Comprehensive Case

Case: Applying Financial Statement Analysis
Comprehensive Case
Applying Financial Statement
Analysis
REVIEW
A comprehensive case analysis of the financial statements and notes of Campbell
Soup Company is our focus. The book has prepared us to tackle all facets of
financial statement analysis. This comprehensive case analysis provides us the
opportunity to illustrate and apply these analysis tools and techniques. This case
also gives us the opportunity to show how we draw conclusions and inferences
from detailed analysis. We review the basic steps of analysis, the building blocks,
and the attributes of an expert analysis report. Throughout the case we
emphasize applications and inferences associated with financial statement
analysis.
Case-1
OUTLINE
Steps in Analyzing Financial Statements
Building Blocks of Financial Statement Analysis
Reporting on Financial Statement Analysis
Specialization in Financial Statement Analysis
Comprehensive Case: Campbell Soup Company

Preliminary Financial Analysis
Short-Term Liquidity
Capital Structure and Solvency
Return on Invested Capital
Analysis of Asset Utilization
Analysis of Operating Performance and Profitability
Forecasting and valuation
Summary Evaluation and Inferences
Case-2
ANALYSIS OBJECTIVES
Describe the steps in analyzing financial statements.
Review the building blocks of financial statement analysis.
Explain important attributes of reporting on financial statement analysis.
Describe implications to financial statement analysis from evaluating

companies in specialized industries or with unique characteristics.
Analyze in a comprehensive manner the financial statements and notes of

Campbell Soup Company.
Case-3
QUESTIONS
1. The six major "building blocks" of financial analysis that we have studied are:
i. Short-term liquiditythe ability to meet short-term obligations.
ii. Cash analysis and forecastingfuture availability and disposition of cash.
iii. Capital structure and solvencyability to generate future revenues and meet
long-term obligations.
iv. Return on invested capitalability to provide financial rewards sufficient to attract
and retain financing.
v. Asset utilization (turnover)asset intensity in generating revenues to reach a
sufficient profitability level.
vi. Operating performance and profitabilitysuccess at maximizing revenues and
minimizing expenses from operating activities over the long run.
The initial step in applying the building blocks to financial statement analysis
involves:
i. Determining the specific objectives of the analysis task.
ii. Arriving at a judgment about which of the six major areas of analysis must be
evaluated with what degree of emphasis and in what order of priority.
2. Financial statement analysis is oriented toward the achievement of specific
objectives. So that an analysis can best serve these objectives, the first step is to
define them carefully. The thinking and clarification leading up to the definition of
objectives is an important part of the analytical process as it insures a clear
understanding of objectives, of what is pertinent and relevant, and thus leads to
avoidance of unnecessary work. This is indispensable to an effective as well as an
efficient analysis. Effectiveness, given the specific objectives, is enhanced because
of a focus on the most important elements of the financial statements in light of the
decision task. It is also efficient in that it leads to an analysis with maximum economy
of time and effort.
3. An analyst of financial statement data must always bear in mind that financial
statements are at best an abstraction of an underlying reality. Further mathematical
manipulation of financial data can result in second, third, and even further levels of
abstractions. As the book mentioned, no set of photos of the Rocky Mountains can
fully convey the grandeur of the terrain. One has to see them to fully appreciate them.
This is because photos, like financial statements, are at best, abstractions. That is
why analysts must, at some point, leave the financial statements and visit the
companies to get a full understanding of the phenomena underlying by the analysis.
This is particularly true because of the static nature of the abstractions found in the
financial statements. In contrast, business reality is dynamic and constantly
changing.
4. The financial analyst must recognize that there are industries with distinct accounting
treatments that arise either from their specialized nature or from the special
conditions in which they operate (such as governmental regulations). The analysis of
the financial statements of such a company requires a thorough understanding of the
accounting peculiarities to which they are subject. Accordingly, the analyst must be
prepared for this task by studying and understanding the specialized areas of
accounting which affect the analysis. Examples of specialized industries include oil
and gas, life insurance, and public utilities. As in any field of endeavor, specialized
Case-4
areas of inquiry require that specialized knowledge be brought to bear upon them.
Financial statement analysis is, of course, no exception.
Case-5
5. A good analysis highlights for the reader the interpretations and conclusions of the
analysis from the facts and data upon which they are based. This helps to distinguish
fact from opinions and estimates. It also enables the reader to follow the rationale of
the analyst's conclusions and allows him/her to modify them as judgment dictates. To
this end, the analysis should contain distinct sections devoted to:
i. A brief "Summary and Conclusion" (executive summary) section as well as a table
of contents to help the reader decide how much of the report he/she wants to read
and which parts of it to emphasize.
ii. General background material on the enterprise analyzed, the industry of which it
is a part, and the economic environment in which it operates.
iii. Financial and other evidential data used in the analysis as well as ratios, trends,
and other analytical measures that have been developed from them.
iv. Assumptions as to the general economic environment and other conditions on
which estimates and projections are based.
v. A listing of positive and negative factors, quantitative and qualitative, by area of
analysis.
vi. Projections, estimates, interpretations, and conclusions based on the
aforementioned data.
Case-6
EXERCISES
Exercise CC-1 (30 minutes)
The factors that would determine the relative PE ratios are:
a.
Growth in earnings per share
Year 5 to 6...........................................
Year 2 to 6...........................................
Axel
21%
150%
Bike
20%
54%
Assuming net income is comparable as far as accounting practices go, Axel

