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Module 2: Introduction to Reformulation- Joy Global

Module 2: Introduction to Reformulation- Joy Global. Thomas Maguire 1/22/2014. Enterprise vs. Financing Activities. Enterprise Operations- business/production a ctivities u ndertaken by company Joy Global- Worldwide leader in manufacturing m ining e quipment

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Module 2: Introduction to Reformulation- Joy Global

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  1. Module 2: Introduction to Reformulation- Joy Global Thomas Maguire 1/22/2014

  2. Enterprise vs. Financing Activities • Enterprise Operations- business/production activities undertaken by company • Joy Global- Worldwide leader in manufacturing mining equipment • Financing Activities- Tangential to core business of manufacturing leading mining equipment • Borrowing/Lending- Interest Expense/Interest Income • Current Financial Statements prepared under GAAP do not distinguish between these two • It is our responsibility through reformulation to separate these two activities

  3. Reformulation • Separates the income and the assets/liabilities associated with operating and financing activities • Allows us to focus solely on the Enterprise Operations of a company in our forecasting and valuation • The process of reformulation requires examining each line item in the Income Statement and Balance Sheet separately and asking: • Is this element a part of enterprise operations or the financing of Joy Global?

  4. Starting Point • To begin the process of reformulation we must identify the current and past: • Enterprise Profit After Tax (EPAT) • Net Enterprise Assets (NEA) • We are trying to identify the Enterprise Operations of Joy Global • Enterprise Assets reported on the Balance Sheet as components of NEA generate the components of EPAT on the Income Statement • After identification, we can use these amounts to forecast future EPAT and NEA allowing us to ultimately come to a valuation

  5. Identifying NEA • Pick through Joy Global’s Balance Sheet line by line • Determine which items are associated with enterprise operations • At each step, we must ask ourselves whether this line item is an integral part of the enterprise operations of the company • Application to Joy Global’s Balance Sheet…

  6. Joy Global Balance Sheet Split (2% Sales) NEA= $3,868,510

  7. Joy Global Balance Sheet (Cont.)

  8. Net Enterprise Asset Calculation

  9. Identifying NFL • Now, we must identify the effect of the company’s net financing activities on the balance sheet • Because Joy Global is a “net borrower”, we will have Net Financial Liabilities (NFL)

  10. Joy Global Balance Sheet NFL= $1,010,141 Split

  11. Joy Global Balance Sheet (Cont.)

  12. Net Financial Liability Calculation

  13. Joy Global Balance Sheet CSE= $2,858,369

  14. Identifying EPAT • Now we must identify the enterprise profitability • (EPAT) • We must go through the companies Income Statement on a line by line basis • Also must consider items in other comprehensive income

  15. Joy Global Income Statement EPAT = $570,956 Adjusted

  16. Joy Global OCI

  17. Income Tax Adjustment • Provision for Income Tax reported on Financial Statements is based on all line items above it: • Some Enterprise Profits, some not • We must take out the tax effect of any financing revenue or expenses (Interest Income and Interest Expense) • Need to take out the tax shield of interest expense deduction • To make this adjustment in 2013 we would:

  18. 2013 Income Tax Adjustment • Have a Net Income that was $57,504 higher • ($66,285- $8,781) • Assuming a Marginal Tax Rate of 37% we can calculate the tax benefit gained through the financing activity • ($57,504 x.37) = $21,277 • Tax should have been $21,277 higher than reported • Total Tax To Include in EPAT= $251,495 • ($230,219 + $21,277)

  19. EPAT Calculation

  20. Identifying FEAT • Financing Expenses after Tax must now be identified • This represents the companies net financing • As most companies are net borrowers, they will usually have a net expense related to financing • This calculation will later be used as an input in determining the cost of capital

  21. Joy Global Income Statement FEAT = $36,228 Adjusted

  22. Joy Global OCI

  23. 2013 Income Tax Adjustment • Ass identified previously, there was a net tax benefit associated with Interest Income and Interest Expense • This amount must now be included in FEAT

  24. FEAT Calculation

  25. Checking our Work! • If we did all calculations right, then thee must hold true: • Current Stockholders Equity = NEA – NFL • $2,858,369= $3,868,510 - $1,010,141 • Comprehensive Income = EPAT – FEAT • $534,728 = $570,956 - $36,228 • They Do! So we can now be confident in our reformulations and use them as inputs in our valuation

  26. Thank You! • Questions?

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