Chapter 2: Accounting Statements and Cash Flow
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Chapter 2: Accounting Statements and Cash Flow
Questions and Problems:
2.1. To find shareholders’ equity, we must construct a balance sheet as follows:
Balance Sheet
Current assets $5,300 Current liabilities $3,900
Net fixed assets 26,000 Long-term debt 14,200
Shareholders’ equity ..??....
Total assets $31,300 Total liabilities & equity $31,300
We know that total liabilities and shareholders’ equity must equal total assets of $31,300. We also know that total liabilities & shareholders’ equity is equal to current liabilities plus long-term debt plus shareholders’ equity, so shareholders’ equity is:
Shareholders’ equity = $31,300 –$14,200 – $3,900 = $13,200
Net Working Capital = Current Assets – Current Liabilities = $5,300 – $3,900 = $1,400
2.2 The income statement for the company is:
Income Statement
Sales $493,000
Costs 210,000
Depreciation 35,000
EBIT $248,000
Interest 19,000
EBT $229,000
Taxes 80,150
Net income $148,850
One equation for net income is:
Net income = Dividends + Addition to retained earnings
Rearranging, we get:
Addition to retained earnings = Net income – Dividends
Addition to retained earnings = $148,850 – $50,000
Addition to retained earnings = $98,850
2.3 To find the book value of current assets, we use:
Net Working Capital = Current Assets – Current Liabilities.
Rearranging to solve for current assets, we get:
Current Assets = Net Working Capital + Current Liabilities
Current Assets = $800,000 + $2,100,000 = $2,900,000
The market value of current assets and net fixed assets is given, so:
Book value Current Assets = $2,900,000 Market value Current Assets = $2,800,000
Book value Net Fixed Assets = $5,000,000 Market value Net Fixed Assets = $6,300,000
Book value assets = $7,900,000 Market value assets = $9,100,000
2.4 To calculate Operating cash flow, we first need the income statement:
Income Statement
Sales $18,700
Costs 10,300
Depreciation 1,900
EBIT $6,500
Interest 1,250
Taxable income $5,250
Taxes 2,100
Net income $3,150
Operating cash flow = EBIT + Depreciation – Taxes
Operating cash flow = $6,500 + $1,900 – $2,100
Operating cash flow = $6,300
2.5 Net capital spending = Net Fixed Assetsend – Net Fixed Assetsbeg + Depreciation
Net capital spending = $1,730,000 – $1,650,000 + $284,000
Net capital spending = $364,000
2.6 The long-term debt account will increase by $35 million, the amount of the new long-term debt issue. Since the company sold 10 million new shares of stock with a $1 par value, the common stock account will increase by $10 million. The capital surplus account will increase by $48 million, the value of the new common shares sold above its par value. Since the company had a net income of $9 million, and paid $2 million in dividends, the addition to retained earnings was $7 million, which will increase the accumulated retained earnings account. So, the new long-term debt and stockholders’ equity portion of the balance sheet will be:
|
Long-term debt |
$ 100,000,000 |
|
Total long-term debt |
$100,000,000 |
|
|
|
|
Shareholders equity |
|
|
Preferred shares |
$ 4,000,000 |
|
Common shares ($1 par value) |
25,000,000 |
|
Accumulated retained earnings |
142,000,000 |
|
Capital surplus |
93,000,000 |
|
Total equity |
$264,000,000 |
|
|
|
|
Total Liabilities & Equity |
$ 364,000,000 |
2.7 Cash flow to creditors = Interest paid – Net new borrowing
Cash flow to creditors = $127,000 – (Long-term debtend – Long-term debtbeg)
2.8 Cash flow to stockholders = Dividends paid – Net new equity
Cash flow to stockholders = $275,000 – [(Commonend + APISend) – (Commonbeg + APISbeg)]
Cash flow to stockholders = $275,000 – ($4,225,000 – $3,890,000)
Cash flow to stockholders = –$60,000
Note, APIS is the additional paid-in surplus.
