FINANCIAL STATEMENT ANALYSIS

EVEREST EMPORIUM
Comparative Income Statement
EVEREST EMPORIUM December 31, 2017
Comparative Balance Sheet (in thousands) 2017 2016
December 31, 2017 Sales 6,522,500 5,642,000
ASSETS Less: Cost of Sales 2,275,000 1,886,000
Current Assets 2017 2016 Gross Profit 4,247,500 3,756,000
Cash 850,000 675,000 Less: Operating Expenses
Accounts Receivable 250,000 130,000 Rent Expense 1,087,500 945,000
Merchandise Inventory707500 707,500 600,000 Salaries Expense 900,000 760,000
Supplies 45,000 17,000 Gas & Oil Expense 465,200 355,000
Total Current Assets 1,852,500 1,422,000 Depreciation Expense 340,000 325,000
Non-Current Assets Utilities Expense 190,000 155,000
Property, Plant & Equipment 3,200,000 3,050,000 Repairs Expense 115,000 100,000
Less: Accumulated Depreciation 665,000 325,000 Supplies Expense 43,300 75,000
Property, Plant & Equipment 2,535,000 2,725,000 Total Operating Expenses 3,141,000 2,715,000
TOTAL ASSETS 4,387,500 4,147,000 Operating Income 1,106,500 1,041,000
LIABILITIES AND SHAREHOLDERS' EQUITY Less: Interest Expense 112,500 135,000
Current Liabilities Net Income Before Tax 994,000 906,000
Accounts Payable 110,000 150,000 Less: 30% Income Tax 298,200 271,800
Unearned Rent 100,000 0 NET INCOME 695,800 634,200
Accrued Taxes 298,200 271,800
Utilities Payable 75,000 55,000
Total Current Liabilities 583,200 476,800
Non-Current Liabilities
Loans Payable 1,250,000 1,500,000
TOTAL LIABILITIES 1,833,200 1,976,800
SHAREHOLDERS' EQUITY
Share Capital 1,750,000 1,536,000
Retained Earnings 804,300 634,200
TOTAL LIABILITIES & EQUITY 4,387,500 4,147,000

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ANALYSIS OF CASH FLOWS (DIRECT METHOD)

Copy Trading Plus

Statement of Financial Position Copy Trading Plus
As of December 31, 2017 Income Statement
ASSETS As of December 31, 2017
Current Assets 2017
Cash 675,000 Sales 5,642,000
Accounts Receivable 130,000 Less: Cost of Sales 1,886,000
Merchandise Inventory 600,000 Gross Profit 3,756,000
Supplies 17,000 Less Operating Expenses:
Total Current Assets 1,422,000 Rent Expense 945,000
Non Current Assets Salary Expense 760,000
Vehicles 2,500,000 Gas & Oil Expense 355,000
Less: Accum Dep - Vehicles 300,000 2,200,000 Depreciation Expense 325,000
Equipment 300,000 Utilities Payable 155,000
Less: Accum Dep - Equipment 10,000 290,000 Repair Expense 100,000
Furniture & Fixtures 250,000 Supplies Expense 75,000 2,715,000
Less: Accum Dep - Furniture & Fixtures 15,000 235,000 Operating Income 1,041,000
Total Non Current Assets 2,725,000 Less: Interest Expense 135,000
TOTAL ASSETS 4,147,000 NET INCOME 906,000

LIABILITIES & EQUITY

Current Liabilities
Accounts Payable 150,000
Utilities Payable 55,000
Total Current Liabilities 205,000
Non Current Liabilities
Loans Payable 1,500,000
Total Liabilities 1,705,000
OWNER'S EQUITY
Reyes, Capital 2,442,000
TOTAL LIABILITIES & EQUITY 4,147,000

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ANALYSIS OF CASH FLOWS (DIRECT METHOD)

Copy Trading Plus Schedule 1:

Statement of Cash Flows Sales Revenue 5,642,000
For the Year Ended December 31, 2017 Less: Accounts Receivable, 12/31/17 130,000
Cash flow from operating activities Cash collected from customers 5,512,000
Cash received from customers (sched 1) 5,512,000
Cash payments for: Schedule 2:
Merchandise purchases (sched 2) 2,336,000 Cost of Sales 1,886,000
Rent 945,000 Add: Merchandise Inventory, 12/31/17 600,000
Salaries 760,000 Total Purchases 2,486,000
Gas and Oil 355,000 Less: Accounts Payable, 12/31/17 150,000
Utilities (schedule 3) 100,000
Payment to suppliers 2,336,000
Repairs 100,000
Supplies (schedule 4) 92,000
Schedule 3:
Interest Expense 135,000 (4,823,000) 689,000
Utilities expense 155,000
Cash flow from investing activities
Less: Utilities payable,
Acquisition of vehicles (2,500,000)
12/31/17 55,000
Acquisition of equipment (300,000)
Payment for utilities 100,000
Acquisition of furniture (250,000) (3,050,000)
Cash flow from financing activities
Schedule 4:
Bank Loans 1,500,000
Supplies Expense 75,000
Investment by owner (schedule 5) 1,536,000 3,036,000
Supplies Unused, 12/31/17 17,000
Cash Balance, December 31, 2017 675,000
Total supplies purchased &
paid 92,000

Schedule 5:
Reyes, Capital, 12/31/17 2,442,000
Less: Net Income 906,000
Investment made by owner 1,536,000
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ANALYSIS OF CASH FLOWS (INDIRECT METHOD)

Sweet Corn Company

Comparative Balance Sheet
As of December 31, 2017
2017 2016
ASSETS
Cash 250,000 350,000
Accounts receivable 600,000 450,000
Merchandise inventory 700,000 450,000
Prepaid expenses 100,000 250,000
Building and equipment 900,000 750,000
Accumulated depreciation (180,000) (80,000)
Land 900,000 400,000
TOTAL ASSETS 3,270,000 2,570,000
LIABILITIES & SHAREHOLDERS' EQUITY
LIABILITIES
Accounts payable 680,000 550,000
Accrued expenses 120,000 180,000
Notes payable (Bank Loan) 0 400,000
Mortgage payable 300,000 0
SHAREHOLDERS’ EQUITY
Share Capital, P10 par 2,090,000 1,590,000
Accumulated Profits & Losses 80,000 (150,000)
TOTAL LIABILITIES & SHE 3,270,000 2,570,000

The following additional data for 2017 were provided:

a. Land was acquired for P500,000 in exchange for ordinary share, par
P500,000 during the year.
b. All equipment purchased was for cash.
c. Equipment costing P50,000 was sold for P20,000, with book value of
P40,000.
d. Cash dividends of P100,000 were charged to Accumulated Profits &
Losses and was the only entry in this account.
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CAPITAL BUDGETING

Project Example on Cash Flow Estimation and Analysis

Silicon Valley Controls Corp. (SVCC), a California-based high-tech firm, has its research and
development department planning to develop a sophisticated computer system that will be designed to
control home appliances, heating, and air condition. SVCC’s marketing department plans to target sales of
the system to owners of larger homes with 2,000 or more square feet of heated and air-conditioned space.
Annual sales are projected at 25,000 units if the system is priced at $2,200 per unit. To manufacture the
product, a new manufacturing facility could be build and made ready for production in 2 years once the “go
ahead” decision is made. Such plant would require a 25-acre site, and SVCC currently has an option to
purchase a suitable tract of land for $1.2 million. If the decision is made to go ahead with the project,
construction could begin immediately and would continue for 2 years. Because the project has an
estimated economic life of 6 years, the overall planning period is 8 years: 2 years for plant construction plus
6 years for operation. The building would cost $8 million and have a 31.5-year life for tax purposes. A $4
million payment would be due the building contractor at the end of each year of construction. Manufacturing
equipment, with a cost of $10 million and a 7-year life for tax purposes, is to be installed and paid for at the
end of the second year of construction, just prior to the beginning of operations. Working capital investment
required shall be equal to 12 percent of estimated sales during the succeeding year. The initial working
capital is to be made at the end of year 2 and is increased at the end of each subsequent period by 12
percent of the expected increase in the following year’s sales.
After completion of the project’s 6-year operation, the land is expected to have a market value of
$1.7 million; the building, a value of $1 million; and the equipment, a value of $2 million. Production
department’s estimate of variable manufacturing costs total would be 65% of sales and that the fixed
overhead costs, excluding depreciation, would be $8 million for the first year of operation. Sales prices and
fixed overhead costs, other than depreciation, are projected to increase with inflation, which is expected to
average 6 percent per year over the 6-year production period.

