1. Accounting for Financial Management
Chapter 6
Accounting for Financial Management

2. Topics covered Income statement Balance sheet Statement of cash flows
Free cash flow
ROIC, MVA and EVA

3. Balance Sheets Figure 6-1 Cash equivalent vs. short-term investments
Common equity (net worth)
total asset – liability – preferred stocks

4. Income Statement
Figure 6-2
EBITDA

5. Statement of Cash Flows
Figure 6-4

6. Cash flows from operating activities
FI Corporate Finance Leng Ling
Cash flows from operating activities
IS means Income Statement
Net income +
Depreciation
Decrease in any asset account related to IS -
Increase in any asset account related to IS
Decrease in any liability account related to IS
Increase in any liability account related to IS =
Net cash flow from operating activities

7. Cash flows from operating activities
Asset accounts related:
Accounts receivable
Inventories
Liability accounts related:
Accounts payable
Accruals

8. Cash flows from investing activities
Buying or selling productive assets (plant & equipment)
Buying or selling financial securities that expire after 1 year (e.g., stock of other companies, bonds)

9. Useful equation when compute cash flows from investing activities
FI Corporate Finance Leng Ling
Useful equation when compute cash flows from investing activities
Change in gross fixed assets
= change in net fixed assets + depreciation

10. Cash flows from financing activities
Loans from creditors (long-term, short-term)
Repayment of principal
Sale or repurchase of stock (common or preferred) from firm’s equity holders
Payment of dividends

11. Net Cash Flow Net cash flow=
Net income + Depreciation and amortization

12. What is free cash flow (FCF)?
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 company’s value depends on the amount of FCF it can generate.

13. Calculating Free Cash Flow in 5 Easy Steps
Earning before interest and taxes
Operating current assets X
(1 − Tax rate) −
Operating current liabilities
Net operating profit after taxes
Net operating working capital
Step 3
Net operating working capital +
Operating long-term assets
Total net operating capital
Step 5
Figure 2-1 in FM13
Step 4
Net operating profit after taxes
Total net operating capital this year −
Net investment in operating capital −
Total net operating capital last year
Net investment in operating capital
Free cash flow

14. Step 1: Net Operating Profit after Taxes (NOPAT)
NOPAT = EBIT(1 - Tax rate)
NOPAT15 = $500( )
= $300

15. Step 2: Net Operating Working Capital (NOWC)=
Operating CA CL
NOWC
NOWC15 = ($50 + $500 + $1000) - ($200 + $300)
= $1,050
NOWC14 = $790

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

17. 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.

18. Step 3:Total net operating capital (operating capital)
Operating Capital= NOWC + Net fixed assets
Operating Capital 2015 = $ $2000 = $3,050
Operating Capital 2014 = $2,490

19. Step 4 and step 5
(6-8)
FCF = NOPAT - Net investment in operating capital
= $300 - ($ $2490)
= $300 - $560
= -$260
(6-9)
FCF = ($300+$200)-$500-($1050-$790)
= $-260

20. Five uses of FCF 1. Pay interest on debt.
2. Pay back principal on debt.
3. Pay dividends.
4. Buy back stock (repurchase).
5. Buy nonoperating assets (e.g., marketable securities, investments in other companies, etc.)

21. Uses of FCF After-tax interest payment = $72
Reduction (increase) in debt =
−$350
Payment of dividends =
$58
Repurchase (Issue) stock = $0
Purch. (Sale) of ST investments =
−$40
Total uses of FCF =
−$260

22. Return on Invested Capital (ROIC)
ROIC = NOPAT / operating capital
ROIC15 = $300 / $3050 = 9.84%.
9.84% <11% (WACC)

23. Did the growth add value?
No. The ROIC is less than the WACC. Investors did not get the return they require.
Note: High growth usually causes negative FCF (due to investment in capital), but that’s ok if ROIC > WACC.

24. Economic Value Added (EVA)
EVA = NOPAT- (WACC)(Operating Capital)
=(Operating Capital)(ROIC) - (WACC)(Operating Capital)
= (Operating Capital)(ROIC-WACC)

25. Economic Value Added EVA = NOPAT- (WACC)(Operating Capital)
= $300 - $335.5
= -$35.5

26. Market Value Added (MVA)
MVA = Market Value of the Firm - Book Value of the Firm
Market Value = (# shares of stock)(price per share) + Market Value of debt
Book Value = Total common equity + Book Value of debt

27. MVA (Continued)
If the market value of debt is close to the book value of debt, then:
MVA = Market value of equity – Book value of equity

28. 2015 MVA for MicroDrive Market Value of Equity 2015:
(50)($27) = $1350.
Book Value of Equity 2015:
$1470.
MVA15 = $ $1470 = -$120

29. MVA vs. EVA EVA is the measure typically used to evaluate the manager.
EVA shows the value added during a given year, while MVA reflects performance over the company’s entire life.
EVA can be applied to individual divisions, whereas MVA applied to the entire firm.

30. Assignment Review slides of Chapter 2 from FINC3131
Chapter 6 problems: 3,4,5,6,10,12,14,15.