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Financial reporting, financial statement analysis and valuation a strategic perspective (with thomson one printed access card) edition 7 librarypirate me Financial reporting, financial statement analysis and valuation a strategic perspective (with thomson one printed access card) edition 7 librarypirate me Financial reporting, financial statement analysis and valuation a strategic perspective (with thomson one printed access card) edition 7 librarypirate me Financial reporting, financial statement analysis and valuation a strategic perspective (with thomson one printed access card) edition 7 librarypirate me Financial reporting, financial statement analysis and valuation a strategic perspective (with thomson one printed access card) edition 7 librarypirate me
LibraryPirate LibraryPirate Financial Reporting, Financial Statement Analysis, and Valuation A Strategic Perspective 7e James M Wahlen Professor of Accounting James R Hodge Chair of Excellence Kelley School of Business, Indiana University • S t e p h e n P B a g i n s k i Herbert E Miller Professor of Accounting J.M Tull School of Accounting Terry College of Business, The University of Georgia • M a r k T B r a d s h a w Associate Professor of Accounting Carroll School of Management Department of Accounting, Boston College Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States LibraryPirate This ia an electronic version of the print textbook Due to electronic rights restrictions, some third party may be suppressed Edition review has deemed that any suppressed content does not materially affect the over all learning experience The publisher reserves the right to remove the contents from this title at any time if subsequent rights restrictions require it For valuable information on pricing, previous editions, changes to current editions, and alternate format, please visit www.cengage.com/highered to search by ISBN#, author, title, or keyword for materials in your areas of interest HLEN-09-1211-FM.qxd: 6/30/10 3:21 PM Page ii LibraryPirate Financial Reporting, Financial Statement Analysis, and Valuation: A Strategic Perspective, Seventh Edition James M Wahlen, Stephen P Baginski, Mark T Bradshaw Vice President of Editorial, Business: Jack W Calhoun Publisher: Rob Dewey © 2011, 2007 South-Western, Cengage Learning ALL RIGHTS RESERVED No part of this work covered by the copyright herein may be reproduced, transmitted, stored, or used in any form or by any means graphic, electronic, or mechanical, including but not limited to photocopying, recording, scanning, digitizing, taping, web distribution, information networks, or information storage and retrieval systems, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without the prior written permission of the publisher Sr Acquisitions Editor: Matthew Filimonov Sr Developmental Editor: Craig Avery Editorial Assistant: Ann Mazzaro Marketing Manager: Natalie Livingston Marketing Coordinator: Nicole Parsons Production Manager: Patricia Matthews Boies For product information and technology assistance, contact us at Cengage Learning Customer & Sales Support, 1-800-354-9706 For permission to use material from this text or product, submit all requests online at www.cengage.com/permissions Further permissions questions can be emailed to permissionrequest@cengage.com Sr Content Project Manager: Kim Kusnerak Media Editor: Bryan England Frontlist Buyer, Manufacturing: Doug Wilke Marketing Communications Manager: Elizabeth Shipp Production Service: Cadmus/KGL Compositor: KnowledgeWorks Global ExamView® is a registered trademark of eInstruction Corp Windows is a registered trademark of the Microsoft Corporation used herein under license Macintosh and Power Macintosh are registered trademarks of Apple Computer, Inc used herein under license © 2008 Cengage Learning All Rights Reserved Limited (KGL) Sr Art Director: Stacy Jenkins Shirley Internal Designer: Beckmeyer Design Inc./ Itzhack Shelomi Cover Designer: Itzhack Shelomi Library of Congress Control Number: 2010930107 ISBN-13: 978-0-324-78941-6 ISBN-10: 0-324-78941-6 Student Edition ISBN 13: 978-0-324-78942-3 Student Edition ISBN 10: 0-324-78942-4 Cover Image: iStock Photo Rights Acquisitions Specialist—Text: Deanna Ettinger South-Western Cengage Learning 5191 Natorp Boulevard Mason, OH 45040 USA Cengage Learning products are represented in Canada by Nelson Education, Ltd For your course and learning solutions, visit www.cengage.com Purchase any of our products at your local college store or at our preferred online store www.CengageBrain.com Printed in the United States of America 14 13 12 11 10 HLEN-09-1211-FM.qxd: 6/30/10 3:21 PM Page iii LibraryPirate For our students, with thanks for permitting us to take the journey with you For Clyde Stickney and Paul Brown, with thanks for allowing us the privilege to carry on their legacy of teaching through this book For our families, with love, Debbie, Jessica, Jaymie, Lynn, Drew, Marie, Kim, Ben, and Lucy HLEN-09-1211-FM.qxd: 6/30/10 3:21 PM Page iv LibraryPirate Preface The process of financial reporting, financial statement analysis, and valuation is intended to help investors and analysts to deeply understand a firm’s profitability and risk and to use that information to forecast future profitability and risk and ultimately value the firm, enabling intelligent investment decisions This process lies at the heart of the role of accounting, financial reporting, capital markets, investments, portfolio management, and corporate management in the world economy When conducted with care and integrity, thorough and thoughtful financial statement analysis and valuation is a fascinating and potentially rewarding activity that can create tremendous value for society However, as the recent financial crises in our capital markets reveal, when financial statement analysis and valuation is conducted carelessly and without integrity, it can create enormous loss of value in our capital markets and trigger deep recession in even the most powerful economies in the world The stakes are high In addition, the game is changing The world is shifting toward a new approach to financial reporting, and expectations for high quality and high integrity financial analysis and valuation are increasing among investors and securities regulators Many of the world’s most powerful economies, including the European Union, Canada, and Japan, have already shifted or will soon shift to International Financial Reporting Standards (IFRS) The U.S Securities and Exchange Commission (SEC) has already begun to accept financial statement filings based on IFRS from non-U.S registrants, and is seriously considering whether to converge financial reporting from U.S Generally Accepted Accounting Principles (GAAP) to IFRS for U.S registrants Given the pace and breadth of financial reform legislation, it is clear that it is no longer “business as usual” on Wall Street and around the world for financial statement analysis and valuation Given the profound importance of financial reporting, financial statement analysis, and valuation, and given our rapidly changing world in accounting and the capital markets, this textbook provides a principled and disciplined approach to analysis and valuation This textbook demonstrates and explains a thoughtful and thorough six-step framework for financial statement analysis and valuation The effective analysis of a set of financial statements begins with an evaluation of (1) the economic characteristics and current conditions of the industries in which a firm competes, and (2) the particular strategies the firm executes to compete in each of these industries It then moves to (3) assessing how well the firm’s financial statements reflect the economic effects of the firm’s strategic decisions and actions This assessment requires an understanding of the accounting principles and methods used to create the financial statements, the relevant and reliable information that the financial statements provide, and the appropriate adjustments that the analyst should make to improve the quality of the information the financial statements provide In this text we embrace financial reporting and financial statement analysis based on U.S GAAP and IFRS—new for the seventh edition Next, the analyst (4) assesses the profitability and risk of the firm using financial statement ratios and other analytical tools, and then (5) forecasts the firm’s future profitability and risk, incorporating information about expected changes in the economics of the industry and the firm’s strategies Finally, the analyst (6) values the firm using various valuation methods, making an investment decision by comparing likely ranges of the value of the share to the share price observed in the capital market This six-step process forms the conceptual and pedagogical framework for this book, and it is a principled and disciplined approach to intelligent analysis and valuation All textbooks on financial statement analysis include step (4), assessing the profitability and risk of a company Textbooks differ, however, with respect to their emphases on the other five steps Consider the following depiction of these steps HLEN-09-1211-FM.qxd: 6/30/10 3:21 PM Page v LibraryPirate Preface (5) Forecasts of Future Profitability and Risk and (6) Valuation of Firms (4) Assessment of Profitability and Risk (1) Industry Economics and (2) Business Strategy (3) Accounting Principles and Quality of Accounting Information Our view is that these six steps must form an integrated endeavor for effective and complete financial statement analysis We have therefore structured and developed this book to provide balanced, integrated coverage of all six elements We sequence our study by beginning with industry economics and firm strategy, moving to a general consideration of GAAP and IFRS and the quality of accounting information, and providing a structure and tools for the analysis of profitability and risk We then delve more deeply into specific accounting issues and the determinants of accounting quality, and then conclude with forecasting and valuation We anchor each step in the sequence on the firm’s profitability and risk, which are the fundamental drivers of value We continually relate each part to those preceding and following it to maintain this balanced, integrated perspective The premise of this book is that you will learn financial statement analysis most effectively by performing the analysis on actual companies The book’s narrative sets forth the important concepts and analytical tools and demonstrates their application using the financial statements of PepsiCo Each chapter contains a set of questions, exercises, problems, and cases based primarily on financial statement data of actual companies Each chapter also contains an integrative case involving Starbucks so you can apply the tools and methods throughout the text A financial statement analysis package (FSAP) is available to aid in the analytical tasks (discussed later) MAJOR CHANGES IN THIS EDITION The most significant change in this edition is the addition of two excellent new coauthors, Stephen Baginski and Mark Bradshaw, to replace Clyde Stickney and Paul Brown Clyde Stickney, the original author of the first three editions of this book and coauthor of the fourth, fifth, and sixth editions, is enjoying his well-earned retirement Paul Brown, a coauthor of the fourth, fifth, and sixth editions, is now the Dean of the College of Business and Economics at Lehigh University Mark and Steve are both outstanding research scholars and award-winning teachers in accounting, financial statement analysis, and valuation They bring many fresh new ideas and insights to produce a new edition with a strong focus on thoughtful and disciplined fundamental analysis, a broad and deep coverage of accounting issues including IFRS, and expanded analysis of companies within a global economic environment The next section discusses the content of each chapter and the changes made in this edition Listed below are the