Topic 2 - Financial Statements Taxes and Cashflows(students) PDF

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Financial Statements Taxes and Cash Flows...

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TOPI C2-FI NANCI ALSTATEMENTS, TAXES& CASHFLOWS Q5. Market Values and Book Values. Cloc’em, Inc., purchased new cloaking machinery three years ago for $4 million. The machinery can be sold to the Romulans today for $6.2 million. Cloc’em 's current balance sheet shows net fixed assets of $2.8 million, current liabilities of $710,000, and net working capital of $130,000. If all the current assets were liquidated today, the company would receive $825,000 million cash. What is the book value of Cloc’em 's assets today? What is the market value? Book value Market value 3 years ago Today value

 value of assets on your accounting recording  value the market willing to pay Cloaking machinery $4 million $6.2 million

Fixed assets Current liabilities Net working capital Current assets

$2.8 million $710,000 $130,000 $840,000

Book Value CA Book NFA Book value assets

= 840,000 = 2,800,000 = 3,640,000

Market value CA Market value NFA Total

= 825,000 = 6,200,000 = 7,025,000

Q6. Calculating Taxes. The SGS Co. had $274,000 in taxable income. Using the rates from Table 2.3 (refer beside), calculate the company's income taxes. Tax liability

Average tax rate Marginal tax rate

= 0.15 (50,000) + 0.25 (75,000 - 50,000) + 0.34 (100,000 – 75,000) + 0.39 (274,000 – 100,000) = 7,500 + 6,250 + 8,500 + 67,860 = 90,110 = Taxes / Income = 90,110 / 274,000 = 32.8% = 39%

Q14.Calculating Total Cash Flows. Sheffield Co. shows the following information on its 2010 income statement: sales = $153,000; costs = $81,900; other expenses = $5,200; depreciation expense = $10,900; interest expense = $8,400; taxes = $16,330; dividends = $7,200. In addition, you're told that the firm issued $2,600 in new equity during 2010, and redeemed $3,900 in outstanding long-term debt. Sales Cogs Other expense Depreciation expense EBIT Interest Expense Taxable Income Taxation Net Income after Tax30,270

153,000 (81,900) (5,200) (10,900) 55,000 (8,400) 46,600 (16,330)

Net Income = Dividends + Retained earnings 30,270 = 7,200 a.

What is the 2010 operating cash flow? Operating Cash flow = Earnings before Interest and Taxes + Depreciation – Taxes = 55,000 + 10,900 – 16,330

= 49,570

Q15.

b.

What is the 2010 cash flow to creditors? Since the company redeemed long-term debt, the net new borrowing is negative Redeemed mean not paying, paying back extra Cash flow to creditors = Interest paid – Net new borrowing = 8,400 – (- 3,900) = 12,300

c.

What is the 2010 cash flow to stockholders? Cash flow to stockholders = Dividends paid – Net new equity raised = 7,200 – 2,600 = 4,600

d.

If net fixed assets increased by $19,475 during the year, what was the addition to NWC? Cash flow from assets = cash flow to creditors + cash flow to stockholders = 12,300 + 4,600 ` = 16,900 Net Capital Spending

= Depreciation + Increased NFA = 10,900 + 19,475 = 30,375

Cash flow from assets 16,900 Change in NWC

= Operating cash flow – Net capital spending – Change in NWC = 49,570 – 30,375 – Change in NWC = -2,295

Using Income Statements. Given the following information for Sookie’s Cookies Co., calculate the depreciation expense: sales = $51,000; costs = $39,800; addition to retained earnings = $2,300; dividends paid = $925; interest expense = $1,230; tax rate = 40 percent Net Income

= Dividends + Addition to Retained Earnings = 925 + 2,300 = 3,225

Net Income

= Taxable Income – (Taxable income)(Tax rate) = Taxable Income (1-Tax Rate) 3,225 = Taxable Income (1-40%) 3,225 = Taxable Income (0.60) Taxable Income = 5,375 EBIT

= Taxable Income + Interest = 5,375 + 1,230 = 6,605

EBIT = Sales – Cost of goods sold – Depreciation expense 6,605 = 51,000 – 39,800 – Depreciation expense Depreciation expense = 4,595

Q16.

Preparing a Balance Sheet: Prepare a balance sheet for Maskara Ltd. as of December 31, 2010, based on the following information: cash = $193,000; patents and copyrights = $847,000; accounts payable = $296,000; accounts receivable = $253,000; tangible net fixed assets = $5,100,000; inventory = $538,000; notes payable = $189,000; accumulated retained earnings = $4,586,000; long-term debt = $1,250,000.

