Question 10 [40 marks] Required: (a) Calculate the return on equity (ROE) in 2010 and decompose it using Dupont decomposition. Use average equity in the calculation of ROE. [12 marks] (b) Calculate the following items for 2010 and discuss Footlocker's credit risk in 2010. You do not need to take into account the nn's operating leases in (b). i. Current ratio ii. EBITDA to interest iii. Total debt to EBITDA [12 marks] CONSOLIDATED STATEMENTS OF OPERATIONS 2010 2009 2008 (in millions, except per share amounts) Sales . . . . . $5,049 $4,854 $5,237 Cost of sales . . . . . . 3,533 3,522 3,777 Selling, general and administrative expenses . . . 1,138 1,099 1,174 Depreciation and amortization . . . 106 112 130 Impairment and other charges . 10 41 259 Interest expense, net . 9 10 5 Other income. . . . . (4) (3) (8) 4,792 4,781 5,337 Income (loss) from continuing operations before income taxes. . . . . . 257 73 (100) Income tax expense (benefit) . . . . . . . . . . . . 26 (21) Income (loss) from continuing operations . . . . . 169 47 (79) Income (loss) on disposal of discontinued operations, net of income tax expense (benefit) of $-, $(1), and $-, respectively . . . . . . (1) Net income (loss) . . . . . . . $ 169 48 $ (80 Basic earnings per share: Income (loss) from continuing operations . . . $ 1.08 $ 0.30 $ (0.52) Income from discontinued operations. . . Net income (loss) . . . . . . . . $ 1.08 $ 0.30 $ (0.52) Diluted earnings per share: Income (loss) from continuing operations . . $ 1.07 $ 0.30 $(0.52) Income from discontinued operations. . . . Net income (loss) . . . . . . $ 1.07 $ 0.30 $ (0.52CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) 2010 2009 2008 (in millions) Net income (loss) . . . . . . .. $169 $ 48 $ (80) Other comprehensive income (loss), net of tax Foreign currency translation adjustment: Translation adjustment arising during the period, net of tax. . . . . . . . . . 11 65 (83) Cash flow hedges: Change in fair value of derivatives, net of income tax . . . . (2) 1 Pension and postretirement adjustments: Net actuarial gain (loss) and prior service cost arising during the year, net of income tax benefit of $1, $4, and $62 million, respectively . . . . . . . . 7 (12) (100) Amortization of net actuarial gain/loss and prior service cost included in net periodic benefit costs, net of income tax expense of $3, $2, and $- million, respectively . . . . . . . . . 8 4 1 Available for sale securities: Unrealized gain (loss) . . . . . . 3 (3) Comprehensive income (loss) . . . . . . $196 $106 $ (264)CONSOLIDATED BALANCE SHEETS 2010 2009 (in millions) ASSETS Current assets Cash and cash equivalents $ 696 $ 582 Short-term investments . 7 Merchandise inventories. . . 1,059 1,037 Other current assets 179 146 1,934 1,772 Property and equipment, net . . . 386 387 Deferred taxes . . 296 362 Goodwill . . . 145 145 Other intangible assets, net . 72 99 Other assets . . . . 63 51 $2,896 $2,816 LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Accounts payable . . $ 223 $ 215 Accrued and other liabilities . . . . 266 218 489 433 Long-term debt. 137 138 Other liabilities 245 297 Total liabilities . . 871 868 Shareholders' equity . . . . . 2,025 1,948 $2,896 $2,816CONSOLIDATED STATEMENTS OF CASH FLOWS 2010 2009 2008 (in millions) From Operating Activities Net income (loss) . . . . . $ 169 $ 48 $ (80) Adjustments to reconcile net income (loss) to net cash provided by operating activities of continuing operations: Discontinued operations, net of tax . . . . . . . . . . . . . . . .. (1) 1 Non-cash impairment and other charges. . . . . . . . . . 10 36 259 Depreciation and amortization . . 106 112 130 Share-based compensation expense. . . . . 13 12 9 Deferred tax provision (benefit) . . . . . 84 2 (44) Qualified pension plan contributions . (32) (100) (6) Change in assets and liabilities: Merchandise inventories . . . . . . (19) 111 128 Accounts payable . . . 7 23 (39) Other accruals 35 (30) (4) Income taxes . . . . . . (9) 9 (7) Payment on the settlement of the net investment hedge . .... . . . . . (24) - - Proceeds from the termination of interest rate swaps. . . 10 - Other, net . . (14 105 36 Net cash provided by operating activities of continuing operations. . . . . . 326 346 383 From Investing Activities Business acquisition .. (106) Gain from lease terminations . . . 3 Gain from insurance recoveries . . . . . . . . . - Reclassification of cash equivalents to short-term investments . . . . . . . - (23) Sales of short-term investments . 9 16 Capital expenditures . . 97 (89) (146) Net cash used in investing activities of continuing operations. . . . . . . . . (87 (72 (272) From Financing Activities Reduction in long-term debt .. (94) Dividends paid on common stock (E6) (94) (93) Issuance of common stock . . . . . . . . . 10 w Purchase of treasury shares . . . . . . . . (50) Treasury stock reissued under employee stock plan 3 Excess tax benefits on share-based compensation. 3 Net cash used in financing activities of continuing operations. . . . . . . . . . (127) (94) (185) Effect of Exchange Rate Fluctuations on Cash and Cash Equivalents 2 18 (29) Net Cash used by Discontinued Operations (1) Net Change in Cash and Cash Equivalents . . 