major changes made in this edition that impact all chapters or groups of chapters v HLEN-09-1211-FM.qxd: 6/30/10 3:21 PM Page vi LibraryPirate vi Preface The chapters on accounting quality have been restructured to provide broader and deeper coverage of accounting for financing, investing, and operating activities The reorganization provides a logical flow of discussion across the primary business activities of firms in the natural sequence in which the activities occur—raising financial capital, investing that capital in productive assets, and operating the business Chapter discusses accounting for financing activities Chapter describes accounting for investing activities, and Chapter deals with accounting for operating activities Chapter describes how to evaluate accounting quality and adjust reported earnings and financial statements to cleanse low-quality accounting items The chapters on profitability analysis (Chapter 4) and risk analysis (Chapter 5) now also provide disaggregation of return on common equity along traditional lines of profitability, efficiency, and leverage, as well as along operating versus financing lines The book contains a new Appendix D with descriptive statistics on 24 commonly used financial ratios computed over the past eleven years as well as the most recent three years for 48 industries These ratios data enable you to benchmark your analyses and forecasts against industry averages Each chapter includes relevant new discussion of how U.S GAAP compares to IFRS, and how analysts should deal with such differences in financial statement analysis End-of-chapter materials contain many problems and cases involving nonU.S companies, with application of financial statement analysis techniques to IFRS-based financial statements Each chapter provides references to specific standards in U.S GAAP using the traditional citations (such as SFAS numbers) as well as the new FASB Codification system The chapters provide a number of relevant new insights from empirical accounting research, added because they are pertinent to financial statement analysis and valuation The end-of-chapter material for each chapter contains portions of an updated, integrative case applying the concepts and tools discussed in that chapter to Starbucks This series of cases builds on the illustrations in the chapter in which the concepts and tools are applied to PepsiCo Each chapter contains approximately 50 percent new or substantially revised and updated end-of-chapter material, including new problems and cases This is a doubling of the amount of new or revised material that appeared in the sixth edition, and this material is relevant, real-world, and written for maximum learning value The Financial Statement Analysis Package (FSAP) available with this book has been substantially revised and made more user-friendly OVERVIEW OF THE TEXT This section describes briefly the content of each chapter, indicating the major changes made since the previous edition Chapter 1—Overview of Financial Reporting, Financial Statement Analysis, and Valuation This chapter introduces the six interrelated sequential steps in financial statement analysis that serve as the organization structure for this book It presents several frameworks for understanding the industry economics and business strategy of a firm and applies them to PepsiCo It also reviews the purpose, underlying concepts, and content of each of the three principal financial statements, including those of non-U.S companies appearing in a different format It also contains a section with key provisions of the Sarbanes-Oxley Act of 2002 that are of particular relevance to the analyst Another new HLEN-09-1211-FM.qxd: 6/30/10 3:21 PM Page vii LibraryPirate Preface vii section provides the rationale for analyzing financial statements in capital market settings, including showing the results from an empirical study of the association between unexpected earnings and market-adjusted stock returns as well as various empirical results showing that fundamental analysis can help investors generate above-market returns The appendix presents an extensive discussion to help students a term project involving the analysis of one or more companies Our examination of the course syllabi of users of the previous edition indicated that most courses require students to engage in such a project This appendix should guide students in how to proceed, where to get information, and so on In addition to the new integrative case involving Starbucks, the chapter includes an updated version of a case involving Nike Chapter 2—Asset and Liability Valuation and Income Recognition This chapter covers three topics we believe our students need to review from previous courses before delving into the more complex topics in this book • First, we discuss the link between the valuation of assets and liabilities on the balance sheet and the measurement of income We believe that students understand topics such as revenue recognition and accounting for marketable securities, derivatives, pensions, and other topics more easily when they examine them with an appreciation for the inherent trade-off of a balance sheet versus income statement perspective A new aspect of this chapter to the seventh edition is that it reviews the trade-offs faced by accounting standard setters, regulators, and corporate managers who attempt to simultaneously provide both reliable and relevant financial statement information We also examine whether firms should recognize value changes immediately in net income or delay their recognition, sending them temporarily through other comprehensive income Second, we present a framework for analyzing the dual effects of economic transactions and other events on the financial statements This framework relies on the balance sheet equation to trace these effects through the financial statements: • ABEG ϭ LBEG ؉ΔA ؉ΔL AEND ϭ LEND ؉ CCBEG ؉ AOCIBEG ؉ΔStock ؉ CCEND ؉ REBEG ؉ ؉NI ؊D REEND ؉OCI ؉ AOCIEND This framework manifests itself in how we present transactions in the text; for example: Assets Cash Land = Liabilities CC Shareholders’ Equity AOCI ϩ300,000 Ϫ210,000 Cash Land Gain on Sale of Land Assets Cash + 300,000 210,000 90,000 = Liabilities + CC Shareholders’ Equity AOCI Ϫ36,000 Income Tax Expense Cash RE Gain on Sale of Land ϩ90,000 (0.40 ϫ [300,000 Ϫ 210,000]) 36,000 36,000 RE Income Tax Expense Ϫ36,000 HLEN-09-1211-FM.qxd: 6/30/10 3:21 PM Page viii LibraryPirate viii Preface • Even students who are well grounded in double-entry accounting find this framework helpful in visually identifying the effects of various complex business transactions, such as corporate acquisitions, derivatives, and leases We use this framework in subsequent chapters as we discuss various GAAP topics Third, we discuss the measurement of income tax expense, particularly with regard to the treatment of temporary differences between book income and taxable income Virtually every business transaction has income tax consequences, and it is crucial that analysts grasp the information conveyed in income tax disclosures Delaying consideration of the income tax consequences until later in the text hinders effective coverage of such topics as restructuring charges, asset impairments, depreciation, and leases The end-of-chapter materials include various new asset and liability valuation problems involving Walmart, Biosante Pharmaceuticals, Prepaid Legal Services, and Nike, as well as an integrative case involving Starbucks Chapter 3—Income Flows Versus Cash Flows: Understanding the Statement of Cash Flows Chapter reviews the statement of cash flows and presents a model for relating the cash flows from operating, investing, and financing activities to a firm’s position in its product life cycle The chapter demonstrates procedures for preparing the statement of cash flows when a firm provides no cash flow information The chapter also addresses EBITDA (earnings before interest, taxes, depreciation, and amortization), which is becoming increasingly widely used by analysts of financial statements We describe the differences between EBITDA and cash flow from operations The chapter also provides new insights that place particular emphasis on how to use information in the statement of cash flows to assess earnings quality The end-of-chapter materials utilize cash flow and earnings data for a number of companies including eBay, Amazon, The Walt Disney Company, Fedex, Kroger, Coca-Cola, Texas Instruments, Sirius XM Radio, Sunbeam, AerLingus, and Fuso Pharmaceuticals A case (Prime Contractors) illustrates the relation between earnings and cash flows as a firm experiences profitable and unprofitable operations and changes its business strategy The classic W T Grant case illustrates the use of earnings and cash flow information to assess solvency risk and avoid bankruptcy Chapter 4—Profitability Analysis This chapter discusses the concepts and tools for analyzing a firm’s profitability, integrating industry economic and strategic factors that affect the interpretation of financial ratios It then applies these concepts and tools to the analysis of the profitability of PepsiCo The analysis of profitability centers on the rate of return on assets and its disaggregated components, the rate of return on common shareholders’ equity and its disaggregated components, and earnings per share The chapter contains a section on the well-publicized measurement of EVA (economic value added) and shows its relation to net income under GAAP This chapter also considers analytical tools unique to certain industries, such as airlines, service firms, and financial institutions A number of new problems and exercises at the end of the chapter cover profitability analyses for companies such as Nucor Steel, Boston Scientific, Valero Energy, Microsoft, Oracle, Dell, Sun Microsystems, Texas Instruments, Hewlett Packard, Georgia Pacific, General Mills, Abercrombie & Fitch, Hasbro, Coca-Cola and many others The integrative case on Starbucks involves analysis of Starbucks in both a time-series setting and in a crosssectional setting in comparison to Panera Bread Company Another case involves the timeseries analysis of Walmart Stores and the cross-sectional analysis of its profitability versus Target and Carrefour E-WAHLEN-09-1211-Appendix D.qxd:CHE-WAHLEN-09-1211 6/30/10 3:19 PM Page 1246 LibraryPirate 1246 Appendix D Financial Statement Ratios: Descriptive Statistics by Industry and by Year 1998–2008 Wholesale Stock Return Market-to-Book Price-Earnings Profit Margin for ROA Total Asset Turnover ROA Profit Margin for ROCE Capital Structure Leverage ROCE Gross Profit Margin SG&A Percentage Operating Income Margin Days Receivable Days Inventory Days Payables Days Revenues in Cash Revenue Growth Earnings Growth Assets Growth Current Ratio Long-Term Debt to Common Equity Interest Coverage Ratio Liabilities to Equity Operating Cash Flow to Current Liabilities 25th Percentile Median 75th Percentile 2008 Median 2007 Median 2006 Median –0.338 0.810 9.000 –0.004 1.320 –0.017 –0.013 0.009 1.392 14.175 0.020 2.041 0.046 0.012 0.434 2.488 21.446 0.046 3.019 0.083 0.035 –0.482 0.992 10.118 0.020 2.155 0.051 0.014 0.030 1.774 14.967 0.029 2.094 0.059 0.022 0.105 1.896 16.811 0.031 2.110 0.061 0.024 1.819 –0.038 0.117 0.089 2.489 0.096 0.203 0.161 3.570 0.180 0.305 0.250 2.260 0.106 0.193 0.142 2.291 0.125 0.187 0.140 2.296 0.133 0.192 0.144 0.005 29.745 26.816 26.470 2.139 –0.044 –0.596 –0.061 1.236 0.029 43.500 52.592 39.168 5.842 0.075 0.106 0.055 1.687 0.065 56.904 88.476 57.219 20.494 0.211 0.656 0.192 2.481 0.032 41.527 43.058 36.733 7.380 0.064 –0.126 0.011 1.763 0.041 41.224 48.238 41.556 6.134 0.079 0.123 0.072 1.824 0.040 41.543 49.354 40.153 6.714 0.095 0.232 0.089 1.764 0.159 –0.028 0.753 0.450 2.782 1.426 1.056 8.564 2.565 0.438 3.208 1.245 0.345 4.675 1.241 0.333 4.757 1.228 –0.028 0.082 0.196 0.113 0.100 0.094 E-WAHLEN-09-1211-Index.qxd: 6/30/10 3:21 PM Page 1247 LibraryPirate Index A Abbott Labs, 1032–1033 ABC Corporation, 144–145 Abercrombie & Fitch industry characteristics, 65 