Questions, Exercises, Problems, and Cases 43

Many firms include all or a portion of their annual reports and SEC filings on their corporate
websites. For example, Clorox provides all of the financial data and analysis provided in
Appendices A and B on the investor relations page of its website ([Link]).
In addition, many firms provide additional financial data on their sites that are not published
in the annual reports. Other useful information in the investor relations section of corporate
websites may include (1) presentations made to analysts; (2) press releases pertaining to new
products, customer acquisitions, and earnings announcements; and (3) transcripts or archived
webcasts of conference calls with analysts.
Firms are required to file reports electronically with the SEC, and filings for recent years are
available at the SEC website ([Link]). Numerous commercial online and financial database
services also provide financial statement information (for example, Bloomberg, Standard &
Poor’s, and Moody’s).

Summary
The purpose of this chapter is to provide a broad overview of the six-step analysis and valua-
tion framework that is the focus of this book and a logical process for analyzing and valuing
companies:
1. Identify the economic characteristics and competitive dynamics of the industry in which
the firm participates.
2. Identify the strategies that the firm pursues to compete in its industry.
3. Assess the quality of the firm’s financial statements, adjusting them, if necessary, for items
lacking sustainability or comparability.
4. Analyze and interpret the profitability, growth, and risk of a firm, assessing the firm’s per-
formance and the strength of its financial position.
5. Prepare forecasted financial statements.
6. Value the firm.
The remaining chapters discuss each step in greater depth.

Questions, Exercises, Problems, and Cases

Questions and Exercises
1.1 Porter’s Five Forces Applied to the Air Courier Industry. Apply Porter’s LO 1-2
five forces to the air courier industry. Industry participants include such firms as FedEx, UPS, and DHL.
(Hint: Access Gale’s Business & Company Resource Center, Global Business Browser, or Standard & Poor’s
Industry Surveys to obtain the needed information.)

1.2 Economic Attributes Framework Applied to the Specialty Retailing LO 1-2

Apparel Industry. Apply the economic attributes framework discussed in the chapter to
the specialty retailing apparel industry, which includes such firms as Gap, Limited Brands, and
Abercrombie & Fitch. (Hint: Access Gale’s Business & Company Resource Center, Global Business
Browser, or Standard & Poor’s Industry Surveys to obtain the needed information.)

1.3 Identification of Commodity Businesses. A recent article in Fortune LO 1-2

magazine listed the following firms among the top 10 most admired companies in the United States:
Dell, Southwest Airlines, Microsoft, and Johnson & Johnson. Access the websites of these
four companies or read the Business section of their Form 10-K reports ([Link]). Discuss the
companies’ strategies using the framework discussed in the chapter, and describe whether you would
view their products or services as commodities. Explain your reasoning.

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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
44 CHAPTER 1 Overview of Financial Reporting, Financial Statement Analysis, and Valuation

LO 1-2 1.4 Identification of Company Strategies. Refer to the websites and the Form 10-K
reports of Home Depot ([Link]) and Lowe’s ([Link]). Compare and contrast
their business strategies.

LO 1-3 1.5 Researching the FASB Website. Go to the website of the Financial Accounting
Standards Board ([Link]). Identify the most recently issued financial reporting standard and
summarize briefly (in one paragraph) its principal provisions. Also search under Project Activities to
identify the reporting issue with the most recent update. Describe the issue briefly and the nature of
the action taken by the FASB.

LO 1-3 1.6 Researching the IASB Website. Go to the website of the International Account-
ing Standards Board ([Link]). Search for the International Financial Reporting Standards (IFRS)
summaries. Identify the most recently issued international financial reporting standard and summarize
briefly (in one paragraph) its principal provisions.

LO 1-2 1.7 Effect of Industry Economics on Balance Sheets. Access the investor rela-
tions or corporate information section of the websites of American Airlines ([Link]), Intel
([Link]), and Disney ([Link] Study the business strategies of each firm. Examine
the following financial ratios and indicate which firm is likely to be American Airlines, Intel, and Disney.
Explain your reasoning.

