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					7352	7050	5654
Gross margin					1373	1422	1182
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					$3401	3416
Noncurrent assets					1449	1379
Current liabilities					(2669)	(2567)
Noncurrent liabilities					(218)	(237)
Net assets					$1963	1991
Cummins' share of net assets					$1144	1116

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	$23771
Net operating profit after tax (NOPAT)	2213
Net nonoperating expense (NNE)	26
Net income attributable to Cummins Inc.	2141
Net operating assets (NOA)	9210
Net nonoperating obligations (NNO)	951
Equity of Cummins Inc. shareholders	7348

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.

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

Use negative signs with answers, when appropriate.

\begin{tabular}{|l|r|r|} \hline & Unadjusted & Adjusted \\ \hline RNOA & 24% & 0% \\ \hline NOPM & 9.3% & 8.2% \\ \hline ROE & 0% & 0% \\ \hline NOAT & 2.58 & 0 \\ \hline FLEV & 0 & 0 \\ \hline \end{tabular} \begin{tabular}{|l|r|r|} \hline & Unadjusted & Adjusted \\ \hline RNOA & 24% & 0% \\ \hline NOPM & 9.3% & 8.2% \\ \hline ROE & 0% & 0% \\ \hline NOAT & 2.58 & 0 \\ \hline FLEV & 0 & 0 \\ \hline \end{tabular}