Balance sheet

1
CHAPTER 4 Valuing the FirmThe Cash Flow Model

• Balance sheet
• Income statement
• Statement of cash flows
• Accounting income versus cash flow
• MVA and EVA
• Personal taxes
• Corporate taxes

2
Balance Sheets Assets

• 1999 1998
• Cash 7,282 9,000
• Short-term inv. 0 48,600
• AR 632,160 351,200
• Inventories 1,287,360 715,200
• Total CA 1,926,802 1,124,000
• Gross FA 1,202,950 491,000
• Less Depr. 263,160 146,200
• Net FA 939,790 344,800
• Total assets 2,866,592 1,468,800

3
Liabilities and Equity
1999
1998
Accts payable
524,160
145,600
Notes payable
720,000
200,000
Accruals
489,600
136,000
1,733,760
Total CL
481,600
Long-term debt
1,000,000
323,432
Common stock
460,000
460,000
Retained earnings
(327,168)
203,768
Total equity
132,832
663,768
Total LE
2,866,592
1,468,800
4
Income Statement
1999
1998
Sales
5,834,400
3,432,000
COGS
5,728,000
2,864,000
Other expenses
680,000
340,000
Deprec.
116,960
18,900
Tot. op. costs
6,524,960
3,222,900
EBIT
(690,560)
209,100
Interest exp.
176,000
62,500
EBT
(866,560)
146,600
Taxes (40)
(346,624)
58,640
(519,936)
Net income
87,960
5
Other Data
1999
1998
No. of shares
100,000
100,000
EPS
(5.199)
0.88
DPS
0.110
0.22
Notice the drop in stock price.
Stock price
2.25
8.50
Lease pmts
40,000
40,000
6
Statement of Retained Earnings (1999)
Balance of retained earnings, 12/31/98 203,768
Add Net income, 1999 (519,936) Less
Dividends paid (11,000) Balance of retained
earnings, 12/31/99 (327,168)
7
Statement of Cash Flows 1999

• OPERATING ACTIVITIES
• Net Income (519,936)
• Adjustments
• Depreciation 116,960
• Change in AR (280,960)
• Change in inventories (572,160)
• Change in AP 378,560
• Change in accruals 353,600
• Net cash provided by ops.

(523,936)
8

• L-T INVESTING ACTIVITIES
• Investments in fixed assets (711,950)
• FINANCING ACTIVITIES
• Change in s-t investments 48,600
• Change in notes payable 520,000
• Change in long-term debt 676,568
• Payment of cash dividends (11,000)
• Net cash from financing 1,234,168
• Sum net change in cash (1,718)
• Plus cash at beginning of year 9,000
• Cash at end of year 7,282

9
What can you conclude about the companys
financial condition from its statement of cash
flows?

• Net cash from operations -523,936, mainly
  because of negative net income.
• The firm borrowed 1,185,568 and sold 48,600 in
  short-term investments to meet its cash
  requirements.
• Even after borrowing, the cash account fell by
  1,718.

10
Does it appear that the sales price exceeds the
cost per unit sold?

• No, the company is spending more on its
  operations than it is taking in so its cash
  account balance has decreased.

11
A better measure for determining whether sales
price exceeds costs is operating cash flow.

• OCF NOPAT Depreciation
• NOPAT EBIT(1 - Tax rate)
• OCF99 -414,336 116,960
• -297,376.
• Since the OCF is negative, the company is
  spending more than the revenues it generates.

12
What effect would each of these actions have on
the cash account?
1. The company offers 60-day credit terms. The
improved terms are matched by its competitors, so
sales remain constant.

• A/R would ?
• Cash would ?

13
2. Sales double as a result of the change in
credit terms.

• Short-run Inventory and fixed assets ? to meet
  increased sales. A/R ? , Cash ?. Company may
  have to seek additional financing.
• Long-run Collections increase and the companys
  cash position would improve.

14
Book Value

• Book Value Common Stock
• Additional Paid in Cap.
• Retained Earnings
• Money that has been
• paid in to the firm by
• stockholders, or
• retained by the firm.