profitability ratios, 319–322 risk ratios, 402 abnormal earnings, 297, 1013, 1046 academic research, 1077–1084 Accenture Ltd., 293–294 Accor, 67 Accounting and Corporate Regulatory Authority (ACRA), 347 accounting classification differences, 753–754 accounting data adjustments, summary of, 752 accounting differences, 1065–1066 accounting information, relevance and reliability of, 102 accounting method, leases, 488–489 accounting principles, 18–19 See also generally accepted account principles changes, 741–745 Accounting Principles Board (APB) Opinion No 20, 742–743 Opinion No 25, 450 accounting quality, 730–735 defined, 730 derivative instruments and, 698–699 earnings persistence over time, 734–735 economic information content, 731–734 accounting system, intent of, 100 accounts payable, 657 accrued expenses and, 172 classifying changes in, 189 projecting, 820 accounts receivable, 171, 377, 649 classifying changes in, 186 projecting, 813–814 accounts receivable turnover, 285–287 accrual basis of accounting, 29–30 in bankruptcy prediction, 388 accruals, 195–197 income-decreasing, 196–197 income-increasing, 196–197 accumulated depreciation, classifying changes in, 189 accumulated non-owner equity account changes, 32 accumulated other comprehensive income (AOCI), 32, 457 classifying changes in, 191 accumulated other comprehensive loss, 32 projecting, 829 acquisition costs, 525–537 adjusted, 104 allocation of, 537–541 historical value of, 103 acquisition method, 566 acquisition reserves, 571–573 acquisitions, 565, 570–576, 605–606 See also joint ventures case studies, 627–629 actual return on plan assets, 675 additional paid-in capital, classifying changes in, 191 Adelphia, 730 adjusted acquisition cost, 526 Adobe Systems, 529–531 advertising costs, 658 Aer Lingus, 213–214 agriculture industry, financial statement ratios, 1199 Ahold, 393 AIG, 393, 730 aircraft industry, financial statement ratios, 1200 airliners, analyzing to supplement ROA in profitability analysis, 292–293 Airtran Holdings, Inc., 292–293, 489 AK Steel, 312–313 Alford, Andrew W., 1072 all-current translation method, 592 Alliance One International, 741 Allied Irish, 393 allowance method, 659–660 allowance or reserve for loan losses, 660 Allstate Insurance, 65 alternative share-based compensation cash-settled share-based plans, 455–456 restricted stock and RSUs, 454–455 Altman, Edward, 383, 388, 391 Altman’s bankruptcy prediction model, applied to W.T Grant Company, 386, 387 Altman’s Z-score, 383–384 Amazon.com, 64, 368 American Airlines current replacement cost accounting, 109 historical value of adjusted acquisition cost, 104 maintenance and repair costs, 531 profitability ratios, 292–293 Amgen Inc., 70, 528 Amoco Enterprises, 212 amortizable intangible assets, 524 projecting, 818 amortization, 658 EBITDA, 182–183, 945, 950 amortized cost, 468 Analog Devices, 375 analytical framework, 133–138 See also profitability analysis; risk analysis Anderson, Robert H., 228 annual report to shareholders, 55 AOL, revenue recognition criteria, 637–638 APB See Accounting Principles Board (APB) Apparel industry, financial statement ratios, 1201 Apple Inc accounting principles changes, 744–745 restated financial statement data, 753 Arise Technologies Corporation, 159–161 Arizona Land Development Company case studies, 713–727 income recognition at time of sale, 717 income recognition using installment method, 717 income recognition using percentageof-completion method, 717–727 asset quality index (AQI), 394–395 asset retirement obligation, 534 asset turnover accounts receivable turnover, 285–287 analyzing total, 285–290 fixed asset turnover, 288–289 inventory turnover, 287–288 other ratios, 289 summary of analysis, 290 summary of ROA analysis, 290 trade-offs between profit margin and, 273–276 asset valuation, 101–111, 120–121 assets See also intangible assets book basis of, 661 classification of, 24 financial, 943–945 operating, 943–945 recognition of, 22–23 tax basis of, 661 that vary as percentage of total assets, projecting, 819 valuation methods for various, 111 valuation of, 23 assets turnover, 266 Assurance Opinion, 40 automobiles and trucks industry, financial statement ratios, 1202 Autorité des Marchés Financiers (AMF), 347 available for sale securities, 552–558 average accumulated expenditures, 532–533 average industry ratios, 306 avoidable interest, 532–533 B Bain Capital, LLC, 375 balance sheet, 19–27 and net income, cash flow relations, 155–183 assessing quality of, 26–27 assets, 22–24 balancing, 832–835 changes in accounts, 26 economic value changes recognized on, 112–120 E-WAHLEN-09-1211-Index.qxd: 6/30/10 3:21 PM Page 1248 LibraryPirate 1248 Index liabilities, 24–25 projecting operating assets and liabilities on, 804–822 shareholders’ equity valuation and disclosure, 25–26 solving for co-determined variables, 834–835 balance sheet accounts, classifying changes in, 186–191 balance sheet approach, 127–129 balance sheet reports, 40 Ball, Ray, 1005, 1077 Banana Republic, 56 banking industry, financial statement ratios, 1203 bankruptcy Altman’s prediction model, applied to W.T Grant Company, 386, 387 case study, 226–245 chapter 11, 381 chapter 7, 381 Chrysler, 381 Circuit City, 381 Eddie Bauer, 381 General Motors, 381 IndyMac Bancorp, 380 Jolt Company, The, 381 Lehman Brothers, 380 process, 380–381 remote, 588 risk, 350–351 risk analysis, 380–391 Saab Automobile, 381 Simmons Bedding, 381 Tribune Group, 381 W T Grant Company, 226–245, 374 Washington Mutual, 381 bankruptcy prediction, 386–388 synthesis of research, 388–391 bankruptcy prediction models, 381–388 stability over time, 388 using logit analysis, 385 using multiple discriminant analysis (MDA), 383 Bartczak, 388 Beaver, William, 381 Bed and Breakfast (B&B), 604–605 beer and liquor industry, financial statement ratios, 1204 beginning-of-the-year balances, 681 Begley, Joy, 388 benefit element, 450 benefit payments, 675, 676 Beneish, Messod D., 394 Beneish’s model, applied to Sunbeam Corporation, 396–398 Bernard, Victor I., 1058, 1080–1082 Best Buy, 65, 133, 405–406 Bhojraj, Sanjeev, 1072 Biogen Idec, 214–216, 527 Biosante Pharmaceuticals, 143–144 Blackboard Inc., statement of cash flow adjustments, 175–177 Black-Scholes model, 451 bonds issued with detachable warrants, 477 book basis of assets, liabilities, and tax loss carryforwards, 661 book value method, 475 of shareholders’ equity, 440 per share, 459 bottling equity income, 278–279 Bowne & Co., 737–739, 751 Bradshaw, Mart T., 258 brand name value Campbell’s Soup, 273 General Mills, 273 most valuable resource, 23 brand recognition, 10, 15–16 bridge loan, 954 Bridgman, Peter A., 1123, 1124 Brinker International, 328–329 broker dealers industry, financial statement ratios, 1205 Brown, Philip, 1005, 1077 Business & Company Resource Center, 59 Business services industry, financial statement ratios, 1206 business strategy, 275–276 business supplies industry, financial statement ratios, 1207 buyer power, 12 C Cadbury Schweppes, 1062 Campbell’s, 157 brand name value, 273 Canadian National Railway Company (CN), 705 candy and soda industry, financial statement ratios, 1208 capacity for debt, credit risk analysis, 378–379 capital in excess of par value, projecting, 827 capital lease method, 486–488 capital leases See also leases accounting for operating leases as, 493 converting operating to, 490–492 capital market efficiency, defined, 1079–1080 capital market, role of financial statement analysis in, 52–53 capital stakeholders, free cash flows for all debt and equity, 948–949, 956–957 capital structure EPS calculation and, 250–252 leverage, 300–302 CAPM (capital asset pricing model), 391, 889–894 , 932–933 evaluating use of to measure cost of equity capital, 895–896 Cardinal Health, 71 Caribou Coffee Company, Inc., 77 Carnival Corporation, 64 Carrefour, 67, 337–344, 637–638 Carroll, Thomas J., 119 case studies Arizona Land Development Company, 713–727 Citigroup Inc (Citi), 773–782 Coca-Cola, 728 Fly-by-Night International Group (FBN), 418–428 Holmes Corporation, 990–1003 Lufthansa Airlines, 513–521 Massachusetts Stove Company, 412–418, 875–883 Millennial Technologies, 428–438 Nike, 85–95 Oracle Corporation, 510–513 Prime Contractors, 224–226 Southwest Airlines, 513–521 Starbucks, 71–85, 150–152, 222–224, 330–334, 411–412, 509, 618–627, 712–713, 769–773, 862–875, 926–927, 988–990, 1039–1040, 1094–1096 W T Grant Company, 226–245 Wal-mart Stores, 334–344 Casey, 388 cash flow hedge, 688, 693–697 cash flow vs accrual variables in bankruptcy prediction, 388 cash flows See also statement of cash flows classification of, 34–36 credit risk analysis, 376–377 CVS Caremark, 166–168 financing, 34 from operations and net income, cash flow relations between, 179–181 investing, 34 operating, 34 to investor vs cash flows to firm, 935–937 cash flows financial ratios, 376 cash flows in projected financial statements, 376–377 cash flows relations among net income and balance sheets, 155–183 among operating, investing, and financing activities, 156–164 Arise Technologies Corporation, 159–161 between cash balances and net cash flows, 164–165 between net income and cash flow from operations, 179–181 Exxon Mobil Corporation, 161–162 General Motors, 162–164 PepsiCo, 156–159, 164–165 cash generating unit, 543 cash, marketable securities, accounts receivable/operating, expenses excluding depreciation, depletion and amortization, 382 cash operating cycle, 367 cash, projecting, 807–811 cash-flow-based valuation models, 954–957 rationale for, 930–931 cash-settled share-based plans, 455–456 cash-to-cash cycle, 367 CEO (chief executive officer), 393 E-WAHLEN-09-1211-Index.qxd: 6/30/10 3:21 PM Page 1249 LibraryPirate Index Cephalon, Inc., statement of cash flow adjustments, 177–178 Chalfont, Inc., acquisitions, 605–606 chapter 11 bankruptcy, 381 See also bankruptcy chapter bankruptcy, 381 See also bankruptcy character of management, 379 chemicals industry, financial statement ratios, 1209 Chen, Kevin C W., 391 ChevronTexaco, 214–216 Chicago Mercantile Exchange, 108, 116 Choice Hotels, 325, 327 Chrysler, 381 Church, Bryan K., 391 Circuit City, 381, 405–406 Cisco Systems, 64 Citigroup Inc., 64 case studies, 773–782 CitiCapital, 776 combined results for discontinued operations, 777–778 commissions and fees, 778–779 consolidated financial statements, 774–775 discontinued operations, 775–778 goodwill and intangible assets, 780–781 goodwill impairment, 781–782 interest revenue and expense, 778 principal transactions, 779–780 restructuring, 780 sale of asset management business, 776–777 sale of life insurance and annuities business, 777 clean surplus accounting, 908, 1012 coal industry, financial statement ratios, 1210 Coca-Cola Company balance sheets, 21, 46–47 brand recognition, 10, 15–16 case studies, 728 comparing financial statement ratios with other firms, 306 competitor in PepsiCo’s beverage segment strategy, 16–17, 1139 derivatives disclosures, 709–710 effects of accounting differences on PE ratios, 1065–1066 free-cash-flows-based valuation, 978–979 income statements, 28, 48 income tax disclosures, 710–712 investments in marketable equity securities, 605 market multiples, 1089, 1091–1092 off-balance-sheet brand equity, 1054 PE ratios comparisons among beverage companies, 1062 pensions, 728 Porter’s five forces classification framework, 11–13 profitability analysis, 252–253, 253–254, 254–255, 256 profitability ratios in cross-sectional setting, 320–325 residual income valuation, 1037–1038 risk ratios, 402–403 statement of cash flows, 37, 205, 206 stock-based compensation, 504–505, 507 strategy analysis framework, 15 co-determined variables, solving for, 834–835 collateral, 377–378 Collins, Daniel W., 100–101 commercial bank, 6, commitments made, cost of, 1008 committed fixed costs, 270 commodities, commodity prices, 347–350 common equity issuance, 441–444 common equity shareholders, 888, 955 common shareholders’ equity, 441 common stock classifying changes in, 191 projecting, 827 transactions, 1027–1029 common-size analysis, 253–254 common-size financial statements, 42–49 communication