The Impact of Working Capital Investment on the Value of a Company

by Dev Strischek n this article, Dev Strischek describes how to use a popular shareholder valuation tool to quantify the impact of working cap- Iital management for use in both credit decisioning and in the financial advisory role. Lenders will be able to show their customers how receivables, inventory, and payables management can increase or decrease their companies’ net worth and share value.

our hundred years ago, English philosopher adjustments would boost your borrower’s cost of debt Francis Bacon observed, “And money is like and ultimately decrease the firm’s shareholder value. Fmuck, not good except it be spread.” Bacon However, if your borrower pays a little more atten- has described the principal property of working capi- tion now to managing its working capital, the future tal, the ubiquitous yet ambiguous financial term for boost to cash flow could pay off in more cash flow the balance sheet’s collection of current assets and later that increases shareholder value and improves liabilities that aggregately fertilize and nurture a your customer’s creditworthiness. company’s growth. Working capital management plays a critical role Working Capital Fundamentals in a company’s quest to maximize its shareholder A company’s working assets and the liabilities value. A key component of shareholder value is the that fund them are collectively referred to as working cost of capital, and credit risk is its driver. Did you capital. Ideally, current assets are partly funded by ever stop to think that how you judge a borrower’s current liabilities and the remainder by the owners. working capital management skills may impact its A banker’s shorthand way of quantifying the excess cost of capital? What if you judge the firm to be too or net investment in current assets over current lia- easygoing in collecting its receivables, too over- bilities is to subtract current liabilities (CL) from cur- stocked in inventory, too slow in paying its trade sup- rent assets (CA) to arrive at net working capital pliers, and too thin in its cash reserves? Is the cus- (NWC), as demonstrated for Green Company over tomer then too risky to bank even with extra risk the past two fiscal years (FYE) 2000 and 2001. (See premium added to the rate? Of course, these mental Figure 1.)

© 2003 by RMA. Dev Strischek is managing director, Corporate and Commercial Credit Policy, Asset Quality/Credit Policy Division, SunTrust Banks, Inc., Atlanta, Georgia. He is a member of the Editorial Advisory Board of The RMA Journal and has served as president of RMA.

