Transcript Payoffs to the capital providers

ACCY 291
Financial Statement Analysis
Steps in Financial Analysis
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Steps in comprehensive financial analysis
1. BUSINESS STRATEGY Analysis
2. ACCOUNTING Analysis
3. FINANCIAL Analysis
4. PROSPECTIVE Analysis
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Business Strategy
Industry analysis and
Competitive strategy analysis
Understand the business and the firm.
Accounting
Evaluate
accounting &
financial reporting
quality.
Financial
Prospective
Evaluate
past performance.
Make forecasts and
Value business.
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BUSINESS STRATEGY Analysis
An effort to learn about the company’s product, strategy, and operating
environment.
 A qualitative analysis of profit drivers, profit potentials, and the associated risk.
 SWOT analysis can be useful

Know the Industry

Know the key players (leaders, followers, newcomers)

What is the source of competitive advantage/weakness?

What are Goals, Strategies, and Implementation history?
 Where does the firm want to go?
 Is the goal achievable?
 Does the firm have a good track record?
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FINANCIAL Analysis
Quantitative evaluation of past performance,
Assessment of the status quo that is informative of the future.
PROSPECTIVE Analysis
Forecast of future financial statements.
Equity valuation.
What is involved is an empirical analysis where, we


Make informed guesses based on past data.
Simplify complex numbers into simpler key parameters.
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ACCOUNTING Analysis
Background

We use “Accrual Accounting” vs. ______ accounting.
 What is an “accrual”?
 Key features?
 Outcome?
Accrual accounting system leads to…

Manager’s accounting and financial reporting discretion.

Manager’s financial reporting strategy.
 Release of voluntary information
 Timing of the release of information
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ACCY 291
Financial Statement Analysis
Financial Analysis
Preliminaries
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Overview of a Firm
from Financial Analysis standpoint
i-freedebt
Assets
i-bearing debt
OE
Investment
Financing
Payoffs to the “capital providers”
(Measure of “Profit” for the “enterprise”)
Managers’ task?
Investment
Operating
Financing
Accounting
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Payoffs to the capital providers
i-free debt
i-bearing debt
Assets
OE
Payoffs to the “capital providers”
Measured in accounting numbers is typically called
____________________
Measured in cash is typically called
____________________
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NOPAT and Free Cash Flow

NOPAT (Net Operating Profit After Tax)
= Accounting profits for both debtholders and shareholders
= All sales, minus expenses payable to all parties except debtholders and
shareholders.
Since debtholders and shareholders are combined into one class, this
measure cannot be influenced by capital structure.

Free Cash Flow (FCF)
= Cash flows for both debtholders and shareholders
= All cash inflows, minus cash outflows to all parties except debtholders
and shareholders.
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Day-to-Day Performance Goals
i-free debt
Assets
i-bearing debt
OE

Managers’ objective (in finance theory)?
Maximize ________________
The market value of the enterprise is considered to be
____________________.

Practical period-by-period Performance Goals
(Typically relevant in conventional Ratio analysis)
Maximize _____________
While
Minimizing____________ “Other things equal”

Together, they imply
Maximizing___________
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A Thought
If the firm’s value is present value of future free cash
flows, then why do we bother with NOPAT in
measuring the firm’s performance in any period?
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Properties of NOPAT
(Net Operating Profit After Tax)
What is NOPAT?
How different from net income?
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NOPAT
is after tax income that would have been obtained regardless of its capital
structure
Revenue
CGS
other S&A expense
depreciation
Interest expense
Pretax income
1000
(500)
(150)
(50)
(100)
200
tax expense (40%)
(80)
Net income
120
NOPAT can be computed either as
1.
2.
EBIT(1- )
net income + interest expense (1- )
NOPAT
if interest expense is 200, not 100?
NOPAT
if interest expense is 0, not 100?
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Properties of NOPAT

Combined income payable to both the debt holders and the
shareholders (the two are often called “capital providers”)

Cannot be affected by the amount of borrowing or borrowing rate.

Further caveats:




Definition of NOPAT can be different for different people.
NOPAT cannot be pulled out from income statement. It needs to be
computed.
NI= (EBIT- Interest expense)*(1-)
EBIT *(1- ) = Net Income + Interest expense*(1- )
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EBIT and NOPAT
Definition for our discussions
______ Income
Financial
assets
?_____
i-free debt
i-bearing debt
______ Income
Operating
assets
OE
Assets
Some authors define NOPAT as one excluding interest income.
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Income statements of CVS & Walgreens
Dec-07
Aug-07
Sales (Net)
76,329.5
53,762.0
Cost of Goods Sold
60,221.8
38,518.1
Gross Profit
16,107.7
15,243.9
Selling, General, & Admin Expenses
10,219.8
11,417.3
Operating Income Before Depreciation
5,887.9
3,826.6
Depreciation, Depletion, & Amortization
1,094.6
675.9
Operating Income After Depreciation
4,793.3
3,150.7
468.3
0.0
33.7
38.4
0.0
0.0
Pretax Income
4,358.7
3,189.1
Income Taxes - Total
1,721.7
1,147.8
0.0
0.0
2,637.0
2,041.3
Extraordinary Items
0.0
0.0
Discontinued Operations
0.0
0.0
2,637.0
2,041.3
Fiscal Year Ending
Interest Expense
Non-Operating Income/Expense
Special Items
Minority Interest
Income Before Extraordinary Items & Discontinued Op.
Net Income (Loss)
NOPAT? ______________ using reported tax rate
NOPAT? ______________ using “normal” tax rate
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