11 4 197 (103) Cash and Cash Equivalents at Beginning of Year . . . . .. 582 385 Cash and Cash Equivalents at End of Year. . . $ 696 $ 582 $ 385 Cash Paid During the Year: Interest . . .. $ 12 12 S 11 Income taxes 53 $ 19 64ADDITIONAL INFORMATION (from Footlocker's MD&A, notes to the financial statements and other sources) Income Statement information The "Other income" line includes non-operating items, such as gains from insurance recoveries, gains on the repurchase and retirement of bonds, royalty income, the changes in fair value, premiums paid and realized gains associated with foreign currency option contracts. The $10m impairment charge recorded in 2010 relates to certain intangible assets with indefinite useful lives. The even triggering the impairment is a decrease in projected revenue. "Interest Expense, net" is composed of: 2010 2009 2003 (In millions) Interest expense . . .. $ 14 $ 13 $ 16 Interest income (5) (11) Interest expense, net . $ 9 $ 10 $ 5 17. Income Taxes A reconciliation of the significant differences between the federal statutory income tax rate and the effective income tax rate on pre-tax income (loss) from continuing operations is as follows: 2010 2009 20 0 Federal statutory income tax fag... . ... . . . ..... . . . .. .. 35 0% 35,0% (35.0)% State and local income taxes, net of federal tax benefit. . . . . . .. 2. 3 D. 2 (6.5) International income taxed at varying rates 1. 0 1.3 (2.1) Foreign tax credits . . . . . [Z.D) (7.4) (5.3) Increase [ decrease) in valuation allowance. . . [0. 4) 0.2 Domestic/foreign tax settlements. . . . . . [2.3) [2.8) (2.2) Federal tax credits . . . [0. 7) [20) (1.2) Non-deductible impairment charges . .. . . . 26.9 Canadian tax rate changes. . . . .. . . .. . . . 60 0.4 Other, net. . . 1 4 5. 7 4.1 Efective income tax rate. . . . . . 34.3% 36.0% (20.81%ADDITIONAL INFORMATION (continued) Balance Sheet information 5. Merchandise Inventories 2010 2003 (In millions) LIFO inventories . . $ 694 FIFO inventories . 365 355 Total merchandise inventories . . . . . $1,059 $ 1,037 The value of the Company's LIFO inventories, as calculated on a LIFO basis, approximates their value as calculated on a FIFO basis. The total merchandise inventories at the end of 2008 amounted to $1,120 million. 6. Other Current Assets 2010 2009 Income tax receivable...... . . . . . . . . $ 47 5 Net receivables . . . . . . . . . . . 41 37 Prepaid expenses and other current assets 31 33 Prepaid rent . . . . . 27 28 Prepaid income taxes . . . . . 18 125 Deferred taxes and costs . . 13 17 Fair value of derivative contracts . . . . . . $ 179 $146 11. Accrued and Other Liabilities 2010 2009 (In millions) Incentive bonuses . . . . . . . . . . . . . . . . . . . . .. . $ 48 19 Other payroll and payroll related costs, excluding taxes. . . 43 46 Taxes other than income taxes . . . . . . . . . . . . . 37 41 Customer deposits(). . .. . 29 29 Current deferred tax liabilities . 20 5 Property and equipment . 19 13 Income taxes payable . . . . 8 Pension and postretirement benefits . . Sales return reserve . . . .. Income taxes . . . . . . . . 10 Reserve for discontinued operations Other operating costs . . 52 48 $266 $218 (1) Customer deposits include unredeemed gift cards and certificates, merchandise credits, and deferred revenue related to undelivered merchandise, including layaway sales. The incentive bonuses are amounts payable to Footlocker's sales agents.Leases information 14. Leases The Company is obligated under operating leases for almost all of its store properties. Some of the store leases contain renewal options with varying terms and conditions. Management expects that in the normal course of business, expiring leases will generally be renewed or, upon making a decision to relocate, replaced by leases on other premises. Operating lease periods generally range from 5 to 10 years. Certain leases provide for additional rent payments based on a percentage of store sales. Most of the Company's leases require the payment of certain executory costs such as insurance, maintenance, and other costs in addition to the future minimum lease payments. These costs, including the amortization of lease rights, totaled $131 million, $138 million, and $147 million in 2010, 2009, and 2008, respectively. Included in the amounts below, are non-store expenses that totaled $15 million in 2010, 2009, and 2008. 2010 2009 2003 Minimum rent . . . . . .. $ 507 $514 $527 Contingent rent based on sales. . . . 16 14 14 Sublease income . ..... ... (1) (2) (2 $ 522 $526 $539 Future minimum lease payments under non-cancelable operating leases, net of future non-cancelable operating sublease payments, are: (In mitBons) 2011 . . . . . . . . $ 481 2012 425 2013 356 2014 . . 303 2015 . . . . . 257 Thereafter . . . . . . . . 596 Total operating lease commitments . $2,418ADDITIONAL INFORMATION (Continued) All tax items on the balance sheet relate to the firm's financial activities. Derivatives contracts relate to hedging against financial risks. Discontinued operations relate to activities outside the firm's core operating cycle