What was net operating working capital for 2015 and 2016

Chapter

Tool Kit Chapter 2 10/27/15

Financial Statements, Cash Flow, and Taxes

2-1 Financial Statements and Reports

The annual report contains a verbal section plus four key statements: the balance sheet, income statement, statement of stockholders' equity, and statement of cash flows.

Our spreadsheets use formulas rather than fixed numbers. For example, the cell for Total assets for the most recent year contains the Sum formula rather than just a fixed number. That way, if the data for any inputs (cash, for instance) change, the spreadsheet will automatically recalculate and provide the correct new value for Total assets.

In financial modeling, it is helpful to users when input data is grouped together, so you should follow this practice in your own models, too.

2-2 The Balance Sheet

INPUT DATA SECTION: Historical Data Used in the Analysis

2016 2015

Year-end common stock price $27.00 $40.00

Year-end shares outstanding (in millions) 50 50

Tax rate 40% 40%

Weighted average cost of captal (WACC) 11.0% 10.5%

Figure 2-1

MicroDrive Inc. December 31 Balance Sheets

(Millions of Dollars)

Assets 2016 2015

Cash and equivalents $ 50 $ 60

Short-term investments - 40

Accounts receivable 500 380

Inventories 1,000 820

Total current assets $ 1,550 $ 1,300

Net plant and equipment 2,000 1,700 Note: Net plant and equipment is equal to cumulative purchases of fixed assets less cumulative depreciation and cumulative disposed assets.

Total assets $ 3,550 $ 3,000

Liabilities and Equity

Accounts payable $ 200 $ 190

Notes payable 280 130

Accruals 300 280

Total current liabilities $ 780 $ 600

Long-term bonds 1,200 1,000

Total liabilities $ 1,980 $ 1,600

Preferred stock (1,000,000 shares) 100 100

Common stock (50,000,000 shares) 500 500

Retained earnings 970 800

Total common equity $ 1,470 $ 1,300

Total liabilities and equity $ 3,550 $ 3,000

2-2 The Income Statement

Figure 2-2

MicroDrive Income Statements for Years Ending December 31

(Millions of Dollars, Except for Per Share Data)

2016 2015

Net sales $ 5,000 $ 4,760

Costs of goods sold except depreciation 3,800 3,560

Depreciation and amortizationa 200 170

Other operating expenses 500 480

Earnings before interest and taxes (EBIT) $ 500 $ 550

Less interest 120 100

Pre-tax earnings $ 380 $ 450

Taxes 152 180

Net Income before preferred dividends $ 228 $ 270

Preferred dividends 8 8

Net Income available to common stockholders $ 220 $ 262

Additional Information

Common dividends $50 $48

Addition to retained earnings $170 $214

Number of common shares 50 50

Stock price per share $27 $40

Per Share Data

Earnings per share, EPSb $4.40 $5.24

Dividends per share, DPSc $1.00 $0.96

Book value per share, BVPSd $29.40 $26.00

Notes:

a MicroDrive has no amortization charges.

b EPS = Net income available to common stockholders Common shares outstanding

c DPS = Dividends paid to common stockholders Common shares outstanding

d BVPS = Total common equity Common shares outstanding

2-4 Statement of Stockholders’ Equity

The statement of stockholders' equity takes the previous year's balance of common stock, retained earnings, and stockholders' equity and then adds the current year's net income and subtracts dividends paid to common stockholders. The end result is the new balance of common stock, retained earnings, and stockholders' equity.

Figure 2-3

MicroDrive Inc. Statement of Stockholders' Equity

(Millions of Dollars, Millions of Shares)

Preferred Stock Common Shares Common Stock Retained Earnings Total Equity

Balances, Dec. 31, 2015 $100 50 $500 $800 $1,400

Changes during year:

Net income $220 $220

Cash dividends (50) (50)

Issuance/repurchase of stock 0 0 0

Balances, Dec. 31, 2016 $100 50 $500 $970 $1,570

Note: In financial statements, parentheses and red colors denote a negative number.

2-5 Statement of Cash Flows

Information from the balance sheet and income statement can be used to construct the Statement of Cash Flows, which is shown below for MicroDrive, in millions of dollars.

