GUIDANCE MANUAL
for
Estimating the Economic Effects
of Pollution Control Costs
by
Office of Analysis and Evaluation
U.S. Environmental Protection Agency
Washington, D.£. 20460
November 1983
-------
-/4(6^3oo I
Page 127 (Exhibit 5-6) is missing from
this document.
The paper copy this was reproduced
from was missing the page.
-------
PREFACE
These two documents — the Guidance Manual and Workbook for Estimating the
Economic Effects of Pollution Control Costs — were prepared by EPA for writers
of NPDES permits 1n state agencies and EPA Regional Offices. The Workbook con-
tains step-by-step instructions and worksheets for performing analyses of a
firm.'s or plant's ability to pay for pollution control. The Guidance Manual
contains background information, more detailed instructions, and examples for
each test; it 1s designed for use by those who find the Workbook too brief.
The Guidance Manual and Workbook for Estimating the Economic Effects of
Pollution Control Costs were prepared for EPA by Pope-Re1d Associates, Inc.
They were based on the Work Book for Determining Economic Achievability for
National Pollutant Discharge Elimination System Permits (Putnam, Hayes 4
BartTett, Inc., August 1982).
-------
TABLE OF CONTENTS
fSSi
CHAPTER 1 - INTRODUCTION
1.1 Background 1
1.2 Problem 2
1.3 Purpose 3
1.4 Overview 4
CHAPTER 2 - THEORY AND DATA
2.1 Introduction 6
2.2 Engineering Analysis and Cost Data 7
2.2.1 Capital Costs 7
2.2.2 Operating and Maintenance Costs 10
2.2.3 Total Annual Costs 10
2.2.3.1 Cost of Capital 12
2.2.3.2 Capital Recovery Cost 13
2.3 Financial Analysis and Data 14
2.3.1 Firm-Level Analysis 14
2.3.1.1 Financial Statement Analysis 14
2.3.1.2 Market Value Analysis 17
2.3.2 Plant-Level Analysis 19
CHAPTER 3 - FIRM-LEVEL ANALYSIS
3.1 Introduction 22
3.2 Financial Statement Analysis 23
3.2.1 Liquidity Ratios 25
3.2.1.1 Current Ratio 26
3.2.1.2 Quick Ratio 35
3.2.2 Solvency Ratios 43
3.2.2.1 Fixed-Charge Coverage Ratio 44
3.2.2.2 Beaver's Ratio 59
3.2.3 Leverage Ratios 68
3.2.3.1 Debt/Equity Ratio 69
3.3 Market Value Analysis 76
3.3.1 Net Present Value Cost of Pollution 77
Control
3.3.1.1 Theory 77
3.3.1.2 Calculation 78
3.3.2 Adjusted Stock Price 81
3.3.2.1 Theory 81
3.3.2.2 Calculation 81
3.3.3 Market-to-Book Ratio 86
3.3.3.1 Theory 86
3.3.3.2 Calculation 86
3.3.3.3 Interpretation 88
-------
TABLE OF CONTENTS (continued)
Page
CHAPTER 4 - PLANT-LEVEL ANALYSIS
4.1 Introduction 92
4.2 Pollution Control Costs and EBT 95
4.2.1 Total Annual Cost of Pollution Control 95
• 4.2.1.1 Theory 95
4.2.1.2 Calculation 95
4.2.2 Earnings Before Taxes 97
4.2.2.1 Theory 97
4.2.2.2 Calculation 100
4.3 Plant-Level Tests 104
4.3.1 Earnings Test 104
4.3.1.1 Theory 104
4.3.1.2 Calculation 105
4.3.1.3 Interpretation 105
4.3.2 Gross Margin Test 107
4.3.2.1 Theory 107
4.3.2.2 Calculation 108
4.3.2.3 Interpretation 110
4.3.3 Revenue Test 112
4.3.3.1 Theory 112
4.3.3.2 Calculation 112
4.3.3.3 Interpretation 114
CHAPTER 5 - ANALYSIS OF TEST RESULTS
5.1 Introduction 116
5.2 Summary of Test Results 117
5.3 Interpretation of Results 122
5.3.1 Interpretation of Firm-Level Tests 122
5.3.2 Interpretation of Plant-Level Test 126
-------
LIST OF EXHIBITS
Paae
Exhibit 2-1. Five Types of Capital Cost Estimates 8
Exhibit 2-2. Sources of Cost Estimating Methodologies
and Data 11
Exhibit 3-1. Data from Moody's - Current Ratio 27
Exhibit 3-2. Data from Morris - Current Ratio 28
Exhibit 3-3. Worksheet la - Current Ratio
Without Cost of Pollution Control 30
Exhibit 3-4. Worksheet lb - Current Ratio Adjusted
for Cost of Pollution Control 33
Exhibit 3-5. Data from Moody's - Quick Ratio 37
Exhibit 3-6. Data from Morris - Quick Ratio 38
Exhibit 3-7. Worksheet 2a - Quick Ratio Without
Cost of Pollution Control 40
Exhibit 3-8. Worksheet 2b - Quick Ratio Adjusted for
Cost of Pollution Control 42
Exhibit 3-9. Data from Moody's - EBIT 46
Exhibit 3-10. Worksheet 3a - Cash Earnings Before
Interest and Taxes (EBIT) 49
Exhibit 3-11. Worksheet 3b - Fixed-Charge Coverage
Ratio Without Cost of Pollution Control 51
Exhibit 3-12. Data from Moody's - Debt Ratio for Firm 52
Exhibit 3-13. Worksheet 3c - Debt Ratio for Firm 54
Exhibit 3-14. Worksheet 3d - Fixed-Charge Coverage Ratio
Adjusted for Cost of Pollution Control 56
Exhibit 3-15. Data from Moody's - Beaver's Ratio 60
Exhibit 3-16. Worksheet 4a - Beaver's Ratio Without
Cost of Pollution Control 6J
Exhibit 3-17. Worksheet 4b - Beaver's Ratio Adjusted for
Cost of Pollution Control 66
Exhibit 3-18. Data from Moody's - Debt/Equity Ratio 70
-------
list OF EXHIBITS (continued)
Page
Exhibit 3-19. Data from Morris - Debt/Equity Ratio 71
Exhibit 3-20. Worksheet 5 - Debt/Equity Ratio Without
Cost of Pollution Control 73
Exhibit 3-21. Data from Value Line - Net Present Value 79
Exhibit 3-22. Worksheet 6 - Net Present Value Cost of
Pollution Control 82
Exhibit 3-23. Data from Moody's - Adjusted Stock Price 83
Exhibit 3-24. Worksheet 7 - Adjusted Stock Price 85
Exhibit 3-25. Data from Moody's - Market-to-Book Ratio 87
Exhibit 3-26. Worksheet 8 - Market-to-Book Ratio 89
Exhibit 4-1. Guidance for Use of Plant-Level Tests 94
Exhibit 4-2. Worksheet 9 - Total Annual Cost of Pollution
Control 98
Exhibit 4-3. Income Statement Components 99
Exhibit 4-4. Hypothetical Plant Income Statement 102
Exhibit 4-5. Worksheet 10 - Earnings Before Taxes (EBT)
for Plant 103
Exhibit 4-6. Worksheet 11 - Earnings Test 106
Exhibit 4-7. Data from Morris - Gross Margin Test 109
Exhibit 4-8. Worksheet 12 - Gross Margin Test 111
Exhibit 4-9. Data from Morris - Revenue Test 113
Exhibit 4-10. Worksheet 13 - Revenue Test 115
Exhibit 5-1. Worksheet 14 - Three-Year Trend Without
Pollution Control Costs 118
Exhibit 5-2. Worksheet 15 - Results for Most Recent Year 119
Exhibit 5-3. Guidelines for Test Results 120
-------
LIST OF EXHIBITS (continued)
Page
Exhibit 5-4. Worksheet 16 - Overall Rating (with Pollution
Control Costs Where Applicable) 121
Exhibit 5-5. Examples of Test Results 124
Exhibit 5-6. Worksheet 16 - Overall Rating (with Pollution
Control Costs Where Applicable), with Final
Conclusion 127
-------
CHAPTER 1
INTRODUCTION
1.1 BACKGROUND
The Clean Water Act requires the U.S. Environmental Protection Agency (EPA) to
regulate wastewater discharges. This is done through the National Pollutant
Discharge Elimination System (NPDES), which is administered by either the EPA
Regional Offices or individual states. To date, 33 states have approved NPDES
programs for wastewater discharges.
EPA has promulgated effluent guidelines for many Industries. These guidelines
include a requirement that permits must be based on the "Best Available
Technology Economically Achievable" (BAT) by 1984. Thus, as permits come up for
renewal they must be based on economic considerations as well as engineering
analyses.
BAT effluent guidelines will be promulgated by 1984 for several major
industries. However, the process by which permits are reviewed and renewed will
begin before then. Thus, some industries may not have promulgated effluent
guidelines for some or all of their process wastewaters by the time permits are
to be renewed.
For certain facilities, permit writers will be required to develop permits on a
plant-by-plant basis using best professional judgement. The industries for
which plant-by-plant permits will need to be written include those:
« for which no BAT effluent guidelines have been promulgated; or
• which generate and discharge process wastewaters not covered by effluent
guidelines.
These permits must also be based on both engineering and economic
considerations.
1
-------
1.2 PROBLEM
The engineering analysis portion of preparing a permit is usually based on
existing technologies -and guidelines. Therefore, while it may not be easy to
perform, it is usually fairly straightforward and is often related to the permit
writer's primary area of expertise and experience. On the other hand, the eco-
nomic evaluation could be performed in several ways or levels of complexity, if
a permit writer does not have a background in financial analysis, evaluating the
ability to pay for pollution control expenditures will be difficult.
The concept of "economic achievability" has many dimensions and is not con-
sistently defined or evaluated. As used in the development of effluent guide-
lines, it includes an assessment of different effects such as: price and
production effects; current and future supply and demand; competition by other
Industries; effects on sales; and product substitution. This manual does not
address these aspects of economic achievability because It 1s not intended for
use in developing permits for only one Industry. Rather, this procedure is
designed to assist the permit writer in determining the economic effects of
pollution control expenditures in terms of "ability to pay" at the firm or plant
level.
2
-------
1.3 PURPOSE
This manual is designed to give someone with no formal background in financial
analysis a structured,•step-by-step approach to estimating the ability of a firm
or plant to pay for pollution control technology. The methodology involves two
types of analyses. The firm-level analysis uses publicly available data to
evaluate the present financial conditon of the firm and to predict the financial
effects of pollution control investments that may be required to comply with
permit requirements. The plant-level analysis uses data provided by the firm to
evaluate the profitability of the plant and to predict the effects of pollution
control investments.
Firm-level analysis is performed for all permit evaluations. Plant-level analy-
sis is performed only if required. Two conditions would indicate a need for
plant-level analysis:
1. the firm contends that pollution control investment would make the
plant unprofitable to operate; or
2. the firm-level analysis indicates that pollution control investment
would have a serious detrimental effect on the firm's financial health.
3
-------
1.4 OVERVIEW
To accomplish this purpose as effectively as possible, EPA has divided the
manual Into two documents (the Guidance Manual for Estimating the Economic
Effects of Pollution Control Costs and the Workbook for Estimating the Effects
of Pollution Control Costs). The Guidance Manual describes the firm-level and
plant-level tests in detail, the data needed to perform the tests, and sources
for these data. It also contains example data and calculations for each test.
The Workbook contains blank worksheets and step-by-step instructions for
completing them..
Chapter 2 of this text provides an introduction to the financial analysis method
used to assess a firm or plant's ability to pay for pollution control. The
types of data needed to conduct the analysis and sources for these data are pre-
sented. Chapter 2 also contains a general discussion of engineering cost esti-
mation and the types and sources of data needed.
Chapter 3 presents the procedure for the firm-level analysis. The firm-level
methodology has two components. The financial statement component analyzes a
firm's reported values by calculating ratios from data in annual reports. This
is essentially a historic perspective on the company's operating performance and
asset values. The second component of the firm-level methodology, the market
value approach, uses stock market data as a proxy for the future performance of
the firm to evaluate a firm's ability to pay for pollution control.
Chapter 4 describes the plant-level methodology. The plant-level test uses con-
fidential, plant-specific financial data provided by the company to evaluate how
the costs of pollution control equipment would Impact the plant's earnings. The
plant-level methodology has three tests from which the permit writer must
choose. The choice is based on which plant-level data are available.
Chapter 5 provides direction for interpreting the combined results of the firm-
level analysis. The methodology does not provide a "cookbook" format for
interpreting all possible combinations of test results. However, Chapter 5
describes several common sets of conflicting results and provides general guide-
lines for interpreting them. It also provides guidance on how to incorporate
the results of the plant-level analysis with those of the firm-level analysis.
4
-------
The Workbook contains blank worksheets for all calculations and tests; sunmaries
of the data needed and sources for these data; and step-by-step instructions for
performing the calculations and tests. If the permit writer has no need for the
detailed information contained in the the Guidance Manual, or she can use the
Workbook to do the firm-level and plant-level analyses.
5
-------
CHAPTER 2
THEORY AND DATA
2.1 INTRODUCTION
Financial analysis assesses the position of a firm or plant at any point in time
up to the present and to predict and interpret future financial changes
resulting from decisions by the firm or plant. Financial analysis measures the
ability of a firm or a plant within a firm to pay for pollution control. The
measures of financial position are calculated to determine the current perform-
ance of the company and estimate the impacts of pollution control requirements
on these various measures.
In order to perform a financial analysis, two types of data are needed. One
obviously is financial data on the firm and plant which are being evaluated.
The other is engineering cost data for the pollution control technology that is
being considered.
This chapter contains a brief discussion of the theory behind financial and cost
engineering analyses. It also describes the two types of data as they are used
in this document and sources of these data.
6
-------
2.2 ENGINEERING ANALYSIS AND COST DATA
The permit writer may either need to do an engineering cost estimate for the
pollution control technology or review an estimate that has been provided by a
firm or plant. This section contains a brief discussion of engineering cost
estimates and data, because the choice of cost estimates will affect the outcome
of the financial analysis.
There are two different costs associated with pollution control treatment. The
costs of purchasing and installing the equipment and building the facilities to
house the equipment are called capital- costs or capital investment. These are
one-time costs which are Incurred at the beginning of the life cycle of the use
a piece of equipment or a process. The costs incurred on a continuing basis to
operate and maintain the equipment or process are called operating and main-
tenance (O&M) costs and are calculated on an annual basis. There are other
recurring charges specifically to recover the capital investment in a process or
facility which are added to O&M costs to obtain total annual costs.
2.2.1 Capital Costs
Capital costs are all of the costs to purchase and Install the equipment and to
provide necessary auxiliaries and appurtenances for the operation and use of
equipment or process facilities. Capital costs include buildings, piping, foun-
dations, instrumentation, spare parts, utilities such as water, electricity, and
natural gas, and all costs for engineering, permitting, and construction. Five
types of capital cost estimates are summarized in Exhibit 2-1.
The most accurate type of capital cost estimate is based on bids received from
suppliers and contractors who propose to provide t(ie equipment and/or build the
facility at the bid price. This type of cost information is available only if
specifications and working drawings have been prepared for the project. This
cost estimate would have a reliability of ± 52 percent. Most projects at the
permit applications stage will not be developed to this extent.
A slightly less accurate type of capital cost estimate 1s based on detailed
engineering design but without the preparation of specifications and working
drawings. The reliability of this cost estimate would be + 10 percent. The
permit applicant 1s also unlikely to have a cost estimate of this type.
-------
Exhibit 2-1
FIVE TYPES OF CAPITAL COST ESTIMATES
Type of Estimate
Characteristics
Purpose
Usual
Reliability
1.
Order-of-Magni tude
Ratio
Rapid. Very rough.
Preliminary Indication.
Result should be checked
by more detailed method.
About + 30%
*60%
2.
Study (commonly
called a factored
estimate)
Requires flow diagram,
material and energy
balance, type and size
of equipment.
For generalized evaluations.
Guidance for further in-
vestigation. Basis for
process selection. R&D
guidance.
+ 30%
3.
Preliminary Budget
Authorization
In addition to above,
includes surveys and
some engineering of
foundations, transpor-
tation facilities,
buildings, structures,
lighting, etc.
Basis for decision to under-
take detailed engineering.
Sometimes basis for budget
authorization. Can be for
generalized evaluation, but
usually for site-specific
installation.
+ 20%
4.
Definitive Project
Control
More detailed engi-
neering, but usually
short of complete spe-
cifications and
working drawings.
Requires experienced
estimating organiza-
tion and substantial
outlay.
Sometimes the basis for
budget authorization.
Provides Improved estimate of
project to be built. For
site-specific installations.
+ 10%
5.
Detailed Firm
Contractor's
Complete site surveys,
specifications,
working drawings.
Made to control cost of
project being built for site-
specific installations.
± 5X
Source: U.S. Environmental Protection Agency, A Standard Procedure for Cost Analysis
of Pollution Control Operations. Volume I. EPA-600/8-79-018a, June 1979.
-------
The next most accurate type of capital cost estimate is based on estimates
obtained from suppliers of the equipment and auxiliaries. Installation costs
and other design and construction costs may be estimated by identifying
materials and labor hour requirements and multiplying each by an appropriate
unit cost. Some of these Items may be estimated as a percentage or multiplier
of a known cost, as a percentage of the total equipment and installation cost,
for example. There are generally accepted multipliers which vary with the type
of equipment, materials handled, and scale of facility. The multipliers used
should be documented by the applicant and should be consistent and appropriate.
Estimates prepared 1n this manner, sometimes called "conceptual estimates,"
would have a typical reliability of + 20 percent.
A fourth type of capital cost estimate (another conceptual estimate) is very
similar to the third, but uses generalized published cost data for the equip-
ment costs Instead of supplier price estimates. The installation and other
design and construction costs are usually estimated using multipliers or percen-
tages as described above. This is a less accurate method, with a reliability of
+ 30 percent, but it is frequently used to obtain estimates early 1n capital
spending and similar resource allocation decision processes.
Where a capital cost.Is required 1n the financial analysis, this cost should be
based on one of the latter two types-of estimates described above (the concep-
tual estimates). This will ensure that the cost estimate is sufficiently
accurate without being costly or time-consuming to prepare. Costs used in EPA
Development Documents are these types of conceptual estimates.
The least accurate type of capital cost estimate is an order-of-magnitude ratio.
It 1s done by estimating average fixed price per unit of plant capacity;
scaling a known cost for a facility of a different size; or calculating a price
based on a plant's turnover ratio (annual revenue divided by total investment).
The reliability of this type of estimate ranges from +30 percent to -60 percent.
The permit writer should not use a capital cost of this type because 1t would
not be accurate enough to make the results of the financial tests meaningful.
An excellent guide for preparing cost estimates, including sources of equipment
costs, is the EPA publication A Standard Procedure for Cost Analysis of
9
-------
Pollution Control Operations, Volumes I and II (EPA-600/8-79-018a and -018b).
Other literature sources for cost estimating methods and cost data are listed
1n Exhibit 2-2. Information on the multipliers and percentages to be used for
various equipment items' and process applications can be obtained from many of
these same literature sources.
2.2.2 Operating and Maintenance Costs
Operating and maintenance (O&M) costs are most likely to be estimated as speci-
fic requirements for each equipment item or processing unit. O&M costs include
labor, supervision, utilities, chemicals and supplies, maintenance, labor and
supplies, waste management and disposal, insurance, taxes, and other recurring
items. In preparing the O&M costs, all significant cost Items must be con-
sidered and the unit costs of each must be reasonable estimates. Unit require-
ments may be estimated from literature data on the specific equipment or process
or by using engineering judgment. Unit costs for labor, chemicals, and
materials may be obtained from various published sources. Other costs such as
insurance and property taxes are usually estimated as percentages of the capital
or operating costs. The data sources listed 1n Exhibit 2-2 can also be used for
preparing O&M cost estimates.
A working knowledge of both the technology and typical costs Is very helpful 1n
preparing or assessing capital and O&M cost estimates. A number of options are
available to the permit writer who lacks this knowledge of familiarity. A com-
parison can be made with costs for similar technologies and capacities. The
reasonableness of capital or O&M costs estimates can also be assessed by calcu-
lating the relative contribution of each cost component to the capital or O&M
total. Some of the publications listed 1n Exhibit 2-2 contain information on
what the relative porportlons the various components of a total cost should be.
2.2.3 Total Annual Costs
The total annual costs of a pollution control system include the O&M costs and
charges to recover the capital Investment—the latter are called capital reco-
very costs. The capital recovery costs are the charges a corporation will
assess on any investment of capital, both to recover the original investment and
to cover the costs Incurred by the firm to raise the capital through all means
10
-------
Exhibit 2-2
SOURCES OF COST ESTIMATING METHODOLOGIES AND DATA
SOURCES TYPES_OF COST_DATA
Capital O&M
Development Documents for Water Pollution X X
Control Regulations—EPA
Permit Writers Guidance Manual/Technical X
Resource Documents—EPA's Office of Research
and Development
Richardson's Process Plant Construction X
Estimating Standards
R. S. Means Building Construction Cost Data X
R. S. Means Site Work Cost Data X
Chemical Engineering Costs by Charles Dryden X X
and Richard Furlow
Cost Engineering Analysis by William R. Park X X
Process Plant Estimating Evaluation and X X
Control by Kenneth M. Guthrie
Plant Design and Economics for Chemical X X
Engineers by Max Peters and Klaus Tlmmerhaus
Chemical Engineers Handbook by Robert Perry X X
and Cecil Chilton
Treatment Alternatives for Hazardous Waste X X
Management in Nine Industry Groups—Li 11a A.
Abron-Robinson (Peer Consultants, Inc.) and
Edward J. Martin (Environmental Quality
Systems, Inc.) for EPA Office of Solid Waste
A Standard Procedure for Cost Analysis of X X
Pollution Control Operations—EPA-600/8-79-018a
and -018b "
Cost Comparisons of Treatment and Disposal X X
Alternatives for Hazardous Wastes—Warren G.
Hansen and Howard L. Rishel (SCS Engineers)
for EPA-MERL
Estimating Water Treatment Costs—EPA-600/2-79-l62a X X
through -162d
Trade Publications and Technical Journals X X
Manufacturers' Literature X X
-------
employed. These costs are usually not current "out-of-pocket" expenditures, but
are charges assessed against the installation to recover the capital involved in
the initial expenditure to purchase and build a facility.
The capital used to purchase and build a system can either come from within the
firm through Its own financial resources such as retained earnings or stock
sales or it can be borrowed by the firm from various outside sources. In either
case, the firm must recover the capital Investment plus the interest paid on
that investment, in order to pay back the loan or to return the money to the
firm for future use on other projects. In the latter case, the investment by
the firm can be viewed essentially as a loan by the firm to itself for the spe-
cific project.
2.2.3.1 Cost of Capital
The assumption used In estimating capital recovery costs Is that a firm uses a
mixture of debt funds (loans or bonds) and internally generated funds—called
equity funds—to finance capital investments In plant and equipment. On the
basis of this assumption—or as given for a specific firm—regarding the mix of
debt and equity funds used to finance the investment, the appropriate cost of
those funds can be determined and assigned to a project. This cost is called
the cost of capital and it 1s expressed 1n the form of an interest rate, i.e. a
percentage of the funds or capital Invested.
The cost of capital is determined for any specific firm as the weighted average
of the cost of debt funds and return on equity funds for that firm. Debt funds
come from long-term loans and bonds. The interest rate for each loan and bond
issue is combined in a weighted average to obtain an overall Interest rate that
would be the cost of debt for the firm. The cost of debt Itself or data needed
to calculate this is available 1n annual reports or directly from the firm. The
return on equity Is calculated as the annual dividend divided by the stock price
plus an expected or projected growth rate of dividends. The overall cost of
capital 1s then calculated for the firm assuming that the funds are used for all
projects without regard to the specific source—debt or equity—and hence
without discriminating as to the cost of the funds, except as an overall
average.
12
-------
In the absence of data on the actual cost of debt and/or the return on equity
for a firm, the former can be estimated as some increment above the prime
interest rate charged by banks. The percentage above the interest rate depends
on the size and financial condition of the firm. Smaller and less sound firms
firms will incur higher increments—perhaps up to three to six points above the
prime rate. Average return on equity for the industry may be the best estimate
of return on equity for the firm when data are lacking. Otherwise, an estimated
interest rate based on the prime bank lending rate may be the only cost of capi-
tal estimate available.
2.2.3.2 Capital Recovery Cost
With the cost of capital or interest rate established, the capital recovery
costs can be estimated. A length of time is selected for which the capital
recovery charges are to be applied to the annual cost of a project to achieve
the recovery of the Invested capital with interest. The time period is usually
less than the expected operating life of the facility or system. A frequent
choice is ten years unless the operating life of the system is less than that.
The interest rate to be used is the cost of capital. The calculation of the
capital recovery cost factor and total annual cost Is described 1n Chapter 4.
It 1s performed using Worksheet 9.
Interest tables are used to obtain the capital recovery cost factor. The
Interest tables are included in most books of standard math tables, in many cost
engineering and corporate finance texts, and in some EPA publication. The capi-
tal recovery cost factor is used as a multiplier, which 1s applied to the capi-
tal investment to obtain the annual cost of capital recovery. This cost, plus
the O&M costs, constitute the total annual costs. The capital recovery cost can
be a very substantial percentage of the total annual costs.
The capital recovery cost factor Is function of the interest rate and the
length of time for capital recovery. Both have significant effect on the value
of the capital recovery cost factor. If information on the Interest rate and/or
the length of time are uncertain or essentially unavailable to the permit
writer, these items could be varied in a sensitivity analysis to assess the
impact on the total annual costs. The Importance of the capital recovery factor
could thereby be assessed and considered in the decision process.
11
-------
2.3 FINANCIAL ANALYSIS AND DATA
The financial analysis presented In this manual Is designed to address the
ability of a firm or pTant to pay for pollution control. Two levels of finan-
cial analysis are included—firm-level and plant-level. The purpose of this
section is to briefly describe these types of financial analyses, the data
needed to perform them, and the sources of these data.
2.3.1 Firm-Level Analysis
The firm-level analysis consists of tests that are designed to measure the
financial health of a firm using publicly available data. The analysis has two
components—financial statement analysis and market value analysis. The finan-
cial statement component analyzes a firm's reported financial condition by
calculating ratios from available data. This provides a historical perspective
on the firm's operating performance and asset values. The market value analysis
uses stock market data as a proxy for the future performance of a firm to eval-
uate the firm's ability to pay for pollution control.
2.3.1.1 Financial Statement Analysis
Financial statement analysis focuses on three primary measures of financial posi-
tion and capability of a firm:
t liquidity;
• solvency; and
• leverage.
All three measures indicate the ability of a firm to meet Its financial
obligations, I.e. to pay Its bills and long-term debts, and the relative level
of Its long-term Indebtedness. The purpose of measuring the liquidity,
solvency, and leverage of a firm is to assess its ability to pay for pollution
control Investments.
Liquidity is a measure of ability to meet short-term obligations, I.e. current
bills and debts that are to be paid In less than one year. Two ratios are used
to measure the liquidity of a firm—the Current Ratio and the Quick Ratio.
These ratios and their use are described 1n more detail in Chapter 3.
14
-------
Solvency is the ability of a firm to meet its fixed and long-term obligations
from current revenues. Two ratios are used to measure solvency. They are the
Fixed-Charge Coverage Ratio and Beaver's Ratio. Both of these measures are
discussed in detail In Chapter 3.
Leverage is a measure of the extent of the use of bonds and/or long-term loans
by a firm as a source of money or capital. There are two basic sources of capi-
tal for a firm—debt, which 1s incurred via long-term loans or bonds, and
equity, which 1s generated through the sale of corporate stock and by retaining
earnings within the firm. The Debt/Equity Ratio Is a measure of the degree of
leverage of a firm.
Each of these ratios 1s evaluated against at least two of the following three
criteria:
• A rule-of-thumb target that is commonly used by analysts to determine
what constitutes acceptable performance in general. These targets can
be considered the empirical "laws" of financial management.
• A cross-sectional analysis 1n which a firm's ratios are compared to the
range of ratios for many of the firms 1n the same industry. This pro-
vides an estimate of how the firm compares with average or exceptional
competitors.
• Comparisons of the movement of a firm's own ratios over time, to indi-
cate how performance is changing over time.
These indicators are calculated for the most current year and for preceding
years to obtain trends and current values. The economic effects of pollution
control requirements are then assessed directly as changes In the value of these
ratios and interpreted 1n terms of the quantitative changes in the ratios.
Financial statements provide the data needed to calculate the measures described
above. These statements are prepared by all firms to report their financial
status and operating results to all parties with an interest and a right to that
information. The statements are prepared and distributed periodically; however,
only the annual statements are of interest as data sources for this manual.
There are two different statements used to communicate the financial infor-
mation. The first—the balance sheet—provides a summary of the firm's finan-
cial condition at a specific point in time, typically the end of the firm's
15
-------
fiscal year. Although the financial data presented can and will change from day
to day, the balance sheet presents the information as 1f all activities of the
firm were at a momentary standstill. This is standard accounting practice, and
all such statements will reflect a similar approach.
The balance sheet 1s divided into two sections. On the left or upper section
are shown the assets, and on the right or lower section are shown liabilities
and stockholders' equity. Assets include all goods and property owned by the
firm as well as money owed to the firm by others which has not yet been
collected. Liabilities Include all debts and payments which are owed by the
firm. The stockholders' equity 1s the amount of money that would theoretically
be divided among the stockholders 1f the firm were sold at its balance
sheet value. It Includes the investment of stockholders in purchasing shares in
the firm and earnings from current and past years retained within the firm.
The income statement 1s the second of the financial statements. It shows how
much money a firm has earned or lost during the fiscal year. The income state-
ment is also called the "earnings report" or "statement of profit and loss."
The income statement contains Information on the revenue received from selling
the firm's products or services and from other sources of income, and the costs
and outlays Incurred In order to operate the company. The costs Incurred
usually consist of cost of goods sold (raw materials, wages and salaries, rent
and supplies), depreciation, Interest paid on borrowed money, and taxes.
Expenses are subtracted from income to obtain the net profit or net loss for the
year.
Financial data on a firm are available from a variety of sources. Publicly held
firms commonly report the current and preceding years' financial results in
their annual reports to stockholders. Publicly held firms are those whose cor-
porate shares are traded on stock markets and are owned by the general
public. Publ1cly-held firms are also required to file a 10K form with the U.S.
Securities and Exchange Commission. The 10K form 1s very similar to an annual
report to the stockholders. All 10K forms and some annual reports to stock-
holders are available in public business libraries or university libraries.
Stock brokerage firms may also have copies of annual reports.
16
-------
In addition to these sources, the firm may be listed in Moody's Industrial
Manual~ This source provides balance sheet and income statement data for firms
that trade stocks on the New York and American Stock Exchanges. Moody's provides
most of the information required to perform the firm-level tests in a concise
and readily available format.
Financial ratios for various industries are available from a variety of sources
as well. The ratios required for the firm-level analysis are available from
Robert Morris Associates' Annual Statement Studies. This source lists financial
ratios for a large number of SIC codes. The information 1s compiled from data
submitted voluntarily by Robert Morris Associates member banks and 1s for firms
with total assets less tha $100 million.
2.3.1.2 Market Value Analysis
The financial statement analysis provides a review of recent historic perfor-
mance and a po1nt-1n-time picture of a firm's financial status. What is not
discernible from this vantage 1s how pollution control costs would affect expec-
tations of the future performance of the firm. To predict the future effects
one needs a prospective look based on expected financial performance of the firm
with and without pollution control expenses.
One way of doing this would be to project jjro forma (predicted) financial state-
ments into future years by extrapolating past behavior and performance trends.
Certain items such as inventory, value, accounts receivable, and accounts
payable could be estimated from past performance of the management of the firm
in terms of ratios to total sales or average length of collection or payment
time, for example. Other items like sales and operating costs could be extended
along recent trend lines. These would allow a permit writer to estimate what
future balance sheets and income statements might look like. Unfortunately,
this would require a detailed understanding of the firm's Industry and market,
including how sales and costs vary with Inflation, who the competitors are, what
new technologies are Influencing the supply and demand for the product, and how
production assets are tied to sales volume and costs. Collecting this Infor-
mation would be a formidable task beyond the scope of the permit writer's
interests or capabilities. Instead a proxy for this forward-looking approach is
17
-------
used—analysis of stock prices. This is the purpose of the second component of
the firm-level analysis—the market value analysis.
Stock prices reflect the opinions of many analysts and participants in the stock
market who set the price of a stock by their buying and selling behavior, in
theory, the price of a corporate stock 1s a measure of the net present value
(NPV) of the future cash flows (profitability) of the firm. The value of money
over time is considered in net present value by reducing—or discounting—the
estimated future cash flow to a lesser amount based on the length of time
involved and an assumed or effective interest rate. Thus stock prices are indi-
cators of Investors' expectations of the future profitability of a firm. They
constitute a single-number substitute for a series of projected future financial
statements. Because there are many security analysts who conduct detailed
financial evaluations of firms for Investors who value such Information very
highly, and many Investors who act on that Information, it can be assumed that
the market price of a firm's stock 1s a good substitute for the more rigorous
and time-consuming analysis.
Any cost associated with pollution control will have only negative value as an
investment for a firm, because the costs will not produce any revenue and will
only result 1n reductions in net Income. However, some waste treatment tech-
nologies, e.g., recycling, flow reduction, or solvent recovery, can partially
offset the gross cost of compliance. This reduction 1n Income would reduce the
stock value. Assuming the stock price represents the per-share amount of pro-
fits available now and 1n the future, 1t thus provides an indication of the
upper limit on the after-tax cost of pollution control that could be incurred by
a firm before deficit operation.
The impact of the present value of the pollution control costs on stock values
is roughly half the cost of the capital and operating cost of the pollution
control technology because the costs are tax-deductible and the stock price is
an indicator of the present value of after-tax profits. The market value ana-
lysis used the ratio of stock market value to "book value" (stockholders1 equity
or net worth) of the firm, with and without the stock price reduced by the cost
of pollution control. Book value is typically reported In financial statements
as stockholder's equity or net worth.
m
-------
Stock market data Include two types of information. Stock prices are recorded
daily in the Wall Street Journal and many other newspapers. Stock listings
typically indicate current prices as well as high and low prices for the current
year. Other Information concerning stock performance is available from Value
Line Investment Survey. This 1s an independent advisory service for pro-
fessional analysts, corporate financial managers, and private Investors. Value
Line provides periodic news reports on companies' performance and predictions
of future performance.
2.3.2 Plant-Level Analysis
The firm-level tests are relatively straightforward and depend on readily
available data. However, these tests may not be sufficient to determine if an
Individual plant can maintain operations when faced with additional pollution
control expenditures. Two conditions would Indicate a need for plant-level
analysis:
e the firm contends that pollution control investment would make the plant
unprofitable to operate; or
• the firm-level analysis indicates that pollution control Investment
would have a serious detrimental effect on the firm's financial health.
The plant-level analysis used 1n this manual 1s based on plant-specific costs
and revenues and is designed to focus on potential plant shutdowns rather than
total corporate ability to pay. This type of analysis can be very complex
because:
• plant-level financial data are usually confidential;
e the necessary data, particularly concerning the allocation of corporate
overhead expenses, are not always collected by firms at the plant level;
and
e the non-standardized accounting procedures used internally by firms do
not facilitate easy verification of reported cost and revenue items.