Maskara Ltd. Balance Sheet as of December 31,2010 Current Assets Current Liabilities Cash 193,000 Accounts Payable Accounts receivable 253,000 Notes payable Inventory 538,000 Total Current Liabilities Total Current Assets 984,000 Non- Current Liabilities Long-term debt Non- Current Assets Total Liabilities Tangible net fixed assets 5,100,000 Intangible Assets (Patents and Copyrights) 847,000 Equity Total Non-Current assets 5,947,000 Owner's Equity Accumulated retained earnings Total Assets

6,931,000

Total Liabilities + Equity

296,000 189,000 485,000 1,250,000 1,735,000

610,000 4,586,000 6,931,000

2.1 Liquidity. What does liquidity measure? Explain the trade-off a firm faces

between high-liquidity and low-liquidity levels. Liquidity measures how quickly and easily an asset can be converted to cash without significant loss in value. It’s desirable for firms to have high liquidity so that they can more safely meet short-term creditors demand. However, liquidity also has an opportunity cost. Firms generally reap higher returns by investing in illiquid, productive assets. It’s up to the firm’s financial management staff to find a reasonable compromise between these opposing needs 2.2 Accounting and Cash Flows. Why is it that the revenue and cost figures shown on a standard income statement may not be representative of the actual cash inflows and outflows that occurred during a period?

The recognition and matching principles in financial accounting call for revenues and the costs associated with producing those revenues, to be ‘booked’ when the revenue process is essentially complete, not necessarily when the cash is collected or bills are paid. Note that this way is not necessarily correct; it’s the way accountants have chosen to do it 2.3 Book Values versus Market Values. In preparing a balance sheet, why do you think

standard accounting practice focuses on historical cost rather than market value? Historical costs can be objectively and precisely measure, whereas market values can be difficult to estimate, and different analysts would come up different numbers. Thus, there is a trade off between relevance (market values) and objectivity (book values) 2.4 Operating Cash Flow. In comparing accounting net income and operating cash flow, what two items do you find in net income that are not in operating cash flow? Explain what each is and why it is excluded in operating cash flow.

Depreciation is a non-cash deduction that reflects adjustments basic values in accordance with the matching principles in financial accounting. Interest expense is a cash outlay, but it’s a financing cost not an operating cost 2.5 Book Values versus Market Values. Under standard accounting rules, it is possible

for a company’s liabilities to exceed its assets. When this occurs, the owners’ equity is negative. Can this happen with market values? Why or why not? Market value can never be negative, imagine a share of stock selling for $20. This would mean that if you place an order for 100 shares, you would get the stock along with a check for $2,000. How many shares do you want to buy? More generally, because of corporate individual bankruptcy laws, net worth of a person or a corporation cannot be negative, implying that liabilities cannot exceed assets in market value 2.6 Cash Flow from Assets. Suppose a company’s cash flow from assets was negative

for a particular period. Is this necessarily a good sign or a bad sign? For a successful company that is rapidly expanding, capital outlays would typically be large, possibly leading to negative cashflow from assets, in general what matter is whether the money is spent wisely, not whether cash flow from assets is positive or negative 2.7 Operating Cash Flow. Suppose a company’s operating cash flow was negative for several years running. Is this necessarily a good sign or a bad sign?

It’s probably not a good sign for an established company, but it would be fairly ordinary for a start-up, so it depends

2.8 Net Working Capital and Capital Spending. Could a company’s change in NWC be negative in a given year? (Hint: Yes.) Explain how this might come about. What about net capital spending?

For example, if a company were to become more efficient in inventory management, the amount of inventory needed would decline. The same might be true if it better at collecting its receivable. In general, anything leads to decline ending NWC relative to beginning NWC would have this effect. Negative net capital spending would mean more long-lived assets were liquidated than purchased 2.9 Cash Flow to Stockholders and Creditors. Could a company’s cash flow to

stockholders be negative in a given year? ( Hint: Yes.) Explain how this might come about. What about cash flow to creditors? If a company raise more money from selling stock than it pays in dividends in a particular period its cash flow to stockholder will be negative. If a company borrow more than it pays in interest, its cash flow to creditors will be negative 2.10 Firm Values. Referring back to the examples used at the beginning of the chapter, note that we suggested that stockholders probably didn’t suffer as a result of the reported loss. What do you think was the basis for our conclusion?

