E10.11. Extracting Information from the Cash Flow Statement with a Reformulation: Microsoft Corporation (Medium) For many years, Microsoft has generated considerable free cash flow. Up to 2004, it paid no dividends and had no debt to pay off, so it invested the cash in interest-bearing securities. Its balance sheet at the end of its second (December) quarter for fiscal year ending June 2005 reported the following among current assets (in millions). December 31, 2004 Cash and equivalents Short-term investments June 30, 2004 $ 15,982 44,610 $ 4,556 29,948 You can see a significant reduction in both cash and short-term investments. During the second quarter, Microsoft decided to pay its first dividend in the form of a large special div- idend. Exhibit 10.2 gives the cash flow statement for the quarter, along with a note on interest received on the investments listed above. The firm's tax rate is 37.5 percent. Answer the following questions about the quarter ended December 31, 2004:

a. What were the cash dividends paid to common shareholders?

b. What was the net dividend paid out to shareholders?

c. Calculate (unlevered) cash flow from operations for the quarter.

d. Calculate cash invested in operations.

e. Calculate free cash flow.

f. Why was the "net cash from investing" number reported for 2004 so different from that for 2003? Is the large difference due to a change in Microsoft's investment in its operations? g. Microsoft maintains $60 million in operating cash. What was its net investment in financial assets during the quarter (before any effect of exchange rates)? After answering these questions, you have the ingredients to construct a reformulated cash flow statement. Go ahead and do it. Real World Connection Exercises on Microsoft are E1.6, E4.14, E6.13, E7.7, E8.10, E17.10, and E19.4. Mini- cases M8.1 and M12.2 also deal with Microsoft. EXHIBIT 10.2 Cash Flow Statement for Microsoft Corporation for Fiscal Second Quarter, 2005 Operations Net income Cash Flow Statements On milions, unaudited) Three Months Ended December 31 2003 2004 $ 1,549 53,463 Unearned revenue Depreciation and amortization Stock-based compensasion Net recognized (gainsVesses on Investments Stock option income tax benefits Deferred income taxes Recognition of uneamed revenue 300 108 3,232 551 (321) 74 148 99 (985) 68 2,774 3,354 (3.166) (3,165) Accounts receivable Other current assets Other long-term assets (1,004) (1,398) 607 373 55 7 Other current labies 1,256 17 Other long-term labies 129 69 Net cash from operations 4,574 3,619 Financing Common stock issued 189 795 Common stock repurchased (730) (969) Common dividends (1,729) (33,498) Not cash from financing (2.270) 033,672) Investing Additions to property and plent (172) (176) Acquisition of companies net of cash acquired Purchases of investments (22.377) (16,013) Maturities of investments 825 19,536 Sales of investments 19,775 20,068 Net cash from investing (1.949) 23,414 Net change in cash and equivalents 355 (6,639) Effect of exchange rates on cash and equivalents 25 Cash and equivalents, beginning of period 5,768 Cash and equivalents, end of period $6.149 54 11,141 $ 4,556

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f. Why was the "net cash from investing" number reported for 2004 so different from that for 2003? Is the large difference due to a change in Microsoft's investment in its operations? g. Microsoft maintains $60 million in operating cash. What was its net investment in financial assets during the quarter (before any effect of exchange rates)? After answering these questions, you have the ingredients to construct a reformulated cash flow statement. Go ahead and do it. Real World Connection Exercises on Microsoft are E1.6, E4.14, E6.13, E7.7, E8.10, E17.10, and E19.4. Mini- cases M8.1 and M12.2 also deal with Microsoft. EXHIBIT 10.2 Cash Flow Statement for Microsoft Corporation for Fiscal Second Quarter, 2005 Operations Net income Cash Flow Statements On milions, unaudited) Three Months Ended December 31 2003 2004 $ 1,549 53,463 Unearned revenue Depreciation and amortization Stock-based compensasion Net recognized (gainsVesses on Investments Stock option income tax benefits Deferred income taxes Recognition of uneamed revenue 300 108 3,232 551 (321) 74 148 99 (985) 68 2,774 3,354 (3.166) (3,165) Accounts receivable Other current assets Other long-term assets (1,004) (1,398) 607 373 55 7 Other current labies 1,256 17 Other long-term labies 129 69 Net cash from operations 4,574 3,619 Financing Common stock issued 189 795 Common stock repurchased (730) (969) Common dividends (1,729) (33,498) Not cash from financing (2.270) 033,672) Investing Additions to property and plent (172) (176) Acquisition of companies net of cash acquired Purchases of investments (22.377) (16,013) Maturities of investments 825 19,536 Sales of investments 19,775 20,068 Net cash from investing (1.949) 23,414 Net change in cash and equivalents 355 (6,639) Effect of exchange rates on cash and equivalents 25 Cash and equivalents, beginning of period 5,768 Cash and equivalents, end of period $6.149 54 11,141 $ 4,556