The plant-level tests are intended and designed as screening tests rather than
rigorous and definitive evaluations of a plant's ability to afford pollution
control costs. If the test results indicate that pollution controls would
impose severe economic impacts, then a more detailed plant closure analysis
10
-------
would be necessary. This would entail working closely with the plant and cor-
porate accountants to gather information on a variety of costs, revenues, and
accounting procedures. Mathematical modelling of the plant's profitability may
be necessary. Information on salvage values of plant equipment as well as pro-
jections of future economic conditions may be desirable or required. A method-
ology for plant closure analysis is not presented- in this document.
Three tests are presented 1n the plant-level analysis: the Earnings Test, the
Gross Margin Test and the Revenue Test. The Earnings Test measures the impact
of pollution control costs on the plant's earnings before taxes. Earnings are
computed as revenues minus the cost of goods sold (raw materials, wages and
salaries, rent, and supplies) and the corporate overhead expenses assigned to
the plant. The results of this test would provide the most clear-cut indication
of a plant's ability to pay for pollution control. The cost of pollution
control would directly reduce earnings to the level Indicated by the results of
this test.
The Gross Margin Test should be used 1f corporate overhead data are not
available. This.test measures the impact of pollution control costs as a frac-
tion of the plant's gross margin. Gross margin 1s computed as revenues minus
cost of goods sold. The test result 1s a fraction which may require more skill
to interpret than the absolute number obtained from the Earnings Test.
The Revenue Test is the simplest. Pollution control costs are considered as a
fraction of total revenues for the plant. No other plant-specific costs are
required to perform this test.
The Earnings Test is probably the most useful to the permit writer and the
Revenue Test Is probably the least useful. However, the former requires the
most data, and the latter requires the least. Whichever test 1s used, signifi-
cant data problems can be expected, Including a lack of specific data; misallo-
cated, biased, or Inappropriate cost data; or incomplete information. The
plant-level analysis will be constrained by such problems but reasonable esti-
mates and informed use of the available data may be sufficient. The calculation
and interpretation of these tests are discussed in more detail In Chapter 4.
Data needed for the plant-level tests must be obtained from the permit applicant
for the plant in question. If there are not sufficient data to perform the
20
-------
Earnings Test and one of the other two tests Is used, industry ratios for com-
parison are available from Morris1 Annual Statement Studies. Data concerning
the cost of pollution control can be obtained from the firm-level analysis
worksheets.
21
-------
CHAPTER 3
FIRM-LEVEL ANALYSIS
3.1 INTRODUCTION
The first stage in the economic analysis of pollution control expenditures Is
the firm-level analysis. This analysis uses publicly available financial data
to determine whether a firm can afford the pollution control technology for a
particular plant.
All of the firm-level tests can be performed using three years of data from
publicly available sources, such 9s annual reports or stock market data.
Evaluation of privately-held firms will be difficult, because the above data
sources are not available for such companies. Dun and Bradstreet reports some
Information on privately held firms that will enable the permit writer to per-
form a limited evaluation. If sufficient data are not available or if conclusions
are difficult to reach, the permit writer may need to ask the firm to provide
confidential financial information.
The firm-level analysis has two components—financial statement analysis and
market value analysis. The financial statement component analyzes a firm's
reported financial condition by calculating ratios from available data. This
provides a historic perspective on the firm's operating performance and asset
values. The market value analysis uses stock market data as a proxy for the
future performance of a firm to evaluate the firm's ability to pay for pollution
control.
22
-------
3.2 FINANCIAL STATEMENT ANALYSIS
The methodology presented In this section concentrates on three accounting indi-
cators of financial strength:
• Liquidity— ability to meet short-term financial obligations;
• Solvency. — ability to meet long-term financial obligations; and
0 Leverage — indebtedness as a percentage of total capital.
Five ratios will be calculated to measure these indicators, using data from
balance sheets and income statements. The ratios should be calculated using
three years of financial data to smooth fluctuations in reported earnings and
asset values over time. They will first be calculated with the firm's reported
revenues and expenses. Then the ratios for the most recent year will be
adjusted for the cost of the pollution control technology to determine how the
control option will Impact the firm's financial health. Each ratio will be eval-
uated against at least two of the following three criteria:
o A rule-of-thumb target that 1s commonly used by analysts to determine
what constitutes acceptable performance in general. These targets can
be considered the empirical "laws" of financial management.
• A cross-sectional analysis in which a firm's ratios are compared to the
range of ratios for many of the firms 1n the same industry. This pro-
vides an estimate of how the firm compares with average or exceptional
competitors. Although 1t 1s impossible to Identify precisely the in-
dustry 1n which a firm competes, it can often be usefully approximated
by the SIC code of the firm. Financial statements of other firms with
the same SIC code provide a distribution of the financial conditions for
firms in the industry. The statements, of the firm in question can then
be compared to those of other firms to assess relative liquidity,
solvency, and leverage.
e Intertemporal or longitudinal comparisons of the movement of a firm's
own ratios over over time, to Indicate how-performance is changing over
time.
In Chapter 5 the results of the firm-level evaluations are assessed as a whole,
and in combination with the results of the plant-level tests.. Chapter 5 also
contains guidance for evaluating conflicting test results.
23
-------
The data needed to perform the financial statement analyses can be found in the
balance sheet and income statement for a firm. The balance sheet shows a finan-
cial picture of a firm at a given point in time, as if all financial activities
of the firm were momentarily at a standstill. Because the balance sheet
reflects a point in time, the data presented on it can change from day to day.
The balance sheet is divided into two sections. On the left or upper section
are shown the assets, and on the right or lower section are shown liabilities
and stockholders' equity. Assets include all goods and property owned by the
firm as well as claims against others (unpaid bills owed to the firm) which have
not yet been collected. Liabilities include all debts and payments which are
owed by the firm. Stockholders' equity 1s the difference between the value of
the firm's assets and the value of its liabilities. This Is the amount of money
that would theoretically be divided among the stockholders 1f the firm were
liquidated at Its balance sheet value. It includes the investment of
stockholders In purchasing shares in the firm and earnings from current and past
years retained within the firm.
The income statement shows how much money a firm makes or loses during Its
fiscal year. It can also be called the "earnings report" or "statement of pro-
fit and loss." The income statement contains information on the amounts
received from selling the firm's products and from other sources of income, and
the costs and outlays incurred 1n order to operate the company. The costs
Incurred usually consist of cost of goods sold (raw materials, wages and
salaries, rent, and supplies); depredation; Interest on borrowed money; and
taxes. When the expenses are subtracted from the Income, the result is a net
profit or a net loss for the year.
The three sets of tests that comprise the financial statement analysis are the:
• liquidity ratios;
• solvency ratios; and
• leverage ratios.
These are discussed in the next sections.
24
-------
3.2.1 Liquidity Ratios
Liquidity ratios indicate a firm's ability to obtain cash to meet short-term
financial obligations, i.e. current bills and debts which must be paid within
one year. They measure the extent to which current assets exceed current lia-
bilities. Ratios are used to relate the excess of current assets to the finan-
cial scale of the company.
The assets considered in liquidity ratios are cash and near-cash items such as
marketable securities, accounts receivable (bills owed to the firm that have
not yet been paid), and inventories. They are described as current assets
because a firm can reasonably expect to convert them to cash within the current
business year, if necessary, to meet Its financial obligations.
Current liabilities are those items that a firm can be obligated to pay for
within the current year. These typically include accounts payable (unpaid
bills owed by the firm), short-term notes payable, the current portion of long-
term debt, and a variety of other accrued expenses.
Liquidity ratios are comparatively easy to calculate because both current assets
and current liabilities are routinely presented as subtotals on balance sheets.
They provide a concise measure of the short-term financial status of the firm.
However, liquidity ratios can significantly understate a firm's ability to meet
its short-term obligations because the firm may have potential sources of
cash that are not considered current assets. These include:
• borrowing from readily-available credit sources;
• sale of fixed assets such as land, buildings,, equipment; and
o reduction of planned expenditures.
The two most commonly used liquidity ratios, the Current Ratio and the Quick
Ratio, are included in this methodology.
25
-------
3.2.1.1 Current Ratio
Theory
The Current Ratio is a measure of a firm's excess current assets. It is
expressed as:
CR * CA
CL
where: CR * Current Ratio
CA x Current assets
CL = Current liabilities
The Current Ratio Is a rather gross measure of liquidity in that all current
assets are assumed to be equally convertable to cash.
Calculation
Data for both current assets and current liabilities can be found on the
Comparative Consolidated Balance Sheet in Moody's Industrial Manual, as shown
in Exhibit 3-1. It should be noted that there may be line Items that are not
listed 1n Moody's. For example, Information for the current portion of long-
term debt is not shown as a line Item 1n Moody's for the sample firm. The per-
mit writer should discuss any such uncertain or missing data with the firm to
obtain the necessary clarification and/or data. The Current Ratio 1s calculated
lated using Worksheets la and lb on pages 6 and 7 of the Workbook. The calcula-
tion should be done using data for the three most recent years for which data
are available. The trend 1n the Current Ratio values over the three years Is
examined, and 1t Is also compared to Current Ratio values for the industry.
Industry averages for the Current Ratio are presented by SIC code in Robert
Morris Associates' Annual Statement Studies (see Exhibit 3-2). These industry
averages reflect data for firms whose fiscal years end between the dates indi-
cated. For example, the most right-hand column in Exhibit 3-2 1s labelled
"6/30/81-3/31/82M; the Current Ratios reflect data for firms whose fiscal years
ended between 6/30/81 and 3/31/82. The permit writer should use the Current
Ratios from the column that corresponds to the end of the firm's most recent
fiscal year. To assess the three-year trend 1n industry Current Ratios, the
-------
1600
MOODY'S INDUSTRIAL MANUAL
Exhibit 3-1
aim include* 828.0 million (*0.62 per sh.) gsin Use.:
on sale of pigment tod methanol assets. Prop., pit. t
311960 include* <5.1 million (*0.lJ per ih.) Canitslwin
charge (or termination of opetationa of the join
twr Urephlhalatt plant at Middleburf. DATA FROM MOODY ' S
CoAsoHdsted Statement of Chun— In i ¦
I Position (in ihousandb):
Reductions ,
CURRENT RATIO ^e¦inno,e,
exenge. of com. (Ik. (or debt:
(199,664)
(22,41?)
(IS. US)
Funds Provided From Operations:
Sources:
lmc. fast. extraord.
gain
Decree,kamort.....
Da. text* on inc.....
Sq. in an inc. oI affil.
cut. in excea* o( 1
diva
Writedown of fad! ..
IM2
•66,861
120,48?
(15.195)
1981
•156.481
118.8.19
15.092
iacruN in invest. .
Net chic, in work,
cap
IJ5.9S0
42,974
(109.217)
69,711
Net fds. prov. fr.
i,704 oper. 11 J,016
5,860 Financing Transaction*:
— ¦ ... Chge. in Ig.-tin. debt:
1*2,7-27. 276,996 New borrowings .... 177.247
(12.972)
5,544
154,846 Incr. in cap. sceta. .
14.754 Extrxordinsry gain ..
Cash dividend*
70489
— Net lin. Iran*
220,289 Ou-ct, it, fgn. curr.
"~ tran*. adj
M|707 Other sources (um) .
Net incr. (deer.)
247,270 in Ida.
58,845
11.55.1
(56.874)
(44.05*1
(H.W4)
6,606
(150,444)
96426
(75,245)
(Si,547)
(51,964)
(44,956)
11464
(9,149)
Wecerd of earnings, year* ended Dm. It (in thousands of dollars): .
Cost and Oth. Inc. It Inc. Bef. Income Net
r Net Sales Expense* Balance Deb. (Net) Taxes Taxes Income
i 476,462 410,627 65.U5 651 66.466 54452 _51,955
64 576,085 499,041 77,044 4895 76.149 58,582 TTU7.767
65 578,649 S02.M8 76JO I 5.751 82.055 55,986 0t6.(H6
1966 661,519 560,025 101,296 J.456 104,752 48,766 55,986
1967.... 670,292 579,956 90,556 dl.OIJ 89,525 40.509 49,014
1968.... 751,055 642.915 108.140 d».425 101.717 46,117 55.600
1969.... 779,687 681.611 91.076 .6«2
005.525
1,477,545
527,521
129,716
24.900
95,819
I2.I4U
(2)1.206
l.45o.J82
515.267
150.779
155 158
89.228
5«.i(«
u:io8
Book Value Deprec. Res, subsidiaries with the exception of finance and come currently. Prior years have nut been re*
•20.461,000 insurance subsidiaries, and Co.'* pro rata stated, For those years, accounts of foreign
1,826.117.000 tMI7.874.000 6hsre of the Hercoflna Joint ventures, companies were translated at current «*•
?f£S-25 JH!f222 Investments in affiliated companies, owned change rates, except that inventories, proper-
154*0.000 6,465,000 20% or more, are accounted for on the equity ty, plant and cnuipmunt. depn.-Mtion, good-
method, aa are wholly-owned finance and in- wii: ¦ ¦ ¦ ¦' *"¦"
166,222,000
Total
_ 82.079,668,000 *1,155,992.000
QIAfter reserve* (1982, *4,918,000).
(DCo. extensively uses the last-In, (int-out (LIPO)
method lor valuing inventories. If valued on thr av-
erage cost method, inventories would have Iwen
•155.000.000 higher than as reported on the LUo
¦lethod at Dec. 51,1982.
(ijStatcd value: *25/48.
QSharea at coat: 1982-80.6.589; 1979-76. 5,689.
U1I978-76: Represents accumulated depreciation
' of acquired company at date uf acquiaition.
— . .. - will, and dclcrrcd taxes arc tran^lutcd at hie-
¦urance subsidiaries (due to their disiimilar torical exchaiuie rate* Revenues, expenses,
business activities). Accordingly consolidated i«ins a^ lol2^ (oth« thin invcntJry roets
net income include. Co/. shaA of their net in- aSJSrtSflJSTSSrf^SSrtSSl.TKodwIU)
COlTICt * a .. ! |J_.^ ika
All significant intercompany uansactions
are eliminated in consolidation.
(b) Translation of Foreign Currencies: As a
result of adopt in* Statement uf Financial Ac-
counting Standard No. 52, ForeiK" Currency
Translation, in 1911, for years ended Dec. Jl,
were translated at rate* prevailing during the
yeur.
(c) Inventories: Invcntiiriu* arc stated at
the lower of ihisI «»r nrnrket. SuliMantiully ail
domestic inventories are valued on the last-in.
first-out (L.IFO) niuthud. and forcitfii invento-
A * •MaHIIIWlM 111 I 6 s »WI 7«llf I CnHCU WVVi «# 6 a , * , , ' , , ,i .« .
1981 and thereafter balance sheet accounta of ries are valued principally on the average coat
foreign companies are translated at current method.
p' 'V'"'u^s rr.SS£h^dn.Vtej:
mcoums M airraet rates of eschaoga. Revenue, expenses, fain* and loates for I oil
ImhMNoM and year, thereafter arc translated at rate*
. (a) Consolidated financial statements In- prevailing during; the year. Foreign currency
chMte the ancouals of Co, ail wholly-owned uanaac^on gaina and Ic •• included in in-
(d) Commitments and Contingent Liabili-
ilea:
Co. ha. certain operating leases, including
office space, snd transportation and data
processing equipment, expiring at various
dates. Rental expense relating to these Ic
-------
Exhibit 3-2
DATA FROM MORRIS - CURRENT RATIO
MANUFACTURERS • PUSTIC MATERIALS ft SYNTHETIC RESINS
net lut
•S
CwnMDatt
•2t8/3aa/3o^i}
~4110/1/11-3/31/12)
ftlMM
^|qhh
rtcmi
Alt
ASSET SI2E
24
w
It
1
111
NUMBER OF STATEMENTS
«
«
%
«
% "
AIIETS
II
41
35
¦
SI
Ca»h 1 CQiMviltnll
3SS
29.6
211
301
AecH. 1 Nolo floi. ¦ Trada(nct)
11 7
22 7
24 9
224
Inxntoiy
1 7
1 2
19
1 4
All Olhai Curiam
ISS
512
S92
599
Hl.l Currant
2S.2
33 1
32.1
311
hut Allklt (not)
1
I.I
.1
1 1
Intanfiblai (nit)
1 1
41
75
74
All Ollti Non Currant
_ _ 100.0
1000
1000
100.0
Total
LIABILITIES
70
II
97
14
Noiat Har4l>lo4liori larni
4.1
3.2
2.7
3 2
Cui Mat t/T.'D
24 1
197
114
117
Acctt I Notai Payabia Trada
4 I
41
1 7
l.l
Acciuad Eiptntaa
10
20
40
32
All Otbar Currant
459
404
394
401
Ti.ial Current
II 1
IIS
25 2
112
l-mj Turn Delll
5 5
2.1
3.0
31
All Otnar Non Cjrraril
37 S
31.3
324
37.1
Ni-I Wbrtn
100 0
100.0
100 0
1000
Total luDilitiui & Nat Worth
mcumf data
100.0
1000
100 0
1000
Nat Salaa
72 1
77 9
77 7
714
Cult 01 S«iaa
27 9
22.2
22.3
232
Gmat ?iolit
24 9
111
I'll
II2
Oei7 10.0
W 73
II 4.3
l.0"
10 7
an
(221
SI
22
1 2
12
(III 3 I
fl
3.7
(»7) 20
I
13 I? 1.3
(12) 2 7 |SS) 4.0 (13) 2.1
I.S 2 3 1 3
.4
I
_2l0_
10
3.2
77
I
I 0
I
II
3.3
311 311
(32) 2S.I (14) 24.0
S.7 I0A.
131
13
1 2
111
II
3.0
.7
13
2J_
13
2.2
310
US
-21
RATIOS
Currtnl
Quick
Salai/Raca»abfat
Cuil <4 Salaa/ln»antoir
Sala».'Woiting Capital
EIIT/intaiait
Caih flew/Cut. Mil. l/T/D
fiiM/Woflh
Oabl/Worth
* Crolil 9«fs>a T«aai/T«ngM./|.
4/1MI
4/10 41-
1/11. ?•
a/ai/7i
Vll/10
I'll II
ALL
AU
AIL
ALL
All
m
144
127
111
* %""
'*
" \
"*
\
12
17
II
1:
51
210
291
215
25 5
30 1
24 3
22 3
241
214
22 4
2 t>
1 4
72
I 4
1 4
60 <
«0 1
12.3
>1 5
III
33 0
33 3
314
32 6
31 1
.4
1 4
1 3
9
1 1
SI
62
4 9
HO
I s
100 0
ICuO
I0U0
iuoo
10l»o
<0 1
10
17
« 3
1 4
37
33
4 1
3 4
32
113
179
20 4
197
19 7
66
11
15
4 7
6 1
2.9
4 1
4 4
3 2
3 2
40 7
311
44 i
31;
40 6
17 1
II 4
177
to 4
15 7
11
2 4
2 1
12
31
403
39 4
.16 0
40 C
37 1
1000
100 0
100 0
IGuO
iuoo
1000
lOOu
10UG
1M.0
tuu 0
75 7
712
74 1
l»3
74 9
24 3
23 9
24 2
JJ 7
23 2
117
11 n
19 4
IC 8
19 2
46
44
4 1
SO
10
1 4
10
1 1
13
1 4
32
41
3 7
31
_3_l
2 1
2.2
3 1
2.1
2.2
1 S
It
1 S
IS
11
.. _l_2
1.2
1 1
1.3
13
13
13
13
.1
1.0
9
1 0
.1
,1
7
_
1
.7
17
37
100
3S IC 4
40
1 2
31
10 2 "
7.1
47
7.7
4« 71
49
7 S
47
7 7
SI
12
**.
SI
1.1 .,
II
62
II
•I
17
29
12 4
34
ion
31
11 2
29
124
II
M
73
M 73
4)
1 4
43
IS
..J 2...
II
S4.
II 53
IS
„16
13
_ tl
II
• i*
« 5
1 i
70
11.3
10
-.1
17.4
13.3
77
3.9
27
11
13 2
7.2
_4 0_
2.1
22
II
I 1
I I
4.0
131
73
_1 S_
134
74
43
24
2.0
1.4
.1 14 1.1
(23) II |I3) 2.0 (17) II
27 33 2.1
2.1
22
17
13
(101) JO
3.2
\ ftdit Ittsr* Tataa-Tatal
Aiaata
Saiat/Nat f»ad AlllU
Slltf/TOMI AlHK
% Dapr. Dtp. AmoityStlit
1.7 .3
(IS) 23 124) I
3.S 1 7
% Laaia I Rantal Eip/Salai
90
21S
11 c
33 9
II S
273
123
32 3
13 2 7 1 1 7 7 1
(13) 4 S (IIS) 31 110$) 2 9 |10l) 21
2 2 16 U 14
74
4.S
_20_
s
«
. 1 s
I
1.1
21
(901
(7
31
IS
.4
I
.1? .
I
1 6
79
(»1|
i 1
3 I
I 4
s
7
J 4
I
I 4
: t
(141
7 9
31
I
10
. u
9
I I
31
3S 7 41 1 3* 4 32 2 3» 7
(III) 22S 1111) 253 |13ll 240 (1231 19 1 (110) 23 4
4 3 129 9 4 7 7 1 4
14 I
I 1
.
104
13
,
2.4
2.1
1 7
II 4
102
. 4>_
10.2
1.1
2.7
2.1
II
15.3
12
2 7.
12 7
79
'..41
2 7
2.2
11
131
10
? 1
II 3
11
43
2 4
2 I
t S
139
7 3
I 9
13 4
74
43
29
22
1 7
IS 13 1 4 14 13
(113) 23 ||0S) 2 3 (134) 2 1 (UaJ i' HOII 20
_3.7 3 9 ...3.4 3 5
7 4 S 4 4
|!il| 1 a (44) 1.0 |?2| 1 2 146) 1 2 l«(l I I
23 20 22 22 20
21 1.1
(II) 4 I (21) 21
IS 43
M9UM I71179M 74MMM
12729M 2I31MM 4*311344
oA»k«n'M*rr>tAM««tatMtll2
(431
22
4 )
IM4J044
4*71*09*
1M441IM,
IM»S73Mt
* Otficai 1' Comp/Siltt
Mai SllM |«| ~'
Ton' ||)
143)
I
2b
4 I
4 4
1129219M
97472IM
131)
Cm 0mmm* f
Itfwva* 00 I ¦ 4m4hoA
.k • »*. LO -- - •
[ I7472IM
24
40
4 J
130473.1M
4S493UM
2 1 2 2
(47) 4 0 |43| I* 1431 3 4
It t 4 4 >
14S2241M 2S14424M 19440 JVM
72S973M 13M301M 1IM473M
-------
permit writer should use industry ratios for the two years prior to the most
recent year. The data used for the sample firm are indicated in Exhibit 3-2.
The steps for calculating the Current Ratio are as follows:
1. Find current assets on the line labelled "Total current assets" on the
Comparative Consolidated Balance Sheet. One component of current assets
may be marketable securities, which are carried on the balance sheet at
either cost or market value. If marketable securities are a large por-
tion of current assets, look at the footnotes to the balance sheet to
determine if the securities are carried at cost and whether the market
values are very different from the cost. If this is the case, use
market value 1n determining current assets because the market value is a
better Indication of economic value. Record values for the three most
recent years on Line 1 of Worksheet la (page 6 of the Workbook).
2. Find current liabilities on the line labelled "Total current liabili-
ties". This usually includes a line item for the current portion
of long-term debt. If there 1s a footnote which indicates that this is
to be refinanced, do not Include the current portion of long-term debt
with current liabilities. Record the values for the three most recent
years on Line 2.
3. For each of the three years, divide Line 1 (current assets) by Line 2
(current liabilities) to get the Current Ratio. Record the Current
Ratios on Line 3 and on Worksheet 14 (page 57 of the Workbook).
4. Determine whether the Current Ratio increased, decreased, or remained
the same over the three-year period. Record the direction and magnitude
of the trend on Summary Line 1 at the bottom of Worksheet la (page 6 of
the Workbook) and on Worksheet 14 (page 57 of the Workbook).
5. Locate Current Ratios for the appropriate industry SIC code in Morris.
Current Ratios for the three most recent years can be found in the
three columns on the right of the page. Record Current Ratio values for
the upper quartlle, median, and lower quartlle on Lines 4a through 4c.
6. Evaluate the firm's performance relative to that of the Industry for the
three years, and record the evaluation oh Summary Line 2 (page 6 of the
Workbook) and on Worksheet 14 (page 57 of the Workbook). An example
evaluation Is:
"Firm's performance was between the median and upper
quartlle for the industry for the past three years.
Current Ratio declined relative to industry median
over the three years but was still above Industry
median.
Exhibit 3-3 shows the calculation of the Current Ratio using the sample firm
data.
29
-------
Exhibit 3-3
WORKSHEET la
CURRENT RATIO WITHOUT COST OF POLLUTION CONTROL
(SIOOO)
Three Most Recent Years
of Company Data
Year 1982 Year 1981 Year 1980
1. Current Assets 782,974 854,210 791,723
2. Current Liabilities 351,567 335,317 405,065
3. Current Ratio 2.2 2.5 2.0
Line (1) divided by Line (2)
4a. Industry Current Ratio -
Upper Quartile 2.2 2.1 2.2
4b. Industry Current Ratio -
Median 1.6 1.5 1.5
4c. Industry Current Ratio -
Lower Quartile 1.1 1.1 1.1
SUMMARY
1. Evaluation of three-year trend for firm: Current Ratio has increased over
1980: however, it has decreased during the latest fiscal year.
2. Comparison of firm's Current Ratio values with'Current Ratios for industry:
Firm's Current Ratio was close to industry's ratios for first and last
years. For middle year 1t was significantly better. Ratios are at or
above 2.0. Closer look at balance sheet indicates significant increase
in inventories between first and second year, and then a decrease in in-
ventories between second and third year.
30
-------
In order to determine the effect of purchasing and installing pollution control
equipment, the firm's Current Ratio is also calculated after the current assets
value, has been adjusted to reflect the cost of pollution control. The Current
Ratio will be affected' by the capital investment only and not by operating and
maintenance (O&M) expenses associated with the control equipment. This is
because the O&M expenses reduce net Income, not the balance sheet items which
are used to calculate the Current Ratio.
The Federal tax laws allow a reduction in tax payments equivalent to 15% of the
capital Investment 1n pollution control technology. This reduction in tax
liability 1s called an "investment tax credit". The Investment tax credit (ITC)
reduces the real cost to the firm of the pollution control technology to 85% of
the Investment. The benefit of this ITC is accounted for by multiplying the
capital cost of pollution control by 0.85. This is a short-cut method of
including the benefit of the tax credit that essentially reduces the capital
cost of the control technology by 15 percent. There are other factors that
affect Federal tax liability when the pollution control ITC Is used. However,
to determine these effects could be a complex and time-consuming process and the
net effect 1s negligible.
Because the pollution control ITC 1s dependent on legislation, the use and value
of the ITC can change when new Federal tax legislation 1s passed. Therefore,
when new tax legislation becomes law the permit writer should contact the
Internal Revenue Service for clarification on the use of the pollution control
ITC. Even if the pollution control ITC 1s repealed, a firm may still be eli-
gible for other types of ITC.
The Current Ratio adjusted for the cost of pollution control 1s calculated on
Worksheet lb on page 7 of the Workbook. The stfeps in the calculation are as
follows:
1. Find current assets on the line labelled "Total current.assets" on Moody's
Comparative Consolidated Balance Sheet (or on Line 1 of Worksheet la).
Record the value for the most recent year on Line 1 of Worksheet lb
(page 7 of the Workbook).
2. Enter the capital cost of the pollution control equipment (as estimated
by the permit writer or provided by the firm) on Line 2a.
31
-------
3. Enter the Investment tax credit factor on Line 2b.
4. Subtract Line 2b from 1; enter the result on Line 2c.
5. Multiply L1ne-2a (capital cost of pollution control equipment) by Line
2c (Investment tax credit factor) to obtain the adjusted capital cost.
Enter this value of Line 2d.
6. Subtract Line 2d (adjusted capital cost) from Line 1 (current assets)
to obtain adjusted current assets. Enter this value on Line 3.
7. Find current liabilities on the line labelled "Total current
liabilities" on the Comparative Consolidated Balance Sheet (or on Line
2 of Worksheet la). Record the value for the most recent year (the
same year as was used for current assets on Line 1) on Line 4.
8. Divide Line 3 (adjusted current assets) by Line 4 (current liabilities)
to obtain the Current Ratio adjusted for the cost of pollution control.
Enter this value on Line 5 and on Worksheet 15 (page 58 of the Workbook).
9. Enter the Industry Current Ratio values for upper quartile, median, and
lower quartile on Lines 6a through 6c. These should be the values for
the most recent year and may be found 1n Morris or on Lines 4a through
4c of Worksheet la.
10. Compare the firm's Current Ratio adjusted for the cost of pollution
control with the industry Current Ratio values. Record the evaluation
on Summary Line 1 at the bottom of Worksheet lb (page 7 of the
Workbook) and on Worksheet 15 (page 58 of the Workbook). An example
evaluation is:
"Current Ratio with pollution control ranks between
the lower quartile and median for the Industry."
Exhibit 3-4 shows the calculation of the Current Ratio adjusted for the cost of
pollution control using the sample firm data.
Interpretation
Four analyses are used to evaluate the Current Ratio. These are:
1. rule of thumb;
2. three-year trend;
3. industry average; and
4. adjusted ratio.
These analyses aire described below. The results and interpretation should be
entered on Worksheets 14 and 15 on pages 57 and 58 of the Workbook. Examples
are provided in Chapter 5.
32
-------
Exhibit 3-4
WORKSHEET lb
CURRENT RATIO ADJUSTED FOR COST OF POLLUTION CONTROL
($1000)
Most Recent Year
of Company Data
Year 1982
1. Current Assets
Worksheet la, Line 1
2a. Capital Cost of Pollution Control Equipment
2b. Investment Tax Credit Factor
2c. 1 - Line (2b)
2d. Adjusted Capital Cost
Line (2a) x Line (2c)
3. Adjusted Current Assets
Line (1) - Line (2d)
4. Current Liabilities
Worksheet la, Line 2
5. Current Ratio
Line (3) divided by Line (4)
6a. Industry Current Ratio -
Upper Quartile
Worksheet la, Line 4a
6b. Industry Current Ratio -
Median
Worksheet la, Line 4b
6c. Industry Current Ratio -
Lower Quartile
Worksheet la, Line 4c
SUMMARY
782,975
10,000
0.15
0.85
8,500
774,475
351,567
2.2
2.2
1.6
1.1
1. Comparison of firm's Current Ratio with Current Ratios for industry:
Adjusted Current Ratio 1s equal to upper quartile for the industry for
the most recent fiscal year.
33
-------
The financial rule of thumb Indicates that a firm with a Current Ratio greater
than 2.0 should not have trouble meeting its short-term obligations. A ratio of
less than 2.0 could imply liquidity problems, but other factors must be con-
sidered before drawing any conclusions. A very high ratio may also be unde-
sirable because 1t could imply a lack of good investment opportunities or
mismanagement of resources.
The three-year trend for the firm indicates whether the firm's Current Ratio
has recently increased, decreased, or remained the same. Generally, a decline 1s
a negative indicator and an Increase is a positive Indicator of the firm's abil-
ity to meet Its short-term obligations. However, the initial Current Ratio for
the three-year period must be considered. For example a decline from a very high
Current Ratio might indicate that the firm has shifted excessive cash holdings
into more profitable long-term investment opportunities.
Industry averages indicate the range of Current Ratios for the SIC group most
closely associated with the firm. Operating characteristics vary among
industries, causing optimal Industry-specific Current Ratios to be greater or
less than the general rule of 2.0. Therefore, comparison with industry norms and
historic ratios is necessary for a more complete understanding of a firm's
Current Ratio values.
Current Ratios for the firm for each of the three most recent years are compared
with upper quartile, median, and lower quartile Current Ratios for the industry
over the same time period. These comparisons Indicate whether the firm has
Improved or declined relative to the industry In its ability to meet short-term
financial obligations. A Current Ratio below the lower quartile value for the
industry indicates that the firm may have difficulty meeting its short-term
obligations.
The adjusted ratio indicates the effect of the proposed pollution control expen-
ditures on the firm's Current Ratio. The adjusted Current Ratio 1s calculated
by subtracting the capital cost of the pollution control device from current
assets. This is not because the firm would always pay for the device out of
current assets, but because this provides a conservative estimate of the firm's
ability to pay. If the capital cost of the control equipment can be paid for
34
-------
from current assets without the Current Ratio going below the target level,
liquidity should not constrain the firm's ability to afford pollution control
equipment. If, on the.other hand, the company cannot pay for the control device
with current assets and remain above target Current Ratio levels, it cannot be
concluded that the pollution, control requirement would be excessive. This is
because the firm would probably not have to pay for the device with cash or
other short-term assets on hand. Instead, loans or installment payments could
be used to spread the cost over time.
These four analyses may produce conflicting results. In general, the Industry
average and the adjusted ratio are the most Important criteria for evaluating
the Current Ratio. If the adjusted current ratio 1s at least equal to the lower
quartile for the industry, the proposed pollution control expenditures will prob-
ably not cause liquidity problems for the firm.
3.2.1.1 Quick Ratio
Theory
The. Quick Ratio compares current assets, excluding Inventories, with
current liabilities. Inventories are classified as current assets, but they
cannot be converted to cash as readily as other assets such as accounts re-
ceivable. In a forced liquidation, inventory may only be salable at a great
discount from book value, which may make the Current Ratio misleading as a
measure of liquidity. This Is particularly Important in evaluating firms In
which inventories represent a large portion of the current assets.
The Quick Ratio 1s therefore a more conservative measure of liquidity. The for-
mula for the Quick Ratio 1s expressed as:
QR = CA-I
CL
where: QR * Quick Ratio
CA 3 Current assets
I = Inventories
CL z Current liabilities
35
-------
Calculation
The Quick Ratio is . also a ratio of assets to liabilities. However,
the value used for assets 1s that for quick assets, which 1s current assets
minus Inventories. Thus, the Quick Ratio 1s the ratio of quick assets to
current liabilities. As with the Current Ratio, data needed to calculate the
Quick Ratio can be found in Moody's Comparative Consolidated Balance Sheet and
Morris' Annual Statement Studies (see Exhibits 3-5 and 3-6). A firm's Quick
Ratio without the cost of pollution control is calculated for the three most
recent years using Worksheet 2a on page 10 of the Workbook and the Quick Ratio
values are compared to those for the industry. The Quick Ratio with pollution
control costs 1s calculated for the most recent year on Worksheet 2b (page 11 of
the Workbook).
The steps for calculating the Quick Ratio (without adjustment for pollution
control costs) are as follows:
1. Find current assets on the line labelled "Total current assets" on the
Comparative Consolidated Balance Sheet (or on Line 1 of Worksheet la).
Record values for the three nest recent years on Line 1 of Worksheet
2a (page 10 of the Workbook).
2. Find Inventory data on the line labelled "Inventories" in the assets
section of the Comparative Consolidated Balance Sheet. Record values
for the three most recent years on Line 2.
