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Firm Valuation And
Financial Analysis
Jacob Armitage [email protected]
Taylor Hadsall [email protected]
Lewis Turner [email protected]
William Read [email protected]
Theodore Ingram [email protected]
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Table of Contents
Table of Contents ........................................................................................................................... 2
Executive Summary ...................................................................................................................... 6 Company Overview ................................................................................................................................. 7 Industry Analysis ..................................................................................................................................... 8 Five Forces Model .................................................................................................................................... 8 Accounting Analysis ............................................................................................................................. 10 Financial Analysis ................................................................................................................................. 11 Valuation Analysis ................................................................................................................................ 15
Company Overview .................................................................................................................... 17 Marine Engine Segment ...................................................................................................................... 17 Boat Segment .......................................................................................................................................... 18 Fitness Segment ..................................................................................................................................... 20 Discontinued Operations ................................................................................................................... 21 Stock Performance ............................................................................................................................... 21 Total Asset Value ................................................................................................................................... 22
Five Forces Model ....................................................................................................................... 23 Rivalry of Existing Firms .................................................................................................................... 24
Industry Growth ................................................................................................................................................ 24 Concentration ..................................................................................................................................................... 25 Differentiation and Switching Cost ............................................................................................................ 26 Learning Economies ........................................................................................................................................ 26 Excess Capacity .................................................................................................................................................. 27 Exit Barriers ........................................................................................................................................................ 28 Conclusion ............................................................................................................................................................ 28
Threat of New Entrants ....................................................................................................................... 29 Scale Economies and Fixed Variable Cost ............................................................................................... 29 First Mover Advantage.................................................................................................................................... 30 Distribution Access .......................................................................................................................................... 30 Relationships ...................................................................................................................................................... 31 Legal Barriers ..................................................................................................................................................... 32 Conclusion ............................................................................................................................................................ 32
Threat of Substitute Products .......................................................................................................... 32 Relative Price and Performance.................................................................................................................. 33 Consumers’ Willingness to switch ............................................................................................................. 34 Conclusion ............................................................................................................................................................ 34
Power of Consumers and Suppliers................................................................................................ 35 Consumer Power – Marine ............................................................................................................................ 35 Supplier Power - Marine ................................................................................................................................ 35 Consumer Power – Exercise Equipment ................................................................................................. 36 Supplier Power – Exercise Equipment ..................................................................................................... 36 Concluding Analysis ......................................................................................................................................... 37
Analysis of Key Success Factors ............................................................................................. 37 Cost Leadership – Low Input Costs ................................................................................................. 38
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Cost Leadership – Economies of Scale ........................................................................................... 38 Cost Leadership – Low Distribution Costs/Efficient Production ......................................... 38 Differentiation Strategy – Wide Variety of Products ................................................................ 39 Differentiation Strategy – Research and Development ........................................................... 39 Differentiation Strategy – Brand Recognition ............................................................................ 40 Cost Leadership vs. Differentiation ................................................................................................ 40
Firm Competitive Advantage Analysis ................................................................................ 40 Cost Leadership ..................................................................................................................................... 41 Economies of Scale................................................................................................................................ 41 Input Costs ............................................................................................................................................... 42 Low Distribution Cost/Efficient Production ............................................................................... 43 Conclusion ............................................................................................................................................... 45
Accounting Analysis ................................................................................................................... 45 Key Accounting Policies ...................................................................................................................... 46 Type I Key Accounting Policies ........................................................................................................ 46
Economies of Scale ........................................................................................................................................... 46 Low Input Cost ................................................................................................................................................... 47 Product Mix ......................................................................................................................................................... 48
Type II Key Accounting Policies ....................................................................................................... 49 Capital and Operating Leases ....................................................................................................................... 50 Research and Development .......................................................................................................................... 51 Goodwill ................................................................................................................................................................ 51 Pensions ................................................................................................................................................................ 52 Derivatives ........................................................................................................................................................... 53
Accounting Flexibility ............................................................................................................... 53 Operating Leases ................................................................................................................................... 54 Research and Development .............................................................................................................. 56 Goodwill ................................................................................................................................................... 56 Conclusion ............................................................................................................................................... 57
Actual Accounting Strategy ..................................................................................................... 57 Level of Disclosure ................................................................................................................................ 58 Aggressive vs. Conservative .............................................................................................................. 59 Conclusion ............................................................................................................................................... 59
Qualitative Disclosure .............................................................................................................. 60 Operating and Capital Leases ........................................................................................................... 60 Goodwill ................................................................................................................................................... 61 Employee Contribution Plans ........................................................................................................... 61 Conclusion ............................................................................................................................................... 62
Potential Red Flags .................................................................................................................... 62 Goodwill ................................................................................................................................................... 63 Operating Leases ................................................................................................................................... 64
Undo Distortions ......................................................................................................................... 65 Goodwill ................................................................................................................................................... 65 Operating Leases ................................................................................................................................... 67 Conclusion ............................................................................................................................................... 70
Financial Statement Restated ................................................................................................ 70
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Restated Balance Sheet ....................................................................................................................... 71 Restated Income Statement .............................................................................................................. 78 Conclusion ............................................................................................................................................... 81
Financial Analysis ....................................................................................................................... 81 Liquidity Analysis ................................................................................................................................. 82 Current Ratio .......................................................................................................................................... 82 Quick Asset Ratio .................................................................................................................................. 83 Inventory Turnover ............................................................................................................................. 85 Days Supply Inventory ........................................................................................................................ 86 Accounts Receivable Turnover ........................................................................................................ 87 Days Sales Outstanding ....................................................................................................................... 88 Cash to Cash Cycle ................................................................................................................................. 89 Working Capital Turnover ................................................................................................................. 90 Conclusion ............................................................................................................................................... 91
Profitability Analysis ................................................................................................................. 92 Gross Profit Margin .............................................................................................................................. 93 Operating Profit Margin ..................................................................................................................... 94 Net Profit Margin ................................................................................................................................... 95 Asset Turnover ...................................................................................................................................... 96 Return on Assets.................................................................................................................................... 97 Return on Equity ................................................................................................................................... 98 Conclusion ............................................................................................................................................. 100
Capital Structure Ratios ......................................................................................................... 101 Introduction .......................................................................................................................................... 101 Debt to Equity ....................................................................................................................................... 101 Times Interest Earned ....................................................................................................................... 104 Altman’s Z-Score .................................................................................................................................. 105 Internal Growth Rate ......................................................................................................................... 107 Sustainable Growth Rate .................................................................................................................. 108 Conclusion ............................................................................................................................................. 109
Financial Forecasting .............................................................................................................. 110 Income Statement ............................................................................................................................... 110 Balance Sheet ....................................................................................................................................... 115 Statement of Cash Flows ................................................................................................................... 122
Cost of Equity and Capital Asset Pricing Model .............................................................. 125
Cost of Debt ................................................................................................................................. 127
Weighted Average Cost of Capital (WACC) ...................................................................... 128
Method of Comparables ......................................................................................................... 131 Trailing P/E Ratio ............................................................................................................................... 131 Forward P/E Ratio .............................................................................................................................. 132 Price to Book Ratio ............................................................................................................................. 133 Dividend to Price ................................................................................................................................. 134 Price Earnings Growth Ratio ........................................................................................................... 135 Price to EBITDA Ratio ........................................................................................................................ 136 Price to Free Cash Flow Ratio ......................................................................................................... 137 Enterprise Value to EBITDA Ratio ................................................................................................ 138
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Conclusion ............................................................................................................................................. 139 Intrinsic Valuation Model ...................................................................................................... 139
Discounted Dividend Model ............................................................................................................ 140 Discounted Cash Flow Model .......................................................................................................... 142 Residual Income Model ..................................................................................................................... 144 Long-Run Residual Income Model ................................................................................................ 146
Analyst recommendation ...................................................................................................... 149
Appendix ...................................................................................................................................... 150
Bibliography ............................................................................................................................... 165
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Executive Summary
Analyst Recommendation: Sell (Overvalued)
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Company Overview
Our team did an equity valuation on Brunswick Corporation. Brunswick was
incorporated in 1845 and later reincorporated in Delaware in 1987. In July of 2014,
Brunswick announced the sell of its bowling centers to Bowlmor AMF for $270
million. Chief Executive Dustan McCoy stated in an interview that Brunswick is a
“consumer-based company that designs and engineers consumer
products…Running entertainment centers is not one of our core competencies.”
After its final exit of the bowling industry in May of 2015, Brunswick operates in its
remaining three industry segments that include marine engine, boating and fitness.
Its marine engine segment is its largest segment consisting of 53% of sales.
Mercury Marine, its main engine manufacturer, just finished a project leading to
new products and an expansion of the company. Some of these new products
included outboard engines, stern drive propulsion systems, inboard engines, trolling
motors, and rigid inflatable boat motors. Brunswick continues to expand by
acquiring several new firms annually. In June of 2014, it acquired Whale, which is a
leading manufacturer of water movement and heating systems for the marine,
recreational vehicle and industrial market. The acquisition of this company with $30
million in annual sales significantly increased Brunswick’s international presence.
Over the past five years, sales in the marine engine segment have grown by
23.63%. Sales growth is attributed to a greater demand for outboard engines, as
well as its acquisitions in the engine accessory business. These acquisitions make
up 35% of the marine engine sales internationally.
Brunswick’s boat segment makes up 27% of sales. This segment operates
under The Boat Group that consists of operations in seven different countries as
well as five states here in the U.S. The Boat Group has a network of 3,000 dealers
and distributors. Brunswick has seen a 22.43% increase in sales over the last five
years. In 2014, it introduced a new product line that featured larger, more
expensive boats. The new line led to an increase in wholesale shipments and sales,
and should continue to increase sales.
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Brunswick’s fitness segment has seen a 37.37% increase in sales in the last
five years with almost half of these sales coming from international operations. This
segment is made up of fitness equipment and billiards. Its fitness segment operates
primarily under Life Fitness. With manufacturing facilities in Kentucky, Illinois,
Wisconsin, Minnesota, and Hungary, its fitness segment is the largest in the world.
The billiards section has seen a steady decline, showing a potential sellout similar
to the one in the bowling industry.
Industry Analysis
Brunswick operates in a highly competitive industry. Due to its operations in
several different industry segments, it has several different competitors. The main
three are Polaris, Nautilus, and Marine West. To stay profitable in an industry with
high competition, these companies have to focus on industry structure. They have
to find new and innovative ways to create products, while focusing on maintaining
a low operating cost. They also have to determine their own corporate strategy,
which involves industry analysis, competitive strategy analysis, and corporate
strategy analysis.
Five Forces Model
This industry has a high threat level of rivalry among existing firms because
each company is fighting for a strategic advantage over the other firms. This results
in price wars. This is a steady growing industry that allows a company to steal and
hold a large portion of market share. With a low switching cost, companies have to
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find new ways to differentiate themselves from competitors. Learning economies
and excess capacity play a big role in this. If a firm can learn new ways to make
their products more efficiently to help keep cost low, they have the opportunity to
steal some of the market share in this industry. High exit barriers make it hard for
companies to find a buyer and exit the industry. This also makes rivalry high
because companies feel more obligated to stay in the industry and compete.
There is a low threat of new entrants in this industry because it takes a large
amount of capital to start up or acquire a business. Because companies in the
industry make deals with suppliers and dealers, it is hard for new firms to come in
and compete on these scales without putting up major capital. Relationships and
legal barriers also make it hard for a new start up. If companies in this industry can
produce a well-know brand, it makes it hard for new companies to enter into their
distribution channels.
A high threat level of substitute products exist in this industry because there
is no unique niche. Companies have to spend a lot on research and development to
produce new and innovative products in order to hold a competitive advantage.
This industry also has a low switching cost making it easy for a consumer to switch
form one product to the next.
Consumers have a high bargaining power due to low switching cost.
Competing firms have to keep cost low so they can offer products at a low
competitive price. In the fitness industry, there is little difference between different
brands of exercise equipment. This is another way a consumer has the bargaining
power.
The companies in this industry are considered to be the price setter because
the necessary raw materials are the same no matter where they choose to buy.
They also have the power to buy derivatives to protect them from price
fluctuations. This allows companies to control their purchasing cost more
effectively.
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Accounting Analysis
The actual accounting strategy used by Brunswick Corporation was found to
be a mixed strategy that possessed characteristics of both aggressive and
conservative accounting strategies. As for its strategy in comparison to its
competitors, they portrayed a relatively high level of disclosure. In accordance with
statements from their 10k, which is cited within the evaluative report, Brunswick
provides a relatively transparent approach to disclosure. As an example, Brunswick
does not consider their research and development costs as a non-current asset, as
many companies do. They use conservative policies in regard to research and
development by listing it as a sunk cost. This is good news for a potential investor
who is seeking to invest in a trustworthy corporation.
However, there are a few exceptions to this finding in the case of Brunswick.
Although, as mentioned above, they provide a relatively high level of transparency,
there are samples of aggressive accounting within their reports that they provide.
The instances of aggressiveness display a lower level of disclosure that is more
comparable to their competitors accounting strategies. In regards to operating
leases, Brunswick lists them as expenses in their report. Typically, a company with
conservative accounting policies would list them as liabilities. This means that
Brunswick considers operating leases as a rent expense, which increases their net
worth on their balance sheet.
Operating leases can be very deceitful, since they on not usually listed on a
company’s 10k with the discount rate used within them. On top of them being
generally uninformative, Brunswick shows us another example of low disclosure by
providing only a broad description of what these leases are used for. These, along
with capital leases, can very commonly be used to distort reports and allow room
for creating an overly ambitious on value estimations. However, Brunswick does
disclose more information about their capital leases. They provide the exact
purpose of use for their capital leases. On the other hand, they resort to a low-
disclosure approach by not providing the discount rate used for capital leases is.
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This is a trend in leases that they follow for capital leases, as well as operating
leases.
Goodwill will be shown as restated in the following valuation. This is
because of the large portion of assets that it accounts for in Brunswick’s financial
statements. Goodwill is oftentimes overstated to lower tax liability, so in the case
of Brunswick, a restatement will omit the distortion that it could likely cause. In the
defense of Brunswick, however, a high amount of acquisitions can often lead to a
higher goodwill value. Brunswick does much acquiring of companies that consist of
their suppliers mostly. With that being said, there is a chance that Brunswick’s
goodwill is accurately listed. But, as a final decision, goodwill will be impaired due
to the fact that Brunswick’s stock value has gradually fallen and a lower tax burden
could be one of their potential strategies for cushioning the damage it may cause.
In finality, we were able to adjust Brunswick’s account to where their
reporting became more reasonable. All distortions that we were able to uncover
were reprimanded with reasoning. This will allow investors to access a better
version of Brunswick’s reports, which will facilitate them more in making investment
decisions involving Brunswick.
Financial Analysis The financial analysis section provides an overview on how the firm has
performed over the past five years relative to its benchmark competitors. Ratio
analysis allows us to compare Brunswick to its competitors regardless of economies
of scale. The two main components that are discussed are liquidity analysis,
profitability analysis, and capital structure ratios.
Liquidity analysis helps us to determine if the firm is able to pay its current
liabilities when they come due. If the firm doesn’t have enough current assets, they
risk becoming insolvent and potentially bankrupt. To determine the level of liquidity
Brunswick and its competitors have, we analyzed seven ratios. Our liquidity
summary analysis summary can be seen in the table below.
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Overall Brunswick maintains good liquidity and is at little to no risk of
becoming insolvent in the near future. Although they had increasing liquidity, they
were also becoming less efficient. This could lead to cash flow problems down the
road if they are not able to collect on their receivables, or turnover inventory in an
efficient manner.
Profitability analysis helps us determine the ability for Brunswick and
competitors to generate returns from sales, assets, and equity. This is an important
analysis to conduct because it measures Brunswick’s ability to generate returns for
investors. In this section, we analyze gross profit margin, operating profit margin,
net profit margin, asset turnover, return on asset, and return on equity. Overall,
Brunswick underperforms its benchmark, but has been improving over the last five
years. Our profitability analysis summary can be seen in the table below.
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The capital structure of a firm is how it finances its operations. Capital
structure includes long-term debt, short-term debt, common equity, and preferred
equity. A firm’s capital structure primarily depends mostly on the level of risk that
its willing to take on. A firm that is in a very competitive market with a lot of rapid
innovation would likely rely more on equity financing rather than debt due to the
level of risk involved. It is optimal for a firm to finance operations with a mixture of
debt and equity to leverage shareholder funds, while maintaining enough liquidity
to pay current obligations. In this section, we analyzed three main capital structure
ratios, including the Debt to Equity, Times Interest Earned, and Altman’s Z-score. A
summary of capital structure ratios can be seen in the table below.
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Brunswick underperforms its benchmark competitors in every category in the
capital structure analysis. As in the profitability analysis, the trend is improving
even though they have been underperforming the industry. After restating the
financial statements, Brunswick’s capital structure performance decreased even
more relative to competitors.
After analyzing Brunswick and benchmark competitor’s financial statements,
we forecasted its financial statements in order to get an idea about how Brunswick
will perform in the next ten years. We did this by using growth rates, and ratios
over the past five years to predict future performance.
The last financial analysis that we conducted is the cost of equity, the cost of
debt, and the weighted average cost of capital. To find the cost of equity, we first
ran regressions using the 20-year treasury rate, Brunswick’s monthly returns, and
the monthly returns of the S&P 500. This produced a beta of 2.38 compared to
Google Finance’s estimate of 2.03. To find the cost of equity, we simply plugged
the beta, risk free rate, market risk premium of 7.13%, and size premium of .01
into the CAPM model as seen below. We can state that within a 95% confidence
interval that the cost of equity will vary between 14.8% and 21.44%.
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CAPM = .0019+2.38(7.13)+.01
The cost of debt was determined by averaging the rates of debt that
Brunswick provided on their 10K. The cost of debt was calculated using only
interest bearing debt only, so it excluded accounts such as accounts payable. We
concluded that Brunswick’s cost of debt is 6.29% on an as stated basis, and 5.79%
on a re-stated basis. This difference is due to the capitalization of operating leases.
The weighted average cost of capital brings the cost of equity and the cost
of debt together to find a weighted average. To do this we determined the amount
of debt and equity financing that Brunswick conducts, which resulted in 9.22% and
90.78% for debt and equity on an as stated basis, respectively. Weighted on a
restated basis were 11.01% and 88.99% for debt and equity, respectively. The
restated weighted average cost of capital on an after-tax basis results in the most
accurate cost of capital for Brunswick. We concluded that Brunswick’s WACC
bounds range from 13.63% and 16.62%.
Valuation Analysis
Now that we’ve analyzed the industry, accounting policies, and the financial
analysis, we can tie all our analysis together and make a valuation for Brunswick.
Our valuation is at a 10% analyst position. This means that a 10% deviation above,
or below Brunswick’s April 1st, 2016 stock price of $50.18, will produce a over
valued, or under valued result respectively. Our valuation of Brunswick uses two
different methods, the method of comparables, and the intrinsic valuation models.
The method of comparables uses eight different ratios to determine an
adjusted price per share, or the share price that the stock should be trading at. The
adjusted price per share is calculated using an industry average of the ratio. The
valuation method produces mixed results because it relies on one year of data, and
many of the ratios vary heavily from firm to firm. Since these models don’t produce
a very accurate valuation, our recommendation is not heavily dependent on it.
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The intrinsic valuation models use forecasted financial statement information
to value the firm based on future performance. The key difference from the method
of comparables is that it’s a forward-looking analysis, and instead of valuing the
firm based on industry averages, it looks at the firm’s future performance. This is
likely to produce a more accurate valuation of Brunswick due to the fact that it is
only looking at Brunswick and its future. The intrinsic valuation models that we
used in this valuation were the discounted dividends, discounted free cash flow,
residual income, and the long-run residual income models. Our conclusion is that
Brunswick is overvalued on an as stated, and a re-stated basis, and should be sold.
This conclusion relies primarily on the residual income, and the long-run residual
income models, but also take into consideration the method of comparables.
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Company Overview
Brunswick Corporation (“Brunswick”) was formed in 1845 and later
reincorporated in Delaware on July 22, 1987. Brunswick was originally a
manufacturer of billiards equipment but now operates in three main segments:
marine engines, boats, and fitness equipment. Brunswick is headquartered in Lake
Forest, Illinois. The purpose of the company overview is to introduce Brunswick’s
operation and performance. In the overview we will first cover the basics of each
business segment and how Brunswick compares to its closest competitors. Next, we
will contrast Brunswick’s total assets relative to its competitors. Lastly, we will
analyze stock performance over the last five years and evaluate it against industry
peers.
Marine Engine Segment
Brunswick’s marine engine segment is the largest segment, making up 53%
of sales. Mercury Marine is the firm’s main engine manufacturer. Mercury Marine is
located in Fond Du Lac, Wisconsin and just finished an expansion project that has
led to new products, including the 5, 90, and 115hp FourStroke outboards, and an
expanded Parts and Accessories department (Brunswick 10k, 2015). Mercury
Marine sells its engines worldwide through a network of 5,500 dealers and
distributors. Some of the marine engines Brunswick manufacturers include
outboard engines, sterndrive propulsion systems, inboard engines, trolling motors
and rigid inflatable boat motors. A small portion of Mercury Marine’s engines are
manufactured in China and Japan, and some parts are manufactured in Florida and
Mexico. In June of 2014, Mercury Marine acquired Whale, which is based in Bangor,
Ireland. This acquisition significantly increases their international presence.
Brunswick has seen consistent sales growth in their marine engine segment.