Firm A Firm B Firm C

Property, plant, and equipment/assets 27.9% 34.6% 62.5%
Long-term debt/assets 18.2% 3.7% 35.7%

LO 1-2 1.8 Effect of Business Strategy on Common-Size Income Statements. Access

the investor relations or corporate information section of the websites of Apple Computer ([Link]
.com) and Dell ([Link]). Study the strategies of each firm. Examine the following common-size
income statements and indicate which firm is likely to be Apple Computer and which is likely to be Dell.
Explain your reasoning. Indicate any percentages that seem inconsistent with their strategies.

Firm A Firm B
Sales 100.0% 100.0%
Cost of goods sold (82.1) (59.9)
Selling and administrative expenses (11.6) (9.7)
Research and development (1.1) (3.1)
Income taxes (1.4) (8.9)
All other items 0.2 0.8
Net income 4.1% 19.2%

LO 1-2 1.9 Effect of Business Strategy on Common-Size Income Statements. Access

the investor relations or corporate information section of the websites of Dollar General ([Link]-
[Link]) and Macy’s Inc. ([Link]). Study the strategies of each firm. Examine the following
common-size income statements and indicate which firm is likely to be Dollar General and which is likely
to be Macy’s. Explain your reasoning. Indicate any percentages that seem inconsistent with their strategies.

Firm A Firm B
Sales 100.0% 100.0%
Cost of goods sold (70.7) (60.3)
Selling and administrative expenses (23.4) (34.1)
Income taxes (0.8) (0.5)
All other items (4.0) (0.1)
Net income 1.0% 5.2%

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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
 Questions, Exercises, Problems, and Cases 45

Problems and Cases

1.10 Effect of Industry Characteristics on Financial Statement LO 1-2, LO 1-4
Relations. Effective financial statement analysis requires an understanding of a firm’s economic
characteristics. The relations between various financial statement items provide evidence of many
of these economic characteristics. Exhibit 1.15 (page 46) presents common-size condensed balance
sheets and income statements for 12 firms in different industries. These common-size balance sheets
and income statements express various items as a percentage of operating revenues. (That is, the
statement divides all amounts by operating revenues for the year.) Exhibit 1.15 also shows the ratio of
cash flow from operations to capital expenditures. A dash for a particular financial statement item does
not necessarily mean the amount is zero. It merely indicates that the amount is not sufficiently large
enough for the firm to disclose it. Amounts that are not meaningful are shown as n.m. A list of the 12
companies and a brief description of their activities follow.
A. [Link]: Operates websites to sell a wide variety of products online. The firm operated at a
net loss in all years prior to that reported in Exhibit 1.15.
B. Carnival Corporation: Owns and operates cruise ships.
C. Cisco Systems: Manufactures and sells computer networking and communications products.
D. Citigroup: Offers a wide range of financial services in the commercial banking, insurance, and
securities business. Operating expenses represent the compensation of employees.
E. eBay: Operates an online trading platform for buyers to purchase and sellers to sell a variety of
goods. The firm has grown in part by acquiring other companies to enhance or support its online
trading platform.
F. Goldman Sachs: Offers brokerage and investment banking services. Operating expenses repre-
sent the compensation of employees.
G. Johnson & Johnson: Develops, manufactures, and sells pharmaceutical products, medical equip-
ment, and branded over-the-counter consumer personal care products.
H. Kellogg’s: Manufactures and distributes cereal and other food products. The firm acquired other
branded food companies in recent years.
I. MGM Mirage: Owns and operates hotels, casinos, and golf courses.
J. Molson Coors: Manufactures and distributes beer. Molson Coors has made minority ownership
investments in other beer manufacturers in recent years.
K. Verizon: Maintains a telecommunications network and offers telecommunications services. Oper-
ating expenses represent the compensation of employees. Verizon has made minority investments
in other cellular and wireless providers.
L. Yum! Brands: Operates chains of name-brand restaurants, including Taco Bell, KFC, and Pizza Hut.

