Module 3

Profitability Analysis and Interpretation

DISCUSSION QUESTIONS
Q3-! "eturn on in#est$ent $easures profitability in relation to t%e
a$ount of in#est$ent t%at %as been $ade in t%e business! A
&o$pany &an al'ays in&rease dollar profit by in&reasin( t%e
a$ount of in#est$ent )assu$in( it is a profitable in#est$ent*! So+
dollar profits are not ne&essarily a $eanin(ful 'ay to loo, at
finan&ial perfor$an&e! Usin( return on in#est$ent in our analysis+
'%et%er as in#estors or business $ana(ers+ re-uires us to fo&us
not only on t%e in&o$e state$ent+ but also on t%e balan&e s%eet!
Q3-.!
A
In&reasin( le#era(e in&reases "OE as lon( as t%e assets earn a
(reater operatin( return t%an t%e &ost of t%e additional debt!
/inan&ial le#era(e is also related to ris,0 t%e ris, of potential
ban,rupt&y and t%e ris, of in&reased #ariability of profits!
Co$panies $ust+ t%erefore+ balan&e t%e positi#e effe&ts of
finan&ial le#era(e a(ainst t%eir potential ne(ati#e &onse-uen&es! It
is for t%is reason t%at 'e do not 'itness &o$panies entirely
finan&ed 'it% debt!
Q3-3! 1ross profit $ar(ins &an de&line be&ause * t%e industry %as
be&o$e $ore &o$petiti#e+ and2or t%e fir$3s produ&ts %a#e lost
t%eir &o$petiti#e ad#anta(e so t%at t%e &o$pany %as redu&ed
sellin( pri&es or is sellin( fe'er units or .* produ&t &osts %a#e
in&reased+ or 3* t%e sales $i4 %as &%an(ed fro$ %i(%er-
$ar(in2slo'ly turnin( produ&ts to lo'er-$ar(in2%i(%er turnin(
produ&ts! De&linin( (ross profit $ar(ins are usually #ie'ed
ne(ati#ely! On t%e ot%er %and+ &ost in&reases t%at refle&t broader
e&ono$i& e#ents or &ertain strate(i& produ&t $i4 &%an(es $i(%t
not be #ie'ed as ne(ati#ely!
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-1
Q3-5! "edu&in( ad#ertisin( or "6D e4penditures &an in&rease &urrent
operatin( profit at t%e e4pense of t%e lon(-ter$ &o$petiti#e
position of t%e fir$! E4penditures on ad#ertisin( or "6D often
&reate lon(-ter$ e&ono$i& benefits!
Q3-7! Asset turno#er $easures t%e a$ount of re#enue &o$pared 'it%
t%e in#est$ent in an asset! 1enerally spea,in(+ 'e 'ant turno#er
to be %i(%er rat%er t%an lo'er! Turno#er $easures produ&ti#ity
and an i$portant &o$pany ob8e&ti#e is to $a,e assets as
produ&ti#e as possible! 9e&ause turno#er is one of t%e
&o$ponents of "OE )#ia "NOA*+ in&reasin( turno#er in&reases
s%are%older #alue! Turno#er is+ t%erefore+ #ie'ed as a #alue dri#er!
Q3-:! "OE;"NOA i$plies a positi#e return on nonoperatin( a&ti#ities!
T%is results fro$ borro'ed funds bein( in#ested in operatin(
assets '%ose return )"NOA* e4&eeds t%e &ost of borro'in(! In t%is
&ase+ borro'in( $oney in&reases "OE!
Q3-<!
A
On&e a business se($ent %as been sold or desi(nated for sale+ it
is &lassified as a dis&ontinued operation! Conse-uently+ sales and
e4penses related to t%e business se($ent are reported separately+
T%us+ t%e in&o$e state$ent reports in&o$e fro$ &ontinuin(
operations+ dis&ontinued operations+ and net in&o$e )'%i&%
in&ludes bot% &ontinuin( and dis&ontinued operations*! On t%e
balan&e s%eet+ t%e business se($ent3s assets and liabilities are
si$ilarly se(re(ated! 9e&ause t%e business se($ent 'as or 'ill
be sold+ it no lon(er &ontributes to t%e operatin( a&ti#ities of t%e
&o$pany! One of t%e pri$ary uses of finan&ial infor$ation is to
pro8e&t future finan&ial results so t%at in#estors and ot%ers &an
properly pri&e t%e &o$pany3s se&urities and e#aluate strate(i&
plans! T%e dis&ontinued operations 'ill not affe&t future results
)ot%er t%an #ia in#est$ent of t%e pro&eeds fro$ t%e sale*+ and+
t%erefore+ s%ould not be &onsidered as a &o$ponent of operatin(
a&ti#ities!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-2
Q3-=! T%e interest ta4 s%ield arises be&ause interest e4pense is
dedu&tible for ta4 purposes! T%us+ interest e4pense >s%ields?
in&o$e fro$ ta4es by redu&in( ta4able in&o$e! T%e after-ta4 &ost
of interest is+ t%erefore+ t%e preta4 &ost $ultiplied by $inus t%e
appropriate ta4 rate )typi&ally t%e su$ of t%e federal and state ta4
rates*!
Q3-@! T%e >net? in net operatin( assets+ $eans operatin( assets >net? of
operatin( liabilities! T%is nettin( re&o(niAes t%at a portion of t%e
&osts of operatin( assets is funded by t%ird parties! /or e4a$ple+
payables and a&&rued e4penses %elp fund in#entories+ 'a(es+
utilities+ and ot%er operatin( &osts! Si$ilarly+ lon(-ter$ operatin(
liabilities also %elp fund t%e &ost of lon(-ter$ operatin( assets!
T%us+ t%ese lon(-ter$ operatin( liabilities are dedu&ted fro$ lon(-
ter$ operatin( assets!
Q3-B! Co$panies $ust $ana(e bot% t%e in&o$e state$ent and t%e
balan&e s%eet in order to $a4i$iAe "NOA! T%is is i$portant+ as
too often $ana(ers loo, only to t%e in&o$e state$ent and do not
fully appre&iate t%e #alue added by effe&ti#e balan&e s%eet
$ana(e$ent! T%e disa((re(ation of "NOA into its profit and
turno#er &o$ponents fo&uses analysis on bot% of t%ese areas!
Q3-! T%ere are an infinite nu$ber of possible &o$binations of profit
$ar(in and asset turno#er t%at 'ill yield a (i#en le#el of "NOA!
T%e relati#e 'ei(%tin( of profit $ar(in and asset turno#er is dri#en
in lar(e part by t%e &o$pany3s business $odel! As a result+ sin&e
&o$panies in an industry tend to adopt si$ilar business $odels+
industries 'ill (enerally trend to'ard points alon( t%e
$ar(in2turno#er &ontinuu$!
Q3-.! Ci-uidity refers to &as%0 %o' $u&% &as% a &o$pany %as+ %o'
$u&% &as% is &o$in( in t%e door+ and %o' $u&% &as% &an be
raised -ui&,ly! Co$panies $ust (enerate &as% in order to pay
t%eir debts+ pay t%eir e$ployees+ and pro#ide t%eir s%are%olders a
return on in#est$ent! Cas% is+ t%erefore+ &riti&al to a &o$pany3s
sur#i#al!
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-3
Q3-3! "atio analysis uses t%e balan&e s%eet+ in&o$e state$ent and
state$ent of &as% flo's! It is+ t%erefore+ dependent on t%e -uality
of t%ose state$ents! Differen&es in t%e appli&ation of 1AAP a&ross
&o$panies or 'it%in t%e sa$e &o$pany a&ross ti$e &an affe&t t%e
reliability of t%e analysis! Ci$itations of 1AAP itself )e!(!+
i$$ediate e4pensin( of "6D+ non-re&o(nition of assets t%at
&annot be reliably $easured* and differen&es in t%e $a,eup of t%e
&o$pany )e!(!+ types of produ&ts or industries in '%i&% t%e
&o$pany &o$petes* &an also affe&t t%e usefulness of ratio
analysis!
Q3-5!
A
Net nonoperatin( obli(ations )NNO* &onsist of t%e e4&ess of
)interest-bearin(* debt o#er in#est$ents in nonoperatin( assets!