3. For each of the three years, subtract Line 2 (Inventory) from Line 1
(current assets) to obtain quick assets. Enter the results on Line 3.
4. Find current liabilities on the line labelled "Total current
liabilities" on the Comparative Consolidated Balance Sheet (or on Line
2 of Worksheet la) and record the values for the three most recent
years on Line 4.
5. Divide Line 3 (quick assets) by Line 4 (current liabilities) to obtain
the Quick Ratio for each of the three years. Record the Quick Ratios
on Line 5 (page 10 of the Workbook) and on Worksheet 14 (page 57 of
the Workbook).
6. Locate Quick Ratios for the appropriate Industry SIC Code In Morris,
immediately below the Current Ratio data. Quick Ratios for the three
most recent years should be taken from the same three columns as the
Current Ratio data were taken. Record Quick Ratio values for the upper
quartlle, median, and lower quartile on Lines 6a through 6c.
36
-------
1600
MOODY'S INDUSTRIAL MANUAL
Exhibit 3-5
01979 includes 121.0 million (tD.il per sh.) gain Uses:
oa sale of pigment aad methanol bhu. Prop., pit.
0)1980 includes Ul million (SO. IJ per sh.) r*r»i»l««
chart* for termination of operations of tile joi
DATA FROM H000VS, - QUICK RATIO
¦Ui PoaHlon (In thousand*)! ————
Reductions ,
Fund* Provided From Operations
Sources:
lac. bef extraord.
tain
Dtprac. It amort.....
Def. taxes on inc. ....
Kq. In net inc. of affll.
cos. In excess of /
diva
Writedown of facil. ..
IM2
SM .Ml
120,4(7
(15,193)
IMI
1136.4*1
111439
15.092
Increaae in invest. .
Net ch*e. in work,
cap
135.950
134.(46
42.97*
14.754
(109.217)
70,61V
69.711
220,2(9
* chge. in note*
pay
Exchge. of com, stk. for debt:
Incr.lncap.accts. ...
Extraordinary gain..
Caah dividenda
(199,644)
(22.437)
(15.123)
3(.M<
11.553
<56,(741
(I JO.444)
9642*
(75J43)
Net fd«. prov. fr.
<12.972) /.704 o|ier. HJ,014
J,544 34*0 Pinaniing TranaacUonas
——- —— Chge. in Ig.-un. debL
1*2,7?7. 276,996 New borrowings .... 177.247
Net tin. tram....
Chges. in Ign. curr.
trans. adj
Other sources (umc) .
' Net Incr. (deer.)
247,270 infds.
16,707
(44.03*1
(54.1114)
(1.5 la l
4.606
<53.5*7 >
(31.M4)
(44.956)
11,0(4
(9.149)
Record of Earning a, year* ended D*c.)1 (in thousand* of dollars):
Net Sale*
476.462
576,0(5
570,649
661,J19
670,292
751.055
779,6*7
(32,761
046,444
972,267
1,154,775
1.525.4*9
1.413,111
1.595,956
Cut and
Expenses
410.627
499,041
502,54*
560,023
579.956
642.915
6*1,611
724 £27
74 J .096
(32.(66
992.201
1455416
1435.932
1.425.916
Balance
65435
77.044
76,501
101,296
90436
10*. 140
91.076
101.734
105,34*
139.401
162.572
170,173
77.179
160.040
Oth. Inc. It
Deb. (Net)
. 631
4*95
5,731
3,456
41,013
<*6.423
411.269
410,9*4
49.M6
411,644
44,931
425374
436.529
40,*91
lac. Bef,
Taxes
66.466
76,149
*2.033
104,752
*9,323
101,717
*6,*07
97,746
95,522
127,757
157,641
144.599
40.650
200.931
Income
Taxes
34,532
3*.3*2
3S.9S6
41,766
40,309
46,117
39,675
45,159
41.9*6
59,224
66,01*
52,575
(.191
94,130
Net
Income
31,935
0)7,767
UJ46.046
55,9*6
49,014
55.600
47.132
52,5*7
053,536
6*,533
91.623
92,024
32,459
I06.S0I
Common
Dividend*
13.643
11.523
19,121
21.372
23.567
23.753
23.741
23.642
23,112
25.143
29.056
33.426
33.579
35,917
I,. 1.595,956 1.435.916 160,040 40,*91 200.931 94,130 106,601 36.917
&Alter special items: 1971, «*l ,2*9,0001 1965, crl2.MO.000; 1964.4/13.615442. UjBefore special Uema: aften 1971, U.4I; 1965, Si.
I pooling of lotereau. [^Restated for Statements of Financial Accounting Noa. fk 7 adopted in 1975. [QRcstated Urrcllcct 2-for-l
1*73 pooling
BALANCE SHEETS
'.3Com. Sh*. QJEam. Per
Ouutand. Com.Sh.
36.543,422 046
Jt.703.6I I mi.C4
39.395.937 Qj|.09
40.247.710 149
40.4*3,104 1,19
40.156.052 IJ6
41,054,192 I.IS
40,753^70 1.29
40,956.636 Q]U7
40419.9*4 1.70
41,732,194 2.21
41412.649 2.20
42.193.700 0.77
424*33)2* 2.44
16: 19M, 50.95. QJReitated Ik
sue. split Apr. 6, 1973.
_ ASSETS
. ar- —-•
| lljlnveptone*, net
I comparative consolidated balance .
^T1?ECT!omi3oSnilc^!I3^tunB^!r
(in thousand* of dollar*)
19*1 19*0
IS OF DEC. 31
Conuniaaion)
1912
2*,«55
5.307
26,700
*56
21.947
7.7S*-
lalll*.
36*.2»1 406,907 337.216 1
791.723 I
1979
52,793
3,533
407,071
321,0(9
1971
47.S71
10,051
332,347
316,779
1977
26.53*
2,524
273,102
297.330
Advaitcea to affiliates
Other investment*
EPropeity. plant It equipment.
CT «*«• Depredation i
Net
Deferred chariee. etc.
Total
„ LIABILITIES
Notaa payable
Accounts payable
U.S., for. It *utelnc. taxes
Accrued expenses.
-»¦
960
21,933
2,079,66*
1.155,992
923,676
I,*21
55,599
2.001454
57,943
161,226
42,910
<9,41*
(.524
4409
2411,5*6
1.110,153
907.733
1,167
52,700
1.997,144
7J.061
151.047
14414
964U
mm mm
Deferred 0.5. It (gn. income taxes 119.2)4 134.447
*,962
5,904
1,112.34*
1,009,692
172.656
4,197
53452
1,U9,6 7 9
I4*,3II
153.294
42,220
61440
7*4.4*5
137,0*7
2.472
6,266
1,703,4*1
930.592
772,119
5.517
si/--
,4*1
Deferred U.S. It fen. income
Pension liability
nonstock ,
isutplu*
a lion ad}ustmeat
QTTraaalj
¦Maiaed
Total stodtholders' equity .
IP e*i' Treasury stock at cost. ¦
Net stockholders' equity...
119.2)4
19,703
23,240
129,(0*
4/96,744
1.022,727
1,079,031
120
l#7*,91l
2,001454
431,407
171,219
41,296
<*1441
121.(41
51,105
CQtf/25,397
134,447
21,667
22,144
90434
rfrt 2,690
9*1,1*7
1,051.477
120
1.051457
1,997.144
51(493
1(9.110
37,64*
crlS,224
111,(39
21.903
BJ4.225
116.700
23.63*
22.111
(9,4(2
miiii
1.009466
120
1,009.746
1419,679
229.163
50496
114,472
35472
1.761.177
*6.26*
166,657
*1,529
63,611
405.072
210,619
104.457
25,607
22.076
11,225
(35, i**
945,4*9
67
945,422
'1,761,177
379,411
195,6*6
107,573
707,055
107,7*0
2.463
9,522
1,61546*
901,0*2
714.2*6
6.292
49.200
1,596.59*
504(2
126.(17
107.567
(9.634
374.400
295,969
(0,201
27,577
22.076
(1.225
70*417
111,511
67
*11,451
1.596.59*
332,455
121,330
43jOI2
599.494
ua'i
*56
9,147
1437,050
115.75*
721.292
*,267
50,214
1.477,543
72.100
V9.7W
27,506
72,54*
271,973
329,443
*9,011
29.546
22,076
U.225
647436
1976
17,091
I34J»
267.912
269425
i«~.i>ixi
70425
5.396
25.710
1,432.234
7324)1
699.3(3
7,15*
54,502
1.4304(2
19,915
(I45(
(9,614
63,514
254.541
326,36*
75437
31.51*
2347*
11,222
631719
757,637
67
742.0*7
67
757,570
1,477.543
327.521
129.716
24.900
742,020
Mm.2I2
313,147
150.779
HUM
106.517
77,007
106,6*3
20412
(£5.523
93.(39
12.140
[4)1.201
(9J2I
59..IV
lilt-
Souk Value Deprec, Rea. subsidiaries with the exception of finance and
(21),4(1,000 Insurance aubsidlaries, and Co/a pro rata
1426,117.000 11,117,(74,000 ah are of the Hercofina joint ventures.
53.266.000
13,5(0,000
166.222400
31,653,000
6,465,000
come currently. Prinr years have nut been re-
ataterl. Kur those years, account* of foreign
companies were translated at current ex-
Total
Mat currant aaaets ,
PROPERTY ACCT.—ANALYSIS
Additions at coat
Retirements or sale*
mpther addition*—deduction* ....
DEPREC. RESERVE—ANALYSIS
Addition* charged to profit It loss..
Retire, renewals charged to rea.....
Other additions
, £319*2;
Land
Bldgs.. mach. It eq. .
Transportation eq. .
MUccilaneou*
Construction is
Prog roe
Total (247944* .000 11.155.992,000
~ Mter reserves (19(2, (4,911,000).
Co. extensively uses the last-in. fint-out (LIFO)
method for valuing inventories. If valued on the av>
erage cost method, inventoriea would have liern
1153,000,000 higher thaa a* reported on the Ufo
method at Dec. 31,19(2.
Slated value; (25/41.
Share* at cost: I912-I0,6,519:1979-76,3,619, B„u »«.¦««« ¦.»« Miimnia •« —;
.1971-76: Repreaents accumulate^ depreciation foreign companies are translated at current . ... ,. .
of acquired company at date of acquiaition. exchange yatca. The reaulting translation ad- . (d) Commitmenta and Contingent utbill
CQAdJuaunent* resultingilrom translating foreign Justmetit I* Included in atockholder'a equity. L
aexouata at currant rates of exchange. Revenues, expenaea, gaina and losses (or 1911 .Co- ha» certain operating leaaea. including
ftsimlMiNii and yeara thereafter are translated at rates office apace, and trans|»ortaiion and data
(a) Consolidated financial statements in- prevailing during th« Foreign currency processing equipment, expiring at various
dMs the accounts of Co., all whoUy-owaad tranaairtlon gaina and yj an included in in- date*. Rental expanse relating to these leasee
, 1omPani". owned chanKe rates, exceiu'thav inventwries, proper
j •ccouitted lor on tfieectuUy ty« pltnt And couinrnvnl. d£f>rt?i*kiiofi» flood*
auralue luSi1lr"S«*?miiB* w'"* deferred taxes are tran^atwl at hia-
1'_^fitorical exchange rate*. Revenue*, cxpenaes,
buaineaa activities). Accordingly consolidated
net income includes Co.'a ahare of their net in-
come.
All aignificant Intercompany transaction*
are eliminated in cnnnnliduuon.
(b) Tranalatinn nf Foreign Currencies: A* a
result of adoiitinM Statement of Kinanrial Ac-
counting Standard No. 52, FurekKn Currency
Translation, in 1911, for years ended Dec. 31
gaina and Iwaaea (other than inventory vcut mrm mum un. ji, firnt-out (LIFO) niwthoil, and forciitn invento.
t9*l and thereafter balance sheet accounts <>{ rie* are valued principally un the average cost
-------
Exhibit 3-6
DATA FROM MORRIS - OUICK RATIO
MANUFACTURERS • PLASTIC MATERIALS ft SYNTHETIC RESINS
K| 2U1
CuntmOat*
S2(6/30-t/30/tl| M<10/I/I14/31/I2|
t-IMM
IHH
i
1664MM
WIOtHM
24
M
It
6
%
%
*
«
16
46
35
SIS
2S.S
26 S
IS 7
22.7
24 9
1 7
1 2
1 9
tiS
SI 2
59 2
212
33 6
32.6
1
1.6
.1
6 1
6 I
75
_
100 0
«. ..
1000
_. ,
100 0
70
St
17
4 1
32
27
24 1
IS.7
16.4
4 t
61
6 7
60
2.0
40
4SS
40.4
3S4
16 1
US
25 2
5 5
21
30
32S
36.3
32 4
100 0
100.0
1000
100.0
tooo
100 0
72 1
77 I
777
279
22 2
223
24 6
16 9
IIS
30
S3
S.4
1 0
13
29
1.6
4.1
26
2.1
21
2.S
1.6
1.4
IS
to
M
t.t
ts
1.2
1.2
1 1
.S
.t
6
.6
.6
M
6 7
3S
10 s
40
9 1
n
4*
74
43
1.4
14
61
47
64
6.7
SI
1.1
M
»4 ..
11
21
16 I
21
12.7
37
100
26
»r
66
42
t.t
10
73
~3
to
67
6.4
.IS 4.3
„_M
" 7.2 _
Ts
6.0
116
13 6
10.7
1INF
327
31 1
S 1
12
37
on
22
(SS)
3 1
(»)
2.0
(101)
.. 1.2.
..I!.
,9_.
S3
S.7
6.3
(12)
27
|SS)
4.0
(13)
26
(64)
-(
ts. _
2 3_
tj
.4
S
.7
S
10
13
_.2._q._
16
2 1
10"
1
11
22
1.6
2.3
3.2
43
396 *
>69
360
122)
25.6
(64)
24.0
16 S
(HO)
4 7
106
-35
AU
_J!L
*
s«
30.1
22 4
I 4
sac
311
I I
7#
>00 0
«4
32
It 7
» t
32
406
n y
36
3? I
1000
1000
76 t
212
IS 2
SO
I 4
36
ASSET SIZE
NUMBED OF STATEMENTS
2.2
I 6
t_1
13
.»
6
ASSETS
C*ih S {rfhlu inorl Taim
Cim Mai-l/T/D
Acelt 1 Nolli Tratfa
' Accmad Ea»an»as
All Olltar Cuirani
Total Cv'i«nt
lung Ittm belli
AM Otnai Non Ctiirant
Ni>t WO'IN
Total lul>tiiiK) & Nat Wonh
INCOME OATA~
NalSalal
Ctfil 01 Silal
Giiitl Profit
OpaniKig Cipfnici
Oparatnv Ciolit
All Oihn Ei|Wihi |hm|
Profn Safari Taiai
RATIOS
Carranl
Caimii'llin Kitiorictl Data
ttxnt
»/jo.i a-
a/jc.n
XI)) fit
i/jt/Jl
1/71/10
All
All
All
JJ >
1 9
2 4
2 1
40 3
394
36 0
tooo
10C0
100 0
1, jo.ia
I'll it
Hull
All
All
127
til
%
%
t:
5«
215
30 1
21 5
27 4
1 4
1 4
bit
SI t
32 1
311
6
1 1
60
7 «
IU0 0
100 0
S3
a 4
34
32
ll>?
19 J
5 7
t 1
32
12
VI 7
40 6
lb 4
!» 7
¦12
36
40 C
37 1
lOuO
tuoo
1000
75 7
243
IS 7
46
14
32
tOOu
76 2
236
isn
st
10
4 S
100 u
75 6
a 2
IV 4
46
I I
3 7
IM.'O
>6 3
23 7
l*S
50
I 3
3.6
(too
JtS 6
23 2
162
SO
I 4
16
13 S
S3
I 2
tS.S
St
3.0
174
132
7,7
132
7.2
40
114
10
___6..
•.I
6 1
40
102
7.7
II
12.4
6.5
_ss.
"7.0
123
32,3 .
76
2 S
.1.4
7.6
1.9
2 I
S
1.0
1 7
.1
1.6
._.3..S_
as 7
23 4
13 6
73
1 S
134
74
4 3
Salai/Raeanablai
Cm ®» S«lat.'ia«*niaif
Salaa/Woiting Capital
EllT/lnlaraat
Cl«l> FlWCar. Mil. l/T/0
Fiaad/Mtorth
OtofWorih
% Profit lalora Taaainangibli
Ml Worth
\ lalora Tataa-Total
Anaii
Stla
3.3
27
I S
2.6
2.2
IS
24
20
I 4
.6 1.4 16
1231 1 • (S3) 2.0 (17) t.t
2 7 13 2J_.
17 .3
|IS> 23 [24) 6
3 8 17
It
22
1 7
1 3
(I0S) 20
3.2
Salat/Total Aimii
% Dap. Dap. Amort/Salai
% Laaia & Raniil Eip/Salal
26 IS
(IS) 4 1 |3*l 2.9
IS 43
' MI32M S7117SM 741499M
12720M nil MM 4UH3M
•HaMii Mania AM»c'iai*a~ liij"
22
(43) 3S
4 J
' 636430M 1M403Sm'
417S20M H0W71M|
% Otl(carl' Comp'Salat
Kai Salai (I)
Tout Attaint)
2 t
22
2.1
21
22
ts
16
1 S
1 s
1 6
12
12
.
1 1
1 j
1 t
t.3
13
1.3
13
13
.9
t.O
1
9
10
6
.6
.7
— 1
7
31
97
37
10.0
3S
10 4
40
6 2
36
10 2
47
71
47
77
44
79
49
7 S
47
7 7
12
S 9
62
SS
SS
St
S»
1) 2
SI
63
42
67
26
126
34
10*
33
11 2
29
12 4
64
66
60
73
to
73
41
a 4
43
65
70 .
5 2_
II.
S 4
t»
S3
66
.16
61.
» 6
it
6 1
65
It
70
107
90
116
11 5
123
_22»
29 S
...
33 9
27 3
22 >
96
132
71
1 7
76
(SS)
3 7
(S3)
4 5
IMS]
3 6
(IDS)
26
1101)
2 6
. . • v.
_16_
. L _ ..
.2.2.
.16
..
1 2
.. . .
1 4
77
74
67
V ?
7 9
|57|
2S
4' S|
4 6
(901
3.1
193)
3 1
164)
39
1 7
IS.
_L.s..
J 5
2 1
4
S
4
S
S
6
1
6
7
to
14
IS
15 .
1 4
J7
9
s
9
S
9
t S
IS
1 6
1 4
1 6
?»,.
21
.7 9.
. 3 S
3$ 7
411
39 4
32 2
35 7
(116)
22S
iiii)
25 3
<13S|
24 0
(123)
161
|H0|
23 4
4,3
J2 9.
~'.i.
7 7
.. ...
H
141
If 4
IS 3
I3S
139
11
102
S 2
SO
73
19
4 1
.J 1.
IS
104
10.2
127
113
134
13
t.t
7 9
6 f
74
37
4.2
. . -i
46.
~4A
..4 i
24
27
2 7
21
21
2.1
2 1
22
2.1
22
1 7
It
„l.6.
. _
...!i
..
1 7
IS
1.3
1 4
1 4
1 3
(113)
23
(<0S)
23
(Ul)
2.1
in»i
i 1
I10S)
20
.._37.
. ?•.
..? *
35
32
7
4
5
S
S
(561
1 6
(
2 2
(43)
4 1
(36)
40
1*7)
4 0
|43)
3 1
l*3l
11
5 «
t 3
16
t 5
4 7
J
1129219M 12047S3M 148225 tM 2S3SS2IM I6M03SM
S747I6M 664I3UM 726973M *36*301M 110667 3M
SI • lltouMiK » I nullum
Sn'||M I llflf 38
-------
7. Compare the firm's Quick Ratio values to those for the Industry for the
three-year period and record the evaluation on Summary Line 1 (page 10
of the Workbook) and on Worksheet 14 (page 57 of the Workbook). An
example evaluation is:
"Firm's Quick Ratio has increased.over the past
three years. The Quick Ratio has been between
median and the lower quartlle for the Industry.
Firm's Quick Ratio has Improved slightly rela-
tive to the Quick Ratio for the industry."
Exhibit 3-7 shows the calculation of the Quick Ratio without the cost of pollu-
tion control using the example firm data.
In order to calculate the Quick Ratio with the cost of pollution control taken
into account, the value for quick assets must be adjusted to reflect the capital
cost of the pollution control equipment. The calculation Is done using Worksheet
2b on page 11 of the Workbook. The steps are as follows:
1. Find current assets on the line labelled "Total current assets" on the
Comparative Consolidated Balance Sheet (or on Line 1 of Worksheet 2a).
Record the value for the most recent year on Line 1 of Worksheet 2b
(page 11 of the Workbook).
2. Find inventory data for the same year on the line labelled "Inventories"
in the Assets section of the Comparative Consolidated Balance Sheet (or
on Line 2 of Worksheet 2a). Record the value on Line 3.
3. Enter the adjusted capital cost from Line 2d of Worksheet lb (the
Current Ratio calculation) on Line 3. This cost is the capital cost of
the pollution control equipment multiplied by 1 minus the investment
tax credit credit factor.
4. Subtract Line 2 (inventory) and Line 3 (adjusted capital cost) from
Line 1 (current assets) to obtain the adjusted quick assets. Record
this value on Line 4.
5. Find current liabilities on the line labelled "Total current liabili-
ties" on the Comparative Consolidated Balance Sheet (or on Line 4 of
Worksheet 2a). Record the value for the most recent year (the same
year as was used for current assets on Line 1) on Line 5.
6. Divide Line 4 (adjusted quick assets) by Line 5 (current liabilities)
to obtain the adjusted Quick Ratio. Record this value on Line 6
(page 11 of the Workbook) and on Worksheet 15 (page 58 of the Workbook).
7. Enter the Industry Quick Ratio values for upper quartlle, median, and
lower quartlle on Lines 7a through 7c. These should be the values for
39
-------
Exhibit 3-7
WORKSHEET 2a
QUICK RATIO WITHOUT
COST OF POLLUTION CONTROL
($1000)
Three Most Recent Years
of Company Data
Year 1982 Year 1981 Year 1980
1. Current Assets
Worksheet la, Line 1
2. Inventory
3. Quick Assets
Line (1) - Line (2)
4. Current Liabilities
Worksheet la, Line 2
5. Quick Ratio
Line (3) divided by Line (4}
6a. Industry Quick Ratio •
Upper Quartlie
6b. Industry Quick Ratio -
Median
6c. Industry Quick Ratio -
Lower Quart He
782,974 854,210
791,723
368,228 406,907 327,216
415,746 447,303 454,507
351,567 335,317 405,065
1.2
1.3
0.9
0.6
1.3
1.3
1.0
0.7
1.1
1.3
0.9
0.6
SUMMARY
1. Comparison of firm's Quick Ratio values with Quick Ratios for industry;
Firm's ratios are always higher than Industry median and are in upper
quartile for one year. All Quick Ratios are greater than 1.0.
40
-------
the most recent year and may be found in Morris or on Lines 6a through
6c of Worksheet 2a.
8. Compare the firm's Quick Ratio adjusted for the cost of pollution
control with the Industry Quick Ratio values. Record the evaluation on
Surmary Line 1 at the bottom of Worksheet 2b (page 11 of the Workbook)
and on Worksheet 15 (page 58 of the Workbook). An example evaluation
is:
"Adjusted Quick Ratio ranks between the median
and lower quartHe for the industry."
Exhibit 3-8 shows the calculation of the Quick Ratio adjusted for the cost of
pollution control using the sample firm data.
Interpretation
The Quick Ratio 1s evaluated using the same types of analysis as the Current
Ratio. These are:
1. rule of thumb;
2. three-year average;
3. industry average; and
4. adjusted ratio.
These analyses are described below. The results should be recorded on
Worksheets 14 and 15 on pages 57 and 58 of the Workbook. Examples are provided
in Chapter 5.
The financial rule of thumb indicates that a firm with a Quick Ratio greater
than 1.0 should not have trouble meeting its short-term obligations. A Quick
Ratio greater than 1.0 indicates that the firm could theoretically pay off all
of Its current liabilities from current assets without liquidating inventories.
The three-year trend for the firm indicates whether the firm's Quick Ratio has
increased, decreased, or remained the same. Generally an Increase reflects
improving financial conditions and a decrease reflects declining conditions.
However, if the Quick Ratio was initially very high a decline may indicate
improved financial management.
Industry averages indicate the range of Quick Ratios for the SIC group most
closely associated with the firm. Industry averages may be greater than or less
than 1.0 depending on operating conditions in the Industry. Quick Ratios for
A1
-------
the firm for each of the past three years are compared with upper quartile,
median, and lower quartile Quick Ratios for the industry over the same time
period. These comparisons indicate whether the firm has Improved or declined
relative to the industry. A Quick Ratio below the lower quartile for the
industry indicates that the firm may have difficulty meeting Its short-term
obligations.
The adjusted Quick Ratio indicates the effect of the proposed pollution control
expenditures on the firm's Quick Ratio. The adjusted Quick Ratio is based on
the same conservative assumption used in the adjusted Current Ratio—that the
firm would pay for the pollution control out of current assets.
These four analyses may produce conflicting results. In general, the industry
average and the adjusted ratio are the most important criteria for evaluating
the Quick Ratio. If the adjusted Quick Ratio is at least equal to the lower
quartile for the industry, the proposed pollution control expenditures will prob-
ably not create liquidity problems for the firm.
3.2.2 Solvency Ratios
Solvency Ratios measure a firm's ability to meet Its fixed and long-term finan-
cial obligations. These are bills and debts that a firm owes on a regular basis
for time periods longer than one year. These ratios can also be used to predict
financial problems that could lead a firm to bankruptcy within the next few years.
Predicting bankruptcy 1s a very complex problem. Recent literature on
bankruptcy has included many studies exploring, the use of ratios and more
complex statistical techniques. The predictive ability of Individual Solvency
Ratios 1s limited. However, they are Included 1n this methodology because they
do provide valuable Insights and because they are the best simple predictive
tools available.
Solvency ratios compare earnings or cash flow to fixed obligations. The two
measures of solvency presented here are the Fixed-Charge Coverage Ratio and
Beaver's Ratio. Earnings and cash flow are very similar terms used to describe
the financial results or performance of a firm. Sometimes the terms are used
43
-------
Exhibit 3-8
WORKSHEET 2b
QUICK RATIO
ADJUSTED FOR COST OF POLLUTION CONTROL
(SIOOO)
Most Recent Year
of Company Data
Year 1982
1. Current Assets
Worksheet 2a, Line 1
2. Inventory
3. Adjusted Capital Cost of
Pollution Control
Worksheet lb, Line 2d
4. Adjusted Quick Assets
Line (1) - Line (2) - Line (3)
5. Current Liabilities
Worksheet 2a, Line 4
6. Quick Ratio
Line (4) divided by Line (5)
7a. Industry Quick Ratio
Upper Quartile
Worksheet 2a, Line 6a
7b. Industry Quick Ratio -
Median
Worksheet 2a, Line 6b
7c. Industry Quick Ratio -
Lower Quart He
Worksheet 2a, Line 6c
782,974
368,228
8,500
406,246
351,567
1.2
1.3
0.9
0.6
SUWARY
1. Comparison of firm's Quick Ratio with Quick Ratios for industry: Adjusted
Quick Ratio 1s between Industry median and upper quartile.
42
-------
interchangeably. However, each has an explicit connotation and more typical
point of use.
Earnings are the residual of revenues front normal operations after all costs
have been subtracted. Earnings are usually described 1n relation to taxes and
fixed charges, e.g. gross earnings, net earnings before taxes, and after-tax
earnings. The designation at each point Indicates the costs and charges which
have been subtracted from the operating revenues of the firm as established by
accepted accounting practices and/or IRS regulations.
The cash flow of a firm is a measure of the cash generated by the normal opera-
tions of the firm and available for use at the discretion of firm. The typical
definition of cash flow 1s after-tax earnings plus depreciation. However, 1t
may also be used to describe the amount of cash available on a pre-tax basis for
payment of interest, other fixed charges, and taxes. Nonrecurring revenues or
losses should always be excluded from either earnings or cash flow.
3.2.2.1 Fixed-Charge Coverage Ratio
Theory
The Fixed-Charge Coverage Ratio is a test which measures a firm's ability
to meet Its current fixed-cost obligations with cash flows from operations.
The fixed-cost obligations (or fixed charges) include Interest payments, rent
or lease payments, pension payments, and the current portion of long-term debt.
The cash flows from operations are expressed as cash earnings before interest
and taxes (EBIT), which is the numerator of the Fixed-Charge Coverage Ratio.
The ratio can be used to evaluate a firm's ability to incur additional medium-to
long-term debt. It is expressed as:
FCCR = NE+T+IE+D+OFP
FC
where: FCCR * Fixed-Charge Coverage Ratio
NE * Net earnings (or net income)
T = Taxes
IE ¦ Interest expense
0 ¦ Depreciation
OFP * Other fixed payments (lease
or rent payments, pension
payments, etc.)
FC s Fixed charges
44
-------
Calculation
The information needed to calculate the Fixed-Charge Coverage Ratio
can be found in Moody's Comparative Consolidated Income Account and Comparative
Consolidated Balance Sheet (see Exhibit 3-9). Supplemental profit-and-loss
information provided by the firm would also be'useful if such information is
available. It should be noted that formats for income and profit-and-loss sta-
tements in Moody's Comparative Consolidated Income Account are less standardized
than Moody's Comparative Consolidated Balance Sheet. The titles for similar
items may vary among different firms. In addition, not all firms will show
entries for extraordinary items in any given year. Specific guidance regarding
terminology will be provided for each Item 1n the calculation.
As with the Liquidity Ratios, the Fixed-Charge Coverage Ratio without pollution
control Investment Is calculated for the most recent three years and the trend
over the three years 1s evaluated. More than the most recent edition of Moody's
may be needed, because in at least some cases Moody's provides depreciation
values for only two years.
The Fixed-Charge Coverage Ratio without the cost of pollution control is calcu-
lated in two stages — calculation of cash earnings before Interest and taxes
(EBIT), and calculation of the Fixed-Charge Coverage Ratio Itself. EBIT is
calculated using Worksheet 3a on page 16 of the Workbook. The steps for per-
forming this calculation are as follows:
1. Find net earnings (also called net Income) on the Comparative
Consolidated Income Account. Record the values for the three most
recent years on Line la of Worksheet 3a (page 16 of the Workbook).
2. Find the data for taxes (it should include U. S. and foreign income
taxes, state Income taxes, and property taxes, less any tax credits)
and record the values for the three most recent years on Line lb.
3. For each of the three years add Line la (net earnings) to Line lb (taxes)
to get net profit before taxes. Record these values on Line lc.
4. Find the data labelled "Interest" (or "Interest expense") on the
Comparative Consolidated Income Account. Record the values for the
three most recent years on Line 2.
45
-------
MOODY'S INDUSTRIAL MANUAL
1599
40% Interest. J Taiwanese investing (Croup*
hold the remnining 60% (n the joint venture.
In Apr. 197J Company nnd Mcxiran Invest-
ment interest* formed Petrocel. S.A. Co. «u >
40% shareholder and the Mexican interests
owned 00%. Petrocel ha* built a multimllliqn
dollar plant at Altamira, Tamaulipu, Mexico,
(or the production «>f DMT (dimethyl tcreph-
thalate) and TPA (tcrephihalic acid), both
products are used in the manufacture of poly*
ester film and polyester fiber. Plant has a
combinrd prnilucilnn rnpnrity of 242,000 met-
ric ions. In to?; contributed interest to llerco-
fina joint venture.
In Feb. 1974 Company and a U.S. affiliate of
Montedison S.p.A. (Milan. Italy) formed
Adria l.nlmrntorii's Im . Ailrin will itorform the
riinhnl tmtinic Ira* lirtr ui> to U.S. Fotid &
Druit Administration ni>i'rov:»l for riruus al-
ready drvcluiM-d and Ix-ini; sold in Europe by
Montedison's' phnrmnceuticnl affiliates. In
-Oct. 1977 Atlria Laboratories, Inc. acquired
Wurrrn Tewi Phnrtnat cuticnls. Inc.
On Auk. .11, 1976, Co. and Amrrlisn Petrofl-
na. Inc. fnrnwtl two joint ventures, llercolina
and tlrrcofina Eunif>c. for production and
marketing of terephthalales. Co. sold to
American Petrofina a 25% interest in lt» ter-
ephthalate assets. Co. contributed jts remain-
in* terephthalnte assets for > 75% interest in
the Joint ventures. Co. interest will be reduced
aa American Petrofina elects ti> invest addi-
tional money for capital expansion,
~ nila
manufactv „ . In Grenoble
France. T Exhibit 3-9 ' 2.000,000 ana
should ata l"A" IL" L J 9 .ird Quarter of
DATA FROM MOODY'S - EBIT
..i-
On Jan. 1, 197* Haven industries. Inc., sub-
sidiary. and Phillips Products Co.. subsidiary
of Phillips Hernleum Co. formed a Joint ven-
ture to develop chemical means of increasing
oil recovery from reservoirs that already have
been tapped, called Custom (Ml Recovery
Technology Co. _
In May 1979 Co. and American Petrofina
Inc., announced thai Hercofina said its metha-
nol plant in Plnquemine. !Tti'
adhesive*. hotmeit adhesive*. printing ink,
nalnt and varnish, and chewing.gum.
»tl«i hiicwiim
o. and Sakai Chemical In-
ustrles Ltd. of Osaka Japan formed a joint
venture, Japan Magnetics Ltd. to develop and
Baton Rouge, Ls.
Brunswick, Ga.
Burlington, N.J.
Chiropec, Mass.
Franklin. Va.
Glbbstown, Nj.
_ Internationals
Traun, Austria
Sao Paulo, Braatt
Burlington. Canada
Middletown. N.V.
Parlln.Njr.
Vero Beach, Ft*.
Houston, Tex.
Orossenbrode,
Germany
Bergamo. Italy
Amersfoort,
Netherlands
Zwiindrecht.
Netherlands
Tarragona. Spain
Sandame. Sweden
ORGANICS.
Lllla Edet, Sweden
EXPLOSIVE AND AEROSPACE
Bessemer, Ala. Louisiana, Mo.
Carthage, Mo. Msxns. Uuh •
Donora. Pa. McGregor. Tex.
Ishpeming, Mich. Pon F.wen. N.Y.
Krnvil, N7J. Rocket Center,
W.Va.
OTHER PRODUCTS
Deer Park, Tex. Pulaski, Va.
Middleton, Del. Wilmington. N.C.
International:
St. Jean, Canadai
MANAGEMENT
Omcers
A.F. Giacco, Chtnn., Pres. Si Chief Exec. Off.
Divisional Vice-Presidents
E.D. Crittenden
A.B. Engebretscn, Treasurer
R.J. Lnhy
* _ . Vice-Presidents
F.L. Burkner K.A. Wagner
D.S; liollingsworth H.A. Schowengerdl
L.G. Maury R.0. Watson
Other Officers
SM. Turk. Vlce-Pres. U Gen. Counsel
R.R.P. Morrow, Secretary
G. MacKenxie, Controller
D.F. Desmond, Asst. Treas.
A.L. Scarl. Ass t Treas.