2.9 Cash flow from assets = Cash flow to creditors + Cash flow to stockholders = $57,000 – $60,000
= – $3,000
Cash flow from assets = Operating cash flow – Change in Net Working Capital
– Net capital spending
–$3,000 = Operating cash flow – (–$87,000) – $945,000
Operating cash flow = –$3,000 – $87,000 + $945,000
Operating cash flow = $855,000
2.10 a. The accounting statement of cash flows explains the change in cash during the year. The accounting statement of cash flows will be:
|
Statement of cash flows |
|
|
Operations |
|
|
Net income |
$95 |
|
Depreciation |
90 |
|
Changes in other current assets |
(5) |
|
Accounts payable |
10 |
|
Total cash flow from operations |
$190 |
|
|
|
|
Investing activities |
|
|
Acquisition of fixed assets |
$(110) |
|
Total cash flow from investing activities |
$(110) |
|
|
|
|
Financing activities |
|
|
Proceeds of long-term debt |
$5 |
|
Dividends |
(75) |
|
Total cash flow from financing activities |
$(70) |
|
|
|
|
Change in cash (on balance sheet) |
$10 |
b. Change in NWC= NWCend – NWCbeg
= (CAend – CLend) – (CAbeg – CLbeg)
= [($65 + $170) – $125] – [($55 + $165) – $115)
= $110 – $105
= $5
c. To find the cash flow generated by the firm’s assets, we need the operating cash flow, and the capital spending. So, calculating each of these, we find:
|
Operating cash flow |
|
|
Net income |
$95 |
|
Depreciation |
90 |
|
Operating cash flow |
$185 |
Note that we can calculate operating cash flow in this manner since there are no taxes.
|
Capital spending |
|
|
Ending fixed assets |
$390 |
|
Beginning fixed assets |
(370) |
|
Depreciation |
90 |
|
Capital spending |
$110 |
Now we can calculate the cash flow generated by the firm’s assets, which is:
|
|
|
|
Cash flow from assets |
|
|
Operating cash flow |
$185 |
|
Capital spending |
(110) |
|
Change in NWC |
(5) |
|
Cash flow from assets |
$70 |
2.11 Operating cash flow = EBIT + Depreciation – Current Taxes
Operating cash flow = $40,000 + $10,000 – $6,000
Operating cash flow = $44,000
Capital spending = $21,000
Change in NWC = $1,900
Cash flow from assets = Operating cash flow - Capital spending - Change in NWC
= $44,000 - $21,000 - $1,900 = $21,100
Cash flow to creditors = Interest expense + debt repayment = $2,000 + $8,600 = $10,600
Cash flow to shareholders = Dividends – shares sold = $14,500 - $4,000 = $10,500
Check whether the cash flow identity holds:
Cash flow to creditors + Cash flow to shareholders = $10,600 + $10,500 = $21,100, which is equal to Cash flow from assets
2.12 a. The interest expense for the company is the amount of debt times the interest rate on the debt.
So, the income statement for the company is:
Income Statement
Sales $1,200,000
Cost of goods sold 450,000
Selling costs 225,000
Depreciation 110,000
EBIT $415,000
Interest 81,000
Taxable income $334,000
Taxes 116,900
Net income $217,100
b. And the operating cash flow is:
Operating cash flow = EBIT + Depreciation – Taxes
Operating cash flow = $415,000 + $110,000 – $116,900
Operating cash flow = $408,100
2.13 To find the operating cash flow, we first calculate net income.
Income Statement
Sales $167,000
Costs 91,000
Depreciation 8,000
Other expenses 5,400
EBIT $62,600
Interest 11,000
Taxable income $51,600
Taxes 18,060
Net income $33,540
Dividends $9,500
Additions to RE $24,040
a. Operating cash flow = EBIT + Depreciation – Taxes
Operating cash flow = $62,600 + $8,000 – $18,060
Operating cash flow = $52,540
b. Cash flow to Creditors = Interest – Net new long-term debt
Cash flow to Creditors = $11,000 – (–$7,100)
Cash flow to Creditors = $18,100
Note that the net new long-term debt is negative because the company repaid part of its long-term debt.
c. Cash flow to stockholders = Dividends – Net new equity
Cash flow to stockholders = $9,500 – $7,250
Cash flow to stockholders = $2,250
d. We know that Cash flow from assets = Cash flow to creditors + Cash flow to stockholders, so:
Cash flow from assets = $18,100 + $2,250 = $20,350
Cash flow from assets is also equal to Operating cash flow – Net capital spending – Change in NWC.