Net nonoperatin( obli(ations &an be eit%er positi#e )e4&ess of
debt* or ne(ati#e )e4&ess of in#est$ents*! Net nonoperatin(
e4pense )NNE* is t%e e4&ess of NOPAT o#er net in&o$e! Net
nonoperatin( e4pense &an also be positi#e )nonoperatin(
e4penses e4&eed nonoperatin( in&o$e* or ne(ati#e! If a &o$pany
reports non&ontrollin( interest+ 'e ad8ust NNO by addin( t%e
non&ontrollin( interest reported on t%e balan&e s%eet+ and 'e
ad8ust NNE by addin( t%e non&ontrollin( interest reported on t%e
in&o$e state$ent!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-$
MINI EDE"CISES
M3-7 )7 $inutes*
)E $illions*
NOA .BB= F E5B+.7 - E757 - )EB+.. - E+B5.* - E.+37 - .<. F E.=+B@3
%ote& In t%e absen&e of infor$ation about >ot%er? &urrent and lon(-ter$ assets and liabilities+ 'e
assu$e t%at t%ese >ot%er? assets and liabilities are operatin( in nature!
M3-: )7 $inutes*
)E $illions*
Tar(et3s net operatin( profit be'ore ta4 F E:<+@@< - E55+:@3 - E7+=5@ - E+::
F E7+=3@!
%ote& Ge treat net &redit &ard re#enues+ and t%e related &redit &ard e4pense+ as operatin( be&ause
Tar(et $aintains its o'n proprietary &redit &ard to support in-store sales! T%e assu$ption+ t%en+
is t%at t%e &redit &ard operations are an inte(ral part of its operatin( a&ti#ities! 1i#en t%is
treat$ent+ t%e a&&ounts re&ei#able relatin( to t%ese &redit &ards is also in&luded as an operatin(
&urrent asset in M3-7!
NOPAT F E7+=3@ H IE+@37 J )E7:: K B!3<*L F E3+:@7!
M3-< ).B $inutes*
)E $illions*
a! "NOA F NOPAT 2 A#era(e net operatin( assets )NOA*
F E:@3 2 I)E3+.@: J E3+3@B*2.L F .B!<3M
b! NOPM F NOPAT 2 "e#enues F E:@3 2 E@+<BB F <!5M
NOAT F Sales 2 A#era(e NOA
F E@+<BB 2 I)E3+.@: J E3+3@B*2.L F .!@B
"NOA F NOPM K NOAT F <!5M K .!@B F .B!<M )B!B.M roundin( differen&e*
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-(
M3-= )7 $inutes*
)E $illions*
NOA F E33+:@@ - E:7. - E5< - E+BB= - )E<+@ - E3:* - E5:< - E:3 - E=33
F E..+775
M3-@ )7 $inutes*
)E $illions*
NOPAT F )E5=+=7 - E3+::3 - E.+BB: - E+7=:* - IE+.= J )E33. K B!3<*L
F E.+.@
M3-.B
9
).B $inutes*
)E $illions*
a! "OE F Net in&o$e 2 A#era(e e-uity
F E=5< 2 I)E7+73B J E5+:73*2.L
F :!:5M
b! PM F Net in&o$e 2 Sales F E=5< 2 E.7+BB3 F 3!3@M
AT F Sales 2 A#era(e assets F E.7+BB3 2 I)E.B+:3 J E.+3BB*2.L
F !@
/C F A#era(e assets 2 A#era(e e-uity
F I)E.B+:3 J E.+3BB*2.L 2 I)E7+73B J E5+:73*2.L
F 5!.
"OA PM K AT K /C F 3!3@M K !@ K 5!. F :!:.M
)B!B.M roundin( differen&e*
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-)
M3-. )7 $inutes*
)E $illions*
a! AN/ "NOA F E7. 2 I)E+B3. J E+B77* 2 .L F 5!7<M
TND "NOA F E+3:5 2 I)E.+B<. J E+@3<* 2 .L F :=!B7M
b! AN/ NOPM F E 7. 2 E 3+5:@ F 5!3=M
TND NOPM F E+3:5 2 E.+@5. F :!..M
AN/ NOAT F E 3+5:@ 2 I)E+B3. J E+B77* 2 .L F 3!3.
TND NOAT F E.+@5. 2 I)E.+B<. J E+@3<* 2 .L F B!@7
AN/ "NOA F 5!3=M K 3!3. F 5!75M )B!B3M roundin( differen&e*
TND "NOA F :!..M K B!@7 F :=!M )B!B:M roundin( differen&e*
&! TND3s "NOA is 5!< ti$es t%at of AN/! TND+ despite operatin( in t%e #alue-
pri&ed se($ent of its industry+ reports a %i(%er NOPM t%an does AN/!
As is typi&al of #alue-pri&ed retailers+ TND3s asset turno#er is %i(%0
NOAT is o#er 3 ti$es t%at of AN/3s! On balan&e+ TND3s business $odel
appears to be $ore su&&essful in .B in t%at t%e &o$pany is able to
$aintain bot% a %i(% NOPM and a %i(% NOAT relati#e to AN/+ resultin( in
a "NOA t%at is &onsiderably (reater t%an AN/3s in t%is year!
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-*
M3-.. )7 $inutes*
)E $illions*
a! .BB total liabilities-to-e-uity F E33+B@3 2 E=:+@. F !73
.BB@ total liabilities-to-e-uity F E5.+<:5 2 E=5+53 F !<B
OeriAon3s total liabilities-to-e-uity ratio %as de&lined so$e'%at+ and is
less t%an t%e !:< a#era(e for &o$panies in t%e tele&o$$uni&ations
industry in .BB!
b! OeriAon is &arryin( a si(nifi&ant a$ount of debt! Alt%ou(% its profitability
and operatin( &as% flo' are fairly stron(+ neit%er is parti&ularly %i(% in
relation to t%e &o$pany3s liabilities and interest &osts! T%ere is so$e
-uestion+ t%erefore+ re(ardin( t%e a$ount of additional debt t%at t%e
&o$pany &an ta,e on! 1i#en its si(nifi&ant &apital e4penditure
re-uire$ents and its &urrent debt load+ OeriAon $ay %a#e to fund future
&apital e4penditures 'it% %i(%er-&ost e-uity! And+ to t%e e4tent t%at its
&o$petitors are not as %i(%ly le#era(ed+ t%is $ay ne(ati#ely i$pa&t
OeriAon3s &o$petiti#e position!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-+
M3-.3 )3B $inutes*
a! Po$e Depot .B NOPAT F E7+=3@ - IE+@37 J )E7:: K B!3<*L F E3+:@7
Co'e3s .B NOPAT F E3+7:B - IE+.= J )E33. K B!3<*L F E.+.@
b! Po$e Depot NOPAT as a per&enta(e of sales F E3+:@7 2 E:<+@@< F 7!53M
Co'e3s NOPAT as a per&enta(e of sales F E.+.@ 2 E5=+=7 F 5!77M
M3-.5
9
)37 $inutes*
a!
Profit $ar(in )Net in&o$e 2 Sales* E5+B=7 2 E.:+::. F 7!3.M
Asset turno#er )Sales 2 A#era(e assets* )E.:+::. 2 IE3B+7: J
E.<+.7BL2.* F B!@3
/inan&ial le#era(e )A#era(e assets 2 A#era(e
e-uity*
))E3B+7: J E.<+.7B*2.* 2
))E7+::3 J E.+<:5*2.*
F .!B.
b!
"OE )Net in&o$e 2 A#era(e e-uity* E5+B=7 2 ))E7+::3 J E.+<:5*2.* F
.=!<5M
Confir$ation 7!3.M K B!@3 K .!B. F .=!<=M
)B!B5M roundin( differen&e*
&! Ad8ust$ents to "OA typi&ally fo&us on t%e nu$erator )spe&ifi&ally+
addin( after-ta4 interest e4pense to net in&o$e*! /or 3M+ t%is ad8ust$ent
follo's0
Ad8usted "OA F )E5+B=7 J E:3 K I - B!3<L* 2 )E3B+7: J E.<+.7B*2. F
5!7@M
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-,
EDE"CISES
E3-.7 )3B $inutes*
a!
)E $illions* "NOA
COS!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! E3+<<< 2 I )E5:+3:B J E57+==@* 2 .L F =!@M
Gal(reen!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! E.+57 2 I)[email protected]+5B*2 .L F 5!<:M
b!
)E $illions* NOPM F NOPAT 2 Sales NOAT F Sales 2 A#era(e NOA
COS!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! E3+<<< 2 E@:+53 F [email protected] E@:+53 2 I)E5:+3:B J E57+==@* 2 .L
F .!B@
Gal(reen!!!!!!!!!!!!!!!!!!!!!!! E.+57 2 E:<+5.B F 3!=M E:<+5.B 2 I)E5+@. J E5+5B* 2 .L
F 5!:5
&! Gal(reen3s "NOA is $u&% %i(%er t%an COS3s+ dri#en pri$arily by a
$u&% %i(%er turno#er rate for NOA as its net operatin( profit $ar(in is
less t%an COS3s! T%is e4a$ple %i(%li(%ts t%e i$portan&e of $ana(in(
t%e balan&e s%eet!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-10
E3-.: )3B $inutes*
a!