48 The RMA Journal April 2003 The Impact of Working Capital Investment on the Value of a Company

Figure 1 All things being equal, working capital should remain proportional to sales, so the increase from Green ($MM) 2000 2001 2000 2001 9.3% to 10.7% of sales suggests that a bigger invest- Cash 11 30 Notes payable -0- -0- ment of inventory and receivables was needed in Mkt sec -0- -0- Cur mat LT dbt 13 56 2003 to gain more revenues. Although sales rose Receivables 147 201 Accounts payable 78 133 Inventory 177 313 Accrued expenses125 158 48%, it took 72% more NWC to support the sales Prepaids -0- -0- Taxes payable 16 20 growth—part of the NWC maintained base sales of Other CA -0- -0- Other C -0 -0- $1,113 and the $74 remaining of the NWC fueled Total CA 335 544 Total CL 232 67 the $535 increase in sales. Another way to look at the NWC/Sls relationship Working Capital Calculation: 335-232 = 103 = NWC at FYE 9/30/00 is to compare the changes in each component, 544-367 = 177 = NWC at FYE 9/30/01 because this view shifts the focus from financial 209-135 = 74 = change in NWC from FYE ’00 to FYE ’01 statement year-end numbers to an incremental approach. How much NWC is needed to support Green’s NWC increased by $74 million from another dollar of sales? Incrementally, the gain in 2000 to 2001 because of more receivables and inven- NWC to the gain in sales was 13.8%, so it took 13.8 tory. Trade credit also increased, but only by $55 mil- cents of new NWC for every new dollar of sales. lion, not enough to fund all of the $136 million Whether looking at the incremental or the total pic- expansion in inventory and the $54 million more in ture, both the borrower and the banker need some receivables. From a banker’s perspective, NWC rep- reference point to determine the right amount of resents the owner’s equity in these working assets, working capital to support sales. and up to a point, that is a good thing. Bank debt Industry comparisons. Many bankers measure and trade credit should not pay for all the earning the appropriateness of working capital investment by assets; the company should have some of its own comparing the company’s working capital ratios with money at risk for these operating assets—but how RMA (Risk Management Association) industry statis- much? After all, NWC expansion absorbs cash that tics. One advantage of RMA data is that most of the might otherwise be available to repay creditors and, companies represented by the financial statements after debt service, be used for capital expenditures, are privately owned, thus mirroring the borrowers in dividends, or just equity accumulation. the portfolios of bank statement contributors.1 NWC and sales growth. One way to gauge the Bankers looking for working capital data on large, appropriateness of NWC is to relate it to sales (Sls). publicly traded companies find CFO’s annual work- After all, working capital investment is a prerequisite ing capital survey useful. The survey compiles data to growing sales. Increasing the inventory depth and on working capital efficiency at public companies. breadth creates more customer appeal. Extending Although lacking RMA’s decades of data, the CFO more liberal credit terms helps the company sell to survey does provide some turnover information on more customers. Thus, sales growth usually requires receivables, inventory, and cash by broad industry more working capital, as illustrated in Figure 2, in segments for large, publicly traded firms. 2 which Green’s figures for fiscal years (FY) 2000 and Green processes vegetable, flower, and grass 2001 indicate sales up 48%, NWC up 72% for the fis- seed for sale to wholesalers and retailers, so it falls cal year, and net working capital to sales up from into the 0181 SIC (Standard Industrial Classification) 9.3% to 10.7% over the two fiscal years. code. The CFO survey does not cover this particular Figure 2 industry segment, but comparison with the RMA statistics for SIC 0181 (Figure 3) yields some prelimi- FY01 sales $1,648 NWC $177 NWC/Sls 10.7% nary observations about Green’s working capital FY00 sale 1,113 NWC 103 NWC/Sl 9.3% management:3 Change 535 74 • First, Green maintains about the same level of Sales up 48% NWC up 72% cash that the industry does, 6.5% versus 5.8% at Change in NWC/Change in Sales = 74/535 = 13.8% FYE 2001, a level that may mean its cash man-

49 The Impact of Working Capital Investment on the Value of a Company

Figure 3 generate more cash out of the conversion of inventory to receivables to cash. In fact, one irony of expanding Green Data RMA Statistics working capital is its absorption of cash. The differ- Green vs RMA Averages 2000 2001 2000 2001 ence in the yield from a revolution of this cash con- Cash/total assets % 6.1 6.5 7.7 5.8 version cycle is the gap between a borrower realizing Accts rec/total assets % 18.5 15.4 14.7 15.0 Inventory/total assets % 24. 27.6 28.6 28.1 market value from its working assets and its lenders Tot curr assets/TA % 50.6 50.8 54.8 52.4 squeezing out liquidation value from the same assets. Accts pay/total assets % 9. 9.5 11. 10.3 The result is that lenders really prefer to stay out Notes pay/total assets % 14.4 13.3 11.4 11.3 of the day-to-day operations and concentrate on the Tot curr liab/TA % 34.0 33.4 38.0 33.0 long-term prospects of the borrower. This emphasis NWC/TA %* 16. 17.4 16.8 19.2 Days receivable 37 29 26 25 on long-term perspective means that bankers and Days inventory 68 76 90 92 investors share a similar view of the importance of Days payable 23 25 26 23 operating cash flows, financing flows, and investing Sales/net wkg cptl (X) 15.1 14.3 11.7 9.7 flows.