As seen in Figure 1, over the past 5 years sales have grown 23.63% while
Brunswick’s closest competitor, Polaris, has seen a continuous decline over the past
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five years. Year-over-year Brunswick has seen more consistency in its sales growth.
The marine engine industry is expected to grow at a healthy rate through out the
rest of the decade. “The marine engines market is expected to reach a value of
USD 11 billion by 2020, at a CAGR of 4.0% from 2015 to 2020”(Marine Engine
Market by Propulsion). This level of growth will match Brunswick’s current
compound annual growth rate if industry predictions are correct. Brunswick
attributes 2014’s sales increase to greater demand for outboard engines and their
new FourStroke engines, as well as acquisitions in the engine accessory business
(Brunswick 10k, 2015). International sales make up 35% of this segment
(Brunswick 10k, 2015).
Figure 1
Boat Segment
Brunswick’s boat segment manufacturers fiberglass pleasure boats, sport
and luxury yachts, aluminum and offshore fishing boats, pontoon boats, deck boats
and inflatable boats. This segment makes up 27% of sales. Brunswick’s boat
segment operates under The Boat Group. The firm operates facilities in Missouri,
Tennessee, Indiana, Minnesota, Florida, Portugal, New Zealand, Mexico, Canada,
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and Brazil and has a contract manufacturing facility in Poland (10k). Just as the
marine engine segment, their boat segment has a significant international
presence. The Boat Group owns brands such as Quicksilver, Rayglass, and Uttern,
who operate in Asia and Europe. These firms work in cooperation with Mercury
Marine who supplies the boats they sell with engines (10k). The Boat Group
operates a network of 3,000 dealers and distributors to sell its boats. The largest
dealer is Marine Max Inc., which makes up 18% of the firm’s sales (10k).
As seen in Figure 2 below, Brunswick’s boat segment took a 0.50% loss in
2012 but has fared well overall with a 34.60% increase in sales over the last five
years. In 2013, their closest competitor, West Marine, encountered a similar
problem when their sales shrunk by 1.78%. Overall West Marine grew only 12.63%
over the last five years.
Figure 2
In 2014, Brunswick introduced a new product line. This product line features
larger, more expensive boats that increased the firm’s average selling price. The
new product line led to an increase in wholesale shipments and sales (10k). This
new product line should continue to grow and increase sales revenue as long as the
economy grows domestically. If the economy starts to trend towards recession the
new product line may hurt the segments bottom line because people are going to
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be less likely to buy an expensive boat, just like the firm is currently experiencing
with declining sales is Europe.
Fitness Segment
Brunswick’s fitness segment does business primarily under the name Life
Fitness, which produced cardiovascular and strength training equipment. “Life
Fitness’ commercial sales customers include health clubs, corporations, schools and
universities, hotels, professional sports teams and the military and governmental
agencies”(10k). Brunswick’s fitness segment is the largest in the world, leading the
industry in sales. Life Fitness manufacturing facilities are located in Kentucky,
Illinois, Wisconsin, Minnesota, and Hungary. Life Fitness also has manufacturing
contracts in China and Taiwan.
Brunswick reports its billiards sales under the fitness segment. Billiards sales
primarily come from the sale of pool tables, table tennis, air hockey games, and
game room furniture. Brunswick sells some of its billiards equipment under
Contender brands and the rest under Brunswick itself. The billiards section of the
business seems to be declining due to the amount of competition and lower prices.
It seems as though the company may continue to separate itself from this part of
the business in the near future, potentially selling it as it recently did with their
bowling business.
As seen in figure 3, Brunswick’s fitness segment has seen a 40.66% increase
in sales over the past five years while Nautilus Inc grew 16.06%. The firm’s fitness
segment has seen significant growth internationally. 49% of fitness sales for 2014
came from their international operation, primarily in Africa, Latin America, and the
Middle East (Brunswick 10k, 2015).
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Figure 3
Discontinued Operations
Brunswick was once a leading innovator of the bowling business. They were
the first to manufacturer the pinsetter and helped create the rules of the game
(CBS News, 2014). In recent years bowling has slowly declined, so in 2014,
Brunswick agreed to sell its bowling centers to AMF bowling for $270 million.
Following the sale of the centers, Brunswick also decided to sell its retail bowling
business to BlueArc Capital Management LLC for an undisclosed amount (Mlive,
2016). The retail bowling centers were the last of the bowling business, so this
segment no longer exists.
Stock Performance
Brunswick’s stock has performed average compared to its competitors. As
seen in Figure 4, Brunswick has had a 5 year return of 102% compared to 68% for
Suzuki, 655% for Nautilus, and -38.65% for West Marine. In the same period of
time, the S&P 500 grew 44.4%.
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Figure 4
(google.com/finance, 2016)
Total Asset Value
Brunswick has by far the most assets compared to competitors. In 2014,
they had more than $3 billion in total assets, with West Marine well behind them
with $386 million. Overall, Brunswick’s total assets have grown slower than it’s
competitors, as shown in Figures 5 and 6.
Figure 5
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Figure 6
Five Forces Model
We will use the Five Forces Model to compare competition within the
industries Brunswick operates in. The profit potential of the companies in these
industries can be estimated from analyzing the profit potential that is found in each
segmented industry that they operate in. These segments include the marine
engine, boat, fitness, and billiards industries. A key influence on its profitability is its
industry structure. To stay profitable, companies must continue to find new and
innovative ways to create products, while keeping a low operating cost. Their
profitability is dependent on the price that they sell their products for in comparison
to the cost of producing them. Additionally, other factors influence the determining
of the product’s price. According to Healy and Palepu cost is dependent upon the
capital markets.
“The capital cost of a firm is determined by the capital markets. Its
profit potential is determined by its own strategic choices: (1) the
choice of an industry or a set of industries in which the firm operates
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(industry choice), (2) the manner in which the firm intends to
compete with other firms in its chosen industry or industries
(competitive positioning), and (3) the way in which the firm expects
to create and exploit synergies across the range of businesses in
which it operates (corporate strategy). This means strategic analysis
involves industry analysis, competitive strategy analysis, and
corporate strategy analysis” (Healy, Palepu, 2008).
These strategic choices can facilitate the firms in earning greater returns on their
capital and increasing the value of their companies.
The Five-Forces Model, described below, shows each of the industry
segment’s profit drivers, as well as what gives each company a competitive
advantage. These profit drivers include rivalry among existing firms, threat of new
entrants, threat of substitute products, bargaining power of buyers, and bargaining
power of suppliers.
Rivalry of Existing Firms
Competition also plays a big role in profitability. If a firm can hold a strategic
advantage over other competing firms, it has the opportunity to become extremely
profitable. When an industry has different companies fighting for market share, you
will see a lot of price wars. Each one of these segments contains a high level of
rivalry with other companies. There are several factors that show the rivalry of
existing firms such as industry growth, concentration, differentiation, switching
costs, scale/learning economies, fixed-variable costs, excess capacity, and exit
barriers.
Industry Grow th
The marine and boat industry is a fairly steadily growing industry. The
industry growth is dependent on a mix of the state of the economy and innovation
25
within the industry. When the economy is in good condition, people are working
and making money. Their consumer confidence is high, making them want to buy
more luxurious things like boats. Boat builders also have an effect on the industry
growth by developing new ideas to attract more consumers every year.
As for the fitness industry, the new inspiration of looking “young and fit” has
increased demand for fitness products. Consumers of all age groups are
implementing fitness into their lifestyles, which drives them to purchase more
fitness equipment and gym memberships. According to the Sports and Fitness
Industry Association, “As the overall economy improves, consumers will spend
more money on fitness equipment. In the U.S., fitness participation remains strong
and continues to show growth potential. Each year consumers are becoming more
active, play more and, hopefully, increase their spending on sports and fitness
items” (sfia.org, 2016).
The fitness segment consists of home products, commercial equipment,
active aging, and well-being. These different lines of products are made up of
cardiovascular fitness equipment (treadmills, total body cross-trainers, stair
climbers, and stationary exercise bicycles) and strength-training equipment under
the Life Fitness and Hammer Strength brands. As mentioned previously, Life Fitness
makes a vast majority of its sales commercially to consumers including health
clubs, corporations, schools and universities, hotels, professional sports teams and
the military and governmental agencies. Because their equipment is so highly
trusted, it gives them the power to price their equipment how they want.
Concentration
“The US fitness equipment manufacturing industry consists of an annual
revenue of $3 billion combined amongst about 100 companies. Major companies
include Cybex International, ICON Health & Fitness, Life Fitness, Nautilus, and
Precor. These top five companies account for more than 50% of revenue making it
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a concentrated industry” (reuters.com, 2016). These companies hold a large
portion of the market by focusing on quality, service, pricing, and advertising.
Differentiation and Sw itching Cost
There is a low level of differentiation in each industry segment that
Brunswick is involved in. The products in the fitness industry are very similar
making it easy for consumers to switch from one product to the other based on
cost. This industry has a low switching cost, making the firms engage in price
competition. Most of the fitness equipment made by the competing firms performs
the same functions. In order to combat the low switching cost, companies can try
to differentiate themselves from their competitors by improving the quality of their
fitness equipment. They need to ensure that customers will have lasting equipment
that will perform better and longer than any equipment sold by other companies.
In the marine industry the products are also very similar. One way that
companies keep a level of differentiation is by putting certain patents and
copyrights on their products, making it hard for other companies to create similar
products. They can also separate themselves in a low differentiation market by
coming up with new designs and fancy features that draw consumers to their
products as opposed to their competitor’s products.
Learning Economies
“Size is an important factor for firms in an industry that has a steep learning
curve or scale economies. It creates incentives to engage in aggressive competition
for market share. Firms also try to reduce prices to utilize installed capacity if the
ratio of fixed to variable costs is high” (Healy, Palepu, 2008). Brunswick employs
thousands of employees worldwide, but employee numbers have dropped from
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15,701 in 2013 to 12,161 in 2014. While size does make a difference, Brunswick
believes that the true difference lies in the skill and level of education that its
employees possess. With having higher skilled and educated workers, they have
saved time and money by operating more efficiently.
In an industry that is constantly looking for newly developed products it is a
competitive advantage to have smarter and more efficient ways of creating and
designing products. There is also a high level of complexity when it comes to
manufacturing boats and engines. Therefore, more experienced workers will be
able to complete the manufacturing process quicker and more efficiently. While
Brunswick is focused on the skill and education of their employees, Polaris is
focusing on learning to be more cost effective. According to Polaris’ 10K, their
income as a percentage of sales increased by ten basis points. This means that
their cost as a percentage of sales is decreasing, which means they are making
products more cost effectively.
Excess Capacity
If the companies’ in these industries major dealers reduce their inventory,
there could be a negative affect on their financials. Dealers could potentially decide
to do so if the demand for their products is lower that the forecasted amount, or if
new products come out and replace older products. This can result in wholesale
reductions in excess of retail reductions, causing lower production levels of
products in the industry. Then the companies will have lower rates of absorption of
fixed costs in their manufacturing facilities resulting in lower margins. To maintain
sales and operations, companies continue working to maintain suitable levels of
dealer inventory.
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Exit Barriers
High exit barriers make it hard for a company to do away with a product.
Due to its specialized products, Brunswick is no stranger to these high barriers. As
mentioned above, Brunswick has to maintain an excess amount of capacity. This
makes it difficult for the company to exit the industry if and when needed. Due to
the specialized products, these assets cannot be easily sold to other producers. If
the company were to have declining sales, it would be forced to stay in the
business because it has invested a considerable amount in its long-term assets.
Therefore, leaving the industry would cost more than the annual losses. In Figure
7, we can see that the dollar value of inventories for companies in this industry is
high. This makes it harder for companies to find a buyer that is willing to acquire
them.
Figure 7
Conclusion
A high amount of rivalry puts a lot of pressure on companies in this industry.
Companies are trying to steal market share and profit from one another, reducing
potential profit throughout the entire industry. Intense rivalry makes competitors
aggressively try to undercut each other and engage in price wars. As shown above
in the learning economies section, competition is evident by the fact that Brunswick
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is decreasing their employee numbers, and Polaris is increasing their income as a
percentage of sales.
Threat of New Entrants
In order to enter into these industries, a company needs a fairly large
amount of capital. As shown in the Industry Inventories graph above, it requires a
large amount of money to acquire a business in the industry. There is a moderate
threat on new entrants in each segment of this industry, because there are several
barriers of entry. These barriers include scale economies, first mover advantage,
distribution access, relationships and legal barriers. It is also a hard task to hold
customer loyalty. For most of the products in this industry, there is little to no
switching costs. This allows consumers to pick and choose between different
companies products based solely on the price tag. Consumers do not typically have
a favorite boat engine, so they usually purchase it based on price. One way a
company can take over the market share is by attracting these consumers with new
creative and innovative features that make their products stand out over
competitor’s products in the same price range.
Scale Economies and Fixed Variable Cost
Brunswick has created large economies of scale by lowering their production
costs from 2.8 billion in 2014 to 2.9 billion in 2015, while increasing their
operations. As you will see in the first mover advantage section below, companies
are able compete in large scale economies by making deals with suppliers to get its
raw materials at discounted rates. By buying these materials in bulk at certain
rates, the company can set fixed variable costs. This allows companies to predict
exactly what its cost will be according to the amount of products they produce. This
lowers the cost of goods sold, making a higher profit margin.
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Without having access to these lower priced raw materials, it becomes more
difficult for new companies to compete on larger economies of scale. “With large
economies of scale, new entrants will have to invest a large capacity, or enter with
less than the full amount of capacity needed” (Healy, Palepu, 2008). Large
investments could be a major risk if used wrongly. This makes it difficult for new
companies to enter because they will begin with a major cost disadvantage when
competing with existing firms.
First Mover Advantage
Each of the segments in this industry can establish a first mover advantage
by making negotiations with suppliers for cheaper raw materials that they use to
build their boats. One strategy companies use to hold this advantage is using
derivatives to hedge future changes in its raw material prices. These raw material
prices fluctuate depending on market conditions. When cost increases, it becomes
difficult for the company to remain competitive while sustaining profitability. With
raw material prices high, companies are faced with the dilemma of raising product
costs to avoid decreasing profitability. However, if they do increase the cost, they
could potentially lose consumers. Another lurking threat is the possibility of supply
shortages and delayed deliveries. Low switching costs allow customers to easily
choose different suppliers, which pose another threat for companies in each
industry.
Distribution Access
Distribution access can also serve as a barrier to entry. When new firms
come into the market, they have limited, if any, distribution channels. This creates
difficulty in establishing new distribution channels. Companies in this industry have
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thousands of dealers worldwide that they use for the majority of their sales. These
dealers also carry product parts and accessories for easy access to the consumers.
Most of these dealers consist of independent companies ranging from small, family-
owned businesses to large, publicly traded corporations. Companies in this industry
will have dealers that sell just their products, and they also might have dealers that
carry competitor’s products as well.
Dealer networks allow companies to ensure quality and service that helps
with consumer experience. This array of distribution channels gives companies
within this industry a superior advantage over new entrants in the market. With
very little beginning capital, it is difficult for a new company to compete against
existing companies that have thousands of distribution centers.
Relationships
A lot of products produced in this industry are seasonal. Most consumers
looking to buy a boat only shop during the warm weathered “boating” season.
These unstable sales make selling hard, at times, for the boat dealers. To solve this
problem, some companies offer their dealers financial assistance, incentive
programs, loan guarantees, and inventory repurchase commitments. These
incentives are vital for saving a good relationship with its dealers. Although some of
this financial support puts companies at risk, it can also be their business’ best
interest to help the distribution channel partners financially. Healthy relationships
not only assist in maintaining a high quality of business, but also keep the
distribution channels loyal to their companies. This makes it harder for new
entrants to come in and take over the channels.
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Legal Barriers
In many industries, there are legal barriers such as patents and copyrights
which make it hard for new companies to enter the market. Patents and copyrights
owned by companies can be vital for maintaining a competitive advantage. In the
marine engine industry, patent rights consist of outboard engines and inboard-
outboard drives, hybrid drives, and pod drives. Most of the patent rights in the boat
segment of the industry pertain to the manufacturing processes including, the
processes for fiberglass hulls, decks, and components for boat products. These
legal barriers give the companies already competing in the industry a competitive
advantage over new companies trying to enter into the industry.
Conclusion
In the profitable industries that Brunswick is associated with, you can expect
companies moving in to stake their claims. However, the economies of scale in this
industry make it hard for new firms to enter and be profitable. Brunswick has an
advantage over new entrants, not only because of its economies of scale, but also
because of its well-known brand names. This makes the industry more attractive
for Brunswick and helps increase its profit potential.
Threat of Substitute Products
There is a high threat of substitute products in these industries because
there is no unique niche in any of these industry segments. Without high research
and development spending, it is rare to see a company take a competitive
advantage. This allows substitutes to claim market share. Substitutes can be
products that possess similar technology and perform similar functions, which allow
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the consumers to do away with existing products. This doesn’t mean consumers will
get rid of old boats, but they will want the newer and more efficient models. “The
threat of substitutes depends on price and performance, and on customers’
willingness to substitute. If two products perform an identical function it would be
difficult for the prices to be different. One thing that allows products like this to
compete is the customers’ willingness to switch” (Healy, Palepu, 2008).
Relative Price and Performance
Research and development expenditures are high. If they are not being
innovative and creating new ideas, it is easy for another company to take market
share by finding a niche in the market. This high level of competition puts company
ownership of market share at risk. Companies in this industry have continuously
increased their investing amounts in research and development to stimulate
innovation. For Brunswick, research and development expenses, as a percentage of
net sales in 2012, 2013 and 2014, were 2.27%, 2.95% and 3.12%. These expenses
have gone up each year in all three segments. Figure 8 shows the research and
development expenses in each business segment for the years 2012-2014.
Figure 8
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Figure 9 shows the high research and development expenditures for three
competing companies in this industry. Nautilus’ R&D expenses are lower because
they only compete with Brunswick in the fitness segment. It also shows an increase
in R&D expenses each year.
Figure 9
Consumers’ W illingness to sw itch
With low switching cost for consumers, companies have to find different
ways to keep a high quality product that consumers will be loyal to. Companies in
this industry rely on their brands for the success of the company's business, and
believe that building their brand maintains consumer base. To remain on top with
these high quality brands, companies must continue to find ways of producing
great quality, while keeping low cost.
Conclusion
There is a high threat of substitutes in this industry, because it has low
consumer switching cost, cheaper substitute products, and newer and higher
quality product production each year. Continuous innovation will be the key to the
future of these companies’ success, as well as maintaining low costs.
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Power of Consumers and Suppliers
Brunswick operates primarily in both the marine and exercise equipment
industries, so in order to fully understand and value the firm, we need to
understand the makeup of these industries. Of particular interest is the bargaining
power of consumers and suppliers. The difference of whether a firm is a price-
setter or price taker in its industry is central to the formation of its operations
strategy and strategic goals.
Consumer Power – Marine
The boating industry has a number of key firms participating, leaving the
market very competitive. For consumers, this gives them high bargaining power.
Switching costs are low due to the number of available companies to buy from.
Combine all of this with the large body of people interested in watercraft and the
fact that most watercraft are bought for recreation, and the boating industry is
thoroughly a consumer price-taker. A firm in this environment will have to do
everything it can to keep its costs down, so it can offer products at low competitive
prices and still profit.
Supplier Power - Marine
On the supplier side, the boating industry has considerable influence. The
necessary fiberglass and metal suppliers are common enough that the boating
industry can afford to switch suppliers easily. There is little difference between
fiberglass and metal provided by one supplier and another, making switching even
simpler. Purchasing companies can also buy derivatives to protect against rises in
commodity prices that may affect suppliers. All of these facts combine to make the
boating industry a price setter with its suppliers. This is helpful to boating firms,
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because it allows them to control their costs more effectively, a necessity for a
consumer price-taker.
Consumer Power – Exercise Equipment
The exercise equipment industry has quite a few key firms, such as Nautilus
and Precor, with intense competition coming from gyms when it comes to their
sales to individuals. Consumers can easily acquire a gym membership and gain
access to exercise equipment and other amenities, so unless the equipment firms
market to those gyms, they will have problems. The good news for firms is that if
they can make sales to those gyms, the gyms will likely purchase a lot of inventory
over the course of their business relationship. The fact there is little difference
between brands of exercise equipment works against the equipment firms however,
as those same gyms and customers can easily swap one firm’s equipment for a
competitor’s. Therefore, consumers in the exercise equipment industry have a
great deal of bargaining power, forcing the resident firms to take offered prices.
This means the exercise equipment must its equipment as cheaply as possible,
while still retaining safety and quality.
Supplier Power – Exercise Equipment
The exercise equipment industry has much more bargaining power on the
supplier side, as the chief materials used in fitness machine construction (metal,
plastic, and rubber) are quite common, with many suppliers ready to meet the
demand. With little difference between metal products, the equipment firms can
easily switch suppliers for a better deal. Such a process is also cheaply done, and
derivatives are readily available to protect firms from drastic shifts in commodity
prices. The exercise equipment firms are the price setters in regards to their
suppliers.
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Concluding Analysis
Considering the similar characteristics of both the marine and exercise
industries, it is perhaps not so surprising that Brunswick decided to diversify into
both industries. Both are price-takers from the customer angle, and price setters
from the supplier angle. With these characteristics matching, while the exact
technical details of the industries may differ, the general strategy for succeeding in
both, at least from the supplier and customer angle, are the same. Both marine and
exercise industries would likely depend on the price controls from the supplier angle
to market competitive-cost products to match consumer-given prices. Combine the
likely synergetic cost-savings from marine products and exercise equipment both
requiring metal and plastic inputs, and Brunswick can use the roughly the same
methods to succeed in both industries.