REQUIRED
Use the ratios to match the companies in Exhibit 1.15 with the firms listed previously and explain your
reasoning using the strategy framework in the chapter.

1.11 Effect of Industry Characteristics on Financial Statement LO 1-2, LO 1-4

Relations. Effective financial statement analysis requires an understanding of a firm’s economic
characteristics. The relations between various financial statement items provide evidence of many of
these economic characteristics. Exhibit 1.16 (page 47) presents common-size condensed balance sheets
and income statements for 12 firms in different industries. These common-size balance sheets and
income statements express various items as a percentage of operating revenues. (That is, the statement
divides all amounts by operating revenues for the year.) Exhibit 1.16 also shows the ratio of cash flow
from operations to capital expenditures. A dash for a particular financial statement item does not
necessarily mean the amount is zero. It merely indicates that the amount is not sufficiently large for
the firm to disclose it. The 12 company names and brief descriptions follow.
A. Abercrombie & Fitch: Sells retail apparel primarily through stores to the fashion-conscious young
adult and has established itself as a trendy, popular player in the specialty retailing apparel industry.
B. Allstate Insurance: Sells property and casualty insurance, primarily on buildings and automobiles.
Operating revenues include insurance premiums from customers and revenues earned from invest-
ments made with cash received from customers before Allstate pays customers’ claims. Operating
expenses include amounts actually paid or expected to be paid in the future on insurance coverage
outstanding during the year.

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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
 46
Exhibit 1 .1 5
Common-Size Financial Statement Data for Firms in 12 Industries (Problem 1.10)
1 2 3 4 5 6 7 8 9 10 11 12
BALANCE SHEET
Cash and marketable securities 2,256.1% 4.1% 20.1% 2.0% 10.6% 96.9% 4.1% 2,198.0% 26.0% 4.5% 1.9% 39.3%
Receivables 352.8 2.8 15.2 8.9 12.0 8.8 4.2 1,384.8 4.0 13.3 2.0 5.1
Inventories — 2.4 7.9 7.0 2.1 3.0 1.5 — 8.9 4.0 1.3 —
Property, plant, and equipment, at
cost — 286.8 43.0 55.4 221.5 33.8 278.8 — 7.8 41.4 61.1 32.9
Accumulated depreciation — (59.8) (20.4) (32.5) (132.6) (22.6) (52.8) — (2.6) (14.1) (28.3) (18.9)
CHAPTER 1

Property, plant, and equipment, net — 227.0% 22.5% 22.9% 88.9% 11.2% 226.0% — 5.3% 27.3% 32.9% 14.0%
Intangibles — 36.5 43.4 39.8 75.2 40.5 6.0 101.9% 5.0 109.4 8.3 90.9
Other assets 57.3% 7.2 24.0 4.8 19.0 28.3 81.0 208.5 7.2 59.7 11.4 33.3
Total Assets 2,666.2% 280.0% 133.2% 85.4% 207.9% 188.6% 322.9% 3,893.3% 56.4% 218.2% 57.9% 182.6%

Current liabilities 2,080.8% 37.8% 32.7% 27.7% 26.6% 37.8% 41.7% 2,878.4% 30.0% 20.7% 15.3% 43.4%
Long-term debt 390.9 69.1 12.7 31.7 48.2 28.5 172.2 596.1 0.4 38.4 31.6 —
Other long-term liabilities 92.6 5.6 21.1 14.6 90.2 15.3 53.8 171.3 4.4 33.9 12.0 9.4
Shareholders’ equity 101.9 167.5 66.7 11.3 42.8 107.0 55.1 247.5 21.4 125.3 (1.0) 129.8
Total Liabilities and
Shareholders’ Equity 2,666.2% 280.0% 133.2% 85.4% 207.9% 188.6% 322.9% 3,893.3% 56.4% 218.2% 57.9% 182.6%

