Microdrive inc

Chapter

Tool Kit Chapter 3 10/27/15

Analysis of Financial Statements

Financial statements are analyzed by calculating certain key ratios and then comparing them with the ratios of other firms and by examining the trends in ratios over time. We can also combine ratios to make the analysis more revealing, one below are exceptionally useful for this type of analysis.

3-1 Financial Analysis

Input Data:

2016 2015

Year-end common stock price $27.00 $40.00

Year-end shares outstanding (in millions) 50 50

Tax rate 40% 40%

After-tax cost of capital 11.0% 10.5%

Lease payments $28 $28

Required sinking fund payments $20 $20

Figure 3-1

MicroDrive Inc. Balance Sheets and Income Statements for Years Ending December 31

(Millions of Dollars, Except for Per Share Data)

Balance Sheets 2016 2015

Assets

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

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 (400,000 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

Income Statements 2016 2015

Net sales $ 5,000 $ 4,760

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

Depreciation 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 (40%) 152 180

Net income before preferred dividends $ 228 $ 270

Preferred dividends 8 8

Net income available to common stockholders $ 220 $ 262

Other Data

Common dividends $50 $48

Addition to retained earnings $170 $214

Lease payments $28 $28

Bonds' required sinking fund payments $20 $20

Common stock price per share $27 $40

Calculated Data: Operating Performance and Cash Flows

2016 2015

Net operating working capital (NOWC) = $1,050 $790

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

Net operating profit after taxes (NOPAT) = $300 $330

Operating profitability (OP) ratio = NOPAT/Sales = 6.00% 6.93%

Capital requirement(CR) ratio = (Total net operating capital/Sales) = 61.00% 52.31%

Return on invested capital (ROIC) = NOPAT/Total net operating capital = 9.8% 13.3%

Free cash flow (FCF) = NOPAT − Net investment in operating capital = -$260 N/A

Net cash flow = Net income + Depreciation = $ 420 $432

Earnings before interest, taxes, depreciation & amortization (EBITDA) = EBIT + Depreciation & amortization = $700 $720

Market capitalization (# shares x price per share) $1,350 $2,000

Calculated Data: Per-share Information

2016 2015

Earnings per share (EPS) $4.40 $5.24

Dividends per share (DPS) $1.00 $0.96

Book value per share (BVPS) $29.40 $26.00

Cash flow per share (CFPS) $8.40 $8.64

EDITDA per share $14.00 $14.40

Free cash flow per share (FCFPS) -$5.20 N/A

3-2 Liquidity Ratios Industry

2016 2015 Average

Liquidity ratios

Current Ratio = CA/CL 2.0 2.2 2.2

Quick Ratio = (CA - Inventories)/CL 0.7 0.8 0.8

3-3 Asset Management Ratios Industry

2016 2015 Average

Asset Management ratios

Total Asset Turnover = Sales/TA 1.4 1.6 1.8

Fixed Asset Turnover = Sales/Fixed assets 2.5 2.8 3.0

Days Sales Outstanding = Accounts receivable/Daily sales 36.5 29.1

Christopher Buzzard: To calculate the DSO ratio, a 365-day accounting year was used. 30.0

Inventory Turnover = COGS/Inventories 4.0 4.5 5.0

3-4 Debt Management Ratios Industry

2016 2015 Average

Debt Management ratios

Debt Ratio = Debt-to-Assets Ratio = Total debt/TA 41.7% 37.7% 25.0%

Debt-to-Equity Ratio = Total debt/Total common equity 1.01 0.87 0.46

Market Debt Ratio = Total debt/(Total debt + Market Cap) 52.3% 36.1% 20.0%

Liabilities-to-Assets Ratio = TL/TA 55.8% 53.3% 45.0%

Times Interest Earned = EBIT/Interest expense 4.2 5.5 10.0

EBITDA Coverage Ratio = (EBIT + Depreciation + Lease pmt) (Interest + Principal pmt + Lease pmt) 4.3 5.1 12.0