Analysis of Key Success Factors
Brunswick works in the marine industry, providing engines under the
Mercury Marine brand name and boats under the Brunswick name. In addition,
Brunswick acts in the exercise equipment industry under the Life Fitness and
Hammer Strength brands. Despite working in different industries, with completion
coming from firms such as Nautilus, West Marine and Polaris, Brunswick’s brands
are global leaders. None of these firms became established in their industries
without carefully developed strategies to develop lasting competitive advantages.
Brunswick adopts a combined cost-leadership and differentiation approach to its
industries, and this approach is commonly used to success by multiple firms in both
the marine and fitness industries.
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Cost Leadership – Low Input Costs
Cost leadership strives to maintain low input costs, which is relatively simple
for the primary marine and fitness industrial inputs of metal, fuel, and fiberglass. It
is commonplace for firms in both industries to use their power as large-scale buyers
of resources to secure profitable price agreements with input suppliers. Brunswick,
along with its competitors Polaris and Nautilus, also maintain financial derivative
positions to hedge exposure to changes in commodity prices. The resultant
lowered costs in inputs from these practices allow for marine and fitness firms to
better compete on costs and win customers through less expensive goods.
Cost Leadership – Economies of Scale
The development of economies of scale is central to cost-leadership, and this
is no exception to cost-leadership in the marine and fitness industries. As
companies produce more products, the amount of costs per each individual product
drops as increases in efficiency result. This results in the dual benefits of selling
more product and having lowered costs of goods sold. Brunswick and its
competitors all have strived to build and obtain production facilities capable of
achieving economics of scale. Brunswick, Nautilus, and Polaris all maintain lower-
cost, high-yield production facilities in China, on top of facilities in the U.S. and near
other important markets, to take full advantage of full-scale production. Lowered
costs and more available product allow the firms to profit more from customers,
both on an individual basis and in terms of quantity.
Cost Leadership – Low Distribution Costs/Efficient Production
Another cost-leadership principle is maintaining low distribution costs
through efficient logistics. The dual benefits of lowered costs and increasing
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product sales rear their heads again as Nautilus, Brunswick, and Polaris have all
spread their distribution networks across the globe, in order to take full advantage.
Polaris has numerous facilities located in France, one of its most important markets.
Brunswick, Polaris, and Nautilus all have recorded contracts with shipping and
trucking companies to ensure their product gets from factory to shelves as
efficiently (quickly and cheaply) as possible. These resultant cost savings and
improved reach allow these firms to boost their sales.
Differentiation Strategy – Wide Variety of Products
On the other side of the coin, one of a differentiation strategy’s mainstays is
providing a wide variety of products. This approach works well in both the marine
and exercise industries, as different consumers will have different wants and needs
to satisfy. Being able to market to nearly every possible consumer marine or
fitness need has allowed Brunswick to profit and expand across the globe. Nautilus
markets different fitness equipment types for muscle group in the human body,
adjustable machines that can exercise multiple body parts, and machines that can
exercise most of the body all at once. This versatility allows them to serve every
type of fitness machine customer.
Differentiation Strategy – Research and Development
Investing a great deal of capital in research and development is of great
benefit to implementing a differentiation strategy. Developing a product that is
unmatched in customer satisfaction is a textbook way to make a differentiation
strategy succeed, and such innovations are unlikely to become feasible without
investment of time and resources. Development of new types of watercraft such as
jet skis revolutionized the marine industry, and the development of hovercraft
caused another revolution. Being the first to develop and market a product
provides the valuable (profitable) first mover advantage.
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Differentiation Strategy – Brand Recognition
It is central to a differentiation strategy to build brand recognition. A
superior reputation can make prospective consumers pick one brand over another,
even in the face of lower cost alternatives. Any new competition will face an uphill
battle in trying to compete with a household name. The Brunswick Life Fitness and
Hammer Strength line and Nautilus are amongst the most popular and most used
fitness brands. Polaris and Brunswick are known throughout the world for their
watercraft, and both companies have made billions from their brands.
Cost Leadership vs. Differentiation
Despite differing priorities and strategies, cost leadership and differentiation
can easily co-exist. This fact has been demonstrated in the consumer retail industry
by Wal-Mart, which provides all manner of daily household goods at affordable
prices. The same principles already apply in the marine industry: Brunswick, Polaris,
and Nautilus all strive to provide a wide range of marine craft known for quality
while also competing on cost. Brunswick and Nautilus do the exact same thing with
their fitness equipment lines. Savings gleaned from economies of scale and efficient
distributions can readily be invested in brand marketing or in research and
development in search of the next great innovation. Innovations are then copied by
competitors and forced to compete on costs. Cost Leadership and differentiation
strategies often synergize quite well.
Firm Competitive Advantage Analysis
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The profitability of a firm does not only rely on the industry that they
compete in, but the strategies that the firm takes to gain a competitive advantage
in their industry. In the case for Brunswick, they have been able to gain a
competitive advantage over their competitors by using a cost leader strategy.
Cost Leadership
According to Paul Healy and Krishna Palepu in their book, Business
Valuation: Using Financial Statements 5th edition, cost leadership is defined as one
of the basic strategies for a firm to gain a competitive advantage in their industry.
Cost leaders operate with little overhead cost, using economies of scale, efficient
distribution and production strategies, and simple product designs (Healy, Palepu,
2008 p.2-12). According to Healy and Palepu, firms that become cost leaders in
their industry are able to determine the price, force their competitors to lower their
prices, earn lower returns, or exit the industry. Brunswick uses the cost leadership
strategy to gain a competitive advantage in the recreational goods industry.
Economies of Scale
What makes Brunswick a cost leader in the recreational goods industry is
their use of economies of scale. According to Richard B. McKenzie and Dwight R.
Lee in their book, Microeconomics for MBAs: The economic way of thinking for
managers 2nd edition, economies of scale is the cost advantage that arises when
the output of goods produced increases along with a rise in technology. This allows
the total cost of production to be spread out with the increase in production of
goods (McKenzie and Lee, pg. 294). This is an advantage for Brunswick who
operates in multiple segments of their industry. To insure that the manufacturing of
their products continues to increase, Brunswick buys their raw materials in high
volume from their supplier. By buying their raw materials in high volume, Brunswick
is able to produce a higher volume of their many products and spreading out their
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fixed costs. Brunswick also gains a competitive advantage from the use of
economies of scale through acquisitions of other firms.
Figure 10: Goodwill (in millions)
Figure 10 above shows the reported goodwill Brunswick and several of their
competitors in the recreational goods industry. For the past five years, Brunswick
has shown to have the most invested in goodwill. Acquisitions expand the
company’s production and control in the industry. According to Brunswick’s 2015
10-K, in January of 2016, Brunswick acquired the privately held Cybex international.
Cybex is one of the leading manufactures in commercial fitness equipment.
Brunswick stated in the 10-K, “The company believes the acquisition will expand
the Fitness segment’s manufacturing footprint to meet current and future demand
more effectively and increase the breadth and depth of its product
portfolio.”(Brunswick Corp, 10K, 2015). By acquiring companies, Brunswick is able
to expand their production through the increase of demand. In return acquisitions
help spread out their fixed costs by increasing the total production of their
products. By using economies of scale, Brunswick is able to gain a competitive
advantage over their competitors in their industry.
Input Costs
For Brunswick input costs are an important part in their use of the cost
leadership strategy to gain an advantage over their competitors. Companies like
Brunswick strive to have low input cost to supply their materials needed to
manufacture their products. By having low input costs, Brunswick would be able to
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produce their products at a lower cost. This helps Brunswick stay competitive and
be profitable.
Figure 11 Gross Profit Margin
Figure 11 above shows the gross profit margin for Brunswick and their
competitor in their industry. The gross profit margin shows how much a firm profits
after the cost to produce their product is taken out of revenue. For the past five
years Brunswick has had the lowest gross profit margin compared to their
competitors. Nautilus had the highest gross profit margin, but according to their
annual report they only compete in the fitness segment. The rest of Brunswick’s
competitors were around the industry average.
Although Brunswick has shown to have the lowest gross profit margin
compared to their competitors, Brunswick produces a wide variety. Using low input
costs help Brunswick increase their profits, but Brunswick’s raw material costs are
dependent on market pricing. If the price for the raw materials increased, this
would affect Brunswick’s profitability. In order for Brunswick to make a profit, they
would have to increase the prices for their products. This would negatively affect
Brunswick, because demand for their products would decrease. To stay competitive
Brunswick needs to continue to have low input costs to produce their products.
Low Distribution Cost/Efficient Production
Firm 2011 2012 2013 2014 2015Brunswick 23.35 25.39 26.11 27.01 27.16
Polaris 27.87 28.83 29.68 29.45 28.37West Marine 28.75 29.34 28.90 28.59 28.67
Nautilus 43.39 46.94 48.66 51.22 51.59Average 30.84 32.63 33.34 34.07 33.95
Gross Profit Margin
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For companies like Brunswick, being efficient in the production of their
products is critical to gain a competitive advantage in the recreational goods
industry. When a company is efficient with the production of their products, they
are able to efficiently move their products through the phases of manufacturing to
selling the product to the customers. In order to show how a firm is efficient in
their production of their products, we will use the inventory turnover ratio to show
the industry average to turnover their products and Brunswick.
Figure 12: Inventory Turnover
Figure 12 above shows the inventory turnover ratio for the recreational
goods industry for the past five years. The inventory turnover shows how many
times a company turns over their inventory in a given year. In 2015, Brunswick had
an inventory ratio of 4.37. This means that Brunswick, turnover their inventory a
little over four times in that year. This was above the average for the industry. The
industry in a whole turned over their inventory about 3.80 times in 2015. Although
Brunswick was above the industry average, Polaris had the highest ratio in the
industry. After examining the inventory ratio, Brunswick has been able to keep a
competitive advantage over many of their competitors by having an efficient
production of their products. In order to insure that they stay cost leaders through
efficient production, Brunswick needs to keep low manufacturing costs and
continue to use economies of scale to spread out their fixed costs to produce their
products.
Firm 2011 2012 2013 2014 2015Brunsiwick 5.39 4.82 4.79 4.30 4.37
Polaris 6.43 6.62 6.36 5.59 4.76West Marine 2.37 2.46 2.32 2.25 2.26
Nautilus 8.79 5.48 7.10 5.38 3.80Industry Average 5.75 4.85 5.14 4.38 3.80
Inventory Turnover Ratio
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Conclusion
A firm’s competitive advantage is examined by the strategies that it uses to
give it an advantage in their industry. The strategies employed to achieve a
competitive advantage are being a cost leader and the differentiation of their
products. Brunswick uses both strategies to gain the advantage to be a leader in its
industry. It uses economies of scale spread of out their fixed cost by increasing the
production of their products and acquisitions of companies. Brunswick uses low
input costs to obtain their raw materials needed to produce their products to make
a profit. Finally Brunswick has a efficient production of the their products and are
able to turnover their inventory more than the industry average. The recreational
goods industry is a competitive market with many companies competing in it. If
Brunswick can continue to be a cost leader in their industry, Brunswick will further
strengthen its competitive advantage over its competitors.
Accounting Analysis
In this section, we will analyze the accounting policies of Brunswick through
their Key Accounting Policies. These policies have been adopted as a guideline to
measure the level of transparency by Brunswick. While the firm has to adhere to
GAAP, there are ways that they may distort financial information through
accounting policies and withholding information that could be important in valuing
the firm. To begin, we will identify and analyze key accounting policies
implemented by Brunswick. Next, we will assess potential accounting flexibility
within key accounting policies. After that we will evaluate actual accounting
strategy by assessing Brunswick’s choice of accounting policies and the level of
disclosure they provide. Next, we will perform a qualitative analysis on the level of
disclosure. Lastly, we will identify potential red flags in the previously mentioned
46
key policies, as well as undo potential distortions. The purpose of doing so will give
us an enhanced understanding of Brunswick’s financial position.
Key Accounting Policies
Key accounting policies are significant factors that allow us to judge
Brunswick’s accomplishments. Identifying key accounting policies are important, so
that we may identify possible accounting distortions. In this case, restating financial
statements will be necessary so that we can have a better understanding of
Brunswick’s financial position, and ultimately an accurate valuation. We will begin
by identifying type I and type II key accounting policies.
Type I Key Accounting Policies Type I key accounting policies are closely related to the key success factors
from the previous section. In the recreational goods industry, keeping input costs
low, and keeping production is important to the firm’s future profitability. Low
prices are what the recreational goods industry’s products apart. This is true for the
industry as a whole, and not just Brunswick. The key success factors that will be
analyzed are economies of scale, low input costs, and efficient production.
Economies of Scale Brunswick owns over 3,000 distribution centers and 29 manufacturing
facilities worldwide. As seen in Figure 13, this is a significant amount more than
benchmark competitors. Brunswick has also completed four acquisitions over the
past year and many more over the past five. This gives Brunswick an advantage
over the competition because of their size and scope.
Figure 13
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Over the past five years, Brunswick has been able to expand its operations
and increase it’s sales and net income through acquisitions. Brunswick’s ability to
obtain financing to make these acquisitions sets it apart from benchmark
competitors and gives it a leg up in international markets. If Brunswick can
continue to make acquisitions without altering its debt-to-equity ratio, it will
outperform its competitors.
Low Input Cost The recreational goods industry is a very competitive industry that strives to
keep costs low. These firms have to constantly evolve to keep costs low. The
primary way that firm’s in this industry keep costs low is by taking advantage of
economies of scale and keep research and development expenses to a minimum.
These firms have a large exposure to aluminum and steel prices, and are able to
hedge this risk by purchasing futures contracts to reduce the risk of price increases.
This could allow them to have lower input costs for a period of time relative to the
industry if prices did go up.
Figure 14
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Figure 14 shows net sales relative to the cost of goods sold for Brunswick
and its benchmark competitors. Brunswick has had a 3.81% decline in costs relative
to sales over the past 5 years, while the competition has stayed relatively constant.
This shows that Brunswick has a competitive advantage over their benchmark
competitors because they can produce products cheaper.
Product M ix
The recreational boating industry heavily depends on the performance of the
economy. It is also a seasonal industry, more boats are sold in the spring and
summer than the fall and winter. Figure 15 shows the number of new recreational
boat sales from 2003 to 2013 (Statistica, 2016).
Figure 15
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This graph show the how cyclical the industry can be with a 62.59%
decrease from 2007 to 2010. This was because the economy was going through a
recession and consumers weren’t spending their discretionary income. Brunswick
isn’t as affected by these downturns as competition is because they also have a
billiards and fitness segment that has $794.6 million in sales, 19.3% of it’s total
revenue.
Brunswick having a diversified portfolio will help it survive an economic
downturn through a different source of revenue in a different industry. This will
help Brunswick continue to grow and make acquisitions at a discounted price.
Type II Key Accounting Policies
Type II accounting policies have the possibility of being distorted in favor of
the firm by management. Brunswick’s policies that have the potential of being
distorted are: capital and operating leases, research and development, goodwill,
pension liabilities, and derivative risk. Each policy will be analyzed individually to
determine if Brunswick’s financial statements are being distorted.
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Capital and Operating Leases
Capital and operating leases are one of the more common distortion found in
firms’ financial statements. According to Brunswick’s 10K, “The Company has
various lease agreements for offices, branches, factories, distribution and service
facilities and certain personal property. The longest of these obligations extends
through 2032” (Brunswick 10k, 2015). Operating leases make up on average 98%
of Brunswick’s lease obligations. Figure 16 shows the amount of operating and
capital leases on Brunswick’s balance sheet over the past five years.
Figure 16
Operating leases are considered to be “off balance sheet,” so it does not
show up on the balance sheet as a liability. Brunswick’s reliance on operating leases
likely distorts debt ratios, making it look as though the company has fewer
obligations than it actually does. The operating lease expense decreases their cash
flow from operations, therefore decreasing net income, and possibly their tax rate
and overall burden. It is possible that management is incentivized to use primarily
operating leases because bonuses could be partially tied to debt ratios. Operating
leases make debt ratios look better, so they get higher bonuses.
Competitors in the industry are inline with Brunswick. Their closest
competitors, West Marine and Nautilus Inc. also only have operating leases. It is
common for the marine industry to not have any capital leases, and only operating
leases. Brunswick only has one capital lease, which makes up the entirety of the
capital lease account. The single capital lease is a construction contract to build a
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distribution and manufacturing facility in Brazil (Brunswick 10k, 2015). Capital and
operating leases should be restated to move some operating leases to capital
leases.
Research and Development
Research and development is an important expenditure for firms to make in
order to keep market share, expand market share, or enter into a new market
completely. As we know, Brunswick is a leader in each segment, so it is important
for them to invest heavily into research and development to maintain their market
share and create new markets.
The issue with research and development is that it is very hard to measure
the economic impact that it has on a company. This is because research and
development has to be recorded as it is incurred, instead of when it creates
revenue for the firm. Analysts have a difficult time identifying the future benefit
these expenses will have on the future of the firm because it is uncertain what
competitors will do and come out with (Healy, Palepu, 2008). It is possible that
management has overstated in-process research and development expenses in the
past to benefit earnings currently, or in the future. We will restate research and
development to take out possible distortions created by accounting policies.
Goodw ill
Goodwill is another common distortion found on the balance sheet. Goodwill
is the premium paid over book value for an acquisition. Brunswick has had four
acquisitions over the past year, and numerous more over the past five years. Figure
17 shows how much goodwill has had on their balance sheet over the past five
years.
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Figure 17
Brunswick’s goodwill has been steadily increasing over the past few years
due to a number of acquisitions, as well as a lack of goodwill impairment. In 2015,
they did not impair goodwill at all and made adjustments to account for foreign
currency translation (Brunswick 10K, 2015). The lack of impairments means that
goodwill is likely being distorted to show greater assets on the balance sheet than
in reality. While this is prohibited by the FASB, there is some gray area where firms
can get away with not impairing goodwill because the firm can argue that the fair
value is greater than the carrying value, which is hard to determine. Brunswick’s
goodwill should be restated to properly impair goodwill.
Pensions A pension plan is when an employee of a company gives up part of their
income to contribute towards their retirement. These funds are pooled together by
the firm and invested for the employee. Once the employee retires, they will
receive payments from the company. Brunswick’s pension liabilities aren’t large
enough to make significant distortions. If they increase in the future, then
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opportunities for the firm to distort pension liabilities could be available. Since
pension liabilities are small, they will not be restated to account for distortions.
Derivatives
Many companies use derivative securities to protect themselves against large
swings in the market. Brunswick uses options and forwards to hedge currency,
commodity swap agreements for aluminum, and interest rate swaps to hedge
against changes in interest rates (Brunswick 10k, 2015). Brunswick’s largest
positions are in currency options contracts and fixed-to-floating interest rate swaps,
making up $273.5 million and $200 million respectively. International revenue
makes up 37% of the marine engine segment and 49% of the fitness segment.
Considering how large their international operation is, it is important for them to be
hedging currency, and it has helped provide an additional $12 million in revenue
(Brunswick 10k, 2015).
While Brunswick mitigates some risk though derivatives over the past year, it
is not always possible to do so. If there is a large swing on the opposite end of the
hedge, it could produce large losses for the firm. Brunswick discloses the total
balance of their derivative account at market value, as well as gains and losses
from each derivative category. Brunswick makes an effort to be transparent about
their use of derivatives to hedge risk, and the amounts of capital at risk in each
category.
Accounting Flexibility
Accounting flexibility gives managers different options in choosing their
accounting policies. Because growing firms experience constant changes in
management and operations, they need an accounting information system with
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flexibility that will allow them to adapt to these changes. In “Business Analysis
Valuation”, Palepu and Healy argue:
“If managers have little flexibility in choosing accounting
policies and estimates related to their key success
factors, accounting data are likely to be less informative
for understanding the firm’s economics. In contrast, if
managers have flexibility in choosing the policies and
estimates, accounting numbers have the potential to be
informative, depending upon how managers exercise this
flexibility.”
With Brunswick Corporation making new acquisitions, its company has
shown lots of growth. In order to track its finances and keep accurate records, its
accounting system has to be flexible enough to change with its constant growth.
While flexibility can help the firm’s changes, it can also cause information
asymmetry because managers have all the knowledge of the firm and they get to
choose how they want investors to receive the information. For Brunswick
Corporation, operating leases, research and development, and goodwill are
analyzed to recognize the flexibility of its accounting policies.
Operating Leases
Firms can maintain certain benefits by choosing to lease long-term assets
instead of buying them outright. As stated above, operating leases make up 97% of
Brunswick’s leases. Since it is allowed to keep them off its financial statements, its
balance sheet is unaffected by the leases and they only effect the income
statement. If Brunswick were to choose capital leases it would take on the risk of
ownership and have to recognize the lease as an asset and the payments as a
liability on the balance sheet. “Most of its leases have renewal options and
escalation clauses, and some contain purchase options or contingent rentals”
(Brunswick Corporation, 10K). Shown in Figure 18 is Brunswick’s total rent
expenses from its operating leases for the years 2013-2015.
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Figure 18
With the ability to expense $32.3 million in 2013, $29.5 million in 2014, and
$34.1 million in 2015 as a rent expense rather than a liability, Brunswick is able to
keep $95.9 million of its liabilities on its balance sheet in the past three years. The
graph below shows the minimum rental payments Brunswick with forgo from now
until 2020 and thereafter under operating lease agreements with non-cancelable
terms.