We already know operating cash flow. Net capital spending is equal to:
Net capital spending = Increase in Net fixed assets + Depreciation
Net capital spending = $22,400 + $8,000
Net capital spending = $30,400
Now we can use:
Cash flow from assets = Operating cash flow – Net capital spending – Change in NWC
$20,350 = $52,540 – $30,400 – Change in NWC.
Solving for the change in NWC gives $1,790, meaning the company increased its NWC by $1,790.
2.14 The solution to this question works the income statement backwards. Starting at the bottom:
Net income = Dividends + Addition to retained earnings
Net income = $1,570 + $4,900
Net income = $6,470
Now, looking at the income statement:
EBT – (EBT × Tax rate) = Net income
Recognize that EBT × tax rate is simply the calculation for taxes. Solving this for EBT yields:
EBT = NI / (1– Tax rate)
EBT = $6,470 / (1 – 0.35)
EBT = $9,953.85
Now we can calculate:
EBIT = EBT + Interest
EBIT = $9,953.85 + $1,840
EBIT = $11,793.85
The last step is to use:
EBIT = Sales – Costs – Depreciation
$11,793.85 = $41,000 – $26,400 – Depreciation
Depreciation = $2,806.15
2.15 The balance sheet for the company looks like this:
Balance Sheet
Cash $274,500 Accounts payable $697,500
Accounts receivable 207,000 Notes payable 217,500
Inventory 445,500 Current liabilities $915,000
Current assets $927,000 Long-term debt 2,325,000
Total liabilities $3,240,000
Tangible net fixed assets 4,393,000
Intangible net fixed assets 860,000 Common shares ??
Accumulated ret. earnings 2,940,000
Total assets $6,180,000 Total liabilities. & equity $6,180,000
Total liabilities and equity is:
Total liabilities & equity = Total debt + Common shares + Accumulated retained earnings
Solving for this equation for equity gives us:
Common shares = $6,180,000 – $3,240,000 – $2,940,000
Common shares= $0
2.16 a. The market value of shareholders’ equity can be stated as: Shareholders’ equity
= Max [(Total assets – Total liabilities), 0]. So, if Total assets are $12,400 and Total
liabilities are $10,900, equity is equal to $1,500
b. The market value of shareholders’ equity cannot be negative. A negative market value in this case would imply that the company would pay you to own the stock. Therefore, if Total assets are $9,600, equity is equal to $0. We should note here that while the market value of equity cannot be negative, the book value of shareholders’ equity can be negative.
2.17 a. Income Statement
Sales $630,000
COGS 470,000
A&S expenses 95,000
Depreciation 140,000
EBIT $(75,000)
Interest 70,000
Taxable income $(145,000)
Taxes (35%) 0
Net income $(145,000)
b. OCF = EBIT + Depreciation – Taxes
OCF = $(75,000) + $140,000 – 0
OCF = $65,000
c. Net income was negative because of the tax deductibility of depreciation and interest expense. However, the actual cash flow from operations was positive because depreciation is a non-cash expense and interest is a financing expense, not an operating expense.
2.18 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 dividend payments.
Change in NWC = Net capital spending = Net new equity = 0 (Given)
Cash flow from assets = OCF – Change in NWC – Net capital spending
Cash flow from assets = $65,000 – 0 – 0 = $65,000
Cash flow to stockholders = Dividends – Net new equity
Cash flow to stockholders = $34,000 – 0 = $34,000
Cash flow to creditors = Cash flow from assets – Cash flow to stockholders
Cash flow to creditors = $65,000 – $34,000
Cash flow to creditors = $31,000
Cash flow to creditors is also:
Cash flow to creditors = Interest – Net new LTD
So:
Net new LTD = Interest – Cash flow to creditors
Net new LTD = $70,000 – $31,000
Net new LTD = $39,000
2022-07-08