C.W.K. Gamble. Ass't Sec.
PJf. Kendall, Asst. Controller
p»m>i
(Showing Principal Corporate Affiliations)
Alexander p. Olaeeo. Chmn., Pres. and Chief
Exec. Off.-, Hercules Inc.
Eugene O. Cilltanilaik, Jr* Divisional Vlce-
Pres,, Hercules. Inc.
Stuart E. tlieniW, Partner, Powell. Gotd-
ateln, Frater It Murphy. Atlanta law firm.
Ardsn I, Engabrs tssn. Divisional Vlce-Prea.
and Treas., Hercules. Inc.
Oavtd 8. HotHngeworth, Vlce-Prea., Herculaa,
Inc.
Robert J. Leahy, Divisional Vlce-Prea., Her-
cules Inc.
Ouy T. McSrMa, Jr, Pres., Colorado School of
Mines.
Arthur C. Nielsen, Jr. Chairman and Chief Ex-
ecutive Off., A.C. Nielsen Co.
John R. Petty, President and Chief Exec. Off.,
Marine Midland Bank, N.A. and President,
Marine Midland Banka. Inc.
St. Jean. Canada
Pendlebury, England
market advanced magnetic particles for use in
high-performance video, audio and computer
tape applications.
In May 1982, Co. and Pechiney Ugine Kuhl-
mann of France formed a joint venture. So- Beringen, Belgium
cietc Europeene de Fibres el Composites, to
INCOME ACCOUNTS
Hattiesburg, Miss.
Kalamazoo, Mich.
Louisiana, Mo.
Milwaukee. Wise.
Portland. Ore.
Savannah. Ga.
West Elisabeth, Pa.
Tampere. Finland
Voreppe. France
Sobernheim,
Germany .
Busnago. Italy
Middetciurg.
Netherlands
Zwijndrecht.
Netherlands
Oenerai Counsel: S.M. Turk.
Director of Purchasing: E.J, Sheehy.
Auditors: Coopers k Lybrand.
Sharaholdar Relations: W.W. Bewley. Jr.. Di-
rector Investor Relatione Tsfc 1(800)441-9274.
Directors Meetings: Last Wednesday of each
month.
Annual Masting: Fourth Tuesday In March.
No. «f Stockholders: Dec. Jt, I9S2, 35.390.
No. of Employees: Dec. 31, (982.21,59*.
aenersi Office: Hercules Plaza, Wilmington,
DE 19899. Tel.: (302)594-5000.
Net sales ft oper. revenues
Cost nf i«mmU s>ild k oiier. espensra
f< PHIInt, itnirrsl N admin. esiieitses
, Oprratinx profit
Gain on sale of assets
Other famine. net
I COMPARATIVE CONSOLIDATED INCOME ACCOUNT.IyEARS ENDED DEC. Jl
^™™"HSHS«nBSR!po3rTlSnnIFtR5!l5rrirBSIiiaii Commission)
(in thousanda of dollars)
19*1 I9M
2.7IRJ0A 2,485,226
2,191.111 J.OJM06
JtWt.JW 291,519
1982
2,468,971
2.040,9ft*
JIMll*
1 IJ.69R
»»7
211.654
¦|V,«i
.154,901
rfltMT
• fitnTBl.TV!
m
m
disi«M
^ed0.S. It fgn. birome taxes
State income tares .
It fgrL inc.^ tax curr, pay.
c
Trati
m.liifrnti!
21.024
9.I9J
crS24
traonlinsry gal
Wet Income
SP
-m
crlJ.950
CI482
ms
m
17,756
J,«S9
mk
.mWfftTwiiMIVW!
Common div!% conm-rtilile sulsmlifiatcd deism-
m—w—mm
S6474
5J.567
50,915
\9T9
2.J45.42S
1.85J.I20
2*0,7*6
211,519
50.166
8,54.1
270J28
31.840
20.56*
258,954
58,864
28,718
6,139
7,100
.172,533
01172,533
708,217
45,562
1978
t.946.477
1.502.1*1
25«.I40
1977
1.697.787
1,346.819
226.964
im
1.595,«S4
1,226,684
209.032
1,022.727
186,156
' iiii
124.004
'(M89
160^40
56,780
2,997
189,067
31.322
20.010
123,515
32,273
14,*37
219,817
31,495
12,609
177,755
53,676
21.466
4.6J2
5.283
I03J64
106,079
41,242
13.033
3.309
9,435
57.930
200.931
67.444
27,565
2,103
2,9*2
106,801
0)103.264
. 647.3.16
42,3*3
(357.930
631.789
42,383
(^106.801
560,975
35,987
981.1*7
898,273
708.21*
647.336
631,789
835,188
ElPrior to appliration of inveslmcnt tax credit: share) and 812.2 million (80.27 per •hare), respective-
1982.19,449,000: 1981, 810.566.000: 1980, 8IS.01J.0tX>-. ly.
1979. 87JCO.OOO; 1978, 85,283,000; 1977, tV.4J5.000; QQI98I Includes II2J million (80.27 per slisre)
1976.82.982.000. write down of fscilitics and investments; 197* in-
CTIncludn gsin on sale of terephthalate assets dudes 84.9 million (80.11 per share) snd 1977 In-
and Ilemiirs, Cslifitmis, plant in the third and eludes MJ million (80.14 per share) write-down of
fourth riuirtltt frf jp;f Inillliirh.
-------
1600
MOODY'S INDUSTRIAL MANUAL
01179 indtidaa mo million 00.62 per (JO gain
oa talc aI pigment and methanol umu.
(Ditto include* tit million (tO.IJ.pcr ih.)
chare* lor termination of operation* of lha joint-ven*
turr tercphthaiate plant at Middleburg.
* Coniolldaled Itatament of Changaa In Hna«».
Mat Poertlon (in thousand*):
Fund* Provided From Operations;
p, Exhibit 3-9 (continued)
c
" DATA FROM MOODY'S - EBIT
Sourcca:
lac. bcf. extraord.
tain
Deprac. It amort.....
Dm. lua on inc
Xq. in act Inc. of affii.
roa. in aaccaa of t
diva
Writedown of fadl. ¦.
IMS
166,661
120,4(7
(13,193)
(12.972)
3J44
1*2,727.
1911
•136.4(1
llt,U9
11,092
Incrcue In Invnt.
Netchge. in work.
cap.
Net fds. prov. fr.
oper. 11 J,014
Financing Transactions:
—~ Chat, in ig.-tin. debt:
376,996 New borrowings .... 177,247
135.950
134,646
42.97*
14.754
(109^17)
70j6*9
69.711
220,2*9
2,704
J,MO
16,707
247,270
Raductlooa
(199,664)
(110,444)
(22,437)
96426
Net chie. in notes
pay.
(15.125)
(7M43)
Exchce. of com. (la. for debu
Incr. in cap. accta. ...
3*^145
Estraortbnary gain..
11.553
Caih dividend*
(56.374)
(53.5*7)
Net fin. treni....
(44.0JKI
(31.964)
Qwm. in fgn.curr.
trana.ad/.
(H.UV4)
(44.956)
Other aourcaa (Mas).
(*.31*1
IIW
Netincr. (dccr.)
in f'da.
Wacattl 1 Kamtoga, yaara aftdad Poo. >1 (in ihoutand* of doliara):
1976.
Net Sale*
476,467
$76,0*}
171.649
661.319
670,292
751,OSS
779,617
•32,761
*41.444
972,267
1,154,773
1.525.4(9
1.413.1 H
1,395,916
Coat and
Expert***
410,627
499.041
502,341
560.023
579,956
642,91$
6*1.611
724,027'
74J.096
*32,666
992.201
M55.3I6
M3S.932
1,435,916
Balance
65.131 .
77,044
76.301
101496
90.J36
106.140
9*,076
106,734
101.34*
139,401
162,572
170.173
77,179
160.040
Oth. Inc. ft
Dab. (Nat)
631
dlWi
5.731
3.456
»«fore apecial itemsiaflcr; 1911, U.4I; 19*5, *1.1
I pooling of Intcrnta. (SRaaiatad for Statements of Financial Accounting Noa. I*7 adopiad in 1971. UJXaaUtKl ufteflect 2-for-1
tcQMPARATlVEToKSOriDATEDMDALANCESHEETlAS OK DEC 31
^*TTB8nf8BT!!SHfllIHHWRSIIHII^WH5Bnip ConmiHion)
1973 pooilnc of Intcrnta. (3Ri
BALANCE SHUTS
6.606
'.3Com. Sh*.
Ouutand-
36,343.422
J»,703,611
39,395.937
40.247.710
40,4*3,101
40.Kl6.nS2
41,034.192
40.7S3.J7o
40,956,636
40.3I9.9M
41,732,194
41412449
42.193,700
424*3,026
16; 1904, tO.»S.
•Ik. split Apr.
ASSETS
Caah k time depoaita
u S. Govt. It outer securities, coat..
fotaa li accounta receivable, net.
Dtoriaa, net
19*2
2*,tl5
1407
• 3*0324
366,266
(In thoueanda of dollara)
19*1
26,700
136
619,747
606,907
I960
2J.947
7.756
417.602
337,216
1979
12,793
3,532
407,071
521,0*9
197*
47 .*71
10,056
332,347
316.779
Total currant aaaata
Inv. In affiliated cus.
Advance* to affiiiataa
Other inveatmcnu
©Property, plant ft equipment •
riff hi Depredationleaervsa ..
7*2,974
214491
960
21,933
2,079,66*
1.115,992
•54410
ltt.001
1,524
6409
2,011.5*6
I.II045J
791.723
152,335
1,962
1.904
I.1*2.34*
1,009.692
7*4,4*5
137,0(7
2.472
6466
1,703.4*1
930.592
707j055
107,7*0
2.463
9,522
I.61546S
901.0*2
1977
26.53*
2.524
273,102
297.330
199,494
*1.273
*16
9.147
1.5J7.010
*11.75*
(9,149)
QEani. Pit
Com. SL
046
rni.M
ffil.09
149
1.19
146
1.15
1.29
0)1-37
1.70
2.21 ¦
2.20
0.77
1976
17.092
13.17*
267512
269.225
lei**
70,325
54*1
25.710
1,432434
732411
Net properly account .
Goodwill
Ddaral charfta, *U.
Toul
LIABILITIES
Nous payable..
Accounta payable
U.S., for.« *ute inc. t
Total current KoMUtfaa
Long-term debt
Deferred U.S. k Ifn. income luce
Pension liability
(•Common atock
Paid-in aurplua
QTrnnalauan adjuatraent
latataed earnings
Total stockholders' equity .
CD ***¦ Traaaury atock at coat..
Net stockholder*' equity,..
Toul
Mot currant aaaata
PROPERTY ACCT.—ANALYSIS
Addition* at coat
Retirement* or aale*
sir
923.676
1.(21
55,599
907.733
1,167
52,700
•72456
4.197
S1JU
7724*9
5.517
52.461
7144*6
6.292
44,200
721.292
•467
50.214
6994*3
7.15*
54402
2A0M54
1,997,144
14*9,679
1,761,177
149649*
M77443
I.UOJ62
57,943
161.226
42,910
¦9,4**
73.06*
11IA47
14,314
96.W*
I4M11
153.294
42.220
61440
•6,76*
166417
•*,529
6J4I*
10412
126417
107,167
•9434
72,100
V9.7.W
27,1*6
72,54*
19,915
•141*
*9,6*4
63.164
351,167
431,919
119,254
19,703
23,240
129 Ml
Cb96,744
1,022,727
331.317
454456
134.447
21.667
22.146
, 90,*34
4(42.690
961.1*7
405.061
334.130
116.700
23.63*
22,111
*9,4*2
*96.273
401.072
2*0.619
104,417
25.607
22,076
UJ2S
<35,i<*
374.400
295.969
•0.201
27.577
22,076
•*.225
7*06,2 i 7
271,973
329,44.1
*V,UI 1
29,146
22,076
*1,225
647,336
214441
326J6*
75437
31.516
22476
*•,222
631*7(9
1.079.031
120
1,061,477
120
1409466
120
¦ 941,4*9
67
*]«,5I*
67
757,637
67
742,0*7
67
1,071,911
1.051.317
1409,746
941,422
• 10,451
717,570
742430
2.001,314
631,407
1.997.144
11IJ93
1.1*9.679
3*6.63*
1.761,177
379,413
1.596.S9*
332.655
1.477,143
327,521
I.4ju.2(2
313467
171.219
41,296
1*9,110
37.64*
229,163
10.296
191,6*6
107,173
121,330
43,012
129.716
24.900
150,779
1J J 336
IllWlilil!!!,
Ot&n addition*
» 4HS-
-4H«J
. 01902:
Land
Bldc*>. mach. it eq. ,
Trantporution aq. .
MiacaQaneouh
Conilmction in
pco«teea
Total
BHr25497 1D4.225
Book Value Deprec. Re*. aubaidiarie* with the exception of finance and
t2u.46t.0UO insurance aubaidiariea, and Co.'e pro ratu
I,*26.117,<100 tl.l 17,174,000 ahare of the Hercofina Joint venture*.
106.517
77,007
106.6*3
20,6*2
00.523
93.NJV
12.140
b)l.706
*9,226
59, tin
li'lot
53,J&*,000
13,5*0,000
166,222m
31*13.000
6,465,000
InveatmanU in affiliated companica, owned
come currently. Prior year* have not Iwcn re-
atatetl. For thuao year*, accounta of foreiRn
companica were Iranalutetl at currant aa-
chanite rales, exrciu that inventoriea. proper-
2V7o or mora, are accounted for on the equity jy, plant and equipment, der»n..-i,«tion. «ood-
method, aa are whoUy-owned finance and in- wiU. and deferred taxe* are tranklatvd at hie-
S2.079.66l.000 •1,111,992,000
Jter reaerve* (19*2. t4.9ll.000).
Jo. exunaively urn the lait-in, firit-out (UFO)
method for valuing inventor!**. If valued on the av-
erage con method, invantoriv* would have been
tll3.000.ooo hirhcr than aa reported on lite Life
authod at Dec. 31,19*2.
- "5utcd value: *31/41.
Share* at cott: 19*2-10.6,5*», 1979-76,3M9.
_it97*-76t Keprtaanta accumulattd depredatioa
« acquired company at data of acquisition.
QAdjuatiaaaia reaultiac '
•ctouata at cunaat rati
Owwai Motaa
. (a) Conaoudated financial atatamanu in-
chid* lha aowntt of Co., all whoiiy-owned
aurance tubmldiarica (due to their diaaimiiar
buainet* activitiea). Accordingly conaolidated
net income includes Co.'e ahare of their net In-
come.
Ail aumificant intercompany tranaactiona
are eliminated in consolidation.
(b) Tranaiation of Foreiicn Currenriea: Aa a
rcauit of adoptliuc Statement of Financial Ac-
counting Standard No. 12. Foreiicn Currency
_ . .. , .... . . . jf
torical Bachanse ratea. Revenue*, expenaea,
¦aina and loa*e* (other than inventory tost*,
depreciation, and amortuiitiun of Koodwill)
were tranalated at rate* prevailing durtn* the
year.
(c) Invi'ntorlcn: Invcninriet ore stated at
the lower of t-imt or murttet. SulMlantially all
domeatir inveninrit** »rc valued on the laat-in,
firat-out (LIKO) nictlnxl. and fortriun invanto-
Tranaiation, in 19SI. for yeara ended ^w. ji, -t" r- •—•r,' :r
IMI and thereafter balance aheet accounta of rtea are valued prmtipully on the average coat
. .... foreign companies are translated at current methocl. .
exchange rate* TTia raauitina tranaiation ad- (d) Commitmenu and Contingent LiafeU-
luaunent i* Inciudad in >lockholder a etiuity. *leai
.a* oi eacMof*. Kevenuea, expenaea. caina and loatea for 19a I
Co. haa certain operatina leaaca, including
apace,
and yeara thereafter are tranalated at rate* office apace, and tranaiwrtation and data
prevailing during the yea lien currency proceealnc equipment, cauirin# at varioua
tranaactloa »aln* and loan * i ncludad in in. n—.-i
-------
5. Find the data for depreciation in Moody's. Depreciation may be found
in: the Supplementary Profit and Loss Data Section of the Comparative
Consolidated Consolidated Income Account; the section called "Sources
and Uses of Funds"; or the Depreciation Reserve—Analysis section, which
is usually attached to the Comparative Consolidated Balance Sheet. If
the depreciation data are found in the Depredation Reserve—Analysis
section, the data may be described as "Additions charged to profit and
loss." Record the values for the three most recent years on Line 3.
6. Find the other fixed payments, which will be labelled as "Rents," "Cost
of rentals," or a similar description. Record the values for the three
most recent years on Line 4.
7. For each of the three years, add Line lc (net profit before taxes), Line 2
(interest), Line 3 (depreciation), and Line 4 (other fixed payments) to
get cash earnings before interest and taxes (E6IT). This is the
numerator for calculating the Fixed-Charge Coverage Ratio. Enter these
values on Line 5.
Exhibit 3-10 shows the calculation of EBIT using the sample firm data.
Worksheet 3b on page 17 of the Workbook Is used for calculating the Fixed-Charge
Coverage Ratio without the cost of pollution control. The ratio is calculated
for the three most recent years and the trend for the three years is evaluated.
The steps for calculating the Fixed-Charge Coverage Ratio are as follows:
1. On Worksheet 3b (page 17 of the Workbook), enter on Line 1 the cash
earnings before Interest and taxes (EBIT) values, from Line 5 of
Worksheet 3a, for the three most recent years.
2. Find the current portion of long-term debt on the Comparative
Consolidated Balance Sheet. Record the values for the three most
recent years on Line 2a.
3. Find the data labelled "Interest" (or "Interest expense") on the
Comparative Consolidated Income Account. These data are also on Line 2
of Worksheet 3a. Enter these values on Line 2b.
4. Find the other fixed payments which will be labelled as "Rents,"
"Cost of rentals," or a similar description, on the Comparative
Consolidated Income Account. These data are also on Line 4 of
Worksheet 3a. Enter these values on Line 2c.
5. For each of the three years, add Line 2a (current portion of long-term
debt), Line 2b (interest), and Line 2c (other fixed payments) to get
total fixed charges. Record these values on Line 3.
6. Calculate the Fixed-Charge Coverage Ratio for each of the three years
by dividing Line 1 (EBIT) by Line 3 (total fixed charges). Enter the
results on Line 4 (page 17 of the Workbook) and on Worksheet 14 (page
57 of the Workbook).
48
-------
Exhibit 3-10
WORKSHEET 3a
CASH EARNINGS BEFORE INTEREST AND TAXES (EBIT)
($1000)
Three Most Recent Years
of Company Data
Year 1982 Year 1981 Year 1980
la. Net Earnings (or Net
Income)
lb. Taxes
lc. Net Profit Before Taxes
Line (la) + Line (lb)
2. Interest Expense
86,861
20,244
107,105
50,707
136,481
51,062
187,543
46,673
114,000
23,361
137,361
37,356
3. Depreciation
4. Other Fixed Payments
(Lease or rent payments,
pension payments, etc.)
5. Cash Earnings Before
Interest and Taxes (EBIT)
Line (lc) + Line (2) +
Line (3) + Line (4)
121,841
279,653
118,839
(not listed)
353,055
114,472
289,189
Note that extraordinary Item has been deducted.
49
-------
7. Compare the Fixed-Charge Coverage Ratio with the following critical
values:
> 2.0 - firm is solvent
1.5-2.0 - grey area - solvency
of firm is uncertain
< 1.5 - firm is insolvent
Evaluate the historical trend over the past three years and
record the evaluation on Summary Line 1 (page 17 of the Workbook)
and on Worksheet 14 (page 57 of the Workbook). An example evaluation
1s:
"The ratio has been between 1.5 and 2.0 for the
past three years, and it has increased each year."
Exhibit 3-11 shows the calculation of the Fixed-Charge Coverage Ratio without
the cost of pollution control using the sample firm data.
Calculating the Fixed-Charge Coverage Ratio adjusted for the cost of pollution
control equipment is a two-step process. The first step is the calculation of
the debt ratio for the firm. For the purposes of this document it is assumed
that the control equipment will be financed with a proportion of debt equal to
this debt ratio. The debt ratio Indicates the portion of total capital which
has been financed by debt. It 1s expressed as:
OR - LTL
TC
where: OR * Debt ratio
LTL * Total long-term liabilities
TC * Total capital
Total long-term liabilities are the sum of long-term debt, other accrued liabil-
ities, deferred Income taxes, and minority interest (stock 1n the firm that is
owned by a subsidiary of the firm). Total capital is the sum of total long-term
liabilities and net shareholders' equity. The calculation 1s done using
Worksheet 3c oh page 18 of the Workbook. Step 1 1s done for the three most
recent years and Steps 2 through 4 are done for the most recent of the three
years. The steps in the calculation are as follows:
1. Find the long-term liability data on Moody's Comparative
Consolidated Balance Sheet (see Exhibit 3-12). For the three most
50
-------
Exhibit 3-11
WORKSHEET 3b
FIXED-CHARGE COVERAGE RATIO WITHOUT
COST OF POLLUTION CONTROL
($1000)
Three Most Recent Years
of Company Data
Year 1982 Year 1981 Year 1980
1. Cash Earnings Before
Interest and Taxes (EBIT)
Worksheet 3a, Line 5
2a. Current Portion of
Long-Term Debt
2b. Interest Expense
Worksheet 3a, Line 2
2c. Other Fixed Payments
Worksheet 3a, Line 4
3. Total Fixed Charges
Line (2a) + Line (2b) +
Line (2c)
4. Fixed-Charge Coverage Ratio
Line (1) divided by Line (3)
279,653 353,055 289,189
(not listed)
50,707 46,673 37,356
(not listed)
50,707
5.5
46,673
7.6
SUfflARY
37,356
7.7
1. Evaluation of three-year trend: Firm seems to be solvent; however, cur-
rent portion of long-term debt and other fixed payments are unknown. Including
these missing data would make the Fixed-Charge Coverage Ratio lower.
51
-------
1600
MOODY'S INDUSTRIAL MANUAL
Exhibit 3-12
Reduction*
E11979 include* 626.0 million (W42 per sh.) (kin Urn:
oa *•!• of pigment and methanol u«u. Prop., pi
Q]I960 includes *5.1 million (M.I3 per sh.) r»nii*l<
ti^&iJphth^e™^^ data FROM MOODY'S - DEBT RATIO FOR FIRM
CmmWiIM Statement ot CMngi
•W Position (in thaussnds):
Fund* Provided From Operation*:
099,644)
Sou rets:
Inc. b«f. eitrsord.
fata
Dtprac. It imort
D«f. luta on inc.....
Iq.inactlnc.ofsffU.
coa. in nccaa of *
diva
Writedown oI fsidL ..
ISM
IMI
•66,661
• 136.461
120,417
I1MJ9
(15,193)
15,092
(12.972)
2.704
3.544
3,160
IU.727.
276,996
Incressein invent.
Netchge. in work,
cap
135,950
134446
42471
14.754
(109417)
70,619
69,711
22041*
Exchge. of com. stk. for debt:
(22,437)
(15,125)
(150,444)
9642*
(75443)
Incr. in cap. sects. ...
Extrsordinsiy gsin ¦.
Cash dividends
31.645
IMS J
(56,674)
(5J467)
Net fds. prov.tr.
open 111,016
Financing Transactional
Chge. In Ig.-tm. debt;
Newborrowings .... 177,247
56,707
247.270
Not fin. Iran*....
Outn. in fgn. curr.
trans. a4}
Other sources (uses).
Net incr. (deer.)
Infils.
(44.036)
(31.964)
.(64 ,U»«)
(44,956)
(6.3 HI
11,064
6,606
W»carit of gamtofla. yar* *nd*d Dec. 61 (in thoutand* of dollar*):
Year
I96J
H1964
1965
31966....
31967....
3l9M....
21969....
3|970....
31971 ....
3(972....
SI97J....
u.1974
I97S
WTO..
Net Sale*
476.462
576.065
576,649
661,319
670.292
751.055
779,647
•32,761
Ml,444
972.267
1,154.775
1425.469
I.4IJ.III
1.595,956
Cost and
Expenses
410.627
499,041
502.341
560.023
579.956
642.915
661.611
724.027
743,096
132,666
992403
1455.316
1,335,932
1,435,916
Balance
65,635
77.044
76,301
101,296
90JJ4
106.140
96,076
106,734
105,346
139,401
162,572
170,173
77,179
160.040
Oth. Inc. k
D&.(Ngf
45.422
Total
Mat currant sssets
PROPERTY ACCT.—ANALYSIS
Addition at coat
Retirements oraales.
mother add i lions—-deductions
dEprec reskrve—analysis
Additions charaed la profit It lo**..
Retire. renewals charted to rss.....
Other addition*.
2.001.354
431,407
17l,2t9
4UH
CT6I.64I
121,641
— S'-,M
2)4/25497
1.997,144
516493
169,110
57 AM
cr15,224
111,1.19
21,903
(2)4,225
1.649.679
3S6.A56
229,163
50496
114.472
35.372
1,761.177
379,413
195,666
I07.57J
106.517
77,007
1976
47.671
10,056
332,347
316.779
707,055
107,710
2,463
9,522
1.615,366
901,012
714,266
6.292
49.200
1,596,596
50i362
126417
107,567
69.634
374,400
295.969
60.201
27,577
22,076
16,225
706,217
•11,511
67
• 11,451
1.596.596
J32MS
121,330
43,012
106,663
20.162
Q15.523
!SCom. Shs.
Omiund.
36.543,422
36.703,611
39J95.937
40,247,710
40,463,104
40.XJa.052
41.054.192
40.753.376
40,956,636
40 J 19,964
4t.732.t94
41.112.649
42.193.700
42J13.021
16; 1964,10.95.
stk. split Apr.
1977
26.531
2.524
273,102
297,330
599.494
16,273
656
9.147
1.537.050
615,751
721.292
1,267
50,214
"l,477,543
72,100
V9.759
27,5*6
72,541
271,971
329,443
69,011
29,546
22,076
16,225
64rjift
757,637
67
757470
1.477.543
327,521
129.716
24.900
(9,149)
BEsrn. Per
Com.Sh.
0.66
B1.04
1.09
149
1.19
1.J6
1.15
1.29
0)147
1.70
2.21 .
2J0
0.77
2.44
(TJR estate* fee
6, 1973.
9J.N39
12.140
0)1.206
1976
17,092
13479
267.912
269.225
70J25
5496
25,710
1,432434
732J5I
699.363
7.151
54402
1,430462
19,915
11456
69,664
63464
""254441
326,366
75437
31.516
22476
•6422
63*1*719
"74/5)67
67
742420
lXu.212
313461
190.779
1.13 J36
69.226
S9.<|6)
lliltt
OI962!
Land
Bidet-. m«ch. k eq. .
Trsnanorutioneq. ..
Miscellaneous
Const ruction in
166.222.000
Tout
Book Value Deprac. Res. aubsidiaries with the exception of finance and come currently. Prior years have nc
620.4614U0 insurance subsidiaries, and Co.'s pro rata stated. For those years, account* or foreign
1,176.117.000 »1.117.674.000 share of the Hercofina joint ventures. companies were translated ut current ex-
53,261,000 31,653400 Investments in affiliated companies, owned chanite rates, except thai invcniiiritn. proper*
13,540,000 6,465,000 20% or more, are accounted for on the equity ty. plant and equipment, deprtriution, «ood-
tnethod. aa are wholly-owned finance and in- will, and deferred taxes arc trxni.la.tcu at his-
auranee subsidisries (due to their dissimilar torical exchange rates. Revenues, expense*,
business activities). Accordingly consolidated Bajn> &nt] (owes (other than inventory ro*ts.
net income include* Co. 6 share of Ihetr net in- depreciation, and amortization of kooiI«III)
c#n\'. , , . were translated at rate* prevailinK during Ik)
All significant intercompany transacuons ycur
A. .
-------
recent years, enter long-term debt on Line la; other accrued liabi-
lities on Line lb; deferred income taxes on Line lc; and. minority
Interest on Line Id of Worksheet 3c (page 18 of the Workbook).
Other accrued liabilities may include such Items as other deferred
charges and pension liabilities. Add lines la through Id to get
total long-term liability; enter results on Line le.
2. Find the net shareholders' equity on Moody's Comparative
Consolidated Balance Sheet (see Exhibit 3-12). Record the value
for the most recent year on Line 2.
3. For the most recent year, add Line 2e (total long-term liability)
and Line 2 (net shareholders' equity) to get total capital. Record
this value on Line 3.
4. For the most recent year, divide line le (total long-term
liability) by Line 3 (total capital) to calculate the debt portion
of total capital (debt ratio) for the firm. Enter the result on
Line 4.
An example of this calculation using the sample firm data 1s shown 1n Exhibit
3-13.
Worksheet 3d on pages 19 and 20 of the Workbook Is used to calculate the
Fixed-Charge Coverage Ratio adjusted for the cost of the pollution control
equipment. One of the data Items needed in this calculation is the interest
rate to be paid on the new long-term debt (for the pollution control equipment).
One source for this information is Moody's Bond Record, which lists average
yields by bond rating classification. The interest rate on the firm's most
recent bond issue should be used to determine the interest rate. If bond
interest rates for the firm are not available, assume the Interest rate to be
three points above the current U.S. Treasury Bill rate. The adjusted Fixed-Charge
Coverage Ratio calculation is done for the most recent of the three years eval-
uated. The steps 1n the calculation are as follows:
1. Subtract the investment tax credit factor from 1 and multiply this
by the capital cost of the pollution control equipment to get the
capital cost of pollution control adjusted for the Investment tax
credit. This adjusted capital cost can also be found on Line 2d of
Worksheet lb. Enter this value on Line 1 of Worksheet 3d (page 19
of the Workbook).
2. Enter the debt ratio for the firm (from Worksheet 3c, Line 4) on
Line 2a.
3. Multiply Line 1 (adjusted capital cost of pollution control) by
Line 2a (debt ratio) to get the portion of the pollution control
expenditure financed with debt. Enter the result on Line 2b.
53
-------
Exhibit 3-13
WORKSHEET 3c
DEBT RATIO FOR FIRM
($1000)
Three Most Recent Years
of Company Data
Year 1982 Year 1981 Year 1980
la. Long-Term Debt
lb. Other Accrued
Liabilities
lc. Deferred Income Taxes
Id. Minority Interest
le. Total Long-Term Liability
Line (la) + Line (lb) +
Line (lc) + Line (Id)
2. Net Shareholders' Equity
3. Total Capital
Line (le) + Line (2)
4. Debt Ratio
Line (le) divided by Line (3)
431,919
19,703
119,254
570,876
1,078,911
1,649,787
0.35
454,356
21,667
134,447
610,470
334,530
23,638
116,700
474,888
54
-------
4. Enter the Interest rate charged on new debt on Line 3.
5. Multiply Line 2b (portion of pollution control expenditure
financed with debt) by Line 3 (interest rate) to get interest
expense before taxes. Enter the result on Line 4.
6. Divide Line 2b (portion of pollution control expenditure financed
with debt) by 5 (assuming a five-year debt retirement) to get the
additional principal payments for pollution control. Enter result
on Line 5.
7. Enter total fixed charges from Line 3 of Worksheet 3b on Line 6.
8. Add Line 4 (interest expense), Line 5 (additional principal pay-
ments), and Line 6 (total fixed charges) to get adjusted fixed
charges. Enter the result on Line 7.
9. Enter cash earnings before interest and taxes (EBIT) from Line 5
of Worksheet 3a on Line 8.
10. Enter annual O&M expenditures associated with the pollution control
equipment on Line 9.
11. Subtract Line 9 (annual O&M expenditures) from Line 8 (EBIT) to
get adjusted cash earnings before interest and taxes. Enter
result on Line 10.
12. Divide Line 10 (adjusted EBIT) by Line 7 (adjusted fixed charges) .
to get the Fixed-Charge Coverage Ratio adjusted for the cost of
pollution control. Enter the result on Line 11 (page 19 of the
Workbook) and on Worksheet 15 (page 58 of the Workbook).
13. Compare the adjusted Fixed-Charge Coverage Ratio with the follow-
ing critical ratios:
> 2.0 - firm 1s solvent
1.5 - 2.0 - grey area - solvency
of firm Is uncertain
< 1.5 - firm is Insolvent
Record the evaluation on Summary Line. 1 (page 20 of the Workbook)
and on Worksheet 15 (page 58 of the Workbook). An example eval-
uation is:
"Fixed-Charge Coverage Ratio adjusted for pollution
control cost is between 1.5 and 2.0. This ratio is
in the grey area."
An example calculation of the Fixed-Charge Coverage Ratio (adjusted for the cost
of pollution control) using the sample firm data Is shown In Exhibit 3-14.
55
-------
Exhibit 3-14
WORKSHEET 3d
FIXED-CHARGE COVERAGE RATIO ADJUSTED
FOR COST OF POLLUTION CONTROL
(SIOOO)
Most Recent Year
of Company Data
Year 1982
I. Adjusted Capital Cost of
Pollution Control
Worksheet lb, Line 2d
2a. Debt Ratio
Worksheet 3c, Line 4
2b. Portion of Expenditure
Financed with Debt
Line (1) x Line (2a)
3. Interest Rate on New Debt
4. Interest Expense (before tax)
Line (2b) x Line (3)
5. Additional Principal Payments
Line (2b) divided by 5
6. Total Fixed Charges
Worksheet 3b, Line 3
7. Adjusted Fixed Charges
Line (4) + Line (5) + Line (6)
8. Cash Earnings Before Interest
and Taxes (E6IT)
Worksheet 3a, Line 5
9. Annual O&M Expenditures
10. Adjusted EBIT
Line (8) - Line (9)
II. Adjusted Fixed-Charge
Coverage Ratio
Line (10) divided by Line (7)
8,500
0.35
2,975
0.14
416.5
595
50,707
51,718.5
279,653
1,000
278,653
5.39
56
-------
Exhibit 3-14 (continued)
WORKSHEET 3d (continued)
SUWARV
1. Evaluation of Fixed-Charge Coverage Ratio against critical values:
Firm appears solvent, but some data are missing from original Fixed-
Charge Coverage Ratio, which way be too high as a result.
57
-------
Interpretation
Three analyses are used to evaluate the Fixed-Charge Coverage Ratio. These are:
1. critical values;
2. three-year trend; and
3. adjusted ratio.
These analyses are described below. The results should be entered on Worksheets
14 and 15 on pages 57 and 58 of the Workbook. Examples are presented 1n Chapter
5.
Critical values for the Fixed-Charge Coverage Ratio were developed from a sta-
tistical study of a small sample of firms (Putnam, Hayes & Bartlett, Inc.,
Testing a Firm's Ability To Pay, prepared for the Economic Analysis Division, Office
of Planning and Evaluation, U. S. EPA, February 9, 1981). Firms with
Fixed-Charge Coverage Ratios greater than 2.0 are classified as solvent. Firms
with ratios between 1.5 and 2.0 are considered to be in the grey area where the
solvency of the firm is uncertain. Firms with a Fixed-Charge Coverage Ratio
less than 1.5 are considered to be insolvent.
The three-year trend for the firm indicates whether the firm's Fixed-Charge
Coverage Ratio has increased, decreased, or remained the same. If the ratio has
been steadily declining there could be some concern over the firm's solvency.