Figure 19
As you can see in Figure 19, Brunswick will expense another $133.9 million
or more in 2015 to the income statement rather than liabilities on the balance
sheet. Its managers choose this option because investors like to invest in
companies with little debt. As stated earlier, operating leases make debt ratios look
better which in turn makes future and current investors more interested in the
company.
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Research and Development
Research and development is a company’s attempt to create and new
products or make improvements on existing products. For Brunswick, it is hard for
the accountant to report research and development cost because the amount of
these expenditures are so big. It is also hard for the firm to predict how successful
its current research and development will be for its future products. According to
U.S. generally accepted accounting procedures, all research and development cost
are expensed in the current period. However, managers do have some flexibility
with this in certain situations. Companies have the option to state some research
and developments cost as noncurrent assets, and expense them or depreciate them
over a certain number of years. Brunswick expenses all of its research and
development cost as incurred. Research and development expenses by segment
are shown below:
Due to this, Brunswick does not have flexibility with its research and
development because it has to expense all of the cost. As shown above, these cost
have gradually gone up over the past three years.
Goodwill
Goodwill is the amount a company pays to acquire a new business minus the
fair market value of net assets of the new business. Goodwill increases when firms
purchase other firms. There is some flexibility with goodwill when it comes to the
generally accepted accounting procedures because it is not required to perform
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impairment test for goodwill. “The Company reviews these assets for impairment at
least annually and whenever events or changes in circumstances indicate that the
carrying value may not be recoverable” (Palepu and Healy). Brunswick reported
that the fair values of its reporting units were less than its carrying values in 2015.
Therefore, it was not required to perform an impairment test. One way Brunswick
adds value to its company is through acquisitions. Because it acquires multiple new
firms each year, Brunswick shows how much goodwill was added annually rather
than from each individual acquisition.
Conclusion
Companies in the marine engine, boating, and fitness industry have a
significant amount of flexibility in choosing policies and estimates. GAAP allows
managers to report figures in a way that best suits the companies’ needs. This
makes their accounting numbers more informative. This flexibility keeps
Brunswick’s records and numbers accurate and accountable while it continues to
expand each year.
Actual Accounting Strategy
The financial reporting of a company is a detailed numerical explanation of a
company’s income, expenses, assets, liabilities, equity, and a statement of cash
flows. However, these statements can be manipulated depending on what kind of
message the company would like to get across to those who view the statement.
Typically, the main concern to the company is how its shareholder’s perceive its
quality. Certain ways that the statement can be curtailed, in favor of the sought
after impression, can cause skepticism to a potential investor. The amount of
disclosure is not based upon the industry, size of company, or past performance.
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Level of Disclosure In the case of Brunswick, the level of disclosure in its financial reporting is
high relative to its competitors. Their statements are well above the GAAP
(generally accepted accounting principals) requirements. Brunswick does not hold
back on explaining the items on its statement and even providing historical
numbers to demonstrate growth or decrease in each of these items, like assets.
For example, in a paragraph provided on Brunswick’s 10-k for 2015 which details
the information regarding some long-term assets, it is explained that,
“The assignment of [assets] does not meet sale criteria as a result
of the Company's contingent obligation to repurchase the
receivables in the event of customer non-payment and therefore is
treated as a secured obligation. Accordingly, these amounts were
recorded in the
Consolidated Balance Sheets under Other long-term assets and
Long-term liabilities – Other.”
This is a demonstration of conservative accounting tactics in that Brunswick
considers some receivables that may or may not be paid by customers, as long-
term liabilities. Simply put, they are taking responsibility on their balance sheet for
customer negligence of payment.
The evidence of Brunswick’s transparency in its financial statement’s give
fuel for investors’ confidence as it outlines relevant, detailed information regarding
each part of the statements. It even provides statements for each segment of its
company (marine engines, boats, fitness), not just reports for the company as a
whole. In conclusion, Brunswick Corporation maintains high disclosure to its
investors in the annual 10-k. Therefore, shareholders can remain confident that all
relevant information regarding their investment decisions will be provided by the
annual 10k of Brunswick.
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Aggressive vs. Conservative
The amount of information provided in a 10-k about financial statements is
not the only aspect of speculation when viewing reports. Depending on how the
company chooses to be perceived through its financial statements can dictate how
certain items are allocated on it. The company can benefit by doing so when it
structures financial reports to appear as if it has profits that are stable. This is done
when using an aggressive approach to accounting policies.
However, Brunswick does not fall into this category as it has conservative
accounting policies. To explain further, Brunswick’s policies could be different,
which would affect the financial statements in a way that reports higher earnings
annually. An example to help demonstrate can be found in the company’s expenses
listing. Some companies consider cash flows for research and development as an
investment with expected returns. This would be an aggressive policy. Brunswick
does the opposite by listing the expense of research and development as a sunk
cost. This is a key piece of evidence in identifying the company’s accounting
policies, which is usually conservative for Brunswick.
Conclusion
Brunswick is a large company with many segments. Identifying the value of
the company can potentially be a daunting task. Luckily, its investors can rest
assured that the financial statements of each of its segments are listed individually.
This transparency, along with the conservative approach to its accounting policies,
allows confidence for potential investors that all relevant information is provided
and not skewed. Regardless of past performance or the outlook of Brunswick future
value, viewers of the financial statement can rest assured knowing that information
in its statements provides an honest and detailed description of financials.
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Qualitative Disclosure
The quality of disclosure is a very important factor when valuing a firm. The
amount of important information a company discloses can affect the valuation in a
positive or a negative way. While GAAP requires firms to disclose some information,
it is usually minimal and not enough to accurately value their financial position.
Management has the ability to distort information to increase their bonuses,
deceive creditors so that they get a higher rating, or to mislead analysts into giving
their firm more favorable valuation. It is important for the analyst to look at the
information presented objectively, and be weary of accounting policies that the firm
has in place. We have identified three main areas that lack financial disclosure,
including operating and capital leases, goodwill, and employee benefit plans.
Operating and Capital Leases
As stated previously, leases are on of the most common distortions in the
financial statements. There are a number of issues with leases, one of which is the
fact that they do not disclose what discount rate they used to calculate the present
value of operating leases. This could be problematic because they could be overly
ambitious on their estimation, leading to lower operating lease expenses than they
actually incur. Operating leases as a whole lacks general disclosure. The 10K only
states what the leases were broadly used for, and then provided nominal amounts
for the next few years’ liability. They also disclose that they are only providing the
minimum possible liability, so it would be beneficial for them to disclose possible
risks associated with increased lease liabilities (Brunswick 10k, 2015). Brunswick
does disclose more details about their capital leases, including exactly what they
were used for, but still does not disclose the discount rate used. Industry
competitors disclose the same amount of information. They also fail to disclose the
discount rate, or more specific uses of operating leases.
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Goodwill
Goodwill is another commonly misstated item on the financial statements. As
mentioned before, goodwill is more relative compared to other write-offs. The firm
sets depreciation at what they believe the life of the asset to be and writes it off
annually as impairment. It is possible that the Brunswick writes off more goodwill
than they should have to lower net income, thus lowering their tax liability.
Likewise, they could also not write-off enough goodwill, resulting in overstated
assets. As seen in figure 20, Brunswick’s goodwill makes up 12% of its total assets
in 2015. Goodwill is a large part of Brunswick’s balance sheet because they actively
acquire companies. Because Brunswick has failed to impair goodwill in more than
five years, it will be beneficial to the analysis if we restate goodwill to obtain a
better picture of their financial condition.
Figure 20
Employee Contribution Plans
Brunswick discloses a substantial amount more about contribution plans
relative to leases and goodwill, but there are still questions about their future
pension liabilities. As stated before, the company faced a lawsuit for underfunding
the fund, and had to payout $191.8 million to employees (Brunswick 10k, 2015). As
of December 31, 2015, the Company’s qualified benefit pension plans were
underfunded on an aggregate project benefit obligation basis by $262.4 million
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which represented a $47.4 million improvement from 2014 due to a discount rate
increase from 3.95% to 4.4%, which was partially offset by unfavorable investment
experience (Brunswick 10k, 2015). Considering that interest rates are currently at
an nearly all-time low, it is possible that Brunswick is being over ambitious with
their discount rate to mislead individuals into thinking their future obligation is
smaller than in actuality. Underfunding has obviously been an issue with Brunswick
in the past, as is common for many companies in general. The lack of disclosure
combined with poor history leads us to be skeptical of future benefit plan liabilities.
Conclusion
In conclusion, Brunswick has a mixed level of disclosure. They have areas
where they make an honest attempt at providing disclosure, but there are also
other areas where they leave out relevant information. We will go into further detail
about Brunswick’s level of disclosure and restate financial statements as needed.
Potential Red Flags
A key part in a business valuation of a company is examining the accounting
practices of the corporation. When examining financial statements it is important to
find potential red flags in the companies’ accounting practices. Corporations will
utilize accounts like goodwill and operating leases to improve the value of the
corporation. Practices like this affects the income statement and balance sheet
alike. After examining Brunswick’s financial statements, we have found several
potential red flags reported in their financial statements for 2015. Brunswick has
some potential red flags in their goodwill and operating lease accounts.
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Goodwill
In the fiscal year of 2015, we examined that Brunswick had potential red
flags in their goodwill account. Goodwill is an in-tangible asset located in the non-
current asset section of the balance sheet. Like most asset accounts, corporations
must write off impairments as an expense. Although corporations do not impair
their goodwill every year, the goodwill account still depreciates over time.
Figure 21 Brunswick’s Goodwill to Fixed Asset Ratio
2010 2011 2012 2013 2014 2015290.90 290.30 291.70 291.70 296.90 298.70
1,142.20 1,137.90 1,064.10 1,867.60 1,162.70 1,063.8025.47% 25.51% 27.41% 15.62% 25.54% 28.08%
Brunswick 's Percentage of Fixed Assests in Goodwill
GoodwillFixed Assets Percentage
Figure 21 above shows the percentage of goodwill to the total amount of
fixed assets in Brunswick’s balance sheet. By calculating the percentage of goodwill
to fixed assets, we are able to determine if their goodwill is over 30 percent of their
total fixed assets. If the goodwill account is more than 30 percent of the fixed
assets, we must undo the distortion in the account.
According to the annual report for the fiscal year of 2015, Brunswick
reported their goodwill to be 28 percent of their total fixed assets (Brunswick 10K,
2015). After pulling information from the previous five years, Brunswick has kept
their goodwill below the 30 percent mark. In 2013, Brunswick’s goodwill was 15.62
percent of total fixed assets (Brunswick 10K, 2013). Although Brunswick has
reported their goodwill account to be less than 30 percent for the fiscal year of
2011 through 2015, Brunswick has not impaired their goodwill account for five
years (Brunswick 10k, 2015).
Although Brunswick has not impaired their goodwill account for the past five
years, Brunswick has added more to their goodwill account. In 2014 and 2015,
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Brunswick has acquired more goodwill assets (Brunswick 10k, 2015). Although in
the annual report, Brunswick claimed that they did not need to impair their goodwill
accounts, due to the fact that they believe that the fair value of their goodwill
accounts is still greater than the book value (Brunswick 10k, 2015).
Although this may be true, we believe that they should have had
impairments in their goodwill account. Without impairing their goodwill account,
this will have an effect on the write-off expenses reported on the income
statement. This will also have an effect on the asset section of the balance sheet.
Assets like goodwill that are not impaired over their useful life will have an effect on
the asset section of the balance sheet. The Asset section will be overstated for each
year the impairment is not performed on certain fixed assets. By calculating the
impairment for the goodwill account, we will be to calculate the adjustments to the
goodwill account and be able to give a more precise assessment of Brunswick’s
financial statements.
Operating Leases
After examining the annual reports submitted by Brunswick, their operating
leases reported in the footnotes of the balance sheet could be a potential red flag.
Earlier in this report we explained the accounting policies Brunswick uses in
regulation with GAAP. The operating leases account, is one of the accounts that
Brunswick does not have to report on their balance sheet. Under GAAP regulations,
corporations like Brunswick to not have to report operating leases on their balance
as an individual account.
Operating leases are property, plant and equipment that is used by the
corporation, but the corporation does not own them. Leases owned by the
Corporation are reported in the capital lease account in the liability section of the
balance sheet. This is an advantage for corporations that have operating leases.
Because corporations are not required to report operating leases, this lowers their
liability section of their balance sheet. To examine Brunswick’s performance for
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2015, we will capitalize the operating leases into capital leases through amortization
thus turning the operating leases into assets for the company.
To capitalize the operating leases, we need to find the present value of the
leases. To find the present value of the lease, we needed a discount rate to find the
present value. Unfortunately, Brunswick did not report the discount rate they used
for their capital leases in their annual report. In order to find a reasonable discount
rate, we used the historical yield for a class a corporate bond from the St. Louis
Federal Reserve Economic Data (St. Louis Federal Reserve Economic Data, 2016).
By using the historical yield we were able to calculate a reasonable present
value for the operating leases. Once we found the present value of the capitalized
operating leases, Brunswick’s total long-term debt will increase dramatically.
Although using the historical yield would give a reasonable present value, the
model is not a true representation of the present value do to the fact that
Brunswick did not report the discount rate that they used for their capital leases. By
capitalizing the operating leases, we will be able to adjust the balance sheet and
show how it has an effect on the liability and asset sections of the balance sheet.
Undo Distortions
Goodwill
To undo the distortion in the goodwill account on Brunswick’s balance sheet,
we will calculate the impairment that should have been done for the past 5 years
for the corporation.
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Figure 22: Change in Goodwill
Change In Goodwill2010 290.9 - 2011 290.3 (0.60) 2012 291.7 1.40 2013 291.7 - 2014 296.9 5.20 2015 298.7 1.80
Goodwill Adjustment (in Millions)Orginal Goodwill
Figure 22 above shows the changes in the goodwill account for the past six
years. The information above is pulled from the annual reports from Brunswick for
the fiscal year of 2010 through 2015. In 2014 and 2015, Brunswick acquired more
goodwill that was added to their account (Brunswick 10k, 2015). After gathering
the new goodwill for each fiscal year, we calculated the impairment cost that
Brunswick should have reported.
Figure 23: Goodwill Impairment Costs (in millions)
2011 2012 2013 2014 201558.18 58.18 58.18 58.18 58.18
(0.12) (0.12) (0.12) (0.12) 0.28 0.28 0.28
- - 1.04
New Goodwill Orginal GW (2010)
20112012201320142015
In figure 23, the impairment that should be expensed for goodwill is
calculated for the fiscal years of 2011 to 2015. The new goodwill for each year is
divided by the useful life of the goodwill asset.
Figure 24 Impairment for Each Year (in millions)
58.18 58.06 58.34 58.34 59.38 - - - - -
58.18 58.06 58.34 58.34 59.38
Should Impair Did Impair
Adjust
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Figure 24 above shows the impairment cost for each year. Since Brunswick
has not impaired their goodwill account for the past five years the adjustment for
the impairment cost will be the impairment for each year.
Figure 25 Adjusted balance for Goodwill (in millions)
2011 2012 2013 2014 2015290.30 231.52 174.86 116.52 63.38
(0.60) 1.40 - 5.20 1.80 - - - - -
58.18 58.06 58.34 58.34 59.38 231.52 174.86 116.52 63.38 5.80
Beginning Balanc eNew Goodwill
New Balance for Goodwill
Should Impair Adjusted Ending Balance
Did Impair
After computing the impairment cost for each year we are able to make
adjustments to the goodwill account. As you can see in Figure 25 above, the ending
balance for each year has been affected by the new impairment for each year. At
the end of 2015, the ending balance for goodwill was $5.80 million. This is
significant adjustment to the goodwill account. The adjustments will have an effect
on the balance sheet and the income statement. The impairment decreases the
goodwill account, thus making the stated balance sheet to be overstated. On the
income statement the impairment cost will increase operating expenses, thus
making the stated expenses to be understated.
After calculating the adjustment for goodwill, we would right off the
impairment cost. The write off of the impairment cost would affect the operating
income in the income statement. This will have an effect on the net income and
equity section of the balance sheet. Because we amortized the goodwill account the
total assets reported on the balance sheets for the past five years would be
overstated.
Operating Leases
To undo the distortion in the operating lease account for Brunswick, we will
capitalize the operating leases through amortization. First we found the minimum
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present value for the lease payments for each year (Brunswick 10k, 2015). Stated
earlier in the previous section, Brunswick did not report the discount rate that they
used for their capital leases in their annual reports. Although Brunswick did not
report the discount rate they used for capital leases, we used the BOFA Merrill
Lynch US Corporate A effective yield as the discount rate for the five years. After
finding the discount rate, we amortized the operating leases for five years.
Figure 26: Capitalizing Operating Leases
3.72%
Period Future Value PV factor Present Value Beg Balance Accrued Int Payment Ending Bal1 32.30 0.96 31.14 93.20 3.47 32.30 64.37 2 24.80 0.93 23.05 64.37 2.39 24.80 41.97 3 17.50 0.90 15.68 41.97 1.56 17.50 26.03 4 13.10 0.86 11.32 26.03 0.97 13.10 13.90 5 9.90 0.83 8.25 13.90 0.52 9.90 4.51 6 4.68 0.80 3.76 4.51 0.17 4.68 0.00
Discount rate: 2011 Capitalization of Operating Leases
Interest Expense Dep. Exp3.47 15.53 2.39 15.53 1.56 15.53 0.97 15.53 0.52 15.53 0.17 15.53
19.00 17.93 17.10 16.50
Total Cap Ol op exp Exp under Op lease treatment
15.70
32.30 24.80 17.50 13.10
9.90 4.68
16.05
2.88%
Period Future Value PV factor Present Value Beg Balance Accrued Int Payment Ending Bal1 28.60 0.97 27.80 88.30 2.54 28.60 62.24 2 21.80 0.94 20.60 62.24 1.79 21.80 42.24 3 16.90 0.92 15.52 42.24 1.22 16.90 26.55 4 12.60 0.89 11.25 26.55 0.76 12.60 14.72 5 9.60 0.87 8.33 14.72 0.42 9.60 5.54 6 5.70 0.84 4.81 5.54 0.16 5.70 0.00
2012 Capitalization of Operating Leases Discount rate:
Interest Expense Dep. Exp2.54 14.72 1.79 14.72 1.22 14.72 0.76 14.72 0.42 14.72 0.16 14.72
17.26 28.60 Total Cap Ol op exp Exp under Op lease treatment
21.80 16.90 12.60
9.60
16.51 15.93 15.48 15.14 14.88 5.70
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2.73%Period Future Value PV factor Present Value Beg Balance Accrued Int Payment Ending Bal
1 32.60 0.97 31.73 106.50 2.91 32.60 76.81 2 27.00 0.95 25.58 76.81 2.10 27.00 51.91 3 22.40 0.92 20.66 51.91 1.42 22.40 30.93 4 15.70 0.90 14.10 30.93 0.84 15.70 16.07 5 11.70 0.87 10.23 16.07 0.44 11.70 4.81 6 4.94 0.85 4.20 4.81 0.13 4.94 (0.00)
2013 Capitalization of Operating Leases Discount rate:
Interest Expense Dep. Exp2.91 17.75 2.10 17.75 1.42 17.75 0.84 17.75 0.44 17.75 0.13 17.75
22.40 15.70 11.70
32.60 27.00
Total Cap Ol op exp Exp under Op lease treatment20.66 19.85 19.17
17.88
18.59 18.19
4.94 2.72%
Period Future Value PV factor Present Value Beg Balance Accrued Int Payment Ending Bal1 28.50 0.97 27.75 91.74 2.50 28.50 65.73 2 24.60 0.95 23.31 65.73 1.79 24.60 42.92 3 20.90 0.92 19.28 42.92 1.17 20.90 23.19 4 13.40 0.90 12.04 23.19 0.63 13.40 10.42 5 7.90 0.87 6.91 10.42 0.28 7.90 2.80 6 2.88 0.85 2.45 2.80 0.08 2.88 0.00
2014 Capitalization of Operating Leases Discount rate:
Interest Expense Dep. Exp2.50 15.29 1.79 15.29 1.17 15.29 0.63 15.29 0.28 15.29 0.08 15.29
Total Cap Ol op exp Exp under Op lease treatment
15.37
28.50 24.60 20.90 13.40
7.90 2.88
15.57
16.46 15.92
17.79 17.08
2.83%
Period Future Value PV factor Present Value Beg Balance Accrued Int Payment Ending Bal1 33.40 0.97 32.48 105.95 3.00 33.40 75.55 2 29.80 0.95 28.18 75.55 2.14 29.80 47.89 3 22.70 0.92 20.88 47.89 1.36 22.70 26.55 4 13.00 0.89 11.63 26.55 0.75 13.00 14.30 5 9.80 0.87 8.52 14.30 0.40 9.80 4.90 6 5.04 0.85 4.26 4.90 0.14 5.04 0.00
2015 Capitalization of Operating Leases Discount rate:
Interest Expense Dep. Exp3.00 17.66 2.14 17.66 1.36 17.66 0.75 17.66 0.40 17.66 0.14 17.66
Total Cap Ol op exp Exp under Op lease treatment20.66
19.01 18.41 18.06 17.80
33.40 29.80 22.70 13.00
9.80 5.04
19.80
70
After amortizing the operating lease payments, we were able to convert
them into capital leases and finding their present value. This has an effect on the
asset and liability section of the balance sheet for Brunswick. By converting them
into capital leases this will increase the non-current asset section. Because we are
making a debit transaction into the asset section, we must also do a credit
transaction for the capitalized leases for each year into the liability section. This
increases the liability section on the balance sheet.
