∑ ∞ FCF WACC
Appendix 1: Calculating the Free Cash Flows When There Are Negative Profi ts We start off with a simple example. A fi rm that has no depreciation, no
4.3 Analyzing the Financial Statements
We’re going to build a set of fi nancial statements with roughly the same format as the historical statements.3 In order to do so, we have to analyze the statements and make some decisions about plausible predictions and projections for the future.
4.3.1 Sales Projections
The sales projection is one of the most critical elements in our model of PPG; it is central to determining the value of the company in the fi nancial model we build. Before we start, here are some details of PPG’s sales between 1990 and 2000:
1
Cost of goods sold 5,334
Selling, general, and administrative
expense 1,646
Operating income nefore depreciation 1,649 Depreciation and amortization 447
Interest expense 193
Nonoperating income (expense) and
special items 8
Pretax income 1,017
Income taxes - total 369
Minority interest 28
Income before extraordinary items 620 Extraordinary items and discontinued
operations 75
Net income (loss) 620
Cash dividends 276
Retained 344
PPG CORPORATION INCOME STATEMENTS, 1991-2000 (Million $)
C D E F G H I J
1999 1998 1997 1996 1995 1994 1993 1992 1991
7,757 7,510 7,379 7,218 7,058 6,331 5,754 5,814 5,673
4,696 4,476 4,397 4,340 4,212 3,866 3,633 3,695 3,676
1,514 1,404 1,318 1,243 1,214 1,137 1,073 1,083 1,079
1,547 1,630 1,664 1,634 1,632 1,329 1,048 1,036 918
415 354 348 340 332 318 331 352 351
142 119 115 108 93 91 109 148 169
-17 137 -26 . . -64 -63 . -44
973 1,294 1,175 1,240 1,262 856 544 542 354
377 466 435 471 480 325 236 218 147
28 27 26 25 15 16 13 4 5
568 801 714 744 768 515 295 319 201
0 0 0 0 0 0 0 -273 0
568 801 714 744 767.6 514.6 22.2 319.4 276.2
264 252 239 237 239 238 221 200 183
304 549 475 507 529 277 -199 120 94
1991 5,673 -3.67% <-- =B4/B3-1
1992 5,814 2.49%
1993 5,754 -1.03%
1994 6,331 10.03%
1995 7,058 11.47%
1996 7,218 2.27%
1997 7,379 2.23%
1998 7,510 1.78%
1999 7,757 3.29%
2000 8,629 11.24%
Compound growth
rate 3.89% <-- =(B13/B3)^(1/10)-1
PPG CORPORATION ANALYSIS OF SALES 1990-2000
PPG, Sales and Sales Growth, 1990–2000
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Sales ($ million)
-6%
3. We already made lots of judgment calls in the historical fi nancial statements. For example, we combined all the debt items into one.
There are two things to notice about PPG’s historic sales:
• Average sales growth is quite low (around 4 percent), as befi ts a company in a mature industry. In such an industry we would expect sales growth to be approximately the average growth of the economy as a whole.
• The growth pattern is very cyclical. This is typical of the chemicals industry. PPG’s growth seems to fl uctuate between low (and even nega-tive) growth and high rates of growth.
Projection In our base-case projection (see section 4.6), we will assume that PPG’s future sales growth is 4 percent. In the exercise at the end of the chapter we will let you use a variation where the growth is high for 2001 and 2002 and much lower afterward.
4.3.2 Profi t and Loss Analysis
We analyze the ratios for the profi t and loss statement. Our general approach is that the primary ratios are percentages of sales:
28
Profit and loss historical ratios 2000 1999 1998 1997 1996 1995 1994 1993 1992
COGS/Sales 61.81% 60.54% 59.60% 59.59% 60.13% 59.68% 61.05% 63.14% 63.55%
SG&A/Sales 19.08% 19.52% 18.70% 17.86% 17.23% 17.19% 17.96% 18.65% 18.62%
Total costs/Sales (sum of above items) 80.89% 80.06% 78.30% 77.45% 77.36% 76.87% 79.02% 81.79% 82.18%
Depreciation/Gross fixed assets 6.31% 6.05% 5.25% 5.15% 5.09% 5.13% 5.15% 5.48% 5.71%
Interest expense/Average debt 6.70% 6.30% 6.96% 7.23% 7.96% 7.88% 8.04% 8.96% 10.30%
Incomes taxes/Pretax income 36.28% 38.75% 36.01% 37.02% 38.00% 38.00% 38.00% 43.41% 40.31%
Minority Interest/(Pretax - Taxes) 4.32% 4.70% 3.26% 3.51% 3.20% 1.92% 3.00% 4.19% 1.24%
Dividends/Net income 44.52% 46.48% 31.46% 33.47% 31.80% 31.12% 46.21% 994.59% 62.49%
Profit and loss--model parameters
COGS/Sales 61.39% <-- =AVERAGE(B29:K29)
SG&A/Sales 18.38% <-- =AVERAGE(B30:K30)
Depreciation/Gross fixed assets 6.31% <-- =B33
Interest rate 6.70% <-- =B34
Tax rate 36.28% <-- =B35
Minority Interest/(Pretax - Taxes) 4.32% <-- =B36
Dividend growth 6.00% <-- See explanation later on
J
Model Parameters Our choice of model parameters (rows 40–46) may appear to be idiosyncratic. In come cases—for examples in COGS/Sales and SG&A/Sales—we have decided to use the historical averages of the parameters. In other cases—for example, the depreciation rate, the fi rm’s interest rate on future borrowings, and the percentage of earnings paid to minority interests—we have chosen to ignore historical information and to use only the last year’s values. In the case of modeling the fi rm’s
Model Parameters We use the historical ratios to project future antici-pated ratios. As in the case of our parameter choice for the income statement, we make no claims for consistency, preferring instead to use our judgment (or lack of judgment). Following are our choices.
