Solution Manual For Finance: Applications and Theory, 5th Edition

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Chapter 2-ReviewingFinancial StatementsCHAPTER 2–REVIEWING FINANCIAL STATEMENTSquestionsLG2-11.List and describe the four major financial statements.The four basic financial statements are:1. Thebalance sheetreports a firm’s assets, liabilities, and equity at a particular point in time.2. Theincome statementshows the total revenues that a firm earns and the total expenses thefirm incurs to generate those revenues over a specific period of time—generally one year.3. Thestatement of cash flowsshows the firm’s cash flows over a given period of time. Thisstatement reports the amounts of cash the firm generated and distributed during a particular timeperiod. The bottom line on the statement of cash flows―the difference between cash sources anduses―equals the change in cashand marketable securitieson the firm’s balance sheet from theprevious year’s balance.4. Thestatement of retained earningsprovides additional details about changes in retainedearnings during a reporting period. This financial statement reconciles net income earned duringa given periodminusany cash dividends paid within that periodto thechange in retainedearnings between the beginning and ending of the period.LG2-12.On which of the four major financial statements (balance sheet, income statement, statement ofcash flows, or statement of retained earnings) would you find the following items?a. earnings before taxes-income statementb. net plant and equipment-balance sheetc. increase in fixed assets-statement of cash flowsd. gross profits-income statemente. balance of retained earnings, December 31, 20xx-statement of retained earningsand balance sheetf. common stock and paid-in surplus-balance sheetg. net cash flow from investing activities-statement of cash flowsh. accrued wages and taxes–balance sheeti. increase in inventory-statement of cash flowsLG2-13.What is the difference between current liabilities and long-term debt?Current liabilities constitute the firm’s obligations due within one year, including accrued wages andtaxes, accounts payable, and notes payable. Long-term debt includes long-term loans and bonds withmaturities of more than one year.LG2-14.How does the choice of accounting method used to record fixed asset depreciation affectmanagement of the balance sheet?Firm managers can choose the accounting method they use to record depreciation against theirfixed assets. Two choices include the straight-line method and the modified accelerated costrecovery system (MACRS). Companies often calculate depreciation using MACRS when theyfigure the firm’s taxes and the straight-line method when reporting income to the firm’s

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Chapter 2-ReviewingFinancial Statementsstockholders. The MACRS method accelerates deprecation, which results in higherdepreciationexpenses, lower taxable income, and lower taxes in the early years of a project’s life. Thestraight-line method results in lower depreciation expenses, but also results in higher taxes in theearly years of a project’s life. Firms seeking to lower their cash outflows from tax payments willfavor the MACRS depreciation method.LG2-15.What is bonus depreciation? How did theTax Cuts and Jobs Act of 2017 temporarily extendand modify bonus depreciation?Since 2001, businesses have had the ability to immediately deduct a percentage of the acquisitioncost of qualifying assets as "bonus depreciation." This additional depreciation deduction wasallowed to encourage business investment. However, bonus depreciation was a temporaryprovision; the rate would have been 50 percent in 2017, 40 percent in 2018, and30 percent in2019, before phasing out in 2020.TheTax Cuts and Jobs Act of 2017extended and modifiedbonus depreciation, allowing businesses to immediately deduct 100 percent of the cost of eligibleproperty in the year it is placed in service, through 2022. The amount of allowable bonusdepreciation will then be phased down over four years: 80 percent will be allowed for propertyplaced in service in 2023, 60 percent in 2024, 40 percent in 2025, and 20 percent in 2026.MACRS or straight-line depreciation is applied to any costs that do not qualify for bonusdepreciation.LG2-16.What are the costs and benefits of holding liquid securities on a firm’s balance sheet?The more liquid assets a firm holds, the less likely the firm will be to experience financialdistress. However, liquid assets generatelittle orno profits for a firm. For example, cash is themost liquid of all assets, but it earnslittle, if any,return for the firm. In contrast, fixed assets areilliquid, but provide the means to generate revenue. Thus, managers must consider the trade-offbetween the advantages of liquidity on the balance sheet and the disadvantages of having moneysit idle rather than generating profits.LG2-27. Why can the book value and market value of a firm differ?A firm’s balance sheet shows its book (or historical cost) value based on Generally AcceptedAccounting Principles (GAAP). Under GAAP, assets appear on the balance sheet at what thefirm paid for them, regardless of what assets might be worth today if the firm were to sell them.Inflation and market forces make many assets worth more now than they were when the firmbought them. So in most cases, book values differ widely from the market values for the sameassets—the amount that the assets would fetch if the firm actually sold them. For the firm’scurrent assets—thosethat mature within a year―the book value and market value of anyparticular asset will remain very close. For example, the balance sheet lists cash and marketablesecurities at their market value. Similarly, firms acquire accounts receivable and inventory andthen convert these short-term assets into cash fairly quickly, so the book valueof these assetsisgenerally close to their market value.LG2-28.From a firm manager’s or investor’s point of view, which is more important―the bookvalue of afirm or the market value of the firm?