would be likely to have a higher PE ratio because of greater historic growth in
earnings per share.
b.
Leverage in capital structure
Axel
33% of its total
capital is debt
Bike
No debt
Axel's earnings are likely to be greater, relative to Bike, because of this

leverage (assuming successful trading on the equity). Accordingly, its growth
in per share earnings is likely to be faster, producing greater market
appreciation. This is likely to produce a higher PE for Axel. However, Axel
does have greater financial risk, which would tend to reduce its PE differential.
c.
Return on common equity
Year 6...................................................
Axel
$2,125
$20,000 = 10.6%
Bike
$2,250
$30,000 = 7.5%
Axel's greater ROCE is mainly due to the leverage in its capital structure. This
will tend to produce a higher PE for the stock (assuming successful trading on
the equity). This will result in larger growth in retained earnings as long as
dividend policies are about the same, and should yield faster growth of the
stockholders' investment. It should also reduce the need to finance expansion
with further stock issuances and the potential dilution of earnings per share.
Case-7
Exercise CC-1continued
d.
Net income as % of sales
Axel
$2,125
$30,000 = 7.1%
Bike
$2,250
$30,000 = 7.5%
The difference is due to Axel's use of debt in its capital structure. If we

calculate net income before tax and interest (assuming a 50% tax rate), Axel is
seen to be more profitable as shown here:
Axel
NI before tax and interest..................... $4,750,000
Interest expense....................................
500,000
NI before tax...........................................
4,250,000
NI before tax & interest as % of sales.
15.8%
Bike
$4,500,000
-4,500,000
15.0%
Axel's interest payment can be considered by the analyst as a cost of

servicing the capital structure. Therefore, a better measure of operating
profitability is the ratio of net income before tax and interest to sales. This
shows Axel to be marginally more profitable in Year 6, which will tend to
produce a faster growth in earnings per share and PE.
e.
Ratios
1. Current ratio................................................
Axel
2.85
Bike
2.97
6.00
8.00
No significant difference.
2. Receivables turnover..................................
Implies Bike has a more efficient and strict collection policy.

3. Ratio of sales to net plant and equip........
2.30
1.88
Suggests Axel is more efficient in utilizing its plant.

f.
Patent position
Axel seems to have a stronger patent position, but to accurately determine
this one would need to know the policy in accounting for patents. These
include answers for questions such as: Will amortization of Axel's patents
cost be a drain on future earnings? Do the patents book values represent
market values?
Case-8
Exercise CC-1concluded
g.
Return on long-term fixed assets
Axel:
Bike:
$2,125,000 / $13,000,000 = 16.35%

