Answers: Operating Income Changes in Net Operating Assets

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Question 01.

Accounting Relations for Kimberly-Clark Corporation (Medium) Below are summary numbers from reformulated
balance sheets for 2007 and 2006 for Kimberly-Clark Corporation, the paper products company, along with
numbers from the reformulated income statement for 2007 (in millions).

a. Calculate the following for 2007 and 2006:

(i) Net operating assets.

(ii) Net financial obligations.

(iii) Shareholders’ equity.

b. Calculate free cash flow for 2007.

c. Show that the accounting relation for change in net operating assets works for Kimberly-Clark.

d. What was the net payment

Answers

a.
The exercise is best worked by setting up the reformulations balance sheet:

2007 2006

Operating assets $18,057.0 $16,796.2


Operating liabilities 6,011.8 5,927.2
Net operating assets (NOA) 12,045.2 10,869.0 a (1)

Financial obligations $6,496.4 $4,395.4


Financial assets 382.7 6,113.7 270.8 4,124.6 a (2)

Common equity (CSE) $ 5,931.5 $ 6,744.4 a (3)

FCF=Operating Income-Changes in Net Operating Assets = 2740.1-(12045.2-10869)=1563.8

b.
Comprehensive income = 2,740.1 – 147.1 = 2,593 million

ROCE = 2,593/6,744.4 = 38.45%

RNOA = 2,740.1/10,869.0 = 25.21%

FLEV = NFO/CSE = 4,124.6/6,744.4 = 0.612

NBC = 147.1/4,124.6 = 3.57%

c.
The financial leveraging equation is:

ROCE = RNOA + [FLEV  (RNOA – NBC)]

= 25.21% + [0.612 × (25.21% - 3.57%)]

= 38.45%

d.

On sales of $18,266 million for 2007,

PM = 2,740.1/18,266 × ATO = 18,266/10,869

15.00% × 1.68

= 25.2%
Q2.

Reformulation and Analysis of Financial Statements

c. Reformulated balance sheet


2009 2008

Operating cash $ 60 50
Accounts receivable 940 790
Inventory 910 840
PPE 2,840 2,710
Operating assets 4,750 4,390

Operating liabilities:
Accounts payable $1,200 1,040
Accrued expenses 390 1,590 450 1,490
Net operating assets 3,160 2,900
Net financial obligations:
Short-term investments $( 550) ( 500)
Long-term debt 1,840 1,290 1,970 1,470
Common shareholders’ equity $1,870 1,430

Reformulated equity statement (to identify comprehensive income):


Balance, end of 2008 $1,430
Net transactions with shareholders:
Share issues $ 822
Share repurchases (720)
Common dividend (180) ( 78)

Comprehensive income:
Net income $ 468
Unrealized gain on debt investments 50 518
Balance, end of 2009 $1,870

Reformulated statement of comprehensive income

Revenue $3,726
Operating expenses, including taxes 3,204
Operating income after tax 522

Net financing expense:


Interest expense $ 98
Interest income 15
Net interest 83
Tax at 35% 29
Net interest after tax 54
Unrealized gain on debt investments 50 4
Comprehensive income $ 518

After calculating the net financial expense, the bottom-up method is used to get
operating income after tax.

Free cash flow = 262

d. Ratio analysis
Profit Margin (PM) = 522/3,726 = 14.01%
Asset turnover (ATO) = 3,726/2,900 = 1.285
RNOA = 522/2,900 = 18%

e. Individual asset turnovers


Operating cash turnover = 3,726/5 = 74.52
Accounts receivable turnover = 3,726/790 = 4.72
Inventory turnover = 3,726/840 = 4.44
PPE turnover = 3,726/2,710 = 1.37
Accounts payable turnover = 3,726/1,040 = 3.58
Accrued expenses turnover = 3,726/450 = 8.28

1/individual turnover aggregate to 1/ATO:

1/ATO = 1/1.285 = 0.778 = 0.013 + 0.212 + 0.225 + 0.730 – 0.279 – 0.121

(allow for rounding error)

f. ROCE = 518/1,430 = 36.22%


Financial leverage (FLEV) = 1,470/1,430 = 1.028
Net borrowing cost (NBC) = 4/1,470 = 0.272%
ROCE = 36.22% = 18.0% + [1.028 × (18.0% - 0.272%)]

g. NBC = 4/1,470 = 0.272% (as in part e)


If RNOA = 6% and FLEV = 0.8,
ROCE = 6.0% + [0.8 × (6.0% - 0.0.272%]
= 10.58%

Note: it is more likely that NBC will be at the core borrowing rate (that excludes
The unrealized gain of debt investments): Core NBC = 54/1,470 = 3.67%.
Chapter 12 identifies core borrowing costs.

h. Implicit cost of operating liabilities = 1,490 × 0.03 = 44.7


522  44.7
Return on operating assets (ROOA) = 12.91%
= 4,390
Operating liability leverage (OLLEV) =

1,490/2,900 = 0.514 RNOA = 18.0% =

12.91% + [0.514 × (12.91% - 3.0%)]

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