*Calculated as the difference between total current assets/total assets % and total current liabilities/total assets % Cash Flows: Dollars and Sense Before FAS 95. Before the implementation of agement is now a little better than its peers’. Financing Accounting Standard (FAS) No. 95 in • However, its receivables levels are higher and its 1987, bankers and analysts used traditional cash flow turnover slower than the industry averages. The (TCF) as a proxy for cash flow to gauge debt repay- slowness could reflect more aggressive market- ment capacity. TCF worked well enough for firms ing to less creditworthy customers or less effec- that had relatively slow, stable rates of sales growth tive credit collections. generating enough cash flow to support working cap- • The offset to the lackluster receivables perform- ital expansion. As the economy accelerated in the ance is a lower level of inventory investment and postwar period, however, TCF tended to overesti- a faster turnover. Of course, the lower inventory mate cash flow. investment may reflect fewer products, which From the late 1950s throughout the 1960s, infla- may also contribute to stock-outs, back orders, tion ranged from less than 1% to slightly more than and customer dissatisfaction. 5% per year. During the same period, the prime rate • On the other side of the balance sheet, Green varied from a low of 2.25% to a high of 8.5%. In such relies a little less on trade debt and a little more a stable, liquid economic environment, management on bank debt to finance its current assets. The strove for profitability while cash flow followed result is that Green’s Sls/NWC is a little higher closely. However, by the mid-1970s, the economy than the industry’s. A traditional rule of thumb is had turned far more volatile. The 1960s’ average that when this ratio is above 10, liquidity may be 2.3% inflation rate was buried by the 1970s’ inflation tight. Both the industry and Green are over the rate ranging between 3.3% and 11.25%, and the 10X mark. Yet Green generates a little more prime rate soared to 11.75%. Profitability and cash 4 sales per dollar of working capital than its indus- flow no longer moved in tandem. In fact, a study of try counterparts. Another way of describing the 45,000 closely held firms that filed for bankrupt- Green’s working capital management is that it cy in 1985 showed that 60% had a profitable bottom has a little less cash tied up in its receivables and line, so traditional cash flow was no longer a reliable 5 inventory working capital assets relative to its cash flow estimate. industry peers, so its cash balances are slightly Ten years earlier, the 1975 W.T. Grant bankrupt- higher than average. cy helped launch the campaign to disclose cash flows. Bankers find cash balances interesting because of Grant’s positive earnings reports masked a receivables their implications for loan repayment. Lenders take collection breakdown and too much unsold inventory receivables and inventory for collateral, but the bor- in its new, larger stores. From its first store in 1906, rower is typically better positioned than its lenders to William T. Grant had built his 25 Cent Store concept

