E-Z-GO 2005 Annual Report Download - page 53

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33
SFAS No. 123-R requires that the excess tax benefits received related to stock option exercises be presented as financing cash inflows. For 2005,
$14 million of these excess tax benefits have been presented as cash provided by financing activities in the Consolidated Statement of Cash
Flows.
The valuation of stock options requires numerous assumptions. Textron determines the fair value of each option as of the date of grant using the
Black-Scholes option-pricing model. This model requires inputs for the expected volatility of Textron’s common stock price, expected life of the
option and expected dividend yield, among others. In addition, we estimate the number of options expected to eventually vest. Expected volatility
estimates are based on implied volatilities from traded options on Textron common stock, historical volatilities and other factors. Textron uses
historical data to estimate option exercise behavior, adjusted to reflect anticipated increases in expected life.
See Note 13 to the Consolidated Financial Statements for additional details.
Item 7A. Quantitative and Qualitative Disclosure about Market Risk
Interest Rate Risks
Our financial results are affected by changes in U.S. and foreign interest rates. As part of managing this risk, we enter into interest rate exchange
agreements to convert certain floating-rate debt to fixed-rate debt and vice versa. The overall objective of our interest rate risk management is to
achieve a prudent balance between floating- and fixed-rate debt. We continuously monitor our mix of floating- and fixed-rate debt and adjust the
mix, as necessary, based on our evaluation of internal and external factors. The difference between the rates Textron Manufacturing received and
the rates it paid on interest rate exchange agreements did not significantly impact interest expense in 2005, 2004 or 2003.
Within the Finance segment, a strategy of matching floating-rate assets with floating-rate liabilities limits our risk to changes in interest rates. This
strategy includes the use of interest rate exchange agreements. At December 31, 2005, floating-rate liabilities in excess of floating-rate assets
were $156 million, net of $2.9 billion of interest rate exchange agreements which effectively converted fixed-rate debt to a floating-rate equivalent
and $122 million of interest rate exchange agreements which effectively converted fixed-rate finance receivables to a floating-rate equivalent. For
Textron Finance, interest rate exchange agreements designated as hedges of debt had the effect of decreasing interest expense by $11 million, $40
million and $43 million in 2005, 2004 and 2003, respectively.
Foreign Exchange Risks
Our financial results are affected by changes in foreign currency exchange rates and economic conditions in the foreign markets in which prod-
ucts are manufactured and/or sold. For 2005, the impact of foreign exchange rate changes from 2004 increased revenues by approximately $31
million (0.4%) and decreased segment profit by approximately $3 million (0.4%).
Textron Manufacturing manages its exposures to foreign currency assets and earnings primarily by funding certain foreign currency denominated
assets with liabilities in the same currency so that certain exposures are naturally offset. During 2005, Textron Manufacturing primarily used bor-
rowings denominated in euro and British pound sterling for these purposes.
In managing its foreign currency transaction exposures, Textron Manufacturing also enters into foreign currency forward exchange and option
contracts. These contracts are generally used to fix the local currency cost of purchased goods or services or selling prices denominated in cur-
rencies other than the functional currency. The notional amount of outstanding foreign exchange contracts, foreign currency options and currency
swaps was approximately $699 million at the end of 2005 and $493 million at the end of 2004.
Quantitative Risk Measures
In the normal course of business, we enter into financial instruments for purposes other than trading. To quantify the market risk inherent in our
financial instruments, we utilize a sensitivity analysis. The financial instruments that are subject to market risk (interest rate risk, foreign exchange
rate risk and equity price risk) include finance receivables (excluding lease receivables), debt (excluding lease obligations), interest rate exchange
agreements, foreign exchange contracts, marketable equity securities and marketable security price forward contracts.
Presented below is a sensitivity analysis of the fair value of financial instruments outstanding at year-end. We estimate the fair value of the finan-
cial instruments using discounted cash flow analysis and independent investment bankers. This sensitivity analysis is most likely not indicative of
actual results in the future. The following table illustrates the sensitivity to a hypothetical change in the fair value of the financial instruments
assuming a 10% decrease in interest rates, a 10% strengthening in exchange rates against the U.S. dollar and a 10% decrease in the quoted mar-
ket prices of applicable marketable equity securities.
Item 7A. Quantitative and Qualitative Disclosure about Market Risk