INCOME STATEMENT
Operating revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales (excluding
depreciation) or operating
expensesa (54.6) (61.6) (29.0) (58.1) (40.1) (36.1) (56.0) (73.4) (85.8) (59.5) (75.1) (26.1)
Depreciation and amortization (2.0) (9.9) (4.4) (2.9) (15.0) (1.5) (10.8) (5.0) (1.5) (5.7) (4.9) (2.8)
Selling and administrative (1.4) (12.1) (29.3) (23.7) (27.6) (27.6) (19.3) (5.1) (2.6) (27.9) (7.6) (33.7)
Research and development (1.6) — (12.2) — — (14.6) — (7.7) (5.1) — — (8.5)
Interest (expense)/income 9.5 (2.8) (0.1) (2.5) (1.9) 1.0 (8.5) 78.4 — (1.8) (2.0) 1.3
Income taxes (14.3) (0.1) (6.2) (3.8) (3.4) (4.3) (2.6) (16.0) (1.0) (2.2) (2.8) (4.7)
Overview of Financial Reporting, Financial Statement Analysis, and Valuation

All other items, net (8.0) 0.1 1.6 — (5.5) — 2.3 (28.8) (0.3) 5.2 0.4 —
Net Income 27.6% 13.6% 20.3% 9.0% 6.6% 17.0% 5.3% 42.3% 3.7% 8.0% 8.0% 25.5%
Cash flow from operations/capital
expenditures n.m.b 1.0 4.9 2.7 1.5 9.8 1.0 n.m.b 8.8 1.8 1.6 5.1

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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
a
See the problem narrative for items included in operating expenses.
b
not meaningful
 Exhibit 1 .1 6
Common-Size Financial Statement Data for Firms in 12 Industries (Problem 1.11)
1 2 3 4 5 6 7 8 9 10 11 12
BALANCE SHEET
Cash and marketable
securities 6.7% 23.0% 9.2% 362.6% 6.0% 1.1% 1.6% 14.7% 8.3% 27.3% 8.8% 11.6%
Receivables 13.7 48.4 25.0 47.7 8.9 4.1 15.7 2.7 43.2 697.5 4.0 16.8
Inventories 11.6 9.6 2.9 — 8.7 10.6 — 10.5 5.0 — 0.5 5.3
Property, plant, and
equipment, at cost 76.3 101.2 272.3 10.3 46.4 15.4 6.9 66.1 13.1 3.2 132.4 18.3
Accumulated depreciation (48.2) (50.9) (92.8) (6.7) (21.8) (6.1) (3.7) (26.6) (7.7) (1.3) (46.3) (8.5)
Property, plant, and
equipment, net 38.1% 50.3% 179.5% 3.6% 24.6% 9.3% 3.1% 39.5% 5.4% 1.9% 86.1% 9.8%
Intangibles 39.1 8.2 — 2.8 112.8 6.0 2.6 — 55.7 40.9 9.5 34.7
Other assets 4.1 58.4 60.5 120.7 9.5 4.1 4.7 12.9 12.0 26.7 12.2 22.0
Total Assets 108.1% 197.9% 277.1% 537.5% 170.6% 35.2% 27.8% 80.5% 129.6% 794.3% 121.0% 100.2%
Current liabilities 23.5% 60.0% 51.2% 391.7% 39.1% 18.7% 10.3% 12.7% 73.0% 122.1% 10.8% 37.5%
Long-term debt 28.9 16.5 70.1 19.4 26.1 2.5 0.9 2.8 22.9 565.5 43.3 12.2
Other long-term liabilities 16.8 42.7 88.9 51.3 25.5 3.6 2.7 12.8 7.4 20.2 10.0 15.1
Shareholders’ equity 38.8 78.7 66.9 75.1 79.8 10.3 13.9 52.1 26.4 86.5 56.9 35.4
Total Liabilities and
Shareholders’ Equity 108.1% 197.9% 277.1% 537.5% 170.6% 35.2% 27.8% 80.5% 129.6% 794.3% 121.0% 100.2%
INCOME STATEMENT
Operating revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales (excluding
depreciation) or operating
expensesa (46.1) (23.4) (60.7) (91.6) (49.2) (75.6) (82.5) (33.3) (87.4) (29.1) (63.3) (76.4)
Questions, Exercises, Problems, and Cases