The adjustments discussed were purely accounting changes, they had no cash flow or market value consequences unless the new accounting information caused stockholders to revalue the company

BASIC 1. Building a Balance Sheet. Bear Tracks, Inc., has current assets of $2,030, net fixed assets of $9,780, current liabilities of $1,640, and long-term debt of $4,490. What is the value of the shareholders’ equity account for this firm? How much is net working capital? Shareholders’ equity = (2,030 + 9,780) – (1,640 + 4,490) = 5,680 NWC = Current assets – Current Liabilities = 2,030 – 1,640 = 390

2. Building an Income Statement. Pharrell, Inc., has sales of $634,000, costs of

$328,000, depreciation expense of $73,000, interest expense of $38,000, and a tax rate of 35 percent. What is the net income for this firm? Sales Cost Depreciation EBIT Interest EBT Tax Net Income

634,000 328,000 73,000 233,000 38,000 195,000 68,250 126,750

Taxable Income $160,000 Taxes = 195,000 * 35% = 68,250 3. Dividends and Retained Earnings. Suppose the firm in Problem 2 paid out $43,000 in

cash dividends. What is the addition to retained earnings? Net Income = Addition to retained earnings + Dividends paid Addition to retained earnings = 126,750 - 43,000 = 83, 750 4. Per-Share Earnings and Dividends. Suppose the firm in Problem 3 had 35,000 shares

of common stock outstanding. What is the earnings per share, or EPS, figure? What is the dividends per share figure? Earnings per share EPS = Net Income / Share outstanding = 126,750 / 35,000 = 3.62 per share Dividends per share DPS = Dividends / Share outstanding = 43,000 / 35,000 = 1.23 per share 5. Calculating Taxes. The SGS Co. had $243,000 in taxable income. Using the rates from

Table 2.3 in the chapter, calculate the company’s income taxes. Taxes

= 0.15 (50,000) + 0.25 (75,000 - 50,000) + 0.34 (100,000 – 75,000) + 0.39 (243,000– 100,000)

= 7,500 + 6,250 + 8,500 + 55,770 = 78,020 6. Tax Rates. In Problem 5, what is the average tax rate? What is the marginal tax rate? Average tax rate = Tax bill / Taxable Income = 78,020 / 243,000 = 0.32 / 32% Marginal tax rate is the tax rate on the next dollar of income Marginal tax rate = 39% 7. Calculating OCF. Hailey, Inc., has sales of $38,530, costs of $12,750, depreciation

expense of $2,550, and interest expense of $1,850. If the tax rate is 35 percent, what is the operating cash flow, or OCF? Sales Cost Depreciation EBIT Interest EBT Taxes Net Income OCF

38,530 (12,750) (2,550) 23,230 (1,850) 21,380 (7,483) 14,347

= Earnings before Interest and Taxes + Depreciation – Taxes = 23,230 + 2,550 – 7,483 = 18,342

8. Calculating Net Capital Spending. Rotweiler Obedience School’s December 31, 2015,

balance sheet showed net fixed assets of $1,975,000, and the December 31, 2016, balance sheet showed net fixed assets of $2,134,000. The company’s 2016 income statement showed a depreciation expense of $325,000. What was the company’s net capital spending for 2016? Net Capital Spending

= Ending NFA – Beginning NFA + Depreciation = 2,134,000 – 1,975,000 + 325,000 = 484,000

9. Calculating Additions to NWC. The December 31, 2015, balance sheet of Maria’s

Tennis Shop, Inc., showed current assets of $1,530 and current liabilities of $1,270. The December 31, 2016, balance sheet showed current assets of $1,685 and current liabilities of $1,305. What was the company’s 2016 change in net working capital, or NWC? Net Working Capital

= Ending NWC – Beginning NWC = (1,685 – 1,350) – (1,530 – 1,270) = 335 – 260 = 75

10. Cash Flow to Creditors. The December 31, 2015, balance sheet of Schism, Inc.,

showed long-term debt of $1,410,000, and the December 31, 2016, balance sheet showed long-term debt of $1,551,000. The 2016 income statement showed an interest expense of $102,800. What was the firm’s cash flow to creditors during 2016? Cash flow to creditors

= Interest paid – Net new borrowing = Interest paid – (Ending LTD – Beginning LTD)

= 102,800 – (1,551,000 – 1,410,000) = - 38,200 11. Cash Flow to Stockholders. The December 31, 2015, balance sheet of Schism, Inc.,

showed $130,000 in the common stock account and $2,332,000 in the additional paid-in surplus account. The December 31, 2016, balance sheet showed $148,000 and $2,618,000 in the same two accounts, respectively. If the company paid out $148,500 in cash dividends during 2016, what was the cash flow to stockholders for the year? Cashflow to stockholders

= Dividends paid – Net new equity raised = 148,500 – [(Ending Common + Ending APIS) – (Beginning Common + Beginning APIS)] = 148,500 – [(148,000 + 2,618,000) – (130,000 + 2,332,000)] = - 155,500 12. Calculating Cash Flows. Given the information for Schism, Inc., in Problems 10 and 11, suppose you also know that the firm’s net capital spending for 2016 was $705,000, and that the firm reduced its net working capital investment by $115,000. What was the firm’s 2016 operating cash flow, or OCF? Cash flow from assets

= Cashflow to creditors + Cashflow to stockholders = - 38,200 – 155,500 = - 193,700

