Building Business Unit Financial Statements  401 million of equity investments in consolidation, leaving only the $76 million stake in the minority-owned cosmetics joint venture as equity investment in the consolidated accounts. In addition, ConsumerCo Corporation has lent $200 million to the private- label unit, which shows up as an intercompany receivable for the parent com- pany and an intercompany payable for the private-label unit. For the parent company, it represents a nonoperating asset that does not generate operating profits and hence should not be included in its operating working capital. For private label, it represents a financial infusion that is similar to equity. In the consolidated financials, the amounts are eliminated. Similarly, the intercom- pany receivables for the branded-products and devices businesses are treated as nonoperating assets that are eliminated in the consolidated financials against the $750 million of parent intercompany payables. Failure to handle the intercompany receivables and payables correctly can generate seriously misleading results. In the ConsumerCo example, if the intercompany accounts had been treated as working capital instead of equity, the private-label busi- ness’s invested capital would have been understated by more than 20 percent, leading to an overstatement of ROIC by roughly the same percentage. Understanding Financial Subsidiaries Some firms have financial subsidiaries that provide financing for customers (for example, John Deere Financial and practically all automotive manufactur- ers). If these subsidiaries are majority owned, they are fully consolidated in the company financial statements. But balance sheets of financial businesses are structured differently from those of industrial or service businesses. The assets tend to be financial rather than physical (largely receivables or loans) and are usually highly leveraged. As detailed in Chapter 38, financial busi- nesses should be valued using cash flow to equity, discounted at the cost of eq- uity. Most companies with significant financial subsidiaries provide a separate balance sheet and income statement for those subsidiaries; the information can be used to analyze and value the financial subsidiaries separately. Exhibit 19.6 shows that in 2020, ConsumerCo’s customer-finance unit has $1,154 million in outstanding customer loans. We estimated the ratio of debt to customer loans required to maintain its current BBB credit rating at 90 percent, so that its funding consists of $1,038 million of debt (0.90 × $1,154 million) and $115 million of equity. The loans generate $77 million in annual interest in- come. After deducting $58 million of interest expenses on debt and taxes of $7 million, after-tax net income of $12 million remains. The return on equity for the customer-finance unit is 10.8 percent ($12 million of net income divided by $115 million of equity), just above its 10.5 percent cost of equity (see also Exhibit 19.1). These loans, debt, and financial income streams need to be val- ued separately from ConsumerCo’s business operations. Looking ahead, the 402  Valuation by Parts customer-finance unit’s loans are assumed to grow in line with the revenues of the devices business (for which it provides the customer loans). Keeping interest rates and the ratio of debt to customer loans stable at 90 percent, the cash-flow-to-equity DCF value is estimated at $150 million (see Exhibit 19.1). Be careful not to double-count the debt of the financial subsidiary in the overall valuation of the company. The equity value of the customer-finance subsidiary is already net of its $1,038 million debt, so when we subtracted debt from ConsumerCo’s total enterprise value to arrive at the consolidated company’s equity value in Exhibit 19.1, we subtracted only the $1,941 million debt associated with business operations. Navigating Public Information For our ConsumerCo example, we have the benefit of complete financial state- ments by business unit. But that will typically not be the case if you are valuing a multibusiness company from the outside in. Exhibit 19.7 shows the disclo- sure of financial information typical of U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) for a company like ConsumerCo. Companies disclose revenues, operating profit (or something similar, such as EBITA), depreciation, capital expenditures, and assets by segment. You must convert these items to NOPAT and invested capital. NOPAT  To estimate NOPAT, start with reported operating earnings by business unit.5 Next, allocate operating taxes, any pension adjustment (to EXHIBIT 19.7  ConsumerCo: Public Information for Business Segments, 2020 Reported financials, $ million Branded products Private label Devices Organic products Corporate center Intersegment eliminations Consolidated Revenues 2,000 1,500 1,250 750 – (500) 5,000 Operating profit 500 143 156 206 (83) (2) 920 Depreciation1 150 59 57 31 42 338 Capital expenditures 208 107 90 79 42 526 Assets 1,872 882 596 531 830 (50) 4,662 Invested capital: Estimate vs. actual Assets/total assets, % 40 19 13 11 18 99 Invested capital estimate, $ million 1,711 806 545 486 759 4,306 Invested capital actual, $ million 1,600 900 563 488 806 4,306 Estimation error, % 6.9 (10.4) (3.1) (0.4) (5.9) 1 Included in operating profit. 5 Companies use different names, such as operating profit, underlying profit, or simply earnings before interest and taxes (EBIT), for business unit results.