On the income statement we debit depreciation and the interest expenses
from amortizing the operating leases for each year. After adding in the depreciation
and interest expense from capitalizing the operating leases this will decrease the
net income in the income statement, which in return will affect retained earnings in
the stockholders’ equity section of the balance sheet. Because we capitalized
Brunswick’s operating leases, we will need to restate the balance sheet and income
statement to show that the liabilities were understated and net income and the
equity section were overstated.
Conclusion
After examining the accounting used by Brunswick to report their financial
statements, we were able to find potential red flags. The Goodwill and operating
leases accounts in Brunswick’s financial statements showed to have potential red
flags in the reporting of the financial information. After finding the red flags in the
financial statements, we adjusted the accounts to undo the distortion.
Financial Statement Restated
When analyzing the accounting practices for Brunswick, we identified and
calculated the distortion in the goodwill and operating lease accounts in Brunswick’s
financial statements. After identifying and calculating the distortion in the accounts,
71
we must restate the financial statements for Brunswick. In order to restate the
financial statements, we must restate the past five years for Brunswick’s balance
sheet and income statement with a trial balance. The calculations used to correct
the distortion in the accounts are located in the appendix. The following sections
will show the stated and restated balance sheet and income statement for
Brunswick.
Restated Balance Sheet
After restating the balance sheet for Brunswick for the past five years, we
were able to see the effects of the corrections we used to correct the accounts. In
order to make the corrections, we used the stated financials from Brunswick’s
annual reports (Brunswick 10k, 2015). To make the corrections, we made a
Capitalizing Operating Leases account in the asset section, and a Capitalizing
Operating Leases Liabilities account in the Liabilities section. We saw that for the
past five years, Brunswick’s assets have been overstated. The liabilities section had
been understated in comparison to the original stated financials. Finally the
stockholders’ equity accounts had been overstated. The figures below are the
restated balance sheets with the trial balance for the past five years.
72
Figure 27
Stated Debit Credit Restated
338 338 346 346
77 77 533 533
15 15 28 28 20 20
1,357 1,357
586 586 93 93
290 58 232
Non Current Assets
Brunswick 2011 Balance Sheet (in millions)
AssetsCurrent Assets
Cash and cash equivalentsAccounts receivable
Short-term investmenstInventories
Defferred income taxesPrepaid expenses
Other current assetsTotal Current Assets
Net PP&ECapitalized Operating Leases
Goodwill
73
49 49 141 141
- - 72 72
1,138 1,173 2,495 2,530
2 2 282 282
11 11 567 567
46 46 - -
908 908
690 690 82 82
593 593 - 93 93
190 190 1,555 1,648 2,463 2,556
77 77 435 435 458 58 400
(541) (541) (398) (398)
31 (27) 2,494 2,530
Short-term debt
Intangible assetsOther long term asset
Defferred income taxesOther long-term assets
Total Non Current AssetsTotal Assets
LiabilitiesCurrent liabilities
Other long term liab
Account payableTaxes payable
Accrued liabilitiesDeferred revenues
Other accrued liabilitiesTotal Current LiabilitiesNon Current Liabilities
Long term debtDeferred income taxes
Pensions and other benefitsCaptialized Operating lease liabilites
Total Non Current LiabilitiesTotal Liabilities
Stockholders EquityCommon stockPaid-in capital
Retained earningsAccumulated OCI
Treasury stockTotal Stockholders Equity
Total Liabilities and SE
74
Stated Debit Credit Restated
284 284 349 349
92 92 576 576
19 19 27 27 13 13
1,360 1,360
581 581 88 16 73
292 116 176 38 38 94 94
- - 58 58
1,063 1,020 2,423 2,381
8 8 334 334
10 10 508 508
47 47 29 29
936 936 -
564 564 93 93
553 553 - 29 88 59
200 200 1,410 1,469 2,346 2,405
- 77 77
441 441 503 103 400
(555) (555) (388) (388)
78 (25) 2,424 2,381
Non Current Assets
Brunswick's 2012 Balance Sheet (in millions)
AssetsCurrent Assets
Cash and cash equivalentsAccounts receivable
Short-term investmenstInventories
Defferred income taxesPrepaid expenses
Other current assetsTotal Current Assets
Short-term debt
Net PP&ECapitalized Operating Leases
GoodwillIntangible assets
Other long term assetDefferred income taxesOther long-term assets
Total Non Current AssetsTotal Assets
LiabilitiesCurrent liabilities
Other long term liab
Account payableTaxes payable
Accrued liabilitiesDeferred revenues
Other accrued liabilitiesTotal Current LiabilitiesNon Current Liabilities
Long term debtDeferred income taxes
Pensions and other benefitsCaptialized Operating lease liabilites
Total Non Current LiabilitiesTotal Liabilities
Stockholders EquityCommon stockPaid-in capital
Retained earningsAccumulated OCI
Treasury stockTotal Stockholders Equity
Total Liabilities and SE
75
Stated Debit Credit Restated
284 284 349 349
92 92 576 576
19 19 27 27 13 13
1,360 1,360
581 581 107 30 76
292 175 117 38 38 94 94
- - 58 58
1,063 965 2,423 2,326
8 8 334 334
10 10 508 508
47 47 29 29
936 936 -
564 564 93 93
553 553 - 55 107 52
200 200 1,410 1,462 2,346 2,398
- 77 77
441 441 503 150 353
(555) (555) (388) (388)
78 (72) 2,424 2,326
Short-term investmenst
Brunswick's 2013 Balance Sheet (in millions)
AssetsCurrent Assets
Cash and cash equivalentsAccounts receivable
Defferred income taxes
InventoriesDefferred income taxes
Prepaid expensesOther current assetsTotal Current AssetsNon Current Assets
Net PP&ECapitalized Operating Leases
GoodwillIntangible assets
Other long term asset
Total Current Liabilities
Other long-term assetsTotal Non Current Assets
Total AssetsLiabilities
Current liabilitiesShort-term debtAccount payable
Taxes payableAccrued liabilitiesDeferred revenues
Other accrued liabilities
Retained earnings
Non Current LiabilitiesLong term debt
Deferred income taxesPensions and other benefits
Captialized Operating lease liabilitesOther long term liab
Total Non Current LiabilitiesTotal Liabilities
Stockholders EquityCommon stockPaid-in capital
Accumulated OCITreasury stock
Total Stockholders EquityTotal Liabilities and SE
76
Stated Debit Credit Restated
284 284 349 349
92 92 576 576
19 19 27 27 13 13
1,360 1,360
581 581 92 48 44
292 233 59 38 38 94 94
- - 58 58
1,063 874 2,423 2,235
8 8 334 334
10 10 508 508
47 47 29 29
936 936 -
564 564 93 93
553 553 - 85 92 7
200 200 1,410 1,417 2,346 2,353
- 77 77
441 441 503 196 307
(555) (555) (388) (388)
78 (118) 2,424 2,235
Short-term investmenst
Brunswick's 2014 Balance Sheet (in millions)
AssetsCurrent Assets
Cash and cash equivalentsAccounts receivable
Defferred income taxes
InventoriesDefferred income taxes
Prepaid expensesOther current assetsTotal Current AssetsNon Current Assets
Net PP&ECapitalized Operating Leases
GoodwillIntangible assets
Other long term asset
Total Current Liabilities
Other long-term assetsTotal Non Current Assets
Total AssetsLiabilities
Current liabilitiesShort-term debtAccount payable
Taxes payableAccrued liabilitiesDeferred revenues
Other accrued liabilities
Retained earnings
Non Current LiabilitiesLong term debt
Deferred income taxesPensions and other benefits
Captialized Operating lease liabilitesOther long term liab
Total Non Current LiabilitiesTotal Liabilities
Stockholders EquityCommon stockPaid-in capital
Accumulated OCITreasury stock
Total Stockholders EquityTotal Liabilities and SE
77
Stated Debit Credit Restated
284 284 349 349
92 92 576 576
19 19 27 27 13 13
1,360 1,360
581 581 106 63 43
292 292 (0) 38 38 94 94
- - 58 58
1,063 813 2,423 2,174
8 8 334 334
10 10 508 508
47 47 29 29
936 936 -
564 564 93 93
553 553 - 111 106 (5)
200 200 1,410 1,405 2,346 2,341
- 77 77
441 441 503 245 258
(555) (555) (388) (388)
78 (167) 2,424 2,174
Short-term investmenst
Brunswick's 2015 Balance Sheet (in millions)
AssetsCurrent Assets
Cash and cash equivalentsAccounts receivable
Defferred income taxes
InventoriesDefferred income taxes
Prepaid expensesOther current assetsTotal Current AssetsNon Current Assets
Net PP&ECapitalized Operating Leases
GoodwillIntangible assets
Other long term asset
Total Current Liabilities
Other long-term assetsTotal Non Current Assets
Total AssetsLiabilities
Current liabilitiesShort-term debtAccount payable
Taxes payableAccrued liabilitiesDeferred revenues
Other accrued liabilities
Retained earnings
Non Current LiabilitiesLong term debt
Deferred income taxesPensions and other benefits
Captialized Operating lease liabilitesOther long term liab
Total Non Current LiabilitiesTotal Liabilities
Stockholders EquityCommon stockPaid-in capital
Accumulated OCITreasury stock
Total Stockholders EquityTotal Liabilities and SE
78
Restated Income Statement
For the past five years we restated the income statement for Brunswick after
calculating the distortion in the goodwill and operating leases accounts. In the
income statement we added a goodwill impairment account to record the
depreciation expense for goodwill. For the operating leases we created an
amortization expense account to account for the depreciation to capitalize the
operating leases. Also we recorded interest expense for operating leases in the
interest expense account. After recording the expenses into their correct accounts,
we were able to see the effects of the restatement for Brunswick’s income statement.
The corrections to those accounts for the five years caused the net income to be
overstated for each year. This had an effect on the retained earnings account on the
balance sheet, which was overstated. Because retained earnings were overstated,
the total stockholders’ equity was overstated for each of the five years. The tables
below are the restated income statements with the trial balance.
Figure 28
Stated Debit Credit Restated 3,748 3,748 2,873 2,873
875 875
98 98 562 562
23 23 - 58 58
683 741 192 134
82 82 (21) (21) 89 31 17 17 72 14
- - 72 14
58
Revenue
Brunswick's 2011 Income Statement (in millions)
Income before taxes
Cost of revenueGross profit
Operating expensesResearch and development
Sales, General and administrativeRestructuring, merger and acquisition
Goodwill ImpairmentTotal operating expenses
Operating incomeInterest Expense
Other income (expense)
Provision for income taxesNet income from continuing operations
Net income from discontinuing opsNet income
Income Summary
79
Stated Debt Credit Restated 3,718 3,718 2,774 2,774
944 944 -
105 105 549 32 517
26 26 - 58 58 - 16 16
680 721 264 223
68 3 71 (15) (15) 181 136
34 34 147 102 (97) (97) 50 5
45
Revenue
Brunswick's 2012 Income Statement (in millions)
Other income (expense)Income before taxes
Cost of revenueGross profit
Operating expensesResearch and development
Sales, General and administrativeRestructuring, merger and acquisition
Amortization Expense Goodwill Impairment
Total operating expensesOperating incomeInterest Expense
Provision for income taxesNet income from continuing operations
Net income from discontinuing opsNet income
Income Summary
Stated Debt Credit Restated 3,718 3,718 2,774 2,774
944 944 -
105 105 549 29 520
26 26 - 58 58 - 15 15
680 724 264 220
68 3 71 (15) (15) 181 134
34 34 147 100 (97) (97) 50 3
47
Restructuring, merger and acquisition
Brunswick's 2013 Income Statement (in millions)
RevenueCost of revenue
Gross profitOperating expenses
Research and developmentSales, General and administrative
Income Summary
Goodwill Impairment Amortization Expense
Total operating expensesOperating incomeInterest Expense
Other income (expense)Income before taxes
Provision for income taxesNet income from continuing operations
Net income from discontinuing opsNet income
80
Stated Debt Credit Restated 3,718 3,718 2,774 2,774
944 944 -
105 105 549 33 516
26 26 - 58 58 - 18 18
680 723 264 221
68 3 71 (15) (15) 181 135
34 34 147 101 (97) (97) 50 4
46
Restructuring, merger and acquisition
Brunswick's 2014 Income Statement (in millions)
RevenueCost of revenue
Gross profitOperating expenses
Research and developmentSales, General and administrative
Income Summary
Goodwill Impairment Amortization Expense
Total operating expensesOperating incomeInterest Expense
Other income (expense)Income before taxes
Provision for income taxesNet income from continuing operations
Net income from discontinuing opsNet income
Stated Debt Credit Restated 3,718 3,718 2,774 2,774
944 944 -
105 105 549 29 521
26 26 - 59 59 - 15 15
680 726 264 218
68 2 70 (15) (15) 181 132
34 34 147 98 (97) (97) 50 1
49
Restructuring, merger and acquisition
Brunswick's 2015 Income Statement (in millions)
RevenueCost of revenue
Gross profitOperating expenses
Research and developmentSales, General and administrative
Income Summary
Goodwill Impairment Amortization Expense
Total operating expensesOperating incomeInterest Expense
Other income (expense)Income before taxes
Provision for income taxesNet income from continuing operations
Net income from discontinuing opsNet income
81
Conclusion
After restating Brunswick’s financial statements for the past five years to
correct the distortions in their accounting practices we were able to show the
difference. The distortion in the goodwill and operating leases accounts had major
effects on the financial statements. On the balance sheet the assets accounts were
overstated for each year, and the liability accounts were understated. This had an
effect on the income statement where operating expenses were understated. This
meant that the net income for each year was overstated in the original stated
financials. This had an effect on the retained earnings for Brunswick and caused
the total stockholders’ equity account to be overstated. After restating the balance
sheet and income statement, we can see that Brunswick has been overvalued.
Financial Analysis
Financial analysis is the assessment of how well the firm has performed
relative to its goals. This analysis will give a broad overview of how the firm has
performed over the past five years, and will give a sense of how it will perform in
the future. Financial analysis has two main components: ratio analysis and cash
flow analysis. Ratio analysis allows us to compare Brunswick’s performance to
competitors and a benchmark regardless of economies of scale. Cash flow analysis
gives a peek into how efficiently management handles policies, such as operating,
investing, or financing strategies. In this section, we will perform ratio analysis and
cash flow analysis to compare Brunswick’s performance relative to its competitors.
82
Liquidity Analysis
Liquidity analysis helps to determine if the firm has the means to pay its
current liabilities when they come due. Firms have to keep a portion of their assets
liquid so that they have cash to pay off their accounts payable, pay employees,
short-term notes payable, and more. If they don’t have enough liquid assets, they
are at risk of becoming insolvent and potentially bankrupt. Liquidity analysis will
help to determine the amount of risk the firm poses to potential creditors and
investors. In this section we will analyze the: current ratio, quick ratio, inventory
turnover, days supply inventory, accounts receivable turnover, days sales
outstanding, and the cash to cash cycle.
Current Ratio
Figure 29
83
Figure 30
The current ratio measures short-term liquidity and if the firm has enough
liquid assets to pay its debt that are due in the next year. It is a comparison of the
firm’s current assets and current liabilities. A current ratio above 1 shows that the
firm can pay its current liabilities with current assets. As seen in Figures 29 and 30
above, everyone in the industry has a healthy current ratio. West Marine is an
outlier, though. It had a current ratio of 4.02 in 2015, which was almost double
Brunswick’s. While it is a good thing to have a current ratio greater than 1, it is a
negative to have one that is too high. It is a red flag that West Marine’s assets
aren’t being as productive as they could be. Brunswick maintains a healthy current
ratio and can cover all current liabilities.
Quick Asset Ratio
Figure 31
84
Figure 32
The quick asset ratio, also known as the acid test, is very similar to the
current ratio, except it does not include inventory. This ratio is going to be a more
accurate depiction of liquidity than the current ratio because inventory in this
industry is not very liquid. If the quick asset ratio is greater than 1, the firm
maintains a very high probability that it will be able to cover current liabilities. If it
is less than one, it is likely that too much of their current assets are made up of
inventory.
As seen in Figure 31, Brunswick’s quick asset ratio has increased from 0.84
to 1.43 in the past four years. This is a significant improvement and shows that it’s
not relying on inventory turnover to pay the bills. Also seen in Figure 32, West
Marine’s quick asset ratio is 1.05 compared to a current ratio of 4.02 in the same
year. The quick asset ratio explains that the reason they’re current ratio was so
high is because they have a large amount of current assets as inventory. As seen in
Figure 32, the industry is trending slightly down, while Brunswick has been trending
up.
85
Inventory Turnover
Figure 33
Figure 34
Inventory turnover measures how many times inventory is sold in a year.
Inventory should turnover multiple times a year so that inventory doesn’t get
outdated and cash flows are efficient. A low inventory turnover means that sales
are probably slow and the firm probably has a lot of cash sitting in inventory. A
high turnover means that the firm is being efficient with their inventory and turning
it into cash quickly. As seen in Figure 33, the industry average has declined from
5.75 to 3.80 over the past five years, but Brunswick’s has had only a slight decline
over the same period of time. Brunswick has performed at par compared to its
competitors. As seen in Figure 34, the industry average is heavily skewed by West
86
Marine, which only turns inventory over around 2.30 times per year. Overall the
industry has been trending downwards to around an inventory ratio of 4 to 5. This
means that the industry as a whole is becoming less efficient at managing
inventory.
Days Supply Inventory
Figure 35
Figure 36
Days supply inventory is another way to present inventory turnover. It is the
numbers of days that it takes inventory to turnover instead of how many times in a
year it turns over. The less number of days it takes to turnover, the more efficient
the firm is at managing inventory. As seen in Figure 35, Brunswick takes 83 days to
turn inventory into cash, up from 68 days five years ago. Just as in the inventory
87
turnover ratio, the industry average doesn’t tell us much in this case. As seen in
Figure 36, West Marine heavily skews inventory turnover and days supply
inventory. As was the case in the inventory turnover ratio, the Industry is getting
less efficient at managing inventory. This ratio has had an upward trend over the
past few five years, and appears to be converging around 80 to 100 days.
Accounts Receivable Turnover
Figure 37
Figure 38
Accounts receivable turnover is how many times in a year a firm collects
their accounts receivable. This shows how effective a firm is a receiving payment
on credit to customers. A high turnover ratio is good because it means accounts
receivable is turned onto cash quicker, while a lower ratio means that cash is tied
88
up in accounts receivable longer. As seen in Figures 37 and 38, the turnover ratio
for the industry varies heavily. This is likely due to different policies being
implemented in each firm, as well as the base they’re selling to. For example, West
Marine’s accounts receivable turnover ratio is so much higher than competitors
because it is in the retail business more than competitors.
Days Sales Outstanding
Figure 39
Figure 40
Days sales outstanding is the number of days it takes to collect on accounts
receivable. Manufacturing firms will typically give customers the opportunity to pay
them at a later date. A lower number of days are better because it provides more
liquidity for the firm through higher cash flows. It is also an indication that the firms
89
credit policies are effective. As seen in Figure 39, the terms for this industry are
likely to be 2/10 net 30. This means that if the debtor pays within 10 days, they get
a 2% discount on their purchase; otherwise payment is due within 30 days. The
terms were determined by looking at the average days sales outstanding, as well as
individual firms. Figure 40 shows how much firms vary in how effective they are at
collecting receivables. This is likely due to the firms setting their own credit policies
and not having an industry standard.
Cash to Cash Cycle
Figure 41
Figure 42
The cash to cash cycle is simply the sum of days supply inventory and days
sales outstanding. This is the length of time that it takes for a firm to convert inputs
90
into cash. This cycle is one tool used by firms to determine how much cash needed
to fund basic operations. Many firms will use short-term notes payable, or lines of
credit from a bank to fund this deficit. As seen in Figures 41 and 42, Brunswick
does well compared to competitors. The industry cash cycle ranges from 88 to 171
days, while Brunswick is at 119 days.
Working Capital Turnover
Figure 43
Figure 44
Working capital turnover measures how efficiently the firm uses working
capital to finance sales. According to Healy and Palepu, “Operating working capital
turnover indicates how many dollars of sales a firm is able to generate for each
dollar invested in operating working capital (Healy, Palepu, 2008). As seen in
91
Figures 43 and 44, Brunswick and most competitors are not efficient turning over
working capital. Polaris is an exception to this, with a turnover of 18, compare to
Brunswick’s 3.5.
Conclusion
The ratios of the industry show that Brunswick does well compared to its
competitors. Brunswick is more liquid than many of its competitors and performs on
average in most categories. While liquidity has improved, some individual aspects
have declined slightly, including the days supply of inventory and inventory
turnover. Brunswick and others in the industry have been holding onto more
inventory and haven’t been able to turn it over as quickly. This area needs to see
some improvement to reverse the trend, and get ahead of competition. In
conclusion, Brunswick has been up to par with competition. Figure 45 shows
Brunswick’s performance relative to the competition.
92
Figure 45
Profitability Analysis
Conducting a profitability analysis will help to determine the ability for
Brunswick and competitors to generate returns from sales, assets, and equity. In
this section we will analyze gross profit margin, operating profit margin, net profit
margin, asset turnover, return on assets, and return on equity. These are important
ratios for Brunswick, as it measures Brunswick’s ability to generate returns for
investors.
