Financial

Statements
Analysis, and
Projection
Balance Sheet: Assets

Cash
A/R
Inventories
Total CA
Gross FA
Less: Dep.
Net FA
Total Assets
2005
$ 15.0
180.0
270.0
$ 465.0
680.0
(300.0)
380.0
$845.0
2004
$40.0
160.0
200.0
400.0
600.0
(250.0)
350.0
$750.0
Balance sheet:
Liabilities and Equity

Accts payable
Notes payable
Accruals
Total Current Liabilities
Long-term debt
Total Liabilities
Common stock
Retained earnings
Total Equity
Total Liabilities & Equity
2005
$30.0
40.0
60.0
$130.0
300.0
$430.0
130.0
285.0
$415.0
$845.0
2004
15.0
35.0
55.0
$105.0
255.0
$360.0
130.0
260.0
$390.0
750.0
Income statement

Sales
COGS
Other expenses
EBITDA
Depr. & Amort.
EBIT
Interest Exp.
Taxable income
Taxes (40%)
Net income
Common Dividends
2005
$1500.0
(1,230.0)
(90.0)
180.0
(50.0)
$130.0
(40.0)
$90.0
(36.0)
$ 54.0
(29.0)
2004
$1435.0
(1,176.7)
(85.5)
173.3
(40.0)
133.3
(35.0)
$98.3
(39.3)
$59.0
(27.0)
Other data

Shares outstanding
EPS
DPS
Stock price
2005
25 million
$2.16
$1.16
$25.00

2004
25 million
$2.36
$1.08
$23.00
Statement of Retained Earnings
(2005)
Balance of retained
earnings, 12/31/04
Add: Net income, 2005
Less: Dividends paid
Balance of retained
earnings, 12/31/05
$260
54
(29)

$285

Methods of Ratio analysis
Bench mark analysis
Time series analysis
Cross section analysis
What are the five major categories of ratios, and
what questions do they answer?
Liquidity: Can we make required payments?
Asset management: right amount of assets vs.
sales?
Debt management: Right mix of debt and
equity?
Profitability: Do sales prices exceed unit costs,
and are sales high enough as reflected in PM,
ROE, and ROA?
Market value: Do investors like what they see
as reflected in P/E and M/B ratios?
Ratio analysis
Ratio 2005 2004 Industry Comment
1. Current 3.6 3.8 4.1
More funds available for
investment
2. Quick 1.5 1.9 2.1 Do
3. Inventory
Turnover.
4.6x 5.9x 7.4x Inventory piled up
4. DSO
(receivable/daily
sales)
43.2 40.7 32.0 Aggressive sales campaign
5. FA TO 3.9x 4.1x 4.0x Sales slowed down
6. TA TO 1.8x 1.9x 2.0x Do
7. Debt Ratio
Total debt/assets
50.9% 48% 45% High gearing of EPS
expected
8. TIE 3.3 x 3.8x 6.5x If profit is certain then OK
Ratio analysis (Contd..)
Ratio 2005 2004 Industry Comment
9. Profit
Margin
(54/1500)
3.6%
(59/1435)
4.1%
4.7%
Inventory procurement
reduced Profit
10. ROA
(54/845)
6.4%
(59/750)
7.87%
9.5%
Both fixed assets and
inventory procured
11. ROE
(54/415)
13.0%
(59/390)
15.1%
17.2%
Equity base has gone up
12. Market:
Book ratio
($25/$16.6)
=1.5 x
($23/$15.6)
=1.7x
2.0 Investors like the strategy,
price of share has gone up
13. P:E ratio
$25/$2.16
=11.6x
$23/$2.36
=9.7x
13.0x Trust of investors has gone
up.
The Sustainable Growth Rate in Sales
)) 1 ( ) 1 ( (
) 1 ( ) 1 (
E
D
d p T
E
D
d p
g
s
+
+
=
064 . 0
)
285 130
300 130
1 ( * )
54
29
1 ( *
1500
54
1500
845
)
285 130
300 130
1 ( * )
54
29
1 ( *
1500
54
=
(