credit risk analysis, 380 industry, financial statement ratios, 1211 compensation, 658 competitive advantage, 2, 3–4 completed-contract method, 645 compound financing instruments, 474 comprehensive income, 31–32, 255–256, 1027 other items, 745–746 computers industry, financial statement ratios, 1212 conditions or covenants, credit risk analysis, 380 consolidated financial statements, 774–775, 1098–1101 consolidation of unconsolidated subsidiaries and affiliates, 581–584 construction industry, financial statement ratios, 1213 construction materials industry, financial statement ratios, 1214 consumer foods industry, PepsiCo’s positioning relative to, 276 consumer goods industry, financial statement ratios, 1215 contingencies, credit risk analysis, 379 contingent obligations, 25, 463–464 continuing dividends, projecting, 911–913 continuing free cash flows, 939 continuing value of future dividends, 911–915 of future free cash flows, 939–943 contracts See also leases executory, 25 unexecuted, 462–463 take-or-pay or throughput, 483 long-term, 641–646 controlling interests, 577 convertible debt, 474 convertible preferred stock, 474 1249 corporate acquisitions and income taxes, 581 corridor, 681 cost allocation method, 539–541 cost of capital, 932 factors causing PE ratios to differ across firms, 1065 cost of common equity capital, 889–894, 932–933 cost of debt capital, 896–897 cost of equity capital, evaluating use of CAPM to measure, 895–896 cost of goods sold, 279–280 projecting, 801–802 cost of preferred equity capital, 897 cost of sales, expense recognition, 650–652 cost-flow assumption, choice of, 656 cost-recovery methods, 647–649 coupon rate, 465 Covance, 70 credit cards, 286 credit history, credit risk analysis, 375 credit policy, 658–660 credit risk, 350–351 credit risk analysis, 374–380 capacity for debt, 378–379 cash flows, 376–377 character of management, 379 collateral, 377–378 communication, 380 conditions or covenants, 380 contingencies, 379 credit history, 375 loans, 374–375 cross-sectional analysis, 247 current accrued liabilities, projecting other, 820–821 current assets, 24 classifying changes in, 188 current assets/current liabilities, 382 current exchange rate, 590 current liabilities classifying changes in, 190 projecting, 821 current ratio, 363–364 current values, 103, 111 fair value, 106–108, 108–109, 109–110 CVS Caremark, 166–168 cyclicality of sales, 270–271 D damaged inventory, 656 data file, creating, 59–60 date of declaration, 444 date of payment, 444 date of record, 444 days revenues held in cash, 369–370 days sales in receivables index (DSRI), 394 debt See also long-term debt projecting short-term and long-term, 823–824 ratios, 371–372, 378 reducing, 471 service, 376 E-WAHLEN-09-1211-Index.qxd: 6/30/10 3:21 PM Page 1250 LibraryPirate 1250 Index debt financing, 459–473 accounting for troubled debt, 471–473 additional issues in, 474–484 application of criteria for liability recognition, 461–463 contingent obligations, 463–464 hybrid securities and, 474–478 long-term debt, 464–467, 467–468 measuring fair value, 468–471 off-balance-sheet financing arrangements and, 478–484 principles of liability recognition, 460 principles of liability valuation, 460–461 reducing debt, 471 Dechow, Patricia M., 113, 195, 393 Deere & Company, 706 defense industry, financial statement ratios, 1216 defensive interval, 370 deferred income taxes classifying changes in, 190 projecting, 822 deferred revenues, 649 deferred tax asset, 126, 661 deferred tax expense, 169 deferred tax liability, 661 defined benefit plan, 672–673 economic status of, 674–676 economics of pension accounting in, 673–682 gain and loss recognition, 681 impact of actuarial assumptions, 681–682 income statement effects, 679–681 pension assets, 673 pension expense calculation, 677–679 pension obligation, 673 reporting income effects in net income and other comprehensive income, 676–677 defined contribution plans, 672–673 degree of financial leverage, 392 degree of operating leverage, 302 Dell Inc., 311–312, 637, 1033–1034 Delta Air Lines, 403–404 demand, in economic attributes framework, 13, 14 depletion, 658 depreciable assets, 548 depreciation, 658 amortization expense and, 169 EBITDA, 182–183, 945, 950 index (DEPI), 395 derivative instruments, 684–699 accounting for, 687–697 cash flow hedges, 688 fair value hedges, 688 speculative investment, 687 treatment of hedging gains and losses, 688–689 accounting quality issues and, 698–699 disclosures related to, 697 nature and use of, 685–687 Deutsche Telekom, 68 development costs, 535–536 Dhaliwal, Dan, 119, 248 Dick’s Sporting Goods, 973–974, 975 Diedrich Coffee, 77 Dieter, R., 499 DIMON Inc., extraordinary gains and losses, 740–741 direct method, 166–168 dirty surplus accounting, 1025–1027 disaggregation of ROCE, 352–361 disclosures fair value, 468 income tax, 662–669 operating lease, 490–492 other risk-related, 350 pro forma, 450 regarding risk, 346–350 related to derivative instruments, 697 required, 449–453 discontinued operations, 736–739 discount rates, 932 for residual income, PepsiCo, 1020 PepsiCo, 958 discretionary fixed costs, 270 diseconomies of scale, 269 Disney, 15 distribution channels, domination of, 10 distributions to shareholders, 440 dividends, 444–447 share repurchases, 448–449 dividends, 444–447 cash flows, and earnings valuation, equivalence among, 887–888 continuing value of future, 911–915 defined, 1011 measuring, 907–909 projecting continuing, 911–913 residual income, and free cash flows value estimates, consistency in, 1029–1031 dividends in arrears, 442 dividends to investor vs cash flows to firm, 903–904 dividends valuation model, 905–907 continuing value of future dividends, 911–915 evaluation of, 920 implementing, 907–920 measuring dividends, 907–909 selecting a forecast horizon, 909–911 sensitivity analysis and investment decision making, 918–920 dividends-based valuation of common equity, Starbucks, 926–927 rationale for, 901–905 dividends-based valuation concepts, 902–905 dividends to investor vs cash flows to firm, 903–904 nominal vs real dividends, 904–905 single-asset firm, 902–903 Dodd, David, 255 domestic risks, 346 double-entry bookkeeping, 99 Dreyer’s Grand Ice Cream, Inc., 76 Dun & Bradstreet, 247, 306 Dunlap, Al, 396 E E I Du Pont de Nemours, 65 E.ON AG, 68 earnings, 27 See also net income; profit degree of market efficiency and inefficiency with respect to, 1080–1082 pro forma, adjusted, or street, 257–259 share prices and, 53–55 earnings before interest and taxes/total assets, 383 earnings management, 393, 757–759 boundaries of, 758–759 disincentives to practice, 758 incentives to practice, 757–758 earnings manipulation, 393 empirical research on, 393–396 motivations for, 393 earnings per common share (EPS), 50, 249–253 basic, 250 calculating, 250–252 criticisms of, 252–253 diluted, 251–252 earnings quality changes in accounting principles, 741–745 changes in estimates, 750 discontinued operations, 736–739 extraordinary gains and losses, 739–741 gains and losses from peripheral activities, 750–752 impairment losses on long-lived assets, 747 other comprehensive income items, 745–746 restructuring and other charges, 747–750 specific events and conditions that affect, 735–752 earnings valuation, 1004–1007 earnings-based valuation, 1009–1011 rationale for, 1007–1009 eBay, 64, 637 EBIAT (earnings before interest after taxes), 261 EBIT, 256 EBITDA (earnings before interest, tax, depreciation, and amortization), 182–183, 256, 945, 950 Eckerd Drugs, 313 economic attributes framework, 13–14 See also industry economic characteristics demand, 13, 14 investing and financing, 13, 14 manufacturing, 13, 14 marketing, 13, 14 supply, 13, 14 economic characteristics of business, 154 economic performance, 32–33 E-WAHLEN-09-1211-Index.qxd: 6/30/10 3:21 PM Page 1251 LibraryPirate Index economic position, 26–27 economic theory, 884–887 economic value added (EA), 298 economic value changes, 112–120 economies of scale, 269 Eddie Bauer, bankruptcy, 381 electric utility, 6, Electrical equipment industry, financial statement ratios, 1217 Electronic Computer Systems (ES), 616–617 electronic equipment industry, financial statement ratios, 1218 Eli Lilly and Company, 506–507 EMC Corporation, 749 empirical properties of PE ratios, 1069–1071 empirical research on earnings manipulation, 393–396 employee stock options, 169–170 employee-related costs, 170 employer contributions, 675 Enron Corporation, 39 earnings manipulation model, 408–409 financial reporting abuses, 730 financial reporting manipulation risk, 393 market multiples and reversedengineering share prices, 1089 misuse of SPEs, 479 entertainment industry, financial statement ratios, 1219 entity, use of another to obtain financing, 478–479 Environmental Protection Agency (EPA), 413 EPS See earnings per common share equity capital, cost of common, 932–933 equity financing, 440–459 accumulated other comprehensive income, 457 alternative share-based compensation, 454–455, 455–456 equity issued as compensation, 449 fair value method and required disclosures, 449–453 investments by shareholders, 441–444 net income, 456 reserves, 458 retained earnings, 456 equity issued as compensation, stock options, 449 equity method, 561 income, 170 equity shareholders, free cash flows for common, 949–950 equity valuation models, 885 Ericsson, 755–756 estimates, changes in, 750 exchange rate changes, effects of on operating results, 599–600 executory contracts, 25, 463 exercise date, 450 exercise price, 450 expected future dividends, 1007 expected future free cash flows, 1007 expected return, 345 on plan assets, 675 expense recognition, 649–661 accounting quality, 655–657 conversion from LIFO to FIFO, 653–655 cost of sales, 650–652, 655–657 criteria, 649–650 investment in working capital, 657 operating profit, 661 reporting changes in fair market value of inventory, 655 SG&A (selling, general, and administrative) costs, 657–660 Experian Information Solutions, valuing leveraged buyout candidate, 976 explicit interest, 265 exploration costs, 534 extraordinary gains and losses, 31, 739–741 Exxon Mobil Corporation, 161–162 F fabricated products industry, financial statement ratios, 1220 fair market value of inventory, reporting changes in, 655 fair value, 106–108 See also current value based on current replacement cost, 108–109 based on net realizable value, 109–110 disclosure, 468 hedges, 688, 689–693 measuring, 468–471 method and required disclosures, 449–453 option, 468 Fannie Mae, financial reporting manipulation risk, 393 FAS 142 Goodwill and Other Intangible Assets, 545–546 FASP, 60 FIFO (first-in, first-out), 650–651 conversion from LIFO to, 653–655 FIN 46R, 586, 589 Financial Accounting Standards Board accounting principles and, 18–19 asset and liability valuation and income recognition under, 120–121 Codification Topic 350, 543 Codification Topic 805, 565 Codification Topic 810, 565 Conceptual Framework, 114 definition of fair value, 106 Interpretation No 46, 608–609 Interpretation No 46R, 550, 561, 608 Interpretation No 47 (FIN 47), 769 SFAC No 1, 114 SFAC No 2, 102 SFAC No 5, 523, 632 SFAC No 6, 523 SFAS 159, 770 SFAS No 13, 227 1251 SFAS No 140, 480 SFAS No 141, 565, 770 SFAS No 141R, 565–567 SFAS No 142, 543 SFAS No 157, 107, 470, 567, 770 SFAS No 158, 676, 743 SFAS No 160, 565, 770–771 SFAS No 161, 697, 771 Statement No 52, 591 Statement No 87, 681 Statement No 95, 164 Statement No 109, 127, 540, 661 Statement No 123, 450–451, 689, 697, 1028 Statement No 143, 742–743, 769 Statement No 154, 742, 752, 755 Statement No 159, 461 financial assets (FA), 943–945 financial leverage, common equity capital and financial income items, projecting, 822–829 financial flexibility, 350–351, 352–361 financial leverage, 300–302 financial liabilities (FL), 943–945 financial reporting abuses, 730 manipulation risk, 350, 352, 393–398 of income taxes, 122–127 worldwide, 755–757 financial statement analysis building blocks for, of risk, 350–352 overview of, 2–5 role of in capital market, 52–53 six interrelated sequential steps, financial statement forecasts, 