$2,250,000 / $15,900,000 = 14.15%
The results from the return on long-term assets increase Axel's return to an
even more favorable comparison with Bikeimplying higher PE for Axel.
Other considerations that one would want to examine for PE include
a. Reputation of the company.
b. Quality of management.
c. Product range and its potential.
d. Accounting policiesinventory, depreciation, amortization of intangibles,
etc.
e. Dividend payout and policies (these policies could markedly affect the
relative PE for these companies if there were significant differences).
f. Capital expenditure programsWill Axel need new plant soon?
g. Expansion programinternal and via acquisition.
Overall Analysis: On most factors, Axel appears to be more efficient and
profitable than Bike. The greater prospects for increases in Axel's earnings per
share and market value are likely to produce a higher PE ratio for Axel.
Exercise CC-2 (25 minutes)
Company
a.
b.
c.
d.
e.
f.
g.
h.
i.
(6)
(2)
(8)
(1)
(9)
(3)
(5)
(7)
(4)
Case-9
Exercise CC-2concluded
Identification Strategy
Industry
Pharmaceuticals
Health care
Expected Characteristics
Company #
High R & D
2
No inventory
8
High plant and equipment
No advertising expense
High cost of goods sold
Utilities
High plant and equipment
1
Large debt (financed with bonds)
Low inventories
Investment advising
No inventory
9
Low plant and equipment
High "other" assets (investments)
High interest expense
Low cost of goods sold
Grocery stores
Low NI as % of sales
5
Low receivables
Low plant and equipment
(operating leases)
Computing equipment
High R&D
7
Higher inventory than
pharmaceutical company
Public opinion surveys
No inventory
4
No R&D
To distinguish between the tobacco manufacturer (6) and the brewery (3), recognize that the
tobacco manufacturer would keep higher inventories, while a brewery would maintain a
higher investment in plant and equipment. This implies that company (6) is the tobacco
manufacturer, and company (3) is the brewery company.
i.
ii.
iii.
iv.
v.
Alternative SolutionExplanations for identification:

Three firms have zero inventory(4), (8) and (9). These likely correspond to firms that have
operating expenses instead of cost of goods soldspecifically, investment advising, health
care, and public survey companies. Since company (8) has a very high property, plant and
equipment account, it is most likely the health care company. Company (9) has large "Other
assets," which probably represents investments, and high current liabilitiesit is most likely
the investment advising company. By process of elimination, company (4) is the public
opinion survey company.
Company (1) has a large plant and equipment account, as well as high long -term debt and
interest expense. It is the utility company.
Companies (2) and (7) have high R&D expense. This would correspond to the pharmaceutical
company and the computing equipment company. Since drugs typically have a shorter
shelf-life than computer equipment, the pharmaceutical company will have lower inventory
relative to sales. Company (2) is, therefore, the pharmaceutical company, while company (7)
manufactures computer equipment.
Company (5) must be the grocery store company since it shows very low receivables (few
sales on account), and very low net income relative to sales (typical for the industry).
Of the two firms left (tobacco manufacturer and brewery), tobacco products require aging.
The tobacco manufacturer would keep higher inventories, while a brewery would represent a
higher investment in plant and equipment. Company (6) is the tobacco manufacturer, and
company (3) is the brewery company.
Case-10
PROBLEMS
Problem CC-1 (55 minutes)
a. 1. Brewing industry compared with the S&P 400
The brewing industry and the S&P 400 are similar in terms of short-term
liquidity as indicated by the current ratio and quick ratiothe ratios are similar
in both absolute value and trend (both ratios are about the same as in Year 2).
However, there are substantial differences in long-term financial risk. While the
industry has experienced a decline in the proportion of debt, the aggregate
market data indicates a higher level of debt. This divergence in trend is also
evident in the flow ratios. While the brewing industry increased interest
coverage and relative cash flow ratios, the aggregate market experienced a
decline in coverage and relative cash flow. In turning to total asset turnover
ratios, the results are similar although the industry is better. Both experienced
an increase in net profit margin, but the industry looked better in the most
recent year. Moreover, the industry increased its return on total assets over
time, while the return for the market declined. In the most recent year, the
industry's return was almost twice as large as the S&P (7.90 percent vs. 3.97
percent). To summarize, the brewing industry showed progress in reducing its
financial risk and increasing its profits and return on assets. It had a better
trend and final position than the market.
2. Anheuser-Busch compared with the brewing industry
Regarding short-term liquidity, BUD is about the same in Year 6 as in Year 2
moreover, its ratios are consistently below the industry. While there is no
deterioration, the firm is less liquid than is normal for the industry. It is
important to determine why BUD is able to maintain such a tight short-term
posture compared to the rest of the industry. BUD's long-term debt posture
has improved slightly over time as evidenced by the debt to asset ratios. The
industry also has improved, so on a relative basis they are about the same as
in Year 2. BUD's interest coverage ratio has declined in absolute terms and
relative to the industry. In Years 2, 3, and 4, BUD had coverage of about 12-13
versus 7-8 for the industry; in Year 6 it is about 10 times for BUD versus 11 for
the industry. BUDs cash flow ratios have improved along with the industry.
Total asset turnover has increased for both BUD and the industry. The profit
margin performance for the industry is somewhat betterit went from 5.36
percent to 6.16 percent, while BUD is stable (6.30% versus 6.17%). Notably,
this stability in the profit margin is impressive considering the sales growth
and industry market share gained by BUD during this time period. Finally, the
return on total assets for BUD has increased over time and has been
consistently above the returns for the industry. In summary, BUD is less liquid
than the industry, but is stable on a relative basis. Its financial risk is mixed
its debt ratios declined, its interest coverage declined on an absolute and
relative basis although it is still a very healthy 10 times, and its cash flow
ratios improved. BUD's profit margin is constant but declined on a relative
basis, and its return on total assets improved but was constant on a relative
basis.
Case-11
Problem CC-1concluded
3. Anheuser-Busch compared with the S&P 400
BUD has maintained its short-term liquidity position, but its liquidity ratios are
consistently below the market. Its long-term financial leverage declined over
time while its market leverage increasedby Year 6, BUD was better on this
factor. This position is also reflected in interest coverage, which declined
somewhat but is still more than twice the market number. Also, the cash flow
ratios for BUD are the same or lower than the market in Year 2, but are
substantially better absolutely and relative to the market in Year 6. BUD's total
asset turnover increased while the market declined slightly over this period.
The net profit margin performance is similarthe market and BUD
experienced small declines over the period. BUD did have a larger return on
assets in Year 2 and increased its spread by Year 6 when it was twice as large
(8.89 percent vs. 3.97 percent). In summary, with the exception of the
short-term liquidity ratios, BUD is superior in an absolute sense and generally
experienced a better trend. As a result, the firm has much lower financial risk
and a much higher return on assets.
b. There should be no problem with extending credit to BUD given its declining debt
ratios, its strong interest coverage ratios, and its strong cash flow ratio that is
already better than the market and trending upward compared to a decline for the
market. With the lone exception of the interest coverage ratio, which declined in
Year 6, all the financial risk measures have improved on an absolute basis and
relative to the market. Even in the case of the coverage ratio, it is still quite large
and about 2.5 times the coverage for the aggregate market. Therefore, one would
not expect a change in the credit rating of BUD based on these financial ratios.
Case-12

a. [Note: Forecast data taken from Exhibit I of Case 10-5.]
ABEX Chemicals
Forecasted Operating Income
For Year Ended Year 10
Petrochemicals
Pipeline
Total
Segment revenues (volume x price)

4,950 x $0.470.......................................... $2,326.50
6,290 x $0.187..........................................
$1,176.23
Segment operating costs (volume x cost)

4,950 x $0.37............................................ 1,831.50
$1,176.23 x (1-27%).................................
Segment operating income......................... $ 495.00
858.65
$ 317.58
Total operating income ($495 + $317.58)...
812.58
b. Additional information necessary to prepare a forecast of net income

includes:
1. Schedule of debt outstanding including interest cost estimates.
2. Estimate for administration cost (such as the trend).
3. Estimate for rental expenses.
4. Estimate for investment income.
5. Tax rates.
6. Schedule of preferred shares outstanding including dividend rates.
7. Average number of shares outstanding.
This information can be obtained from the following primary sources: (1)
quarterly reports, (2) annual reports, (3) company information packages, (4)
prospectuses, (5) management interviews, (6) 10-K filings, and (7) 10-Q filings.
Case-13
c. 1. Incremental EPS =
Incremental operating income x (1-tax rate)