)E $illions* "NOA
Aber&ro$bie 6 /it&%!!!!!!!!!!!!!!!!!!!!! E 7. 2 I)E+B3. J E+B77* 2 .L F 5!7<M
T%e 1ap+ In&!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! E+@7 2 I)E.+5@ J E.+3=* 2 .L F 7B!57M
b!
)E $illions* NOPM F NOPAT 2 Sales NOATF Sales 2 A#era(e NOA
Aber&ro$bie 6
/it&%!!!!!!!!!!!!!!!!!!!!!!!!!!!
E 7. 2 E 3+5:@
F 5!3=M
E 3+5:@ 2 I)E+B3. J E+B77* 2 .L
F 3!3.
T%e 1ap+ In&!!!!!!!!!!!!!!!!!! E+@7 2 E5+::5
F =!7M
E5+::5 2 I)E.+5@ J E.+3=* 2 .L
F :!@
&! T%e 1AP3s "NOA is $ore t%an t%ree ti$es t%at of A6/! T%is %i(%er
"NOA is t%e result of a $u&% %i(%er net operatin( profit $ar(in and a
$u&% %i(%er net operatin( asset turno#er rate in &o$parison 'it%
Aber&ro$bie 6 /it&% in t%is year!

Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-11
E3-.< )3B $inutes*
a!
)E $illions* "NOA
Nordstro$!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! E:@3 2 I)E3+.@: J E3+3@B* 2 .L F .B!<3M
Ci$ited 9rands!!!!!!!!!!!!!!!!!!!!!!!!!!! E=.: 2 I)E.+=75 J E3+B3* 2 .L F .<!<3M
b!
)E $illions* NOPM F NOPAT 2 Sales NOAT F Sales 2 A#era(e NOA
Nordstro$!!!!!!!!!!!!!!!!!!!!! E:@32E@+<BB
F <!5M
E@+<BB2I)E3+.@: J E3+3@B*2.L
F .!@B
Ci$ited
9rands!!!!!!!!!!!!!!!!!!!!!!!!!!!
E=.:2E@+:3
F =!7@M
E@+:32I)E.+=75 J E3+B3*2.L
F 3!.3
&! T%e Ci$ited 9rands3 %i(%er "NOA is dri#en by bot% a %i(%er net
operatin( profit $ar(in and a %i(%er turno#er of net operatin( assets!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-12
E3-.= )3B $inutes*
-nstructor note& -ntel has ./#0.%/A due to its substantial in1estment in mar2etable securities3
a!
)E $illions*
"OE!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! E+5:5 2 I)E5@+53BJE5+<B5* 2 .L F .7!:M
"NOA!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! E+.7B 2 I)E.=+:7. J E.@+.3.* 2 .L F 3=!=<M
b!
)E $illions* NOPM F NOPAT 2 Sales NOAT F Sales 2 A#era(e NOA
Intel!!!!!!!!!!!!!! E+.7B 2 E53+:.3
F .7!<@M
E53+:.3 2 I)E.=+:7. J E.@+.3.*2.L
F !7
T%e NOPM of .7!<@M $eans t%at Intel earns operatin( profit after all
e4penses+ in&ludin( ta4 of $ore t%an .:Q for e#ery dollar of sales! T%is
is a si(nifi&ant profit $ar(in! T%e NOAT of !7 i$plies t%at t%e &o$pany
(enerates $ore t%an E!7B of sales for ea&% dollar of net operatin(
assets! T%e &o$pany is bot% profitable and produ&ti#e!
&! "NOA is !7K "OE0 3=!=<M 2 .7!:M F !7! Ge &an infer Intel3s
nonoperatin( return by &al&ulatin( t%e differen&e bet'een "OE and
"NOA0 .7!:M - 3=!=<M F -3!<M! A ne(ati#e nonoperatin( return li,ely
o&&urs be&ause Intel %as a substantial a$ount of in#est$ents+ per%aps
in $ar,etable se&urities! T%is is not un&o$$on for t%e %i(%-te&%
industry '%ere &o$panies need to $aintain a (reater le#el of li-uid
assets to ta,e ad#anta(e of opportunities or to respond -ui&,ly to
strate(i& $o#es by &o$petitors! T%is li-uidity re-uire$ent adds a layer
of &osts t%at depresses Intel3s "OE! Anot%er 'ay of t%in,in( of it is t%at
t%e $ar,etable se&urities are earnin( a return t%at3s lo' &o$pared to t%e
return on t%e &o$pany3s operatin( assets!
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-13
E3-.@ )3B $inutes*
a!
)E $illions*
"OE!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! E =5< 2 I)E7+73B J E5+:73* 2 .L F :!:5M
"NOA!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! E+.B@2 I)E+5@JE+::7*2 .L F B!55M
b!
)E $illions* NOPM F NOPAT 2 Sales NOAT F Sales 2 A#era(e NOA
Ma&y3s!!!!!!!!! E+.B@ 2 E.7+BB3
F 5!=5M
E.7+BB32 I)E+5@JE+::7*2.L
F .!:
Ma&y3s NOPM is %i(%er and its NOAT is lo'er t%an t%e $edians for
apparel retailers of 5!5:M and .!=+ respe&ti#ely )see e4%ibit 5!5*! Its
"NOA is belo' t%e $edian for apparel retailers of .!33M!
&! T%e ratio of "NOA to "OE is :3M )B!55M2:!:5M*! Ma&y3s debt is
finan&in( assets t%at earn a return in e4&ess of t%e &ost of debt+ t%us
i$pro#in( t%e returns to s%are%olders! In t%is &ase+ finan&ial le#era(e is
in&reasin( t%e return to s%are%olders! Ge &an &o$pute t%e
nonoperatin( return as follo's0 "OE H "NOA F :!:5M - B!55M F :!.BM!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-1$
E3-3B )3B $inutes*
-nstructor note& Cisco has ./#0.%/A due to its substantial in1estment in mar2etable securities3
a!
)E $illions*
"OE!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! E<+<:< 2 I)E55+.:< J E3=+:5<* 2 .L F =!<5M
"NOA!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! E<+:B@ 2 I)E@+<B= J E3+@<* 2 .L F 57!@M
b!
)E $illions* NOPM F NOPAT 2 Sales NOAT F Sales 2 A#era(e NOA
Cis&o!!!!!!!!!!!! E<+:B@ 2 E5B+B5B
F @!BBM
E5B+B5B2I)E@+<B= J E3+@<*2.L
F .!3=
&! T%e ratio of "NOA to "OE is .!54 )57!@M 2 =!<5M*! A ratio (reater t%an
!B $eans t%at "NOA e4&eeds "OE! T%is is atypi&al! One e4planation for
t%is relation is t%at Cis&o is %oldin( si(nifi&ant nonoperatin(
in#est$ents li,ely in $ar,etable se&urities! T%is is not un&o$$on for
t%e %i(%-te&% industry in '%i&% &o$panies need to $aintain li-uidity to
ta,e ad#anta(e of opportunities or to respond -ui&,ly to strate(i&
$o#es by &o$petitors! T%is li-uidity+ '%i&% only earns a $ar,et rate of
return+ $ust be funded by %i(%-&ost e-uity &apital! T%is depresses its
"OE!
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-1(
E3-3 )3B $inutes*
a!
)E $illions* Ciabilities-to-e-uity
.BB!!!!!!!!!!!!!! E<5+BB 2 E55+535 F !:<
.BB@!!!!!!!!!!!!!! E:@+@.. 2 E5.+= F !:3
Co$&ast3s total liabilities-to-sto&,%olders3 e-uity ratio of !:< is at
$edian for &o$$uni&ations &o$panies )see E4%ibit 3!:*+ and %as
re$ained fairly &onstant o#er t%e t'o-year period!
b! Co$&ast %as an a&&eptable le#el of debt+ but its li-uidity is lo'! T%at is
so$e &ause for &on&ern about t%e &o$pany3s ability to in&rease its debt
load! T%is is espe&ially troubleso$e (i#en t%e substantial le#els of
&apital e4penditures t%at 'ill be re-uired to up(rade its infrastru&ture in
order to re$ain &o$petiti#e 'it% OeriAon!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-1)
E3-3. )3B $inutes*
a!
)E $illions* Ciabilities-to-e-uity
.BB!!!!!!!!!!!!!! E33+B@3 2 E=:+@. F !73
.BB@!!!!!!!!!!!!!! E5.+<:5 2 E=5+53 F !<B
OeriAon3s liabilities-to-e-uity ratio %as de&lined fro$ .BB@ as OeriAon %as
used a#ailable &as% flo's to redu&e t%e le#el of debt relati#e to e-uity!