Depreciation and
amortization (4.7) (6.8) (12.6) (0.9) (3.9) (1.8) (0.8) (5.1) (1.8) (1.7) (5.1) (4.2)
Selling and administrative (20.4) (24.1) — (10.7) (23.9) (18.2) (15.3) (49.4) — (25.0) (4.9) (6.0)
Research and development (5.8) (20.1) — — (2.6) — — — — — — (2.5)
Interest (expense)/income (0.4) (1.1) (4.8) 21.0 (1.7) (0.2) — 0.3 (0.6) (32.7) (2.2) (0.6)
Income taxes (6.5) (8.4) (3.3) (6.9) (5.1) (1.5) (0.5) (5.0) (4.1) (3.7) (7.8) (1.5)

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All other items, net (0.0) 16.7 (10.6) 4.2 0.7 (0.5) (0.1) — 1.2 (3.3) 1.7 (2.1)

Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
Net Income 16.1% 32.7% 8.1% 15.2% 14.3% 2.2% 0.8% 7.4% 7.5% 4.5% 18.3% 6.7%
Cash flow from operations/
capital expenditures 4.3 5.1 0.8 18.7 4.6 1.4 1.6 1.3 6.6 100.9 2.8 3.6
47
48 CHAPTER 1 Overview of Financial Reporting, Financial Statement Analysis, and Valuation

C. Best Buy: Operates a chain of retail stores selling consumer electronic and entertainment equip-
ment at competitively low prices.
D. 3M: Manufactures a wide variety of industrial and consumer products (the firm lists 45 product
categories on its website), ranging from home, office, and school products (such as Post-it Notes
and Scotch Tape), to wound and skin care (such as Ace bandages), to adhesives for the aerospace
and aircraft industries.
E. Hewlett-Packard: Develops, manufactures, and sells computer hardware. The firm outsources
manufacturing of many of its computer components.
F. HSBC Finance: Lends money to consumers for periods ranging from several months to several
years. Operating expenses include provisions for estimated uncollectible loans (bad debts expense).
G. Kelly Services: Provides temporary office services to businesses and other firms. Operating rev-
enues represent amounts billed to customers for temporary help services, and operating expenses
include amounts paid to the temporary help employees of Kelly.
H. McDonald’s: Operates fast-food restaurants worldwide. A large percentage of McDonald’s restau-
rants are owned and operated by franchisees. McDonald’s frequently owns the restaurant buildings
of franchisees and leases them to franchisees under long-term leases.
I. Merck: A leading research-driven pharmaceutical products and services company. Merck discov-
ers, develops, manufactures, and markets a broad range of products to improve human and animal
health directly and through its joint ventures.
J. Omnicom Group: Creates advertising copy for clients and is the largest marketing services firm in
the world. Omnicom purchases advertising time and space from various media and sells it to clients.
Operating revenues represent commissions and fees earned by creating advertising copy and selling
media time and space. Operating expenses include employee compensation.
K. Pacific Gas & Electric: Generates and sells power to customers in the western United States.
L. Procter & Gamble: Manufactures and markets a broad line of branded consumer products.
REQUIRED
Use the ratios to match the companies in Exhibit 1.16 with the firms listed previously, and explain your
reasoning using the strategy framework in the chapter.
LO 1-2, LO 1-4 1.12 Effect of Industry Characteristics on Financial Statement
Relations: A Global Perspective. Effective financial statement analysis requires an
understanding of a firm’s economic characteristics. The relations between various financial statement
items provide evidence of many of these economic characteristics. Exhibit 1.17 (page 49) presents
common-size condensed balance sheets and income statements for 12 firms in different industries.
These common-size balance sheets and income statements express various items as a percentage of
operating revenues. (That is, the statement divides all amounts by operating revenues for the year.)
A dash for a particular financial statement item does not necessarily mean the amount is zero. It
merely indicates that the amount is not sufficiently large for the firm to disclose it. The names of the 12
companies, the headquarter countries, and brief descriptions follow.
A. Accor (France): World’s largest hotel group, operating hotels under the names of Sofitel, Novotel,
Motel 6, and others. Accor has grown in recent years by acquiring established hotel chains.
B. Carrefour (France): Operates grocery supermarkets and hypermarkets in Europe, Latin America,
and Asia.
C. Deutsche Telekom (Germany): Europe’s largest provider of wired and wireless telecommunication
services. The telecommunications industry has experienced increased deregulation in recent years.
D. [Link] AG (Germany): One of the major public utility companies in Europe and the world’s largest
privately owned energy service provider.
E. BNP Paribas (France): A multinational bank and financial services company. Offers insurance and
banking services. Operating revenues include insurance premiums received, investment income,
and interest revenue on loans. Operating expenses include amounts actually paid or amounts it
expects to pay in the future on insurance coverage outstanding during the year.
F. Interpublic Group (U.S.): Creates advertising copy for clients. Interpublic purchases advertising
time and space from various media and sells them to clients. Operating revenues represent the com-
missions or fees earned for creating advertising copy and selling media time and space. Operating
expenses include employee compensation.
G. Marks & Spencer (U.K.): Operates department stores in England and other retail stores in Europe
and the United States. Offers its own credit card for customers’ purchases.