784 financial statement information sources, 55–56 financial statement ratios, 50–51, 1198–1246 comparisons with corresponding ratios of earlier periods, 305–306 interpreting, 304–306 interpreting, comparisons with corresponding ratios of other firms, 306 financial statements See also consolidated financial statements; quality of financial statements adjustments, 154 analyzing projected, 843–846 effects of transactions on, 132–138 examples of combined impacts of various events and transactions, 99 important information with, 36–40 managers’ and independent auditors’ attestations, 38–40 MD&A, 38 notes to, 36–38 preparing forecasts, 786–791 reading of, 59–60 reporting income taxes in, 130 Starbucks, 77–85 Financial Statements Analysis Package (FSAP), 5, 247 E-WAHLEN-09-1211-Index.qxd: 6/30/10 3:22 PM Page 1252 LibraryPirate 1252 Index financial statements forecasts analyzing projected financial statements, 843–846 balancing balance sheet, 832–835 forecasting principles, 786–787 projecting financial assets, financial leverage, common equity capital and financial income items, 822–829 projecting nonrecurring or unusual items, provision for income tax, and change in retained earnings, 829–832 projecting operating assets and liabilities on balance sheet, 804–822 projecting operating expenses, 800–804 projecting sales and other revenues, 792–800 projecting the statement of cash flows, 835–840 sensitivity analysis and reactions to announcements, 846–847 seven-step forecasting game plan, 787–791 shortcut approaches to forecasting, 840–843 using FSAP, 791 financing arrangements, inventory, 657 financing cash flows, 34 financing factors, bankruptcy prediction research, 389 financing, operating, and investing activities, cash flow relations among, 156–164 firm value, 4–5 projected by PE ratios from permanent earnings, 1062–1063 firm’s strategies, 2, 3–4, 15–17, 154 framework for strategy analysis, 15–16 firm’s value, 51–52, 62, 155 firm-specific risks, 346–347 First Call, 1005 first mover advantage, 15 fixed asset turnover, 288–289 fixed charges coverage ratio, 373 fixed costs committed, 270 discretionary, 270 Flight Training Corporation, 218–220 Fly-by-Night International Group (FBN) case studies, 418–428 notes to financial statements, 423–428 food products industry, financial statement ratios, 1221 Ford Credit, 587–589 Ford Motor Company, 120, 587–589 Ford Motor Credit Company, 501–502 forecast horizon, selecting, 909–911, 938–939 forecasted financial statements, 4, 51, 61–62, 155 forecasting financial statements, 786, 787–791, 840–843 introduction to, 784–786 principles, 786–787 projected sales and income approach, 841 projected total assets approach, 841–843 statement of cash flows, tips for, 835–836, 836–840 techniques, operating assets and liabilities on balance sheet, 811–812 foreign currency is functional currency, 592–595 foreign currency translation, 589–600 functional currency concept, 590–592 income taxes and, 599 translation methodology, 592–599 foreign exchange, 349 adjustment, 590 Forest, Mark, 413 Form 10-K report, 55, 58–59 Form 10-Q quarterly report, 55 Fortis, 68–69 framework for strategy analysis, 15–16 application of to PepsiCo’s beverage segment, 16–17 degree of geographical diversification, 15 degree of industry diversification, 15–16 degree of integration in value chain, 15 nature of product or service, 15 Frankel, Richard, 885, 1082–1084 free cash flows, 887, 931 for all debt and equity capital stakeholders, 948–949, 956–957 for common equity shareholders, 949–950, 955 framework for, 943–945 measuring periodic, 943–954 pretax vs after-tax, 938 realization approach, 1008 free cash flows measurement, 945 alternative starting pints, 950–853 free cash flows for all debt and equity capital stakeholders, 948–949 free cash flows for common equity shareholders, 949–950 statement of cash flows as starting point, 945–947 which should be used, 953–954 free cash flows measures valuing asset acquisition, 953–954 valuing equity shares, 954 valuing leveraged buyout, 954 free cash flows valuation method, evaluation of, 971 free cash flows valuation of common equity, Starbucks, 988–990 free cash flows value estimates, residual income, and dividends, consistency in, 1029–1031 free-cash-flows-based valuation concepts, 931–943 cash flows to investor vs cash flows to firm, 935–937 computing continuing value of future free cash flows, 939–943 computing weighted average cost of capital, 933 cost of common equity capital, 932–933 free cash flows valuation examples for single-asset firm, 933–935 nominal vs real cash flows, 937–938 pretax vs after-tax free cash flows, 938 risk, discount rates, and cost of capital, 932 selecting forecast horizon, 938–939 Frito-Lay North America (FLNA), 8, 793, 1136, 1152 degree of industry diversification, 17 sales growth, 795–796 FSAP See Financial Statements Analysis Package full costing, 534–535 functional currency concept, 590–592 fundamentals-driven valuation process, 1042 Fuso Pharmaceutical Industries, 216–218 future earnings, 1061 future free cash flows, computing continuing value of, 939–943 G GAAP See generally accepted accounting principles (GAAP) gain and loss recognition, defined benefit plan, 681 gains and losses, 170 from peripheral activities, 750–752 nonrecurring operating, 804 Gale Business & Company Resource Center, 58 Gap Inc., 56, 208–209, 503–504 General Dynamics Corporation, 765–769 General Electric Company (GE), 507–508 General Mills, brand name value, 273, 314–315 General Motors Corporation (GM), 162–164, 381, 651–652 generally accepted accounting principles (GAAP), 2, 18, 440 fair value estimates under, 107 mixed attribute accounting model, 101–102 summary of valuations under, 110–111 unrealized gains and losses, 117–118 Genzyme Corporation, 527 geographical diversification, degree of, 15 Georgia-Pacific Corporation, 314–315 gift cards, delayed revenue recognition, 640 Global Business Browser, 58 Global Crossing, 39, 393, 638, 730 Goldman Sachs, 64 Goodman, Richard, 1123, 1124 goodwill, 537 and nonamortizable intangible assets, projecting, 818 impairment of, 543–546 E-WAHLEN-09-1211-Index.qxd: 6/30/10 3:22 PM Page 1253 LibraryPirate Index Google, 110 Graham, Benjamin, 255 grant date, 449 Grant See W T Grant Company Graybar Electric, 109 grocery store chain, 5, gross margin index (GMI), 394 growth bankruptcy prediction research, 390 factors causing PE ratios to differ across firms, 1066 PE ratio measurement issues, 1069 GTI, Inc., 220–222 guarantee, 464 H H J Heinz, 214–216, 760–762 Hall, W K., 275 Hartford Financial Services Group, revenue recognition criteria, 635–636 Harvard Industries, 406–407 Hasbro, 315–319, 401–402 Healthcare industry, financial statement ratios, 1222 HealthSouth, financial reporting abuses, 730 Healy, Paul M., 757 hedging gains and losses, treatment of, 688–689 held-to-maturity investments in debt securities, 558 Herrmann, Don, 756–757 Hewlett-Packard Corporation (HP), 65, 313 Hill, Chuck, 257 historical earnings, 1061 historical exchange rate, 590 historical interest rate, 460 historical values, 102, 111 acquisition cost, 103 adjusted acquisition cost, 104 initial present value, 105–106 Hitachi Ltd., statement of cash flow adjustments, 172–173 Hodder, Leslie D., 119 Holmes Corporation case studies, 990–1003 LBO valuation, 990–1003 Home Depot, 105–106, 114, 214–216, 310 Hopkins, Patrick E., 119 Hopwood, William, 390 HSBCF Finance, 65 Hung, Mingyi, 121 hybrid securities, 474–478 I I/B/E/S, 1005 IASB (International Accounting Standards Board), 440 accounting principles and, 18–19 asset and liability valuation and income recognition under, 120–121 definition of fair value, 107 IAS 2, 1028 IAS 7, 164 IAS 12, 127 IAS 39, 461 IBM, 104, 529–531, 922–923, 1032–1033 IFRS (International Financial Reporting Standards), 2, 18, 440 fair value estimates under, 107 IAS 1, 442 IAS 36, 543 IAS 39, 472 IFRS No 3, 565 IFRS No 7, 107 mixed attribute accounting model, 101–102 summary of valuations under, 110–111 treatment of upward asset revaluations, 546–548 unrealized gains and losses, 117–118 impairment and restructuring charges, 171, 262–263 impairment losses on long-lived assets, 747 implicit interest, 265 income components of before taxes, 663–664 from continuing operations, 30–31 from discontinued operations, 31 income recognition, 111–121, 717–727 case studies, 713–727 summary of, 120–121 income statement, 27–41 approach, 127–129 accrual basis of accounting, 29–30 assessing quality of earnings, 32–33 classification and format in, 30–31 comprehensive income, 31–32 economic value changes recognized on, 112–120 effects, defined benefit plan, 679–681 income tax disclosures, 662–669 income tax expense components of, 662–663 measuring, 127–129 income taxes, 121–131, 280–281, 661–672 assessing a firm’s tax position, 669–670 overview of financial reporting of, 122–127 projecting provision for, 829, 830 reconciliation of at statutory rate, 664–669 reporting in financial statements, 130 required income tax disclosures, 662–669 review of accounting, 661–662 income taxes payable, 172, 821 indirect method adjustments, 168–179 indirect method, 166–168 industry characteristics and bankruptcy prediction, 386 industry diversification, degree of, 15–16 industry economic characteristics, 2, 3, 5–7 commercial bank, 6, electric utility, 6, grocery store chain, 5, 1253 industry economics, tools for studying, 10–13, 13–14 pharmaceutical company, industry economics company strategies and, 58–59 tools for studying, 7–14 industry risks, 346 IndyMac Bancorp, bankruptcy, 380 Inland Steel, 214–216 In-N-Out Burger, 103, 115, 134–135 Inoue, Tatsuo, 756–757 installment methods, 646, 647–649 installment sales, revenue recognition methods for, 647 in-substance defeasance of debt, 471 Insurance industry, financial statement ratios, 1223 intangible assets classifying changes in, 189 costs of acquiring, 536–537 impairment of, 543 intangibles, 24, 378 Intel, 12, 375, 764–766, 1033–1034 intercompany loans and receivables, 576 intercompany payable and receivables, 577 intercompany sales and purchases, 576 interest See also variable-interest entity (VIE) avoidable, 532–533 controlling, 577 EBITDA, 182–183, 945, 950 explicit, 265 historical rate, 460 implicit, 265 minority, 260 projecting minority, 827 interest coverage ratios, 372–373, 379 interest expense, projecting, 824–825 interest income, projecting, 825–826 interest on PBO, 674 interest rates, 349–350, 1119 interest revenue, 279 interest rate swaps, 1117–1118 Internal Revenue Service (IRS), 262 International Accounting Standards Board See IASB International Financial Reporting Standards See IFRS International Paper Company (IP), 502–503 international risks, 346 Interpublic Group, 69 intrinsic value method, 450 inventories, 23, 171, 377 classifying changes in, 188 obsolete or damaged, 656 projecting, 814 rapid turnover and price stability, 656 reporting changes in fair market value of, 655 inventory and accounts payable, 657 inventory financing arrangements, 657 inventory turnover, 287–288 investing and financing, in economic attributes framework, 13, 14 E-WAHLEN-09-1211-Index.qxd: 6/30/10 3:22 PM Page 1254 LibraryPirate 1254 Index investing cash flows, 34 investing, operating, and financing activities, cash flow relations among, 156–164 investment decision making, 918–920, 967–970, 1025 investment factors, bankruptcy prediction research, 389 investment in working capital, 649, 657 investments, 24 in long-lived operating assets, 524–549 in noncontrolled affiliates, 670–671, 815 investments by shareholders, 440 distributions to shareholders, 444–447 investments in securities, 549–589 classifying changes in, 188–189 income tax consequences of, 589 percentage of ownership, 550–581 Iomega Corporation, 749 J JCPenney, 226–227, 313–314 JetBlue, profitability ratios, 292–293 Johnson & Johnson, 64, 70 joint ventures, 585 See also acquisitions Jolt Company, The, bankruptcy, 381 JPMorgan Chase, historical value of adjusted acquisition cost, 104 K Kellogg’s, 64 Kelly Services, 65, 325, 326 Kendrick, James G., 228–229 Kimpton Hotels, 117, 121, 108 