(a) Analyze Facebook's financial statements and excerpts from the company's 2013

Form 10-K. Your analysis should include the preparation of common-size finan-

cial statements, key financial ratios, and an evaluation of short-term solvency,

operating efficiency, capital structure and long-term solvency, profitability, and

market measures. (The financial statement analysis template can be accessed and

used at www.pearsonhighered.com/fraser.)

(b) Using your analysis, list reasons for and against investment in Facebook's com-

mon stock.

The following excerpts are from the 2013 Form 10-K of Facebook, Inc.11

11 Extracted from 10-K filings for Facebook, Inc. 2013. Obtained from U.S. Securities and Exchange

Commission. www.sec.gov.

Facebook, Inc.

Consolidated Balance Sheets

(In millions, except for number of shares and par value)

December 31,

2013 2012

Assets

Current assets:

Cash and cash equivalents $ 3,323 $ 2,384

Marketable securities 8,126 7,242

Accounts receivable, net of allowances for doubtful

accounts of $38 and $22 as of December 31, 2013 and

December 31, 2012, respectively 1,109 719

Income tax refundable 51 451

Prepaid expenses and other current assets 461 471

Total current assets 13,070 11,267

Property and equipment, net 2,882 2,391

Goodwill and intangible assets, net 1,722 1,388

Other assets 221 57

Total assets $17,895 $15,103

Liabilities and stockholders' equity

Current liabilities:

Accounts payable $ 87 $ 65

Developer partners payable 181 169

Accrued expenses and other current liabilities 555 423

Deferred revenue and deposits 38 30

Current portion of capital lease obligations 239 365

Total current liabilities 1,100 1,052

Capital lease obligations, less current portion 237 491

Long-term debt 1,500

Other liabilities 1,088 305

Total liabilities 2,425 3,348

Commitments and contingencies

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Chapter 5 The Analysis of Financial Statements 259

Facebook, Inc.

Consolidated Statements of Income

(In millions, except per share amounts)

Year Ended December 31,

2013 2012 2011

Revenue $ 7,872 $ 5,089 $ 3,711

Costs and expenses:

Cost of revenue 1,875 1,364 860

Research and development 1,415 1,399 388

Marketing and sales 997 896 393

General and administrative 781 892 314

Total costs and expenses 5,068 4,551 1,955

Income from operations 2,804 538 1,756

Interest and other income (expense), net:

Interest expense (56) (51) (42)

Other income (expense), net 6 7 (19)

Income before provision for income taxes 2,754 494 1,695

Provision for income taxes 1,254 441 695

Net income $ 1,500 $ 53 $ 1,000

Less: Net income attributable to participating

securities 9 21 332

Net income attributable to Class A and Class B

common stockholders $1,491 $ 32 $ 668

2013 2012

Stockholders' equity:

Common stock, $0.000006 par value; 5,000 million Class

A shares authorized, 1,970 million and 1,671 million

shares issued and outstanding, including 6 million and

2 million outstanding shares subject to repurchase as of

December 31, 2013 and December 31, 2012, respectively;

4,141 million Class B shares authorized, 577 million and

701 million shares issued and outstanding, including

6 million and 11 million outstanding shares subject to

repurchase as of December 31, 2013 and December 31,

2012, respectively

Additional paid-in capital 12,297 10,094

Accumulated other comprehensive income 14 2

Retained earnings 3,159 1,659

Total stockholders' equity 15,470 11,755

Total liabilities and stockholders' equity $ 17,895 $ 15,103

See Accompanying Notes to Consolidated Financial Statements.

(Continued )

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260 Chapter 5 The Analysis of Financial Statements

Year Ended December 31,

2013 2012 2011

Earnings per share attributable to Class A and

Class B common stockholders:

Basic $ 0.62 $ 0.02 $ 0.52

Diluted $ 0.60 $ 0.01 $ 0.46

Weighted average shares used to compute

earnings per share attributable to Class A and

Class B common stockholders:

Basic 2,420 2,006 1,294

Diluted 2,517 2,166 1,508

Share-based compensation expense included

in costs and expenses:

Cost of revenue $ 42 $ 88 $ 9

Research and development 604 843 114

Marketing and sales 133 306 37

General and administrative 127 335 57

Total share-based compensation expense $ 906 $ 1,572 $ 217

See Accompanying Notes to Consolidated Financial Statements.