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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
 Exhibit 1 .1 7
Common-Size Financial Statement Data for Firms in 12 Industries (Problem 1.12)
1 2 3 4 5 6 7 8 9 10 11 12
BALANCE SHEET
Cash and marketable
securities 2,649.8% 15.8% 21.8% 4.9% 53.1% 32.7% 151.5% 17.9% 43.4% 4.7% 6.0% 6.5%
Receivables 1,754.2 11.9 48.8 12.0 17.7 69.6 14.5 38.8 20.4 6.9 6.6 12.2
Inventories — 22.4 6.9 2.1 0.7 — 0.6 5.8 12.2 5.9 7.8 8.5
Property, plant, and
equipment, at cost 83.7 172.5 66.2 195.3 102.7 23.2 21.9 134.7 62.9 82.6 34.5 42.0
Accumulated depreciation (31.5) (126.2) (36.5) (127.9) (48.5) (15.2) (11.1) (76.0) (24.9) (29.3) (17.7) (22.8)
Property, plant, and
equipment, net 52.2% 46.3% 29.7% 67.4% 54.2% 8.1% 10.8% 58.7% 38.0% 53.3% 16.8% 19.2%
Intangibles 32.4 1.8 — 87.5 18.0 46.3 13.3 26.5 32.3 4.4 14.1 34.1
Other assets 330.4 29.5 16.2 25.9 16.8 17.5 18.7 28.5 12.7 4.9 7.7 16.1
Total Assets 4,819.1% 127.6% 123.5% 199.7% 160.4% 174.1% 302.8% 176.2% 158.8% 80.1% 59.0% 96.6%
Current liabilities 3,345.8% 30.1% 45.4% 40.3% 36.4% 98.8% 46.4% 40.6% 25.3% 25.5% 32.2% 30.2%
Long-term debt 425.3 27.7 22.8 8.8 49.2 25.7 105.6 21.3 6.2 23.4 10.8 5.8
Other long-term liabilities 706.2 34.2 10.1 80.7 3.4 14.2 21.8 43.5 15.0 8.1 3.6 10.7
Shareholders’ equity 241.8 63.2 45.1 69.9 71.4 35.6 129.0 70.8 112.4 23.2 12.4 50.0
Total Liabilities and
Shareholders’ Equity 4,819.1% 127.6% 123.5% 199.7% 160.4% 174.1% 302.8% 176.2% 158.8% 80.1% 59.0% 96.6%
INCOME STATEMENT
Operating revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales (excluding
depreciation) or
operating expensesa (20.0) (80.0) (76.2) (56.1) (68.1) (62.4) (17.8) (64.5) (28.5) (62.8) (77.9) (51.3)
Depreciation and
Questions, Exercises, Problems, and Cases