Figure 2-4

MicroDrive Statement of Cash Flows for Year Ending Dec. 31

(Millions of Dollars)

Operating Activities 2016

Net Income before preferred dividends $ 228

Noncash adjustments

Depreciationa 200

Working capital adjustments

Increase in accounts receivableb (120)

Increase in inventories (180)

Increase in accounts payable 10

Increase in accruals 20

Net cash provided (used) by operating activities $ 158

Investing Activities

Cash used to acquire fixed assetsc $ (500)

Sale of short-term investments 40

Net cash provided (used) by investing activities $ (460)

Financing Activities

Increase in notes payable $ 150

Increase in bonds 200

Payment of common and preferred dividends (58)

Net cash provided (used) by financing activities $ 292

Summary

Net change in cash and equivalents $ (10)

Cash and securities at beginning of the year 60

Cash and securities at end of the year $ 50

Notes:

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

bAn increase in a current asset decreases cash. An increase in a current liability increases cash. For example, inventories increased by $180 million and therefore reduced cash by the same amount.

cThe net increase in fixed assets is $300 million; however, this net amount is after a deduction for the year’s depreciation expense. Depreciation expense must be added back to find the increase in gross fixed assets. From the company’s income statement, we see that the year's depreciation expense is $200 million; thus, expenditures on fixed assets were actually $500 million.

2-6 Net Cash Flow

2016 2015

Net income $220.0 $262.0

Depreciation $500.0 $480.0

Net cash flow $720.0 $742.0

2-7 Free Cash Flow: The Cash Flow Available for Distribution to Investors

Net Operating Profit After Taxes

NOPAT is the amount of profit MicroDrive would generate if it had no debt and held no financial assets.

NOPAT = EBIT x (1-T)

2016 2015

Tax rate 40% 40%

Earnings before interest and taxes (EBIT) $500 $550

x (1-T) 60% 60%

NOPAT $300 $330

Net Operating Working Capital

The current assets (CA) used in operations are called operating current assets. Operating CA include the cash needed for operations, accounts receivable and inventories. The current liabilities (CL) that are due to operations are called operating current liabilities. Operating CL include accounts payable and accruals. Net operating working capital (NOWC) is equal to operating CA minus operating CL. NOWC is the net amount that a company's operations tie up in current assets and current liabilities.

Calculating Operating Current Assets

2016 2015

Cash and equivalents $50 $60

+ Accounts receivable $500 $380

+Inventories $1,000 $820

Operating current assets $1,550 $1,260

Calculating Operating Current Liabilities

2016 2015

Accounts payable $200 $190

+ Accruals $300 $280

Operating current liabilities $500 $470

Calculating Net Operating Working Capital

2016 2015

Operating current assets $1,550 $1,260

− Operating current liabilities $500 $470

Net operating working capital $1,050 $790

Total Net Operating Capital (also just called Operating Capital or just Capital)

The Total Net Operating Capital is Net Operating Working Capital plus any long-term fixed assets or net plant, property, and equipment used in operations.

Calculating Total Net Operating Capital

2016 2015

Net operating working capital $1,050 $790

+ Net plant and equipment $2,000 $1,700

Total net operating capital $3,050 $2,490

Alternative Calculation of Total Net Operating Capital (also just called Operating Capital)

Total Funds Provided by Investors

2016 2015

Notes payable $280 $130

Long-term bonds $1,200 $1,000

Preferred stock $100 $100

Total common equity $1,470 $1,300

Total investor supplied funds $3,050 $2,530

Total Funds Provided by Investors for Operations

2016 2015

Total investor supplied capital $3,050 $2,530

Less short-term investments $0 $40

Total investor-supplied operating capital $3,050 $2,490

Free Cash Flow

MicroDrive's Free Cash Flow calculation is the cash flow actually availabe for distribution to investors after the company has made all necessary investments in fixed assets and working capital to sustain ongoing operations. Free cash flow is equal to NOPAT minus the investment made in total net operating capital. The investment in total net operating capital is equal to the current year's total net operating capital minus the previous year's total net operating capital.

Calculating the Investment in Total Net Operating Capital

2016 2015

Total net operating capital $3,050 $2,490

Investment in total net operating capital $560

Calculating Free Cash Flow

2016

NOPAT $300

− Investment in total net operating capital $560

Free cash flow -$260

Here is an alternative calculation of FCF that is sometimes used in the financial press.

2016 FCF = NOPAT + Depreciation − Gross investment in fixed assets − Investment in NOWC

= $500.0 − $500 − $260

2016 FCF = -$260.0

Uses of Free Cash Flow

1. After-tax interest payments

2016 After-tax interest expense = (Pre-tax interest expense) x (1-T)

= $120.0 x 60%

= $72.0

2. Net repayment of debt

The amount of debt that is repaid is equal to the amount at the beginning of the year minus the amount at the end of the year. This includes notes payable and long-term debt. If the amount of ending debt is less than the beginning debt, the company paid of some of its debt. But if the ending debt is greater than the beginning debt, the company actually borrowed additional funds from creditors. In that case, it would be a negative use of FCF.