50 The RMA Journal April 2003 The Impact of Working Capital Investment on the Value of a Company into a 500-store chain by 1953, and the company’s illustrate the adverse impact of the rapid sales expansion continued into the 1960s. In 1969 alone, growth in its receivables and the inventory expan- 410 new stores were opened. In 1973, the company’s sion’s absorption of cash flow from operations. stock was selling at nearly 20 times earnings and peaked at $70 5/8 per share. As late as September Figure 4 1974, a bank syndication lent the company $600 mil- Green's Indirect Cash Flow ($MM) 2000 2001 lion. Nevertheless, the market sensed the liquidity PAT 36 63 crisis, and by December 1974, W.T. Grant’s stock was +depreciation 22 29 trading at $2 a share. The company closed 107 stores +amortization 16 31 and laid off 7,000 employees in September 1975, but traditional cash flow (TCF) 74 123 on October 2, 1975, the nation’s largest retailer filed (incr)/decr: receivables (43) (54) for Chapter 11 bankruptcy. Four months later, the (incr)/decr: inventory (31) (136) creditors’ committee voted for liquidation, and W.T. decr/(incr): accounts pay 24 55 Grant ceased to exist. Subsequent analysis of the decr/(incr): accrued expense 67 33 company’s financials revealed that the company’s decr/(incr): taxes payable (10) 4 sub-tot (incr)/decr NWC 7 (98) cash flow from operations had been negative over the 10 years between 1966 and 1975.6 The W.T. Grant Cash flow from operations (CFO) 81 25 bankruptcy is a grim example of the consequences of poor working capital management: its positive work- Imagine the disappointment of bankers in 2001 ing capital was comprised of uncollectible receivables expecting $123 million of TCF available to repay and unsalable inventory that absorbed so much cash their loans when, instead, they find that working flow, it killed the company. capital expansion has swallowed $98 million and left The advent of FAS 95. FAS 95 established the them with only $25 million. current cash flow format to replace the old sources- As its inventory and receivables growth has out- and-uses-of-funds statement in 1987. Bankers lob- stripped trade supplier credit, the gap between TCF bied hard for this change, which segregates cash and cash flow from operations (CFO) has widened to flows into operating, investing, and financing flows. almost $100 million. Bankers betting on $123 million In particular, operating cash flow is desirable to to repay a $100 million loan would be very disap- lenders because of its incorporation of working capi- pointed in the actual $25 million CFO, especially tal changes into the income statement. when examining the debt service requirements and The working capital changes are easier to see in trying to meet the basic principle that cash flow the indirect method than in the direct method for- available to service the debt (CASD) should be equal mat. While there are supporters of both methods to or greater than debt service (DS). To measure among bankers, FAS 95 tilts toward the indirect accurately the cash flow pool available to cover prin- method, because the direct method requires the cipal and interest, bankers typically add back the alternative indirect method to be presented as well, interest expense to CFO so all the debt service can but not vice versa. As a consequence, only 2-3% of be summarized in one place, as shown in Figure 5. firms use the direct method.7 Nearly all publicly Although the coverage passes muster at 1.02, traded companies opt for the indirect method, partly there is not much left over for capital expenditures, to save an extra page in their annual reports but working capital, and dividends, especially if the mainly because the majority of investors still evalu- lenders are anticipating more cash flow from the ate companies at the bottom line. It’s easier for them additional sales, which, in turn, ultimately depend on to reconcile net income to cash flow rather than from expanding fixed assets and working capital while the sales level down through the income statement, mollifying investors with dividend payments and as depicted under the direct cash flow method. stock price appreciation. Green is a public company Green’s NWC problems. Despite its better- that has established a reputation among analysts as a than-average comparisons with industry statistics, reliable, predictable dividend payer, and that return Green’s most recent two years, seen in Figure 4, to stockholders is an implicit part of its market price.