amortization (4.0) (5.6) (5.7) (17.8) (5.8) (2.5) (6.8) (5.1) (3.5) (4.5) (2.1) (2.4)
Selling and administrative (5.0) (8.2) (5.9) (15.9) (14.2) (26.4) (24.4) (22.7) (20.5) (24.7) (16.3) (30.2)
Research and development — — (3.6) — — — (15.6) — (18.5) — — (1.8)
Interest (expense)/income (45.5) (0.4) 0.5 (4.0) (1.1) (1.7) (3.1) (1.4) 0.5 (1.8) (0.6) (1.0)
Income taxes (8.1) (2.6) (3.5) (2.3) (2.4) (2.2) (6.9) (0.1) (6.9) (2.2) (0.8) (3.4)
All other items, net (1.0) (0.3) 0.9 (0.1) (3.5) (0.5) (1.3) 1.1 0.1 1.6 0.1 7.6

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Net Income 16.2% 3.8% 6.5% 3.8% 4.9% 4.2% 24.0% 7.3% 22.6% 5.6% 2.3% 17.3%

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Cash flow from operations/
capital expenditures 4.2 1.9 2.1 2.3 0.6 6.3 7.2 1.7 4.0 2.7 1.8 2.2
49

a
See the problem narrative for items included in operating expenses.
50 CHAPTER 1 Overview of Financial Reporting, Financial Statement Analysis, and Valuation

H. Nestlé (Switzerland): World’s largest food processor, offering prepared foods, coffees, milk-based
products, and mineral waters.
I. Roche Holding (Switzerland): Creates, manufactures, and distributes a wide variety of prescrip-
tion drugs.
J. Nippon Steel (Japan): Manufacturer and seller of steel sheets and plates and other construction
materials.
K. Oracle (U.S.): Offers a comprehensive and fully integrated stack of cloud applications and platform
systems. Oracle outsources a majority of its manufacturing.
L. Toyota Motor (Japan): Manufactures automobiles and offers financing services to its
customers.

REQUIRED
Use the ratios to match the companies in Exhibit 1.17 with the firms listed previously, and explain your
reasoning using the strategy framework in the chapter.

LO 1-2, LO 1-4 1.13 Value Chain Analysis and Financial Statement Relations. Exhibit 1.18
represents common-size income statements and balance sheets for seven firms that operate at various
stages in the value chain for the pharmaceutical industry. These common-size statements express all
amounts as a percentage of sales revenue. Exhibit 1.18 also shows the cash flow from operations to capi-
tal expenditures ratios for each firm. A dash for a particular financial statement item does not necessarily
mean the amount is zero. It merely indicates that the amount is not sufficiently large for the firm to disclose
it. A list of the seven companies and a brief description of their activities follow.
A. Wyeth: Engages in the development, manufacture, and sale of ethical drugs (that is, drugs requir-
ing a prescription). Wyeth’s drugs represent primarily mixtures of chemical compounds. Ethical-drug
companies must obtain approval of new drugs from the U.S. Food and Drug Administration (FDA).
Patents protect such drugs from competition until other drug companies develop more effective
substitutes or the patent expires.
B. Amgen: Engages in the development, manufacture, and sale of drugs based on biotechnology
research. Biotechnology drugs must obtain approval from the FDA and enjoy patent protection
similar to that for chemical-based drugs. The biotechnology segment is less mature than the ethical-
drug industry, with relatively few products having received FDA approval.
C. Mylan Laboratories: Engages in the development, manufacture, and sale of generic drugs.
Generic drugs have the same chemical compositions as drugs that had previously benefited from
patent protection but for which the patent has expired. Generic drug companies have benefited in
recent years from the patent expiration of several major ethical drugs. However, the major ethical-
drug companies have increasingly offered generic versions of their ethical drugs to compete against
the generic-drug companies.
D. Johnson & Johnson: Engages in the development, manufacture, and sale of over-the-counter
health care products. Such products do not require a prescription and often benefit from brand
recognition.
E. Covance: Offers product development and laboratory testing services for biotechnology and phar-
maceutical drugs. It also offers commercialization services and market access services. Cost of goods
sold for this company represents the salaries of personnel conducting the laboratory testing and
drug approval services.
F. Cardinal Health: Distributes drugs as a wholesaler to drugstores, hospitals, and mass merchandis-
ers. Also offers pharmaceutical benefit management services in which it provides customized data-
bases designed to help customers order more efficiently, contain costs, and monitor their purchases.
Cost of goods sold for Cardinal Health includes the cost of drugs sold plus the salaries of personnel
providing pharmaceutical benefit management services.
G. Walgreens: Operates a chain of drugstores nationwide. The data in Exhibit 1.18 for Walgreens
include the recognition of operating lease commitments for retail space.

