Financial Statements, Cash Flow,

1

• Chapter 3
• Financial Statements, Cash Flow, Taxes

2
Modifying Accounting Data for Managerial Decisions

• Working capital is equal to current assets minus
  current liabilities.
• Net operating working capital (nowc) omits the
  interest-bearing items (marketable securities and
  notes payable).
• NOWC reflects the net investment in w/c to
  support operations.

3

• Operating capital is equal to NOWC plus net fixed
  assets, and represents the net total investment
  in operations.
• NOPAT is the operating profit after taxes, and
  represents what net income would be without
  financing costs.

4

• Find each of these measures for MicroDrive for
  2007 (p. 86, 89)

5

• Free cash flow (FCF) measures excess profit after
  necessary investments to support growth.
• Free cash flow is found by NOPAT minus the change
  in operating capital over the prior year.
• A negative FCF indicates that the company needed
  to go to outside financing to finance its growth.

6

• Economic value added (EVA) represents the true
  economic (i.e., excess) profit earned above and
  beyond expectations, and is found by
• If after-tax operating profits exceed
  expectations, EVA is positive (and management
  should be rewarded).

7

• Return on invested capital (ROIC) is a percentage
  way to express NOPAT
• If EVA is positive, ROIC will be greater than the
  wacc.
• Assume OpCap(2006) is 1455 and wacc(2007) is 11.
  Find EVA(2007) and ROIC(2007).

8

• Market value added (MVA) measures how much has
  been added to shareholder wealth through stock
  price increases since the companys inception,
  and is equal to the market value of equity (i.e.,
  market cap) less the book value of equity.
• Given a stock price of 50 per share, find MVA
  for 2007.

9

• Which is more useful MVA or EVA?
• For additional information, see
  http//www.EVA.com

10
Independent Reading

• For a corporation in the USA
• Which financing cost produces a tax saving
  interest expense or dividend payments?
  (p.108-109)
• Which source of financial income is taxed at a
  lower rate interest income or dividend income?
  (p.107)
• Are US corporations allowed to engage in income
  averaging? (p.109-110)

11

• If a US corporation wishes to shield its
  shareholders from paying taxes on dividend
  income, can it simply let the cash build up in
  the corporation? (p.110)
• Are US corporate profits earned by its foreign
  subsidiaries taxed twice once by the host
  country and again by the US federal government?
  (p.110)

12
Omitted Topics

• Basic financial statements (p.84-95)
• S Corporations and personal taxes (p.111-112)