Facebook, Inc.

Consolidated Statements of Cash Flows

(In millions)

Year Ended December 31,

2013 2012 2011

Cash flows from operating activities

Net income $ 1,500 $ 53 $ 1,000

Adjustments to reconcile net income to net cash

provided by operating activities:

Depreciation and amortization 1,011 649 323

Lease abandonment expense 117 8

Loss on disposal or write-off of equipment 56 15 4

Share-based compensation 906 1,572 217

Deferred income taxes (37) (186) (30)

Tax benefit from share-based award activity 602 1,033 433

Excess tax benefit from share-based award activity (609) (1,033) (433)

Changes in assets and liabilities:

Accounts receivable (378) (170) (174)

Income tax refundable 400 (451)

Prepaid expenses and other current assets (45) (14) (24)

Other assets (142) 2 (5)

Accounts payable 26 1 6

Developer partners payable 12 (2) 96

Accrued expenses and other current liabilities (38) 152 37

M05_FRAS4037_11_SE_C05.indd 260 11/11/14 4:01 pm

Chapter 5 The Analysis of Financial Statements 261

2013 2012 2011

Deferred revenue and deposits 8 (60) 49

Other liabilities 833 43 50

Net cash provided by operating activities 4,222 1,612 1,549

Cash flows from investing activities

Purchases of property and equipment (1,362) (1,235) (606)

Purchases of marketable securities (7,433) (10,307) (3,025)

Sales of marketable securities 2,988 2,100 113

Maturities of marketable securities 3,563 3,333 516

Investments in non-marketable equity securities (1) (2) (3)

Acquisitions of businesses, net of cash acquired,

and purchases of intangible assets (368) (911) (24)

Change in restricted cash and deposits (11) (2) 6

Net cash used in investing activities (2,624) (7,024) (3,023)

Cash flows from financing activities

Net proceeds from issuance of common stock 1,478 6,760 998

Taxes paid related to net share settlement of equity

awards (889) (2,862)

Proceeds from exercise of stock options 26 17 28

Proceeds from long-term debt, net of issuance cost 1,496

Repayment of long-term debt (1,500) (250)

Proceeds from sale and lease-back transactions 205 170

Principal payments on capital lease obligations (391) (366) (181)

Excess tax benefit from share-based award activity 609 1,033 433

Net cash (used in) provided by financing

activities (667) 6,283 1,198

Effect of exchange rate changes on cash and cash

equivalents 8 1 3

Net increase (decrease) in cash and cash

equivalents 939 872 (273)

Cash and cash equivalents at beginning of period 2,384 1,512 1,785

Cash and cash equivalents at end of period $ 3,323 $ 2,384 $ 1,512

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262 Chapter 5 The Analysis of Financial Statements

Item 1. Business

Overview

Our mission is to give people the power to share and make the world more open and

connected.

We build technology to enable faster, easier and richer communication. Hundreds

of millions of people use Facebook's websites and mobile applications every day to

stay connected with their friends and family, to discover and learn what is going on in

the world around them, and to share and express what matters to them to the people

they care about.

Our business focuses on creating value for users, marketers, and developers.

How We Create Value for People Who Use Facebook

Our top priority is to build useful and engaging products that enable people to:

Connect and Share with Friends.

Discover and Learn.

Express Yourself.

Stay Connected Everywhere.

We had 757 million daily active users (DAUs) on average in December 2013, an

increase of 22% compared to December 2012. We had 556 million DAUs who accessed

Facebook from a mobile device on average in December 2013, an increase of 49%

compared to December 2012.

Facebook, Inc.

