Following the acquisition of Kraft during Year 8, the Philip Morris Companies released its Year 8...

Question

Following the acquisition of Kraft during Year 8, the Philip Morris Companies released its Year 8 financial statements. The Year 8 financial statements and
 other data are reproduced on the next page.

PHILIP MORRIS COMPANIES, INC.

Balance Sheets ($ millions)

December 31, Year 8 and Year 7

Year 8

Year 7

Assets

Cash and cash equivalents

$ 168

$ 90

Accounts receivable

2,222

2,065

Inventories

5,384

4,154

Current assets

7,774

6,309

Property, plant, and equipment, net

8,648

6,582

Goodwill, net

15,071

4,052

Investments.

3,260

3,665

Total assets

$34,753

$20,608

Liabilities and Stockholders" Equity

Short-term debt

$ 1,259

$ 1,440

Accounts payable

1,777

791

Accrued liabilities

3,848

2,277

Income taxes payable

1,089

727

Dividends payable

260

213

Current liabilities

8,233

5,448

Long-term debt

17,122

6,293

Deferred income taxes

1,719

2,044

Stockholders" equity

7,679

6,823

Total liabilities and stockholders" equity

$34,753

$20,608

PHILIP MORRIS COMPANIES, INC.

Income Statement ($ millions)

For Year Ending December 31, Year 8

Sales

$ 31,742

Cost of goods sold

(12,156)

Selling and administrative expenses

(14,410)

Depreciation expense

(654)

Goodwill amortization

(125)

Interest expense

(670)

Pretax income

3,727

Income tax expense

(1,390)

Net income

$ 2,337

PHILIP MORRIS PURCHASE OF KRAFT

Allocation of Purchase Price ($ millions)

Accounts receivable

$ 758

Inventories

1,232

Property, plant, and equipment

1,740

Goodwill

10,361

Short-term debt

(700)

Accounts payable

(578)

Accrued liabilities.

(530)

Long-term debt

(900)

Purchase price (net of cash acquired)

$11,383

Required:

a. Prepare a statement of cash flows (indirect method) for Philip Morris. (Hint: Acquisition of Kraft requires you to remove the assets acquired and
 liabilities incurred as a result of that acquisition from the balance sheet before computing changes used in preparing the statement of cash flows. Philip
 Morris pays $11.383 billion for Kraft, net of cash acquired—see the Allocation of Purchase Price table.)

b. Calculate cash flows from operations using the direct method for Philip Morris.

c. Based on your answer to a, compute Philip Morris"s free cash flow for Year 8. Discuss how free cash flow impacts the company"s future earnings and
 financial condition.

David · Accepted Answer

a. As an initial step, the effect of the Kraft acquisition must first be removed from 
the Philip Morris (PM) accounts. The resulting balance sheet changes are 
 
  Philip Morris Unadjusted   PM Adj. 
 Year 7 Year 8 Change Kraft Change 
Accts. Recble.   $2,065 $ 2,222 $    157 $    758 $  (601) 
Inventories  ...  4,154 5,384 1,230 1,232 (2) 
PP&E  ............  6,582 8,648 2,066 1,740 326 
Goodwill  .......  4,052 15,071 11,019 10,361 658 
S-T Debt ........   1,440 1,259 (181) 700 (881) 
Accts. Pay.  ...  791 1,777 986 578 408 
Accrued liab.  2,277 3,848 1,571 530 1,041 
L-T Debt ........  6,293 17,122 10,829 900 9,929 
 
This permits one to derive the statement of cash flows—indirect format 
 PHILIP MORRIS COMPANIES, INC. 
 Statement of Cash Flows 
 For the Year Ended December 31, Year 8  ($ millions) 
Cash flows from operating activities 
Net income ....................................................................   $ 2,337 
Add (deduct) adjustments to cash basis 
Depreciation expense .............................................      654 
Amortization of goodwill ........................................      125 
Decrease in accounts receivable...........................      601 
Decrease in inventories ..........................................        2 
Decrease in deferred taxes ....................................     (325) 
Increase in accounts payable ................................      408 
Increase in accrued liabilities ................................    1,041 
Increase in income taxes payable .........................      362 
Net cash flow from operating activities .....................   $ 5,205 
 
Cash flows from investing activities 
Increase in property, plant & equipment 
  (before depreciation) .................................................   (980) 
Increase in goodwill (before amortization) ...............      (783) 
Decrease in investments ............................................       405 
Acquisition of subsidiary—Kraft * .............................  (11,383) 
Net cash used by investing activities ........................   (12,741) 
 
Cash flows from financing activities 
Decrease in short-term debt .......................................   (881) 
Increase in long-term debt .........................................    9,

Following the acquisition of Kraft during Year 8, the Philip Morris Companies released its Year 8 financial statements. The Year 8 financial statements and other data are reproduced on the next page....

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PHILIP MORRIS COMPANIES, INC. Balance Sheets ($ millions)
December 31, Year 8 and Year 7
	Year 8	Year 7
Assets
Cash and cash equivalents	$ 168	$ 90
Accounts receivable	2,222	2,065
Inventories	5,384	4,154
Current assets	7,774	6,309
Property, plant, and equipment, net	8,648	6,582
Goodwill, net	15,071	4,052
Investments.	3,260	3,665
Total assets	$34,753	$20,608
Liabilities and Stockholders" Equity
Short-term debt	$ 1,259	$ 1,440
Accounts payable	1,777	791
Accrued liabilities	3,848	2,277
Income taxes payable	1,089	727
Dividends payable	260	213
Current liabilities	8,233	5,448
Long-term debt	17,122	6,293
Deferred income taxes	1,719	2,044
Stockholders" equity	7,679	6,823
Total liabilities and stockholders" equity	$34,753	$20,608

PHILIP MORRIS COMPANIES, INC.
Income Statement ($ millions) For Year Ending December 31, Year 8
Sales	$ 31,742
Cost of goods sold	(12,156)
Selling and administrative expenses	(14,410)
Depreciation expense	(654)
Goodwill amortization	(125)
Interest expense	(670)
Pretax income	3,727
Income tax expense	(1,390)
Net income	$ 2,337

PHILIP MORRIS PURCHASE OF KRAFT
Allocation of Purchase Price ($ millions)
Accounts receivable	$ 758
Inventories	1,232
Property, plant, and equipment	1,740
Goodwill	10,361
Short-term debt	(700)
Accounts payable	(578)
Accrued liabilities.	(530)
Long-term debt	(900)
Purchase price (net of cash acquired)	$11,383