+
+
+
+
+
+
=
s
g
T =Ratio of total assets to sales
p =Net profit margin on sales
d =dividend payout ratio
Forecasting with different g
Current
Current
year
(2005)
Next year
2006 gs
following
year
2007 gs
following
year 2008
gs
next year
g=20%
Contextual next
year
Sales 1500 1596. 1698. 1807.43 1800 1597
Net Income 54 57.46 61.14 65.06 64.8 81
Dividend (Current 29/54) 29 30.85 32.84 34.94 34.80 43.50
Addition to retained earnings 25 26.60 28.31 30.12 30.00 37.50
Total assets 845 899.2 956.8 1018.1 1014 870
Total Debt 430 457.5 486.8 518.10 516 458
Common stock 130 130 130. 130.00 130 130
Retained earnings 285 311. 339.9 370.03 315.0 322.50
Total Financing 845 899.1 956.8 1018.14 961.0 910.50
Funds needed 0 -0.001 0.00 0.00 53.00 -40.50
Debt: Equity ratio 1.04 1.04 1.04 1.04 1.28 .92
Sustainable Growth Rate 0.0641 0.064 0.064 0.064 0.072 0.095
12
Notes:
With a single growth rate of sales, as well as, of all the
cost and current liability and long term liability there
remains following constraints:
Higher growth of sales is not sustainable
Floatation of new shares is not a variable
Addition to retained earnings depends on net income
as well as payout ratio
Assets would be automatically financed by sales at the
sustainable growth rate. So leverage remains constant.
To finance assets needed for higher growth of sales,
External Funds Needed (EFN) should be identified that
often raises further debt and increases the Debt:
Equity ratio. So leverage can not be constant.
At any other rates of growth of sales, if leverage is
constant then dividend policy can not be fixed.
Increasing the Sustainable
Growth Rate
A firm can do several things to increase its
sustainable growth rate:
Sell new shares of stock
Increase its reliance on debt
Reduce its dividend-payout ratio
Increase profit margins
Decrease its asset-requirement ratio
Contextual Forecasting: Since the firm piled up inventories and fixed assets, we suppose,
the firm is already prepared to finance higher sales in the next year. So, we keep these
away from growth. Assume: g
s
=6.5%. Does this explain increase in share price?
Sales 1597
COGS (only 50% of direct cost follows growth)
[{(1230/2)+90+50+40)}*1.065]+[1230/2] 1462
Taxable income 135
Net Income 81
Dividends 43
Addition to Retained earnings 38
Current assets (without increase in inventories) 478
Fixed assets (Only half of Fixed assets has increased) 392
Total assets 870
Total debt 458
Equity (Common stock +Retained Earnings) 453
Total financing 910
Funds needed (This is negative debt or lending) -40
Debt: Equity 0.92
Growth 0.094520
Comment on contextual analysis
The firm is better prepared for growth of
sales in the next year by means of higher
acquisition of inventory and fixed assets.
This may results in higher income of $81m.
against the normal income of $57m. for the
next year. Sustainable growth rate of the
firm would increase to 9.5% from the next
year against the current one of 6.5%. This
may be known to investors and might be
the reason for increased share price.
Prediction of Distress and Turnaround
Models for distress prediction
Several models to predict distress have been developed over the
years. One of the more popular and robust models is the
Altmans Z-score model:







Bankruptcy prediction when Z is less than 1.2,
Z within the range between 1.2 and 2.9 is gray area.
Z above 3 is safe.
Calculation of Z score
X1 Net working
capital/Total assets
(465-130)/845