Consolidated Statements of Cash Flows

(In millions)

Year Ended December 31,

2013 2012 2011

Supplemental cash flow data

Cash paid during the period for:

Interest $ 38 $ 38 $ 28

Income taxes $ 82 $ 184 $ 197

Cash received during the period for:

Refund of income taxes $ 421 $ 131 $

Non-cash investing and financing activities:

Net change in accounts payable and

accrued expenses and other current

liabilities related to property and

equipment additions $ 53 $ (40) $ 135

Property and equipment acquired under

capital leases $ 11 $ 340 $ 473

Fair value of shares issued related to

acquisitions of businesses and other assets $ 77 $ 274 $ 58

See Accompanying Notes to Consolidated Financial Statement

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Chapter 5 The Analysis of Financial Statements 263

How We Create Value for Marketers

Facebook focuses on providing value for all kinds of marketers, including brand mar-

keters, direct marketers, small and medium-sized businesses, and developers. We help

marketers achieve their business objectives, such as increasing online sales, in-store

sales, or awareness of their brands, products, or services. We generate the substantial

majority of our revenue from selling advertising placements to marketers.

How We Create Value for Developers

Facebook provides a set of development tools and application programming interfaces

(APIs) that enable developers to easily integrate with Facebook to create mobile and

web applications. We are focused on providing developers with unique tools to support

their mobile and web applications. We generate revenue from developers who use our

Payments infrastructure to sell virtual and digital goods to our users on personal com-

puters. We also generate revenue from developers who choose to purchase ads from us.

Note 9. Long-term Debt

In October 2012, we amended and restated our bridge credit facility, and converted it

into a three-year unsecured term loan facility. The unsecured term loan allowed us to

borrow up to $1.5 billion with interest payable on borrowed amount set at LIBOR plus

1.0%, as well as an annual commitment fee of 0.10% on the daily undrawn balance of

the facility. We fully drew down on this facility in October 2012 and fully repaid the

$1.5 billion outstanding principal balance in August 2013.

Concurrently, we also terminated our unsecured five-year revolving credit facility

that allowed us to borrow up to $5 billion. We had not drawn down on this facility.

In August 2013, in connection with the termination of these facilities, we entered

into a five-year senior unsecured revolving credit facility (2013 Revolving Credit Facility)

that allows us to borrow up to $6.5 billion to fund working capital and general corporate

purposes with interest payable on the borrowed amounts set at LIBOR plus 1.0%, as well

as an annual commitment fee of 0.10% on the daily undrawn balance of the facility. We

paid origination fees at closing of the 2013 Revolving Credit Facility, which fees are being

amortized overthe term of the facility.Any amounts outstanding underthis facility will

be due and payable on August 15, 2018. As of December 31, 2013, no amounts had been

drawn down, and we were in compliance with the covenants under this facility.

Note 10. Commitments and Contingencies

Commitments

Leases

We entered into various capital lease arrangements to obtain property and equipment

for our operations. Additionally, on occasion we have purchased property and equip-

ment for which we have subsequently obtained capital financing under sale-leaseback

transactions. These agreements are typically for three years, except for building leases

which are for 15 years, with interest rates ranging from 1% to 13%. The leases are

secured by the underlying leased buildings, leasehold improvements, and equip-

ment. We have also entered into various non-cancelable operating lease agreements

M05_FRAS4037_11_SE_C05.indd 263 11/11/14 4:01 pm

264 Chapter 5 The Analysis of Financial Statements

for certain of our offices, equipment, land and data centers with original lease periods

expiring between 2014 and 2029. We are committed to pay a portion of the related

actual operating expenses under certain of these lease agreements. Certain of these

arrangements have free rent periods or escalating rent payment provisions, and we

recognize rent expense under such arrangements on a straight-line basis.

The following is a schedule, by years, of the future minimum lease payments

required under non-cancelable capital and operating leases as of December 31, 2013

(in millions):

Capital

Leases

Operating

Leases

2014 $255 $142

2015 127 142

2016 21 139

2017 15 131

2018 16 112

Thereafter 127 312

Total minimum lease payments $561 $978

Less: amount representing interest and taxes (85)

Less: current portion of the present value of minimum

lease payments (239)

Capital lease obligations, net of current portion $237

Operating lease expenses totaled $130 million, $196 million, and $219 million for

the years ended December 31, 2013, 2012 and 2011, respectively.

