836  Appendix H
For each of the financial statements, we provide the historical values re-
ported by the company as well as our forecasts of future performance. The 
final year is denoted by CV, which represents the base year used in continuing 
value. We discuss continuing value later in this appendix.
Exhibit H.2: Balance Sheet. We present the balance sheet as reported by the 
company, with three exceptions. First, we aggregate cash and short-term in-
vestments into a single account.
Second, we separate deferred taxes from other current assets, other assets, 
and other liabilities. This allows us to estimate cash taxes, identify tax loss car-
ryforwards, and reclassify remaining amounts as equity equivalents during 
reorganization. Costco reports deferred taxes and their location on the balance 
sheet in Note 8, Taxes.
Third, because capital leases are a form of debt financing, we separate them 
from other current liabilities and other liabilities. In our experience, most compa-
nies embed capital leases within debt, but this is not the case for Costco. The com-
pany reports capital leases and their location on the balance sheet in Note 5, Leases.
Exhibit H.3: Statement of Shareholders’ Equity. The statement of sharehold-
ers’ equity explains the change in equity from one year to the next. The state-
ment includes the translation adjustment for foreign operations, stock-based 
compensation, repurchases of common stock, and dividends. These accounts 
are required for reconciling free cash flow to cash flow available to investors. 
For some accounts, like dividends, the account appears directly in the recon-
ciliation of cash flow. In other cases, it is used to eliminate a noncash change in 
a balance sheet account, such as the foreign-currency translation adjustment.
Exhibit H.4: Tax Reconciliation Table. The tax reconciliation table is required 
to estimate operating taxes and reconcile net operating profit after taxes 
(NOPAT) to net income. Costco reports the tax reconciliation table in Note 8, 
Taxes. While most companies report the table in either their home currency or 
percentages, Costco reports both versions.
Reorganizing the Financial Statements
With financial statements in hand, we next reorganize them into NOPAT, op-
erating taxes, invested capital, and total funds invested. Here we briefly de-
scribe the reorganization; Chapter 11 presents a full description of how to 
reorganize the financial statements.
Exhibit H.5: NOPAT. This exhibit reorganizes the income statement into 
NOPAT and reconciles NOPAT to net income. In the case of Costco, unad-
justed EBITA matches operating profit as reported on the company’s income 
statement. This is not always the case. As we discuss in Chapter 21, many 
companies include nonrecurring items such as restructuring costs as part of 

Appendix H  837
operating profit. Only ongoing operating expenses should be deducted from 
revenue to estimate EBITA.
As we prescribed in Chapter 11, we remove operating lease interest from 
operating profit and treat it as a financial expense. The lease interest is cal-
culated by multiplying the cost of debt by capitalized operating leases in the 
previous year, which can be found in Exhibit H.8. Do not add back interest 
expense related to capital leases. This item is already incorporated into inter-
est expense.
Exhibit H.6: Taxes. To calculate NOPAT and its reconciliation to net income, it 
is necessary to disaggregate taxes into operating taxes, taxes on nonoperating 
accounts, and other nonoperating taxes. Exhibit H.6 estimates operating cash 
taxes, using the three-step method introduced in Chapter 11 and discussed in 
detail in Chapter 20. First, multiply EBITA by the statutory tax rate presented 
in Exhibit H.4. The statutory tax rate equals the sum of the federal income and 
state income tax rates.
Next, adjust statutory taxes on EBITA by ongoing, operating-related ad-
justments. Use judgment to identify which adjustments are ongoing and op-
erating related. For Costco, we adjust statutory taxes on EBITA by two items: 
the foreign tax differential and tax related to the employee stock ownership 
plan. Finally, to convert operating taxes into operating cash taxes, subtract the 
increase in operating-related deferred-tax liabilities, net of deferred-tax assets. 
An increase in deferred tax liabilities means the company paid less in taxes 
than reported on its income statement.
Exhibit H.7: Deferred Taxes. To create the inputs needed for the cash tax rate, 
reorganize the deferred-tax table into tax loss carryforwards; operating de-
ferred-tax assets, net of liabilities; and nonoperating deferred-tax assets, net 
of liabilities. As with the tax reconciliation table, classification of an account 
as operating or nonoperating requires judgment. Ask yourself which accounts 
are operating related and likely to scale with revenue. To calculate the amount 
of operating taxes that are deferred, add (subtract) the increase (decrease) in 
the operating deferred account to (from) operating taxes.
For more on the concepts underpinning the operating tax rate and the 
treatment of deferred taxes, see Chapter 20.
Exhibit H.8: Invested Capital and Total Funds Invested. To estimate invested 
capital, pull each account directly from the balance sheet, except two: operat-
ing cash and capitalized operating leases. Operating cash is estimated at 2 
percent of revenues. Cash in excess of 2 percent of revenues is classified as 
excess cash.
Starting with fiscal years that end in December 2019, new accounting 
standards require companies to capitalize operating leases onto their balance 
sheet. Costco uses an August 31 year-end, so its 2019 financial statements are 
reported under the previous standards, whereby the value of the leases is not