NO1...

Theis chamster is both a reviw and synhesis of the coneepts and techimquesd in prior chapters it
showas how reported data can be adjusted to ereatc more useful input for val-lation models : those
models are discused in (hapter 19the financial analisis in this chapter is ilusterated using wevaco whose
financial stattemenis are procid on the CD and wapsite the objektifis of equity and credit analisis are
similar with differences only in emphasas creditors are perimarily cornenetd with evaluating the from s
ability to service and repay its debt both when exlending credit and while credit is outstanding credit
analisis is an improtet factor in seting the iaterest rate and deht cos eants

Short-team cereditors such as banks were historically mere concemed with nquitey as they expected to
be repad in a short time period isurance companies pension plans and other investors in long-team
bunds on long-team profitability and asseet protedtions given their loger time horizon as more bank
credit risk equity investors bear the residual of the tirm thear investemet redrum depends on the long
term profitability may not surveif they connot manage their eredit needs however the utmate objedtife
of equity analisis is valuation such valuation tech miques as proce/cash flow and discoudted cash flow all
use financial statemen data researeh ented in carher chapsters showes Statement data used to make
investemen and credit decisions shoud be ajusted to reflet aconting di fferencees curret values and the
use of off-balance- sheet financial theningquis these ad usmetis shoald bemade regardiess of whether
the oh jective is credit or equity analysis we stsrt with the balance sheet

NO 2..

ANALYSIS OF AND ADJUSTMENTS TO BALANCE SHEET

The balance sheet shows the recorded asset liabilitis and equity of firm as ilustrated itroughout the
text.the repoted balance sheet suffers from two defects :

1.some usets and liabilitis are reecorded

2.the amortas at which asses and liabilitis are measumed may differ significantly from ther ecoromic
value

For these reanes the useliales of the reported balance sheet for investemen decisions is limited its
ultility can ehenced by the linlowing ajusments to addres those deficiencies.

*off-balance-sheet and liability are added to the balance sheet.

*allussets and liabilitis are measured at currei value

The first part of this chapcer is concemed with the adjusments requred to perepere a currnt value
halance sheet one of the objektivis of that xcise es a beteer etismate of book value parshare.

ANALYSIS OF BOOK VALUE

Book value is the reported stoek holders equity of the company less the lequidating value of ary
perevered shures aithogh book value per commong shere is offen displayed in comporace and
ivestemen repors it is frequity misudersed espot by condecence book walue equats melher the market
value of the from nor the fair value of ist met assets it perimanty

N0.3..

ANALYSIS OF AND ADUSMENTS TO THE BALANCE SHEEI

The acumulation of aconting antr.es and ajustments over the livertime of the comany and contais the
following there elements :

1.ogional capital used to stsrt the fim.plus perocesed forom any additional sheres issued less the cost of
shares tepurchased

2.ratamed carnings acomulated over the firm s life

3.acconting ajusments certaing acconting standes resulit in enterises diredty to equality whots flowing
theough the income stattemen examples incelude the minimum liability provision for pension plans
changes in the market value of long team marketabiliy scurites and foreign exchangge rate effects.

Firms do not dishnguish between original capital and subsekuenshare issuance the treasury stok account
accumulates the cost of sheres repurchased although firms may from time to time retretereasury shares
elimiting this account such technical retiremed has no analitycal sigafine the direet to equity accounting
adjustments reflek acconting are value balence snet requres reniktin of all such efenst aconting some
based on management diseretin with recognitin of all known cconomic effects becaus of the acconting
eholies avalue and the selektif reptonition inherent in GAAP .book value after ajusmet ma bemore
useful for desciason making the balance sheet ajusmet required to campute anjusment may be more
useful for decision making the balances sheet adjustments requrad to computer ajused book value are
discussed in the folowing sctions

NO4..

The reported book values of assets ahoulud be ajusted to comen market value to apormale their value
as corogeral for ereditors and nesauces avaluble to equity holdes the equmen market valuc also facilitas
an asumsimet of the carning power and cash generiting poten tail of the asets the asut mused be
adjusled for the impact of acconting choces forxspile ajusmet of of last in frst-out (lifo)ivestories to frest-
in frut out (fifo)gaap reques acors and devermals may impeks reputed seset amout and muat
beevaluated for their relevance for ulevered tax asets anal the impect of exehange rate chagesminabel
market value for such falapancial assets as almar ketbele sue of market value for such funcial asset as
marketbele securites bank loans morgages and private piacemet debt,some financial assets ineluding
real extate timberlen and mineral peropetis should also be marked to market these asset have almative
used and thesis market values can be etimaced with suficeen reability hover the estimated curend value
of an operating facility (such as apelmil or computer manufaktur facility )is far more subjektif as its value
is deved perimery mill of cumputer manufaktur facelity)is far more sujektive as its not clear whet
measure of cumed value shold be used (see appendinx 8-A for a disecussoin of this issue)for other
assets notability such integible duscussd in lev and sugianis (1996) SEE CHAPTER 7 )to individual firemay
be fasible albeit fragoat with stancal divilulici thus somenhore a line must be drawin betwen those asset
(and liabilitis that are revalued inlev and sugianias to draw betwen those aset ring decisiaon dependes
on the purpase of the analisis and a judgamen of the reability of the current valus data

NO.5..

Market value adusments and rection of effect of accounting checes are equatly anpelicable to liabilies
for the same reasons given carlier for assets the recoertion ef offbelance-sheet aktifitis ineluding ail off-
balance-hett debt condesation of ucolsonhed afihates deemed to be intergral to the firm.s.opereations
and repicmen of the balance sheet accrual for pensions and other postetmen tbenefits with the actual
status of the plan are especialiy important.

These adjustments recognize obligtions the do not meet the accounting definition of debt or whouse
recornition is not requered under curent GAAP note that some of these adjustimet both assets and
liabilitis :for example the capitalization of operating leses incerses both assets (peroperty)and liabilitis

Finaliyy some reported liabilitis must be eliminated or redlasified some liability balances are not debt as
they are indicatrs of a firem s furture sales or perofability rather than cash oulflow fxamles of liabilites
that sholud be exeluded from debt follow:

Advaces from costomers income from the sale of syndication righes for filims to be shown on television
or cable.for examle. Is recornizetd over the term of the contract with the unesmed amount showen as a
liability.the cost of creating the cost of ereting the film has areday been incored the deferrd amount is
unearicd income not debt.

Investment tax etedits rwcornizetd under the defernal method are arexher examle:they are purely
urenized income.not debt.

Defemed income taxes this liability enterites furture taxes payabe if the tex bassis of meome
measurement catehes up to the aconting bassis the defered tax liability batafe may contunusly groe
especially if arising from deperecation and the net tineting defdereng will not referense in grow
especialiy if asing from deferecation and the net timing deverencet wiill not reverense in the near fulure
when the deferred tax liability (or asset ) is sigehed the analiset shouled examine its susre and the
likelihod of us reverensial compars that are likely to reverense should be inceluded but restated to
prosent value.