Cash flow from assets -193,700 -OCF

= OCF – NCS – Changes in NWC = OCF – 705,000 – (- 115,000) = 193,700 – 705,000 + 115,000 = 396,300

13. Market Values and Book Values. Klingon Widgets, Inc., purchased new cloaking

machinery three years ago for $6 million. The machinery can be sold to the Romulans today for $4.8 million. Klingon’s current balance sheet shows net fixed assets of $3.3 million, current liabilities of $850,000, and net working capital of $220,000. If all the current accounts were liquidated today, the company would receive $1.05 million cash. What is the book value of Klingon’s total assets today? What is the sum of NWC and the market value of fixed assets? 14. Calculating Cash Flows. Weiland Co. shows the following information on its 2016 income

statement: sales = $173,000; costs = $91,400; other expenses = $5,100; depreciation expense = $12,100; interest expense = $8,900; taxes = $21,090; dividends = $9,700. In addition, you’re told that the firm issued $2,900 in new equity during 2016 and redeemed $4,000 in outstanding long-term debt. a. What is the 2016 operating cash flow? b. What is the 2016 cash flow to creditors? c. What is the 2016 cash flow to stockholders? d. If net fixed assets increased by $23,140 during the year, what was the addition to NWC? LO 2 15. Using Income Statements. Given the following information for Sookie’s Cookies Co.,

calculate the depreciation expense: sales = $67,000; costs = $49,200; addition to retained earnings = $3,500; dividends paid = $2,170; interest expense = $1,980; tax rate = 40 percent.

16. Preparing a Balance Sheet. Prepare a balance sheet for Alaskan Strawberry Corp. as of

December 31, 2016, based on the following information: cash = $197,000; patents and copyrights = $863,000; accounts payable = $288,000; accounts receivable = $265,000; tangible net fixed assets = $5,150,000; inventory = $563,000; notes payable = $194,000; accumulated retained earnings = $4,586,000; long-term debt = $1,590,000.

17. Residual Claims. Chevelle, Inc., is obligated to pay its creditors $8,400 during the year.

a. What is the value of the shareholders’ equity if assets equal $9,300? Owners’ equity is the maximum of total assets minus total liabilities or xero. Although value of owners’ equity can be negative, the market value of owners’ equity cannot be negative Owner’s equity = Max [(9,300-8,400),0] Owner’s equity = 900 b. What if assets equal $6,900? Owner’s equity = Max [(6,900-8,400),0] Owner’s equity = 0 18. Marginal versus Average Tax Rates. (Refer to Table 2.3.) Corporation Growth has

$76,500 in taxable income, and Corporation Income has $7,650,000 in taxable income. a. What is the tax bill for each firm? b. Suppose both firms have identified a new project that will increase taxable income by $10,000. How much in additional taxes will each firm pay? Why is this amount the same? The marginal tax rate on the next $1 of earnings. Each firm has a marginal tax rate of 34% on the next $10,000 of taxable income, despite their different average tax rates, so both firms will pay an additional $3,400 in taxes 19. Net Income and OCF. During the year, Belyk Paving Co. had sales of $2,350,000. Cost of

goods sold, administrative and selling expenses, and depreciation expense were $1,295,000, $530,000, and $420,000, respectively. In addition, the company had an interest expense of $245,000 and a tax rate of 35 percent. (Ignore any tax loss carryback or carryforward provisions.) a. What is the company’s net income? Sales 2,350,000 Cogs (1,295,000) Selling expenses (530,000) Depreciation expense (420,000) EBIT 105,000 Interest expense 245,000 EBT (140,000) Taxes (35%) 0 Net Income (140,000) The tax are zero since we are ignoring any carryback or carryforward provisions

b. What is its operating cash flow? Operating Cash Flow = EBIT + Depreciation – Taxes = 105,000 + 420,000 – 0 = 525,000 c. Explain your results in parts (a) and (b). Net income was negative because of tax deductibility of depreciation and interest expense. However, the actual cashflow from operations was positive because depreciation is a non-cash expense and interest is financing, not an operating, expense

20. Accounting Values versus Cash Flows. In Problem 19, suppose Belyk Paving Co. paid out

$395,000 in cash dividends. Is this possible? If net capital spending was zero, no new investments were made in net working capital, and no new stock was issued during the year, what do you know about the firm’s long-term debt account? A firm can still pay out dividends if net income is negative; it just has to be sure there is sufficient cash flow to make the dividends payments The assumption made in the question are Net Capital Spending = Net working Capital = Net new equity raised = 0 Cash flow from assets = OCF + NCS + Changes in NWC = 525,000 + 0 + 0 = 525,000 Cash flow to stockholders

= Dividends paid – Net new equity raised = 395,000 – 0 = 395,000...