0.4 (400-105)/750 0.39
X2 Cumulative retained
earnings/Total
assets
285/845 0.34 260/750 0.35
X3 EBIT/Total Assets 130/845 0.15 133/750 0.18
X4 Market value of equity/
Total liabilities
(25*25)/ (845-415) 1.45 (25*23)/(750-390) 1.6
X5 Sales/Total Assets 1500/845 1.78 1435/750 1.91
Z2005=(1.2*0.4)+(1.4*0.34)+(3.3*0.15)+(0.6*1.45)+(1.78)=3.4
Z2004=(1.2*0.39)+(1.4*0.35)+(3.3*0.18)+(0.6*1.6)+(1.91)=4.4
Comment: The firm is safe. The score decreased in 2005 against 2004.
The investors had not taken that under consideration as the scores
are above the hurdle of 3 and so stock price has rather gone up.
Problem 2:
Off-balance sheet financing
Income Statements
Figures in million taka
2009 2008
Sales 1870 1500
COGS -970 -900
Gross Profit 900 600
Fixed operating exp. -350 -300
Depreciation -120 -80
EBIT 430 220
Interest -100 -30
EBT 330 190
Tax (30%) -99 -57
Net income 231 133
Other information
Net income for common stockholders
(Tk in million) 231 133
Common dividends (Tk in million) 100 80
Addition to retained earnings (Tk in million) 131 53
Book value per share (Tk) 1,368 1,106
EPS (Tk) 462 266
DPS (Tk) 200 160
Market price per share (Tk) 990 1,020
Question: Share price has gone down, although sales
increased, net income (EPS) increased, DPS increased,
retention and equity increased. Why?
Balance Sheet: Assets
Assets 2009 2008 Revised (2009)
Cash 65 45 65
Accounts receivable 170 100 170
Inventory 150 70 150
Total current assets 385 215 385
Gross plant and equipment 1000 705 1450
Accumulated depreciation -240 -120 -240
Net Plant & Equipment 760 585 1180
Total assets 1145 800 1595
Increased gross plant and equipment is just equal to the
amount of off-balance sheet financing (see next slide).
Depreciation assumed same for simplification of calculation.
Balance Sheet: Liabilities & Equity
Liabilities 2009 2008 Revised (09)
Accounts payable 155 90 155
Accruals 43 27 43
Notes payable 33 30 33
Total current liability 231 147 231
Long term bond 230 100 680
Total liabilities 461 247 881
Common stock (500,000) 500 500 500
Retained earnings 184 53 184
Owners' equity 684 553 684
Total liability & equity 1145 800 1565
Revised long term debt: i=12%. Interest increased by 70 refers to new debt
of 583. Out of that, B/S increase of debt is 133, i.e., (33+230)-(30+100). Rest
of the increase in debt might be the off-balance sheet financing like 450=
(583-133).
Calculation of Z- Score
2009 2008
Revised
2009
X1 Net working capital/Total assets 0.13 0.09 0.10
X2 Cumulative retained earnings/Total assets 0.16 0.07 0.12
X3 EBIT/Total Assets 0.38 0.28 0.27
X4 Market value of equity/ Total liabilities 1.07 2.07 0.54
X5 Sales/Total Assets 1.63 1.88 1.17
Z Score 3.489 3.71 2.40
Comment on Financial Distress: The firm is in financial distress as Z-
score is below 3 if off-balance sheet financing is converted in to debt
financing. Investors can not be fooled by that. Hence, price has gone
down as the firm goes through distress although sales, income, EPS,
DPS, equity increased.
Problem 3: Capital Investment
Decision: (SEC)
Solar Electronics Corporation (SEC) has recently
developed the technology for solar powered jet engines.
Cost of capital is 15%.The investment will cost $1500
million. Production will occur over the next 5 years.
Annual sales would be 30% of the market of 10,000.
Sales price is $2 million per unit and variable costs are $1
million per unit. Fixed costs estimated are $1,791 million.
The following table represents other possibilities as well.
Find out the NPVs under different situation.
The current market price per share is $645. Number of
shares outstanding are 150 million. The firm holds a
growth rate of 3% annually. What would be the your
prediction of share price of the next year assuming the
project is accepted and expected scenario prevails?
Pessimistic Expected Optimistic
Market size 5,000 10,000 20,000
Market share 20% 30% 50%
Price (in million dollar) 1.9 2 2.2
Variable cost in $m (per plane) 1.2 1 0.8
Fixed cost (per year) $m 1891 1791 1741
Investment $m 1900 1500 1000
Ke 12% 15% 17%
NPV
Market size -1802 1517 $8,154
Market share -695 1517 5942
Price (in million dollar) 853 1517 2844
Variable cost in $m(per plane) 189 1517 2844
Fixed cost (per year) $m 1,295 1517 1627
Investment $m 1208 1517 1903
Ke 1744 1517 1379
Problem 3: Scenario Analysis
Worksheet: Problem 3
Y
0
Y
1-5
Investment -1500
Sales (No) 3000
Revenue 6000
TVC -3000
FC -1791
Depreciation -300
Pretax Profit 909
Tax (.34) 309.06
Net profit 599.94
Annual Cash Inflow 899.94
PVIFA (i=.15,n=5) 3.352155
PV (Cash Inflow) 3017
NPV 1517
Prediction of share price
Current market capitalization in million
dollar 645*150 96,750
Market capitalization of the next year
assuming 3% growth 96750*1.03 99652.5
Market capitalization including the
project 99652.5+1517 101169.5
Share price of the next year in dollar 101169.5/150 674.46