SVCC’s marginal federal-plus-state income tax rate is 40 percent. Its weighted average cost of
capital is 15 percent. Cash flows are assumed to occur at the end of each year and thus the first operating
cash flows would be realized at the end of year 3, since the plant would begin operations at the start of year
3. A 15 percent corporate cost of capital is appropriate for the project.

Investment Outlay Analysis for SVCC’s New Plant Investment Project

Yr 0 Yr 1 Yr 2 Total Costs MV Ending

Land $1,200,000 $0 $0 $1,200,000 $1,700,00
Building 0 4,000,000 4,000,000 8,000,000 1,000,000
Equipment 0 0 10,000,000 10,000,000 2,000,000
Total Fixed Assets $1,200,000 $4,000,000 $14,000,000 $19,200,000
Net Working Capital 0 0 6,600,000 6,600,000
Total Investment $1,200,000 $4,000,000 $20,600,000 $25,800,000

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 3 4 5 6 7 8
Unit sales 25,000 25,000 25,000 25,000 25,000 25,000
Sale price $ 2,200 $ 2,332 $ 2,472 $ 2,620 $ 2,777 $ 2,944
Net sales 55,000,000 58,300,000 61,800,000 65,500,000 69,425,000 73,600,000
Variable costs 35,750,000 37,895,000 40,170,000 42,575,000 45,126,250 47,840,000
Fixed costs 8,000,000 8,480,000 8,988,800 9,528,128 10,099,816 10,705,805
Depreciation-Building 120,000 240,000 240,000 240,000 240,000 240,000
Depreciation-
Equipment 2,000,000 3,200,000 1,900,000 1,200,000 1,100,000 600,000
Earnings before taxes 9,130,000 8,485,000 10,501,200 11,956,872 12,858,934 14,214,195
Taxes (40%) 3,652,000 3,394,000 4,200,480 4,782,749 5,143,574 5,685,678
Net Operating Income 5,478,000 5,091,000 6,300,720 7,174,123 7,715,361 8,528,517
Add back noncash exp 2,120,000 3,440,000 2,140,000 1,440,000 1,340,000 840,000
Cash flow fr
Operations 7,598,000 8,531,000 8,440,720 8,614,123 9,055,361 9,368,517
Investment in NWC (396,000) (420,000) (444,000) (471,000) (501,000) 8,832,000
New Salvage values 5,972,000
Total Projected Cash
Flows 7,202,000 8,111,000 7,996,720 8,143,123 8,554,361 24,172,517
Net Cash Flows from Operations for New Plant Investment Project

Depreciation rates were estimated as follows:

Cost 3 4 5 6 7 8
Bldg $8m 1.50% 3% 3% 3% 3% 3%
Equip $10m 20% 32% 19% 12% 11% 6%

As illustrated, cash flow estimation involves a detailed analysis of demand, cost, and tax
considerations.

CAPITAL BUDGETING DECISION RULES

1. Net Present-Value Analysis

2. Profitability Index or Benefit-Cost Ration Analysis
3. Payback Period Analysis
NET PRESENT-VALUE (NPV) ANALYSIS

This is the most commonly employed method for long-term investment project evaluation
NPV is the difference between the present value of cash inflows and present value of cast outflows of the
investment project. The net nominal value is a misleading measure of the attractiveness of the project and
thus net cash flows must be expressed in present value (PV) terms.
Net Present Value = PV of Cash Inflows—PV of Cash Outflows of Investment Project
The value of the firm is simply the discounted present value of the difference. An appropriate
discount rate, or cost of capital, or cost of using funds, is used for the analysis.
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 In the Cash flow analysis table of SVCC’s New Plant Investment project below, the discount rate
used is 15% of the firm’s cost of capital. The net nominal cash flow of $38,379,720 is a misleading measure
of the attractiveness of the project because cash outlays necessary to fund the project must be made
substantially before cash inflows are realized. A relevant measure of the attractiveness of the project is net
cash flow expressed in present-value (PV) terms. The NPV for SVCC’s investment project is given by the
cumulative net discounted cash flow of $7,732,321 earned over the entire life of the project.