T%e .BB ratio is !73+ sli(%tly belo' t%e $edian for &o$$uni&ations
&o$panies of !:: )see E4%ibit 3!:*!
b! OeriAon %as an a&&eptable le#el of debt relati#e to e-uity+ '%i&%
$iti(ates any &on&ern about its finan&ial le#era(e! 1i#en t%e substantial
le#els of &apital e4penditures t%at 'ill be re-uired to up(rade its
infrastru&ture to re$ain &o$petiti#e 'it% Co$&ast+ %o'e#er+ it is
doubtful '%et%er OeriAon 'ill be able to $ar,edly in&rease its debt! T%is
&ould be proble$ati& for t%e fir$!
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-1*
E3-33 )3B $inutes*
a!
)E $illions* Ciabilities-to-e-uity
Industrial!!!!!!!!!!!!!! E@7+<.@ 2 E.3+B35 F B!<=
/inan&ial!!!!!!!!!!!!!! E73=+73B 2 E<B+5= F <!:=
Total!!!!!!!!!!!!!!!!!!!!!! E:.<+B= 2 E.5+@= F 7!B7
b! 1E3s liabilities-to-e-uity ratio of 7!B7 is relati#ely %i(%! Most of t%e
debt+ %o'e#er+ is &on&entrated in t%e finan&ial ser#i&es se($ent! T%is
se($ent %as t%e profile of a typi&al finan&ial institution+ 'it% %i(% debt
le#els and relati#ely lo' operatin( $ar(ins! As lon( as 1E3s loans and
leases are of (ood -uality )t%at is+ t%ey are &olle&tible*+ t%e finan&ial
subsidiary s%ould %a#e no proble$ $eetin( its debt re-uire$ents as t%e
&as% flo's re&ei#ed fro$ its loans2leases are typi&ally 'ell $at&%ed 'it%
t%e debt pay$ent re-uire$ents!
&! Consolidated finan&ial state$ents &o$bine t%e perfor$an&e and
finan&ial position of t%e parent &o$pany and all of its subsidiaries! As
su&%+ t%ey are a blend of finan&ial state$ents fro$ a #ariety of
>&o$panies!? Se($ent analysis is often useful to e#aluate t%e finan&ial
stru&ture of ea&% se($ent a(ainst its respe&ti#e business $odel! In t%is
&ase+ t%e relati#ely %i(% debt le#el for 1E as a '%ole is a 'ei(%ted
a#era(e of t%e less-finan&ially-le#era(ed $anufa&turin( subsidiary 'it%
t%e %i(%ly-le#era(ed finan&ial ser#i&es subsidiary!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-1+
E3-35
A
)3B $inutes*
a! To &al&ulate /CEO 'e $ust first &al&ulate NNO! "e&all t%at NNO is t%e
differen&e bet'een NOA and Sto&,%olders3 e-uity! T%en to &al&ulate
Spread+ 'e re-uire NNEP )NNE 2 A#era(e NNO*! "e&all t%at NNE is t%e
differen&e bet'een NOPAT and Net in&o$e attributable to t%e Gal$art
sto&,%olders!
NNO .B F E5+B5B - E:=+75. F E57+5@=
NNO .BB F EB:+3.B - E<B+5:= F E37+=7.
/CEO F A#era(e NNO 2 A#era(e Sto&,%olders3 e-uity
F I)E57+5@= J E37+=7.* 2 .L 2 I)E:=+75. J E<B+5:=* 2 .L F B!7=7
NNE F E<+... - E:+3=@ F E=33
NNEP F E=33 2 I)E57+5@= J E37+=7.* 2 .L F .!B5=M
Spread F 7!:3M - .!B5=M F 3!7=.M
b! "OE F 7!:3M J )B!7=7 K 3!7=.M* F .3!7<7M
T%e "OE &al&ulated 'it% /CEO and SP"EAD is .3!7<7M and t%e "OE
fro$ t%e $id-$odule re#ie' is .3!7=M! T%e differen&e of B!BB7M
)B!BBBB7* is a roundin( differen&e!
E3-37 ).B $inutes*
T%e /ederal and State ta4 rate for .B as reported in TND3s ta4 footnote is
3@!M )37M J 5!M*! Usin( t%is /ederal and State ta4 rate+ TND3s NOPAT is
&o$puted as follo's )a$ounts in Et%ousands*0
TND .B NOPAT F )E.+@5.+@3 - E:+B5B+5: - E3+<B+B73 J E+77B* H
)E=.5+7:. J B!3@ K E3@+3<*
F E+3:3+3:5
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-1,
P"O9CEMS
P3-3: )57 $inutes*
)E $illions*
a! .BB NOPAT F E7+@= - IE+7@. J )E:3 K B!3<*L F E5+.::
b! .BB NOA F
)E3B+7: - E3+3<< - E+B- E75B - E5:* - )E:+B=@ - E+.:@* - E.+B3 - E+=75
F E:+3B7
.BB@ NOA
F )E.<+.7B - E3+B5B - E<55 - E=.7 - EB3* - )E5+=@< - E:3* - E.+..< - E+<.<
F E5+3BB
&! .BB "NOA F E5+.:: 2 I)E:+3B7 J E5+3BB* 2 .L F .<!==M
.BB NOPM F E5+.:: 2 E.:+::. F :!BBM
.BB NOAT F E.:+::. 2 I)E:+3B7 J E5+3BB* 2 .L F !<5
.BB "NOA F :!BBM K !<5 F .<!=5M )B!BBB5 roundin( error*

d! .BB NNO F )E+.:@ J E5+=3* - )E3+3<< J E+BJ E75B J E5:* J E375
F E:5.
Confir$0
.BB NOA F NNO J SE )3M s%are%olders*
E:+3B7 F E:5. J E7+::3
.BB@ NNO F )E:3 J E7+B@< J E73=* - )E3+B5B J E<55 J E=.7 J EB3*
F E+73:
Confir$0
.BB@ NOA F NNO J SE )3M s%are%olders*
E5+3BB F E+73: J E.+<:5
e! .BB "OE F E5+B=7 2 I)E7+::3 J E.+<:5* 2 .L F .=!<5M
f! .BB nonoperatin( return F "OE H "NOA F .=!<5M - .<!==M F B!=:M
(! "OE;"NOA i$plies t%at 3M is able to borro' $oney to fund operatin(
assets t%at yield a return (reater t%an t%e &ost of t%e debt! T%e e4&ess
a&&rues to t%e benefit of 3M3s sto&,%olders!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-20
P3-3< )3B $inutes*
a! .BB total liabilities-to-e-uity F E5+3@ 2 E:+B< F B!==
.BB@ total liabilities-to-e-uity F E3+@5= 2 E3+3B. F !B7
3M3s total liabilities-to-e-uity de&reased durin( .BB and is 'ell belo'
t%e $edian for publi&ly traded &o$panies! T%is ratio indi&ate $odest
finan&ial le#era(e!
b! 3M is fairly li-uid )&urrent ratio near . and -ui&, ratio (reater t%an * and
is not %i(%ly finan&ially le#era(ed! T%e &o$pany3s ability to $eet its
debt re-uire$ents is not at issue!
P3-3=
A
)5B $inutes*
a! .BB NNO F NOA H 3M s%are%olders sto&,%olders3 e-uity
F E:+3B7 - E7+::3
F E:5.
.BB@ NNO F E5+3BB - E.+<:5
F E+73:
.BB /CEO F I)E:5. J E+73:* 2 .L 2 I)E7+::3 J E.+<:5* 2 .L F B!B=
.BB NNE F NOPAT H Net in&o$e attributable to 3M s%are%olders
F E5+.:: - E5+B=7
F E=
NNEP F E= 2 )IE:5. J E+73:L 2 .*
F :!:.M
Spread F "NOA - NNEP
F .<!==M - :!:.M
F !.:M
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-21
P3-3=
A
)&on&luded*
b! "OE F .<!==M J )B!B= K !.:M*
F .=!<=M )!BBB5 roundin( error*
&! 3M is able to borro' funds and in#est t%e pro&eeds in operatin( assets
yieldin( a return in e4&ess of t%e &ost of its debt! T%e e4&ess )>spread?*
a&&rues to 3M3s sto&,%olders!

P3-3@ )57 $inutes*
)E $illions*
a! .B NOPAT F )E.+5 J E.* - IE<5 J )E=< - E7* K B!3<*L F E+3=@
b! .B NOA F E<+=5@ - E+B3 - E.. - )E=+::3 - E77< - E55* - E+=3
F E<+=<:
.BB NOA F E=+3B. - E+=.: - E@B - )E=+@<= - E::3 - E37* - E+.7:
F E:+=7B
&! .B "NOA F E+3=@ 2 I)E<+=<: J E:+=7B* 2 .L F =!=:M
.B NOPM F E+3=@ 2 E7B+.<. F .!<:M
.B NOAT F E7B+.<. 2 I)E<+=<: J E:+=7B* 2 .L F :!=3
.B "NOA F .!<:M K :!=3 F =!=7M )!BBB roundin( error*
99R3s "NOA of =!=:M is si(nifi&antly %i(%er t%an t%e industry $edian
of about M! It is dri#en pri$arily by t%e #ery %i(% turno#er of net
operatin( assets of :!=3+ 'ell in e4&ess of t%e industry $edian of 3!.<!
