell by $5m.
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What are operating current assets?

Operating current assets are the CA needed to support operations.
Op CA include: cash, inventory, receivables. Op CA exclude: short-term investments, because these are not a part of operations.
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What are operating current liabilities?

Operating current liabilities are the CL resulting as a normal part of operations.
Op CL include: accounts payable and accruals. Op CL exclude: notes payable, because this is a source of financing, not a part of operations.
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Net Operating Working Capital (NOWC)

NOWC = Operating current assets Operating current liabilities
= ($10 + $375 + $615) - ($60 + $140) = $800 million Use (Cash + A/R + inventories) (A/P + accruals) to try NOWC2008.
NOWC2009
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Total net operating capital (also called operating capital)

Total net operating capital = NOWC + operating long-term assets. (TN)OC2009 = $800 + $1,000 = $1,800 million (TN)OC2008 = $585 + $870 = $1,455 million
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Net Operating Profit after Taxes (NOPAT)

NOPAT = EBIT(1 - Tax rate) = Operating income ( 1 Tax rate) NOPAT2009 = $283.8 (1 - 0.4) = $170.3 million NOPAT2008 = $157.8 million
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What is free cash flow (FCF)? Why is it important?

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FCF is the amount of cash available from operations for distribution to all investors (including stockholders and debtholders) after making the necessary investments to support operations. A companys value depends upon the amount of FCF it can generate.
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What are the five uses of FCF?

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1. Pay interest on debt. 2. Pay back principal on debt. 3. Pay cash dividends. 4. Buy back stock. 5. Buy non-operating assets (e.g., marketable securities, investments in other companies, etc.)
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Free Cash Flow (FCF) for 2009

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FCF = NOPAT - Net investment in operating capital = $170.3 - ($1,800 - $1,455) = $170.3 - $345.0 = -$174.7 million How do you suppose investors reacted?
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Free Cash Flow (FCF) for 2009

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FCF = Operating cash flow gross investment in operating capital OCF = NOPAT + depreciation Gross investment in operating capital = net investment in op. capital + depreciation = ($170.3 + $100) - ($345 + $100) = $270.3 - $445.0 = -$174.7 million (same as before)
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Return on Invested Capital (ROIC)

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ROIC = NOPAT / operating capital ROIC2009 = $170.3 / $1,800 = 9.46% Is this enough to cover the firms cost of capital?
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Market Value Added (MVA)

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MVA = Market Value of the Firm Book Value of the Firm Market Value = (# shares of stock)(price per share) + Value of debt Book Value = Total common equity + Value of debt
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MVA (contd)
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If the market value and book value of debt are close, then MVA is: MVA = Market value of equity book value of equity MVA = (Shares outstanding)(Stock price) total common equity MVA = Total market value total investors supplied capital
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2009 MVA (Assume market value of debt = book value of debt)

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Market Value of Equity 2009:

(50,000,000)($23) = $1,150 million
Book Value of Equity 2009:

$896 million
MVA09 = $1,150 - $896 = $254m MVA08 = $1,300 - $840 = $460m
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The firms cost of capital is 11%. Did the growth add value?
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No. The ROIC of 9.46% is less than the WACC of 11%. Investors did not get the return they require. Note: High growth usually causes negative FCF (due to investment in capital), but that is fine if ROIC > WACC. Firm had high growth, negative FCF, but a high ROIC.
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Economic Value Added (EVA)

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WACC is weighted average cost of capital EVA = NOPAT- [(WACC)(Capital)]
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Economic Value Added (WACC = 11% for 2009)

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EVA = NOPAT- (WACC)(Capital) EVA = (Operating capital)(ROIC WACC) EVA09 = $170.3 - (0.11)($1,800) = $170.3 - $198.0 = -$27.7 million EVA09 = $1,800 (0.0946 0.11) = $1,800 (-0.0154) = -$27.7 million
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Key Features of the Tax Code

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Corporate Taxes
Rate vary with firm size, location, and type of income being earned Both the federal and provincial governments tax companies
Individual Taxes
Rate are progressive Income tax must be paid at the federal and provincial level
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2009 Corporate Tax Rates