Shares outstanding
Volume x Price increase per pound x (1-tax rate)
Shares outstanding
= [4,950 lbs. x ($0.47)(8%) x (1- 0.44)] / 305

= $0.34 per share increase
2. Incremental EPS =
Volume increase x (Price - Cost) x (1-tax rate)

Shares outstanding
= [(4,950 lbs.)(8%) x ($0.47-$0.37) x (1- 0.44) / 305

= $0.07 per share increase
In this case, an 8% increase in price has a much greater impact than an 8%
increase in volume. This is because higher volume creates an increase in
variable costs. If costs rise as much as prices, then the impact on EPS is
reduced. Note that higher prices often coincide with higher volume if both
occur due to an increase in demand that is greater than an increase in
capacity. This is why it is particularly important for analysts to pay attention to
industry conditions of supply, demand, capacity, inventories, prices, and
costs.
Case-14

a. The principal limitation of the four ratios computed is that they say little about the
company's ability to generate cash. It is a lack of cash that ultimately forces a
company into bankruptcy. First, lets look at the quick ratio. Notice that FGC is
able to maintain its quick ratio over the period. This occurs while its working
capital declines from $448.7 million in Year 4 to negative $8.3 million in Year 5 to
$5.4 million by the middle of Year 6. Similarly, neither the receivables turnover nor
the inventory turnover help in revealing this decline in liquidity. Adding to the
decline in liquidity is the companys increasing reliance on external financing.
This is evidenced by the marked increase in long-term debt. Again, the four ratios
computed ignore this implication to liquiditythat is, interest costs must be paid.
Finally, its operating margin trend over the 2 1/2 years is equally deceptive in not
revealing the decline in liquidity. This is primarily because this margin is
computed before interest and taxes. Consequently, it fails to reflect the dramatic
increase in interest expenses over this period. The operating profit margin after
interest expense would reflect this decline in liquidity. In summary, these four
ratios do not reflect the decline in FGCs liquidity.
b. Several better measures of liquidity and operating performance exist (or at least
can supplement the four ratios computed). There are two such measures
reported in FGCs "Selected Cash Flow Data" schedule: (i) Cash flow from
operations and (ii) Net liquid balance.
The operating cash flow data clearly show a decline in FGC's liquidity over the
recent 2 1/2 years. Moreover, the components of this measure also evidence a
decline in liquidity. Specifically, notice that earnings from continuing operations
falls from $173.2 million for Year 4 to only $10.4 million for the first 6 months of
Year 6. Furthermore, noncash working capitalwhich declines in Years 4 and 5
(thereby acting as a source of cash)increases in the first half of Year 6,
reflecting a further $84.1 million drain on cash (admittedly, seasonal factors could
explain some of this decline).
The net liquid balance reflects that part of working capital that is most liquidit
excludes items of working capital that are less liquid. In the case of FGC, the net
liquid balance was already negative in Year 4, even before the recapitalization of
FGC. This suggests that FGC was overdependent on short-term external sources
of financing. This measure remained negative throughout this period. Indeed, the
net liquid balance appears to be a good leading indicator of default riskat least
in the case of FGC.
Other potentially useful measures are times interest earned, return on assets, and
return on common equity. Times interest earned reflects the ability of operating
income to cover the expense of long-term debt. The computation of this ratio
reveals a dramatic decline from a comfortable 5.4 in Year 4 to only 1.1 in the first
half of Year 6. A value less than 1.0 is a red flag for solvency risk. Return on
assets and return on
Case-15
equity also reflect FGC's long term financial prospects. Without sufficient returns,
the company's debt holders cannot expect security for their claims on income or
assets. Return on assets slipped from 10.9% in Year 4 to 6.4% in the first half of
Year 6. Both metrics reveal the decline in FGCs liquidity.
c. Based on the information provided, you should seek to sell the bonds. Indeed,
you should probably accept bid prices as low as the lower 50s. The bonds are
subordinated debentures, meaning they do not have first claim on assets in case
of bankruptcy. Also, the default risk for these bonds appears to be unacceptably
high. Industry conditions appear to have deteriorated due to a combination of
lower demand and increased supply. Reduced capacity utilization has put
downward pressure on prices. The fact that FGC's major competitor is also highly
leveraged may reduce the risk of unbridled price competition. On the other hand,
it could lead to aggressive pricing policies in the event both companies become
desperate to spur sales to service their large debt loads. The industry is cyclical,
so being highly leveraged places an even greater risk on FGC. It also calls into
question the past decisions of management. Given the poor ability of FGC to
generate cash and its weak net liquid balancealong with its heavy reliance on
external, short-term financingyou are well advised to recommend the sale of its
bonds.
Case-16
CASES
Case CC-1 (90 minutes)
The answers to the case depend on the company selected for analysis. The
comprehensive case analysis of Campbell Soup Company should serve as
excellent guidance for a student in completing the requirements of this case.