2016 Repayment to debtholders = All debt at beginning of year - all debt at end of year

= $1,130.0 - $1,480.0

= -$350.0

3. Total dividend payments

This includes all dividends to preferred stockholders and dividends to common stockholders.

2016 Dividends = Prefered dividends + common dividends

= $8.0 + $50.0

= $58.0

4. Net repurchase of stock

The amount of stock that is repurchased is equal to the amount at the beginning of the year minus the amount at the end of the year. This includes preferred stock and common stock. If the amount of ending stock is less than the beginning stock, the company made net repurchases. But if the ending stock is greater than the beginning stock, the company actually made net issuances. In that case, it would be a negative use of FCF.

2016 Repurchase stock = Preferred stock and common stock at beginning of year - Preferred stock and common stock at end of year

= $600.0 - $600.0

= $0.0

5. Net purchase of short-term investments

The amount of net purchases of ST investments is equal to the amount at the end of the year minus the amount at the beginning of the year. If the amount of ending investments is greater than the beginning investments, the company made net purchases. But if the ending investments are less than the beginning investments, the company actually sold investments. In that case, it would be a negative use of FCF.

2016 Purchase ST investments = ST investents at end of year - ST investments at beginning of year

= $0.0 - $40.0

= -$40.0

Summary of uses of FCF

2016

1. After-tax interest payments $72.0

2. Net repayment of debt -$350.0

3. Total dividend payments $58.0

4. Net repurchase of stock $0.0

5. Net purchase of short-term investments -$40.0

Total uses of FCF = -$260.0

Notice that the total uses of FCF equals the previously calculated value of FCF.

2-8 Performance Evaluation

The Return on Invested Capital (ROIC)

The Return on Invested Capital tells us the amount of NOPAT per dollar of operating capital.

2016 ROIC = NOPAT ÷ Total net operating capital

$300.00 ÷ $3,050

2016 ROIC = 9.84%

2015 ROIC = NOPAT ÷ Total net operating capital

$330.00 ÷ $2,490

2015 ROIC = 13.25%

The Operating Profitability Ratio (OP)

The operating profitability ratio show the amount of NOPAT per dollar of sales.

2016 OP = NOPAT ÷ Sales

$300.00 ÷ $5,000

2016 OP = 6.00%

2015 OP = NOPAT ÷ Sales

$330.00 ÷ $4,760

2015 OP = 6.93%

The Capital Requirement Ratio (CR)

The capital requirement ratio show the amount of operating capital that is needed to generate a dollar of sales.

2016 CR = Total net operating capital ÷ Sales

$3,050 ÷ $5,000

2016 CR = 61.00%

2015 CR = Total net operating capital ÷ Sales

$2,490 ÷ $4,760

2015 CR = 52.31%

Market Value Added

Market Value Added is the difference between the market value of MicroDrive's stock and the amount of equity capital supplied by shareholders.

2016 MVA = Stock price x # of shares - Total common equity

= $27.00 x 50 - $1,470

= $1,350 - $1,470

2016 MVA = -$120

2015 MVA = Stock price x # of shares - Total common equity

= $40.00 x 50 - $1,300

= $2,000 - $1,300

2015 MVA = $700

Economic Value Added

Economic Value Added represents MicroDrive's residual income that remains after the cost of all capital, including equity capital, has been deducted.

2016 EVA = NOPAT - Operating Capital x Weighted average cost of capital

= $300.00 - $3,050 x 11%

= $300.0 - $335.5

2016 EVA = -$35.5

2015 EVA = NOPAT - Operating Capital x Weighted average cost of capital

= $330.00 - $2,490 x 11%

= $330.0 - $261.5

2015 EVA = $68.6

Figure 2-6

Calculating Performance Measures for MicroDrive

(Millions of Dollars)

2016 2015

Calculating NOPAT

EBIT $500 $550

x (1 − Tax rate) 60% 60%

NOPAT = EBIT(1 − T) $300 $330

Calculating Net Operating Working Capital (NOWC)

Operating current assets $1,550 $1,260

− Operating current liabilities $500 $470

NOWC $1,050 $790

Calculating Total Net Operating Capital

NOWC $1,050 $790

+ Net plant and equipment $2,000 $1,700

Total net operating capital $3,050 $2,490

Calculating Return on Invested Capital