93
Gross Profit Margin
Figure 46
Figure 47
A gross profit margin is sales minus the cost of goods sold divided by sales.
According Healy and Palepu, “gross profit margin is an indication of the extent to
which revenues exceed direct costs associated with sales (Healy, Palepu, 2008).
The higher gross profit margin is the more profitable the firm is. Gross profit
margins for Brunswick, Polaris, and West Marine have converged over the past five
94
years. Nautilus’ gross profit margin is much higher, likely because Brunswick sales
more boats than fitness equipment, and the cost of goods sold for fitness
equipment will be lower. As seen in Figures 46 and 47, Brunswick underperforms
compared to its competition given that its profit margin is 1% lower than
competition. All of the firms in the industry other than Nautilus have been
converging over the past five years at around a 30% gross profit margin.
Operating Profit Margin
Figure 48
Figure 49
Operating profit margin measures what portion of revenue is left over after
paying expenses such as salaries and wages, and materials. A high operating profit
95
margin means that the firm is keeping costs low and is managing operations
efficiently. Operating margin is calculated by dividing operating income by net
sales. As seen in Figures 48 and 49, Brunswick has maintained a low to average
operating margin over the past five years. There has been a lot of volatility in the
industry with a slight increase overall. Overall, Brunswick is performing slightly
below average compared to competition.
Net Profit Margin
Figure 50
Figure 51
Net profit margin is the amount of revenue that the firm has left over after
paying all expenses, interest, and taxes. This is the amount that is left over for the
96
firm to reinvest, or pay out to shareholders through dividends. As seen in Figure
50, Nautilus and Brunswick has unusually large profit margins. Nautilus’ increase in
2013 was due to a $38.9 million income tax credit from a deferred tax asset
allocation allowance (Nautilus 10k, 2013). The case was the same for Brunswick. It
received $545.6 million from deferred taxes in 2013, driving up their net income
and net profit margin (Brunswick 10k, 2013). As seen in Figure 51, Brunswick
maintains a slightly lower than average net profit margin. Overall its profit margin
has increased over the past five years, with a slight decrease in the past year.
Asset Turnover
Figure 52
97
Figure 53
Asset turnover measures how well the firm’s assets generate sales. The
higher asset turnover is, the better the firm is performing because assets are being
used efficiently. Asset turnover is found by dividing sales by total assets. As seen in
Figures 52 and 53, the industry’s asset turnover has been in a decline over the past
five years. Brunswick maintains a lower than average ratio, and is underperforming
relative to the competition. Overall, the industry has a healthy asset turnover.
Return on Assets
Figure 54
98
Figure 55
Return on assets (ROA) measures how profitable the firm is compared to its
total assets and how well the firm is using assets to generate net income. Return
on assets is found by dividing net income by total assets. As stated under the net
profit margin analysis, net income in 2013 for Brunswick and Nautilus is skewed
because of income tax benefits that they received. Because net income is skewed,
ROA is also skewed. As seen in Figures 54 and 55, the overall industry trend has
been positive with a slight decline in the past year. Despite the increase in ROA,
Brunswick is still underperforming relative to the competition.
Return on Equity
Figure 56
99
Figure 57
Figure 58
Return on equity (ROE) is the amount of net income that is distributed to
shareholders through dividends. Return on equity is calculated by dividing net
income by total shareholders equity. As seen in Figures 56 and 57, Brunswick
100
maintained a much higher ROE in the first three years, before falling to below
average in the past two. As mentioned before, the large spikes are due to income
tax benefits received by Brunswick and Nautilus. Figure 58 excludes Brunswick’s
2013 ROE to get a better picture of the competition’s performance. Overall, the
industry has been very volatile with an overall decreasing trend.
Conclusion
As seen in Figure 59, analysis of Brunswick’s profitability ratios show that it
is underperforming in every category except operating profit margin, in which it’s
performing at average. Gross margin, net profit margin, asset turnover, return on
assets, and return on equity ratios were all underperforming compared to the
competition.
Figure 59
101
Capital Structure Ratios
Introduction
The capital structure of a firm is how it finances its operations. This includes
long-term debt, short-term debt, common equity, and preferred equity. A firm’s
capital structure depends mostly on the level of risk that its willing to take on. For
example, a firm that is in a very competitive market with a lot of rapid innovation
would likely rely more on equity financing rather than debt financing because it is
less risky. Optimally, a firm would finance operations with a mix of debt and equity
to leverage shareholders funds while still maintaining enough liquidity to pay
current debts. In this section, we will analyze three main capital structure ratios
including the Debt to Equity, Time Interest Earned, and Altman’s Z score.
Debt to Equity
Figure 60
102
Figure 61
The debt to equity ratio measures how much debt a firm is using to finance
its operations relative to equity. It is calculated by dividing total liabilities by total
stockholders equity. A high debt to equity ratio indicates that the firm is financing
the firm with a lot of debt, while a low debt to equity indicates that the firm isn’t
aggressively debt financing. As seen in Figures 60 and 61, Brunswick’s restated
debt to equity ratio is heavily distorting the graph due to its now negative retained
earnings from changes in retained earnings.
103
Figure 62
As seen in Figure 62, excluding Brunswick’s 2011 and 2012 debt to equity
ratios allows us to see an overall trend. The industry has trended slightly downward
as has Brunswick, but they still maintain the highest ratio in the industry.
Brunswick’s high debt to equity ratio tells us that it’s aggressively financing its
growth and operations with debt. The higher ratio makes Brunswick riskier than its
competition. After restating Brunswick’s balance sheet, we see that debt to equity
increases even more. This is due to the increase in liabilities from capital operating
leases. On an as stated basis and a restated basis Brunswick’s ratio is greater than
the industry average by more than 1. Having a higher debt to equity ratio should
also produce a higher ROE, but this is not the case for Brunswick and the industry;
as stated above, Brunswick’s ROE is less than the industry. This tells us that
Brunswick is inefficient at managing the funds it uses to leverage the firm.
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Times Interest Earned
Figure 63
Figure 64
Times interest earned measures how many times over the firm can cover its
interest expenses before tax. It is found by dividing earning before interest and
taxes by interest expense. A low ratio indicates that the firm has too much debt
and is having a difficult time covering the interest. A high ratio indicates that the
firm has too little debt and isn’t maximizing shareholder funds.
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As seen in Figure 63 and 64, times interest earned varies greatly from firm
to firm. The industry average more than doubles due to Nautilus’ ratio going from 7
to 183. There isn’t a clear industry trend that is identifiable, but they all have the
ability to service their debt. Brunswick’s ratio was low in 2011, but they have
steadily increased it to 9.17 on a restated basis. Even so it still has a much lower
times interest earned ratio than its competition. This goes back to Brunswick being
more leveraged than the rest of the industry, because they have more debt they
have more interest to cover, therefore their times interest earned is higher, making
them more risky overall.
Altman’s Z-Score
Figure 65
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Figure 66
Altman’s Z-Score calculates the equivalent of a corporations credit score. It
computes the likelihood of a corporation going bankrupt. A credit score below 1.8
indicates that the corporation is likely headed towards bankruptcy, while a credit
score above 3.0 is unlikely to go bankrupt. Altman’s Z-Score is calculated by: Z-
score = 1.2*(working capital/total assets) + 1.4*(retained earnings/total assets) +
3.3*(EBIT/total assets) + 0.6*(Market value of equity/total liabilities) +
1.0*(sales/total assets).
As seen in Figures 65 and 66, Brunswick’s Z-score is far less than industry
average. On a restated basis, Brunswick has a Z-score of 9.17 while the industry
average is 56.66. Every firm in the industry is far from going into bankruptcy as
they are all well above 3. Brunswick’s has increased by 7 over the past five years,
moving even further away from potential bankruptcy. While Brunswick has the
worst Altman’s Z-score in the industry, it is very unlikely that they will go bankrupt
in the near future.
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Internal Growth Rate
Figure 67
Figure 68
The internal growth rate is the rate at which a firm can grow without taking
on any more debt. The internal growth rate is calculated by multiplying ROA by the
dividend payout ratio. This measures efficient assets are at growing the firm
without external resources.
Figures 67 and 68 show the internal growth rates for the industry.
Brunswick’s restated internal growth rate is less than stated because goodwill
impairment caused total assets to fall. This in turn caused return on assets to fall,
leading to a lower internal growth rate. Brunswick’s internal growth rate explains
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why their debt to equity ratio is so high; they can’t grow at more than 1.61%
without leveraging their assets. Brunswick is 3.69% below the industry in internal
growth rates. In conclusion, Brunswick can hardly grow as fast as inflation without
using outside funding.
Sustainable Growth Rate
Figure 69
Figure 70
The sustainable growth rate is the rate at which a firm can grow without
changing its debt to equity ratio. This means that the firm must take on debt at the
same interval in which it increases equity. Sustainable growth rate is calculated by
multiplying ROE by 1 – dividend payout ration.
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Figures 69 and 70 show the sustainable growth rates for the industry. Even
though Brunswick has trended up the past five years, they can still sustain less
growth than every competitor other than West Marine. This is partially due to the
fact that Brunswick has paid out an average of 22.3% of their net income in
dividends, while Nautilus and West Marine haven’t paid a dividend in the past five
years. Brunswick’s restated sustainable growth rate is less than reported because of
the capitalization of operating leases. In conclusion, Brunswick’s sustainable growth
rate has been increasing, but is still well below industry averages.
Conclusion
Compared to competitors, Brunswick’s Capital Structure ratios are well below
industry average. Figure 71 summarized our findings and the trends for each ratio.
Brunswick underperformed in every category but is making improvements.
Restating the financial statements showed us that the capital structure of the firm
is worse than it is as stated.
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Figure 71
Financial Forecasting
Financial forecasting is an important aspect in valuing a firm. A financial
forecast is an estimate of the future profits and growth of a company. Using past
performances of the company, it shows investors an estimate of what will
financially happened to a firm in the future. Forecast can also help assist in the
management of finances. We forecasted the income statement, balance sheet and
statements of cash flow using various forecasting methods including ratios, trends
and estimated assumptions.
Income Statement We started with the income statement because many of the numbers in it
are tied directly into the balance sheet and statements of cash flows. The income
statement is used to identify the profit made during each period. The most
important figure on this statement is the net income. The net income ties in to
several different ratios we used. The first forecast we made on the income
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statement was the sales growth for the past five years. Brunswick’s sales growth
had a lot of fluctuations each year. We calculated a 6.95 percent sales growth in
2015, and forecasted the growth to reach 5.57 percent by 2025.
Following the sales growth, we created a common size income statement.
This shows all of the items on the income statement as a percentage of revenues.
It is useful to create one in common size because it helps with the analysis
between the industry competitors and also between different periods of Brunswick’s
operations. In the past five years Brunswick’s gross profit has stayed between 23-
27 percent. We estimate it to stay within this same range throughout the next ten
years. We also used an average of 3 percent of net income to be used for research
and development expenses each year for the next ten years.
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Figure 72
113
Figure 73
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Restated Forecast
Restated Common Sized Forecast
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Balance Sheet We continued with our numbers in the income statement to help forecast
our balance sheet. It is important for a firm to forecast out their balance sheet to
help estimate asset growth, and help show how it can be sustained by increased
financing through debt and equity. This helps with the management in additional
financing. The forecasted sales revenue on the income statement helps us
forecast the balance sheet because it is related to items such as inventory,
receivables and payables. The major item we had to forecast on the balance
sheet was the total assets. We used the asset turnover ratio to connect these
items. Our asset turnover ratio fluctuated between 1.3 and 1.6 in the previous 5
years, and we estimate it to stay around that same range through 2025. After
calculating out total assets, we created a common size balance sheet to forecast
the rest of our assets. To find current assets and non-current assets, we divided
them by the total assets. Next, we forecasted accounts receivable and the
inventory using the accounts receivable turnover and inventory turnover. To
make the balance sheet balance, we first calculated the total equity. Then, we
subtracted it out from the total assets to get the total liabilities. Shown below
Figure 75 are the restated forecasted balance sheets.
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Figure 74
117
Figure 75
118
119
120
Restated Forecasted Cash Flows
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Restated Forecasted Common Sized Statement of Cash Flows
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Statement of Cash Flows Forecasting a cash flow is important for a firm because it allows them to
estimate the amount of cash in and out they can expect to have in the future. If
a company runs out of cash they will become insolvent. Forecasting cash flows
allows management to recognize potential losses in advance, make sure it will
have the funds to pay suppliers, and predict future problems with payable
collecting. In the statement of cash flows we forecasted CFFO, CFFI and
dividends paid. We chose to calculate dividends because it allows us to estimate
the amount of payments to share holders in the future. To calculate this, we
multiplied our estimated amount of shares by our estimated earnings per share.
When forecasting CFFO we compared CFFO/Net income, CFFO/Operating
income, and CFFO/Sales. To forecast CFFI we used the ratio of CFFI/Sales.
Figures 76 and 77 show the actual forecasted cash flow statements. The restated
cash flow statements are shown above.
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Figure 76
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Figure 77
Cost of Equity and Capital Asset Pricing
Model
For an equity investor, the cost of equity is the amount of return the
investor requires, in order for them to purchase equity in a company. An
efficient way of calculating this is by using what we call the Capital Asset Pricing
Model or CAPM. The CAPM formula is:
CAPM = Rf+Beta(MRP)+SP
CAPM is described by equaling the risk-free rate (Rf) plus Beta (a
portfolio/stock’s market related risk), multiplied by the market risk premium. A
size premium is then added. CAPM provides a visual, of these values.
To find the cost of equity, collection of data is needed. This data includes
historical prices and dividends of an equity security, in our case Brunswick.
Along with this historical data of Brunswick, we must find information on the risk-
free rate, which is found using the return rate of a treasury bonds. The monthly
risk-free rate was calculated with the 20-years Treasury bond, which is 2.28%
(research.stlouisfed.org). We divide this percentage by twelve to obtain a
monthly rate, giving us a rate of .19%. Rm was calculated by finding the average
monthly return of the market in the past 20 years. We did so by using the
monthly return of the S&P 500, which is a value-weighted index of the stock
market. The average return came out to be 7.32% (Yahoo). The market risk
premium (MRP) is Rm minus Rf. The difference of the two is 7.13%, which will
serve as the MRP. As shown in the table found in the Business Analysis &
Valuation Textbook, Brunswick falls into the eighth decile of size premiums,
which gives it a size premium of 1%.
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Figure 78
As for beta, a simple explanation of what it is would be the market related
risk of a company. Beta can be found with regression analysis.
Figure 79
When deciding on which analysis represented beta best, we chose the 72-
month observation on the regression analysis. This is due to the fact that it has
the largest R^2, which means more of its risk is systematic than all of the other
observations. This leads us to select a beta of 2.38 when using CAPM to calculate
cost of equity.
With all of the values, we find that the expected return comes out to be,
when formulated with CAPM:
CAPM = .0019+2.38(7.13)+.01 = 18.16%
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With our use of CAPM, we conclude that an accurate cost of equity for an
investor equals 18.16%. Also, within a 95% confidence interval, we can state
that the cost of equity will vary between 14.8% and 21.44%, according to our
regression table.
Cost of Debt
Weighted average cost of debt is the weighted average of the rates of
interest on the debts a firm takes on, such as bank loans and company bonds.
With so many business activities dependent on acquiring necessary capital via
debt, the cost of that debt plays a large part in determining the courses
businesses can afford to take and the value they gain. This cost of debt is best
acquired by determining the total amount and types of debt Brunswick has taken
on, and determining the “weights” of the various types of debt, that is, the
amount of a given type of debt compared to total amount, all in terms of
monetary value.
Once the weights of all debt types are calculated and added up to 100%,
we multiply the respective weights of each debt type by each debt type’s
respective rates. Once the products of the respective weights and rates are
added up, we have our complete weighted average cost of debt, according to
Brunswick’s 10k financial data. This process is shown below, for both stated and
restated cost of debt, in Figures 80 and 81.
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Figure 80
Figure 81
Weighted Average Cost of Capital (WACC)
The weighted average cost of capital is a crucial number for the firm and
its potential investors, as it represents the amount of return the company’s
combined operations and investments will have to earn in order to break even.
Therefore, it represents the return investors will demand from Brunswick in
return for their investment. Determining the weighted average cost of capital is
done very similarly to the weighted costs of equity and debt. By determining the
debt and equity “weights,” or the percentages of Brunswick that are financed by
debt and equity compared to the total value of the company, and multiplying
those weights by the costs of debt and equity which we have acquired, we can
determine the weighted average cost of capital for Brunswick Corporation. This
process is shown below, in Figures 82 and 83.
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WACCbt = (Wd*Vd)+(We*Ve)
WACCat = ((Wd*Vd)*(1-tax rate))+(We*Ve)
Figure 82
Figure 83
The market value of equity was determined by multiplying the per share
price by the total outstanding shares. This came out to be $4.42 billion. Market
value of liabilities was determined by adding up all interest-bearing debt held by
the firm. Brunswick’s restated market value of liabilities is different than on as
stated basis because it includes capitalized operating leases. This change doesn’t
have a significant impact on the weights, but it does affect the WACC. The tax
rate was determined by taking an average over the past five years. To calculate
the after-tax WACC, the market value of liabilities was multiplied by (1-tax rate).
Our analysis going forward will use the after-tax WACC.
The weighted average cost of capital on a restated basis is only slightly
different than on an as-stated basis. This is because the market value of
liabilities only changed slightly after including capitalized operating leases, and
didn’t have an effect on the rates. Because the weighted average cost of capital
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varies so much, lower and upper bound sensitivity analysis with a 95%
confidence interval were calculated as seen in Figures 84, 85, 86, and 87 below.
Figure 84
Figure 85
Figure 86
Figure 87
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Method of Comparables
Method of comparables is the analysis of a number of different ratios to
produce an estimated Price Per Share (PPS) for the firm. This method is good
because it is easy to calculate and all of the data is easily accessible on Yahoo!
Finance, but it is flawed in that benchmarks don’t always produce an accurate
PPS estimate. The PPS in each ratio is calculated using the average of
benchmark competitors, and this is used to create an estimate. Only the latest
years data is used, so there isn’t very much data, making it skewed sometimes.
For this analysis, we will use Polaris, and Nautilus as benchmark competitors.
For this analysis, we will use a 10% analyst position based on the stock
price on April 1, 2016, $48.27. This means that a price above $53.10 would be
undervalued, and a price below 43.44 would be overvalued. This analysis will
include a price target on a stated and restated basis. Data for the as-stated
analysis will largely come from Yahoo! Finance, while the restated data will come
from our own restatements and forecasts.
Trailing P/E Ratio
The trailing P/E ratio measures the share price relative to net income over the
past year. It is calculated by dividing the share price by the last 12 months
Earnings Per Share (EPS). The trailing P/E for Brunswick and its benchmark
competitors can be seen in Figure 88 below.
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Figure 88
The adjusted price per share was calculated by multiplying the industry
average trailing P/E by the trailing EPS for Brunswick. This produced a stated
and restated PPS of 68.21 and 57.82 respectively, both well above the 10%
analyst position of $53.10. This ratio indicated that the stock is undervalued. It is
important to note that West Marine’s P/E skews the results, as it is much higher
than the rest of the industry. When we excluded West Marine’s trailing P/E, the
adjusted PPS for Brunswick on an as stated and a restated basis was $50.73 and
$43.01, respectively. This would put Brunswick’s stock at a reasonable valuation.
Given that the P/E ratio only uses a small amount of data, we would say that it
doesn’t produce a very accurate PPS estimate.
Forward P/E Ratio The forward P/E Ratio is similar to the trailing P/E ratio in that it looks at
earnings over a period of time, but instead of looking into the past, it looks at
predicted earnings per share. The forward P/E is calculated by dividing the
current share price by the forecasted earnings per share. Figure 89 below shows
the forward P/E for Brunswick and benchmark competitors.
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Figure 89
The adjusted PPS for the forward P/E was calculated by multiplying the
industry average by the forward EPS. This produced a stated and restated PPS of
65.58 and 51.09 respectively. This means that on an as stated basis the firm is
undervalued, while on a restated basis the firm is fairly valued. It is important to
note that the forward P/E also uses very little data and is an estimate of future
earnings, so it is possible that the PPS is not accurately valued.
Price to Book Ratio
The price-to-book ratio is a comparison between a firm’s market value and
book value. This ratio is calculated by dividing the current price per share by the
firm’s Book Value Per Share (BPS). To compute the BPS, we divided the total
book value of equity by the number of outstanding shares. To calculate the
adjusted PPS, we multiplied the BPS by the P/B ratio, as seen in Figure 90.
Figure 90
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West Marine was an outlier in this case, as it has a PPS that is lower than
the BPS. This could be a sign that the market has incorrectly valued the firm, but
it is more likely that it is just an unattractive investment as it has had some
significant problems that hurt its valuation. These problems include an 85%
decline in net income over the past five years despite a steady increase in sales.
The as-stated adjusted PPS indicated Brunswick is undervalued by $4, but the
restated adjusted PPS indicated that it is overvalued by $0.46. Although,
excluding the outlier, West Marine, from this calculation brings the restated
adjusted PPS to $51.54, a fair valuation. Since West Marine has such an unusual
price-to-book ratio, we will use the restated adjusted PPS that doesn’t include
West Marine. This means that the price-to-book ratio indicated that Brunswick is
fairly valued.