a. $7,000 = Net income - Cash dividends = $10,000 - $3,000
(Note: The 10% stock dividend has no effect on total stockholders' equity.)
b. Two accounts are increased by the following amounts:
Property, plant & equipment.................................
$1,000
Long-term debt......................................................
$1,000
These accounts are increased to record these leases at the present value of
their future rental payments.
These leases are reflected in the statement of cash flows as a separate
disclosure as a significant noncash activity.
c.
Repaid in Year 6
Long-Term Debt (includes current portion)

16,200
Beginning balance
7,500
Issuance per SCF
2,500
4,800
From TRO acquisition
1,000
Capital lease (noncash)
27,000
Ending balance
ZETA's statement of cash flows (SCF) reports "Reduction in long-term debt"

at $1,500. The only way an external analyst could arrive at this amount is to
assume that the capital lease is included in the $7,500 issuance of long-term
debt. Unresolved is the question of why the capitalized lease, a noncash
transaction, is seemingly included in this amount.
Case-17
Case CC-2continued
d. 1. and 2.
ZETA's change in accounting for inventories had the following effects:
(1)
(2)
BALANCE SHEET
Effect of change
Analytical
change
to new method in
to restate Year 5
Year 6
to new method
Inventories........................................
$2,800 *
$2,000
Income taxes payable......................
1,400 **
1,000
Retained earnings............................
1,400
1,000
* Cumulative pre-tax effect of $2,000 plus pre-tax effect on Year 6 income from continuing
operations (per note 5, statutory tax rate is 50%).
** 50% of $2,800 restatement of cumulative income.
RETAINED EARNINGS
Beginning balance...........................
$ 700 *
Net income........................................
1,400
300 *
Ending balance.................................
$1,400
$1,000
* Pro forma income data shows that Year 5 income from continuing operations is increased
by $300 based on retroactive application of the accounting change. Thus, the remaining
$700 ($1,000 - $300) after-tax effect must pertain to prior years.
INCOME STATEMENT
Cost of sales.........................................
$ (800)
$ (600)
Income tax expense.............................
400
300
Income from continuing operations....
400
$ 300
Cumulative effect (net of $1,000 tax)...
1,000
Net income............................................
$1,400
3. The accounts increased, along with their respective amounts, to record the
$1,000 cumulative effect are:
Inventories....................................................................$2,000
Income taxes payable................................................. 1,000
Retained earnings (cumulative effect).................. 1,000
Notice there is no effect on cash. The cumulative effect of $1,000 (net)
should be included with expenses. It will then be offset by the change in
inventories and in tax payable which will all net to zero.
Case-18
Case CC-2continued
e. 1. TRO must be a separate entity because minority interest is outstanding. If
100% of TRO had been acquired, we would be unable to determine whether
it was maintained as a separate legal entity or dissolved into ZETA.
2.
ZETA Corporation balance sheet:
The following accounts are affected by these amounts:
Investment in subsidiary............................................$8,000 (increase)
Cash.............................................................................. 8,000 (decrease)
Consolidated balance sheet (per SCF):
Receivables & Inventories..........................................$4,200 (increase)
Property, plant & equipment...................................... 6,000 (increase)
Goodwill....................................................................... 2,000 (increase)
Current liabilities......................................................... 3,200 (increase)
Long-term debt............................................................ 4,800 (increase)
Minority interest........................................................... 400 (increase)
Cash (net of 4,200 acquired)...................................... 3,800 (decrease)
3. Pro forma revenues (per note 3)................................$205,000
Reported revenues (without TRO)............................. 186,000
TRO's revenues........................................................... $ 19,000
f. 1.
Investment in Associated Companies
Beginning balance
11,000
Equity in income (per IS)
2,000
Dividends received [a]
Additional investment (per SCF)
1,600 600
Ending balance
14,000
[a] Dividends received:
Equity in NI..........................................
Less undistributed portion................
Distributed equity................................
$2,000
1,400 (per SCF)
$ 600
2. Sources of Cash Flows