Kmart, 227 Kohlberg Kravis Roberts & Co., 375 Kraft Foods, 76 Kroger, 1034 L lagged or trailing-twelve-months earnings per share, 1060 Landsittel, D., 499 Latin America Foods (LAF), 8, 17, 797, 1137, 1153–1154 LBO (leveraged buyout), 954 valuation, case studies, 990–1003 leases, 484–493 See also capital leases; joint venture capital lease method, 486–488 choosing the accounting method, 488–489 converting operating to capital, 490–492 impact of accounting for operating leases as capital leases, 493 operating lease method, 485–486 Lee, Charles M.C., 885, 1072, 1082–1084 Lehman Brothers, 380 Lev, Baruch, 295 leverage index (LVGI), 395 Lexington Corporation, 605–606 liabilities book basis of, 661 classification of, 25 classifying changes in noncurrent, 190 classifying changes in current, 190 deferred tax, 661 financial, 943–945 operating, 804–822, 943–945 recognition of, 24–25 tax basis of, 661 valuation methods for various, 111 valuation of, 25 liabilities to assets ratio, 371 liabilities to shareholders’ equity ratio, 371 liability (actuarial) gains and losses, 675 liability recognition additional issues in, 474–484 application of criteria for, 461–463 hybrid securities and, 474–478 off-balance-sheet financing arrangements and, 478–484 principles of, 460 liability valuation, 101–111 principles of, 460–461 summary of, 120–121 LIFO (last-in, first-out), 650–651 conversion from, to FIFO, 653–655 LIFO adopters, characteristics of, 652 LIFO inventory layers, liquidation of, 656 LIFO layer liquidation, 651–652 LIFO liquidation, 651–652 LIFO reserve, 653 Limited Brands, 503–504 limited-life intangible assets, useful life for, 538–539 Linear Technology, 375 Linsmeier, Thomas J., 119 liquidating dividends, 445 liquidation of LIFO inventory layers, 656 liquidity risk analysis, short term, 361–370 current ratio, 363–364 days revenues held in cash, 369–370 operating cash flow to current liabilities ratio, 365 quick ratio, 364–365 revenues to cash ratio, 368–369 working capital turnover ratios, 365–368 loan losses, allowance or reserve for, 660 loans in credit risk analysis, 374–375 National Semiconductor, 375 Toys“R”Us, 375 Wal-Mart Stores, 375 logit analysis, bankruptcy prediction models using, 385 long-lived assets impairment losses on, 747 impairment of, 541–543 relationship between book values and market values, 541–548 replacement, 548–549 long-lived operating assets, investments in, 524–549 long-lived resources consumed, 1008 long-lived tangible assets, useful life for, 538–539 long-run negative growth, 1077 long-term contractors, choice of reporting method by, 645–646 long-term contracts, revenue recognition under, 641–646 long-term debt classifying changes in, 190 fair value disclosure and fair value option, 468 financial reporting of, 467–468 financing with, 464–467 projecting, 823–824 long-term debt to long-term capital ratio, 371 long-term debt to shareholders’ equity ratio, 371 long-term liquidity risk, 350–351 long-term solvency risk analysis, 370–374 case studies, 513–521 debt ratios, 371–372 interest coverage ratios, 372–373 operating cash flow to total liabilities ratio, 373–374 loss contingency, 463 losses, gains and, 170 low-cost leadership, 15, 275–276 Lufthansa Airlines case studies, 513–521 long-term solvency risk, 513–521 Lustenberger, Louis C., 227 M machinery industry, financial statement ratios, 1224 Macy’s, operating profitability, 310 Majesco Entertainment Company, 132–133 majority, active investments, 564–581 Management Assessment, 39 managers’ and independent auditors’ attestations, 38–40, 41 mandatorily redeemable preferred stock, 474 manufacturing firm, operating cycle for, 29 manufacturing, in economic attributes framework, 13, 14 market beta, 890 market efficiency and inefficiency with respect to earnings, degree of, 1080–1082 market equity beta adjusting to reflect new capital structure, 894–895 risk, 391–392 market equity risk, 350, 352 market multiples, 1043, 1089, 1089–1091, 1091–1094 of accounting numbers, 1044–1045 of comparable firms, using, 1072 market price, 450 per share, 459 market value, 1043 method, 475 market value of equity/book value of liabilities, 383 E-WAHLEN-09-1211-Index.qxd: 6/30/10 3:22 PM Page 1255 LibraryPirate Index marketable securities, 377 classifying changes in, 186–188 projecting, 812–813 marketing costs, 658 marketing, in economic attributes framework, 13, 14 market-to-book ratios See MB ratios Marks & Spencer, 69 mark-to-market accounting, 107 adjustments, 263 Marvel Entertainment, 406–407 Walt Disney Company acquisition of, 627–629 Massachusetts Stove Company (MSC) bank lending decision, 412–418 case studies, 412–418, 875–883 equity of privately held firm, 977–978 gas appliance market, 875–876 notes to financial statements, 418 valuing equity of privately held firm, 924–925 woodstove market, 875 Massey Ferguson, historical value of initial present value, 106 Mather, Douglas C., 418 Maxim Integrated Products, 375 May Department Stores (May), 974–976 Maydew, Edward L., 100–101 Mayer, Richard W., 227, 228 MB (market-to-book) ratios, 103, 459, 1043, 1045–1051 and VB ratios may differ from 1, reasons why, 1054–1056 articulation of PE ratios and, 1070–1071 empirical data on, 1056 empirical research results on predictive power of, 1056–1058 McDonalds, 12, 65, 75, 77, 157, 328–329 McKeown, James C., 390 MD&A (management discussion and analysis), 38, 41 MEAA (Middle East, Africa & Asia), 1137, 1156 measuring and control equipment industry, financial statement ratios, 1225 medical equipment industry, financial statement ratios, 1226 Merck, 65, 481–483 MGM Mirage, effect of industry characteristics on financial statement relationships, 64 microeconomic theory, 273–275 Microsoft Corporation, 12, 137–138 accounts receivable turnover ratios, 310–311 computing residual income, 1033–1034 delayed revenue recognition, 640–641 economic value changes, 119–120 excess cash, 354 income tax exposure, 122 software development costs, 529–531 MicroStrategy, Inc., 200–202, 640, 636–637 Millennial Technologies case studies, 428–438 financial statement irregularities, 429–431 industry and products, 428–429 Ming, Jin, 388 minority active investments, 561–564 passive investments, 550–560 minority interest, 260, 577 projecting, 827 mixed attribute accounting model, introduction to, 97–101 Mollydooker Wines, 103, 115, 135 Molson Coors Brewing Company, 64, 607–610 monetary assets, 22–23 monetary item, 596 monetary/nonmonetary translation method, 595 Monsanto Company, 603–604 Monster Worldwide, 293–294 Montgomery Ward, 211–213, 226–227 Moody’s, 228, 247, 306 Morrissey Tool Company, 1035 motivations for earnings manipulation, 393 Motorola, Inc., 446–447 multiple discriminant analysis (MDA), bankruptcy prediction models using, 383 Mutchler, Jane F., 390 Mylan Laboratories, 70 N National Semiconductor, 375 natural resources, cost of acquiring, 534–536 Nestlé, 70 net book value of the asset, 524 net income, 27, 456, 830–831 See also earnings; profit and balance sheets, cash flows relations, 155–183 and cash flow from operations, cash flow relations between, 179–181 portions of attributable to equity claimants other than common shareholders, 1029 net income plus depreciation, depletion, and amortization/total liabilities (long-term solvency risk), 381 net income/total assets (profitability), 381 net realizable value, 658 fair value based on, 109–110 net working capital/total assets, 382, 383 New World Restaurant Group, Inc., 77 NewMarket Corporation, 603–604 Nichols, D Craig, 53–55, 183, 785, 1005, 1077, 1080–1082 Nike Corporation acquisition of Umbro, 545–546 case study, 85–95 financial statements, 87–94 1255 income tax disclosures, 147–149 industry economics, 85–95 nominal vs real cash flows, 937–938 nominal vs real dividends, 904–905 nonamortizable intangible assets, 524 noncurrent assets, projecting other, 819 noncurrent liabilities classifying changes in, 190 projecting other, 821 nondiversifiable risk, 392 non-metallic and industrial metal mining industry, financial statement ratios, 1227 nonmonetary assets, 22–23 nonmonetary items, 596 nonrecurring or unusual items, projecting, 829–830 provision for income tax, 829, 830 net income, 830–831 retained earnings, 831–832 nontaxable reorganization, 581 nonworking capital adjustments, 168, 169 Nooyi, Indra K., 1123, 1124, 1130–1133 NOPAT (net operating profit adjusted for tax), 261, 356, 945, 950 Nordstrom, gift cards, 640 normal earnings, 1013 Nortel Networks, analytical framework for financial statement analysis, 133 Northrop Grumman Corporation, 763 notes payable, classifying changes in, 190 notes to the financial statements, 36–38, 41 Nucor Corporation, 312–313, 653–655 O O’Neil, Jane, 413 Obligations arising from advances from customers on unexecuted contracts and agreements, 462–463 contingent, 463––464 under mutually unexecuted contracts, 463 with estimated payment dates and amounts, 461–462 with fixed payment amounts but estimated payment dates, 461 with fixed payment dates and amounts, 461 Occidental Petroleum Corporation, 742–743 off-balance-sheet financing arrangements, 478–484, 502–503 product financing arrangements, 481 research and development financing arrangements, 481–483 sale of an existing asset, 478 sale of receivables, 479–481 take-or-pay or throughput contracts, 483 use of another entity to obtain financing, 478–479 Ohlson, James A., 385, 388, 391 Old Navy, 56 Olin Corporation, 603–604 Omnicom Group, 65 E-WAHLEN-09-1211-Index.qxd: 6/30/10 3:22 PM Page 1256 LibraryPirate 1256 Index OneSource, 58, 59 operating assets (OA), 943–945 operating assets and liabilities on balance sheet forecasting techniques, 811–812 projecting, 804–822 operating cash flow to current liabilities ratio, 365 operating cash flow to total liabilities ratio, 373–374 operating cash flows, 34 operating cycle for manufacturing firm, 29 operating expenses, projecting, 800–804 cost of goods sold, 801–802 nonrecurring operating gains and losses, 804 other, 803 selling, general, and administrative expenses, 802–803 operating factors, bankruptcy prediction research, 389–390 operating income, 256 operating, investing, and financing activities, cash flow relations among, 156–164 operating lease method, 485–486 operating leases accounting for as capital leases, 493 converting to capital leases, 490–492 operating leverage, 269–270 operating liabilities (OL), 943–945 operating profit, 661 operating ROA, 357–359 Oracle Corporation, 310–311 case studies, 510–513 share-based compensation effects/statement of shareholders’ equity, 510–513 other comprehensive income, 457 Others industries, financial statement ratios, 1228 Ou, Jane, 785 P Pacific Gas & Electric, 65, 214–216 Panera Bread Company, 77 profitability comparison with Starbucks, 331–334 Parametric Technology Corporation (PTC), 702–704 Parmalat, 393 PE (priced-earnings) ratios, 1043, 1059–1072, 1060–1071 and MB ratios, articulation of, 1070–1071 as predictors of future earnings growth, 1069–1070 comparisons among beverage companies, 1062 descriptive data on, 1063 empirical properties of, 1069–1071 factors causing to differ across firms, 1063–1066 accounting differences, 1065–1066 cost of capital, 1065 growth, 1066 profitability, 1065 risk, 1065 incorporating earnings growth into, 1066–1068 perpetuity-with-growth approach, 1066–1067 price-earnings-growth approach, 1067–1068 project firm value from permanent earnings, 1062–1063 summary of, 1071–1072 PE ratio measurement issues, 1069 growth, 1069 transitory earnings, 1069 PEG (priced-earnings-growth) ratios, 1043 Penman, Stephen H., 785, 1069–1070 pension assets, 673, 674 market-related fair value, 674 unfunded plan, 674 pension expense calculation, defined benefit plan, 677–679 pension obligation, 673 pensions and other postretirement benefits, 672–684 economics of pension accounting in defined benefit plan, 673–682 signals about earnings persistence, 682–683 pensions, 170 case studies, 728 PepsiCo (PepsiCo, Inc and Subsidiaries), 5, 76 2008 annual report, 1130–1133 accounting principles changes, 743–744 analysis spreadsheet, 1164–1172 analytical framework for