1. 1 FINANCIAL ANALYSIS 1. Financial Statement Analysis 2. Common Size Statement Analysis 3. Ratio Analysis 4. Sources/ Uses of Funds 5. Statement of Cash Flow 6. Free Cash Flow, MVA, EVA

2. 2 Table 3-1 Allied Food Products: December 31 Balance Sheets ($ Millions) ASSETS 2005 2004 LIABILITIES & EQUITY 2005 2004 Cash & equivalents $ 10 $ 80 Accounts payable$ 60 $ 30 Notes payable 110 60 Accounts receivable 375 315 Accruals 140 130 Inventories 615 415 Total current liabilities $ 310 $ 220 Total current assets $1,000 810 Long-term bonds 750 580 Net plant & Total debt $1,060 $ 800 equipment 1,000 870 Common stock (50,000,000 shares) 130 130 Retained earnings 810 750 Total common equity$ 940 $ 880 Total assets $2,000 $1,680 Total liabilities & equity $2,000 $1,680

3. 3 Table 3-2 Allied Food Products: Income Statements for Years Ending December 31 ($ Millions, except for per-share data) 2005 2004 Net sales $ 3,000.0 $ 2,850.0 Operating costs except depreciation 2,616.2 2,497.0 Earnings before interest, taxes, and depreciation (EBITDA) $ 383.8 $ 353.0 Depreciation 100.0 90.0 Earnings before interest & taxes (EBIT) $ 283.8 $ 263.0 Less interest 88.0 60.0 Earnings before taxes (EBT) $ 195.8 $ 203.0 Taxes (40%) 78.3 81.2 Net income $ 117.5 $ 121.8 Common dividends $ 57.5 $ 53.0 Addition to retained earnings $ 60.0 $ 68.8 Per-share data: Common stock price $ 23.00 $ 26.00 Earnings per share (EPS) a $ 2.35 $ 2.44 Dividends per share (DPS) a $ 1.15 $ 1.06 Book value per share (BVPS) a $ 18.80 $ 17.60 Cash flow per share (CFPS) a $ 4.35 $ 4.24

4. 4 Table 3-2 Allied Food Products: Income Statements for years ending December 31 ($ Millions, except for per-share data) a There are 50,000,000 shares of common stock outstanding. Note that EPS is based on earnings after preferred dividends - that is, on net income available to common stockholders. Calculations of EPS, DPS, and BVPS for 2004 are as follows: EPS = Net income = $117,500,000 = $2.35 Common shares outstanding 50,000,000 DPS = Dividends paid to common stockholders = $57,500,000 = $1.15 Common shares outstanding 50,000,000 BVPS = Total common equity = $940,000,000 = $18.80 Common shares outstanding 50,000,000 CFPS = Net income + Depreciation + Amortization = $217,500,000 = $4.35 Common shares outstanding 50,000,000 =

5. 5 Table 3-4 Allied Food Products: Statement of Retained Earnings for year ending December 31, 2005($ Millions) Balance of retained earnings, Dec 31, 2004 $ 750.0 Add: Net income, 2005 117.5 Less: Dividends to common stockholders (57.5) a Balance of retained earnings, Dec 31, 2005$ 810.0 a Here, and throughout the book, parentheses are used to denote negative numbers.

6. 6 Income Statement Common Size Analysis % of Sales Ind. ave Net sales $ 3,000 100 % Costs excluding depreciation 2,616. 2 87. 2 62 % Depreciation 100 3. 3 8 Total operating costs 2,716. 2 90. 5 % 70 % Net Operating Income, or Earnings before interest and taxes (EBIT) $ 283. 8 9. 5 % 30 % Less interest expense 88 2. 9 5 Earnings before taxes (EBT) $ 195. 8 6. 5 22 Taxes ( 40% ) 78. 3 2. 6 4 Net Income available to C. S. 117. 5 3. 9 18 Common Dividends 57. 5 1. 9 8 Add. to Retained Earnings 60 2. 0 9