Other contractual commitments

We also have $258 million of non-cancelable contractual commitments as of December 31,

2013, primarily related to network infrastructure for our data center operations and, to

a lesser extent, construction of our data center sites. The majority of these commitments

are due within five years.

Item 7. Management's Discussion and Analysis of Financial

Condition and Results of Operations

Components of Results of Operations

Revenue

We generate substantially all of our revenue from advertising and from fees associated

with our Payments infrastructure that enables users to purchase virtual and digital

goods from our developers with applications on the Facebook website.

Cost of revenue. Our cost of revenue consists primarily of expenses associated with

the delivery and distribution of our products. These include expenses related to the

operation of our data centers such as facility and server equipment depreciation,

facility and server equipment rent expense, energy and bandwidth costs, support

and maintenance costs, and salaries, benefits, and share-based compensation for

M05_FRAS4037_11_SE_C05.indd 264 11/11/14 4:01 pm

Chapter 5 The Analysis of Financial Statements 265

employees on our operations teams. Cost of revenue also includes credit card and

other transaction fees related to processing customer transactions.

Results of Operations

2013 Compared to 2012. Revenue in 2013 increased $2.78 billion, or 55% compared to

2012. The increase was due primarily to a 63% increase in advertising revenue during

2013 as compared to 2012.

The most important factor driving advertising revenue growth was an increase

in revenue from ads in News Feed on both mobile devices and personal computers.

News Feed ads are displayed more prominently, have significantly higher levels of

engagement and a higher price per ad relative to our other ad placements. In 2013,

we estimate that mobile advertising revenue represented approximately 45% of total

advertising revenue, as compared with 11% in 2012. Other factors that influenced our

advertising revenue growth in 2013 included an increase in the number of market-

ers actively advertising on Facebook, which we believe increased demand for our ad

inventory, and a 22% growth in average DAUs from December 2012 to December 2013.

In 2013 compared to 2012, we increased the number of ads shown by 20% and the

average price per ad by 36%. The increase in average price per ad was driven primar-

ily by the increased number of News Feed ads on both mobile devices and personal

computers, offset partially by product changes including our decision to lower the

market reserve price, i.e. the minimum price threshold accepted in our auction. The

increase in the number of ads shown was driven by user growth and the reserve price

change, partially offset by a shift towards more usage on mobile devices, where we

show fewer ads than on personal computers.

Payments and other fees revenue in 2013 increased $76 million, or 9%, compared

to 2012. The increase in Payments and other fees revenue is a result of increased Pay-

ments revenue from games played on Facebook on personal computers, and to a lesser

extent, the inclusion of other fees revenue in 2013 from user Promoted Posts and our

ad serving and measurement products.

In 2013, we generated approximately 46% of our revenue from marketers and

developers based in the United States, compared to 51% in 2012. The change is due to

a faster growth rate of international users and to the expansion of international sales

offices and payment methods. The majority of our revenue outside of the United

States came from customers located in Western Europe, Canada, Australia and Brazil.

2012 Compared to 2011. Revenue in 2012 increased $1.38 billion, or 37% compared

to 2011. The increase was due primarily to a 36% increase in advertising revenue dur-

ing 2012 as compared to 2011.

Advertising revenue grew due to a 32% increase in the number of ads delivered

during 2012 and to a 3% increase in the average price per ad. The increase in ads

delivered was driven primarily by user growth.

Growth in the average price per ad during 2012 compared to 2011 was driven

primarily by an increase in price per ad in the United States, which benefited from

growth in ads in News Feed across desktop and mobile devices. Ads in News Feed

have a significantly higher average price per ad due to factors which include the

prominent position of the ads. The increase in price per ad in the United States was

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266 Chapter 5 The Analysis of Financial Statements

partially offset by an increased percentage of our worldwide ads being delivered in

the Asia and Rest of World geographies where the average price per ad, while grow-

ing on a year-over-year basis, is relatively lower. The average price per ad was also

affected by a decline in the average price per ad in Europe in 2012 compared to 2011

due to the impact of foreign exchange rate changes, an increase in the percentage of

ads being delivered in European regions where the average price per ads is relatively

lower, and in part, we believe, to continuing weak economic conditions in that region

affecting advertiser demand.