99R3s NOPM is sli(%tly belo' t%e $edian of 3!3.M! 99R3s %i(%
perfor$an&e is dri#en by its e4&eptional $ana(e$ent of its balan&e
s%eet!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-22
P3-3@ )&on&luded*
d! .B NNO F )E77< J E55 J E<* H )E+B3 J E..* J E:@B F E+.<5
Confir$0
.B NOA F NNO J 99R3s s%are%olders sto&,%olders3 e-uity
E<+=<: F E+.<5 J E:+:B.
.BB NNO F )E::3 J E37 J E+B5* H )E+=.: J E@B* J E:55 F E73B
Confir$0
.BB NOA F NNO J 99R3s s%are%olders sto&,%olders3 e-uity
E:+=7B F E73B J E:+3.B
e! .B "OE F E+.<< 2 I)E:+:B. J E:+3.B* 2 .L F @!<:M
f! .B nonoperatin( return F "OE H "NOA F @!<:M - =!=:M F B!@BM
(! "OE ; "NOA i$plies t%at 9est 9uy is able to borro' $oney to fund
operatin( assets t%at yield a return (reater t%an t%e &ost of its debt! T%e
e4&ess a&&rues to t%e benefit of 99R3s sto&,%olders!
P3-5B )3B $inutes*
a!
.B liabilities-to-e-uity F )E=+::3 J E+=3 J E<* 2 E<+.@.
F !57
.BB liabilities-to-e-uity F )E=+@<= J E+.7: J E+B5* 2 E:+@:5
F !:3
)Note0 Ge &o$puted t%is ratio usin( total )&onsolidated* sto&,%olders3 e-uity+ not 8ust t%e
e-uity of 99R3s s%are%olders be&ause t%e liabilities in t%e nu$erator in&lude total
&onsolidated liabilities!*
9est 9uy3s liabilities-to-e-uity ratio is at t%e $edian for publi&ly-traded
&o$panies! Ge %a#e no &on&erns about 9est 9uy3s ability to $eet its
debt obli(ations!
b! 9est 9uy is not parti&ularly li-uid )&urrent ratio near !. and -ui&, ratio
near B!5*+ but is not finan&ially le#era(ed! T%e &o$pany (enerates
siAeable operatin( profits and &as% flo'! In su$+ no sol#en&y &on&erns
are e#ident for 9est 9uy!
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-23
P3-5
A
)5B $inutes*
a! .B NNO F )E77< J E55 J E<* - )E+B3 J E..* J E:@B F E+.<5
.BB NNO F )E::3 J E37 J E+B5* - )E+=.: J E@B* J E:55 F E73B
.B /CEO F I)E+.<5 J E73B* 2 .L 2 )IE:+:B. J E:+3.BL 2 .* F B!5
.B NOPAT F )E.+5 J E.* - IE<5 J )E=< - E7* K B!3<*L F E+3=@
.B NNE F NOPAT H Net in&o$e to 99R s%are%olders F E+3=@ - E+.<<
F E.
.B NNEP F E. 2 I)E+.<5 J E73B* 2 .L F .!5.M
.B Spread F "NOA H NNEP F =!=:M - .!5.M F :!55M
b! "OE F =!=:M J )B!5 K :!55M* F @!<:M
&! 9est 9uy is able to borro' funds and in#est t%e pro&eeds in operatin(
assets yieldin( a return in e4&ess of t%e &ost of its debt! T%e e4&ess
a&&rues to t%e benefit of its sto&,%olders!

Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-2$
P3-5. )3B $inutes*
)Note to instru&tor0 Intel3s "OES"NOA! T%is is an e4a$ple of e-uity supportin( t%e strate(i&
in#est$ent in li-uidity at so$e &ost to "OE!*
a! .BB NOPAT F )E7+7== J E<* - )E5+7= - B!3< K )EB@ J E.3**L
F E+.7B
)Note0 Ge treat (ains on e-uity $et%od in#est$ents of E< as operatin( sin&e t%e
in#est$ents are treated t%at 'ay in NOA! T%ese in#est$ents are $ore strate(i& in nature! See
Module < for a des&ription of t%ese in#est$ents! T%e ot%er e-uity in#est$ents are typi&al
in#est$ents in $ar,etable se&urities and are+ t%erefore+ &lassified as nonoperatin(!*
b! .BB NOA F )E:3+=: - E7+5@= - E+.@5 - E7+B@3 - E+BB=* - )E@+3.< -
E3=* - E@B - E@.: - E+.3:
F E.=+:7.
.BB@ NOA F )E73+B@7 - E3+@=< - E7+.=7 - E5+:5= - E<<3* - )E<+7@ -
E<.* - E@3 - E777 - E+BB3
F E.@+.3.
&! .BB "NOA F E+.7B 2 I)E.=+:7. J E.@+.3.* 2 .L F 3=!=<M
.BB NOPM F E+.7B 2 E53+:.3 F .7!<@M
.BB NOAT F E53+:.3 2 I)E.=+:7. J E.@+.3.*2.L F !7
d! .BB NNO F E3= J E.+B<< - E7+5@= - E+.@5 - E7+B@3 - E+BB=
F )E.B+<<=*
Confir$0 E.=+:7. F E).B+<<=* J E5@+53B
.BB@ NNO F E<. J E.+B5@ - E3+@=< - E7+.=7 - E5+:5= - E<<3
F )E.+5<.*
Confir$0 E.@+.3. F E).+5<.* J E5+<B5
e! .BB "OE F E+5:5 2 I)E5@+53BJE5+<B5* 2 .L F .7!:M
f! .BB nonoperatin( return F "OE H "NOA F .7!:M - 3=!=<M F )3!<M*
(! "NOA ; "OE i$plies t%at Intel3s sto&,%olders are fundin( a siAeable
a$ount of li-uidity in t%e for$ of in#est$ents in $ar,etable se&urities!
T%is is not un&o$$on for t%e %i(%-te&% industry '%ere &o$panies need
to $aintain a suffi&ient le#el of li-uidity to ta,e ad#anta(e of
opportunities or to respond to strate(i& $o#es by &o$petitors! T%is
li-uidity re-uire$ent adds a layer of &osts t%at depresses its "OE!
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-2(
P3-53 )57 $inutes*
)E in $illions*
a! .B NOPAT F E+= - )E3<= J )E.< K B!3<* F E:@3
b! .B NOA F E<+5:. - E+7B: - E=5: - E3<7 - E:7. - E5@7 - E.@.
F E3+.@:
.BB NOA F E:+7<@ - E<@7 - E<.: - E33: - E7@: - E5:@ - E.:<
F E3+3@B
&! .B "NOA F E:@3 2 I)E3+.@: J E3+3@B* 2 .L F .B!<3M
.B NOPM F E:@3 2 E@+<BB F <!5M
.B NOAT F E@+<BB 2 I)E3+.@: J E3+3@B* 2 .L F .!@B
.B "NOA F <!5M K .!@B F .B!<M )B!BBB. roundin( error*
Nordstro$3s net operatin( profit $ar(in is si(nifi&antly abo#e t%e
industry $edian of 5!5:M+ '%i&% is not surprisin( (i#en t%e &o$pany3s
%i(%-end produ&t! Nordstro$3s net operatin( asset turno#er rate is also
%i(%er t%an t%e $edian of .!=! Nordstro$ is $ana(in( bot% its in&o$e
state$ent and its balan&e s%eet #ery 'ell!
d! .B NNO F E: J E.+<<7 - E+7B: F E+.<7
Confir$0 E3+.@: F E+.<7 J E.+B.
.BB NNO F E37: J E.+.7< - E<@7 F E+==
Confir$0 E3+3@B F E+== J E+7<.
e! .B "OE F E:3 2 I)E.+B. J E+7<.* 2 .L F 35!.M
f! .B nonoperatin( return F "OE H "NOA F 35!.M - .B!<3M F 3!3@M
(! "OE;"NOA i$plies t%at Nordstro$ is able to borro' $oney to fund
operatin( assets t%at yield a return (reater t%an t%e &ost of its debt! T%e
e4&ess a&&rues to t%e benefit of Nordstro$3s sto&,%olders!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-2)
P3-55 )3B $inutes*
)E $illions*
a! .BB NOPAT F E7+::: H )E+5< J B!3< K E.+B.5* F E3+<<B
)Note0 'e %a#e treated t%e earnin(s fro$ and (ain on t%e sale of t%e dis&ontinued operations
as nonoperatin(! On&e t%e de&ision is $ade to sell t%e operatin( entity+ it is re&lassified as
nonoperatin( and any net assets and earnin(s related to t%at entity are &lassified as
nonoperatin(!*
b! .BB NOA F E@7+.=@ - E.+5= - )E7+::B - E<7B - E+7* - E<+@=5 - E.+3=.