51 The Impact of Working Capital Investment on the Value of a Company

Figure 5 use EBITDA/revenues as a proxy for a core earnings 2000 2001 measure of operating cash flow margin. Cash flow from operations (CFO) 825 A more realistic measure of repayment capacity +existing interest expense 32 79 is the resulting free cash flow (FCF), which, in cash available to service debt (CASD) 113 104 effect, suggests that repayment ability depends on a -Debt service (DS): going, growing concern. The company must be given interest expense on existing debt 32 79 the resources to continue its growth in order to gen- interest expense on proposed debt ------erate the cash to satisfy all its stakeholders, owners, preferred stock dividends 10 10 principal on existing debt 1 13 investors, creditors, and lenders. Green’s problem is principal on proposed debt ------basic, as seen in Figure 6; it cannot satisfy everyone. total principal, prfd div, and interest (DS) 43 102 Figure 6 Excess cash to pay CAPEX, NWC, com div 70 2 CASD/DS > 1.00 2.63 1.02 Green's FCF ($MM) 2000 2001 PAT 36 63 So what’s the value of working capital to the stock +depreciation (D) 22 29 price? Put another way, what does working capital +amortization (A) 16 31 investment add to enterprise value? traditional cash flow (TCF) 74 123 +existing interest (I) 32 79 To answer this question, we now need to shift +taxes (T) 25 48 our focus from that of commercial lender and credit EBITDA before extraordinary charge 131 250 analyst to that of investment banker and market ana- +extraordinary charge 1 6 lyst. Fortunately, both groups share the view that EBITDA 132 256 value is determined by cash flow and all that differs -taxes (T) (25) (48) is the definition of cash flow. Market analysts look at -CAPEX (73) (91) the drivers of operating cash flow, project future cash -(increase)/decrease in working capital* 7 (98) free cash flow (FCF) 41 19 flows, and discount the flows back to the present to calculate the share price. One of the primary drivers -existing interest (32) (79) is working capital, and each driver’s impact on share -proposed interest ------existing principal ( 1) (13) value can be quantified. -proposed principal ------existing prerferred dividends (10) (10) Market Analyst’s View of Cash Flow and Debt Service -total debt service (DS) (43) (102) Market analysts start with bottom-line profitabili- excess cash flow available for ty and add back items in a manner reminiscent of common dividends, acquisitions, banking’s traditional cash flow while dealing with share repurchase, etc. ( 2) (83) working capital, capital expenditures, dividends, and FCF/DS > 1.00 .95 .19 the like a little later in the process. The object of the *Changes in working capital excludes changes in cash, notes payable, analysis is to arrive at a core earnings figure that cor- current maturities of long-term debt. responds to a core cash flow. So they start with profit after taxes and add back the noncash charges associat- Green has several options for improvement. It ed with the earning assets, depreciation, and amorti- can work harder at improving its profit margins, zation, and the result, of course, is traditional cash improve its revenue generation from its asset base, or flow. However, the analysts go a few steps further to reduce its taxes. Each of these options can add real add back taxes and interest expense to arrive at earn- value to Green’s market valuation. ings before interest, taxes, depreciation, and amorti- Shareholder value models.8 How does better zation (EBITDA). This controversial number reflects working capital management increase shareholder the pretax pool of cash flow available to service tax- value? How do we calculate shareholder value? deductible interest expense as well as after-tax princi- There are a number of valuation models in financial pal repayment, working capital expansion, capital literature, and most of them employ a discounted expenditures, and dividends. Market analysts like to