On the other hand, if the ratio is in the grey area but is increasing towards
2.0 the firm's condition is probably Improving.
The adjusted ratio indicates the effect of pollution control expenditures on the
firm's Fixed-Charge Coverage Ratio. If the adjusted ratio is greater than 2.0
the firm should be able to afford the pollution controls without difficulty. If
the adjusted ratio Is less than 1.5, the pollution controls can be expected to
cause solvency problems for the firm. Between 1.5 and 2.0 the adjusted ratio is
in a grey area.
These three analyses can produce conflicting results. Two combinations of
results can be interpreted as indications that the firm may encounter solvency
problems. These are:
1) The Fixed-Charge Coverage Ratio is greater than 2.0 or between 2.0 and
1.5 and the adjusted ratio is less than 1.5;
58
-------
2) The Fixed-Charge Coverage Ratio and the adjusted ratio are both between
2.0 and 1.5 and the three-year trend is declining.
3.2.2.2 Beaver's Ratio
Theory
This test, developed by William H. Beaver, 1s designed to assess the
short-term solvency of a firm. A study by Beaver published in 1967 indicated
that this ratio was the single best predictor of bankruptcy up to two years
prior to failure when judged against other individual ratios or combinations of
ratios. However, it should be noted that the recent literature has been criti-
cal of Beaver's results. In addition to Indicating likelihood of bankruptcy,
Beaver's Ratio indicates the extent of a decrease 1n earnings that a firm can
endure without defaulting on its fixed financial obligations.
Beaver's Ratio involves calculating the ratio of internally generated cash flow
to total debt. Internally generated cash flow is defined as net income after
taxes plus depreciation. Internally generated cash flow would also normally
include other non-cash expenses such as deferred taxes. In order to be
consistent with Beaver's study, however, non-cash expenses other than depre-
ciation are not included. Total debt is defined as the sum of current liabili-
ties and long-term debt. Beaver's Ratio 1s expressed as:
BR « CF
TD
where: BR • Beaver's Ratio
CF ¦ Cash flow
TD « Total debt
Calculation
The Calculation of Beaver's Ratio without pollution control costs uses data from
Moody's Comparative Consolidated Income Account and Comparative Consolidated
Balance Sheet (Exhibit 3-15). The calculation is done using Worksheet 4a on
page 24 of the Workbook. It is performed for the three most recent years and
the steps are as follows:
1. Find net income after taxes on the line labelled "Net Income" 1n Moody's
Comparative Consolidated Income Account. Enter values for the three
most recent years on Line 1 of Worksheet 4a (page 24 of the Workbook).
59
-------
MOOPrS INDUSTRIAL MANUAL
1899
Inter** 1. J Taiwanese investing group* manufac _ ..... - , _ In
hold the remaining % m the joint venture. France. Exhibit 3-15 I2.<
In Apr. 1073 Company nn.A. (Miliin, Italy) formed
Adria 1-nlKjrAtfirii'n Inc. Adria will perform the
clinical leallng Iriwlinr up to U.S. Food 8c
Drug Administration aptiroviil for drum ni-
renuy di-vclnpcil nnd lit-inK sold in F.uni|K by
Montedison'* pharmaceutical affiliates. In
Oct. 1077 Adria Lnljornturieft. Inc. acquired
Warren •Tcptl Pharmaceuticals, Inc.
On Auu. .11, l«76, Co. nnd American Petrofl-
na. Inc. formed two joint ventures, I Icrcolimt
and Ht-rcofinn Kuroiie, for production and
marketing of terephthnlatc*. Co. aold to
Americttn Petrofina a 2S% intereat in ita ter-
ephthalate asset*. Co. contributed ita remain-
Ins terephthalate assets for a 75% interest in
the Joint ventures. Co. interest will be reduced
aa American Petrofina elects to invest addi-
tional money for capital expansion.
On J an. 1. 1978 Havcg Industries. Inc.. sub-
sidiary, and Phillips Products Co.. subsidiary
of Phdlips Petroleum Co. lormed a Joint ven-
ture to develop chemical mvans of Increasing
oil recovery from reservoirs that already have
been tapped, called Custom Oil Recovery
Technology Co.
In May 1079 Co. and American Petrofina
Inc., announced that Hercofina sold ita metha-
nol plant In Plaquemine. I-a. to International
Minerals h Chemical Corp. who will form a
joint venitfp with Ashland Chemical Co.
In Mar. 19»'>. Co. and Boot* Co., Ltd. En-
gland formed a joint venture. Boots Hercules
Agro-Chemical CO., to make agricultural
chemicnl in North America.
In May 1079, Co. and Solvay Et Cle, of
nniasels, Belgium formed two joint venture
partnerships, Lextar in North America and in
uurope, to commercialize polyoleffn pulpa.
These steps 'uriher implement existing Her-
cules/Solvaj synthetic pulp development ven-
ture. Scmicommerci.il quantities of these syn-
thetic pulps will he miinufactured at a Solvay
plant in Rnsignnno, Italy. The joint venture
constructi-d n facility located in Deer Park,
Tes. for production of these synthetic pulps.
In Dec. 1981, Co. purchased all of Solvay Et
Cie a Interests in the joint venture partnership.
In Apr. IM0, Co. nni1 Shin Ninon Rika of
Japan formed a joint venture, Rika Hercules
K.Kh to construct a synthetic resin plant in
".The
W.Va.
~ _ . OTHER PRODUCTS
Deer Park. Tex. Pulaski. Va.
Middleton. Del, Wilmington, N.C.
WATER SOLUBLE PRODUCTS
Polymers. Gum and Costings
Flavors & Fragrances
Water Management Chemicals
ORGAN ICS
Resins
Elastomers It Specialty Chemicals
Paper Chemicals
EXPLOSIVES AND AEROSPACE
Explosive*
Aerospace
Graphite Fiber*
OTHER PRODUCTS
Terephthalates
Graphic Systems
Recording Products
Synpulp
PRINCIPAL PLANTS * PROPERTIES
PLASTICS
International:
St. Jean. Canada
Bay
.Teg.
yport.
Union, Mo.
galhoun, Ca.
ovington, Va.
Crowley, La.
Lake Charles. La.
International:
Beringen, Belgium
~ tna ""
Middletown, Del.
Oxford. Ga.
Marshallton, Del.
Terre Haute. Tnd.
Wlnooskl, Vt.
Varennes, Canada
Brantham, Eng.
WATER-SOLUBLE PRODUCTS
Brunswick. Ga.
Harbor Beach, Mich.
Hopewell. Va.
Louisiana. Mo.
International:
Sao Paulo, Broxil
Lille Skensvcd,
Denmark
Pcrlvn'e, Kngland
Alicay, France
Bremen, Germany
Middletown. N.Y.
Parlin, N.J.
Vero Beach, Flo.
Houston. Tex.
Groasenbrode,
Germany
Bergamo, Italy
Amerefoort,
Netherlands
ZwHndrecht,
Netherlands
Tarragona, Spain
Sandarne, Sweden
. OROANICS
Baton Rouge, La. Hattiesburg. Ml:
MANAGEMENT
OWIeeia
A.F. Giacco, Chmn.. Pres. ft Chief Exec. Off.
_ _ Divisional Vice-Prenidents
E.D. Crittenden
A.B. Engebretsen, Treasurer
R.J. Leahy
Vice-President*
F.L. Ilurkner K.A. Wagner
D.S. I lolling* worth H.A. Schowengerdt
L.G. Maury R.O. Wauon
. — . ... Other Officer*
S.M. Turk, Vice-Pres. & Gen. Counsel
R.R.P. Morrow, Secretary
G. MacKetuie, Controller
D.F. Desmond. Asst. Treaa.
A.L. Searl, Ass't Treaa.
C.W.K. Gamble, Ass't Sec.
Pit. Kendall. Aaat. Controller
Directors
(Showing Principal Corporate Affiliations)
-Alexander P. Otaeeo, Chmn.. Pres. and Chief
Exec. Oil.; Hercules I nc.
_ lugene D. Crittenden, Jr„ Divisional Vlee-
Pres., Hercules, Inc.
Stuart C. (Immm, Partner, Powell, Gold-
stein. Frater fe Murphy, Atlanta law firm.
Amen B. Engebretsen, Divisional Vice-Pre*,
and Treas., Hercules. Inc.
OavM S. NoMntmrarth, Vlce-Pres., Hermlaa,
Inc.
Robert J, laahy, Divisional VIce-PTes., Her-
cules Inc.
Ouy T. MeBrtde, 4r„ Pres., Colorado School oI
Mines.
Arthur C. Nlafsen, Jr, Chairman and Chief Ex-
ecutive Off., A.C. Nielsen Co.
John R. Petty, President and Chief Exec. ON..
Marine Midland Bank, N.A. and President,
Marine Midland Banks, Inc.
Brunswick, Ga.
Burlington, N J.
Chicopee. Mass.
japan. Terms were not disclosed. The new ....
venture will be I'lcaU'd In Tokushima City. Franklin. Va.
The prodix is will include, pressure-sensitive Gibbstown, NJ.
sdnesives. hotmelt adhesives, printing ink,
riaint and varnish, and chewing gum. International:
In Dec. I9S1. Co. and Sakai Chemical In- Traun. Austria
dustries Ltd. of Osaka Japan formed a Joint Sao Paulo. Braxil
venture, Japan Magnetics Ltd, to develop and Burlington, Canada
market advanced magnetic particles for use In
high-performance video( audio and computer
tape applications.
In May 19U, Co. and Pechiney Ugine Kuhl-
mann of France formed a Joint venture, So-
deie Europeene de Fibres et Composites, to
INCOME ACCOUNTS
St. Jean. Canada
Pendlebury, England
Beringen, Belgium
Kalamaxoo, Mich.
Louisiana. Mo.
Milwaukee. Wise.
Portland. Ore.
Savannah, Ga.
West Eliaabcth, Pa.
Tampere, Finland
Voreppe, France
Sobernheim,
Germany
Busnago, Italy
Mlddelburg,
Netherlands
Zwijndrccht.
Netherlands
General Counseh S.M. Turk.
Dtrectoc of PurefMdng: E J. Sheehy.
Auditors: Coopers k Lybrand.
Shareholder ReWMne: W.W. Bewley. Jr.. Di-
rector Investor Relstions Tel: 1(800)441-9274.
Director* MeelMfls: Last Wednesday of each
month.
Annuel Meeting: Fourth Tuesday In March.
No. of StoeMioMera: Dec. St. 1982,35,390.
No. of Employees: Dec. 31,1982,21.598.
General Office: Hercules Plasa. Wilmington,
DE 19899. TeL: (J02 >594-5000.
I COMPARATIVeToNSOLIDATRD*TnCOM?^CCOUNt| VfeARS ENDED DEC Jt
^^^^T™30TBnSRBn!lHroBrSJBIBBHnMn!!!n«nge Commission)
Net sabs It oper. revenues
Cost of goods told It o|wr. expense*
P Rcllittg. genersi H admin, espenses
1982
2,468,971
2.040,968
JI4rM)i
(In thousands of dollars)
1981
2.7I8J66
2,198,111
J08.S09
1980
2,485,226
2,038,806
291,519
197*
2449.425
1,853.120
280.786
1978
1,946.477
1,502,181
258,140
1977
1.697.787
U46.8I9
226.964
197*
1,591,958
1,226.884
209,032
_ Operating profit
Gain on sale of assets
Other income, net
113.698
20497
• 211,656
Ys',461
154,901
diijtm
211419
50.166
8443
186.156
"2*911
124.004
-------
1600
MOODY'S INDUSTRIAL MANUAL
3-15 (continued)
0)19*0 Include* tSJ million 1 (In thousands of dollars):
Net Sales
474.442
574,085
571,449
641J19
670.292
751,055
779367
832,741
•41,444
972.247
1,154.775
1,525,489
1.411,111
1,593.956
Coat and
Eapenies
410,627
499,041
502,548
340,022
579,956
642.915
681,611
724,027
743,096
832.844
992,202
1,355,316
1,335.932
1,435,914
Balance
65,835
77.044
76 JO I
101,294
90.336
108,140
98,074
108,734
105,348
139,401
142,572
170,173
77,179
140,040
.. inc.«
b. (Net)
431
<*95
5.731
3.454
c/1,013
cM.423
d 11.249
dlO.988
d9,826
dl 1,444
in.
first-out (LI FO> method, and foreign invento-
ffll 978-74: Representa arcumulated desrKiatloB '¦ i»"»« mww •ngiwi ""are valued principally on the average coat
efwquircdcomplwaitiu^MouStialnr 'oreign companies are transUted at current method.
{QAdiusUBents resulting from tranalatin* fortiM exchange rates. The^ resulting translation ad- (d) Commitments and Contingent Uabkli-
•CBMiMs at cvtraot raits afeschsan. wstment ia included in stockholder's equity, ties:
« Revenuee. eapensM, gain* and loaaea for 1981 Co. baa certain operating leaaea. including
(at */i ii-JSTT "b0 Vfars thcre*fUr are translated at rate* office apace, and Iranapertation' and data
««u^Sn^UdJ?,lg^,^®o,ini£i IW proccaaln#
82.079.448.000 81,155.992,000
Jt«r reserves (1982, 84.918.000).
Co. extensively uses the laat-in, first-out (LIFO)
method for valuing inventories. If vslued oa the av-
erage cost method, inventories would have been
8153.000,000 higher lhaa as reported on the Ufo
¦Mthod st Dec. 31. 1982.
(iBtatcd value: 825/48,
Shares at ro«L- 19I7-80,4.569; .1979-76.3,489.
(b) Translation of Foreign Currencies; Aa a
result of adopting Statement uf Financial Ac-
counting Standard No. 52, Foreign Currency
Translation, io 1981, for years ended Dec. 31,
1981 and thereafter balance aheet accounta of
-------
2. Find the data for depredation in Moody's or on Line 3 of Worksheet 3a.
Enter values for the three most recent years on Line 2.
3. For each of the three years subtract Line 2 (depreciation) from Line 1
(net income after taxes) to get cash flow. Enter results on Line 3.
4. Find current liabilities on the line labelled "Total current
liabilities" on the Comparative Consolidated Balance Sheet or on
Line 2 of Worksheet la. Enter values for the three most recent years on
Line 4.
5. Enter total long-term liabilities (from Line le of Worksheet 3c) for the
three most recent years on Line 5.
6. For each year add Line 4 (current liabilities) and Line 5 (total long-
term liabilities) to get total debt. Enter results on Line 6.
7. For each year divide Line 3 (cash flow) by Line 6 (total debt to get
Beaver's Ratio. Enter results on Line 7 (page 24 of the Workbook) and on
Worksheet 14 (page 57 of the Workbook).
8. Compare Beaver's Ratio for the three years with the following critical
values:
> 0.2 - firm is solvent
0.15-0.2 - grey area - solvency
of firm Is uncertain
< 0.15 - firm 1s insolvent
Record the evaluation on Sutrmary Line 1 (page 24 of the Workbook and on
Worksheet 14 (page 57 of the Workbook). An example evaluation is:
"Ratio has been 1n grey area for past two
years after being in the Insolvent range
for the previous year. Historical trend
Indicates Improvement but ratio still
indicates uncertain position."
An example of the Beaver's Ratio calculation (without the cost of pollution
control) is shown in Exhibit 3-16 using the sample,firm data.
Beaver's Ratio 1s also calculated after being adjusted for the cost of the
pollution control equipment, using the conservative assumption that the equip-
ment will be financed partly by borrowing rather than by issuing new stocks. In
this calculation, any additional expenditures serve to decrease the internally
generated cash flow of the firm while increasing the firm's total debt, thus
decreasing the ratio of cash flow to total debt.
62
-------
Exhibit 3-16
WORKSHEET 4a
BEAVER'S RATIO WITHOUT COST OF POLLUTION CONTROL
($1000)
Three Most Recent Years
of Company Data
Year 1982 Year 1981 Year 1980
1. Net Income After Taxes
2. Depreciation
Worksheet 3a, Line 3
3. Cash Flow
Line (1) + Line (2)
4. Current Liabilities
Worksheet la, Line 2
5. Total Long-Term Liabilities
Worksheet 3c, Line le
6. Total Debt
Line (4) + Line (5)
7. Beaver's Ratio
Line (3) divided by Line (6)
98,414
121,841
220,255
351,567
570,876
922,443
0.24
136,481 114,000
118,839 114,472
255,320 228,472
335,317 405,065
610,470 474,888
945,787 879,953
0.27
0.26
SUMMARY
1. Evaluation of Beaver's Ratio values: Ratios indicate solvency for all
three years.
63
-------
To account for the pollution control costs, all additional interest payments and
annual operating and maintenance costs are subtracted from the firm's internally
generated cash flow, and any additional debt which will be incurred to finance
any capital expenditures are added to the firm's total debt. Any tax shield
realized from the additional depreciation Is added to the firm's cash flow
because depreciation is a non-cash tax-deductible expense. Thus, for any
Increase in depreciation, the firm's Income after taxes will decline by the
amount of the depreciation expense after tax (or (1-tax rate) x depreciation).
The cash flow will Increase by the amount of depreciation less the depreciation
expense after tax since depredation 1s added to after-tax Income to arrive at
cash flow. Therefore cash flow will Increase by an amount equal to the increase
in depreciation multiplied by the tax rate. This Is often referred to as the
depreciation tax shield.
Beaver's Ratio adjusted for the cost of pollution control is calculated for the
most recent of the three years using Worksheet 4b on pages 25 and 26 of the
Workbook. The steps In the calculation are as follows:
1. Enter portion of capital expenditures financed by debt (from Line 2b of
Worksheet 3d) on Line 1 of Worksheet 4b (page 25 of the Workbook).
2. Enter interest expense before tax (from Line 4 of Worksheet 3d) on Line
2.
3. Enter marginal tax rate for firm (1f available or use 0.46) on Line 3.
4. Subtract Line 3 (marginal tax rate) from 1; enter result on Line 4.
5. Multiply Line 2 (Interest expense before tax) by Line 4 to get after-
tax interest expense. Enter result on Line 5.
6. Enter annual O&M expenditures for pollution control equipment (from
Line 9 of Worksheet 3d) on Line 6.
7. Multiply Line 4 by Line 6 (annual O&M expenditures) to get after-tax
O&M expenditures. Enter result on Line 7.
8. Multiply the capital cost of the pollution control equipment by the
investment tax credit factor to get the adjusted capital cost, or find
this value on Line 1 of Worksheet 3d. Enter this value on Line 8a.
9. Divide Line 8a (adjusted capital cost) by 5 (years until debt retire-
ment) to get additional tax depreciation. Enter result on Line 8b.
64
-------
10. Multiply Line 4 by Line 8b (additional tax depreciation) to get tax
shield from-depreciation. Enter result on Line 8c.
11. Enter cash flow (from Line 3 of Worksheet 4a) on Line 9.
12. Subtract Line 5 (after tax interest expense) and Line 7 (after-tax O&M
expense) from Line 9 (cash flow) and add Line 8c (tax shield from
depreciation) to get adjusted cash flowi Enter result on Line 10.
13. Enter total debt (from Line 6 of Worksheet 4a) on Line 11a.
14. Add Line 1 (portion of capital cost financed with debt) to Line 11a
(total debt) to get adjusted total debt. Enter result on Line lib.
15. Divide Line 10 (adjusted cash flow) by Line lib (adjusted total debt)
to get Beaver's Ratio adjusted for pollution control expenditures.
Enter result on Line 12 (page 26 of the Workbook) and on Worksheet 15
(page 58 of the Workbook).
16. Compare the adjusted Beaver's Ratio with the following critical values:
> 0.2 - firm 1s solvent
0.15-0.2 - grey area - solvency
of firm 1s uncertain
< 0.15 - firm Is insolvent
Record the evaluation on Summary Line 1 (page 26 of the Workbook) and
on Worksheet 15 (page 58 of the Workbook). An example evaluation is:
"Adjusted Beaver's Ratio Is between 0.15
and 0.2, indicating borderline solvency."
An example of the Beaver's Ratio calculation adjusted for the cost of pollution
control is shown 1n Exhibit 3-17 using the sample firm data.
Interpretation
Three analyses are used to evaluate Beaver's Ratio. These are:
1. critical values;
2. three-year trends; and
3. adjusted ratio.
These are described below. The results should be entered on Worksheets 14 and
15 on pages 57 and 58 of the Workbook. Examples of this are presented 1n
Chapter 5.
65
-------
Exhibit 3-17
WORKSHEET 4b
BEAVER'S RATIO ADJUSTED FOR COST OF POLLUTION CONTROL
($1000)
Most Recent Year
of Company Data
Year 1982
1. Portion of Expenditure Financed with Debt
Worksheet 3d, Line 2b 2,975
2. Interest Expense (before tax)
Worksheet 3d, Line 4 416.5
3. Marginal Income Tax Rate 0.46
4. 1 - Tax Rate 0.54
5. After-Tax Interest Expense
Line (2) x Line (4) 224.9
6. Annual O&M Expenditures for Pollution
Control Equipment
Worksheet 3d, Line 9 1,000
7. After-Tax O&M Expenditures
Line (4) x Line (6) 540
8a. Capital Cost of Pollution Control
Adjusted for ITC
Worksheet 3d, Line 1 8,500
8b. Additional Tax Depredation
Line (8a) divided by 5 1,700
8c. Tax Shield from Depredation
Line (4) x Line (8b) 918
9. Cash Flow-
Worksheet 4a, Line 3 220,255
10. Adjusted Cash Flow
Line (9) - Line (5) - Line (7) + Line (8c) 220,408.1
11a. Total Debt
Worksheet 4a, Line 6 922,443
66
-------
Exhibit 3-17 (continued)
WORKSHEET 4b (continued)
Most Recent Year
of Company Data
Year 1982
lib. Adjusted Total Debt 925,418
Line (1) + Line (11a)
12. Adjusted Beaver's Ratio
Line (10) divided by Line (lib) 0.24
SUMMARY
1. Evaluation of Beaver's Ratio: With costs of pollution control» firm is
still in solvency range.
67
-------
Critical values are ranges for Beaver's Ratio which indicate the relative proba-
bility of bankruptcy. In Beaver's study of 79 pairs of firms (each pair con-
sisting of one firm which went bankrupt and another that remained solvent) the
mean ratio of the failed firms was about 0.15 five years prior to failure and it
declined steadily thereafter. Using his results as target values, the firm
should be classified as solvent if it has a Beaver's Ratio (cash flow to total
debt) which exceeds 0.20. If this ratio falls below 0.15, the firm is con-
sidered insolvent. A grey area exists between 0.15 and 0.20.
The three-year trend indicates whether the firm's Beaver's Ratio has increased,
decreased, or remained the same in recent years. Generally an increase indicates
improving financial conditions. Industry averages are not available for com-
parison with the three-year trend.
The adjusted ratio indicates the effect of pollution control expenditures on the
Beaver's Ratio for the firm. If the adjusted Beaver's Ratio is above 0.20, this
test indicates a low probability of bankruptcy; below 0.15 indicates a high prob-
ability of bankruptcy. Values between 0.20 and 0.15 are considered to be in a
grey area.
These three analyses can produce conflicting results. Two combinations of
results can be interpreted as indications of potential solvency problems. These
are:
1) Beaver's Ratio is less than 0.20 and the adjusted ratio is less than
0.15; and
2) Both the Beaver's Ratio and the adjusted ratio are 1n the grey area
between 0.20 and 0.15) and the three-year trend 1s declining.
3.2.3 Leverage Ratios
Leverage Ratios measure the extent to which a firm has fixed financial obliga-
tions. Leverage is the proportion of a firm's value that Is financed by debt
relative to that which is financed by stockholders. Leverage Ratios can
Indicate in a general way how much more debt financing (loans) a firm could
expect to receive. A highly levered firm (one with a high Leverage Ratio) 1s
likely to have problems borrowing more. The Debt/Equity Ratio is the most com-
monly used measure of leverage.
68
-------
3.2.3.1 Debt/Equity Ratio
Theory
The Debt/Equity Ratio 1s the ratio of long-term debt to total stockholders'
equity. In general, the debt holders (banks, etc.) In a highly levered firm
(one with a high Debt/Equity Ratio) bear more risk than those 1n a less levered
company, especially if there is some probability of bankruptcy. Thus, while the
Debt/Equity Ratio alone 1s not a particularly useful number for assessing finan-
cial health, It can be used in combination with the Solvency Ratios to evaluate
the stability of a firm's operations.
The Debt/Equity Ratio is calculated for the three most recent years and is not
adjusted for the cost of pollution control. This is because the firm is assumed
to be at Its optimal debt/equity level before the pollution control equipment is
added. Investment in pollution control is a capital Investment that does not
increase a firm's borrowing power because 1t will not produce future cash flows
to repay the debt. It 1s assumed that the pollution control equipment will be
paid for with amounts of debt and equity which are proportional to the total
debt ratio of the firm.
The Debt/Equity Ratio is expressed as:
D/E - LTL
TSE
where: D/E ¦ Debt/Equity Ratio
LTL * Total long-term liabilities
TSE « Total stockholders' equity
Calculation
The data needed to do this calculation are found 1n the liabilities section of
Moody's Comparative Consolidated Balance Sheet (Exhibit 3-18) and in Morris'
Annual Statement Studies (Exhibit 3-19). The three-year trend in a firm's
Debt/Equity Ratios is evaluated and 1t is compared to average industry values.
These Industry ratios are Debt/Worth Ratios, in which total long-term liabili-
ties are divided by tangible net worth. The Debt/Equity calculation is done
using Worksheet 5 on pages .29 and 30 of the Workbook. The steps are as follows:
69
-------
1600
MOODY'S INDUSTRIAL MANUAL
01979 includea 128.0 million ($043 pel
am sak ai pigment tad methanol Miitt.
QJ1980 include* ISA million (10.1J
charge for termination of operation* of ih
tar* lerephthalate plant n Middleburg.
ConaoiMaiad Statement of Chang*
oM Position (in U>ou*anda):
Fundi Provided From Operation*:
*h.)g*in
per ah.)
prop^piLii Exhibit 3-18
Capiui e*|w
Reduction* U99.M4) (ISC.444)
DATA FROM MOODY'S
IA7.IM
DEBT/EOUITY RATIO
e. in notes
Source
lBC.bef.cxtraord.
tain
Decree. It amort.....
Dei. laze* on inc. .. • •
Kq. la act inc. of affil,
roe. in excea* of t
diva.
Writedown of facd. ..
1M2
186,861
120,487
(1S.I9J)
1911
1IJ6.4SI
118.839
. 15.093
Increaae in invest....
Net chse. in work,
cap.
135,950
134,846
42,978
14,754
(109.217)
70,689
69,711
220,289
. of cum. stk. for debt;
Caah dividend*.
Netfda.prov.fr.
j.70i oper 113.016
2,880 Financing Transactions:
Chfe.JnifMin.debt:
182,727* 274,994 Nrw borrowing 177.247
(12.972)
1.544
Net fin. Iran*....
lie*. in fgn. curr.
Iran*, adj
5^ 707 Other sources (um) .
Net incr. (deer.)
247.270 in Ida.
(22.437)
(15,125)
38.M4«
1US.I
(Sti,874)
(44.03SI
18.318)
6,606
96,826
(75,343^
(33.347)
(31,964)
(44,956)
11,OH
(».!«»)
of farr\i«B*t |rsara enM
>Vns5cRSo!3c»*iquuy
SR
Toul.
OPERTY ACCT.—ANALYSIS
Additiona at coat
Reiiremenu or aalea
QOther addition* deduction* ....
DEPREC. RESERVE—ANALYSIS
Additions charged to profit It loea..
Retire, renewal* charged tores.....
Other addition*
031982:
Land
Bid**..mach.lt eq.
Tranaportation eq. ..
Miactuaneoua
Construction in
1,078,911
2,001.354
421.407
17UI9
48,296
crtlMI
121.841
51.105
ay*r2s.s97
I.05M57
1,997.144
5IM92
189,110
27.648
a-15,224
118.839
21.903
(SUM
1,009.746
1489,679
3*4,658
229,162
50,296
114.472
21,272
945,422
1978
47.871
10,058
222.347
316.779
707.025
107.780
2.462
9422
1,615,368
901,082
714.286
6,292
49.200
1,596,598
50J82
126.817
107,567
89.634
274.400
295.969
80.201
27.577
22.076
U225
708,2i7
818,518
67
818,451
'3Com. »hi.
Outstand.
J6.543.42J
38.7U3.6I I
J9J95.937
40.247,710
40.483.104
40.XSA.052
4I.0S4.I92
40.753.370
40.956.636
40 J 19.984
41,732.194
41,812,649
42.193.700
42.383.028
16: l«04.10.95.
¦Lit. split Apr.
1977
26.538
2,524
273.102
297,330
599.494
18 J7J
<56
9.147
1,527.050
615.758
721.292
8.267
50,214
1,477,543
72.IUO
V9.7W
27.506
72.548
271.973
229.443
89.011
29546
22,076
M.J 25
(SEarn. Ptr
Com. Sb.
0.86
S1.04
1.09
U9
1.19
IJ4
1.15
1J9
CS1.37
1.70
2.21
2.20
0.77
2.44
(SKntatedfer
6. 1973.
1*7*
I7.0»J
13.57*
267.912
269 225
"m;.m
70JJJ
5.396
25,710
1,432.
732.851
i
699.. .
7,158
54,502
647.336
757,627
67
757.570
1,420,281
19,915
8M58
89.6*4
62,584
254.541
226 J68
75.827
31.516
22,076
88,222
621* 789
"TuoaJ
67
742.020
1.761.177
279,412
195,686
107,573
106.517
77,007
1.596,598
232,655
I2IJ20
42,012
106,682
20.882
GQ5J22
1,477,543
227,521
129,716
24,900
93.819
12,140
Sll.208
1,4ju.282
213^67
190.779
U3 338
89./28
5».i(0
ILI08
Book Value Diprac. Kn.
120,481,000
IJ26.II7.U00 11,117.874.000
52.268,000 11,653.000
12.580,000 6,465.000
106,322,000
aubaidiariei with the exception of finance and
Inauranca aubaidiarie*. and Co. a pro rata
¦hare of the Hercofina Joint venture*.
Investment* in affiliated companies, owned
20% or mora, arc accounted for on the equity
method, a* are whcilly>owned finance and.in*
come currently. Prior years have not been re-
atateil. Kor those yeura, account* of foreign
companies were translated at current ex*
change rates, except that Inventories, proper-
ty, plant and equipment, depri.-mnon. good-
will, and deferred tsac* are irankluicd at hia>
Total
f&Afti
©Co.
method
•urance aubsidiariea (due to their dissimilar torical excharute rate*. Revenues, expenses,
_ business acuvities). Accordingly consolidated w|n, and losses (other than inventory roat*.
g2.07«.A68!0qa tl.155,992.000 net income includes Co.'a ihart of their net in- depreciation and amortization or goodwill)
"All' algniflcant Intercompany tranaactions w«e tranalat^ at rat« prevailing during tha
eJiminated in consolidation^ (c) Inventories: Inventoried arc stated at
ter reserve* (1982, *4.918,000).
extensively uae* the laat-ln, first-out (LIFO)
for valuing Inventories. If valued on the av-
erage cost method, inventories would have been
$153400,000 higher than as reported on the Lifo
method at Dec. 21, 1982.
l£Btated value: 125/48.
QBharcs at coit: 1982-80.6.589-. 1979-76,3.689.
[J)19?8-76; Represent* accumulated depradatioa
af acquired company at data of acqulaition.
(T]Adju*tmenta mulling from translating foreign
msmtli a* cunal rates of exdianga.
thiYowcroT^Mor'^rkA-SuCMa^rfriPrii
PorcLft Cuprtncv domc»llc Inventories arc vnJued on ihc iMl-ln
«"t-out (LIKO) nietlitiil. and foreign invemo
counting Standard No. 52, Foreign Currency
mlTand thereaf'er i>«Jan^e*ahe"V«ountaJof rt«* *"> valued principally on the average coe
foreign companies are translated at current metnoq.
exchange Vatca. The resulting translation ad-
iuatment la Included in stockholder * equity.
Icvcnues, expenaea, gains and losses for 1981
and years thereafter are translated at rates
_ prevailing during the year. Foreign currency
the accounts of Co- all wholly-owned tranaactlon gains aac* are included in ln-
70
OefwelHoW
CooaoUdAUd ita±K»d*l luumcnu in:
Billtltl, . | » i|,
(d) Commitmsnu and Conungent Liabtli-
tins
Co. haa certain operating leasea. including
office space, and uanaportauon and data
procesaing equipment, expiring at vanoua
dates. Rental aspens* relating to these 1
-------
Exhibit 3-19
DATA FROM MORRIS - DEBT/EQUITY RATIO
MANWAUIUHtKS • PLASTIC MATERIALS ft SYNTHETIC RESINS
IIC« 21J1
IS
Cwimttott
OtMM
1IPUN
IftMWM
IfrlOOMM
AU
ASSET SIZE
24
66
11
«
116
_JIUMJ£« 0F STATEMENTS
%
5
ft
*
ft
AtSlliT
l«
46
35
56
Cllh 6 fqui»alantl
355
295
269
30 1
ACCU. i Notat Ate • Trada(nat)
10 7
22 7
24 9
22 4
InvvtltMy
1 7
12
I 9
1 4
All Otliar Curiam
6SS
512
56 2
59 6
Total Currant
2S.2
33 6
32.6
31 6
Fuad Aitatt (nail
1
1.6
6
1 1
fniangitlai friat)
9 1
66
•
75
7 6
All OtKar Non CurraM
1000
100 0
1000
100.0
Total
LIABILITIES
7.0
II
6 7
64
Notat Payjbl.ibhoH farm
4.1
32
2.7
32
Cm Mat t/T.'O
24.1
19 7
16.4
19 7
Aceta 6 Natal Piytbit Trada
4 6
66
6 7
6 1
Acciuad Eapantat
60
20
40
32
All Otlio) Currant
41 9
40.4
394
40 6
Total Cvtant
f* 1
16 5
25 2
>6.7
long Term D«bt
5 5
26
30
36
All Otnar Non-Currant
325
363
32.4
37 1
Nat Wonii
100.0
100.0
100 0
100.0
Total liabilities fc Nat Worth
INCOMf DATA
100.0
1000
100.0
1004)
Nal Salat
72 1
77 6
77 7
766
Cult 01S A la ft
27.9
22.2
22.3
23.2
Giiiii Profit
24.9
169
166
162
Opatal.iip fipantai
3.0
5.3
5 4
50
Oporatmp Prolit
10
13
2 9
14
All Olda/ Eapantat Inat)
I.t
4 1
2.6
36
Prolu 6tfpra_Taioi_
RATIOS
2 1
21
2.5
2.2
1.6
1.4
15
16
Currant
10
1 1
l.l
1 1
1.5
1.2
1.2
1.3
1 1
.6
.6
.9
Quick
6__
6
*
.6
Jf
• 7
36
105
40
9.1
36
10.2
n
74
43
6.4
64
66
47
7.7
Salat/Racaivablat
64
67
66
..6.3
6*
.5.4
66
J?