- E3+B5: - E3+5: F E:.+=7
.BB@ NOA F E::+<5 - E.+B - )E+5@ - E573 - E73* - 5+7B= - E+<:7
- E.+=: - E.+3= F E5.+=:
&! .BB "NOA F E3+<<B 2 I)E:.+=7 J E5.+=:* 2 .L F <!=M
.BB NOPM F E3+<<B 2 E5@+.B< F <!::M
.BB NOAT F E5@+.B< 2 I)E:.+=7 J E5.+=:* 2 .L F B!@5
.BB "NOA F <!::M K B!@5 F <!.BM )B!BBB. roundin( error*
Traft3s net operatin( profit $ar(in is si(nifi&antly abo#e t%e industry
$edian of :!..M+ but its net operatin( asset turno#er rate is $u&% lo'er
t%an t%e $edian of !::! O#erall+ t%e lo' turno#er of net operatin(
assets is resultin( in a "NOA t%at is lo'er t%an t%e industry $edian of
o#er @M!
d! .BB NNO F E<7B J E+7 J E.:+=7@ - E.+5= J EB= F E.:+37
Confir$0 E:.+=7 F E.:+37 J E37+=35
.BB@ NNO F E573 J E73 J E=+B.5 - E.+B J E@: F E:+@=7
Confir$0 E5.+=: F E:+@=7 J E.7+=<:
e! .BB "OE F E5+5 2 I)E37+=35 J E.7+=<:* 2 .L F 3!33M
f! .BB nonoperatin( return F "OE H "NOA F 3!33M - <!=M F :!7M
(! "OE;"NOA i$plies t%at Traft is able to borro' $oney to fund operatin(
assets t%at yield a return (reater t%an t%e &ost of its debt! T%e e4&ess
a&&rues to t%e benefit of Traft3s sto&,%olders!
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-2*
P3-57 ).B $inutes*
)E in $illions*
a!
.BB liabilities-to-e-uity F E7@+3=< 2 E37+@5. F !:7
.BB: liabilities-to-e-uity F E5B+<5. 2 E.7+@<. F !7<
T%e liabilities-to-e-uity %as in&reased+ but t%is ratio re$ains at
&o$fortable le#els! T%ere are no i$$ediate &on&erns about Traft3s
ability to $eet its debt obli(ations!
b! Alt%ou(% Traft is not parti&ularly li-uid+ it is not %i(%ly finan&ially
le#era(ed! T%ere are no i$$ediate &on&erns about its sol#en&y!
P3-5:
A
)3B $inutes*
)EUs in $illions*
a! .BB NNO F E<7B J E+7 J E.:+=7@ - E.+5= J EB= F E.:+37
.BB@ NNO F E573 J E73 J E=+B.5 - E.+B J E@: F E:+@=7
.BB /CEO F A#(! NNO 2 A#(! Traft3s Sto&,%olders3 e-uity
F I)E.:+37 J E:+@=7* 2 .L 2 I)E37+=35 J E.7+=<:* 2 .L
F B!<B
NNEP F NNE )NOPAT H Net in&o$e to Traft s%are%olders* 2 A#(! NNO
F )E3+<<B - E5+5* 2 I)E.:+37 J E:+@=7* 2 .L
F )!7@*M
Spread F "NOA H NNEP F <!=M J !7@M F =!<<M
b! "OE F "NOA J )/CEO K Spread* F <!=M J )B!<B K =!<<M* F 3!3.M
)B!BBB roundin(*
&! "OE;"NOA i$plies t%at Traft is able to borro' $oney to fund operatin(
assets t%at yield a return (reater t%an t%e &ost of its debt! T%e e4&ess
a&&rues to t%e benefit of Traft3s sto&,%olders! T%is year+ Traft %as a
ne(ati#e NNE be&ause dis&ontinued operations (enerated in&o$e and
or a (ain durin( .BB!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-2+
P3-5< )3B $inutes*
a!
T%is (rap% is si$ilar to t%e one in t%e $odule and re#eals t%e trade-off
bet'een profit $ar(in and asset turno#er! 9asi& e&ono$i&s su((est t%at
&o$panies 'it% %i(% turno#er %a#e lo' $ar(in and #i&e #ersa!
b! Pi(% perfor$in( &o$panies are t%ose t%at e4%ibit a %i(%er profit
$ar(in '%en %oldin( asset turno#er &onstant+ and %a#e a %i(%er
turno#er '%en %oldin( profit $ar(in &onstant! T%us+ in&reasin( "NOA
re-uires $ana(ers to $ana(e bot% t%e in&o$e state$ent and t%e
balan&e s%eet!
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-2,
P3-5=
9
)37 $inutes*
a!
Net profit $ar(in )Net in&o$e 2 sales* E+.<< 2 E7B+.<. F .!75M
Asset turno#er )Sales 2 A#era(e
assets*
E7B+.<. 2 )IE<+=5@ J E=+3B.L2.*
F .!<=
/inan&ial le#era(e )A#era(e assets 2
A#era(e e-uity*
)IE<+=5@ J E=+3B.L2.* 2
)IE:+:B. J E:+3.BL2.
F .!=B
b!
"OE )Net in&o$e 2 A#era(e e-uity* E+.<< 2 )IE:+:B. J E:+3.BL2. F @!<:M
Confir$ation .!75M K .!<= K .!=B F @!<<M
)B!BBB roundin( error*

&! Ad8ust$ents to "OA typi&ally fo&us on t%e nu$erator )spe&ifi&ally+ 'e
add ba&, after-ta4 interest e4pense to net in&o$e*! /or 9est 9uy+ t%is
ad8ust$ent follo's0
Ad8usted "OA F )E+.<< J IE3: K ) - B!3<*L* 2 )IE<+=5@ J E=+3B.L2.*
F <!@M
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-30
P3-5@
9
)37 $inutes*
a!
Net profit $ar(in )Net in&o$e 2 Sales* E5+3@ 2 E5@+.B< F =!5M
Asset turno#er )Sales 2 A#era(e
assets*
E5@+.B< 2 )IE@7+.=@ J E::+<5L 2 .*
F B!:B<
/inan&ial le#era(e )A#era(e assets 2
A#era(e e-uity*
)IE@7+.=@ J E::+<5L 2 .* 2
)IE37+=35 J E.7+=<:L 2 .*
F .!:.7
b!
"OE )Net in&o$e 2 A#era(e e-uity* E5+3@ 2 )IE37+=35 J E.7+=<:L 2 .*
F 3!5M
Confir$ation =!5M K B!:B< K .!:.7 F 3!5BM
)B!BB roundin( error*
&! Ad8ust$ents to "OA typi&ally fo&us on t%e nu$erator )spe&ifi&ally+
addin( after-ta4 interest e4pense to net in&o$e*! /or Traft+ ad8usted
"OA is0 E5+3@ J ) - B!3<* K E.+B.5 2 )IE@7+.=@ J E::+<5L 2 .* F :!:=M
T%e unad8usted "OA is0 E5+3@ 2 )IE@7+.=@ J E::+<5L 2 .* F 7!M
T%e differen&e bet'een t%e t'o is fairly si(nifi&ant )!7<M*! T%is
represents t%e effe&t of debt finan&in( H t%e "OA of 7!M refle&ts t%e
interest e4pense on borro'ed $oney! T%e ad8usted "OA of :!:=M is t%e
return on t%e assets %oldin( apart t%e $anner in '%i&% t%ey 'ere
funded!
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-31
I/"S APPCICATIONS
I3-7B )7 $inutes*
a!
)E $illions* "NOA
S%ell E+<@3 2 I)E:@+.@5 J E5=+B<B*2 .L F <!5M
9P E:+=BB 2 I)E3=+.<7 J E.7+=35* 2 .L F .!<M
b!
)E $illions* NOPM F NOPAT 2 Sales NOAT F Sales 2 A#era(e NOA
S%ell E+<@32E.=3+:5 F 5!.M E.=3+:52I)E:@+.@5JE5=+B<B*2.L
F!<=
9P E:+=BB2E.53+<3 F :!@M E.53+<32I)E3=+.<7JE.7+=35*2.L
F!=5
&! 9P3s "NOA of .!<M is si(nifi&antly %i(%er t%an S%ell3s "NOA of <!5M+
for t'o reasons! /irst+ 9P %as a %i(%er net operatin( profit $ar(inV :5M
(reater t%an S%ell3s NOPM ):!@M &o$pared to 5!.M*! Se&ond+ 9P is
$ore effi&ient 'it% its net operatin( asset turno#er+ '%i&% $a,es t%e
&o$pany $ore profitable o#erall!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-32
I3-7 )7 $inutes*
a!