15
Market Value

• Market Value is the present value of all of the
  cash flows that are expected to accrue to the
  shareholders into the future.

16
Why is BV not equal to MV?

• BV is the amount of capital that has been paid in
  over time. It is a historical figure--backward
  looking.
• MV is the present value of all of the expected
  future cash flows--forward looking.

17
How was the firms expansion financed?

• The expansion was financed primarily with
  external capital.
• The company issued long-term debt which reduced
  its financial strength and flexibility.

18
What were some other sources of financing used in
1999?

• Selling financial assets Short-term investments
  decreased by 48,600.
• Bank loans Notes payable increased by 520,000.
• Credit from suppliers A/P increased by
  378,560.
• Employees Accruals increased by 353,600.

19
Would external capital have been required if they
had broken even in 1999 (Net income 0)?

• Yes, the company would still have to finance its
  increase in assets.

20
What effect did the expansion have on net
operating profit after taxes (NOPAT)?

• NOPAT EBIT(1 - Tax rate)
• NOPAT99 -690,560(1 - 0.4)
• -690,560(0.6)
• -414,336.
• NOPAT98 125,460.

21
What effect did the expansion have on net
operating working capital (NOWC)?
Non-interest bearing CA
Non-interest bearing CL
NOWC
-

• NOWC99 (7,282 632,160 1,287,360)
• - (524,160 489,600)
• 913,042.
• NOWC98 793,800.

22
What effect did the companys expansion have on
its net cash flow and operating cash flow?
NCF99 NI DEP -519,936 116,960
-402,976.
NCF98 87,960 18,900 106,860.
OCF99 NOPAT DEP -414,336 116,960
-297,376.
OCF98 125,460 18,900 144,360.
23
What was the free cash flow (FCF)for 1999?

• FCF NOPAT - Net capital investment
• -414,336 - (1,852,832 - 1,138,600)
• -414,336 - 714,232
• -1,128,568.
• How do you suppose investors reacted?

24
What is the companys EVA? Assume the firms
after-tax cost of capital (COC) was 11 in
1998 and 13 in 1999.
EVA99 NOPAT- (COC)(Capital) -414,336 -
(0.13)(1,852,832) -414,336 - 240,868
-655,204.
EVA98 125,460 - (0.11)(1,138,600) 125,460
- 125,246 214.
25
Would you conclude that the expansion increased
or decreased MVA?
Equity capital supplied
Market value of equity
MVA -
.
During the last year stock price has decreased
73, so market value of equity has declined.
Consequently, MVA has declined.
26
Pro Forma Balance Sheet Assets
2000E
Cash
14,000
71,632
ST investments
AR
878,000
Inventories
1,716,480
Total CA
2,680,112
Gross FA
1,197,160
Less Deprec.
380,120
Net FA
817,040
Total assets
3,497,152
27
Liabilities and Equity
2000E
Accounts payable
436,800
Notes payable
600,000
Accruals
408,000
Total CL
1,444,800
Long-term debt
500,000
Common stock
1,680,936
Retained earnings
(128,584)
Total equity
1,552,352
Total L E
3,497,152
28
Pro Forma Income Statement
2000E
Sales
7,035,600
COGS
5,728,000
Other expenses
680,000
Depreciation
116,960
Tot. op. costs
6,524,960
EBIT
510,640
Interest exp.
88,000
EBT
422,640
Taxes (40)
169,056
Net income
253,584
29
On the basis of the pro forma financial
statements, what is the firms free cash flow in
2000?

• Step 1 Calculate total operating capital in 2000
  and 1999 to determine the net investment in
  operating capital.

Total Operating NOWC NFA. capital
(More)
30

• OC00 (14,000 878,000 1,716,480) -
  (436,800 408,000) 817,040
• 2,580,720.
• OC99 1,852,832.

Net Investment in Operating Capital
2,580,720 - 1,852,832 727,888.
31
2000 Free Cash Flow Calculation

• Step 2 Determine Free Cash Flow.