financial statement analysis, 132 analyzing projected financial statements, 843–846 application of strategy framework to beverage segment, 16–17 application of VB model, 1051–1058 reasons why VB ratios and MB ratios may differ from 1, 1054–1056 balancing balance sheet, 832–834 brand recognition, 10, 15–16 cash flows relations, 156–159, 164–165 combined sales growth, 799–800 comparing financial statement ratios with other firms, 306 computing PDIFF for, 1074–1075 computing required rate of return on equity capital for, 893–894 computing weighted average cost of capital for, 900–901 consolidated financial statements, 1098–1101 data spreadsheet, 1160–1163 derivatives disclosures, 698 discontinued operations, 737 effects of accounting differences on PE ratios, 1065–1066 financial statement analysis package (FSAP), 1159–1196 financial statements balance sheets, 20, 43–44 income statements, 27, 45 statements of cash flows, 35–36 financing activities, 440–493 cash-settled share-based plans, 456 distributions to shareholders, 447, 449 operating lease disclosures, 490–492 forecasting financial statements, 786, 791 forecasts development spreadsheet, 1185–1188 forecasts spreadsheet, 1173–1184 free cash flows valuation of, 957–970 computing free cash flows, 959 computing required rate of return on equity capital, 958 computing weighted average cost of capital, 958–959 discount rates, 958 free cash flows to all debt and equity capital stakeholders, 959–962 free cash flows to common equity, 962–963 necessary adjustments to computer common equity share value, 967 sensitivity analysis and investment decision making, 967–970 using free cash flows to all debt and equity capital stakeholders, 964–966 using free cash flows to common equity shareholders, 963–964 income tax disclosures, 670–672 deferred tax asset valuation allowances, 671–672 intangible assets other than nondeductible goodwill, 671 investment in noncontrolled affiliates, 670–671 net carryforwards, 671 postretirement benefits, 671 property, plant, and equipment, 671 stock-based compensation, 671 investing activities, 523–600 management’s discussion and analysis, 1135–1158 accounting policies, 1144–1149 brand and goodwill valuations, 1145–1146 income tax expense and accruals, 1146 pension and retiree medical plans, 1146–1148 recent accounting pronouncements, 1148–1149 revenue recognition, 1144–1145 business risks, 1139–1144 changes in legal and regulatory environment, 1141–1142 damage to reputation, 1141 demand for products, 1139 disruption of supply chain, 1142 failure to maintain good relationships, 1141 E-WAHLEN-09-1211-Index.qxd: 6/30/10 3:22 PM Page 1257 LibraryPirate Index global economic crisis, 1140 information technology infrastructure, 1140 loss of key customer, 1141 market risks, 1143–1144 operating results, 1139–1140 risk management framework, 1142–1143 trade consolidation, 1141 unable to hire or retain key employees, 1141 unstable political conditions or civil unrest, 1142 business, 1135–1144 competition, 1139 customers, 1138 distribution network, 1138 customer warehouse, 1138 direct-store-delivery, 1138 foodservice and vending, 1138 executive overview, 1135–1136 financial results, 1149–1158 items affecting comparability, 1149–1150 our liquidity and capital resources, 1156–1158 results of operations–consolidated review, 1150–1151 results of operations–division review, 1152–1156 new organizational structure, 1137 operations, 1136–1137 other relationships, 1139 management’s report on internal control over financial reporting, 1124 management’s responsibility for financial reporting, 1123 market multiples, 1091–1092 measuring dividends for, 908–909 Middle East, Africa & Asia sales growth, 798–799 notes to consolidated financial statements, 1102–1122 Note 1, basis of presentation and divisions, 1102–1104 Note 2, significant accounting policies, 1105–1106 Note 3, restructuring and impairment charges, 1106–1107 Note 4, property, plant and equipment and intangible assets, 1107–1108 Note 5, income taxes, 1109–1110 Note 6, stock-based compensation, 1110–1111 Note 7, pension, retiree medical and savings plans, 1112–1115 Note 8, noncontrolled bottling affiliates, 1116–1117 Note 9, debt obligations and commitments, 1117–1118 Note 10, financial instruments, 1118–1120 Note 11, net income per common share, 1120–1121 Note 12, preferred stock, 1121 Note 13, accumulated other comprehensive loss, 1122 Note 14, supplemental financial information, 1122 off-balance-sheet brand equity, 1054 operating activities, 631–699 PE ratios comparisons among beverage companies, 1062 pensions and other postemployment benefits, 683–684 Porter’s five forces classification framework, 11–13 profitability analysis, 246–249, 291 common-size analysis, 253–254 comparing profitability with Coca-Cola, 256 cross-sectional analysis with Coca-Cola Company, 247 disaggregating ROA, 266–267 EPS calculation, 252–253 impairment and restructuring charges, 262–263 percentage change analysis, 254–255 positioning relative to consumer foods industry, 276 profit margin analysis, 276–285 ROCE, 295–304 segment data, 281–284 tax benefits, 263–264 time-series analysis, 262 total assets turnover, 285–290 profitability ratios in cross-sectional setting, 320–325 projecting bottling equity income, 626 projecting financial assets, financial leverage, common equity capital and financial income items, 822–829 projecting nonrecurring or unusual items, provision for income tax, and change in retained earnings, 829–832 projecting operating assets and liabilities on balance sheet, 804–822 projecting operating expenses, 800–804 projecting sales revenues, 793–800 projecting the statement of cash flows, 835–840 reconciliation of GAAP and non-GAAP information, 1127 report of independent registered public accounting firm, 1125 reporting of income taxes, 130–131 restructuring and other charges, 749–750 reverse engineering stock price, 1076–1077 risk analysis financial flexibility, 354–361 long-term solvency risk, 370–374 short-term liquidity risk analysis, 361–370 risk management, disclosures 1257 regarding risk, 346–350 risk-adjusted rates of return and the dividends valuation model, 886–921 selected financial data, 1126 sensitivity analysis and investment decision making, 918–920 statement of cash flows adjustments, 169–171 strategy analysis framework, 15 using dividends valuation model to value, 915–918 computing common equity value per share, 918 midyear discounting, 918 valuation of using residual income model, 1019–1025 book value of equity and residual income, 1020–1022 computing common equity share value, 1022–1024 discount rates for residual income, 1020 discounting residual income to present value, 1022 sensitivity analysis and investment decision making, 1025 valuation spreadsheet, 1189–1196 value chain analysis, 8–9 PepsiBottling Group’s (PBG’s), 262 impairment and restructuring charges, 262–263 profitability analysis, tax benefits, 263–264 PepsiCo Americas Beverages (PAB), 8, 793, 797–798, 1131–1132, 1137, 1154–1155 PepsiCo Americas Foods (PAF), 8, 793, 1131 PepsiCo International (PI), 8, 793, 798, 1132–1133 percentage change analysis, 254–255 percentage change statements, 49 percentage-of-completion method, 641–645 period costs, 650 permanent differences, 124 perpetuity-with-growth approach, 1066–1067 personal services industry, financial statement ratios, 1229 Petroleo Brasileiro, 105, 108, 116–117, 136 petroleum and natural gas industry, financial statement ratios, 1230 Petroni, Kathy R., 119 PetroQuest Energy, Inc., 173–175 pharmaceutical company, value chain analysis, 7–9 pharmaceutical products industry, financial statement ratios, 1231 Platt, Harlan D., 386 Platt, Marjorie B., 386 point-of-sale revenues, 649 Porter, Michael E., 10, 275 Porter’s five forces classification framework, 10–13 E-WAHLEN-09-1211-Index.qxd: 6/30/10 3:22 PM Page 1258 LibraryPirate 1258 Index buyer power, 12 rivalry among existing firms, 10 supplier power, 12–13 threat of new entrants, 10 threat of substitutes, 10–12 portfolios, use of valuation models to form, 1082–1084 postretirement benefits, other, 682 precious metals industry, financial statement ratios, 1232 preferred stock, 442 projecting, 827 prepaid expenses, 172 and other current assets, projecting, 814–815 Prepaid Legal Services, 145–147 present value, initial, 105–106 price, 885 price differentials (PDIFF), 1043, 1072–1075 price-based multiples, 1045 price-earnings ratios, 249 price-earnings-growth approach, 1067–1068 Priceline.com, 637 Prime Contractors, case studies, 224–226 principles-based approach, revenue recognition, 633 printing and publishing industry, financial statement ratios, 1233 prior service cost, 674–675 Priority Contractors, 1035 pro forma disclosures, 450 Procter & Gamble, 65 product costs, 650 product differentiation, 15, 275–276 product financing arrangements, 481 product life cycle, 271–273 product, nature of, 15 profit margin, 42 analyzing for ROA, 276–285 trade-offs between total assets turnover and, 273–276 profitability, 4, 246 factors causing PE ratios to differ across firms, 1065 profitability analysis, 41–51, 61–62, 155 case study, 338–344 common-size financial statements, 42–49 financial statement ratios, 50–51 overview of, 248–249 PepsiCo, 246–249, 291 percentage change statements, 49 summary of, 284–285 supplementing ROA in, 290–295 tools of, 42–51 profitability data Accenture, 293–294 Monster Worldwide, 293–294 VisionChina Media, 293–294 profitability ratios, 50 Airtran, 292–293 American Airlines, 292–293 JetBlue, 292–293 summary of, 307 Target, 292 Wal-Mart, 292 profitable operating and investing activities, 441 profits, 27 See also earnings; net income alternative definitions of, 255–259 comprehensive income, 255–256 operating income, EBIT, EBITDA, 256 pro forma, adjusted, or street earnings, 257–259 segment profitability, 256–257 projected benefit obligation (PBO), 673 projected financial statements, analyzing, 843–846 projected sales and income approach, 841 projected total assets approach, 841–843 projecting nonrecurring or unusual items, provision for income tax, and change in retained earnings, 829–832 projecting operating assets and liabilities on balance sheet, 804–822 property, plant, and equipment, 24, 378 accounting for acquisition of, 526 classifying changes in, 189 projecting, 815–817 prospectus or registration statement, 55 Public Company Accounting Oversight Board (PCAOB), 39 Pulte Homes, 110 Q Quaker Foods North America (QFNA), 8, 17, 793, 796, 1136, 1153 Qualcomm Incorporated, 558–560 qualified audit opinion, bankruptcy prediction research, 390–391 quality of financial statements, 4, 17–41 accounting principles, 18–19 assessing, 59–61 balance sheet, 19–27 balance sheet reports, 40 income statement, 27–41 managers’ and independent auditors’ attestations, 41 MD&A, 41 notes to the financial statements, 41 statement of cash flows, 33–36, 41 quick ratio, 364–365 Qwest Communications, 39, 638 R rate of return, 465–466 risk-adjusted expected, 888–901 rate of return on assets (ROA), 259–295 analyzing profit margin for, 276–285 analyzing total assets turnover, 285–290 calculation of, 264–266 disaggregating, 266 economic and strategic factors of, 267–276 impairment and restructuring charges, 262–236 in profitability analysis, supplementing, 290–295 mark-to-market accounting adjustments, 263 realized vs expected, 268–273 tax benefits, 263–264 trade-offs between profit margin and total assets turnover, 273–276 rate of return on common shareholders’ equity (ROCE), 50, 295–304, 1046–1049, 1054–1056 benchmarks for, 297–299 disaggregating, 301–304, 352–361 relating ROA to, 299–301 rationale for cash-flow-based valuation, 930–931 dividends-based valuation, 901–905 earnings-based valuation, 1007–1009 real estate industry, financial statement ratios, 1234 realization, 114 reasonably estimable of amount, 464 reclamation cost, 534 recreation industry, financial statement ratios, 1235 related parties, minority, active investments, 563 related party transactions, 576–577 relevance of accounting information, 102 reliability of accounting information, 