)W t%ousands*
"OE W<:+@3 2 I)WB+B35+<=7 J W@+3:3+.53* 2 .L F <!5M
"NOA W7.:+B5 2 I)W3+BB.+37B J W.+B.=+B.5* 2 .L F 5!.M
b!
)Wt%ousands* NOPM F NOPAT 2 Sales NOAT F Sales 2 A#era(e NOA
OMO 1roup W7.:+B5 2 W<+@<+.:<
F .!@M
W<+@<+.:< 2 I)W3+BB.+37B J
W.+B.=+B.5*2.L
F !53
&! "NOA is 7<M of "OE+ &al&ulated as follo's0 5!.M 2 <!5M F B!7< )or 7<M*!
Ge &an infer OMO3s nonoperatin( return by &al&ulatin( t%e differen&e
bet'een "OE and "NOA0 <!5M - 5!.M F 3!.M!
I3-7. )7 $inutes*
)W $illions*
a!
)W $illions* Ciabilities-to-e-uity
.BB= W3+<7: 2 W+B7 F !.5
.BB@ W3+<: 2 W+=== F !:
S&%neider Ele&tri&3s total liabilities-to-sto&,%olders3 e-uity ratio is
$oderate to %i(% bet'een !: and !.5+ but %as de&reased sli(%tly fro$
.BB= to .BB@! To $a,e a $ore infor$ed assess$ent+ 'e 'ould li,e to
,no' t%e ratio for fir$s in t%is industry and (eo(rap%i& area!
b! S&%neider Ele&tri&3s debt le#el is not e4&essi#e! It %as (ood li-uidity
and %i(% earnin(s! It %as a stron( $ar(in to &o#er its interest e4penses!
Ge 'ould &on&lude t%at t%e &o$pany is li-uid and sol#ent!
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-33
I3-73 )57 $inutes*
)X $illions*
a! .BB NOPAT F X7@= J )X:B H X* K ) H B!37@* F X:.@
.BB@ NOPAT F X5:B J )X:B H X55* K ) H B!3:B* F X5<B
b! .BB NOA F )X<+::: H X..@ J X+B@5 H X< H X.57*
H )X.+7. H X.3 J X+:7@ H X+B.<* F X7+:55
.BB@ NOA F )X<+:B H X.5. H X= J X+B:: H X3.<*
H )X.+B.5 H X J X+:=. H X+B5@* F [email protected]
&! .BB "NOA F X:.@ 2 I)X7+:55 J [email protected]* 2 .L F !@M
.BB@ "NOA F X5<B 2 I)[email protected] J X5+:::* 2 .L F @!=M
.BB NOPM F X:.@ 2 X7+5B F 5!M
.BB@ NOPM F X5<B 2 X5+7.= F 3!.M
.BB NOAT F X7+5B 2 I)X7+:55 J [email protected]* 2 .L F .!@.
.BB@ NOAT F X5+7.= 2 I)[email protected] J X5+:::* 2 .L F 3!B3
Morrison3s "NOA in&reased fro$ .BB@ to .BB! Its NOPM in&reased by
B!@ per&enta(e points '%i&% in&reased "NOA! Po'e#er+ t%e NOAT
de&reased sli(%tly fro$ 3!B3 to .!@.+ '%i&% de&reased "NOA! T%e net
effe&t of t%e t'o 'as to in&rease "NOA!
d! .BB NNO F )X.3 J X+B.<* H )X..@ J X<J X.57* F X:@7
.BB@ NNO F )X J X+B5@* H )X.5. J X= J X3.<* F X5BB
Confir$0
.BB NOA F NNO J SE
X7+:55 F X:@7 J X5+@5@
.BB@ NOA F NNO J SE
[email protected] F X5BB J X5+7.B
e! .BB "OE F X7@= 2 I)X5+@5@ J X5+7.B* 2 .L F .!:M
.BB@ "OE F X5:B 2 I)X5+7.B J X5+3<=* 2 .L F B!3M
f! .BB nonoperatin( return F "OE H "NOA F .!:M H !@M F B!<M
.BB@ nonoperatin( return F "OE H "NOA F B!3M H @!=M F B!7M
(! "OE;"NOA i$plies t%at Morrison3s is able to borro' $oney to fund
operatin( assets t%at yield a return (reater t%an t%e &ost of t%e debt! T%e
e4&ess a&&rues to t%e benefit of Morrison3s sto&,%olders!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-3$
I3-75 ).7 $inutes*
)X $illions*
a!
.BB total liabilities-to-e-uity F )X+:7@ J X.+7.* 2 X5+@5@ F B!<<
.BB@ total liabilities-to-e-uity F )X+:=. J X.+B.5* 2 X5+7.B F B!=.
Morrison3s total liabilities-to-e-uity de&reased sli(%tly!
b! Morrison3s is fairly illi-uid )&urrent ratio and -ui&, ratio less t%an *+ but
t%is $ay not a bi( &on&ern if t%e &o$pany is able to turn o#er its
in#entory of foodstuffs )sto&,s* #ery -ui&,ly! T%e &o$pany is not %i(%ly
finan&ially le#era(ed! T%e &o$pany3s ability to $eet its debt
re-uire$ents is not at issue!
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-3(
DISCUSSION POINTS
D3-77 )3B $inutes*
a! "aisin( pri&es and2or redu&in( $anufa&turin( &osts are not ne&essarily
independent solutions+ and are li,ely related to ot%er fa&tors! T%e effe&t
of a pri&e in&rease on (ross profit is a fun&tion of t%e de$and &ur#e for
t%e &o$pany3s produ&t! If t%e de$and &ur#e is relati#ely elasti&+
&usto$ers are sensiti#e to pri&e %i,es! T%us+ a pri&e in&rease &ould
si(nifi&antly redu&e de$and+ t%ereby de&reasin(+ rat%er t%an in&reasin(+
(ross profit )an e4a$ple is a BM in&rease in pri&e and a .BM de&rease
in de$and*! A pri&e in&rease 'ill %a#e a $ore desired effe&t if t%e
de$and &ur#e is relati#ely inelasti& )an e4a$ple is a BM pri&e in&rease
'it% a 3M de&rease in de$and*!
Cuttin( $anufa&turin( &osts 'ill in&rease (ross profit )#ia redu&tion of
CO1S* if t%e $ore ine4pensi#ely $ade produ&t is not per&ei#ed to be of
lesser -uality+ t%ereby redu&in( de$and!
b! "aisin( pri&es is diffi&ult in &o$petiti#e $ar,ets! As t%e nu$ber of
produ&t substitutes in&reases+ &o$panies are less able to raise pri&es!
"at%er+ t%ey $ust be able to effe&ti#ely differentiate t%eir produ&ts in
so$e $anner in order to redu&e &onsu$ers3 substitution! T%is &an be
a&&o$plis%ed+ for e4a$ple+ by produ&t desi(n and2or ad#ertisin(! T%ese
efforts+ %o'e#er+ li,ely entail additional &ost+ and+ '%ile (ross profit
$i(%t be in&reased as a result+ S16A e4pense $ay also in&rease 'it%
little effe&t on t%e botto$ line!
Manufa&turin( &osts &onsist of ra' $aterials+ labor and o#er%ead! Ea&%
&an be tar(eted for &ost redu&tion! A redu&tion of ra' $aterials &osts
(enerally i$plies so$e redu&tion in produ&t -uality+ but not ne&essarily!
It $i(%t be t%e &ase t%at t%e produ&t &ontains features t%at are not in
de$and by &onsu$ers! Eli$inatin( t%ose features 'ill redu&e produ&t
&osts 'it% little effe&t on sellin( pri&e!
Si$ilarly+ &o$panies &an utiliAe less e4pensi#e sour&es of labor )off-
s%ore produ&tion+ for e4a$ple*+ t%at &an si(nifi&antly redu&e produ&t
&osts and in&rease (ross profit+ pro#ided t%at produ&t -uality is
$aintained!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-3)
D3-77 )&on&luded*
/inally+ $anufa&turin( o#er%ead &an be redu&ed by $ore effi&ient
produ&tion! Ga(es and depre&iation e4pense are t'o si(nifi&ant
&o$ponents of $anufa&turin( o#er%ead! T%ese are lar(ely fi4ed &osts+
and t%e per unit produ&t &ost &an often be redu&ed by in&reasin(
&apa&ity utiliAation of $anufa&turin( fa&ilities )pro#ided+ of &ourse+ t%at
t%e in&reased in#entory produ&ed &an be sold*!
