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Chapter 3 Financial Statements, Cash Flow, and Taxes


Table 3-2

Allied Food Products: Income Statements for Years Ending December 31 (Millions of Dollars, Except for Per-Share Data)
2008 2007 $2,850.0 2,497.0 90.0 $2,587.0 263.0 60.0 $ 203.0 81.2 $ 121.8

Net sales Operating costs except depreciation and amortization Depreciation and amortization Total operating costs Operating income, or earnings before interest and taxes (EBIT) Less interest Earnings before taxes (EBT) Taxes (40%) Net income Here are some related items: Total dividends Addition to retained earnings Net income Total dividends Per-share data: Common stock price Earnings per share (EPS)a Dividends per share (DPS)a Book value per share (BVPS)

$3,000.0 2,616.2 100.0 $2,716.2 283.8 88.0 $ 195.8 78.3 $ 117.5

$ $

57.5 60.0

$ $

53.0 68.8

$ 23.06 $ 2.35 $ 1.15 $ 18.80

$ 26.00 $ 2.44 $ 1.06 $ 17.60

Allied has 50 million shares of common stock outstanding. Note that EPS is based on net income available to common stockholders. Calculations of EPS and DPS for 2008 are as follows: Earnings per share EPS Dividends per share DPS Net income $117,500,000 $2:35 Common shares outstanding 50,000,000

Dividends paid to common stockholders $57,500,000 $1:15 Common shares outstanding 50,000,000

When a firm has options or convertibles outstanding or it recently issued new common stock, a more comprehensive EPS, diluted EPS, must be calculated. Its calculation is a bit more complicated, but you may refer to any financial accounting text for a discussion.

Different firms have different amounts of debt, different tax carry-backs and carry-forwards, and different amounts of non-operating assets such as marketable securities. These differences can cause two companies with identical operations to report significantly different net incomes. For example, suppose two companies have identical sales, operating costs, and assets. However, one company uses some debt and the other uses only common equity. Despite their identical operating performances, the company with no debt (and therefore no interest expense) would report a higher net income because no interest was deducted from its operating income. Consequently, if you want to compare two companies operating performances, it is best to focus on their operating income.7 From Allieds income statement, we see that its operating income increased from $263.0 million in 2007 to $283.8 million in 2008, or by $20.8 million. However,
7 Operating income is important for several reasons. First, as we noted in Chapter 1, managers are generally compensated based on the performance of the units they manage. A division manager can control his or her divisions performance but not the firms capital structure policy or other corporate decisions. Second, if one firm is considering acquiring another, it will be interested in the value of the target firms operations; and that value is determined by the target firms operating income. Third, operating income is normally more stable than total income, as total income can be heavily influenced by write-offs of bonds backed by subprime mortgages and the like. Therefore, analysts focus on operating income when they estimate firms long-run stock values.