Reformulating Financial Analysis for Equity Method Investments

Cummins Inc. reports investments in affiliated companies, consisting mainly of investments in six manufacturing joint ventures. Cummins provides the following financial information on its investee companies in a footnote to its 10-K report.

Equity Investee Financial Summary					As of and for the years ended Dec. 31
$ millions					2018	2017	2016
Net sales					$7,352	$7,050	$5,654
Gross margin					1,373	1,422	1,182
Net income					647	680	499
Cummins' share of net income					$336	$308	$260
Royalty and interest income					58	49	41
Total equity, royalty and interest from investees					$394	$357	$301
Current assets					$3,401	$3,416
Noncurrent assets					1,449	1,379
Current liabilities					(2,669)	(2,567)
Noncurrent liabilities					(218)	(237)
Net assets					$1,963	$1,991
Cummins' share of net assets					$1,144	$1,116

Make the following assumptions about the above data.

• All assets are operating assets.
• All current liabilities are operating liabilities.
• Non-current liabilities are loans that bear interest at 8%.
• EMI (Equity Method Investments) investees tax rate is 22%.

The following information is derived from the 2018 form 10-K for Cummins Inc., the investor company.

$ millions
Revenue	$23,771
Net operating profit after tax (NOPAT)	2,213
Net nonoperating expense (NNE)	26
Net income attributable to Cummins Inc.	2,141
Net operating assets (NOA)	9,210
Net nonoperating obligations (NNO)	951
Equity of Cummins Inc. shareholders	7,348

Hint: You should be able to compute the following for Cummins' investee companies:

$ millions	2018
Nonoperating expense before tax	$17
Net nonoperating expense (NNE)	$13

a. Compute net operating profit after tax (NOPAT) for the EMI investees.

Round to the nearest whole number.

$Answer

million

b. Compute net operating assets (NOA) and net nonoperating obligations (NNO) for the EMI investees.

NOA $Answer

million

NNO $Answer

million

c. Following the process in Analyst Adjustments box 9.1, reformulate the following ratios for Cummins for 2018. For simplicity only, use year-end balance sheet numbers provided instead of averages.

First, compute the adjusted balances. (Use a negative sign with adjustment answer if it reduces the unadjusted amount.)

Income Statement	Cummins	Adjustment	Adjusted Balances
Revenue	Answer	Answer	Answer
NOPAT: Subtract share of EMI earnings	Answer	Answer	Answer
Add EMI NOPAT*	Answer	Answer	Answer
Net nonoperating expense	Answer	Answer	Answer
Net income	Answer

*Note: For "Add EMI NOPAT" row, only enter an answer under the Adjustment column (EMI NOPAT). Leave Cummins and Adjusted Balances answers blank (use row above to enter Cummins' NOPAT and Adjusted NOPAT balance).

Next, compute the following ratios: 1. using Cummins' figures (unadjusted) and 2. using the adjusted balances as computed above.

• Round RNOA, NOPM, and ROE to one decimal place (ex: 0.2345 =23.5%)

• Round NOAT and FLEV to two decimal places.
• Hint: Adjusted Net income is $2,452 million.

	Unadjusted	Adjusted
RNOA	Answer	Answer
NOPM	Answer	Answer
ROE	Answer	Answer
NOAT	Answer	Answer
FLEV	Answer	Answer