Consolidated End-of-Year Net Cash Flow Analysis for SVCC’s New Plant Investment Project.
Year Net Nominal Cash Flows PVIF Net Discounted Cash Flows
Per year Cumulative at 15% Per year Cumulative

0 $ (1,200,000) $(1,200,000) 1.0000 $(1,200,000) $(1,200,000)

1 (4,000,000) (5,200,000) 0.8696 (3,478,261) (4,678,261)
2 (20,600,000) (25,800,000) 0.7561 (15,576,560) (20,254,821)
3 7,202,000 (18,598,000) 0.6575 4,735,432 (15,519,389)
4 8,111,000 (10,487,000) 0.5718 4,637,491 (10,881,898)
5 7,996,720 (2,490,280) 0.4972 3,975,783 (6,906,115)
6 8,143,123 5,652,843 0.4323 3,520,497 (3,385,618)
7 8,554,360 14,207,203 0.3759 3,215,901 (169,717)
8 24,172,517 38,379,720 0.3269 7,902,039 7,732,322

Total $38,379,720 $7,732,322

In equation form, the NPV for SVCC’s plant expansion project is:

NPV = PV of Cash Inflow—PV of Cash Outflows

= $27,987,141—$20,254,820
= $7,732,321
Because dollar inflows received in the future are worth less than necessary dollar outlays at the
beginning of the project, the NPV of the project in the above example is much less than the $38,379,720
received in net nominal cash flows. This divergence between nominal and discounted cash flow figures
reflects the time value of money.
Firms typically make investments in projects showing positive net present values, reject those with
negative net present values, and choose between mutually exclusive investments on the basis of higher net
present values. This method is applicable when the firm has a substantial capital budget.

PROFITABILITY INDEX (PI) or BENEFIT/COST RATIO ANALYSIS

This is applicable to use when firm’s capital is scarce. The PI shows the relative profitability of a
project, or the present value of benefits per dollar or peso of cost.

Profitability Index, PI = PV of Cash Inflows

PV of Cash Outflows

= $ 27,987,141 = 1.38
$ 20,254,820

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 The PI reflects that for each dollar or peso of cost, a firm shall invest on projects that provide more
than a dollar of discounted benefits. In PI analysis, a project with PI > 1 should be accepted and a project
with PI < 1 should be rejected.

PAYBACK PERIOD ANALYSIS

The payback period is the expected number of years of operation required to recover an initial
investment. When project cash flows are discounted using an appropriate cost of capital, the discounted
payback period is the expected number of years required to recover the initial investment from discounted
net cash flows. Payback period can be thought of as a breakeven time period. The shorter the payback
period, the more desirable is the investment project.

In the given SVCC’s new plant investment project, based on the nominal dollar cash outflows and
inflows, the payback period is completed after the end of year 5 and before the end of year 6. Thus,

Payback Period = 5.00 years + $2,490,280 / $8,143,123

= 5.30 years
Based on cash outflows and inflows discounted using the firm’s 15 percent cost of capital, the
payback period is completed after the end of year 7 and before the end of year 8. Thus,

Payback Period = 7.00 years + $169,717 / $7,902,039

= 7.02 years

The payback period calculations are based on the typical assumption that cash inflows are received
continuously throughout the operating period. The exact length of the payback period would depend on
underlying assumptions concerning the pattern of cash inflows. Because cash flows expected in the distant
future are generally regarded riskier than near-term cash flows, the discounted payback period is a useful
but rough measure of liquidity and project risk.

Capital Budgeting Decision Rule Conflicts

NET PRESENT VALUE (NPV) PROFITABILITY INDEX (PI)

NPV > 0 PI > 1
Absolute measure of project attractiveness Relative measure of project attractiveness
Measures present value differences between Reflects the differences between the
revenues and costs marginal revenues & marginal costs in ratio
form
Leads to the highest ranking for large Leads to the highest ranking for projects that
profitable projects return the greatest amount of cash inflow per
dollar or peso of outflow, regardless the
project size
Used when resources are substantial Used when resources are scarce

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