7. 7 Balance Sheet Common Size Analysis % of Total Assets Ind. Ave. Comment Cash / Securities $10 0. 50 % 10% very low Accounts Receivable 37518. 75 15 OK Inventories 61530. 75 40 low Total Current Assets $1,00050 % 65 % low, risky Net Plant & Equip. 1,00050 45 OK Total Assets $2,000 100 % Accounts payable $ 60 3 % 7 OK Notes payable 1105. 5 4 slightly high Accruals 1407 10 slightly low Total Current Lia. $31015. 5 % 21 low Long-term Bonds 75037. 5 22 high Total Debt 1,060 53% 43 high Common stock 130 6. 5 15 low Retained earnings 81040. 5 40 OK Total Common Equity $940 47% 65 low Total Lia. & Equity $2,000100%

8. 8 Allied Food Products: Summary of Financial Ratios ($ Millions) Ind. Ratio Formula Calculations Ratio Avg Comment Liquidity Current Current assets $1,000 = 3.2x 4.2x Poor Current liabilities $310 Quick, or Current assets - Inventories $385 = 1.2x 2.2x Poor acid test Current liabilities $310

9. 9 Allied Food Products: Summary of Financial Ratios ($ Millions) Ind. Ratio Formula Calculations Ratio Avg Comment Asset Management Inventory Sales $3,000 = 4.9x 10.9x Poor turnover Inventories $615 Days sales Receivables $375 = 46 days 36 days Poor outstanding (DSO) Annual sales/365 $8.22 Fixed assets Sales $3,000 = 3.0x 2.8x O.K. turnover Net fixed assets $1,000 Total assets Sales $3,000 = 1.5x 1.8x Somewhat turnover Total assets $2,000 low

10. 10 Allied Food Products: Summary of Financial Ratios ($ Millions) Ind. Ratio Formula Calculations Ratio Avg Comment Debt Management Total debt to Total debts $1,060 = 53% 40.0% High total assets Total assets $2,000 (risky) Times-interest Earnings before interest & taxes (EBIT) $283.8 = 3.2x 6.0x Low earned (TIE) Interest charges $88 (risky) EBITDA EBITDA + Lease payments $383.8 + $28 coverage I nterest + Principal + Lease $88 + $20 + $28 charges payments payments $411.8 = 3.0 x 4.3x Low $136 (risky)

11. 11 Allied Food Products: Summary of Financial Ratios ($ Millions) Ind. Ratio Formula Calculations Ratio Avg Comment Profitability Profit margin Net income available to common stockholders $117.5 = 3.9% 5.0% Poor on sales Sales $3,000 Basic earning Earnings before interest & taxes (EBIT) $283.8 = 14.2% 18% Poor power (BEP) Total assets $2,000 Return on total Net income available to common stockholders $117.5 = 5.9% 9.0% Poor assets (ROA) Total assets $2,000 Return on Net income available to common stockholders $117.5 = 12.5% 15% Poor common equity Common equity $940 (ROE)

12. 12 Allied Food Products: Summary of Financial Ratios ($ Millions) Ind. Ratio Formula Calculations Ratio Avg Comment Market Value Price/earnings Price per share $23.00 = 9.8x 11.3x Low (P/E) Earnings per share $2.35 Price/cash flow Price per share $23.00 = 5.3x 5.4x Low Cash flow per share $4.35 Market/book Market price per share $23.00 = 1.2x 1.7x Low (M/B) Book value per share $18.80

13. 13 Allied Food Products: Summary of Financial Ratios ($ Millions) Ratio Formula Other Ratios Dividend payout ratio : Div. = $57.5 = 48.9% N I $117.5 Retention ratio: 1 - payout ratio = 1 – 48.9% = 51.1% or Retained earnings = $60 = 51.1% N I $117.5

14. 14 Du Pont Analysis (Allied Food Products) ROE = Profit x Total assets x Equity margin turnover multiplier NI = NI x Sales x TA Equity Sales TA Equity Firm: 12.5% = 3.9% x 1.5 x 2.13 Industry: 15.0% = 5.0% x 1.8 x 1.67

15. 15 Allied Food Products: Changes in Balance Sheet Accounts During 2005 ($ Millions) CHANGE 12/31/05 12/31/04 Sources Uses Cash & marketable securities$ 10$ 80$ 70 Accounts receivable 375 315$ 60 Inventories 615 415 200 Gross plant & equipment 1,500 1,270 230 Less Accum. Depreciation (500) (400) 100 Net plant & equipment 1,000 870 Accounts payable 60 30 30 Notes payable 110 60 50 Accruals 140 130 10 Long-term bonds 750 580 170 Common stock 130 130 Retained earnings 810 750 60 Totals $490 $490