In 2012, we estimate that mobile advertising revenue as a percentage of advertis-

ing revenue was approximately 11%. As mobile advertising was not offered prior to

the first quarter of 2012, comparisons to prior year are not meaningful.

Payments and other fees revenue in 2012 increased $253 million, or 45%, com-

pared to 2011. Excluding the one-time increase in Payments revenue described above,

Payments and other fees revenue in 2012 increased 34% compared to 2011. Facebook

Payments became mandatory for all game developers accepting payments on the

Facebook website with limited exceptions on July 1, 2011. Accordingly, comparisons

of Payments and otherfees revenue to periods before this date may not be meaningful.

In 2012, we generated approximately 51% of our revenue from marketers and

developers based in the United States, compared to 56% in 2011. The change is due

primarily to a faster growth rate of international users and, to a lesser extent, to the

expansion of international sales offices and payment methods. The majority of our

revenue outside of the United States came from customers located in western Europe,

Canada, Australia and Brazil.

No customer represented 10% or more of total revenue during the years ended

December 31, 2013 and 2012 and one customer represented 12% of total revenue for

the year ended December 31, 2011.

Cost of revenue

2013 Compared to 2012. Cost of revenue in 2013 increased $511 million, or 37%, com-

pared to 2012. The increase was primarily due to operational expenses related to

expanding our data center and technical infrastructure, including a $275 million

increase in depreciation in 2013. In addition, we recognized $117 million of lease aban-

donment expense in 2013 primarily due to exiting certain leased data centers resulting

from the migration of operations to our own data centers. In the event that circum-

stances change such that we decide to re-occupy and utilize any of the data centers

we have exited, we would reverse the remaining lease abandonment liability associ-

ated with those facilities. The increase in cost of revenue in 2013 was partially offset

by a $46 million decrease in share-based compensation expense compared to 2012

mainly due to the recognition of expense in the prior period related to Pre-2011 RSUs12

as a result of our IPO in May 2012.

2012 Compared to 2011. Cost of revenue in 2012 increased $504 million, or 59%,

compared to 2011. The increase was primarily due to expenses related to expanding

our data center operations, including a $257 million increase in depreciation in 2012.

Share-based compensation expense increased by $79 million in 2012 compared to 2011

12 An RSU is a restricted stock unit that employers grant to employees.

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Chapter 5 The Analysis of Financial Statements 267

mainly due to the recognition of expenses related to Pre-2011 RSUs triggered by the

completion of our IPO in May 2012 and, to a lesser extent, Post-2011 RSUs. Increases

in payroll and benefits expenses resulting from a 65% increase in employee headcount

also contributed to the increase in cost of revenue in 2012. These expenses supported

our user growth, the increased usage of products by users, developers, and marketers,

and the launch of new products.

We anticipate that the cost of revenue will increase in dollar amount in 2014 and

for the foreseeable future as we expand our data center capacity and technical infra-

structure to support user growth, increased user engagement, and the delivery of

new products and offerings. The expected increase in cost of revenue may be partially

mitigated to the extent we are able to realize improvements in server and network

performance and the efficiency of our technical operations.

Provision for income taxes

2013 Compared to 2012. Our provision forincome taxes in 2013 increased $813 million,

or 184%, compared to 2012, primarily due to an increase in pretax income. Our effec-

tive tax rate decreased primarily due to a lower amount of non-deductible share-based

compensation resulting from recognition of expense related to Pre-2011 RSUs as a

result of our IPO in May 2012. Our effective tax rate in 2013 was also lower due to the

reinstatement in 2013 of the federal tax credit for research and development activities.

We recognized the benefit from the reinstatement of the tax credit for 2012 and 2013

during the year ended December 31, 2013.

2012 Compared to 2011. Our provision for income taxes in 2012 decreased

$254 million, or 37%, compared to 2011, primarily due to a decrease in pre-

tax income. Our effective tax rate increased primarily due to the impact of non-

deductible share-based compensation and the losses arising outside the United

States in jurisdictions where we do not receive a tax benefit. Our effective tax rate

in 2012 was also higher due to the expiration of the federal tax credit for research and

development activities.