Dividend to Price
The dividend to price ratio, also known as dividend yield, indicated how
much in dividend the firm pays out relative to its price per share. This ratio is
calculated by dividing dividends per share by the price per share. For this ratio,
we will exclude West Marine and Nautilus from our analysis because they do not
pay dividend and would distort inaccurately produce an undervalued result. Our
results can be seen in Figure 91.
Figure 91
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The adjusted PPS was calculated by dividends by the industry average
dividend to price ratio. It should also be noted in that calculating the industry
average Brunswick was only counted once as the stated and re-stated dividend
to price ratio is the same. This ratio produces an overvalued valuating because
Brunswick pays less than industry average.
Price Earnings Growth Ratio
The price Earnings Growth Ratio (PEG) is a valuation tool that takes into
account future earnings growth. The key difference between PEG and everything
else we’ve analyzed so far is that it takes into account future growth potential.
PEG is calculated by dividing the P/E ratio by next year’s forecasted earnings per
share. Typically, a PEG below 1 is considered to be an undervalued stock. As
seen in Figure 92 below, Brunswick and its benchmark competitors all have PEGs
below 1. Polaris has been excluded from this analysis as it has a negative growth
rate and it heavily skews the average due to a -4.21 PEG.
Figure 92
Brunswick’s PEG on an as-stated basis is lower than average, but on a
restated basis it is around average. This likely means that it is fairly valued
compared to its competitors. The adjusted PPS was calculated by dividing the
trailing P/E by the industry average PEG. Brunswick’s adjusted PPS on both on an
as-stated and restated basis fall well below the 10% analyst position, meaning
that it is overvalued. This is likely due to the fact that the industry as a whole is
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growing rapidly and the market is expecting greater growth rates in the near
future. Higher expectations could inflate the price of the stock above what it
should be valued at.
Price to EBITDA Ratio
The price to EBITDA ratio is similar to the P/E ratio in that it measures the
amount a shareholder is paying for earnings. The difference is that this ratio
looks at how much earnings before income tax, depreciation, and amortization
the firm creates relative to market capitalization. This is a good alternative
because it takes out a lot of the noise like income tax benefits, or poor
accounting principles that inflate depreciation. Our results for this ratio can be
seen in Figure 93 below.
Figure 93
Brunswick’s restated IBITDA is lower than on an as-stated basis due to
the capitalization of operating leases. This drives up the price to EBITDA and
makes the firm less attractive to investors. To calculate the adjusted PPS, we
multiplied the firm’s EBITDA with the industry average price-to-EBITDA and
divided it by the number of shares outstanding. This ratio suggests that
Brunswick is undervalued on an as-stated basis and overvalued on a restated
basis.
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Price to Free Cash Flow Ratio
The price to free cash flow ratio measures the firm’s market price to its
free cash flows, which are cash flows from operating activities minus cash flows
from investing activities. Cash flows are typically really volatile, especially in
smaller firms. This is true for Brunswick’s competitor West Marine who is in a
stage of rapid growth and spends a lot of its cash on property plant and
equipment. This is also the case for Nautilus. Figure 94 shows our results
including Brunswick and all of its benchmark competitors. Because West Marine,
and Nautilus’ free cash flow is so low relative to their market capitalization, we
will exclude them from this particular analysis. Our results can be seen in Figure
95 below.
Figure 94
Figure 95
The adjusted PPS was calculated by multiplying the price to free cash flow
by the free cash flow, and then dividing this by the number of shares
outstanding. This would give Brunswick a fair valuation, but it is inaccurate due
to the lack of representation of the industry. The larger companies, Brunswick
and Polaris, have free cash flows that make up around 5% of their market
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capitalization while the smaller companies have free cash flows that make up
around 2% of their market cap. This heavily distorts the results of this particular
analysis as they are in two different positions. Overall, the price to free cash flow
ratio shows that Brunswick is fairly valued.
Enterprise Value to EBITDA Ratio
The enterprise value to EBITDA ratio is a good valuation tool as it is a
better measure of a firm’s underlying profit potential. This ratio is better in this
industry than the P/E ratio is because firms in this industry are structured so
much differently. A firm that has funded their business on primarily debt will
have a lower P/E than one that has funded it with primarily equity. This ratio isn’t
affected by the capital structure, or the amount of leverage that is used. Another
benefit is that it excludes depreciation. This industry has a lot of PP&E and
infrastructure that it uses, which comes with a high depreciation expense every
year. This is especially true with West Marine, who has been investing heavily in
PP&E over the past few years. The EV to IBITDA ratio is calculated simply by
dividing the enterprise value by the EBITDA. Our results can be seen in Figure 96
below.
Figure 96
The adjusted PPS was calculated by multiplying the EBITDA by the
EV/EBITDA, and then dividing this by the number of shares outstanding. This
calculation produced an undervalued result on an as-stated basis, and an
overvalued result on a restated basis. This is due to the fact that EBITDA is
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significantly lower on a restated basis due to the capitalization of operating
leases. Overall, this in an accurate representation of Brunswick’s valuation and is
overvalued overall.
Conclusion
Figure 97
Figure 97 above shows a summary of the method of comparables
analysis. Overall this analysis produced overvalued results for Brunswick. This
type of analysis has some flaws in it because these firms are structured slightly
differently even though they are in the same industry. The analysis in the next
section will reinforce our results from the method of comparables.
Intrinsic Valuation Model
In this section of the equity valuation of Brunswick, we will use the
intrinsic valuation models to valuate Brunswick’s forecasted performance. The
intrinsic valuation models help analyst analyze future forecasted performance of
a given firm. After gathering the information from the forecasts, we discounted
the future cash flows back to their present value. After calculating the present
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values of future cash flows, we performed a sensitivity analysis using different
growth rates and cost of equity. These models help us valuate Brunswick based
on present value for forecasted future cash flows. In this section we use the
discounted dividend model, discounted cash flow model, residual income and
long run residual income models to valuate Brunswick.
Discounted Dividend Model
The first valuation model we used was the discounted dividend model.
This model valuates a firm from their future forecasted dividends that would be
paid out to shareholders. A limitation of the discounted dividend model is that it
only values a firm based on the future dividend payments. Even though the
discounted dividend model only uses future dividend payments, it is a
foundational model used to valuate firms. According to Paul Healy and Krishna
Palepu, Business Valuation: Using Financial Statements 5th edition, the
discounted dividend model is the popular approach for stock price valuation. The
model valuates the firm based on their dividend payments.
Another limitation for the discounted dividend model is that is hard to
valuate firms that do not pay a dividend or have low dividend payments (Healy,
Palepu, 2008 p.7-4). If a firm does not pay a dividend payment or has very low
dividends, it makes it fairly difficult to forecast the future dividends. This is why
the valuation model isn’t accurate for all firms.
For Brunswick, we used the discounted dividend model to evaluate the
firm. In order to use the model we used the forecasted future dividend
payments. To calculate the future dividend payments, we used a step up
function to determine the future payments. After calculating the future dividend
payments, we used the cost of equity for Brunswick to discount the dividend
payments to their present value for the 10 years. Also we calculated the present
value for the perpetuity for year 11 going forward. To calculate the dividend
payments for the 10 forecasted years and the perpetuity for year 11 to infinity,
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we used a cost of equity of 18 percent. For the growth rate we used 5 percent.
The growth rate we used was based on the forecasted sales growth for
Brunswick. After adding the present value for the forecasted years we were able
to calculate the model price for Brunswick.
Next, we calculated the time consistent price for April 1st of 2016. With a
cost of equity of 18 percent and a growth rate of 5 percent, the time consistent
price for Brunswick came out to $6.06. We compared this price to the share price
of $50.18 for Brunswick on April 1st. We observed that 11 percent of the share
price supported by dividends. After collecting the time consistent price and the
observed share price we conducted a sensitivity analysis for Brunswick. Figure 97
below is the sensitivity analysis conducted for the discounted dividend model.
Based on this model, Brunswick is overvalued. In the sensitivity analysis
we used several cost of equity and growth rates to find different time consistent
prices for Brunswick. After applying our 10% analysis and finding a fair value for
Brunswick’s share price between $45.16 and $55.20, we found that Brunswick
was extremely over valued. As you can see in Figure 97, Brunswick’s highest
value for the time consistent price was when it had a 12 percent cost of equity
and a 10 percent growth rate. Although Figure 97 shows that Brunswick is over
valued, the discounted dividend model does have some uncertainties due to the
fact that the model only uses future dividend payments to evaluate the firm.
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Figure 97
6.06 2.00% 4.00% 6.00% 8.00% 10.00%12% 9.57 10.70 12.59 16.36 27.6714% 7.85 8.50 9.47 11.08 14.3216% 6.63 7.03 7.58 8.42 9.8018% 5.72 5.98 6.32 6.80 7.5120% 5.02 5.19 5.41 5.71 6.1221% 4.72 4.87 5.05 5.28 5.61
Cost of Equity
(Ke)
Growth Rate (g)
LB 10% UB 10%$45.16 $55.20Over-Valued < < Under-Valued
Discounted Cash Flow Model
For this valuation we used the discounted cash flow model. This model
uses discounted future cash flows to find the time consistent price to be used in
a sensitivity analysis of the firm’s share price. We used the forecasted future
cash flows from operating activities minus the forecasted future cash flows from
investing activities to find Brunswick’s future cash flows from their assets. The
discounted cash flow model has some uncertainties in the valuation. In the
discounted dividend model, the future dividends payment was the only tool being
used to evaluate the firm. This made the results to be uncertain because firms
do not always pay dividends to shareholders. The discounted cash flow model
can produce results with uncertainty. One uncertainty is that it is hard for
companies to forecast future capital expenditures that the firm must pay in the
future.
To valuate Brunswick with the discounted cash flow model, we calculated
the forecasted cash flow from operating activities and investing activities for 10
years. After we subtracted the cash flows from the investing activities from
operating activities, we found the present value for the firm’s assets. For year 11
to infinity we calculated the perpetuity by using the Gordon Growth Model to find
the present value of the perpetuity. We used the weighted average cost of
capital before taxes (WACCbt) and the growth rate (g) to calculate it. For the
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weighted average cost of capital we used 17 percent, and for the growth rate we
used 5 percent. We calculated the market value of Brunswick’s assets by
summing all present values.
Once we found the market value for Brunswick’s assets, we calculated the
time consistent price for the stock and compared it to the observed stock price
for Brunswick through a sensitivity analysis. For the observed stock price we
used the same price from the previous model. Figure 98 below shows the
sensitivity analysis conducted for the discounted dividend model. After
conducting the sensitivity analysis for the discounted cash flow model, we were
able to evaluate Brunswick. The sensitivity analysis used different weighted
average cost of capital and growth rates to find values for the firm. We used a
10 percent analysis of Brunswick’s fair price. The values from the sensitivity
analysis showed that Brunswick is over valued.
In Figure 98 below, Brunswick’s highest value were with an 11 percent
weighted average cost of capital at an 8 to 10 percent growth rate. The problem
with the 8 to 10 percent growth rates was that they are unrealistic growth rates
for a firm. Although the discounted cash flow model can have some uncertainties
in the valuation, Brunswick has shown to be over valued through the use of this
model.
Figure 98
5.52 4% 6% 8% 10%11% 26.13 33.25 49.84 132.8115% 14.79 16.64 19.54 24.7517% 11.75 12.85 14.43 16.9221% 7.81 8.27 8.87 9.6925% 5.37 5.59 5.86 6.21
WACC (Before
Tax)
Growth Rate (g)
LB 10% UB 10%$45.16 $55.20Over-Valued < < Under-Valued
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Residual Income Model
The third valuation model we used was the residual income model. The
residual income model shows the earnings that a given firm should make minus
the stockholders demand for a return on equity for their ownership in the firm.
This is done by adding the forecasted net income for the firm to the previous
year’s book value of equity and subtracting the dividend payment to find the new
equity. Once we have found the new book value of equity, we multiplied the cost
of equity and previous year’s book value of equity to find the benchmark. After
finding the benchmark, we subtracted it from the net income to find the annual
residual income. Next, we calculated the present value for the forecasted years 1
through 10, by discounting the annual residual income by the cost of equity.
We used the Gordon Growth Model to find the perpetuity for year 11 to
infinity. Once we found the present values for all the forecasted years, we
summed up all the present values to find the market value of equity for the firm.
After finding the market value of equity, we found the time consistent price for
Brunswick at April 1st.
When comparing the intrinsic valuation models, the residual income model
has the highest explanatory power. The residual income model focuses on if the
firm’s net income and if they are efficiently making the required return to their
shareholders. For Brunswick we used a 12.5 percent cost of equity and a -30
percent growth rate to find the time consistent price. In the residual income
model we used a negative growth rate. Using this negative growth rate we
would be able to return the residual income back to equilibrium. For the residual
income model, we will perform a stated sensitivity analysis and a restated
sensitivity analysis to show the corrections to the operating leases and goodwill
accounts made on the balance sheet. In Figures 99 and 100, we have the
sensitivity analysis performed for the stated and restated residual income. We
performed a 10 percent analysis and found a fair value for Brunswick to be
between $45.16 and $55.20. The tables show the sensitivity analysis performed
145
for Brunswick. In both the stated and restated, Brunswick was significantly over
valued.
Figure 99 (As Stated)
15.34 -10% -20% -30% -40% -50%12.50% 15.13 15.27 15.34 15.38 15.4114.50% 12.63 12.93 13.09 13.19 13.2716.50% 10.66 11.04 11.25 11.39 11.4918.50% 9.10 9.50 9.74 9.90 10.0120.50% 7.85 8.25 8.49 8.65 8.76
Cost of Equity (K)
Growth Rate (g)
LB 10% UB 10%45.16$ 55.20$ Over-Valued < < Under-Valued
Figure 100 (Restated)
14.81 -10% -20% -30% -40% -50%12.50% 14.91 14.84 14.81 14.79 14.7814.50% 12.43 12.57 12.65 12.70 12.7416.50% 10.50 10.74 10.89 10.98 11.0418.50% 8.97 9.26 9.43 9.55 9.6320.50% 7.74 8.05 8.23 8.36 8.45
Growth Rate (g)
Cost of Equity
(Ke)
LB 10% UB 10%45.16$ 55.20$ Over-Valued < < Under-Valued
146
Long-Run Residual Income Model
For this section of our valuation of Brunswick, we will use the long-run
residual income model. The long-run residual income model is similar to the
residual income model, but it uses four main inputs to solve for the market value
of equity. The four inputs needed to use the model are the book value of equity,
return on equity for year 10, the cost of equity and the growth rate. In this
model, we will use a negative growth rate to reach an equilibrium price. Once we
have found the inputs needed to calculate the market value of equity we used an
equation to solve for it. The equation below is the long run residual income
model formula used to calculate the market value of equity.
MVE = BVE [(1 + ((ROE –Ke) / (Ke-g))]
After we found the market value of equity, we calculated the price per
share by dividing the market value of equity by the shares outstanding. Once we
found the price per share, we discount the price per share to find the time
consistent price for April 1st. For Brunswick we used the 2015 book value of
equity, which was $1,281. We used 11 percent from the tenth year on the
residual income model for the return on equity. We reported the cost of equity at
16 percent. We went with a -30 percent for the growth rate because it was the
growth rate that brought us back to equilibrium at an expected rate. Once we
calculated the time consistent price for Brunswick, we used a sensitivity analysis
to evaluate the firm based on the stated and restated financials.
Figures 101 and 102 below show the sensitivity analysis for both the
stated and restated financials. We used a 10 percent analysis to calculate to the
fair value for Brunswick’s share price. Our lower bound 10 percent was $45.16
and our upper bound 10 percent was $55.20. The fair value lies between these
two values. After examining the results, Brunswick appeared to be significantly
over-valued in both the stated and restated sensitivity tests.
147
Figure 101 (As Stated)
13.36 12% 14% 16% 18% 20%12.00% 15.03 14.40 13.83 13.30 12.8214.00% 15.74 15.08 14.48 13.93 13.4316.00% 16.46 15.77 15.14 14.57 14.0418.00% 17.17 16.46 15.80 15.20 14.6520.00% 17.89 17.14 16.46 15.83 15.26
Cost of Equity
Return on Equity
Hold Growth Constant g= -30%
LB 10% UB 10%$45.16 $55.20Under-Valued < < Over -Valued
13.36 11% 13% 15% 17% 19%-10% 14.83 13.60 12.57 11.69 10.93-20% 14.83 13.99 13.25 12.59 12.00-30% 14.83 14.20 13.63 13.11 12.63-40% 14.83 14.33 13.87 13.45 13.04-50% 14.83 14.42 14.04 13.68 13.34
Growth
Hold Constant ROE= 11%Cost of Equity
LB 10% UB 10%$45.16 $55.20Under-Valued < < Over -Valued
13.36 12.00% 14.00% 16.00% 18.00% 20.00%-10% 12.69 13.84 14.99 16.15 17.30-20% 13.33 14.16 14.99 15.83 16.66-30% 13.69 14.34 14.99 15.65 16.30-40% 13.92 14.46 14.99 15.53 16.07-50% 14.09 14.54 14.99 15.45 15.90
Hold Cost of Equity Costant Ke=16%Return on Equity
Growth
LB 10% UB 10%$45.16 $55.20Under-Valued < < Over-Valued
148
Figure 102 (Restated)
11.57 12% 14% 16% 18% 20%12.00% 12.41 11.89 11.42 10.98 10.5814.00% 13.00 12.46 11.96 11.51 11.0916.00% 13.59 13.02 12.50 12.03 11.5918.00% 14.18 13.59 13.05 12.55 12.1020.00% 14.77 14.15 13.59 13.08 12.60
Hold Growth Constant g= -30%Cost of Equity
Return on Equity
LB 10% UB 10%$45.16 $55.20Under-Valued < < Over -Valued
11.57 11% 13% 15% 17% 19%-10% 13.41 12.30 11.37 10.57 9.88-20% 13.04 12.30 11.65 11.07 10.54-30% 12.84 12.30 11.81 11.35 10.93-40% 12.73 12.30 11.91 11.54 11.19-50% 12.65 12.30 11.97 11.67 11.38
Hold Constant ROE= 11%Cost of Equity
Growth
LB 10% UB 10%$45.16 $55.20Under-Valued < < Over -Valued
11.57 12.00% 14.00% 16.00% 18.00% 20.00%-10% 10.48 11.43 12.38 13.33 14.29-20% 11.01 11.69 12.38 13.07 13.76-30% 11.30 11.84 12.38 12.92 13.46-40% 11.50 11.94 12.38 12.82 13.27-50% 11.63 12.01 12.38 12.76 13.13
Return on Equity
Growth
Hold Cost of Equity Costant Ke=16%
LB 10% UB 10%$45.16 $55.20Under-Valued < < Over-Valued
149
Analyst recommendation
In our equity valuation of Brunswick, we researched the industry and the
accounting practices used in regulation with GAAP. We also analyzed Brunswick’s
financials compared to their competitors, and we forecasted their financials into
the future. Through these steps, we were able to gain a better understanding of
Brunswick. In the first step of analyzing the industry, we identified Brunswick’s
competitors to be Polaris, Nautilus, and West Marine. After we identified
Brunswick’s competitors, we used the Five Forces Model to analyze the industry’s
performance and competition.
After conducting our analysis of the industry, we focused on the
accounting policies that Brunswick uses in regulation with GAAP. We found the
potential red flags in Brunswick’s accounting practices. The potential red flags we
identified were in their reporting of their goodwill and operating lease accounts.
Next, we made corrections to the account by undoing the distortion for the
goodwill and operating leases. We then restated the balance sheet and income
statement. The third step we perform was analyzing the financials and ratios for
Brunswick and their competitors. This allowed us to forecast the balance sheet
and income statement out to ten years into the future.
After analyzing all three of these steps, we gathered all the data for the
comparable and the intrinsic valuation models. We used to the information
gathered from the comparable to make comparisons to Brunswick and their
competitors. After analyzing the comparables, we used the intrinsic valuation
models to valuate Brunswick. After using the intrinsic valuation models, we
concluded that Brunswick stock price has been overvalued. Our recommendation
for individuals that own shares in Brunswick is to sell their shares because
Brunswick is overvalued.
150
Appendix
In the tables below are the calculations used in our equity valuation of
Brunswick Corporation.