3-5 Profitability Ratios Industry

2016 2015 Average

Profitability ratios

Profit Margin = Net income/Sales 4.4% 5.5% 6.2%

Basic Earning Power = EBIT/TA 14.1% 18.3% 20.2%

Return on Assets = Net income/TA 6.2% 8.7% 11.0%

Return on Equity = Net income/Total common equity 15.0% 20.2% 19.0%

3-6 Market Value Ratios Industry

2016 2015 Average

Market Value ratios

Price-to Earnings Ratio = Price/(Net income/# shares) 6.1 7.6 10.5

Price-to-Cash Flow Ratio = Price (Net income + Depreciation)/# shares 3.2 4.6 6.3

Price-to-EBITDA Ratio = Price (EBIT + Depreciation)/# shares 1.9 2.8 4.0

Market-to-Book Ratio = Price/(Total common equity/#shares) 0.9 1.5 1.8

Market-to-Book Ratio = (Price x #shares)/(Total common equity) 0.9 1.5 1.8

3-7 Trend Analysis, Common Size Analysis, and Percentage Change Analysis

TREND ANALYSIS

Trend analysis allows you to see how a firm's results are changing over time. For instance, a firm's ROE may be slightly below the benchmark, but if it has been steadily rising over the past four years, that should be seen as a good sign.

A trend analysis and graph have been constructed on this data regarding MicroDrive's ROE over the past 5 years. (MicroDrive and indusry average data for earlier years has been provided.)

ROE

MicroDrive Industry

2012 15.0% 14.0%

2013 18.0% 15.0%

2014 21.0% 18.0%

2015 20.2% 17.0%

2016 15.0% 19.0%

Figure 3-2

MicroDrive, Inc.: Return on Common Equity

COMMON SIZE ANALYSIS

In common size income statements, all items for a year are divided by the sales for that year.

Figure 3-3

MicroDrive Inc.: Common Size Income Statements

Industry Composite MicroDrive

2016 2016 2015

Net sales 100.0% 100.0% 100.0%

Costs of goods sold except depreciation 75.5% 76.0% 74.8%

Depreciation 3.0% 4.0% 3.6%

Other operating expenses 10.0% 10.0% 10.1%

Earnings before interest and taxes (EBIT) 11.5% 10.0% 11.6%

Less interest 1.2% 2.4% 2.1%

Pre-tax earnings 10.4% 7.6% 9.5%

Taxes (40%) 4.1% 3.0% 3.8%

Net income before preferred dividends 6.2% 4.6% 5.7%

Preferred dividends 0.0% 0.2% 0.2%

Net income available to common stockholders 6.2% 4.4% 5.5%

In common sheets, all items for a year are divided by the total assets for that year.

Figure 3-4

MicroDrive Inc.: Common Size Balance Sheets

Industry Composite MicroDrive

2016 2016 2015

Assets

Cash and equivalents 1.8% 1.4% 2.0%

Short-term investments 0.0% 0.0% 1.3%

Accounts receivable 14.0% 14.1% 12.7%

Inventories 26.3% 28.2% 27.3%

Total current assets 42.1% 43.7% 43.3%

Net plant and equipment 57.9% 56.3% 56.7%

Total assets 100.0% 100.0% 100.0%

Liabilities and Equity

Accounts payable 7.0% 5.6% 6.3%

Notes payable 0.0% 7.9% 4.3%

Accruals 12.3% 8.5% 9.3%

Total current liabilities 19.3% 22.0% 20.0%

Long-term bonds 25.4% 33.8% 33.3%

Total liabilities 44.7% 55.8% 53.3%

Preferred stock 0.0% 2.8% 3.3%

Total common equity 55.3% 41.4% 43.3%

Total liabilities and equity 100.0% 100.0% 100.0%

PERCENT CHANGE ANALYSIS

In percent change analysis, all items are divided by the that item's value in the beginning, or base, year.