52 The RMA Journal April 2003 The Impact of Working Capital Investment on the Value of a Company cash flow approach driven by several key variables to stock price while holding the other drivers constant arrive at a shareholder value. Alfred Rappaport’s over the next five years—2002-2006. The base driver model, for example, uses six variables or drivers— values are drawn from Green’s 2000-2001 historical sales growth rate, operating profit margin, tax rate, results, as seen in Figure 7. working capital investment, capital expenditures, and the cost of capital. Figure 7 Rappaport’s shareholder value approach esti- cash flow and valuation drivers: Base NWC mates the economic value of an investment over a -sales growth rate 15.0% same period of time by discounting forecasted cash flows -operating profit (EBITDA/sales) 13.7% same by the cost of capital. In turn, these cash flows serve -tax rate (taxes/profit before tax) 41.0% same as the foundation for shareholder returns from divi- -working capital investment/sales 13.8% 10.0% dends and share-price appreciation. To determine -CAPEX investment/sales 25.0% same -cost of capital 10.0% same shareholder value, one must first determine the value of the total firm, and corporate value is com- share price valuation (Exhibits 2&3) $33.99 $35.66 prised of two parts—the present value of forecasted cash flow from operations and the residual value, Decreasing working capital investment from which represents the present value of the business 13.8% to 10% of sales would add $1.65 to Green’s attributable to the period beyond the cash flow fore- stock price and $46.2 million ($1.65/share x 18MM cast period. shares) to its equity. Changing the other drivers may Cash flow from operations is the difference have more leverage on shareholder value, but increas- between cash inflows and cash outflows, and it can ing profit margins while increasing sales is often a mar- be expressed in terms of the drivers mentioned pre- keting oxymoron. It is no easier to reduce fixed-asset viously: investment, cut dividends, or lower tax rates. Besides, Cash flow = cash inflow - cash outflow, working capital management is day-to-day operating where cash inflow = [(sales in prior year)(1 + sales growth rate) execution of credit and collections to keep receivables (operating profit margin)(1 - cash income tax rate), in line and of purchasing, warehousing, and shipping to and cash outflow = incremental CAPEX + incremental WC investment. minimize inventory investment. The shareholder valu- For purposes of the model’s mechanics, each of ation calculation shows the value of working capital these drivers is expressed in terms of sales. The sales management and explains in part why both banks and growth rate is annual percentage increase in sales. the markets should pay attention to how well compa- The operating profit margin is the ratio of pre-interest, nies collect their receivables, turn over their invento- pretax operating profit to sales, or EBITDA/sales. ries, and service their trade creditors. Incremental CAPEX is additional new fixed assets needed to support the growth in sales, so we subtract depreciation expense from the total CAPEX to elimi- Conclusion The Irish dramatist Richard Sheridan warned his nate the fixed-asset component for maintaining and tailor two centuries ago, “It is not my interest to pay replacing existing fixed assets. Similarly, incremental the principal, nor my principle to pay the interest.” working capital investment is the additional working Even today banks still have a few borrowers cut from capital required to support the new sales, so it is a the same cloth as Sheridan, but bankers prefer to change in working capital/change in sales calculation. have their notes repaid with interest now out of oper- The cash income tax rate is usually the book income ating cash flow supplied regularly by sound working tax expense, less deferred tax changes divided by pre- capital management. The purpose of this article has tax income. The last driver is the cost of capital, which been to show how better working capital manage- is the weighted average of the costs of debt and equity. ment increases cash flow that, in turn, adds value to a Additional value. The details of the model’s company’s equity. Lenders and investors alike have a computations are beyond the scope of this article vested interest in sound collection practices, invento- (see Exhibit 1), but we can summarize the impact of ry controls, and trade credit. Efficient working capital a change in working capital investment on Green’s management means more cash flow to repay bankers

53 The Impact of Working Capital Investment on the Value of a Company and more value to reward Notes 1 Risk Management Association, Annual 3 2002-2003 RMA Annual Statement Studies, pp. investors. Working capital just may Statement Studies, One Liberty Place, suite 2300, 100-101. be the most interesting and fertile Philadelphia, PA 19103-7398, or call 800-677- 7621 for more information on this publication. 4 James E. Perry, “Cash Flow—the Most Critical subject of finance. ❐ Issue of the 1980’s,” A Special Collection from 2 “The 2002 Working Capital Survey,” CFO, the Journal of Commercial Bank Lending: Cash Contact Strischek at August 2002, pp. 69-82. Flow, Robert Morris Associates: Philadelphia, 1989, pp. 62-63. [email protected]