13
16 1
26
12.7
37
100
29
12.4
>7
91
42
6.6
60
7 3
43
65
Coil si Salai/lnaaatory
to
6.1
67
64
66
43
63
56
7.2
7.5
6.0
7.0
116
13.5
10.7
123
Salat/Woiking Capital
1INP
327
311
32.3
SI
62
37
7.6
<2»
22
|56|
3 1
07)
2.0
1101)
2.6
(SlT/lbiatati
—
__1 2
. 1!.
_...,t
• -
J ¦*. .
63
6.7
6.3
7.9
2.7
(56|
4.0
(131
26
194)
3.9
Caih Plow/Cur. Mat. L/T/0
1,5..
J.3.
_J.J
_ 2 1
.4
.6
.7
.6
.6
10
1.3
1.0
Fuad/Worth
2.0
16
2 1
J7._
10
~t
13
.9
2.2
1.6
22
1.6
I Oabl/Worth 1
7 7
3.2
4.3
35
122)
396
(64)
36.6
36 0
36.7
ft Prolil Baleia Tuil/Tangibla
25.6
24.0
165
II10)
234
Nal Worth
5.7
10.6
•
-25
64
13 6
15.6
11.3
139
1 Prolit 6alpia Taata/Total
6 3
(6
5 0
73
Attait
1 2
3.0
.. |
1 6
17.4
132
9.1
134
13.2
7.2
6 1
74
Salai/Nil Find Altai!
7.7
4.0
40
¦—
43
,
3.3
27
19
2.9
iJ
1.1
2.4
2.0
1 4
e t< i«
(23) 19 (13) 2.0 (17) 1.9
27 3J JJ_
1.7
(15) 2.3 (24)
_1S_
29
(K)
.3
I 7
2.1
2.2
JJ
1 3
(10ft) 3.0
32
.6
(46) 1.1
. 20
4.1 (21) 2 9
6 5 4 3
•*13214 171176M
127 MM 2631MM
iwbtonUorhiMiociit«i~Tll2
741499M
46316361
22
(43) 3 i
4 7
63443044 ~t964039M
<3712044 I10«673M|
Companiin Hit ureal Dtu
Salat/Total Altai*
% Dapr. Dtp. Amort/Salti
11 Luu t Rantil E»p/Sll«i
% OHicarl' Ccmp/Sllf ft
NM Salai («|
Total Allatt|l)
I
- • 9
1/30-77
a. jo./i
4.40.71
kjO.ID-
• Mil
1/11/71
J/J1/71
J/31.10
1/11 II
1/11/42
*U
AU
All
*11
All
120 116
144
W
lit
ft
ft
V
%
...
ft
62
67
66
6}
56
26 0
296
26.5
29 5
30 1
24 3
22 3
246
21 S
224
20
1 4
J J
1 4
1 4
60 6
60 1
62]
>6 5
696
33.0
33 3
316
32 6
316
I 1
4
1 4
13
6
5 9
52
49
60
7 6
100 0
lObO
1000
IUOO
IOOO
10 1
60
«7
a 3
1 4
' 37
3 3
4 1
34
32
16.3
179
20 4
16 7
197
6.6
6.6
6.5
57
6 1
29
4 1
44
32
3 2
40.7
396
4«2
3"> 7
40 6
17.1
>6 4
177
Id 4
16 7
1.9
2.4
2.1
32
36
40 3
39 4
36 0
40 6
37 1
100 0
100 0
1000
100 0
IO00
"
. —.
. . . _
—
100.0
100 0
100 0
101/ 0
100 0
75.7
762
7!) 6
>6 3
76 6
243
23 6
24 2
13 I
23 2
19 7
160
194
1*
I) 2
46
5 6
46
50
60
14
10
1 1
13
14
32
46
3 7
3 6._
36
. " ""' —
¦-
- *¦*
2.1
2.2
2 1
2 t
22
1 5
1 6
1 5
15
16
1 2
1 ?
1 1
t 1
-J-L
1.3
1 3
13
13
13
.9
1.0
9
10
9
.6
.7
....
.7..
.. .*
36
6 7
37
10.0
36
104
40
9 2
36
10 2
47
76
47
7.7
46
79
49
75
47
7 7
62
.56
62
59
55
.66
6>
6 2
. 66
63
42
67
29
126
34
106
33
11 2
26
124
M
66
60
73
60
>3
43
64
43
65
.. .7?.
_52_
-Jf.
. A-!.
6$
.53,
.15
,_5 6..
61
.56
66
6 I
65
69
" 7 0
107
90
116
115
123
22 9
.29 5..
33 9.
27 3.
iJ.J
96
132
It
• 7
76
(95)
3 7
163)
45
IMS)
3 9
|10S|
29
1101)
2 6
1.6.
22
16
1 i
1 4
77
74
67
V 7
7 9
l«7|
26
(76)
45
(90)
36
l»3|
3 1
164)
39
1 7
20
IJ.
...I?
..2.1.
4
5
4
.5
«
6
.«
6
7
10
- I*_
_ I5_
i *
6
*6
.9
6
9
16
1 5
16
1 4
1 6
. ?.*_
. 2 • .
Jf
35
35 7
41 6
3(4
32 2
35 7
|1I6|
22 5
till)
25 3
|136|
24 0
H23)
IP 1
|l 10)
23 4
_ - . .
43
129
- J-i_
.. 11..
. .M.
14 6
164
153
13 6
139
ft 1
102
1 2
60
73
—
19
.4.1
.. 2-'.
2 1
1 6
104
10.2
127
113
13 4
63
6.6
79
66
7 4
. ...
.
42
..!«
. 4.3 _
. i?
24
2.7
2 7
26
2 9
2.1
21
22
2 I
22
„ . .
.J 7
_ .16
, J 6.
_. 1.5
1 7
1 5
13
1 5
1 4
1 3
(113)
2.3
1105)
23
(1341
2 1
11141
2 I
(106)
20
__3 7
. ?.».
.
34
3 5.
32
7
4
5
5
5
|56|
1 6
Hi)
1 0
(72)
1 2
|56»
t 2
|46|
1 5
23
20
22
22
20
20
25
2 1
20
22
14 3 j
4 I
13 »l
40
H'l
4 I)
(431
3»
|43|
)»
&»
a j
<6
t !¦
a 7 .
1129219M (204793M 148175IM 7619576M 196A039M
674729M 654930M 72517 JM 136430IM I106673M
If • IMOuaar
Saa I ttiraugfc 12 «•
71
. ImiMn
won of Aanot ai>0 0
-------
1. Enter total long-term liabilities for the three most recent years
(from Line le of Worksheet 3c) on Line 1 of Worksheet 5 (page 29 of the
Workbook).
2. Find common stock at par (the value of the stock at its original
purchase price) on the Comparative Consolidated Balance Sheet and
subtract the value of any treasury stock. Record the results for
the three most recent years on Line 2.
3. Find additional paid-in capital (may also be listed as "Capital Sur-
plus") on the Comparative Consolidated Balance Sheet. Record values
for the three most recent years on Line 3.
4. Find the total value of the preferred stock (1f any Is listed) on the
Comparative Consolidated Balance Sheet. Record values for the three
most recent years on Line 4.
5. Find retained earnings on the Comparative Consolidated Balance Sheet.
Record values for the three most recent years on Line 5.
6. For each year add Line 2 (common stock at par), Line 3 (additional
pa1d-1n capital), Line 4 (preferred stock), and Line 5 (retained earn-
ings) to get stockholders' equity. Enter the results on Line 6.
7. For each year divide Line i (total long-term liabilities) by Line 6
(stockholders1 equity) to get the Debt/Equity Ratio. Enter the results
on Line 7 (page 29 of the Workbook) and on Worksheet 14 (page 57 of
the Workbook).
8. Locate Debt/Worth Ratios for the appropriate SIC code in Morris1 Annual
Statement Studies. Record upper quartile, median, and lower quartile
values for Debt/Worth Ratios for the three most recent years on Lines
8a through 8c.
9. Evaluate the three-year trend In the firm's Debt/Equity Ratios. Record
the evaluation on Sunmary Line 1 (page 29 of the Workbook) and
Worksheet 14 (page 57 of the Workbook). An example evaluation is:
"Debt/Equity Ratio has declined over the past three years,
Indicating an improvement in the firm's leverage position."
10. Compare the firm's Debt/Equity Ratios with the industry average
Debt/Worth Ratios. Record the evaluation on Sumnary Line 2 (page
30 of the Workbook) and on Worksheet 14 (page 57 of the Workbook). An
example evaluation is:
"The firm has had a Debt/Equity Ratio between the industry
median and upper quartile for the past three years. The
ratios have declined relative to Industry averages over the
past three years, indicating an improved leverage position."
An example calculation of the Debt/Equity Ratio using the sample firm data 1s
shown in Exhibit 3-20.
72
-------
Exhibit 3-20
WORKSHEET 5
OEBT/EQUITY RATIO WITHOUT COST OF
POLLUTION CONTROL
($1000)
Three Most Recent Years
of Company Data
Year 1982 Year 1981 Year 198D
1. Total Long-Term Liabilities
Worksheet 3c, Line le 570,876 610,470 474,888
2. Common Stock at Par 23,120 22,126 21,991
3. Additional Paid-in
Capital 129,808 90,834 89,482
4. Preferred Stock — —
5. Retained Earnings 1,022,727 981,187 898,273
6. Stockholders' Equity
Line (2) + Line (3)
Line (4) + Line (5) 1,175,655 1,100,147 1,009,746
7. Debt/Equity Ratio
Line (1) divided by Line (6) 0.49 0.55 0.47
8a. Industry Debt/Worth Ratio
Upper Quartile 0.9 0.8 0.9
8b. Industry Debt/Worth Ratio
Median 1.8 1.4 1.6
8c. Industry Debt/Worth Ratio
Lower Quartile 3.5 2.8 2.9
SUWARY
1. Evaluation of three-year trend 1n Debt/Equity Ratios: Firm's Debt/Equity
Ratio has remained fairly constant over three years.
73
-------
Exhibit 3-20 (continued)
WORKSHEET 5 (continued)
2. Comparison of Debt/Equity Ratios with Industry averages: Firm is in much
better position than rest of industry,
74
-------
Interpretation
Two analyses are used to evaluate the Debt/Equity Ratio. These are:
X. industry averages; and
2. three-year trend.
The results should be recorded on Worksheets 14 and 16 on pages 57 and 58 of the
Workbook. Examples are provided in Chapter 5.
No critical values are available because the degree of leverage that Is
desirable is a function of a firm's operating characteristics and therefore
varies among Industries and even over the life cycle of one firm. No adjusted
ratio Is calculated because pollution controls will not affect the Debt/Equity
Ratio, assuming that the expenditure will be financed at the prevailing debt
ratio.
Industry average Debt/Worth Ratios are more Important comparative Indicators
than the three-year trend, since they depict the level of debt commonly asso-
ciated with the riskiness of that line of business. Industry median and quar-
tlle ratios are used for comparison because better targets do not exist, but
this comparison alone is often too simplistic. Operating characteristics may
vary considerably within an industry, causing target leverage ratios to be dif-
ferent. Industry averages should, therefore, be used only as general indicators
of the firm's degree of leverage. A Debt/Equity Ratio greater than the upper
quartile Debt/Worth Ratio for the Industry Indicates that the firm may have
trouble borrowing additional capital.
The three-year trend Indicates whether the Debt/Equity Ratio has increased,
decreased, or remained the same 1n recent years. If the Debt/Equity Ratio is
above the industry median, an Increase may indicate potential problems. A high
Debt/Equity Ratio 1s a problem 1f there 1s a fair degree of uncertainty about
future earnings of the firm. This uncertainty could be caused by unstable busi-
ness conditions 1n the firm or the industry as a whole. A company with small
fluctuations in earnings over a long period of time can afford to have a higher
Debt/Equity Ratio than a less stable firm. An unstable firm is likely to have
periods of low earnings during which the risk of defaulting on loans is high.
75
-------
3.3 MARKET VALUE ANALYSIS
The financial statement analysis provides a review of recent historic perfor-
mance and a po1nt-1n-t1me picture of a firm's financial status. What is not
discernible from this vantage is how pollution control costs would affect expec-
tations of the future performance of the firm. To predict the future effects
one needs a' prospective look based on expected financial performance of the
firm with and without pollution control expenses.
One way of doing this would be to project pro forma (predicted) financial state-
ments into future years by extrapolating past behavior and performance trends.
Certain items such as inventory value, accounts receivable, and accounts
payable could be estimated from past performance of the management of the firm
in terms of ratios to total sales or average length of collection or payment
time, for example. Other Items like sales and operating costs could be extended
along recent trend lines. These would allow a permit writer to estimate what
future balance sheets and income statements might look like. Unfortunately,
this would require a detailed understanding of the firm's industry and market,
Including how sales and costs vary with inflation, who the competitors are, what
new technologies are influencing the supply and demand for the product, and how
production assets are tied to sales volume and costs, collecting this infor-
mation would be a formidable task beyond the scope of the permit writer's
interests or capabilities. Instead a proxy for this forward-looking approach is
used—analysis of stock prices. This is the purpose of the second component of
the firm-level analysis—the market value analysis.
Stock prices reflect the opinions of many analysts and participants in the stock
market who set the price of a stock by their buying and selling behavior. In
theory, the price of a corporate stock is a measure of the net present value
(NPV) of the future cash flows (profitability) of the firm. The value of money
over time is considered in net present value by reducing—or discounting—the
estimated future cash flow to a lesser amount based on the length of time
Involved and an assumed or effective interest rate. Thus stock prices are indi-
cators of investors' expectations, of the future profitability of a firm. They
constitute a single-number substitute for a series of projected future financial
statements. Because there are many security analysts who conduct detailed
76
-------
financial evaluations of firms for investors who value such information very
highly, and many Investors who act on that information, it can be assumed that
the market price of a firm's stock is a good substitute for the more rigorous
and time-consuming analysis.
Any cost associated with pollution control will have only negative value as an
investment for a firm, because the costs will not produce any revenue and will
only result in reductions in net Income. This reduction in income would reduce
the stock value. Assuming the stock price represents the per-share amount of
profits available now and in the future, 1t thus provides an indication of the
upper limit on the after-tax cost of pollution control that could be incurred by
a firm before deficit operation.
The market value analysis 1s performed in three steps. The first Is the calcu-
lation of the NPV of the pollution control investment. The second 1s the deter-
mination of the stock price adjusted for the cost of pollution control. The
third step is the calculation of the Market-to-Book Ratio of the stock, with and
without the cost of pollution control.
3.3.1 Wet Present Value Cost of Pollution Control
3.3.1.1 Theory
Comparisons involving expenditures and/or receipts at different times over a
span of years are valid only if all are expressed relative to one point in time.
The most convenient point in time to use Is the present, and net present value
(NPV) of a flow of receipts and/or expenditures Is the standard method employed.
Future cash flows, whether positive or negative, are expressed as a present
value by discounting the specific cash flow, at a given or assumed interest
rate, over the period of time from the present td the time of occurrence of the
cash flow. Cash flow 1n this context Is the gross amount of money received or
spent in a transaction. The cash flow determination does not consider such
things as the form or source of the funds or taxes or credits that may be
involved in the transaction. For example, money expended In the current year to
purchase and install pollution control equipment 1s a negative cash flow. It 1s
not subject to discounting because 1t occurs in the current year. Operating and
maintenance costs for this equipment are also negative cash flows, and revenue
77
-------
received from the sale of by-products recovered by this equipment would be posi-
tive cash flows. Both of these future cash flows would have to be discounted to
be correctly included in aggregate cash flow estimates for pollution control
systems of interest. These discounted cash flows plus the present cash flow are
summed to obtain the net present value, which may be negative for expenditures
or positive for receipts. The net present value (NPV) of the cost of pollution
control equipment may be approximated as the Initial cost of the equipment plus
the present value of the operating expenses discounted at an interest rate equal
to the cost of equity (see Section 2.1 for a further discussion of cost of
equity). Worksheet 6 on page 34 of the Workbook is used to calculate the cost
of equity and the present value of the pollution control equipment. This is
done for the most recent year for which data are available. In this calcula-
tion, the O&M costs are also discounted at the cost of equity.
The estimate of the cost of equity 1s based on the sum of a risk-free Interest
rate, e.g. the rate on U.S. Treasury Bills, and a historical rate of return on
stocks 1n excess of the risk-free rate. The latter 1s calculated for a specific
firm using the Value line beta ty3). This value Is used as a multiplier to
reflect an estimate of the comparative financial risk associated with a specific
firm 1n relation to all firms listed on the New York Stock Exchange (NYSE). A
firm representing a higher risk would expect Its cost of equity to be higher,
hence Its beta would be greater than the NYSE average of 1.0.
3.3.1.2 Calculation
The data needed to calculate the NPV of the pollution control equipment can be
obtained from the Value Line report on the firm (see Exhibit 3-21) and Standard
& Poor's Daily Stock Price Record. Information concerning the pollution control
equipment Itself (O&M cost, estimated life, and, rate of growth O&M cost, for
Instance) must be developed by the permit writer or supplied by the firm. The
NPV calculation 1s done on Worksheet 6 (page 34 of the Workbook), and the steps
are as follows:
1. Multiply the capital cost of the pollution control equipment by 1 minus
the Investment tax credit factor or find the adjusted capital cost on
Line 8a of Worksheet 4b. Enter this value on Line 1 of Worksheet 6
(page 34 of the Workbook).
78
-------
flR—HB >mi»
13
Exhibit 3-21
DATA FROM VALUE LINE - NET PRESENT VALUE
*te an**I . m
i I MM ¦ Ml
IT HHW
SI. tM
I
tmm. mti
104 US M l
W Cay»»i>M« ClmriCT)
m o^ukmwii
1129 6* Sorowra Iran
-iiSuii-illH
t0- 90(150-275*)
40. tt( 135-2551)
itrn
».4 4.1*
114 Ul
¦*"
lio
ns
iffl BBSSMr- I i 123 H\ til'WI
1117 GnJlwtM Hoieol
ll»3 &(yMgMCan»
111 IST^alA
## tto HgiNliM
IX 172 Gumma ind.
I- 14 ( N- 25*) MJ
10. 4S IM-IJC*) 4.7 U*
9/30 411
9/30 Ul
ITS
9/10 <21
t/30 411
1/30 41
1/31 Jl
-ta-
IWl .39
an .is
13/3
12/31 m.
ivii m.
w-
1/31 20
12/11- «»
IJJ1 J&-
74
ffl8aaw,"ta>
t!9 Cj« RnogiMt t Own.
711 OJI Slim IM.
writB-SlfSSSSr
1117 QgltsAM.
ill MMWM.IM.
JT Iwl. Ine
Jtsti.
Ml!* II M ij: >f lit A i-18 * It
SO 44 14 1.10 «• 9S (50-115* M Ml 4.19 IM It
« II 11 1.0S 40. 10 (10- IS*) 11.1 1.2* 2.54 It 44
-w—H-K8 ii:remits *8*8 «
1175 Ml HT
m MfHitt
«t 11 4 1 1.20 IS- 50(170 140*) M M 1SI M. II
0SU II 4 1 70 20- 30 (S5-110*) t-2ll.lt 2-01 140 19
•g ft SI L» it: 2 flhiW lU i» fii1 ft H
«U. 11 11 MS 20. » (SS-IS0*) 94 S.0* Ul .10 42
11 II 1.20 12> 2S (10-125*) IM Ml IM ML 71
Hackwuck#15
2974 H«l (frank B.) 4 Co.
ItSI KW«unsn Co.
tbit
fJH 29
hil 19
TT
4 I
1 1
TO
.70
1.30
JW1
1L
TO/ST
11/10 *J4
10^1 Jl
j/ii .iir
12/11 IS
12/n m.
snyitV-tMH) ii 16.1*
so. 70 (70-140*) 12.1 Ml
ts« IS (IS-U5f) 9.1 Ml
HI lit M
2.3t 1.70 29
3.93 1M W
V 11 it: il"3I 25 IS
12/11 « 50l_
—mi 11
1724 ru»anan EMC. »< 11 11 ,t0 IS* SS (4S- 75*) 10.4 1.7* 2.99 1«0 M
714 H^m-AiDwi Corn Nir n 4 4 90 17- 2K ISO 270*1 M « 11.11 M. N
IML Mais w«$
Jill 1441 M-a imc > -n ifbt itf. > Mit-M
A •::<»> it • '-i-n .t tianit
• !-—tujuit: • 3«M ;rt via*
•»|.4» :»/ir«i" i» rii xwit " :r« «'•« ;.vw t»r
'-• -•ii Bi'ja ;i 1 to Mt' •••-in i'-ut
1981-17. Of Cii-iim Cirr-n 12 -»•.~! !> t-10'13 'M
-o^* *o-cn-|iiiB'|.i-|ica:ai km
!.ri'p wit imi !'« •••« :'!"(• :-s»i «n an-
•i'' 154.*N if t*a h>m|i -u«" • i-r :imi :•»
«MM!*a««•<«<*(lira a" |1-4co.«i-»»
M in* '«>*! ol tit* «>MnM at «*auiicrt si sow nu
• Nn ¦ |u,« IM MM.
U u:« «4k>!N lor tmowKat ilaca )|M M II» Ji«ar4
te itc :n« it P11-.411. 9iwi
ai (1c1.su :.U'.c.:«a 01 it «t * a"?
l> Cvk« Mi
:ti :i-ii tii-aiaa aanqr fm» s>: ra• ' |wf4 S«l lij IM
X nm urititm. ** m 'm
79
-------
2. Enter annual O&M expenditures for pollution control (from Line 6 of
Worksheet 4b) on Line 2.
3. Record the operating life of the pollution control equipment (should
not be greater than 10 years) on Line 3.
4. Record the rate of growth or inflation in O&M cost (in percent per
year expressed as a decimal fraction) on Line 4.
5. Find the company beta (/£) in the Value Line report for the firm.
Record this value on Line 5.
6. Enter the risk-free rate of interest on Line 6. Use the current rate
of return on six-month U.S. Treasury Bills to approximate the risk-free
interest rate. This will be available from a local bank or the Federal
Bank of the appropriate Federal Reserve District.
7. Mutiply Line 5 (company beta) by 0.08 and add this to Line 6 (risk-free
interest rate) to get the discount rate. Record the result on Line 7.
The 0.08 1s the excess return on the stock market over the risk-free
rate and 1t has historically been about eight percent.
8. Enter the value of recovered by-products from the pollution control
equipment (1f any) on Line 8. Use cost of production if recovered
materials are produced at the specific plant and price as the value of
raw materials are recovered. Prices of many chemicals and other sub-
stances are reported 1n the Chemical Marketing Reporter and other trade
journals.
9. Using the following formula, calculate the present value of the 0&M
costs discounted and suimied over the life of the pollution control
equipment:
Enter the result on Line 9a.
10. Using the following formula, calculate the present value of recovered
materials discounted and summed over the life of the pollution control
equipment:
PV0M »
where: PV0M * Present value of 0&M costs
L 3 Life of equipment (Line 3)
0M *. Annual 0&M costs (Line 2)
g ¦ Rate of growth in 0&M costs (Line 4)
r » Discount rate (Line 7)
80
-------
PVRM =
(CR) x(l-(l+r)Q
-r
where: PVRM » Present value of recovered materials
L 81 Life of equipment (Line 3)
CR s Credits for.product recovery (Line 8)
r = Discount rate (Line 7)
Enter the result on Line 9b.
11. Add Line 1 (adjusted capital cost) and Line 9a (present value of O&M
costs) and subtract Line 9b (present value of recovered materials) to
get the net present value of the costs of pollution control. Enter the
result on Line 9c.
Exhibit 3-22 demonstrates this calculation using the sample firm data.
3.3.2 Adjusted Stock Price
3.3.2.1 Theory
Because the stock price reflects the net present value of expected future cash
flows (profitability), subtracting the after-tax NPV of pollution control costs
from the firm's market value provides an estimate of the Impact of the equipment
on the present value of future cash flows. In essence, the difference between
market value and the NPV of pollution control costs is what the firm's market
value would be 1f the control were required. Worksheet 7 on page 37 of
the Workbook is used to perform this calculation.
3.3.2.2 Calculation
The data needed to calculate the adjusted stock price can be found in Moody's,
Standard & Poor's Dally Stock Price Record, or Value Line. High and low stock
prices for the year and the average number of shares outstanding can generally
be found in the Financial and Operating Data section of Moody's (see Exhibit
3-23). This Is the best source of these data. If the data are not available 1n
Moody's, the permit writer should check the other sources. The stock price data
in Standard & Poor's are expressed as 25-7, 22-1, etc., which means 25-7/8,
22-1/8, etc. The permit writer must go through an entire year's data to find
the annual high and low stock prices 1n Standard & Poor's. The calculation is
done for the most recent year and the steps are as follows:
81
-------
Exhibit 3-22
WORKSHEET 6
NET PRESENT VALUE COST OF POLLUTION CONTROL
($1000)
Most Recent Year
of Company Data
Year 1982
1. Capital Cost of Pollution Control
Adjusted for ITC
Worksheet 4b, Line 8a
2. Annual Operating and Main-
tenance Cost (OM)
Worksheet 4b, Line 6
3. Estimated Life of Equipment
1n Years (L)
4. Expected Rate of Growth 1n
O&M cost (g)
5. Company Beta
6. Risk-Free Rate (r)
7. Discount Rate (r)
Line (6) + (0.08 x Line (5))
8. Credits for Product Recovery (CR)
9a. Present Value of 04M Costs (PVOM)
(OM) x(l-(l+r))
pvom - M
8,500
1,000
5
0.05
1.10
0.0944
0.0953
0
4,603
9b. Present Value of Recovered Materials (PVRM)
PVRM =
(CR) x
C l-Q+r)L)
-r
9c. Present Value of Pollution
Control Costs
Line (1) + Line (9a) - Line (9b)
13,103
82
-------
MOODY'S INDUSTRIAL MANUAL ifl)!
wu *41,100,000 in 19*2 and*#37400.000 In ance methc . . _ no dlltlei (¦ de- AudKore Report
1981. preeimted o Exhl D11 3-23 naining uae- The 5" •*e*D>* 'rom the Report
At Dec. 31. 1982, minimum rent*! payment. »
companies, aggregating *22.350.00p. . . predated or amortiaed principally on straight* their operations and changes In their financial
Co. has adopt% a Restricted Stock lncen- line method. PJ>*^on to the years ended DetemSer Ji,
tivcP!*" Providing for awards of up to a total Maintenance, repair*, and minor renewals «ener-
^SSi lh*™' un certain terms and ,rt charged to income; major renewal* and ftl di!rfn» 5w b?52?p conJ>»le,}t-
e0?e^ Property.jplant and equipment are sue frtt.rment, are capitalized Upon normal re- &
ed at cost. For financial accounting purposes. Jwrat or replacement, coat of property (less method of acrounting for foreign currency
Co. depreciate* major portion of »ts process- proceeds of sale or salvage) is charted to ac- translation, as described in Note 2 to fte cc»£
ingfaclHUMj^^jg^^no^fieddeclmTn* bal- cumulated depredation, soiidated financial statements."
f FiNANclETo^R^TDATn
¦ iiminsr^Kww"——
Earned per share— 19(2 1911 1M0 1979 1971 1977 igji
—torn.«( com. eq. onyr.end. sh*. IK3-16 IBH.t? JER'5® 0H-M ffiK"55 ED**-14 [3*2.36
—com. & com. eq. on avie. sits. (5(2.22 B55.09 UX2.60 0IJ.B9 u£j.36 uSlJA 0x2.44
(1.26 $1.20 —common 2*V<-I6*A I 26W-18V. 25-I5V4 IZVt-lt'A UVrWA 28'A-HV. is.m
4CjBn«^luirsiuI buh.uuc (wl1: 1 "ijwiiwfl 1 *s-»j «%•«» ,«-7« 10J44-12S m-wy.
Notes.»%.. 198j 99V.-WIA 94W-87W 97-82W 9*^*614 IM-* IOSVrlOl8 106H-IO*
Net tangible assets per ah.—common *24.14 *24.70 *23.69 122.11 <19:B 817.68 *17.34
Times charges esmed:
Before Income taxes 3.11 3.02 4M 9.13 6.6* 4.29 7.38
^ttetLtfOBUfies 2.71 3.92 4.05 6.42 4J0 2.7* 4.19
4««i.1Tin 42.314.438 42.44I.47t 42.383.028 42.383,028 42.383.028 42.383.028
t ¦"C^yWrnon. iv'r«¥.. .TTTTTTT'. "7 1,1 WJMlifl 42,308.368 42.420,225 42.3aj.02g 42JS3.028 42.383.028 42.332.732
1 ymwiuiuimuiiwuniiBHiiwii *
Current asseta+currentliabiliiie* 2J1 2.33 1,95 1.94 IJ9 2.20 2.23
% cash It securities to current assets 4.36 3.23 4.64 7.16 1.19 . 4J3 5.40
% inventory to current asset* 47.04 47.64 45,39 40.93 44.(0 4?.60 47.41
% net current assets to net worth 39.99 49.35 38.29 40.13 40.64 43.23 42.22
% property depreeisted 35.39 55.03 53.64 54.63 33.78 53.07 51.17
%ann. depr.il amort, to gross prop 5.79 5.19 6.0* 6.23 6.60 6.11 6.23
Capititlltadon:
% lung term debt 28.J9 3a IS 24M 22.89 26.56 30J1 30.55
% common stk.lt surplus 7t.41 69.82 75.11 77.11 73.44 69.69 69.45
Sales-inventory 6.70 6.6* 7.37 7 JO 6.14 5.71 5.93
SsJea*- receivables 6.49 6.41 5.95 5.76 5.86 (22 5.96
% sales 10 net property 267.30 299.47 2*4.79 303.46 272.51 235.3* 228.19
ft tales to toUJ assets 123J7 136.11 13IJ2 133.17 121.91 114.91 111.5*
% net income to total assets 4.92 6.S3 6.03 9.80 6.47 3.92 7.47
% net income to net worth 9.12 12.9* 11.29 18.25 12.62 7j65 14.39
Analysis of Operations % % % % % % %
Sales, less discrete. 10000 100:00 100.00 I0a00 100.00 100X0 100.00
Cost of goods sold *2.66 *0.(6 82.04 79.01 77.17 79J3 76J7
Sell., gen. It sdm. cxp 12.73 I1J5 11.73 11.97 13.26 13.37 13.10
Bslsnce 4.61 7.79 6.23 9.02 9.57 7JO 10.03
Other income 1.7* J3 0Mr 3.38 1.1* 0.85 4.33
Total income 6.39 (.62 7AI 12.40 ia75 *.15 14.56
Interest tt debt expense.....' 2.05 1.72 1.50 1J6 U1 1.90 1.97
Net income before Income casta, etc 4.34 6.90 5.53 11.04 9.14 6.25 12.59
Income It franchise taxes 0,82 IJ* 0.94 3.6* 3J3 2.84 5.90
Extraordinary gain 0.47
Net income 3.99 5.02 4.59 7J6 SJ1 J.4I 6.69
^Includes (0.66 nonrecurring gains. Qffnciudes *0.14 plant write-down. QJIndudes <0.11 plant write-down. [Btndudn (0j62 gain on sale of pigment and
methanol assets. QjIndudes (0.1J loss from terminating operations at Joint-venture terephthalste plant at Ulddieburt- QHnclvdes 50.27 write-down of fscilities and
investments. QUncludes <0.25 extraordinary gain. ,
LONQ TEAM DEBT stHcted aubaidUry in favor of the United thereto would become subject to the Uen of
. ¦¦¦ n/.v. 1U,. ' States of America or any State thereof, or in such mortgage, unless the notes shall be se-
1. Hercules inc. ¦%* iwea. «!• IMS. favor of any other country, or any agency. In- cured by a direct lien upon all such important
,,_.r n .... strumentality or political subdivision thereof, property, prior in rank to all liens other than
00.000,000; outstg., Dec. 31, 19*2, to secure certain payments pursuit to any any theretofore existing thereon, subject to
DATED^Apr, 1, ,975. DUE-Apr. 1.19*3. SrTVw.WdSft?? S^'fEASEBAC^ROVISION-Sal.
^N^I^^F^^er^. *1,000 ^^"fn^l^mcnrunde^^^ R~rob^ whlS ^uld be^m^ed
part at any «SB ~r SSint^to^S:
time on or after Apr, 1. 19*1 on at least 30 but any vendor, lessor or aasignor reserves or ex- P .1 tb) an amount equal to the proceeds
not more than 60 days notice at 100, plus ac- cepts an interest in oil, tas or any other miner* ?' ??'? ®r "i8 *•.'?' of V?eJprop, y J9*d
erued interest, j] Qf proceeds thereof, (ix) conveyances or (whichever is higher) Is applied to the retire*
ii^ni?t$v'U8r1*"~Nron?j r~ aasignmenu under the terms of whic£ Co. or a "J*"1 ofindeMeXjeMformoney borrowed by
SECURITY-Kot secured. Co. nor any re- restricted subsidiary conveys or assigns an in- Co. or a restricted subsidiary, which was re-
stricted subsidiary may create, assume or tercet Si oil, gas or other mineral or the pro- corded as funded debt as of the date of its ere-
guarantee any secured debt without making ceeds thereof, (x) liens on any property owned ation and which, in ease of such indebtedness
effective provision for securing the notes (and by Co. or a restricted subsidiary, or In which of Co., is not subordinate and Junior in right of
any other mdebtedness of, or indebtedness Co, or a restricted subsidiary owns an interest, payment to the prior payment of the notes,
guaranteed by, Co, or such restricted subsidi- to secure payment of Co.'a or such restricted Co. *rill not itself, and wUI not permit any
arythen entitiedthereto) equally and ratably subsidiary's proportionate part of the expens- restricted sutnidiary to, transfer any Impor-
wttn sucn secured aebt, except lor ci) ceruin es of developing or conducting operations for tant property to any unrestricted subsidiary,
, l{,r recovery, storage, transportation or sale of without retiring indebtedness as summarised
fSS^5? th* mineral resources of such property, or (ad) in clause (b) of the precedingparapaph. .
aS? *By •*?«"»<"!. ren«««l ««• replacement (or INDENTURE MODIFICATION—Inden-
ary, (UJ certain mortgages on property of Co. successive extensions, renewals or replace- ture mav be modified, exceot aa provided,
or a restricted subsidiary on which new plants menu), In whole or In part, of any mortgage. SKk consent^of ttlLo^oMsoutstg
are constructed If. in the opinion of the board pledge. Uen or encumbrance referred to in the LJSTEr{!Io2^New'Vori?S?oik E«hanee
of directors, such property was substantlaUy foregoing clauses (I to x). inclusive. Notwlth- tor* time on at least 30 but not more than 60 days
(vii) mortgages on property of Co. or a re* tant property owned by C ediately prior notice to each June 29, aa follows:
-------
1. Obtain the high and low stock prices for the most recent year from
Moody's, Value Line, or Standard It Poor's. Record the values on Lines
la and lb of Worksheet 7 (page 37 of the Workbook).
2. Obtain the average number of shares outstanding during the most recent
year from Moody's, Value Line, or Standard & Poor's Daily Stock Price
Record. Record the value on Line 2.
3. Multiply Lines la and lb (high and low stock prices) by Line 2 (number
of shares outstanding) to get the high and low market values of the
firm. Record the results on Lines 3a and 3b.
4. Enter the NPV cost of pollution control (from Line 9c of Worksheet 6)
on Line 4.