Figure 3-5

MicroDrive Inc.: Income Statement Percent Change Analysis

Base year = 2015 Percent Change in

2016

Net sales 5.0%

Costs of goods sold except depreciation 6.7%

Depreciation 17.6%

Other operating expenses 4.2%

Earnings before interest and taxes (EBIT) (9.1%)

Less interest 20.0%

Pre-tax earnings (15.6%)

Taxes (40%) (15.6%)

Net income before preferred dividends (15.6%)

Preferred dividends 0.0%

Net income available to common stockholders (16.0%)

MicroDrive, Inc.: Balance Sheet Percent Change Analysis (not in textbook)

Base year = 2015 Percent Change in

2016

Assets

Cash and equivalents (16.7%)

Short-term investments (100.0%)

Accounts receivable 31.6%

Inventories 22.0%

Total current assets 19.2%

Net plant and equipment 17.6%

Total assets 18.3%

Liabilities and Equity

Accounts payable 5.3%

Notes payable 115.4%

Accruals 7.1%

Total current liabilities 30.0%

Long-term bonds 20.0%

Total liabilities 23.8%

Preferred stock (400,000 shares) 0.0%

Common stock (50,000,000 shares) 0.0%

Retained earnings 21.3%

Total common equity 13.1%

Total liabilities and equity 18.3%

3-8 DuPont Analysis

ROE = Profit margin x TA turnover x Equity multiplier

MicroDrive 2016 15.0% 4.40% 1.41 2.415

MicroDrive 2015 20.2% 5.50% 1.59 2.308

Industry Average 20.3% 6.20% 1.80 1.818

Suppose MicroDrive can improve its total asset turnover ratio.

Improved TA turover ratio = 1.8

ROE = Profit margin x TA turnover x Equity multiplier

19.1% 4.40% 1.80 2.415

MicroDrive

2012 2013 2014 2015 2016 0.15 0.18 0.21 0.20153846153846153 0.14965986394557823 Industry

2012 2013 2014 2015 2016 0.14000000000000001 0.15 0.18 0.17 0.19

ROE (%)

MicroDrive

2012 2013 2014 2015 2016 0.15 0.18 0.21 0.20153846153846153 0.14965986394557823 Industry

2012 2013 2014 2015 2016 0.14000000000000001 0.15 0.18 0.17 0.19

ROE (%)

3-2

SECTION 3-2

SOLUTIONS TO SELF-TEST

Morris Corporation has the following information on its balance sheets: Cash = $40, accounts receivable = $30, inventories = $100, net fixed asset = $500, accounts payable = $20, accruals = $10, short-term debt (matures in less than a year) = $25, long-term debt = $200, and total common equity = $415. What is its current ratio? Its quick ratio?

Cash $40

Accounts receivable $30

Inventories $100

Net fixed assets $500

Total $670

Accounts payable $20

Accruals $10

ST debt $25

LT debt $200

Total common equity $415

$670

Current assets $170

Current liabilities $55

Current ratio 3.1

Current assets − Inventories $70

Current liabilities $55

Quick ratio 1.3

A company has current liabilities of $800 million, and its current ratio is 2.5. What is its level of current assets? If this firm’s quick ratio is 2, how much inventory does it have?

Current liabilities ($M) $800

Current ratio 2.5

Current assets ($M) $2,000

Current liabilities ($M) $800

Current ratio 2.5

Quick ratio 2

Current assets - Inventories ($M) $1,600

Inventories ($M) $400

3-3

SECTION 3-2

SOLUTIONS TO SELF-TEST

Morris Corporation has the following information on its balance sheets: Cash = $40, accounts receivable = $30, inventories = $100, net fixed asset = $500, accounts payable = $20, accruals = $10, short-term debt (matures in less than a year) = $25, long-term debt = $200, and total common equity = $415. Its income statement reports: Sales = $820, costs of goods sold (excluding depreciation) = $450, depreciation = $50, interest expense = $20, and tax rate = 40%. Calculate the following ratios: total assets turnover, fixed assets turnover, days sales outstanding (based on a 365 day year), inventory turnover. Hint: This is the same company used in the previous Self-Test.

Cash $40

Accounts receivable $30

Inventories $100

Net fixed assets $500

Total assets $670

Accounts payable $20

Accruals $10

ST debt $25

LT debt $200

Total common equity $415

$670

Sales $820

COGS (excluding depreciation) $450

Depreciation $50

Other operating expenses $100

EBIT $220

Interest expense $20

Pre-tax earnings $200

Tax rate 40%

Tax expense $80

Net income $120

Days in year 365

Sales $820

Total assets $670

Total assets turnover 1.2

Sales $820

Fixed assets $500

Fixed assets turnover 1.6

Daily average sales $2.25

Accounts receivable $30

Days sales outstanding 13.4

COGS including depreciation $500

Inventories $100

Fixed assets turnover 5.0

A firm has $200 million annual sales, $180 million costs of goods sold, $40 million of inventory, and $60 million of accounts receivable. What is its inventory turnover ratio?