Included in net income....................................... $ 2,000 Cr. (increase)
Items not affecting cash..................................... (1,400) Dr. (decrease)
Effect on cash from operations.........................
600 Cr. (increase)
Uses of Cash Flows:
Investment in associated companies............... $ 1,600 Dr. (decrease)
Case-19
Case CC-2continued
g. 1.
Minority interest
800
Beginning balance
400
TRO acquisition (note 3)
200
Share of net income (per IS)
1,400
Ending balance
2. There is NO relation between these accounts. Minority Interest relates to

consolidated companies, while the Investment in Associated Companies
relates to unconsolidated companies.
h.
LIFO
Beginning inventory.............................. $ 38,000
+ Purchases............................................
P
- Ending inventory................................. (56,000)
= Cost of goods sold............................. P-18,000
Difference
$ 4,500
-(6,000)
(1,500)
FIFO
$ 42,500
P
(62,000)
P-19,500
Therefore: $1,500 difference less 50% taxes = $750 increase in Net Income
Alternate solution: From Note 2: Inventories, the change in the LIFO reserve x (1tax rate) = ($6,000 - $4,500) x (1-.50) = $750.
1. Loss on disposal *............................................................ $1,400 (increase)

Property, plant & equipment............................................ 1,000 (decrease)
Inventories..........................................................................
100 (decrease)
Accounts payable & accruals..........................................
300 (increase)
Taxes payable....................................................................
700 (decrease)
Loss on disposal *............................................................
700 (decrease)
* These amounts could be nettedthey are separated here to emphasize that they arise
from two separate transactions.
2. There is no effect on cash flows. The effect of the loss on disposal is reported
as follows in the statement of cash flows:
Included in net income..................................................... $(700) Dr. (decrease)
Items not affecting cash..................................................
700 Cr. (increase)
Effect on CFO.................................................................... $ 0
3. The $1,100 operating loss consists of the following gross amounts (revenues
per note 4; expenses are a plug):
Revenues........................................................................... $18,000
Expenses............................................................................ 19,100
Net loss............................................................................... $(1,100)
The $1,100 would be part of the statement of cash flows as shown here:
Included in revenues.........................................................$18,000
Included in expenses........................................................ 19,100
Case-20
Case CC-2concluded
i.
Discontinued operations cannot be segregated because the changes in

operating current assets and current liability accounts represent both
continuing and discontinued operations.
j. Under current GAAP, there is no amortization of goodwill. Therefore, the

statement of cash flows is unaffected. In the event of an impairment, the
impairment loss will be reflected in net income and added back in the
Statement of Cash Flows as a noncash expense for no net effect on operating
cash flows.
k. (Note: All amounts per the statement of cash flows.)
Beginning balance
Additions for cash
TRO acquisition
Ending balance
Property, Plant, and Equipment (net)