5. Enter the marginal tax rate for the firm (if available or use 0.46; can
also be found on Line 3 of Worksheet 4b) on Line 5a.
6. Subtract Line 5a (marginal tax rate) from 1; enter result on Line 5b.
7. Multiply Line 4 (NPV cost of pollution control) by Line 5b to get the
after-tax NPV cost of pollution control. Record the result on Line 6.
8. Subtract Line 6 (after-tax NPV cost of pollution control) from Line 3a
(market value - high) or Line 3b (market value - low) to get the high
and low market values adjusted for the after-tax NPV cost of pollution
control. Record the results on Lines 8a and 8b.
9. Divide Line 7a (adjusted market value - high) or Line 7b (adjusted
market value - low) by Line 2 (number of shares outstanding) to get the
high and low stock prices adjusted for the after-tax NPV cost of pollu-
tion control. Record the results on Lines 8a and 8b.
10. Divide Line 6 (after-tax NPV cost of pollution control) by Line 3a
(market value - high) or Line 3b (market value - low) to get a measure
of the impact of the pollution control cost on the firm. It is
expressed as what fraction the after-tax NPV pollution control cost is
of the high and low market values of the firm. Record these values on
Lines 9a and 9b.
An example of the above calculations using the sample firm data Is shown in
Exhibit 3-24.
84
-------
Exhibit 3-24
WORKSHEET 7
ADJUSTED STOCK PRICE
Most Recent Year
of Company Data
Year 1982
la. Stock Price (S/share) - High 28.75
lb. Stock Price ($/share) - Low 16.875
2. Number of Shares Outstanding (X1000) 43,212
3a. Market Value ($1000) - High
Line (la) x Line (2) 1,242,345
3b. Market Value ($1000) - Low
Line (lb) x Line (2) 729,203
4. NPV Cost of Pollution Control ($1000)
Worksheet 6, Line 9c 13,103
5a. Marginal Tax Rate
Worksheet 4b, Line 3 0.46
5b. 1 - Line (5a) 0.54
6. NPV Cost of Control After Tax ($1000)
Line (4) x Line (5b) 7,076
7a. Adjusted Market Value ($1000) - High
Line (3a) - Line (6) 1,235,269
7b. Adjusted Market Value ($1000) - Low
Line (3b) - Line (6) 722,127
8a. Adjusted Stock Price ($/share) - High
Line (7a) divided by Line (2) 28.59
8b. Adjusted Stock Price ($/share) - Low
Line (7b) divided by Line (2) 16.71
9a. NPV Cost of Control After Tax as a
Fraction of Market Value - High 0.0057
Line (6) divided by Line (3a)
9b. NPV Cost of Control After Tax as a
Fraction of Market Value - Low
Line (6) divided by Line (3b) 0.0097
85
-------
3.3.3 Market-To-Book-Ratio
3.3.3.1 Theory
The third part of the market value analysis is the calculation of Market-to-Book
Ratio. This ratio measures the value the stock market places on a firm in rela-
tion to an estimate of the tangible asset value of the firm "on the books", i.e.
the net worth of the firm. Net worth, or book value, is computed as total
assets minus total liabilities. Book value is expressed per share as is the
stock market price. Stockholders' equity is an alternative measure of net
worth, as used on Worksheet 8 on pages 40 and 41 of the Workbook. The
Market-to-Book Ratio is used to assess the trend in stock market evaluation of
the firm over a period of time relative to the book evaluation for the same
time. The effect of the cost of pollution control equipment on market eval-
uation is expressed as the net present value of the total cost after-tax sub-
tracted from the current stock market price. The Market-to-Book Ratio is re-
computed with market value adjusted as described previously. Changes in the
ratio are indicators of the pollution control cost effects.
3.3.3.2 Calculation
The Market-to-Book Ratio Is calculated using Worksheet 8 on pages 40 and 41 of
the Workbook. The calculation is done for the three most recent years without
the cost of pollution control and for the most recent year adjusted for the cost
of pollution control. The data needed are available in Value Line Industry
Surveys, Moody's (Exhibit 3-25), Standard and Poor's Industry Reports, or the
firm's annual reports. The steps 1n the calculation of Market-to-Book Ratio are
as follows:
1. Obtain the high and low values of the firm's stock from Moody's (see
Exhibit 3-25), Value Line, or Standard & Poor's Daily Stock Price
Record. Record values for the three most recent years on Lines la and
lb of Worksheet 8 (page 40 of the Workbook).
2. Enter stockholders' equity, from Line 6 of Worksheet 5, for the three
most recent years on Line 2a.
3. Enter average number of shares outstanding for the three most recent
years on Line 2b. This Information can be found on Line 2 of Worksheet
86
-------
MOODTS INDUSTRIAL MANUAL
1601
*u 141,100,000 In 19S2 and *S37,3O0.0od in ance meth 0 oc idtitlce U de- Auditor's Report
t9Bt. , , precnted EXniDlt J-O imainln* u*«- The following!* an excerpt iTotn ^ ReDort
Al Dee. 31. I9»2. minimum rcnul paymenu ful lives. l. ... -vMr of Indeoendenl Auditor*. Cooper* it Lvbranrf
under noncanceflable lea*e* "red in 1981 Annual Report.
?5i5:\s?^%»hIinch.??4S:0M DATA FROM MOODY'S - MARKET-TO-BOOK RATIO
*'ai DeefV" ivil." Cofwii'con'SnienU v Usble »"umi penoas. Kemauiing facilities o( Co. and and'*ub*]iiary comp*ni«f ai'" D«emS£?:fi>
* guarantor of notes payable of affiliated fariUties of consolidatedI subsidiaries arc de* 1962 and *nd the consolidated results ol
T_ 11 .> am * ' — 1 * 1 11 —ik«if nn«Mt am inf( u .l > <¦ to m total Maintenance, repairs, and minor renewals l*®2; JMJJ*®1? 5PJ?lor5,'fy w,th fener-
of <500.000 shares, based un certain terms and are charged to income: major renewals and duS® ?i5iri£2?Bilp,es consistent-
conditions. k-..... i?«__ —- IV appuea aunng uie period exceot for Ihf
i'' *
Co. depredates major portion of it« process- proceeds of safe or aalvi— ..... _ — - — -,-7 „
in* facilities, using a modified declining bal- cumulated depredation. solidated financial statements."
' D,TA'
m£B mis dS aJjS a® ra'S iJfii
—com. It com. eq, on avge. ths 0312.22 ESi.09 0*2.60 GjUM 1292.34 [2tl.J6 QS2 44
7>A *1.00 11.00 Toss
Price R*n*e—common UV.-\tV. Z6W.I1UJ5-15>/. ¦ 22V..I6I/C UVt.I2>/i MU.ni/. " "
Lww.murmJ.umuui iww 1 tmam T ''»'»> n-il 102&12G 117-93%
Notts. »>/,«. 1»«T MV4-93'/| MVM7M M %-M'A 103.94 Wi'/rmV, lOMVlOl
Net tangible ***et* per «h, common *24.1] <24.70 <23.69 t22.ll <19.16 SI7.M 117J4
Ttmes charges earned:
Before Income taxes 3.11 5.02 4.61 9.1 J 6.6S 4j» jjg
2.71 3.92 4.03 <.42 4.J0 j.jg 4j$
42411,021 42.3U.02S 42.313,021 42.UJ.0IS
Current aueu+current liablli1 ie* 2.23 2.SS 1.93 1.94 149 229 2.23
%ca*h It securities to current asset* 4.34 3,23 4.44 - 7.11 1.19 , 4.15 S.40
% inventory to current asset* 47.04 47.64 42J9 40.93 44.10 49.40 47.41
% net current aueti to net worth 39.99 49.33 31.29 40.13 40.44 43.23 42.22
% property depreciated 55.59 55.03 S3.44 54.43 55.71 S3.07 51.17
% ann. depr. it amort, to iron prop. 5.79 S.I9 • 6.01 6.2S 4.40 4.11 6J3
Capiulization:
% lun( term debt 21.39 30.1* 1439 22.19 24.54 30.JI 30.35
% common si*.* surplus 71.41 49.12 75.11 77.11 . 73.44 49.49 49.45
Safe* "-inventory 4.70 6.61 7J7 7 JO 4.14 S.71 5.93
Sales" receivable* 4.49 4.4* 5.93 S.74 546 4.22 5.94
% sales to net property 267.30 299.47 284.79 303.46 272.51 235J! 221.19
% sales to totdasseu 123.37 134.11 131.52 133.17 121.91 114.91 III4S
% net income to total assets 4.92 MJ 6.03 9.10 6.47 3.92 7.47
% net income to net worth 9.12 12.91 11.29 1S.25 12.42 7.65 I4J9
Analysis of Operations %%%%%%%
Sale*, less disc., etc 100.00 100.00 100.00 100.00 100.00 100.00 100.00
Coat of food* sold (2.64 10.16 >2.04 79.01 77.17 79.33 76.17
Sell., ten. lcadm.exp. 12.73 I1J5 11.73 11.97 13.26 13.37 13.10
Balinc 4.61 7.79 4J3 9.02 9.57 7.30 10.03
Other income 1.71 J3 0M tM US 045 4.53
Toul income 6.J9 «,42 7.03 12.40 10.75 1.15 14.56
Intereit It debt expense 2.05 1.72 1J0 IJ6 1j6I 1.90 1.97
Net income before income taxea,etc 4J4 6.90 5.13 11.04 9.14 6.25 12.39
Income & franchise taxes 042 141 0.94 3.6S 343 244 5.90
Extraordinary tain 0.47
Net Income 3.99 5.02 4.59 7J6 5.31 3.41 649
Concludes 10A6 nonrecurring gaini. COTndudea 10.14 plant write-down. Qjlncludes SO. 11 plant write-down. BHachides 10.62 nin on sale of pigment and
methanol asiet*. Qjlndude* SO. 13 loss from terminating operations at joint-venture terephthaiale plant at Middleburg. [Qtndudet S0.27 write-down of facilities and
investments. Conclude* S0.25 extraordinary gain, (
LONQ TERM DEBT stricted subaldiiry in favor of the United thereto would become subject to the lien of
e M«m» iiw, ¦»/.«. mm« *1. «<1 Pledge, lien or encumbrance referred to in the LISTElEIoi. Ne^ vllk Exchanee
Pf fueiLp,ro,>ei!?iw*" n foregotng clauses (i to x), inclusive. Notwith- Y°t* st
unimproved for its intended use prior to such a tending the above, Co. and one or more re- .~T;,rr'^~ reduc* dome*tic
SSn,.^iS,™22i. ' mortgagee, pledges, liens or strict ed subsidiaries msy, without securing the fte?pM?£2J«ioo!S» mn\ ., >m rnrafceds
encumbrances on property existing at the time notes, issue, assume or guarantee aecured OFFERED—*!100,000,000) at 100 (proceeds
of acquiiition thereof, whether or not assumed debt which would otherwise be subject to the J? C°- 99 JO) on MarM. 1975 thru Lehman
by Co. or a restricted subsidiary, (iv) mort- foregoing restrictions, provided that, after giv- Brothers, Int and Merrill Lynch, Pierce. Fen-
gages, pledges,, liens or. encumbrances on ing effect thereto, the aggregate amount of ner Smith, Inc. and associates.
—t -hen ouutg. (not including & Hercules, Inc. convertible subordlnoied de-
^ itted under the foreeoing benture 6Vis, duo 1M«
-t,"- ary, (v) mort- exceptions) and the aggregate "value of aale --
cage*, pledges, lien* _or encumbrances on and leaseback tranaactlona (other than auch ., , .... ®
?u°P of.*i ,coT°^on exitting at the time uansactions in connection with which indebt- ^nnS'f»5 ; ouut*" • ,l' lM2,
aucn corporation is BtersM into or consolidat* edness has been» or will be* retired to accord* i?9tS«4?^a .. ....
ed w'th Co. or a restricted subsidiary or at the ance with the /oliowing provision) at such Pt/ub*^2'
time of a sale, lease or other disposition of the time does not exceed 5% of shareholders' INTEREST—»J30 St D31 to holders registered
properties of a corporation or firm aa an en- ownership. JStP IS. _ _
Orety or substandally as an entirety to Co. or The indenture will Provide that no consoli- TRUSTEE—Banker* Truat Co., NYC _
a restrictMi subaidiary. (vi) mortgagee, datlon or merger of Co. and no aale of all or DENOMINATION—Fully r«gl*tered. Sl.000
' ntially all of iu property shsll be made or integral multiple thereol.
r to another corporation having any ob- CALLABLE—As a whole or in part at any
i-;,. _ —ligations secured by mortgage if any impor- time on at least 30 but not more than 60 daya
(vil) mortgages on property of Co. or a re- tant property owned " Immediately prior notice to each June 29, aa follows:
-------
7 (for the most recent year) and Moody's» Value Line, or Standard &
Poor's Daily Stock Price Record. It should be noted that the number of
shares outstanding can change from year to year so the values may not
all be the same.
4. For each year divide Line 2a (stockholders' equity) by Line 2b (number
of shares outstanding) to get book value per share. Enter the results
on Line 2c.
5. For each year divide Line la (market value/share - high) or Line lb
(market value/share - low) by Line 2c (book value/share) to get the
Market-to-Book Ratios. Record the results on Lines 3a and 3b and on
Worksheet 14 (page 57 of the Workbook).
6. For the most recent year, enter high and low adjusted market values per
share (from Lines 8a and 8b of Worksheet 7) on Lines 4a and 4b.
7. Divide Line 4a (adjusted market value/share - high) or Line 4b (adjusted
market value/share - low) by Line 2c (book value/share) to get the
Market-to-Book Ratios adjusted for the cost of pollution control.
Record the results on Lines 5a and 5b and on Worksheet 15 (page 58 of
the Workbook).
8. Evaluate the three-year trend in stock prices and Market-to-Book
Ratios. Record results of this evaluation on Summary Line 1 (page 40
of the Workbook) and on Worksheet 14 (page 57 of the Workbook).
9. Evaluate the change in Market-to-Book Ratio due to the cost of pollu-
tion control. Record results of this evaluation on Summary Line 2
(page 41 of the Workbook) and on Worksheet 15 (page 58 of the Workbook).
Exhibit 3-26 shows a calculation of Market-to-Book Ratios using the sample firm
data.
3.3.3.3 Interpretation
Two analyses are used to evaluate the Market-to-Book ratio. These are:
1. three-year trend; and
2. adjusted ratios.
These analyses are described below. The results and interpretation should be
entered on Worksheets 14 and 15 on pages 57 and 58 of the Workbook. Examples
are provided 1n Chapter 5.
Critical values and industry averages are not used because Market-to-Book Ratios
vary widely from industry to industry and from firm to firm. In addition,
Market-to-Book Ratios may vary widely over the life cycle of a given firm.
88
-------
Exhibit 3-26
WORKSHEET 8
MARKET-TO-BOOK RATIO
($)
Three Most Recent Years
of Company Data
Year 1982 Year 1981 Year 1980
la. Market Value per Share - High 28.75 26.375 25.0
lb. Market Value per Share - Low 16.875 18.75 15.125
2a. Stockholders' Equity (S1000) 1,175,655 1,100,147 1,009,746
2b. Number of Shares Outstanding (X1000) 43,212 42,508 42,420
2c. Book Value per Share
Line (2a) divided by Line (2b) 27.21 25.88 23.80
3a. M/B Ratio - High
Line (la) divided by Line (2c) 1.06 1.02 1.05
3b. M/B Ratio - Low
Line (lb) divided by Line (2c) 0.62 0.72 0.64
4a. Adjusted Market Value
per Share - High
Worksheet 7, Line 8a 28.59
4b. Adjusted Market Value
per Share - Low
Worksheet 7, Line 8b 16.71
5a. Adjusted M/B Ratio - High
Line (4a) divided by Line (2c) 1.05
5b. Adjusted M/B Ratio - Low
Line (4b).divided by Line (2c) 0.61
SUWARY
1. Three-year trend 1n stock prices and Market-to-Book Ratios: Stock prices
and Market-to-Book Ratios have been fairly constant over the past three
years.
89
-------
Exhibit 3-26 (continued)
WORKSHEET 8 (continued)
2. Change in Market-to-Book Ratios due to cost of pollution control: No
noticeable changes in Market-to-Book Ratios due to pollution control costs.
90
-------
The three-year trend indicates whether the Market-to-Book Ratio has increased,
decreased, or remained the same in recent years. In general, a decreasing ratio
is a negative sign because it indicates decreasing investor confidence in the
earning potential of the firm. A stable or increasing ratio Indicates investor
confidence. However, two factors must be considered in using the Market-to-Book
Ratio. First, stock prices frequently rise and fall in response to other fac-
tors other than the expected performance of the firm. As a result, changes in stock
price, and consequently in the Market-to-Book Ratio, may be largely unrelated
to the expected performance of the firm. Second, market prices may be affected
by changes in dividend payments by the company, which may not be directly
related to the financial health of the firm.
The adjusted ratio indicates the Market-to-Book Ratio that would be expected if
the pollution control investment is made. The adjusted ratio will always be
less than the unadjusted ratios. The reduction in the ratio is to be considered
in relation to the recent trends of the ratio:
0 does 1t seem to indicate that the cost will seriously Jeopardize an
already precarious corporate situation; or
• will it turn a marginally promising situation into a questionable one;
or
0 will the effect be no greater than the variation found in the recent
past?
The adjusted ratio' can also be considered 1n terms of the percent reduc tion
from the unadjusted ratio. The significance of the reduction is a qualitative
judgement, as 1s the comparison to recent trends. No precise guidelines are
available as to what would constitute acceptable or un- acceptable Impacts on
the Market-to-Book Ratio. Substantial reductions or changes may be viewed as
one set of adverse indicators to be considered with the other firm-level
results discussed in this chapter.
91
-------
CHAPTER 4
PLANT-LEVEL ANALYSIS
4.1 INTRODUCTION
The firm-level tests presented in Chapter 3 are relatively straightforward and
depend on readily available data. However, these tests may not be sufficient to
determine If an individual plant can maintain operations when faced with addi-
tional pollution control expenditures. Even though a firm could afford the
additional cost, it may be more profitable to close a plant rather than install
the pollution control equipment. Two conditions would indicate a need for
plant-level analysis:
• the firm contends that Investment 1n pollution control would make the
plant unprofitable to operate; or
• the firm-level analysis indicates that Investment 1n pollution control
would have a serious detrimental effect on the firm's financial health.
The plant-level analysis described 1n this chapter 1s based on plant-specific
costs and revenues and 1s designed to focus on potential plant shutdowns rather
than total corporate ability to pay. An analysis of a plant's ability to pay
for pollution control can be very complex because:
• plant-level financial data are usually confidential;
• the necessary data, particularly concerning the allocation of corporate
overhead expenses, are not always collected by firms at the plant level;
and
• non-standardized accounting procedures used Internally by firms do not
facilitate easy verification of reported cost and revenue items.
The plant-level tests are intended and designed as screening tests rather than
rigorous and.definitive evaluations of a plant's ability to afford pollution
control costs. If the test results indicate that pollution controls would
impose severe economic impacts, then a more detailed plant closure analysis
would be necessary. This would entail working closely with the plant and cor-
porate accountants to gather Information on a variety of costs, revenues, and
accounting procedures. Mathematical modelling of the plant's profitability may
92
-------
be necessary. Information on salvage values of equipment as well as projections
of future economic conditions may be desirable or required. A methodology for
plant closure analysis is not presented In this document.
Three tests are presented in this chapter: the Earnings Test, the Gross Margin
Test, and the Revenue Test. The choice of .test to be used depends on the
availability of data. The Earnings Test, which is the most accurate of the
three tests, also requires the most data. The permit writer should use Exhibit
4-1 as.a guide in determining which test to perform.
These tests are designed to be simple to perform. However, the data needed may
not always be readily available or easily derived. The most significant data
problems are summarized below.
• Corporate overhead expenses are not usually allocated to Individual
plants, and if they are, biases in the allocation method are not easily
detected.
• Gross margin at the plant level may not be explicitly calculated and the
components of gross margin may not be recorded.
• The components of cost of goods sold are subject to biases and misallo-
cations.
» Transfer prices for inputs "purchases" by the plant from other parts of
the company can be inflated to bias costs upward.
• Transfer prices that are assigned to Intermediate products "sold" to
other parts of the company may be artificially low, causing revenues to
be biased downward.
• Average Industry ratios of earnings before taxes (EBT) to gross margin
and EBT to revenue may not reflect specific plant ratios.
93
-------
Exhibit 4-1
GUIDANCE FOR USE OF PLANT-LEVEL TESTS
Test
Earnings Test
Gross Margin
Test
Revenue Test
Plant Data Needed
Total annual cost of
pollution control;,
revenues; cost of goods
sold; corporate overhead
Total annual cost of
pollution control;
revenues; cost of goods
sold
Total annual cost of
pollution control;
revenues
Worksheets Needed
9, 10, 11
9, 10, (Lines 1-3),
9, 10 (Line 1), 13
94
-------
4.2 POLLUTION CONTROL COSTS AND E8T
Once the permit writer has obtained the available data from the plant, two Items
must be calculated before a plant-level test can be performed. These are the
total annual cost of pollution control and the plant's earnings before taxes
(EBT). These calculations are described in this section.
4.2.1 Total Annual Cost of Pollution Control
4.2.1.1 Theory
Any piece of pollution control equipment has two types of costs associated with
it:
• Capital Cost - the cost of buying and installing the equipment; and
• Operating and Maintenance (O&M) Costs - the annual expenses necessary to
maintain and operate the equipment.
The plant-level tests require comparisons of pollution control costs to annual
income statement items, so 1t is necessary to put the lump sum capital cost 1n
annual terms. A capital recovery factor (CRF) is used to annualize capital
investment cost over the useful life of the equipment. This factor, when
multiplied by the capital cost of the equipment, defines a series of annual cash
flows. When these values are added to the annual O&M cost, the result is the
total annual cost of the pollution control technology.
4.2.1.2 Calculation
The formula for the capital recovery factor is:
CRF « 1(1 + 0"
(1+1)n - 1
where: CRF * Capital recovery factor
1 ¦ Cost of capital (or Interest rate)
n = Life of pollution control equipment
Ideally, the cost of capital (1) would be calculated for every firm based on its
debt/equity ratio, borrowing rate, market risk, and state and local tax rates. This
95
-------
is discussed in more detail in Chapter 2 (Section 2.2.3.1). Because information
needed to calculate the cost of capital for a firm can be very 'time-consuming to
collect, the interest rate 1s usually substituted for the cost of capital. This is
the value for interest rate on new debt used 1n Worksheet 3d (Line 3). As can be seen
in the formula, the capital recovery factor is a function of the Interest rate (or
cost of capital) and the life of the pollution control equipment. Both of these items
therefore will have a significant effect on the value of the capital recovery factor.
If information on the interest rate and/or equipment life are uncertain or essentially
unavailable to the permit writer, these items could be varied in a sensitivity analy-
sis to assess their impact on the total annual costs. All of the data neede'd to
calculate the total annual cost of the pollution control technology can be found on
the worksheets which were used in the firm-level analysis. The calculation of the
total annual cost Is performed using Worksheet 9 on page 45 of the Workbook. The
steps in the calculation are as follows:
1. Enter the capital cost of the pollution control technology (from Line
2a of Worksheet lb on page 7 of the Workbook) on Line 1 of Worksheet
9 (page 45 of the Workbook).
2. Enter the interest rate on new debt (from Line 3 of Worksheet 3d on
page 19 of the Workbook) on Line 2a.
3. Enter the estimated life of the pollution control equipment 1n years
(from Line 3 of Worksheet 6 on page 34 of the Workbook) on Line 2b.
4. Calculate the capital recovery factor (CRF) using the following
formula:
CRF " HI ~ D"
(1+1)" - 1
where : CRF » Capital recovery factor
1 ¦ Interest rate on new debt (Line 2a)
n » Estimated life of pollution control equipment in years
(Line 2b)
Enter the result on Line 2c.
5. Multiply Line 1 (capital cost of pollution control equipment) by Line
2c (capital recovery factor) to get the annualized capital cost.
Record the result on Line 3.
6. Enter the annual O&M cost for pollution control (from Line 6 of
Worksheet 4b on page 25 of the Workbook) on Line 4.
96
-------
7. Add Line 3 (annualized capital cost) and Line 4 (annual O&M cost) to
get the total annual cost of pollution control. Enter the result on
Line 5.
Exhibit 4-2 shows the calculation of total annual cost using the sample plant
data.
4.2.2 Earnings Before Taxes
4.2.2.1 Theory
The.three plant-level tests use Items from the Income statement of a plant. The
basic components of a plant-level income statement are revenues, cost of goods
sold, and corporate overhead, as shown 1n Exhibit 4-3. The plant should be able
to provide some or all of this information.
Many companies do not keep records of revenues for each plant. Instead they
maintain only cost records for the plant and record revenues and earnings at the
division or firm level. However, most products have identifiable market prices.
When revenues are not available for a plant, they can be calculated by
multiplying the market price per unit of product by the number of units produced
over the year to get total revenues. A permit writer can verify the prices for
each product by checking with the appropriate trade journals. Sometimes,
however, products produced at one plant are used as inputs to processes in
another plant in the same firm. These products ave no external market and are
called "intermediate goods". To determine the "revenues" associated with these
products, a transfer price needs to be assigned. The plant should be able to
provide this information. It should be noted that a plant can bias revenue
estimates downward and cause their financial condition to appear worse than it
is by assigning an artificially low transfer price to intermediate goods.
Because transfer prices are often developed by bargaining between plants within
the firm, very little can be done to detect biased transfer prices.
Revenues which are unrelated to the product or services produced at the plant
should not be included 1n plant revenues. Examples of such revenues are the sale
of property or rental income. If the firm Is unable to supply revenue data, or
if revenues cannot be estimated by the permit writer, none of the plant-level
tests can be performed.
97
-------
Exhibit 4-2
WORKSHEET 9
TOTAL ANNUAL COST OF POLLUTION CONTROL
($1000)
1. Capital Investment Cost (C)
Worksheet lb, Line 2a 10,000
2a. Interest Rate on New Debt (i)
Worksheet 3d, Line 3 0.14
2b. Estimated Life of Pollution Control
Equipment in Years (n)
Worksheet 6, Line 3 5
2c. Capital Recovery Factor (CRF)
CRF - i(l+i)n 0.291
(l+i)n -1
3. Annualized Capital Cost 2,910
Line (I) x Line (2c)
4. Annual O&M Cost
Worksheet 4b, Line 6 1,000
5. Total Annual Cost of Pollution Control
Line (3) + Line (4) 3,910
98
-------
Exhibit 4-3
INCOME STATEMENT COMPONENTS
REVENUES
• (Units of Product) x (Price per Unit)
COSTS OF GOODS SOLD
« Cost of materials
0 Direct labor cost
• Production overhead cost (Indirect labor, rent, heat, etc.)
0 Extraordinary costs should not be included
GROSS MARGIN
• (Revenues) - (Cost of Goods Sold)
CORPORATE OVERHEAD
0 Selling, general, and administrative expenses
0 Interest expense
0 R&D expense
0 Depredation on common property
EARNINGS BEFORE TAXES
0 (Revenues) • (Cost of Goods Sold) - (Corporate Overhead)
99
-------
The cost of goods sold Includes the cost of materials, direct labor, and produc-
tion overhead (indirect labor, rent, heat, etc.). Standard costs can be used 1n
process Industries like the chemicals Industry to assign costs to each of those
categories 1f necessary, but actual costs are more descriptive of the true cost of
goods sold during the year. Extraordinary costs that are unusual 1n nature and
occur Infrequently (such as the purchase of equipment) should not be Included in
the cost of goods sold, nor should any Items described. 1n Exhibit 4-3 as corporate
overhead.
Corporate overhead 1s the fraction of total corporate expenses that Is allocated
to an Individual plant. There are a number of different bases by which firms
allocate these expenses, and these expenses are often difficult to determine for
a particular plant. Because of the relatively arbitrary nature 1n which cor-
porate overhead expenses may be allocated, a firm could assign artificially
large portions of corporate costs to a plant In order to misrepresent its earn-
ings before taxes.
The Income statement format In Exhibit 4-3 1s based on "standard absorption
costing.11 Under the standard absorption costing method, each unit of product
produced absorbs a pro-rated share of both the fixed and variable costs of pro-
duction during each accounting period. Most firms use the standard absorption
costing method. However, many firms use the "variable costing" method. This
costing method assigns only variable costs to the costs of goods sold. Fixed
costs of production realized during an accounting period are treated as expenses
of that period when determining net income, but are not Included In cost of
goods sold. Net income will be different under the two costing systems when
production 1n a period does not equal sales of that period. Because the income
statement format 1n Exhibit 4-3 1s based on standard absorption costing, the
permit writer1 should verify that the plant's cost and revenue data are recorded
using the same method. If not, 1t is possible that the plant would record
enough information to derive the data needed to complete the Income statement.
4.2.2.2 Calculation
Earnings before taxes (EBT) are calculated for the most recent year by
subtracting the cost of goods sold and the plant's share of corporate overhead
100
-------
from the plant's revenues. Exhibit 4-4 shows the Income statement data for a
sample plant in the sample firm. These data are for a hypothetical plant,
although .they do represent realistic numbers. The calculation of EBT Is done
using Worksheet 10 on page 48 of the Workbook. The steps in the calculation are
as follows:
1. Enter tne plant's revenues for the most recent year on Line 1 of Worksheet
10 (page 48 of the Workbook).
2. Enter the cost of goods sold (excluding extraordinary Items) for the most
recent year on Line 2.
3. Subtract Line 2 (cost of goods old) from Line 1 (revenues) to get gross margin.
Enter the result on Line 3.
4. Enter the plant's portion of the corporate overhead for the most recent year
on Line 4.
5. Subtract Line 4 (corporate overhead) from Line 3 (gross margin) to get the
plant's earnings before taxes (EBT). Enter the result on Line 5.
Exhibit 4-5 shows a calculation of the EBT for a plant using the sample plant
data.
101
-------
Exhibit 4-4
HYPOTHETICAL PLANT INCOME STATEMENT
($1000)
REVENUES 200,000
COST OF GOODS SOLD
Cost of Materials 90,000
Direct Labor 38,000
Production Overhead 20,000
Extraordinary Costs -0-
Total 148,000
CORPORATE OVERHEAD
Selling, General, Administrative 15,000
Interest 2,000
Research and Development 7,000
Depreciation 18,000
Total 42,000
102
-------
Exhibit 4-5
WORKSHEET 10
EARNINGS BEFORE TAXES (EBT) FOR PLANT
($1000)
Most Recent Year
of Company Data
Year 1982
1. Revenues 200,000
2. Cost of Goods Sold 148,000
3. Gross Margin
Line (1) - Line (2) 52,000
4. Corporate Overhead 42,000
5. Earnings Before Taxes (EBT)
Line (3) - Line (4) 10,000
103
-------
4.3 PLANT-LEVEL TESTS
This section describes the three plant-level tests, which use the total annual
cost of pollution control and EBT information calculated on Worksheets 9 and 10
to obtain an estimate of the impact of pollution control expenditures on plant
operations. Only one of the plant-level tests needs to be performed. The per-
mit writer should determine which test to perform based on the availability of
the necessary data.
4.3.1 Earnings Test
4.3.1.1 Theory
The Earnings Test seeks to answer the question "Are earnfngs before taxes
greater than zero?". The Earnings Test assumes that a plant will continue to be
profitable if the EBT minus the total annual cost of pollution control 1s
greater than zero. This test 1s strict but reasonable because a plant which can
cover all fixed and variable costs with earnings before taxes will in the long
run remain 1n operation. In the short run, plants are concerned with covering
variable costs only and could operate with EBT less than zero. EBT of zero does
not permit a plant to earn its entire required return on investment because
depreciation alone will not supply the required return. However, because depre-
ciation Is a noncash expense, actual cash flow will be greater than zero even
when EBT equals zero, and money would be available for reinvestment in assets.
Thus, EBT of zero does not preclude a plant from taking advantage of growth
opportunities and from earning future profits.
Although the Earnings Test 1s appropriate conceptually, it has some significant
practical problems. Most Importantly, corporate overhead expenses are not
usually allocated to Individual plants explicitly; instead they are assigned to
division-level profit centers. If a plant or firm can provide corporate
overhead expense data which relate to a specific plant, then this test should be
performed. However, the permit writer must recognize that biases in the
overhead allocations will be difficult to detect without a very detailed plant-
level questionnaire.
104
-------
4.3.1.2 Calculation
The Earnings Test 1s very straightforward to perform; the necessary data are
obtained from Worksheets 9 and 10 on pages 45 and 48 of the Workbook, respec-
tively. The test is done using Worksheet 11 on page 50 of the Workbook. The
steps in the calculation are as follows:
1. Enter earnings before taxes (from Line 3 of Worksheet 10 on page 48 of
the Workbook) on Line 1 Worksheet 11 (page 50 of the Workbook).
2. Enter the total annual cost of pollution control (from Line 5 of
Worksheet 9 on page 45 of the Workbook) on Line 2.
3. Subtract Line 2 (total annual cost of pollution control) from Line 1
(E8T) to get the EBT adjusted for the cost of pollution control. Enter
the result on Line 3 of Worksheet 11 (page 50 of the Workbook) and on
Worksheet 15 (page 58 of the Workbook).
4. Indicate whether the adjusted EBT (from Line 3) is greater than, less
than, or equal to zero on Summary Line 1 of Worksheet 11 (page 50 of
the Workbook) and on Worksheet 15 (page 58 of the Workbook).
Exhibit 4-6 shows an Earnings Test calculation using the sample plant data.
4.3.1.3 Interpretation
Interpreting the result of the the Earnings Test Involves comparing earnings
before taxes (EBT) adjusted for the cost of pollution control to zero. If the
adjusted EBT value is greater than zero, the plant should be able to absorb the
annual costs of pollution control and still maintain positive EBT. This would
mean that the financial Impact due to the cost of pollution control would not
be severe enough to cause the plant to become unprofitable. An adjusted EBT
value of less than zero indicates that the annual' costs associated with pollu-
tion control would have a negative economic effect on the plant. A grey area
exists if the adjusted EBT value is zero (or close to zero). In this case a
more detailed plant closure analysis would be needed. It should be noted that
the other plant-level tests will not be helpful if the results of the Earnings
Test are 1n the grey area. The Interpretation of the Earnings Test, if it is the
plant-level test performed by the permit writer, should be entered on Worksheet
15 on page 59 of the Workbook. An example is provided in Chapter 5.
105
-------
Exhibit 4-6
WORKSHEET 11
EARNINGS TEST
($1000)
Earnings Before Taxes (EBT)
Worksheet 10, Line 5 10,000
Total Annual Cost of Pollution Control
Worksheet 9, Line 5 3,910
Adjusted EBT
Line (1) - Line (2) 6,090
SUMMARY
Is the adjusted EBT greater than, less than, or equal to zero? Adjusted
EBT is greater than zero, plant should be able to afford pollution control,
106
-------
If the Earnings Test cannot be performed because data which allocate corporate
overhead to Individual plants are not available, one of the two following tests—
the Gross Margin Test or the Revenue Test—should be used for the plant-level
analysts. Like the Earnings Test, both of these tests are based on the goal of
maintaining an EBT value which 1s greater than zero.