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Province/Territory British Columbia Alberta Saskatchewan Manitoba Ontario Quebec New Brunswick Nova Scotia PEI Newfoundland Northwest Terr. Nunavut Yukon
Active Business Income 30.0% 29.0 31.0 32.0 33.0 30.9 32.0 35.0 35.0 33.0 30.5 31.0 34.0
Small Business Income 13.5% 14.0 15.5 13.0 16.5 19.0 16.0 16.0 14.2 16.0 15.0 15.0 15.0
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Features of Corporate Taxation

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In Alberta, small business income up to $400,000 earned by a CCPC:

Below $400,000, the combined tax rate is set at 14%. Above $400,000, the combined tax rate becomes 29%.
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Features of Corporate Taxes (contd)

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A corporation can:
deduct its interest expenses but not its dividend payments. carry back losses for 3 years, carry forward losses for 10 years.* Exclude 100% of dividend income if received from another Canadian corporation
*The loss treatment is to avoid penalizing corporations whose incomes fluctuate substantially from year to year.
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Example
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Assume a small Alberta Canadiancontrolled private corporation (CCPC) has $500,000 of taxable income from operations, $25,000 of interest income, and $50,000 of dividend income. What is its tax liability?
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Example (contd)
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Operating income Interest income Taxable dividend income Taxable income
$500,000 25,000 0* $525,000
*Dividend earned from Canadian companies faces no taxation

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Example (contd)
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Taxable Income = $525,000 Tax on base @14% = $56,000 = $400,0000.14 Amount over base = $525,000 - $400,000 = $125,000 Total Tax = $56,000 + 0.29 ($125,000) = $92,250
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Key Features of Individual Taxation

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Individuals face progressive tax rates, from 15% to 29%. The rate on capital gains is one half the rate of ordinary income. Dividends consist of a gross up of the actual dividend, calculating tax on the grossed up dividend and then taking a tax credit on the grossed up amount.
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PowerPoint Presentation

Traven Reed Canadore College

Corporate Valuation and Financial Statements

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Financial Statements and Reports

Balance Sheet: Assets

2008 15 65 315 415 $810 870 $1,680

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Balance Sheet: Liabilities & Equity

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Implications on Liabilities & Equity

Stock Price and Other Data

2008 50,000,000 $2.36 $1.06 $16.80 $4.16

Copyright 2011 by Nelson Education Ltd. All rights reserved.

What happened to sales and net income?

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Statement of Retained Earnings, 2009

$710.0 113.5 (57.5) $766.0

Net Cash Flow

Statement of Cash Flows: 2009

$117.5 100.0 (60.0) (200.0) 30.0 10.0 ($2.5)

Statement of Cash Flows: 2009 (contd)

(230.0) 65.0 ($165.0)

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Statement of Cash Flows: 2009 (contd)

50.0 174.0 (61.5) $162.5

Copyright 2011 by Nelson Education Ltd. All rights reserved.

(2.5) (165.5) 162.5 ($5.0) 15.0 $10.0

What can you conclude from the statement of cash flows?

What are operating current assets?

Copyright 2011 by Nelson Education Ltd. All rights reserved.

What are operating current liabilities?

Net Operating Working Capital (NOWC)

Total net operating capital (also called operating capital)

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Net Operating Profit after Taxes (NOPAT)

What is free cash flow (FCF)? Why is it important?

What are the five uses of FCF?

Free Cash Flow (FCF) for 2009

Free Cash Flow (FCF) for 2009

Return on Invested Capital (ROIC)

Market Value Added (MVA)

2009 MVA (Assume market value of debt = book value of debt)

Market Value of Equity 2009:

Book Value of Equity 2009:

MVA09 = $1,150 - $896 = $254m MVA08 = $1,300 - $840 = $460m

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Economic Value Added (EVA)

WACC is weighted average cost of capital EVA = NOPAT- [(WACC)(Capital)]

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Economic Value Added (WACC = 11% for 2009)

Key Features of the Tax Code

2009 Corporate Tax Rates

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Features of Corporate Taxation

In Alberta, small business income up to $400,000 earned by a CCPC:

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Features of Corporate Taxes (contd)

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Operating income Interest income Taxable dividend income Taxable income

$500,000 25,000 0* $525,000