Exhibit 1 Details of Valuation Model

Units = $000s; all numbers are in millions. Sales = $1,648 is actual historic figure used for base year. G = 15%: annual sales growth rate. P = 13.7%: operating profit as % of sales. T = 41%: cash tax rate, essentially accrual taxes adjusted for changes in deferred taxes and expressed as a % of operating profit. F = 10%: change in capital expenditures as a % of change in sales, or the additional fixed assets needed to support the additional sales growth. W = 13.8% and 10.0%: change in working capital as a % of change in sales, or the additional working capital needed to support the additional sales growth. K = 10%: weighted average cost of debt and equity capital; cost of debt based on current cost of new debt, not historical debt; cost of equity equals a risk-free rate plus an equity risk premium. N = 5 years: management's best estimate of the number of years that investments can be expected to yield rates of return greater than the cost of capital; this so-called "value growth duration" ranges from 15 to 25 years for companies with proven competitive advantages to a duration approaching zero for poorly positioned competitors or those in highly competitive industries. Mkt. Securities = 10; marketable securities on the balance sheet. Mkt. Value Debt = 1,007; current value of long-term debt on balance sheet. # of Shares = 28 million; number of shares outstanding. Year = 2001 followed by five-year projection 2002 through 2006. Sales = 1,648 followed by projected sales increasing by 15% annually. Operating Costs and Operating Profit = projected years derived by applying 86.3% and 13.7% to sales in order to derive operating costs and operating profit, respectively. Taxes = 41% tax rate applied to operating profit. NOPAT = net operating profit after taxes = operating profit - taxes. Incr. F = fixed-asset investment required to support additional sales = 25% X $increase in sales each year. Incr. W = working capital investment required to support additional sales = 13.8% and 10.0% X $increase in sales each year. Cash Flow (CF) = NOPAT - (Incr. F + Incr. W). Discount Factor = weighted average cost of capital = 1/(1 + K)n = 1/(1 + .10)1 = .9091 for year 2001 and so on. PV of CF = present value of cash flow = CF/DF = 66.7/.9091 = 60.6 for year 2001 and so on. Cum PV of CF = cumulative present value of cash flow = 60.6 for year 2001, then add 63.4 for 2002 to get cumulative 124.0 through 2003and so on. Residual Value = value of cash flow before F and W investment = NOPAT/K = 153.2/10% = 1531.9 for year 2001 and so on. PV of Perpetuity RV = present value of residual value = RV X Discount Factor = 1,531.9 X .9091 = 1,392.6 for year 2001 and so on. Corporate Value (CV) = sum of Cum PV of CR plus PV of Perpetuity RV plus Mkt. Securities = 60.6 + 1,392.6 + 10.0 = 1,463.2 for year 2001 and so on. Thus, corporate value reflects the present value of future cash flows generated by additional fixed asset and working capital investment plus current value of marketable securities. Shareholder Value (SHV) = corporate value less market value of debt = 1,463.2 - 1,007.2 = 456.2 for year 2001 and so on. Share Price = market value per share = shareholder value/# of shares = 456.2/28 = $16.29 per share for year 2001, culminating in $35.66 by year 2004 based on 10% working capital investment.

Source: Alfred Rappoport, Creating Shareholder Value, pp. 32-58.