4.3.2 Gross Margin Test
4.3.2.1 Theory
Gross margin (or gross profit) Is equal to revenue minus the cost of goods sold.
It 1s a measure of the profit at a plant before corporate overhead expenses have
been deducted. Thus, the use of the Gross Margin Test avoids the difficult
problem of determining what corporate overhead expenses are allocated to a
plant. Since the cost of pollution control technology relative to EBT Is the
standard by which a permit writer decides whether the technology Is economically
achievable, the Gross Margin Test has been designed to provide a similar
measure.
The Gross Margin Test measures the total annual cost of pollution control as a
fraction of gross margin. If total annual pollution control costs exceed a
defined range, then the technology may adversely affect the plant's profitabi-
lity. The range is defined by the ratio of EBT to gross margin for a specific
industrial sector or SIC code. If total annual pollution control costs exceed
this range, the EBT may be less than zero and the technology could cause the
plant to close.
The Gross Margin Test Is easy to perform and it avoids the need for data on cor-
porate overhead expenses. It still has limitations, however. First, it 1s only
a substitute for the Earnings Test; actual EBT are not known. The EBT/gross
margin ratio is only an industry average and may not accurately reflect the
actual plant's situation.
Implicitly assumed in the Gross Margin Test 1s that plants cannot pass through
any of the added pollution control costs to customers through higher prices. In
this sense, the test is conservative because 1f prices could be raised then
some of the impact could be reduced.
107
-------
Although the problem of obtaining corporate overhead allocation data is avoided
with the Gross Margin Test, the potential for misrepresenting revenues and plant
costs still exists. If revenues include intermediate goods that are assigned
transfer prices by the company, there 1s little the permit writer can do to
check the accuracy of the prices. Thus, revenues could be biased downward. Costs
can also be misallocated because of the variety of methods of inventory
valuation. Standard costs are used most frequently and they are based on prede-
termined production levels. Actual year-end costs, rather than standard costs,
should be requested, although the former may not be representative in unusual
years.
4.3.2.2 Calculation
The data needed to perform the Gross Margin Test are obtained from Worksheets 9
and 10 (pages 45 and 48 of the Workbook, respectively) and Robert Morris
Associates' Annual Statement Studies. Exhibit 4-7 shows an example of where to
find the data in Morris. The Gross Margin Test Is done using Worksheet 12 on
page 52 of the Workbook. The steps in the calculation are as follows:
1. Enter the gross margin (from Line 3 of Worksheet 10 on page 48 of the
Workbook) on Line 1 of Worksheet 12 (page 52 of the Workbook).
2. Enter the total annual cost of pollution control (from Line 5 of
Worksheet 9 on page 45 of the Workbook) on Line 2.
3. Find the EBT data (called "Profit before taxes") for the appropriate
SIC code In Morris' Annual Statement Studies. Enter the data for up to
four firm sizes on Line 3a. (The data in Annual Statement Studies is
presented for different firm sizes. The,EBT/GM ratio Is calculated for
each firm size in the appropriate SIC code.)
4. Find the gross margin data (called "Gross' profit") for the same SIC code
in Morris. Enter the data for up to four plant sizes on Line 3b. The
plant sizes for the industry EBT and the gross margin data should be the
same.
5. For each plant size, divide Line 3a (Industry EBT) by Line 3b (industry
gross margin) to get industry EBT/gross margin (GM) ratios. Record the
results on Line 3c.
6. Enter the lowest of the EBT/GM ratios (from Line 3c) on Line 3d.
7. Divide Line 2 (total annual cost of pollution control) by Line 1 (gross
margin) to get the total annual cost of pollution control as a fraction
108
-------
Exhibit 4-7
DATA FROM MORRIS - GROSS MARGIN TEST
MANUFACTURERS ¦ PLASTIC MATERIALS It SYNTHETIC RESINS
IIC# 2(21
, CwimiOttt
12(1/304/30/111 14(10/1/11-3/31/12)
»1MM
24
II
M.1C0MM
<
*
35 S
it;
>.7
95 6
25 2
I
( 1
1090
JO
4.1
21 1
4 (
60
45 9
19 I
5!
32 5
tooo
100.0
»
4.1
29 9
22.7
1 2
592
33 9
1.6
9 9
100.0
98
3.2
19.7
99
20
40.4
IIS
2.9
39.3
100.0
%
3$
29 6
249
1 9
992
32 9
.9
7.9
1000
97
2.7
164
9 7
40
394
2$ 2
30
324
1000
279
-m-
1000
*
1000
si 1
30
¦H"
53
*
223 I
-fir
9.4
Ml
111
*'
59
30 I
22 4
I 4
599
319
II
79
100 0
9 4
32
197
I I
32
409
It 7
39
37 I
tooo_
100.0
79 9
23.2
19 2
50
1 4
>1
ASSET SIZE
_NUMBEIIOF STATEMENTS
AIIITS
Cith 6 Eauivalanti
Atcta 6 Notts Arc • Trada(nat)
Inventory
All Oihur Curiam
Total CgrriAi
Find An«II |r«l)
Inungibtal |n*l) -
All Omar Non Currant
Toul
LIAUUTIES
Nstrt Payahia&itoU Tam
Cm. Mat UT,0
Accta t Ngtai Payahla ¦ Trtd*
Aiuuaj EiptiMt
All Oltitr Currant
Tt'KI Currant
i 'jng Term Drlu
All Glftoi Nen Currant
Krt Wortll
Total Intuitu:* & Nat Worth
~ " INCOMf DATA ~ "
Mai Stlta
I full m fill ny,
I Pfollt I
1 uuiiuijjeiiiiiiivi1
Qptrliiny Profit
MjuudumauiJUil
fPfOlllBflor#TlItl|
MATIOS
Currant
Ouiek
Salai/Aacaivablat
Coal el Salai/iniraniorr
Satat/Working Capital
E6ITAritara»t
ComparUiM Katorietf Dm
93 9.7 9.3
(12) 2 7 (65) 4.0 113) 2 6
_ 1.5 _ 2 3 1.3
4 I (26| 2.9
65 4 3
M932M I71179M 7414HM
1272099 2631S0M 40316394
t*«0i ilM»f 1992
2.2
(43) 3.5
4 7
I394J0M 1904036m'
43761099 1109973Mj
I/J4 77-
I/J0.3I
4/M.M
a.io ib
130 .
J/31'71
3/31/71
J/31.10
l.'ii it
3/31
All
120_
All
All
All
all
Ml >44
127
hi
" *
~» V"
"*
*
62
6 7
6 B
6 .•
56
210
29 6
29.5
US
30 1
24 3
22 3
24 e
21 S
22 4
20
1 4
22
1 4
1 4
10 6
60.1
62 t
Si 5
59 6
330
33 3
319
32 9
319
4
1 4
1 3
a
1 1
59
$ 2
4 9
90
1 b
100 0
1000
1000
IVOO
IOOO
10 1
90
9 7
93
9 4
3.7
33
4 1
34
32
163
17 9
204
19.?
19 7
56
66
6 S
57
6 1
29
4 1
4 4
32
1 :
40 7
399
442
J<7
4U6
17 1
164
177
10 4
Id 7
1 9
24
2 1
.12
36
403
3*4
360
40 G
37 1
- .
100 0
100 0
1000
1VC0
IOOO
1000
1011.1
100 0
ll.i.'II
1 lm U
75 7
79 2
751
16 3
76 9
24 J
239
24 2
23 1
23 2
19 7
19 ft
1*4
199
19 2
46
51
4 9
SO
6 U
1 4
10
1 1
1 3
I 4
3 2
41
_ 37
.3 6_
39
21
2.2
2 1
2 1
22
16
16
1 5
IS
16
1.2
1.2
II .
1.1.
I J.
1.3
1 3
13
1 3
ll
.9
1.0
9
10
.9
¦¦ - ¦'
6
.7
6_
•7_
.9
39
• 7
37
10.0
36 10 4
40
92
35
102
47
71
47
7.7
46 79
49
75
47
7 7
•2
59
62
5 9
66 6 9
69
* *
69
63
42
17
29
126
J4 10 9
33
112
29
12 4
64
6.6
60
7.3
60 7 3
43
94
43
65
_.70_
69
...6.4...
69 53
. «
S6_
63,
.. 5 J
61
6 1
sS
69
70
107
90
116
11.5
123
.22 9
29 6
33 9
27 3
. "J
99
13 2
79
9 7
76
(961
37
(131
4$
(115) 39
(105)
26
(10l|
29
16
22
1 6
1 2
1 4
7 7
7 4
6.7
7 7
79
(97|
21
(791
46
(90) 3 6
(93)
3 1
(94|
39
1 7
20
1.5.
, 1 5
2 1
.4
S
4
5
5
9
«
9
7
1 0
1_4__
_J;5_
.' J
1 4.
J 7
9
9
9
9
16
IS
1 9
1 4
1 9
25 .
„
29.
2 9 ,
29
3 5
35 7
41 9
39 4
32 2
35 7
(11«>
22 5 I
urn
25 )
1136) 240
(1231
19 9
(HO)
23 4
4 U
129
9 4
7 7
6 4
146
164
163
rj 9
139
« 1
102
92
90
7 3
. 18 ..
4 1 2 7.
2 1
1 9
104
10.2
127
11 3
13 4
63
6.9
79
96
7 4
. .
37_
4 7
46
_ 4 3_
*3
24
2.7
27
29
29
2.1
2 1
22
2 1
22
_ J..7_.
_
19
II
15
1 7
I 6
1.3
15
1 4
1 3
('131
23 1
IIOSJ
23
(134) }l
(1i»l
2 I
It 09;
20
_ I7
39
.34
35
3*
7
4
5
»
5
l'«6)
1 6
(4ii|
10
(721 1 2
IS III
1 1
(46)
1 9
23
20
22
22
20
20
2.6
2.1
20
22
(43)
4 1
139|
40
(57) 4 0
(43)
36
(43)
3»
59
is
It
i 5
4 7
I12I2I9M
1204793W
1 146225IM
1 2S39579M
1 1994039M
67472649
664930M
726973M
1 I36430IN
1 I106I73M
OT • lirawVBH « IMHMn
U« P««** ' »«««» 121* 2Qg»li(w> «' *atioi »»« Oaia
-------
of gross margin. Enter the result on Line 4 of Worksheet 12 (page 52
of the Workbook) and on Worksheet 15 (page 58 of the Workbook).
8. Determine whether the total annual cost of pollution control as a frac-
tion of gross margin (from Line 4) is greater than, less than, or equal
to the lowest industry EBT/GM ratio (from Line 3d). Record the eva-
luation on Sunmary Line 1 of Worksheet 12 (page 52 of the Workbook) and
on Worksheet 15 (page 58 of the Workbook).
Exhibit 4-8 shows an example of the Gross Margin Test performed using the sample
plant data.
4.3.2.3 Interpretation
The Gross Margin Test compares the total annual cost of pollution control
(expressed as a fraction of the plant's gross margin) to the Industry's
EBT (expressed as a fraction of the Industry's gross margin). If the total
annual cost of pollution control/plant gross margin ratio 1s less than the
EBT/gross margin ratio for the Industry, the plant will probably be able to
afford the pollution control technology without experlency negative economic
effects. Conversely, If the pollution control cost/plant gross margin ratio is
greater than the EBT/gross margin ratio for the Industry, the economic effects
on the plant could be severe. A grey area exists if these two ratios are equal.
In this case a more detailed plant closure analysis would be needed. The
interpretation of the Gross Margin Test, 1f it is the plant-level test performed
by the permit writer, should be entered on Worksheet 15 on page 59 of the Workbook.
If the data on cost of goods sold are not available and gross margin cannot be
calculated for a plant, the Gross Margin Test cannot be performed. The Revenue
Test, which is described in the next section, does not require any cost data and
therefore avoids the use of information that may be unavailable or potentially
biased.
110
-------
Exhibit 4-8
WORKSHEET 12
GROSS MARGIN TEST
($1000)
1. Gross Margin
Worksheet 10, Line 3
2. Total Annual Cost of Pollution Control
Worksheet 9, Line 5
3. Threshold Values - Industry EBT/GM Ratios
Plant Size
#1
1.9
3a. Industry EBT
3b. Industry Gross
Margin 27.9
3c. Industry EBT/GM
Ratios
Line (3a) divided
by Line (3b) 0.07
3d. Lowest EBT/GM Ratio 0.07
4. Total Annual Cost of
Pollution Control as
a Fraction of Gross
Margin
Line (2) divided by
Line (1) 0.06
Plant Size
#2
4.1
22.2
0.18
52,000
3,910
Plant Size
#3
2.6
22.3
0.12
Plant Size
#4
SUMMARY
1. Is Line 4 greater than, less than, or equal to Line 3d? Because the total
annual cost of pollution control as a fraction of gross margin is less than
the industry's lowest EBT/GM ratio, the plant should be able to afford
pollution control.
111
-------
4.3.3 Revenue Test
4.3.3.1 Theory
The Revenue Test is one step simpler than the Gross Margin Test and Is therefore
less sophisticated. To perform the test, the total annual cost of pollution
control is measured as a fraction of the plant's revenues. If total annual
pollution control costs exceed a defined range, then the plant may not be able
to afford the technology. The range is defined by the ratio of E8T to revenues
for a specific industrial sector or SIC code. If total annual pollution control
costs exceed this range, EBT may be less than zero and the technology might
cause the plant to close.
The Revenue Test requires only information on plant revenues. As mentioned
above, if individual plants do not record revenues, they can be calculated by
multiplying the market or transfer price per unit of product by the number of
units of product produced. The Revenue Test should be used when gross margin
(or the data to calculate it) is not available for a plant because the plant's
accounting system does not gather costs 1n the appropriate manner.
Because the Revenue Test requires very little Information from the plant, it is
easy to perform. However, It 1s also somewhat crude because it does not con-
sider specific plant costs but depends almost entirely on industry average data.
In addition, as with the other tests, biased Information could be a problem
because the firm or plant must provide transfer prices for intermediate goods.
4.3.3.2 Calculation
The data needed to perform the Revenue test are obtained from Worksheets 9 and
10 (pages 45 and 48 of the Workbook, respectively) and from Morris. Exhibit
4-9 shows an example of where to find the data 1n Morris. The Revenue test is
done using Worksheet 13 on page 54 of the Workbook. The steps In the collection
are as follows:
1. Enter revenues (from Line 1 of Worksheet 10 on page 48 of the Workbook)
on Line 1 of Worksheet 13 (page 54 of the Workbook).
2. Enter the total annual cost of pollution control (from Line 5 of
Worksheet 9 on page 45 of the Workbook) on Line 2.
112
-------
Exhibit 4-9
DATA FROM MORRIS - REVENUE TEST
MANUFACTURERS • PLASTIC MATERIALS 4 SYNTHETIC RESINS
SKf 2121
II
nit/M-i/u/iu
l-MMM
M
CtfVMtOtU
•4(10/1/1 M/31/12)
¦4-IMMM
II (
ASSET SIZE
_NUMBUOf STATEMENTS
" ASSETS
C*r Currant
Total Currant
futi Aitati (nail
Inianfiblat (nil) •
All Oinn Noti'Currtal
Total
" LIAIILITIfS
Mocai Payihla ihort Ttrm
Cut Mil L/T.'D
Aeeii k Notai PiytDia Tradt
Aeciuad Eiptnui
AM Olt>«r Cuirant
T-.Mil CuMtni
lung Term Oulit
All Glitar No" Currant
Mc< Worm
Toul Luuiliiivt a NfI Worth
Campari iim HMwneal Oiu
HO >7
•!
4/JC II
•.JO. 10.
HOI
Wlrll
VJl/>l
3/31/10
3/31.11
fcll/l
AU
All
All
ail
AU
12°
111
144
127
*
«
V
' ~ii
¦ %
<2
1 7
es
62
56
21.0
291
21.5
29 5
30 1
24 3
223
24 6
2U
22 4
20
1 4
22
1 4
1 4
«0«
<0 1
62 3
at S
19 6
330
333
31 6
32 6
316
4
1 4
13
9
1 1
SI
52
4 9
ao
It
100 0
1000
1000
IliOO
100 0
10 1
so
<7
13
' 1 4
37
33
4 1
34
32
113
179
20 4
192
197
56
66
(S
5 7
C 1
29
4 1
44
37
32
407
391
442
3A7
406
in
IS 4
17 7
III 4
l» 7
1.9
2.4
2 1
32
36
403
394
36 0
40 6
37 1
100.0
1000
1000
100 0
ivOo
29 1.1
|lt| «• (26) 21
.. . «» 43
S4932M S7117SM
I2720M 2631S0M
•AaMn MuiilVuooiuf l«|2
741499M
M11IM
22
(4)1 36
4 7
S36430M 1964039M*
WHOM 1 t04|73Mj
% OlfComp'Saiaa
NaiSalalil)
loiti aimii (•)
i IIMUOMI
— ~-
-
1000
100 ll
I0UU
Hill (I
100 0
75 7
16 2
»l
lb 3
74 6
24 J
231
24 2
23 7
23 2
19.7
110
1»4
IM
16 2
46
54
41
50
SO
14
1.0
1 1
13
1 4
32
41
....
3 7
36
_36
2 1
22
2 1
2 1
2.2
1 S
l<
15
15
IS
12
1.2
1 1
1 1
1.3
13
IJ
13
13
9
1.0
9
10
1
.. „
.6
.7
-
... , *.
— .
_.7_
6
34
>7
37 10.0
35
10 4
40
92
31
102
47
71
47 7.7
46
79
49
7 S
47
77
•2
59
62 59
. 56
66
S»
«2
66.
63
42
17
29 12 4
34
106
33
112
21
174
64
69
60 7 3
60
73
43
64
43
65
_70_
_ S3
66 54
B
53
_ .M
_ii6
•?_
5.6
61
6 1
¦ 5
64
70
>0 7
90
116
115
>2 3
— . —
_22 9 __ 29 5.
33 9
VK
32 3
• 1
132
7 1
6 7
76
l»5|
37
(S3) 4 S
(115)
3 S
(¦OS)
29
H01J
21
.•.
22
IS
12
1 4
7 7
74
6 7
V 7
79
(«7)
21
(76) 4 S
|90|
36
|»3|
} 1
(64|
3 9
1.7
10.
._1_S
.1 5
2 1
4
5
4
5
6
6
«
1
1
10
- )J..
J 5
t_s
1 4
- J '
9
1
9
1
9
1 5
1 5
>6
1 4
1 1
JS.
2 6
2.6
2 0
J*
35 7
41 1
39 4
32 2
35 7
|116)
22 5
(111) 253
(131)
24 0
|123j
¦ 11
(HOI
234
. 5J-
121
1 4
7 7
64
14 9
l« 4
16 3
13 6
t3l
8 1
102
62
10
73
_ < »
4 1
.. 2».
.2.1
. J >
104
10.2
12 7
113
134
63
61
79
66
74
_
37
42
.4 6
. <3
.43
24
27
2 7
26
29
2.1
2 1
22
2 1
2 2
1.7 _
16
1 J
1 S
.1 7
15
13
1 5
1 4
1 3
|H3I
23
(10S) 2 3
(134]
2 1
(||«I
t 1
not)
20
3.7
3 9
3ji
3 5
32
7
«
5
5
5
(561
16
(441 «0
(721
• 2
l51j
1 7
(46)
1 5
1
21
20
22
22
70
2 0
25
2 1
:IM JSjSSVl* 1994036M
| 674729M 664930M 726973M 1J64301M M06673M
Jw I through 12 I9i IMI> ®' Aitiui ul Dal*
-------
3. Find the EBT data (called "Profit before taxes") for the appropriate
SIC code in'Morris' Annual Statement Studies. Enter the data for up to
four plant sizes on Line 3a.
4. Find the revenue data (called "Net sales") for the same SIC code in
Morris. Enter the data for up to four plant sizes on Line 3b. The
plant sizes for the industry EBT and revenue data should be the same.
5. For each plant size, divide Line 3a (industry EBT) by Line 3b (industry
revenues) to get industry EBT/revenue ratios. Record the results on
Line 3c.
6. Enter the lowest of the EBT/revenue ratios (from Line 3c) on Line 3d.
7. Divide Line 2 (total annual cost of pollution control) by Line 1 (gross
margin) to get the total annual cost of pollution control as a fraction
of gross margin. Enter the result on Line 4 of Worksheet 13 (page 54
of the Workbook) and on Worksheet 15 (page 58 of the Workbook).
8. Determine whether the total annual cost of pollution control as a frac-
tion of gross margin (from Line 4) is greater than, less than, or equal
to the lowest industry EBT/6M ratio (from Line 3d). Record the eval-
uation on Sumnary Line 1 of Worksheet 13 (page 54 of the Workbook) and
on Worksheet 15 (page 58 of the Workbook).
Exhibit 4-10 shows an example of the Gross Margin Test performed using the sample
plant data.
4.3.3.3 Interpretation
The Revenue Test compares the total annual cost of pollution control (expressed
as a fraction of the plant's revenues) to the industry's EBT (expressed as a
fraction of the industry's revenues). If the ratio of the annual cost of pollu-
tion control to the plant's revenue is less than the EBT/revenue ratio for the
industry, the plant will probably be able to afford the pollution control tech-
nology without experiencing negative economic effects. Conversely, if the ratio
of the pollution control cost to the plant's revenue is greater than the
EBT/revenue ratio for the Industry, the economic effects on the plant could be
severe. A grey area exists 1f these two ratios are equal. In this case a more
detailed plant closure analysis would be needed. The interpretation of the
Revenue Test, if 1t 1s the plant-level test performed by the permit writer,
should be entered on Worksheet 15 on page 58 of the Workbook.
114
-------
Exhibit 4-10
WORKSHEET 13
REVENUE TEST
(S1000)
1. Revenues
Worksheet 10, Line 1
2. Total Annual Cost of Pollution Control
Worksheet 9, Line 5
3. Threshold Values -
Industry EBT/Revenue Ratios
3a. Industry EBT
3b. Industry Revenues
Plant Size
#1
1.9
100.0
3c. Industry EBT/
Revenue Ratios
Line (3a) divided
by Line (3b) 0.02
3d. Lowest EBT/
Revenue Ratio 0.02
4. Total Annual Cost
of Pollution Control
as a Fraction of
Revenues
Line (2) divided by
Line (1) 0.02
Plant Size
#2
4.1
100.0
0.04
200,000
3,910
Plant Size
#3
2.6
100.0
0.03
Plant Size
#4
SUWARV
1. Is Line 4 greater than, less than, or.equal to Line 3d? Because the plant's
total annual cost of pollution control as a fraction of revenues is equal
to the lowest industry EBT/revenue ratio, the Revenue Test cannot be used
to conclude whether the plant can afford pollution control.
US
-------
CHAPTER 5
ANALYSIS OF TEST RESULTS
5.1 INTRODUCTION
Chapters 3 and 4 discussed several measures of financial health and described
how they could be Interpreted. The insights provided by these tests must be
intergrated to evaluate the economic effect of pollution controls on a firm or
plant. The purpose of this chapter is to assist the permit writer with inte-
grating the results of the firm-level and plant-level analyses and interpreting
them as a whole.
In some instances all of the test results will suggest the same evaluation. If
all tests uniformly indicate that a firm is financially healthy and can afford
pollution control equipment, the economic effect is clearly acceptable.
Similarly, 1f all tests Indicate poor financial condition, the economic effect
would probably not be acceptable. Unfortunately, the results of each test are
unlikely to agree with regard to the financial condition of the firm, and some
total evaluation or tradeoff among test results will be necessary.
This chapter provides a framework for evaluating such conflicting results.
Explanation of all possible combinations is not possible within the scope of
this text. This methodology, therefore, does not provide a "cookbook" format to
follow in evaluating conflicting results. However, It provides an understanding
of the interactions among the tests that will assist the permit writer in eval-
uating some of the possible combinations.
116
-------
5.2 SUWARY OF TEST RESULTS
The first step in Interpreting the firm-level tests together and In conjunction
with the plant-level analysis 1s to summarize the test results. This 1s done by
entering the numerical results and sumnary comments for each test on Worksheets
14 and 15 on pages 57 and 58 of the Workbook. This 1s included If) the step-by-
step instructions for performing each test, so that by the time the permit
writer has completed all of the necessary firm-level and plant-level tests,
Worksheets 14 and 15 should be complete. Exhibits 5-1 and 5-2 show these two
worksheets completed using the sample firm and plant data.
The next step in summarizing the test results involves completing Worksheet 16
on page 59 of the Workbook. This is done by comparing the test results on
Worksheets 14 and 15 with the guidelines shown in Exhibit 5-3. Each test is
given an overall sumnary result in the form of a "+u or sign. Exhibit 5-4
shows the test results summarized in this way for the sample firm and plant
data.
117
-------
Liquidity Ratios
Current Ratio
Quick Ratio
Exhibit 5-1
WORKSHEET 14
THREE-YEAR TREND WITHOUT POLLUTION CONTROL COSTS
Year 1982 Year 1981 Year 1980 Industry Comparison
2.2
1.2
2.5
1.3
2.0
1.1
close to or better than upper
quart He
always higher than median
Solvency Ratios
Fixed-Charge Coverage Ratio 5.5
Beaver's Ratio 0.24
7.6
0.27
7.7
0.26
not applicable
not applicable
Leverage Ratio
Debt/Equity Ratio. 0.49 0.55 0.47 much better than
rest of industry
Market-to-Book Ratio
0.62-1.06
0.72-1.02 0.64-1.05 not applicable
-------
Firm-Level Testis
Liquidity Ratios
Current Ratio
Quick Ratio
Exhibit 5-2
WORKSHEET 15
RESULTS FOR HOST RECENT YEAR
Without Pollution With Pollution
Control Costs Control Costs
Beaver's Ratio
Leverage Ratio
Debt/Equity Ratio
Market-to-Book Ratio
Plant-Level Tests*
Earnings Test
Gross Margin Test
Revenue Test .
2.2
1.2
Solvency Ratios
Fixed-Charge Coverage Ratio 5.5
0.24
0.49
0.62-1.06
N/A
N/A
N/A
2.2
1.2
5.39
0.24
N/A
Change/
Industry
Comparison
no change/at
ind. upper quartile
no change/near In-
dustry upper quar-
tile
little change
no change
much lower than
industry
0.61-1.05 little change
well above
zero
N/A
N/A
N/A
N/A - not applicable
1 one of the three plant-level tests should be performed
119
-------
Exhibit 5-3
GUIDELINES FOR TEST RESULTS
Firm-Level Tests
Positive
Grey Area
Negative
Liquidity Ratios
Current Ratio
Quick Ratio
Solvency Ratios
Fixed-Charge Coverage Ratio
Beaver's Ratio
Leverage Ratio
Debt/Equity Ratio
Market-to-Book Ratio
> 2.0
> 1.0
> 2.0
> 0.2
declining
high/Increasing
N/A
N/A
1.5 - 2.0
0.15 - 0.2
N/A
N/A
< 2.0
< 1.0
< 1.5
< 0.15
Increasing
low/decreasing
Plant-Level Tests
Earnings Test
Gross Margin Test
Revenue Test
> 0 N/A
> lowest Industry N/A
EBT/GM ratio
> lowest industry N/A
EBT/revenue ratio
< 0 .
< lowest industry
EBT/GM ratio
< lowest industry
EBT/revenue ratio
N/A - not applicable
-------
Exhibit 5-4
WORKSHEET 16
OVERALL RATING (WITH POLLUTION CONTROL COSTS WHERE APPLICABLE)
Firm-Level Tests
Liquidity Ratios
Current Ratio +
Quick Ratio +
Solvency Ratios
Fixed-Charge Coverage Ratio +
Beaver's Ratio +
Leverage Ratio
Debt/Equity Ratio +
Market-to-Book Ratio constant
Conclusion:
Plant-Level Tests*
Earnings Test +
Gross Margin Test
Revenue Test
Final Conclusion:
+ = positive test result or economic effect not negative
- » negative test result or economic effect
* one of the three plant-level tests should be performed
1 91
-------
5.3 INTERPRETATION OF RESULTS
The results of the financial analysis are Interpreted and conclusions are drawn
for the firm-level tests as a group and then 1n conjunction with the plant-level
test result to determine the overall economic effect of pollution control expen-
ditures. When these evaluations have been made, the results are entered In the
"conclusions" sections of Worksheet 16 and final conclusions noted.
Interpretation of the firm-level and plant-level test results will be discussed
in the next two sections.
5.3.1 Interpretation of Firm-Level Tests
In some Instances, all of the firm-level test results will suggest the same
conclusion. Such results provide a clear picture of the economic effects of the
pollution control requirement. For example, the economic effects would almost
certainly be acceptable for a firm with:
• Liquidity Ratios relatively high;
• Solvency Ratios high;
•. Leverage Ratios low; and
• Market-to-Book Ratio high.
More typically, test results for a firm will include a combination of positive
and negative indicators. No firm rules can be stated for evaluating conflicting
results from different types or ratios. However, the general pattern of results
is often apparent upon inspection. A financially weak firm will have several
negative indicators among the firm-level tests. Similarly, a financially sound
firm may have one or two negative Indicators but will have a positive overall
pattern. These general trends should be noted' in evaluating the economic
effects of pollution controls. Following are examples of four common com-
binations of ratios that may appear to be conflicting with some explanations for
interpreting each.
Positive Indicator: Liquidity Ratios High
Negative Indicator: Solvency Ratios Low
Debt/Equity Ratio High
122
-------
In general, if Liquidity Ratios are high, indicating that the pollution control
equipment can be paid for with cash and equivalent current assets, the purchase
of such equipment should be considered to have a negligible economic effect.
The exception to this Is when the Liquidity Ratios have recently increased, the
Debt/Equity Ratio has increased, and Solvency Ratios have decreased. These
changes may indicate that the firm has recently borrowed money to Invest in a
new business opportunity and Is holding that money temporarily as cash or mar-
ketable securities. This can be verified if debt has recently increased on the
balance sheet. If the firm were required to spend this cash on pollution
control, an investment with no return, Instead of investing 1n the new business
opportunity, they would either have to forfeit the business Investment or issue
bonds or borrow to pay for it. In this case, rely on the Interpretation of the
Solvency Ratios to determine economic effects. This is shown as Example #1 in
Exhibit 5-5. The conclusion would be that an Investment 1n pollution controls
would probably cause the firm financial hardship. Examples #2 through #4 in
Exhibit 5-5 show variations on this example of the firm-level test results and
the conclusions that would be drawn.
Positive Indicator: Debt/Equity Ratio Low
Negative Indicator: Market-to-Book Ratio Low
This combination of indicators probably means that the firm's assets (expressed
1n these ratios as stockholders1 equity and book value of the firm's stock) have
been overvalued for some reason. If these assets were not overvalued, the
Debt/Equity Ratio (which was a positive Indicator) would be higher—a less posi-
tive Indicator. Place emphasis on the Liquidity and Solvency Ratios to deter-
mine the economic effect of a pollution control option. Examples #5 and #6 1n
Exhibit 5-5 show two situations based on these indicators and the firm-level
conclusions that would be drawn when the Liquidity and Solvency Ratios are
Included.
Positive Indicator: Debt/Equity Ratio Low
High Bond Ratings
Negative Indicator: Solvency Ratios Low
Solvency Ratios (Fixed-Charge Coverage Ratio and Beaver's Ratio) measure the
ability of average cash flows to cover parents on bonds and long-term debts.
123
-------
Exhibit 5-5
EXAMPLES OF TEST RESULTS
Example;
Firm-Level Tests »1 »2 #3 #4 #S »6 »7 #8 #9 #10
Liquidity Ratios
Current Ratio' + + -- + - ND + - +
Quick Ratio + + -- + - ND + - +
Solvency Ratios
Fixed-Charge Coverage -++--+ - - -
Ratio
Beaver's Ratio . + + ._ + - - -
Leverage Ratio
Debt/Equity Ratio ..-~ + ~ + ND ND ND
Market-to-Book Ratio HD ND ND ND - - ND + +
Conclusion: - + - +* +
2
Plant-Level Tests
Earnings Test
Gross Margin Test ) - + ND + - + ND ND
Revenue Test
Final Conclusion: -+-?? ?+*+
1 if bond ratings are above Ba/BB
one of the three plant-level tests should be performed
+ = positive test result or economic effect not negative
- » negative test result or economic effect
ND = no data
? a results indeterminate - plant closure analysis needed
124
-------
Low ratios, therefore, could mean that cash flow may be inadequate to cover
debt. If the Debt/Equity Ratio is also low and, more importantly, 1f bond
ratings are high (both indicating low risk of defaulting on debt) low Solvency
Ratios can be ignored. In general, bond ratings are good indicators of default
risk and they can be relied upon over the Solvency Ratios. Moody's Industrial
Manual and Standard and Poor have bond-rating services that assign a firm's
bonds to one of nine rating categories:
Moody1s Standard & Poor
Aaa AAA
Aa AA
A A
Baa BBB
Ba BB
B B
Caa CCC
Ca CC
C C
Aaa and AAA are the best ratings, assigned to bonds with the smallest degree of
investment risk. Thus, if other indicators are positive, trade off low
Solvency Ratios against a high bond rating (above Ba/BB) and conclude that the
firm can afford pollution control. This is shown 1n Example #7 in Exhibit 5-5.
Positive Indicator: Market Value of Stock Not Declining
Liquidity Ratios Above Cutoff
Negative Indicator: Solvency Ratios Declining
If Solvency Ratios are lower than 1n previous years while other indicators show
steady or improving conditions, 1t could be due to the lagging effect of a new
Investment on the income statement. For example, if long-term debt 1s Increased
and stock is Issued to purchase new process equipment, the following balance
sheet Items are affected:
• Long-Term Debt — increased;
• Common Stock — increased; and
• Property, Plant, and Equipment — increased.
-------
Payments on the loan as a result of the purchase are expenses that occur on the
Income statement, causing a decrease 1n net income.
Because the capital outlay for process equipment does not immediatley produce an
increase in revenues, the Solvency Ratios (which use income statement items in the
numerator and balance sheet items in the denominator) would Indicate worse finan-
cial conditions than before the purchase. These ratios are misleading, however,
because the new process equipment will increase income 1n future periods and
perhaps improve the firm's financial condition. Rely on the Liquidity Ratios
and market value of the stock to draw conclusions. This set of conditions and
variations on it are shown in Examples #8 through #10 in Exhibit S-S, along with
the conclusions that would be drawn concerning the firm-level analysis.
5.3.2 Interpretation of Plant-Level Test
The final step in interpreting the results of the financial analysis is
assessing the result of whichever plant-level test 1s performed in conjunction
with the conclusion reached for the firm-level analysis. Obviously, this only
needs to be done 1f a plant-level analysis was deemed necessary and was per-
formed. If the firm-level analysis Indicates that the firm can pay for
pollution control and the plant-level test result indicates likewise, the final
conclusion should be that there would be no negative effect due to an investment
1n pollution control. If both the firm-level and plant-level analyses indicate
a negative economic effect due to a pollution control investment, the conclusion
should be that the plant could not afford the technology and that a less costly
technology should be evaluated. A more detailed closure analysis would be
necessary 1f the conclusions of the firm-level and plant-level analyses disagree
with each other. Various combinations of firm-level and plant-level results and
the appropriate final conclusions are shown in Exhibit 5-5. Exhibit 5-6 shows
the firm-level and final conclusions using the sample firm and plant data.
i?#;
------- |