39
Balance sheet--historical ratios
ASSETS 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991
Cash and short-term investments
Receivables/Sales 18.11% 20.55% 18.19% 18.34% 16.98% 17.64% 19.41% 17.32% 17.60% 18.65%
Inventories/Sales 12.99% 13.10% 12.21% 11.70% 11.03% 10.45% 10.84% 11.88% 12.77% 15.43%
Other current assets/Sales 3.45% 3.79% 3.32% 3.24% 2.84% 2.65% 3.01% 4.07% 2.13% 3.57%
Operating CA/Sales 35.84% 39.47% 35.42% 35.02% 31.81% 32.24% 34.25% 35.21% 33.55% 38.31%
Property, plant, equipment, gross/Sales 82.15% 88.42% 89.73% 91.58% 92.66% 91.59% 97.34% 105.01% 105.91% 109.52%
Annual depreciation/PPE 6.31% 6.05% 5.25% 5.15% 5.09% 5.13% 5.15% 5.48% 5.71% 5.65%
Property, Plant, equipment, net/Sales 34.08% 37.81% 38.68% 38.69% 40.36% 40.17% 43.31% 48.44% 51.11% 56.12%
Other assets/Sales 16.12% 15.91% 15.85% 14.35% 16.74% 15.36% 15.53% 14.57% 12.72% 12.33%
Other assets, growth rate since 1991 7.93% <-- =(B14/K14)^(1/9)-1
LIABILITIES
Accounts payable/Sales 8.85% 9.73% 8.39% 8.75% 8.34% 8.27% 8.18% 7.58% 7.69% 9.17%
Accrued expense/Sales 7.02% 8.37% 8.44% 7.64% 6.98% 7.37% 7.60% 7.34% 5.56% 6.13%
Other Current liabilities/Sales 0.14% 0.34% 0.15% 0.11% 0.21% 0.58% 0.87% 1.17% 0.83% 1.09%
Operating CL/Sales 16.02% 18.43% 16.98% 16.51% 15.52% 16.21% 16.64% 16.09% 14.08% 16.40%
Debt Debt/Equit
K
y 95.93% 89.83% 59.65% 67.80% 59.70% 47.52% 44.74% 45.66% 48.42% 59.28%
Debt/Assets 32.56% 31.30% 23.26% 24.77% 23.01% 19.71% 19.41% 19.98% 23.08% 25.98%
Other liabilities/Sales 11.64% 12.50% 13.14% 12.90% 11.92% 11.86% 12.10% 13.95% 5.26% 6.12%
Other liabilities, growth rate since 1991 12.53% <-- =(B26/K26)^(1/9)-1
4. And just to make sure, we’ll do sensitivity analysis on the parameters to test whether a different choice would have an impact.
future dividends, we have chosen another approach entirely—we will assume that the fi rm’s total dividends will grow by 4.13 percent per year;
an explanation for this assumption is given in section 4.9.
In every case we tried to make our parameter choice an intelligent, informed refl ection of our knowledge of the fi rm.4
4.3.3 Balance Sheet Analysis
We analyze the balance sheet ratios as follows:
Net Fixed Assets/Sales PPG made great efforts over the 1991–2000 decade to become more effi cient. These are refl ected in the steady decline of the ratio of net plant, property, and equipment to sales.
67
Balance sheet--model parameters
ASSETS
Cash and short-term investments constant
Receivables/Sales 18.28% <-- =AVERAGE(B42:K42)
Inventories/Sales 12.24% <-- =AVERAGE(B43:K43)
Other current assets/Sales 3.21% <-- =AVERAGE(B44:K44)
Operating CA/Sales 35.11% <-- =AVERAGE(B45:K45)
Property, plant, equipment, gross =accrued depreciation + net plant, property, equipment Accrued depreciation =previous year's accrued + this year's depreciation from income Property, plant, equipment, net/Sales 34.08% <-- =B49
Other assets, annual growth rate 7.93% <-- =B52
LIABILITIES
Accounts payable/Sales 8.50%
Accrued expense/Sales 7.25%
Other current liabilities/Sales 12 <-- constant at current level
Debt/Assets 32% <-- approximately current level
Deferred taxes grows at sales growth
Minority Interest 128 <-- constant at current level
Other liabilities, annual growth rate 12.53% <-- =B65
EQUITY
Common stock 484
Capital surplus 102
Retained earnings =previous year's retained + this year's retentions from income statement Treasury stock - total dollar amount PLUG
G
PPG became much more effi cient during the 1990s: In 1991 it took about $560 of net fi xed assets to produce $1,000 of sales; by 2000 it took only $340 of fi xed assets to produce $1,000 of sales. The modeling ques-tion is whether this trend will continue. In our model we have assumed that it will not, and that PPG will maintain (but not improve) its current level of effi ciency.5