16. 16 Allied Food Products: Statement of Cash Flows for 2005 ($ Millions) OPERATING ACTIVITIES Net income$117.5 Additions (Sources of Cash) Depreciation a 100.0 Increase in accounts payable 30.0 Increase in accruals 10.0 Subtractions (Uses of Cash) Increase in accounts receivable (60.0) Increase in inventories (200.0) Net cash provided by operating activities ($ 2.5) LONG-TERM INVESTING ACTIVITIES Cash used to acquire fixed assets b ($230.0) FINANCING ACTIVITIES Increase in notes payable$ 50.0 Increase in bonds 170.0 Payment of common dividends (57.5) Net cash provided by financing activities$ 162.5 Net decrease in cash & marketable securities($ 70.0) Cash & securities at beginning of year 80.0 Cash & securities at end of year $ 10.0

17. 17 Allied Food Products: Statement of Cash Flows for 2005 ($ Millions) a Depreciation is a non-cash expense that was deducted when calculating net income. It must be added back to show the correct cash flow from operations. b The net increase in fixed assets is $130 million; however, this net amount is after a deduction for the year’s depreciation expense. Depreciation expense should be added back to show the increase in gross fixed assets. From the company’s income statement, we see that 2004 depreciation expense is $100 million; thus, the acquisition of fixed assets equals $230 million.

18. 18 Stock Markets and Stock Reporting I. Stock markets A. New York stock exchange (NYSE) B. American stock exchange (AMEX) C. Over-the-counter (OTC) markets D. Smaller regional markets Ii. Stock market reporting 52 weeks Yld. P-E sales net High low stock div. % Ratio 100s high low close chg. 175 7/8 102 IBM 4.40 3.8 16 27989 118 1/4 115 1/4 117 1/4 +1 3/4 Dividend yield = D/P = $4.40 / $117.25 = 3.8%

19. 19 Free Cash Flow, MVA, EVA, and Stock Valuation

20. 20 FREE CASH FLOW 2004 2005 CA (Current Asset) 810 1,000 AP (Account Payable) -30 -60 Accruals -130 -140 Total Operating Working Capital (TOWC) 650 800 Net Fixed Asset 870 1,000 Total Operating Capital (TOC) 1,520 1,800 Net Investment in Oper. Cap (NIOC)  280 Depreciation (2002) 100 Gross Investment in Operating Cap (GIOC) 380

21. 21 NET OPERATING PROFIT AFTER TAX (NOPAT): NOPAT = EBIT ( 1 – TAX ) 283.8 (1- 0.4) = 170.3 FREE CASH FLOW CALCULATION: FCF = NOPAT – NIOC = 170.3 - 280 = - 109.7 FCF = NOPAT + Depreciation – GIOC = 170.3 + 100 – 380 = - 109.7 (NOPAT + Depreciation = Operating Cash Flow) FREE CASH FLOW

22. 22 STOCK VALUATION Total Corporation Value = PV (FCF 1 )+PV (FCF 2 )+....+ PV ( FCF n ) + PV (Terminal Value) Where i = WACC Terminal Value = FCF n +1 WACC - g Value of Common Stock Equity = Total Corp. Value – Market Value of Debt – Market Value of Preferred Stock

23. 23 MARKET VALUE ADDED (MVA) MVA measure the effects of managerial actions since the inception of a company MVA = Market Value – Book Value MVA = (Stock Price * No of shares) – Common Stock Equity MVA = ( 23 * 50 mil shares) – 940 MVA = $ 210

24. 24 ECONOMIC VALUE ADDED (EVA) EVA measures the managerial effectiveness in a given year EVA = Net Oper. Profit After Tax- After Tax Dollar Cost of Operating Capital EVA = NOPAT – (Total Operating Capital * WACC) EVA = EBIT (1–T) – (TOC * WACC) EVA = 283.8 (1-0.4) – (1800 * 10%) EVA = 170.3 – 180 EVA = $ - 9.7