54 The RMA Journal April 2003 The Impact of Working Capital Investment on the Value of a Company

5 Christine B. Emmanuel, “Cash Flow Reporting, 1998. See also J.A. Largay and C. P. Stickney’s 8 Alfred Rappaport, Creating Shareholder Value, Part 2: Importance of Cash Flow Data in Credit “Cash Flows, Ratio Analysis, and the W.T. Grant The Free Press, A Division of Simon & Schuster: Analysis,” A Special Collection from the Journal of Bankruptcy,” Financial Analysis Journal, July- New York, 1998, pp. 32-58. Commercial Bank Lending: Cash Flow, Robert August 1980. Morris Associates: Philadelphia, 1989, pp. 3-4. 7 Gopal V. Krishman and James A. Largay, “The 6 Skousen, Albrecht, Stice, and Stice, “Chapter 13: Predictive Ability of Direct Method Cash Flow The Statement of Cash Flows,” Accounting Information,” presented at the 1998 Annual Concepts and Applications, 7th Edition, South- Meeting of the American Accounting Association, Western College Publishing: Cincinnati, Ohio, August 18, 1998. Green Corporation Green Shareholder Value:Shareholder $952 ------Shareholder Value Per Share: Per Value Shareholder $33.99 ======Operating ProfitOperating Taxes454.1 259.6 298.6 343.4 394.9 NOPATIncr. FIncr. WCash Flow (CF)Factor186.2 106.5 122.4 140.8 161.9 Discount 267.9 153.2 176.2 202.6 233.0 PV of CF0.6209 0.9091 0.8264 0.7513 0.6830 108.1 57.3 61.8 71.1 81.7 94.0 (RV)59.7 34.1 39.2 45.1 51.9 Cum PV of CF Value 65.9 2,679.3 1,531.9 1,761.7 2,025.9 2,329.8 Residual RVPV of Perpetuity (CV) 75.7 Mkt. Securities Value 52.1 1,958.7 1,454.7 1,572.4 1,695.5 1,824.2 52.1 1,392.6 (SHV)$447.7 87.1 Corporate $951.7 1,455.9 $565.4 $688.5 $817.2 of DebtValue Mkt 106.5 54.4 Value 100.2 1,522.1 Shareholder 10.0 10.0 10.0 163.4 Price 1,591.3 56.9 1,007.0 1,663.6 Share 1,007.0 222.9 59.5 1,007.0 285.1 1,007.0 62.2 $33.99 $15.99 $20.19 $24.59 $29.19 1,007.0 Units: $000s Year 0)Sales (Year 1,648 GP 2001TF 2002WKN 2003DebtMkt. SecuritiesMkt. Value 15.0% 2004# of Shares 13.7%1,007 1,007 1,007 15.0% 41.0% 2005Year 13.7% 25.0%CostsSales 13.8% 15.0%10 55555 41.0%10 10 10 2006 Operating 13.7% 10.0% 25.0% 15.0% 13.8% 2001 41.0% 1,648.0 3,314.7 1,895.2 2,179.5 2,506.4 2,882.4 2,860.6 1,635.6 1,880.9 2,163.0 2,487.5 13.7% 25.0% 10.0% 28 15.0% 13.8% 41.0% 2002 13.7% 25.0% 10.0% 13.8% 41.0% 28 2003 25.0% 10.0% 13.8% 10.0% 2004 28 2005 28 2006 28 Exhibit 3 Green Corporation Green ------Shareholder Value:Shareholder $998 Shareholder Value Per Share: Per Value Shareholder $35.66 ------Units: $000s Exhibit 2 Year 0)Sales (Year 1,648 GP 2001TF 2002WKN 2003DebtMkt. SecuritiesMkt. Value 15.0% 2004# of Shares 13.7%1,007 1,007 1,007 15.0% 41.0% 2005Year 13.7% 25.0%CostsSales 10.0% 15.0% 55555 41.0%10 10 10 2006 Operating 13.7% 10.0% 25.0% 15.0% 10.0% 2001 41.0% 1,648.0 3,314.7 1,895.2 2,179.5 2,506.4 2,882.4 2,860.6 1,635.6 1,880.9 2,163.0 2,487.5 13.7% 25.0% 10.0% 28 15.0% 10.0% 41.0% 2002 13.7% 25.0% 10.0% 10.0% 41.0% 28 2003 25.0% 10.0% 10.0% 10.0% 2004 28 2005 28 2006 28 Operating ProfitOperating Taxes454.1 259.6 298.6 343.4 394.9 NOPATIncr. FIncr. WCash Flow (CF)Factor186.2 106.5 122.4 140.8 161.9 Discount 267.9 153.2 176.2 202.6 233.0 PV of CF0.6209 0.9091 0.8264 0.7513 0.6830 108.1 66.7 61.8 71.1 81.7 94.0 (RV)43.2 24.7 28.4 32.7 37.6 Cum PV of CF Value 2,156.8 1,722.3 1,860.8 2,005.5 76.7 2,679.3 1,531.9 1,761.7 2,025.9 2,329.8 1,589.9 Residual RVPV of Perpetuity (CV)1,463.2 88.2 Mkt. Securities Value 60.6 60.6 1,392.6 101.4 (SHV)$456.2Corporate $998.5 1,455.9 $582.9 $715.3 $853.8 of DebtValue Mkt 124.0 63.4 Value 116.6 1,522.1 Shareholder 10.0 10.0 10.0 190.2 1,591.3 66.2 1,007.0 1,663.6 ======1,007.0 259.5 ======69.3 ======1,007.0 331.9 ======1,007.0 72.4 1,007.0