Annual Sales ($M) $200

Costs of good sold ($M) $180

Inventory ($M) $40

Accounts receivable ($M) $60

Inventory turnover 4.5

Annual Sales ($M) $200

Inventory ($M) $40

Accounts receivable ($M) $60

Days sales outstanding 109.5

3-4

SECTION 3-4

SOLUTIONS TO SELF-TEST

Morris Corporation has the following information on its balance sheets: Cash = $40, accounts receivable = $30, inventories = $100, net fixed asset = $500, accounts payable = $20, accruals = $10, short-term debt (matures in less than a year) = $25, long-term debt = $200, and total common equity = $415. Its income statement reports: Sales = $820, costs of goods sold (excluding depreciation) = $450, depreciation = $50, interest expense = $20, and tax rate = 40%. Calculate the following ratios: Debt-to-assets ratio, debt-to-equity ratio, liabilities-to-assets ratio, times-interest earned ratio, and EBITDA coverage ratio (the firm has no lease payments or required principal payments). Hint: This is the same company used in the previous Self-Test.

Cash $40

Accounts receivable $30

Inventories $100

Net fixed assets $500

Total assets $670

Accounts payable $20

Accruals $10

ST debt $25

LT debt $200

Total common equity $415

$670

Sales $820

COGS (excluding depreciation) $450

Depreciation $50

Other operating expenses $100

EBIT $220

Interest expense $20

Pre-tax earnings $200

Tax rate 40%

Tax expense $80

Net income $120

Days in year 365

Lease payments $0

Required principal payments $0

Total debt $225

Total assets $670

Debt-to-assets ratio 33.6%

Total debt $225

Total common equity $415

Debt-to-equity ratio 54.2%

Total liabilities $255

Total assets $670

Liabilities-to-assets ratio 38.1%

EBIT $220

Interest expense $20

Times-interest-earned ratio 11.0

Suppose the previous company has 100 shares of stock with a price of $15 per share. What is its market debt ratio (assume the market value of debt is close to the book value)? How does this compare with the previously calculated debt-to-assets ratio? Does the market debt ratio imply that the company is more or less risky than the debt-to-assets ratio indicated?

Number of shares 100

Price per share $15

Total debt $225

Market value of equity $1,500

Market debt ratio 13.0%

Notice that the market debt ratio is much less than the debt ratio based on book values, implying that the firm is less risky than indicated by the ratio based on book values.

A company has EBITDA of $600 million, interest payments of $60 million, lease payments of $40 million, and required principal payments (due this year) of $30 million. What is its EBITDA coverage ratio?

EBITDA ($M) $600

Interest payments $60

Lease payments $40

Principal payments $30

EBITDA coverage 4.9

3-5

SECTION 3-5

SOLUTIONS TO SELF-TEST

Morris Corporation has the following information on its balance sheets: Cash = $40, accounts receivable = $30, inventories = $100, net fixed asset = $500, accounts payable = $20, accruals = $10, short-term debt (matures in less than a year) = $25, long-term debt = $200, and total common equity = $415. Its income statement reports: Sales = $820, costs of goods sold (excluding depreciation) = $450, depreciation = $50, interest expense = $20, and tax rate = 40%. Net profit margin, operating profit margin, basic earning power ratio, return on total assets , and return on common equity. Hint: This is the same company used in the previous Self-Test.

Cash $40

Accounts receivable $30

Inventories $100

Net fixed assets $500

Total assets $670

Accounts payable $20

Accruals $10

ST debt $25

LT debt $200

Total common equity $415

$670

Sales $820

COGS (excluding depreciation) $450

Depreciation $50

Other operating expenses $100

EBIT $220

Interest expense $20

Pre-tax earnings $200

Tax rate 40%

Tax expense $80

Net income $120

Net income $120

Sales $820

Net profit margin 14.6%

EBIT $220

Sales $820

Operating profit margin 26.8%

EBIT $220

Total assets $670

Basic earnings power ratio 32.8%

Net income $120

Total assets $670

Return on total assets 17.9%

Net income $120

Total common equity $415

Return on common equity 28.9%

A company has $200 billion of sales and $10 billion of net income. Its total assets are $100 billion, financed half by debt and half by common equity. What is its profit margin? What is its ROA? What is its ROE?