T%e botto$ line is t%at in&reasin( (ross profit is a diffi&ult pro&ess t%at
&an only be a&&o$plis%ed by effe&ti#e $ana(e$ent and inno#ation!
D3-7: )3B $inutes*
a! Gor,in( &apital $ana(e$ent is an i$portant &o$ponent of t%e
$ana(e$ent of a &o$pany! 9y redu&in( t%e le#el of 'or,in( &apital+
&o$panies redu&e t%e &osts of &arryin( e4&ess assets! T%is &an %a#e a
si(nifi&antly positi#e effe&t on finan&ial perfor$an&e! Co$$on 'ays to
de&rease re&ei#ables and in#entories+ and in&rease payables+ in&lude
t%e follo'in(0
"edu&e re&ei#ables
Constri&tin( t%e pay$ent ter$s on produ&t sales
9etter &redit poli&ies t%at li$it &redit to %i(%-ris, &usto$ers
9etter reportin( to identify delin-uen&ies
Auto$ated noti&es to delin-uent a&&ounts
In&reased &olle&tion efforts
Prepay$ent of orders or billin( as $ilestones are rea&%ed
Use of ele&troni& )ACP* pay$ent
Use of t%ird-party (uarantors+ in&ludin( ban, letters of &redit
"edu&e in#entories
"edu&e in#entory &osts #ia less &ostly &o$ponents )of e-ual
-uality*+ produ&e 'it% lo'er 'a(e rates+ eli$inate produ&t features
)&osts* not #alued by &usto$ers
Outsour&e produ&tion to redu&e produ&t &ost and2or
in#entories t%e &o$pany $ust &arry on its balan&e s%eet
"edu&e ra' $aterials in#entories #ia 8ust-in-ti$e deli#eries
Eli$inate bottlene&,s in $anufa&turin( to redu&e 'or,-in-
pro&ess in#entories
"edu&e finis%ed (oods in#entories by produ&in( to order
rat%er t%an produ&in( to esti$ated de$and
In&rease payables
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-3*
E4tend t%e ti$e for pay$ent of lo' or no-&ost payablesYso
lon( as t%e relations%ip 'it% suppliers is not %ar$ed
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-3+
D3-7: )&on&luded*
b! Pay$ent ter$s to &usto$ers are a $ar,etin( tool+ si$ilar to produ&t
pri&e and ad#ertisin( pro(ra$s! Many &o$panies pro$ote pay$ent
ter$s separately fro$ ot%er pro$otions )no pay$ent for si4 $ont%s or
interest-free finan&in(+ for e4a$ple*! As &o$panies restri&t &redit ter$s+
t%e le#el of re&ei#ables 'ill li,ely de&rease+ t%ereby redu&in( 'or,in(
&apital! T%e restri&tion of &redit ter$s $ay also %a#e t%e undesirable
effe&t of redu&in( de$and for t%e &o$pany3s produ&ts! T%e &ost of
&redit ter$s $ust be 'ei(%ed a(ainst t%e benefits+ and &redit ter$s
$ust be $ana(ed 'it% &are so as to opti$iAe &osts rat%er t%an $ini$iAe
t%e$! Credit poli&y is as $u&% art as it is s&ien&e!
Ci,e'ise+ t%e dept% and breadt% of t%e in#entories t%at &o$panies &arry
i$pa&t &usto$er per&eption! At t%e e4tre$e+ in#entory sto&,-outs result
in not only t%e loss of &urrent sales+ but also t%e potential loss of future
sales as &usto$ers are introdu&ed to &o$petitors and $ay de#elop an
i$pression of t%e &o$pany as >t%inly sto&,ed!? In#entories are &ostly to
$aintain+ as t%ey $ust be finan&ed+ insured+ sto&,ed+ $o#ed+ and so
fort%! "edu&tion in in#entory le#els &an redu&e t%ese &osts! On t%e ot%er
%and+ t%e a$ount and type of in#entories &arried is a $ar,etin( de&ision
and $ust be $ana(ed 'it% &are so as to opti$iAe t%e le#el in#entories+
not ne&essarily to $ini$iAe t%e$!
One &o$pany3s a&&ount payable is anot%er3s a&&ount re&ei#able! So+
8ust as one &o$pany see,s to e4tend t%e ti$e of pay$ent to redu&e its
'or,in( &apital+ so does t%e ot%er &o$pany see, to redu&e t%e a#era(e
&olle&tion period to a&&o$plis% t%e sa$e ob8e&ti#e! Capable+
dependable suppliers are a #aluable resour&e for t%e &o$pany+ and t%e
supplier relation $ust be %andled 'it% &are! All &o$panies ta,e as lon(
to pay t%eir a&&ounts payable as t%e supplier allo's in its &redit ter$s!
E4tendin( t%e pay$ent ter$s beyond t%at point be(ins to ne(ati#ely
i$pa&t t%e supplier relation+ ulti$ately resultin( in t%e loss of t%e
supplier! T%e supplier relation $ust be $ana(ed 'it% &are so as to
opti$iAe t%e ter$s of pay$ent+ rat%er t%an ne&essarily to $ini$iAe
t%e$!
Cambridge Business Publishers, 2013
Solutions Manual, Module 3
3-3,
D3-7< )3B $inutes*
a! T%e parties affe&ted by s&%e$es to $ana(e earnin(s is often $u&%
broader t%an first t%ou(%t! It in&ludes t%e follo'in( affe&ted parties0
! e$ployees abo#e and belo' t%e le#el at '%i&% t%e s&%e$e is
i$ple$ented
.! sto&,%olders and ele&ted $e$bers of t%e board of dire&tors
3! &reditors of t%e &o$pany )suppliers and lenders* and t%eir
e$ployees+ sto&,%olders+ and board of dire&tors
5! &o$petitors of t%e &o$pany
7! t%e &o$pany3s independent auditors
:! re(ulators and ta4in( aut%orities
b! Mana(ers often belie#e t%at earnin(s $ana(e$ent a&ti#ities 'ill be
s%ort-li#ed+ and 'ill be &urtailed on&e its operations >turn around!?
Often+ t%is does not pro#e to be t%e &ase! Inter#ie's 'it% $ana(ers and
e$ployees '%o %a#e en(a(ed in t%is a&ti#ity often re#eal t%at t%ey
started rat%er inno&uously )8ust $ana(in( earnin(s to >$a,e t%e
nu$bers? in one -uarter*+ but+ -ui&,ly+ earnin(s $ana(e$ent be&a$e a
slippery slope! Ulti$ately+ t%e parties t%e &o$pany 'as tryin( to prote&t
)s%are%olders+ for e4a$ple* are %urt $ore t%an t%ey 'ould %a#e been
%ad t%e &o$pany reported its results &orre&tly+ e4posin( proble$s early
so t%at &orre&ti#e a&tion &ould be ta,en )possibly by re$o#in(
$ana(ers* to prote&t t%e broader sta,e%olders in t%e &o$pany!
&! Co$pany $ana(ers are 8ust ordinary people! T%ey desire to i$pro#e
t%eir &o$pensation+ '%i&% is often lin,ed to finan&ial perfor$an&e!
Mana(ers $ay a&t to $a4i$iAe t%eir &urrent &o$pensation at t%e
e4pense of lon(-ter$ (ro't% in s%are%older #alue! T%e redu&tion in t%e
a#era(e e$ploy$ent period at all le#els of t%e &o$pany %as
e4a&erbated t%e proble$!
d! Unfortunately+ t%e separation of o'ners%ip and &ontrol often leads to
less infor$ed s%are%olders '%o are unable to effe&ti#ely $onitor t%e
a&tions of t%e $ana(ers t%ey %a#e %ired! To t%e e4tent t%at
&o$pensation pro(ra$s are lin,ed to finan&ial $easures+ $ana(ers &an
use t%e fle4ibility (i#en to t%e$ under 1AAP to t%eir benefit+ e#en
'it%out #iolatin( 1AAP per se! T%ese a&tions &an only be un&o#ered by
effe&ti#e auditin( and enfor&ed by an effe&ti#e audit &o$$ittee of t%e
board! Corporate (o#ernan&e %as (ro'n &onsiderably in i$portan&e
follo'in( t%e a&&ountin( s&andals of t%e early .BBBs! T%e Sarbanes-
O4ley A&t $andates ne' le#els of &orporate (o#ernan&e! T%e sto&,
$ar,et and t%e &ourts are %elpin( to enfor&e t%is $andate!
Cambridge Business Publishers, 2013
Financial Statement Analsis ! "aluation, 3rd #dition
3-$0