Goodwill
Change In Goodwill2010 290.9 - 2011 290.3 (0.60) 2012 291.7 1.40 2013 291.7 - 2014 296.9 5.20 2015 298.7 1.80
Goodwill Adjustment (in Millions)Orginal Goodwill
2011 2012 2013 2014 201558.18 58.18 58.18 58.18 58.18
(0.12) (0.12) (0.12) (0.12) 0.28 0.28 0.28
- - 1.04
New Goodwill Orginal GW (2010)
20112012201320142015
58.18 58.06 58.34 58.34 59.38 - - - - -
58.18 58.06 58.34 58.34 59.38
Should Impair Did Impair
Adjust
2011 2012 2013 2014 2015290.30 231.52 174.86 116.52 63.38
(0.60) 1.40 - 5.20 1.80 - - - - -
58.18 58.06 58.34 58.34 59.38 231.52 174.86 116.52 63.38 5.80
Beginning Balanc eNew Goodwill
New Balance for Goodwill
Should Impair Adjusted Ending Balance
Did Impair
151
2010 2011 2012 2013 2014 2015290.90 290.30 291.70 291.70 296.90 298.70
1,142.20 1,137.90 1,064.10 1,867.60 1,162.70 1,063.8025.47% 25.51% 27.41% 15.62% 25.54% 28.08%
Brunswick 's Percentage of Fixed Assests in Goodwill
GoodwillFixed Assets Percentage
Capitalizing Operating Leases (in millions) 3.72%
Period Future Value PV factor Present Value Beg Balance Accrued Int Payment Ending Bal1 32.30 0.96 31.14 93.20 3.47 32.30 64.37 2 24.80 0.93 23.05 64.37 2.39 24.80 41.97 3 17.50 0.90 15.68 41.97 1.56 17.50 26.03 4 13.10 0.86 11.32 26.03 0.97 13.10 13.90 5 9.90 0.83 8.25 13.90 0.52 9.90 4.51 6 4.68 0.80 3.76 4.51 0.17 4.68 0.00
Discount rate: 2011 Capitalization of Operating Leases
Interest Expense Dep. Exp Difference3.47 15.53 (13.30) 2.39 15.53 (6.87) 1.56 15.53 (0.40) 0.97 15.53 3.40 0.52 15.53 6.15 0.17 15.53 11.02
19.00 17.93 17.10 16.50
Total Cap Ol op exp Exp under Op lease treatment
15.70
32.30 24.80 17.50 13.10
9.90 4.68
16.05
2.88%
Period Future Value PV factor Present Value Beg Balance Accrued Int Payment Ending Bal1 28.60 0.97 27.80 88.30 2.54 28.60 62.24 2 21.80 0.94 20.60 62.24 1.79 21.80 42.24 3 16.90 0.92 15.52 42.24 1.22 16.90 26.55 4 12.60 0.89 11.25 26.55 0.76 12.60 14.72 5 9.60 0.87 8.33 14.72 0.42 9.60 5.54 6 5.70 0.84 4.81 5.54 0.16 5.70 0.00
2012 Capitalization of Operating Leases Discount rate:
Interest Expense Dep. Exp Difference2.54 14.72 (11.34) 1.79 14.72 (5.29) 1.22 14.72 (0.97) 0.76 14.72 2.88 0.42 14.72 5.54 0.16 14.72 9.18
17.26 28.60 Total Cap Ol op exp Exp under Op lease treatment
21.80 16.90 12.60
9.60
16.51 15.93 15.48 15.14 14.88 5.70
152
2.73%Period Future Value PV factor Present Value Beg Balance Accrued Int Payment Ending Bal
1 32.60 0.97 31.73 106.50 2.91 32.60 76.81 2 27.00 0.95 25.58 76.81 2.10 27.00 51.91 3 22.40 0.92 20.66 51.91 1.42 22.40 30.93 4 15.70 0.90 14.10 30.93 0.84 15.70 16.07 5 11.70 0.87 10.23 16.07 0.44 11.70 4.81 6 4.94 0.85 4.20 4.81 0.13 4.94 (0.00)
2013 Capitalization of Operating Leases Discount rate:
Interest Expense Dep. Exp Difference2.91 17.75 (11.94) 2.10 17.75 (7.15) 1.42 17.75 (3.23) 0.84 17.75 2.89 0.44 17.75 6.49 0.13 17.75 12.94
22.40 15.70 11.70
32.60 27.00
Total Cap Ol op exp Exp under Op lease treatment20.66 19.85 19.17
17.88
18.59 18.19
4.94 2.72%
Period Future Value PV factor Present Value Beg Balance Accrued Int Payment Ending Bal1 28.50 0.97 27.75 91.74 2.50 28.50 65.73 2 24.60 0.95 23.31 65.73 1.79 24.60 42.92 3 20.90 0.92 19.28 42.92 1.17 20.90 23.19 4 13.40 0.90 12.04 23.19 0.63 13.40 10.42 5 7.90 0.87 6.91 10.42 0.28 7.90 2.80 6 2.88 0.85 2.45 2.80 0.08 2.88 0.00
2014 Capitalization of Operating Leases Discount rate:
Interest Expense Dep. Exp Difference2.50 15.29 (10.71) 1.79 15.29 (7.52) 1.17 15.29 (4.44) 0.63 15.29 2.52 0.28 15.29 7.67 0.08 15.29 12.49
Total Cap Ol op exp Exp under Op lease treatment
15.37
28.50 24.60 20.90 13.40
7.90 2.88
15.57
16.46 15.92
17.79 17.08
2.83%
Period Future Value PV factor Present Value Beg Balance Accrued Int Payment Ending Bal1 33.40 0.97 32.48 105.95 3.00 33.40 75.55 2 29.80 0.95 28.18 75.55 2.14 29.80 47.89 3 22.70 0.92 20.88 47.89 1.36 22.70 26.55 4 13.00 0.89 11.63 26.55 0.75 13.00 14.30 5 9.80 0.87 8.52 14.30 0.40 9.80 4.90 6 5.04 0.85 4.26 4.90 0.14 5.04 0.00
2015 Capitalization of Operating Leases Discount rate:
Interest Expense Dep. Exp Difference3.00 17.66 (12.74) 2.14 17.66 (10.00) 1.36 17.66 (3.69) 0.75 17.66 5.41 0.40 17.66 8.26 0.14 17.66 12.76
Total Cap Ol op exp Exp under Op lease treatment20.66
19.01 18.41 18.06 17.80
33.40 29.80 22.70 13.00
9.80 5.04
19.80
153
Restated Balance and Income Statement with a trial balance
Stated Debit Credit Restated
338 338 346 346
77 77 533 533
15 15 28 28 20 20
1,357 1,357
586 586 93 93
290 58 232 49 49
141 141 - -
72 72 1,138 1,173 2,495 2,530
2 2 282 282
11 11 567 567
46 46 - -
908 908
690 690 82 82
593 593 - 93 93
190 190 1,555 1,648 2,463 2,556
Non Current Assets
Brunswick 2011 Balance Sheet (in millions)
AssetsCurrent Assets
Cash and cash equivalentsAccounts receivable
Short-term investmenstInventories
Defferred income taxesPrepaid expenses
Other current assetsTotal Current Assets
Short-term debt
Net PP&ECapitalized Operating Leases
GoodwillIntangible assets
Other long term assetDefferred income taxesOther long-term assets
Total Non Current AssetsTotal Assets
LiabilitiesCurrent liabilities
Other long term liab
Account payableTaxes payable
Accrued liabilitiesDeferred revenues
Other accrued liabilitiesTotal Current LiabilitiesNon Current Liabilities
Long term debtDeferred income taxes
Pensions and other benefitsCaptialized Operating lease liabilites
Total Non Current LiabilitiesTotal Liabilities
154
77 77 435 435 458 58 400
(541) (541) (398) (398)
31 (27) 2,494 2,530
Stated Debit Credit Restated 3,748 3,748 2,873 2,873
875 875
98 98 562 562
23 23 - 58 58
683 741 192 134
82 82 (21) (21) 89 31 17 17 72 14
- - 72 14
58 210 210
Revenue
Stockholders EquityCommon stockPaid-in capital
Retained earningsAccumulated OCI
Treasury stockTotal Stockholders Equity
Total Liabilities and SE
Brunswick's 2011 Income Statement (in millions)
Income before taxes
Cost of revenueGross profit
Operating expensesResearch and development
Sales, General and administrativeRestructuring, merger and acquisition
Goodwill ImpairmentTotal operating expenses
Operating incomeInterest Expense
Other income (expense)
Provision for income taxesNet income from continuing operations
Net income from discontinuing opsNet income
Income Summary
155
Stated Debit Credit Restated
284 284 349 349
92 92 576 576
19 19 27 27 13 13
1,360 1,360
581 581 88 16 73
292 116 176 38 38 94 94
- - 58 58
1,063 1,020 2,423 2,381
8 8 334 334
10 10 508 508
47 47 29 29
936 936 -
564 564 93 93
553 553 - 29 88 59
200 200 1,410 1,469 2,346 2,405
- 77 77
441 441 503 103 400
(555) (555) (388) (388)
78 (25) 2,424 2,381
Non Current Assets
Brunswick's 2012 Balance Sheet (in millions)
AssetsCurrent Assets
Cash and cash equivalentsAccounts receivable
Short-term investmenstInventories
Defferred income taxesPrepaid expenses
Other current assetsTotal Current Assets
Short-term debt
Net PP&ECapitalized Operating Leases
GoodwillIntangible assets
Other long term assetDefferred income taxesOther long-term assets
Total Non Current AssetsTotal Assets
LiabilitiesCurrent liabilities
Other long term liab
Account payableTaxes payable
Accrued liabilitiesDeferred revenues
Other accrued liabilitiesTotal Current LiabilitiesNon Current Liabilities
Long term debtDeferred income taxes
Pensions and other benefitsCaptialized Operating lease liabilites
Total Non Current LiabilitiesTotal Liabilities
Stockholders EquityCommon stockPaid-in capital
Retained earningsAccumulated OCI
Treasury stockTotal Stockholders Equity
Total Liabilities and SE
156
Stated Debt Credit Restated 3,718 3,718 2,774 2,774
944 944 -
105 105 549 32 517
26 26 - 58 58 - 16 16
680 721 264 223
68 3 71 (15) (15) 181 136
34 34 147 102 (97) (97) 50 5
45 297 297
Revenue
Brunswick's 2012 Income Statement (in millions)
Other income (expense)Income before taxes
Cost of revenueGross profit
Operating expensesResearch and development
Sales, General and administrativeRestructuring, merger and acquisition
Amortization Expense Goodwill Impairment
Total operating expensesOperating incomeInterest Expense
Provision for income taxesNet income from continuing operations
Net income from discontinuing opsNet income
Income Summary
Stated Debit Credit Restated
284 284 349 349
92 92 576 576
19 19 27 27 13 13
1,360 1,360
581 581 107 30 76
292 175 117 38 38 94 94
- - 58 58
1,063 965 2,423 2,326
Short-term investmenst
Brunswick's 2013 Balance Sheet (in millions)
AssetsCurrent Assets
Cash and cash equivalentsAccounts receivable
Defferred income taxes
InventoriesDefferred income taxes
Prepaid expensesOther current assetsTotal Current AssetsNon Current Assets
Net PP&ECapitalized Operating Leases
GoodwillIntangible assets
Other long term asset
Other long-term assetsTotal Non Current Assets
Total Assets
157
8 8 334 334
10 10 508 508
47 47 29 29
936 936 -
564 564 93 93
553 553 - 55 107 52
200 200 1,410 1,462 2,346 2,398
- 77 77
441 441 503 150 353
(555) (555) (388) (388)
78 (72) 2,424 2,326
Stated Debt Credit Restated 3,718 3,718 2,774 2,774
944 944 -
105 105 549 29 520
26 26 - 58 58 - 15 15
680 724 264 220
68 3 71 (15) (15) 181 134
34 34 147 100 (97) (97) 50 3
47 387 387
Total Current Liabilities
LiabilitiesCurrent liabilitiesShort-term debtAccount payable
Taxes payableAccrued liabilitiesDeferred revenues
Other accrued liabilities
Retained earnings
Non Current LiabilitiesLong term debt
Deferred income taxesPensions and other benefits
Captialized Operating lease liabilitesOther long term liab
Total Non Current LiabilitiesTotal Liabilities
Stockholders EquityCommon stockPaid-in capital
Restructuring, merger and acquisition
Accumulated OCITreasury stock
Total Stockholders EquityTotal Liabilities and SE
Brunswick's 2013 Income Statement (in millions)
RevenueCost of revenue
Gross profitOperating expenses
Research and developmentSales, General and administrative
Income Summary
Goodwill Impairment Amortization Expense
Total operating expensesOperating incomeInterest Expense
Other income (expense)Income before taxes
Provision for income taxesNet income from continuing operations
Net income from discontinuing opsNet income
158
Stated Debit Credit Restated
284 284 349 349
92 92 576 576
19 19 27 27 13 13
1,360 1,360
581 581 92 48 44
292 233 59 38 38 94 94
- - 58 58
1,063 874 2,423 2,235
8 8 334 334
10 10 508 508
47 47 29 29
936 936 -
564 564 93 93
553 553 - 85 92 7
200 200 1,410 1,417 2,346 2,353
- 77 77
441 441 503 196 307
(555) (555) (388) (388)
78 (118) 2,424 2,235
Short-term investmenst
Brunswick's 2014 Balance Sheet (in millions)
AssetsCurrent Assets
Cash and cash equivalentsAccounts receivable
Defferred income taxes
InventoriesDefferred income taxes
Prepaid expensesOther current assetsTotal Current AssetsNon Current Assets
Net PP&ECapitalized Operating Leases
GoodwillIntangible assets
Other long term asset
Total Current Liabilities
Other long-term assetsTotal Non Current Assets
Total AssetsLiabilities
Current liabilitiesShort-term debtAccount payable
Taxes payableAccrued liabilitiesDeferred revenues
Other accrued liabilities
Retained earnings
Non Current LiabilitiesLong term debt
Deferred income taxesPensions and other benefits
Captialized Operating lease liabilitesOther long term liab
Total Non Current LiabilitiesTotal Liabilities
Stockholders EquityCommon stockPaid-in capital
Accumulated OCITreasury stock
Total Stockholders EquityTotal Liabilities and SE
159
Stated Debt Credit Restated 3,718 3,718 2,774 2,774
944 944 -
105 105 549 33 516
26 26 - 58 58 - 18 18
680 723 264 221
68 3 71 (15) (15) 181 135
34 34 147 101 (97) (97) 50 4
46 452 452
Restructuring, merger and acquisition
Brunswick's 2014 Income Statement (in millions)
RevenueCost of revenue
Gross profitOperating expenses
Research and developmentSales, General and administrative
Income Summary
Goodwill Impairment Amortization Expense
Total operating expensesOperating incomeInterest Expense
Other income (expense)Income before taxes
Provision for income taxesNet income from continuing operations
Net income from discontinuing opsNet income
Stated Debit Credit Restated
284 284 349 349
92 92 576 576
19 19 27 27 13 13
1,360 1,360
581 581 106 63 43
292 292 (0) 38 38 94 94
- - 58 58
1,063 813 2,423 2,174
Short-term investmenst
Brunswick's 2015 Balance Sheet (in millions)
AssetsCurrent Assets
Cash and cash equivalentsAccounts receivable
Defferred income taxes
InventoriesDefferred income taxes
Prepaid expensesOther current assetsTotal Current AssetsNon Current Assets
Net PP&ECapitalized Operating Leases
GoodwillIntangible assets
Other long term asset
Other long-term assetsTotal Non Current Assets
Total Assets
160
8 8 334 334
10 10 508 508
47 47 29 29
936 936 -
564 564 93 93
553 553 - 111 106 (5)
200 200 1,410 1,405 2,346 2,341
- 77 77
441 441 503 245 258
(555) (555) (388) (388)
78 (167) 2,424 2,174
Stated Debt Credit Restated 3,718 3,718 2,774 2,774
944 944 -
105 105 549 29 521
26 26 - 59 59 - 15 15
680 726 264 218
68 2 70 (15) (15) 181 132
34 34 147 98 (97) (97) 50 1
49 539 539
Total Current Liabilities
LiabilitiesCurrent liabilitiesShort-term debtAccount payable
Taxes payableAccrued liabilitiesDeferred revenues
Other accrued liabilities
Retained earnings
Non Current LiabilitiesLong term debt
Deferred income taxesPensions and other benefits
Captialized Operating lease liabilitesOther long term liab
Total Non Current LiabilitiesTotal Liabilities
Stockholders EquityCommon stockPaid-in capital
Restructuring, merger and acquisition
Accumulated OCITreasury stock
Total Stockholders EquityTotal Liabilities and SE
Brunswick's 2015 Income Statement (in millions)
RevenueCost of revenue
Gross profitOperating expenses
Research and developmentSales, General and administrative
Income Summary
Goodwill Impairment Amortization Expense
Total operating expensesOperating incomeInterest Expense
Other income (expense)Income before taxes
Provision for income taxesNet income from continuing operations
Net income from discontinuing opsNet income
161
Regressions
Regression StatisticsMultiple R 0.776237485R Square 0.602544633Adjusted R Square 0.596866699Standard Error 0.074481332Observations 72 ANOVA
df SS MS F Significance FRegression 1 0.58869963 0.58869963 106.1204 1.14563E-15Residual 70 0.388322814 0.005547469Total 71 0.977022444
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.004752407 0.008882606 0.535023991 0.594329 -0.012963392 0.022468207 -0.012963392 0.022468207X Variable 1 2.379681826 0.231003971 10.30147583 1.15E-15 1.918958933 2.840404719 1.918958933 2.840404719
Intrinsic Valuation Models
Discounted Dividend Model
6.06 2.00% 4.00% 6.00% 8.00% 10.00%12% 9.57 10.70 12.59 16.36 27.6714% 7.85 8.50 9.47 11.08 14.3216% 6.63 7.03 7.58 8.42 9.8018% 5.72 5.98 6.32 6.80 7.5120% 5.02 5.19 5.41 5.71 6.1221% 4.72 4.87 5.05 5.28 5.61
Cost of Equity
(Ke)
Growth Rate (g)
LB 10% UB 10%$45.16 $55.20Over-Valued < < Under-Valued
Discounted Cash Flow Model
5.52 4% 6% 8% 10%11% 26.13 33.25 49.84 132.8115% 14.79 16.64 19.54 24.7517% 11.75 12.85 14.43 16.9221% 7.81 8.27 8.87 9.6925% 5.37 5.59 5.86 6.21
WACC (Before
Tax)
Growth Rate (g)
LB 10% UB 10%$45.16 $55.20Over-Valued < < Under-Valued
162
Residual Income Model (Stated)
15.34 -10% -20% -30% -40% -50%12.50% 15.13 15.27 15.34 15.38 15.4114.50% 12.63 12.93 13.09 13.19 13.2716.50% 10.66 11.04 11.25 11.39 11.4918.50% 9.10 9.50 9.74 9.90 10.0120.50% 7.85 8.25 8.49 8.65 8.76
Cost of Equity (K)
Growth Rate (g)
LB 10% UB 10%45.16$ 55.20$ Over-Valued < < Under-Valued
Residual Income Model (Restated)
14.81 -10% -20% -30% -40% -50%12.50% 14.91 14.84 14.81 14.79 14.7814.50% 12.43 12.57 12.65 12.70 12.7416.50% 10.50 10.74 10.89 10.98 11.0418.50% 8.97 9.26 9.43 9.55 9.6320.50% 7.74 8.05 8.23 8.36 8.45
Growth Rate (g)
Cost of Equity
(Ke)
LB 10% UB 10%45.16$ 55.20$ Over-Valued < < Under-Valued
Long Run Residual Income Model (Stated)
13.36 12% 14% 16% 18% 20%12.00% 15.03 14.40 13.83 13.30 12.8214.00% 15.74 15.08 14.48 13.93 13.4316.00% 16.46 15.77 15.14 14.57 14.0418.00% 17.17 16.46 15.80 15.20 14.6520.00% 17.89 17.14 16.46 15.83 15.26
Cost of Equity
Return on Equity
Hold Growth Constant g= -30%
LB 10% UB 10%$45.16 $55.20Over-Valued < < Under -Valued
163
13.36 11% 13% 15% 17% 19%-10% 14.83 13.60 12.57 11.69 10.93-20% 14.83 13.99 13.25 12.59 12.00-30% 14.83 14.20 13.63 13.11 12.63-40% 14.83 14.33 13.87 13.45 13.04-50% 14.83 14.42 14.04 13.68 13.34
Growth
Hold Constant ROE= 11%Cost of Equity
LB 10% UB 10%$45.16 $55.20Over-Valued < < Under -Valued
13.36 12.00% 14.00% 16.00% 18.00% 20.00%-10% 12.69 13.84 14.99 16.15 17.30-20% 13.33 14.16 14.99 15.83 16.66-30% 13.69 14.34 14.99 15.65 16.30-40% 13.92 14.46 14.99 15.53 16.07-50% 14.09 14.54 14.99 15.45 15.90
Hold Cost of Equity Costant Ke=16%Return on Equity
Growth
LB 10% UB 10%$45.16 $55.20Over-Valued < < Under-Valued
Long Run Residual Income (Restated)
11.57 12% 14% 16% 18% 20%12.00% 12.41 11.89 11.42 10.98 10.5814.00% 13.00 12.46 11.96 11.51 11.0916.00% 13.59 13.02 12.50 12.03 11.5918.00% 14.18 13.59 13.05 12.55 12.1020.00% 14.77 14.15 13.59 13.08 12.60
Hold Growth Constant g= -30%Cost of Equity
Return on Equity
LB 10% UB 10%$45.16 $55.20Over-Valued < <Under -Valued
164
11.57 11% 13% 15% 17% 19%-10% 13.41 12.30 11.37 10.57 9.88-20% 13.04 12.30 11.65 11.07 10.54-30% 12.84 12.30 11.81 11.35 10.93-40% 12.73 12.30 11.91 11.54 11.19-50% 12.65 12.30 11.97 11.67 11.38
Hold Constant ROE= 11%Cost of Equity
Growth
LB 10% UB 10%$45.16 $55.20Over-Valued < < Under -Valued
11.57 12.00% 14.00% 16.00% 18.00% 20.00%-10% 10.48 11.43 12.38 13.33 14.29-20% 11.01 11.69 12.38 13.07 13.76-30% 11.30 11.84 12.38 12.92 13.46-40% 11.50 11.94 12.38 12.82 13.27-50% 11.63 12.01 12.38 12.76 13.13
Return on Equity
Growth
Hold Cost of Equity Costant Ke=16%
LB 10% UB 10%$45.16 $55.20Over-Valued < < Under-Valued
165
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