REQUIRED
Use the ratios to match the companies in Exhibit 1.18 with the firms listed previously, and explain your
reasoning using the strategy framework in the chapter.

Copyright 2023 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
 Walmart 51

Exhibit 1 .1 8
Common-Size Financial Statement Data for Seven Firms in the Pharmaceutical Industry
(Problem 1.13)
1 2 3 4 5 6 7

BALANCE SHEET
Cash and marketable securities 12.5% 1.9% 63.7% 63.7% 12.1% 4.1% 20.1%
Receivables 22.7 5.7 13.8 16.0 18.7 3.9 15.2
Inventories 20.7 7.2 13.8 13.1 3.7 10.7 7.9
Property, plant, and equipment, at cost 34.2 3.9 66.6 73.9 74.2 22.6 43.0
Accumulated depreciation (13.5) (2.0) (27.4) (24.9) (27.1) (5.5) (20.4)
Property, plant, and equipment, net 20.7% 1.9% 39.2% 49.0% 47.1% 17.1% 22.5%
Intangibles 109.3 6.1 95.5 20.5 5.8 2.3 43.4
Other assets 16.8 2.5 16.9 30.5 8.5 1.6 24.0
Total Assets 202.6% 25.2% 242.9% 192.8% 96.0% 39.7% 133.2%

Current liabilities 30.1% 11.5% 32.6% 30.0% 25.2% 10.7% 32.7%

Long-term debt 100.5 3.3 61.2 47.4 0.0 3.7 12.7
Other long-term liabilities 19.4 1.7 13.3 31.5 5.4 2.6 21.1
Shareholders’ equity 52.6 8.8 135.9 84.0 65.4 22.7 66.7
Total Liabilities and
Shareholders’ Equity 202.6% 25.2% 242.9% 192.8% 96.0% 39.7% 133.2%

INCOME STATEMENT
Operating revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales (excluding depreciation) or
operating expenses (59.7) (94.4) (15.3) (27.4) (62.5) (72.2) (29.0)
Depreciation and amortization (8.3) (0.4) (7.2) (4.1) (3.9) (1.5) (4.4)
Selling and administrative (12.2) (3.1) (20.1) (25.9) (13.7) (21.1) (29.3)
Research and development (6.2) 0.0 (20.2) (14.8) 0.0 0.0 (12.2)
Interest (expense)/income (6.9) (0.2) 0.2 (0.1) 0.4 (0.1) (0.1)
Income taxes (2.7) (0.5) (7.0) (8.4) (4.3) (1.8) (6.2)
All other items, net 0.1 0.0 (2.5) (0.1) (5.3) 0.0 1.6
Net Income 4.1% 1.3% 28.0% 19.3% 10.5% 3.2% 20.3%
Cash flow from operations/capital
expenditures 2.3 3.0 8.9 4.4 4.0 2.2 4.9

LO 1-2, LO 1-3, LO 1-4

INTEGRATIVE CASE 1.1
Walmart

The first case at the end of this chapter and numerous subsequent chapters is a series of integrative
cases involving Walmart, Inc. (Walmart). The series of cases applies the concepts and analytical tools
discussed in each chapter to Walmart’s financial statements and notes. The preparation of responses to
the questions in these cases results in an integrated illustration of the six sequential steps in financial
statement analysis discussed in this chapter and throughout the book.

Copyright 2023 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.