Net Investment in Operating Capital
FCF00 NOPAT - (510,640)(0.6) -
727,888 -421,504.
32
Calculate the value of Computrons operations and
equity given the following facts FCF00
-421,504 FCF01 50,700 FCF02 145,000 g
after 2002 constant 6 Cost of capital 9.6.

• 12/31/99

12/31/00
12/31/01
12/31/02
12/31/03
k 9.6
g 6
-421,504
50,700
145,000
-384,584 42,207 3,353,083 3,010,706
vop 12/31/99
Vop02 145,000(1.06) 0.096 - 0.06
4,269,444 4,414,444
(More)
33
Total firm value

• vop 12/31/99 Marketable securities
• 3,010,706 0 3,010,706.

Value of common equity
Total firm value - N/P - LT Debt 3,010,706
- 720,000 - 1,000,000 1,290,706.
Price per
12.91. share
34
What is the effect of the 346,624tax credit
received in 1999?

• This suggests the company paid at least 346,624
  in taxes during the past 2 years.
• If the payments over the past 2 years were less
  than 346,624 the firm would have had to carry
  forward the amount of its loss that was not
  carried back.
• If the firm did not receive a full refund its
  cash position would be even worse.

35
INCOME TAXES
36
1997 Tax Year Single IndividualTax Rates
Taxable Income
Tax on Base
Rate
0 - 24,650
0
15
24,650 - 59,750
3,697.50
28
59,750 - 124,650
13,525.50
31
124,650 - 271,050
33,644.50
36
Over 271,050
86,3480.50
39.6
Plus this percentage on the amount over the
bracket base.
37
Assume your salary is 45,000, and you received
3,000 in dividends.You are single, so your
personal exemption is 2,650 and your itemized
deductions are 4,550.

• On the basis of the information above and the
  1997 tax year tax rate schedule, what is your tax
  liability?

38
Calculation of Taxable Income
Salary
45,000
Dividends
3,000
Personal exemptions
(2,650)
Deductions
(4,550)
Taxable Income
40,800
39
40,800 - 24,650

• Tax Liability
• TL 3,697.50 0.28(16,150)
• 8,219.50.
• Marginal Tax Rate 28.
• Average Tax Rate
• Tax rate 20.15.

8,219.5 40,800
40
1997 Corporate Tax Rates
Taxable Income
Tax on Base
Rate
0 - 50,000
0
15
50,000 - 75,000
7,500
25
75,000 - 100,000
13,750
34
100,000 - 335,000
22,250
39
... ...
...
Over 18.3M
6.4M
35
Plus this percentage on the amount over the
bracket base.
41
Assume a corporation has 100,000 of taxable
income from operations, 5,000 of interest
income, and 10,000 of dividend income.

• What is its tax liability?

42
Operating income
100,000
Interest income
5,000
Taxable dividend
income
3,000
Taxable income
108,000
Tax 22,250 0.39(8,000) 25,370.
Dividends - Exclusion 10,000 - 0.7(10,000)
3,000.
43
Taxable versus Tax Exempt Bonds

• State and local government bonds (municipals, or
  munis) are generally exempt from federal taxes.

44

• Exxon bonds at 10 versus California muni bonds
  at 7.
• T Tax rate 28.
• After-tax interest income
• Exxon 0.10(5,000) - 0.10(5,000)(0.28)
• 0.10(5,000)(0.72) 360.
• CAL 0.07(5,000) - 0 350.

45
At what tax rate would you be indifferent between
the muni and the corporate bonds?

• Solve for T in this equation
• Muni yield Corp Yield(1-T)
• 7.00 10.0(1-T)
• T 30.0.

46
Implications

• If T gt 30, buy tax exempt munis.
• If T lt 30, buy corporate bonds.
• Only high income, and hence high tax bracket,
  individuals should buy munis.

47
Conclusion

• NOPAT
• Free Cash Flow
• MVA and EVA
• Personal Taxes
• Corporate Taxes
• Corporate Value Model