33,000
6,500
6,000
Depreciation expense
6,000
1,000
Write-down of disc. operations
500
Disposal of equipment
38,000
Case-21

a. 1. Short-term liquidity
Four of the ratios are indicators of short-term liquidity. KO has a greater
current ratio and acid-test ratio. CCE has a significantly higher inventory
turnover ratio. Turnover of accounts receivable is virtually the same for both
companies. On balance, KO is slightly more liquid, and is in a stronger
position since CCE has virtually no cash.
2. Capital structure and solvency
Looking at the ratio of long-term debt to equity, CCE has significantly greater
financial leverage. CCE's large investment in fixed assets and purchased
goodwill is mainly debt financed. This ratio, which ignores short-term debt,
exaggerates the difference between the two companies. Total debt to total
capital ratios are much closer. CCE's greater dependence on interest-bearing
debt and lower profitability result in significantly lower interest coverage as
measured by the times interest earned ratio.
3. Asset Utilization
Both ratios in this category show KO to be superior. Asset turnover and
property, plant and equipment turnover are higher for KO. CCE's capital
intensive business is responsible for this disparity.
4. Profitability
KO is clearly the more profitable enterprise by all four measures. The higher
gross profit margin is carried down to net income. KO's return on assets and
return on common equity also are superior to those of CCE. KO's better
competitive position is reflected in its profitability ratios.
b.
Potential Analytical Adjustments

1. Remove non-recurring items from income statement of CCE. (From income
statement take $104 million gain on sale of operations, less $27 million
provision for restructuring, and add from footnote #2 the $8.5 million gain on
repurchase of debt to equal a net $85.5 million pre-tax nonrecurring gain.)
Reduce pretax earnings by $85.5 million for CCE.
Impact: CCE profitability reduced further in comparison to that of KO (ROA,
profit margins, ROCE). No other ratios affected.
2. Add back LIFO reserve to inventory for both companies. Effect is $30 million
for KO (cost of goods sold drops and reported profits rise) and $2 million for
CCE. Equity increases by same amounts. (Footnote 1 for both companies.)
Impact: KO current ratio improves slightly.
KO inventory turnover decreases.
KO debt ratios decline due to higher equity.
Effects on CCE immaterial as LIFO reserve relatively small.
3. Recognize market value of KO investments in excess of carrying value$291
million (footnote 2).
Impact: Higher equity reduces debt ratios and return on equity.
Higher assets reduce turnover and return on assets.
Case-22
Case CC-3concluded
4. Recognize off-balance sheet obligations for KO. KO has guarantees of $133
million (footnote 3).
Impact: Higher debt ratios for KO. Guarantees also added to assets affecting
asset-based ratios: decreasing ROA and turnover.
5. Recognize off-balance sheet obligations for CCE. CCE has operating leases
(footnote 3) for which analyst must estimate present value of "liability." One
potential simple calculation follows:
Year
Future value
PV factor *
Present value
9
11,749
0.909
10,680
10
8,436
0.826
6,969
11
6,881
0.751
5,168
12
4,972
0.683
3,396
13
3,485
0.621
2,164
14
3,727 **
2,102
15
3,727 **
1,912
16
3,727 **
1,741
34,132
*
**
Assumed interest rate of 10%.

Dividing payments beyond Year 13 ($11,181) by Year 13 payment ($3,485) results in
3.21 years. As an approximation, the payments beyond Year 13 are spread equally
over Years 14-16.
Impact: Higher debt ratios for CCE.

Current portion of lease obligation reduces CCE current ratio.
Leases would also be added to asset side of balance sheet,
affecting all asset-based ratios. Lease would increase fixed
assets, reducing turnover ratio and ROA.
6. Add pension plan surplus to equity for both companies. Excess of plan
assets over projected benefit obligation is $83 million for KO and $46
million for CCE. (Footnote 4 for both companies).
Impact: About the same for both companies as relative impacts the
similar. Debt ratios decline due to higher equity. ROCE decreases
due to higher equity base.
7. Remove purchased goodwill from balance sheets of both companies,
reducing assets and shareholders equity by $56 million for KO and $2,935
million for CCE (wiping out shareholders equity).
Impact: Not material for KO.
CCE debt ratios sharply higher because of lower equity.
CCE asset turnover improved because of lower assets.
CCE ROE and ROCE more than doubled because of lower base.
Case-23

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Case: Applying Financial Statement Analysis

Case: Applying Financial Statement Analysis

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