102 replacement cost, fair value based on, 108–109 reported amounts, assessing quality of, 60–61 reporting unit, 543 required earnings, 1013 research and development (R&D) costs, accounting for, 526–529 research and development financing arrangements, 481–483 Research in Motion Limited, 178–179 reserve recognition accounting (RRA), 535 reserves, 458 residual income, 297, 1013, 1046 dividends, and free cash flows value estimates, consistency in, 1029–1031 residual income measurement and valuation illustrations of, 1014–1017 intuition for, 1013–1014 residual income model implementation issues common stock transactions, 1027–1029 dirty surplus accounting, 1025–1027 residual income valuation, 1006, 1008 illustrations of residual income measurement and valuation, 1014–1017 intuition for residual income measurement and valuation, 1013–1014 theoretical and conceptual foundations for, 1011–1017 residual income valuation model, 1013 crucial but common mistake, 1019 E-WAHLEN-09-1211-Index.qxd: 6/30/10 3:22 PM Page 1259 LibraryPirate Index with finite horizon earnings forecasts and continuing value computation, 1017–1019 resources consumed, 1008 restated financial statement data, 752–753 restaurants, hotels, motels industry, financial statement ratios, 1236 restoration costs, 534 restricted stock, 454–455 restricted stock unit (RSU), 303 restructuring and other charges, 747–750 retail industry, financial statement ratios, 1237 retailers, analyzing to supplement ROA in profitability analysis, 291–292 retained earnings, 456, 831–832 classifying changes in, 191 retained earnings/total assets, 383 retrospective treatment, 741 return on common equity (ROCE), 248–249 return on plan assets, 675 return on total assets (ROA), 248–249 revenue passenger miles, 292 revenue recognition, 632–649 at time of sale, 638–640 case studies, 712–713 choice of reporting method by longterm contractors, 645–646 completed-contract method, 645 cost-recovery methods, 647–649 delaying when substantial performance remains, 640–641 installment method, 646, 647–649 investment in working capital, 649 methods for installment sales, 647 percentage-of-completion method, 641–645 under long-term contracts, 641–646 when cash collectability is uncertain, 646–649 revenue recognition criteria, 632–634 application of, 635 revenues earned, 1008 revenues from sales, projecting, 792–793 revenues to cash ratio, 368–369 reverse engineering, 1075–1077 reverse-engineering share prices, 1043 risk, 4, 246 commodity prices, 347–350 disclosures regarding, 346–350 discount rates, and cost of capital, 932 factors causing PE ratios to differ across firms, 1065 financial statement analysis of, 350–352 firm-specific risks, 346–346 framework for financial statement analysis of, 351 risk analysis, 41–51, 61–62, 155 bankruptcy, 380–391 case study, 338–344 credit history, 375 credit, 374–380 capacity for debt, 378–379 cash flows, 376–377 character of management, 379 collateral, 377–378 communication, 380 conditions or covenants, 380 contingencies, 379 loans, 374–375 long-term solvency, 370–374 debt ratios, 371–372 interest coverage ratios, 372–373 operating cash flow to total liabilities ratio, 373–374 short-term liquidity, 361–370 current ratio, 363–364 days revenues held in cash, 369–370 operating cash flow to current liabilities ratio, 365 quick ratio, 364–365 revenues to cash ratio, 368–369 working capital turnover ratios, 365–368 tools of, 42–51 common-size financial statements, 42–49 financial statement ratios, 50–51 percentage change statements, 49 risk management, disclosures regarding, 346–350 commodity prices, 347–350 firm-specific risks, 345–346 risk ratios, 50–51 risk-adjusted expected rates of return, 888–901 adjusting market equity beta to reflect new capital structure, 894–895 computing weighted average cost of capital, 897–901 cost of common equity capital, 889–894 cost of debt capital, 896–897 cost of preferred equity capital, 897 evaluating use of CAPM to measure cost of equity capital, 895–896 risk-related disclosures, other, 350 rivalry among existing firms, 10 RNOA (return on net operating assets), 302 ROA See return on total assets (ROA) Robert Morris Associates, 247, 306 ROCE See rate of return on common shareholders’ equity (ROCE) Roche Holding, 70 Royal Dutch Shell, 923–924 RSUs, 454–455 Rubber and plastic products industry, financial statement ratios, 1238 run rate, 370 Ryanair, 213 S Saab Automobile, bankruptcy, 381 sale of an existing asset, 478 sales cyclicality of, 270–271 projecting revenues from, 792–793 sales and income, shortcut approaches to forecasting, 841 1259 sales and other revenues, projecting, 792–800 sales growth index (SGI), 395 sales mix data for PepsiCo, 282 sales/total assets, 383 Sam’s Club, 640 SAP AG, 455 Sapient Corporation, 704–705 Sarbanes-Oxley Act, principal provisions of, 39 Satyam, 393, 394 Schrand, Catherine M., 258–259 Schultz, Howard, 75–76 Sears, 226–228 SEC See Securities and Exchange Commission Securities and Exchange Commission (SEC), 16, 259, 442, 632, 744 accounting principles and, 18 SAB104, 632 securities investments, 549–589 income tax consequences of, 589 percentage of ownership, 550–581 security analyst, relevance of academic research for work of, 1077–1084 segment data, 281–284 segment profitability, 256–257 self-construction costs, 531–532 selling and administrative expense index (SAI), 395 selling, general, and administrative expenses See SG&A sensitivity analysis investment decision making, 918–920, 967–970, 1025 reactions to announcements, 846–847 service cost, 674 service firms, analyzing to supplement ROA in profitability analysis, 293–294 service, nature of, 15 ServiceMaster, 214–216 SG&A (selling, general, and administrative), 280 advertising costs, 658 amortization, 658 compensation, 658 costs, 657–660 credit policy, 658–660 depletion, 658 depreciation, 658 marketing costs, 658 warranty expense, 660 share premium, 441 share price, 1043 share prices and earnings, 53–55 share repurchases, 448–449 share-based compensation plan tax benefits, 171 shareholders, annual report to, 55 shareholders’ equity valuation and disclosure, 25–26 shipbuilding, railroad equipment industry, financial statement ratios, 1239 shipping containers industry, financial statement ratios, 1240 E-WAHLEN-09-1211-Index.qxd: 6/30/10 3:22 PM Page 1260 LibraryPirate 1260 Index short-term debt, projecting, 823–824 short-term liquidity risk, 350–351 short-term liquidity risk analysis, 361–370 current ratio, 363–364 days revenues held in cash, 369–370 operating cash flow to current liabilities ratio, 365 quick ratio, 364–365 revenues to cash ratio, 368–369 working capital turnover ratios, 365–368 Simmons Bedding, 381 Singapore Airlines, 751–752 single-asset firm dividends valuation for, 902–903 free cash flows valuation examples for, 933–935 Sirius XM Radio Inc., 209–210 size, bankruptcy prediction research, 390 size of firm and bankruptcy prediction, 386 Sloan, Richard G., 196, 258, 393 Smithfield Foods, 108, 116, 135–136, 121 Societe General, financial reporting manipulation risk, 393 soft drink/beverage industry See also Coca Cola Company; PepsiCo economic attributes of, 14 Porter’s five forces in, 11 value chain analysis, software development costs, accounting for, 529–531 Software Publishers Association, 530 Sougiannis, Theodore, 295 sources of financial statement information, 55–56 Southwest Airlines case studies, 513–521 computing residual income, 1034 long-term solvency risk, 513–521 SPE (special-purpose entity), 479, 585 speculative investment, 687 Staley, Edward, 227, 228 Standard & Poor’s Industry Surveys, 59, 228 Standard Commercial Corporation, 741 Starbucks accounting policy, 618–620 asset retirement obligations, 769–770 brand name, 627 business combinations, 620–622 case studies, 71–85, 150–152, 222–224, 330–334, 411–412, 509, 618–627, 712–713, 769–773, 862–875, 926–927, 988–990, 1039–1040, 1094–1096 competition in the specialty coffee industry, 77 comprehensive income, 771–773 dividends-based valuation of common equity, 926–927 financial statements, 77–85 free cash flows valuation of common equity, 988–990 gift cards, 640 growth strategy, 71–75 income tax disclosures for, 151 insurance reserves, 770 introduction, 71 investments in long-lived assets, 627 long-lived assets, 769 minority active investments, 624–626 minority, passive investments, 622–624 product supply, 76 profitability comparison with Panera Bread Company, 331–334 recent accounting pronouncement, 770–771 recent performance, 75–76 residual income valuation of common equity, 1039 restructuring charges, 771 retail revenues, 712 revenue recognition, 712 risk ratios, 411–412 specialty revenues, 712–713 statement of cash flows, 222–224 stored value cards, 712 valuation of common equity using market multiples, 1094–1096 Starwood Hotels, 325, 327 stated rate, 465 statement of cash flow adjustments Blackboard Inc., 175–177 Cephalon, Inc., 177–178 Hitachi Ltd., 172–173 PetroQuest Energy, Inc., 173–175 Research in Motion Limited, 178–179 statement of cash flows, 33–36, 41, 376 Aer Lingus, 213–214 as starting point, free cash flows measurement, 945–947 algebraic formulation, 184–186 classification of cash flows, 34–36 classifying changes in balance sheet accounts, 186–191 illustration of the preparation procedure, 191–194 MicroStrategy, Inc., 200–202 operating section of, 165–179 preparing, 183–202 projecting, 835–840 rationale for, 33–34 specific steps for forecasting implied, 836–840 tips for forecasting, 835–836 using to assess earnings quality, 194–202 statutory merger, 565, 567–570 Steak ’n Shake, 1035–1037 Stebbins Corporation, 614–616 Steel works industry, financial statement ratios, 1241 Stern Stewart & Co., 298 Stewart, J., 499 stock appreciation rights plans, 455 stock dividends, 445–447 stock options, 449 stock splits, 445–447 Stora Enso, 753–754 strategy analysis See also framework for strategy analysis Subramanyam, K R., 119, 248 subscription agreement, 442 subsidiary, 564 Subway, 12 successful efforts, 534–535 Sumitomo Metal, 70 Sun Microsystems effect of industry characteristics on financial statement relationships, 70 economic value changes, 116–117 historical value of initial present value, 105 industry differences in statement of cash flows, 214–216 inventory turnover ratios, 311–312 risk and bankruptcy prediction ratios, 404–405 valuation methods, 108 Sunbeam Corporation, 210–211, 393, 396–398 Supervalu, 310 supplier power, 12–13 supply, in economic attributes framework, 13, 14 Sweeney, Amy P., 393 Sysco Corporation, 76 systematic risk, 392 T take-or-pay or throughput contracts, 483 tangible assets, 23, 524 tangible equity, 536 Target Stores, 133 calculating cost of capital, 922–923 comparing financial statement ratios with other firms, 306 computing residual income, 1032–1033 profitability and risk analysis, 338–344 profitability ratios, 292 tax basis of assets, liabilities, and tax loss carryforwards, 661 tax benefits, 263–264 tax, EBITDA, 182–183, 945, 950 tax loss carryforwards book basis of, 661 tax basis of, 661 TCBY Enterprises Inc., 649 technological feasibility, 530 technology-based firms, analyzing to supplement ROA in profitability analysis, 294–295 temporary differences, 125, 128, 661 term project, selecting companies for, 58 Texas Instruments (TI), 205, 207, 313, 375 Textiles industry, financial statement ratios, 1242 The Street.com, 198 Thomas, Jacob, 1080–1082 Thomas, Wayne, 756–757 threat of new entrants, 10 threat of substitutes, 10–12 ... “business as usual” on Wall Street and around the world for financial statement analysis and valuation Given the profound importance of financial reporting, financial statement analysis, and valuation, ... PM Page xx LibraryPirate CONTENTS Preface About the Authors Chapter Chapter Overview of Financial Reporting, Financial Statement Analysis, and Valuation Overview of Financial Statement Analysis. .. Financial Reporting, Financial Statement Analysis, and Valuation Chapter 2: Asset and Liability Valuation and Income Recognition Chapter 3: Income Flows Versus Cash Flows Chapter 4: Profitability Analysis