Sales ($B) $200

Net income ($B) $10

Total assets ($B) $100

Debt ratio 50%

Profit margin 5.00%

Sales ($B) $200

Net income ($B) $10

Total assets ($B) $100

Debt ratio 50%

ROA 10.00%

Sales ($B) $200

Net income ($B) $10

Total assets ($B) $100

Debt ratio 50%

ROE 20.00%

3-6

SECTION 3-6

SOLUTIONS TO SELF-TEST

A company has $6 billion of net income, $2 billion of depreciation and amortization, $80 billion of common equity, and one billion shares of stock. If its stock price is $96 per share, what is its price/earnings ratio? Its price/cash flow ratio? Its market/book ratio?

Net income ($B) $6

Amortization and depreciation ($B) $2

Common equity $80

Number of shares ($B) 1

Stock price per share $96

Earnings per share $6

P/E ratio 16.00

Cash flow $8.00

Cash flow per share 8.00

Price/cash flow 12.00

Book value per share 80.00

Market/Book 1.20

3-8

SECTION 3-8

SOLUTIONS TO SELF-TEST

A company has a profit margin of 6%, a total asset turnover ratio of 2, and an equity multiplier of 1.5. What is its ROE?

Profit margin 6.0%

Total asset turnover 2.0

Equity multiplier 1.5

ROE 18.0%

Mini Case Data

10/27/15

Mini Case Data

Input Data:

2014 2015 2016

Bart Kreps: Projections

Year-end common stock price $8.50 $6.00 $12.17

Year-end shares outstanding 100,000 100,000 250,000

Tax rate 40% 40% 40%

Lease payments $40,000 $40,000 $40,000

Balance Sheets

Assets 2014 2015 2016

Cash and equivalents $9,000 $7,282 $14,000

Short-term investments $48,600 $20,000 $71,632

Accounts receivable $351,200 $632,160 $878,000

Inventories $715,200 $1,287,360 $1,716,480

Total current assets $1,124,000 $1,946,802 $2,680,112

Gross Fixed Assets $491,000 $1,202,950 $1,220,000

Less Accumulated Dep. $146,200 $263,160 $383,160

Net Fixed Assets $344,800 $939,790 $836,840

Total Assets $1,468,800 $2,886,592 $3,516,952

Liabilities and Equity

Accounts payable $145,600 $324,000 $359,800

Notes payable $200,000 $720,000 $300,000

Accruals $136,000 $284,960 $380,000

Total current liabilities $481,600 $1,328,960 $1,039,800

Long-term bonds $323,432 $1,000,000 $500,000

Total liabilities $805,032 $2,328,960 $1,539,800

Common stock (100,000 shares) $460,000 $460,000 $1,680,936

Retained earnings $203,768 $97,632 $296,216

Total common equity $663,768 $557,632 $1,977,152

Total liabilities and equity $1,468,800 $2,886,592 $3,516,952

Income Statements

2014 2015 2016

Net sales $3,432,000 $5,834,400 $7,035,600

Costs of Goods Sold Except Depr. $2,864,000 $4,980,000 $5,800,000

Depreciation and amortization $18,900 $116,960 $120,000

Other Expenses $340,000 $720,000 $612,960

Total Operating Cost $3,222,900 $5,816,960 $6,532,960

Earnings before interest and taxes (EBIT) $209,100 $17,440 $502,640

Less interest $62,500 $176,000 $80,000

Pre-tax earnings $146,600 ($158,560) $422,640

Taxes (40%) $58,640 ($63,424) $169,056

Net Income before preferred dividends $87,960 ($95,136) $253,584

EPS $0.880 ($0.951) $1.014

DPS $0.220 $0.110 $0.220

Book Value Per Share $6.638 $5.576 $7.909

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