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Chapter 2-ReviewingFinancial StatementsBalance sheet assets are listed at historical cost. Managers would thus see little relation between thetotal asset value listed on the balance sheet and the current market value of the firm’s assets.Similarly, the stockowners’ equity listed on the balance sheet generally differs from the true marketvalue of the equity—in this case, the market value may be higher or lower than the value listed on thefirm’s accounting books. So,financial managers and investors often find that balance sheet values arenot always the most relevant numbers.LG2-39.How did theTax Cuts and Jobs Act of 2017 change corporate tax laws?The Tax Cuts and Jobs Act (TCJA) of 2017 is the most recent revision of corporate tax laws andrepresents one of the most significant changes in more than 30 years.The Act permanently lowerscorporate taxes from a progressive schedule that saw tax rates as high as 35 percent to a flat 21percent starting in 2018.LG2-310.Whatis thedifference between an average tax rate and a marginal tax rate?A firmcan figure the average tax rate as the percentage of each dollar of taxable income that thefirm pays in taxes. From your economics classes, you can probably guess that the firm’s marginaltax rate is the amount of additional taxes a firm must pay out for every additional dollar oftaxable income it earns.LG2-311.How did theTax Cuts and Jobs Act of 2017 changethe tax deductibility of corporateinterest in debt?TheTax Cutsand Jobs Act of 2017contains a new limitation on the deductibility of net interestexpense (interest expense minus interest income) that exceeds 30 percent of a firm’s “adjustedtaxable income” starting in 2018. For tax years beginning before January 1, 2022, “adjusted taxableincome” is measured as a business’ EBITDA. For subsequent tax years, “adjusted taxable income” ismeasured as EBIT, no longer including an add-back for depreciation and amortization. Thus,beginning in 2022, the new limitation will become more severe.Priorcorporate tax laws generallyallowed full deduction of interest paid or accrued by businesses.LG2-312.How does the payment of interest on debt affect the amount of taxes the firm must pay?Corporate interest payments appear on the balance sheet as an expense item, so we deducttheallowable portion ofinterest payments from operating income when the firm calculates taxableincome. But, any dividends paid by corporations to their shareholders are not tax deductible. This isone factor that encourages managers to finance projects with debt financing rather than to sell morestock. Suppose one firm uses mainly debt financing and another firm, with identical operations, usesmainly equity financing. The equity-financed firm will have very little interest expense to deduct fortax purposes. Thus, it will have higher taxable income and pay more taxes than the debt-financedfirm. The debt-financed firm will pay fewer taxes and be able to pay more of its operating income toasset funders, i.e., its bondholders and stockholders. So,as long as interest on debt isunder the 30percent allowablecap for tax deduction,even stockholders prefer that firms finance assets primarilywith debt rather than with stock.

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Chapter 2-ReviewingFinancial StatementsLG2-413.The income statement is prepared using GAAP. How does this affect the reported revenue andexpense measures listed on the balance sheet?Company accountants must prepare firm income statements following GAAP principles.GAAPprocedures require that the firm recognize revenue at the time of sale, but sometimes thecompany receives the cash before or after the time of sale. Likewise, GAAP counsels the firm toshow production and other expenses on the balance sheet as the sales of those goods take place.So production and other expenses associated with a particular product’s sale only appear on theincome statement (for example, cost of goods sold and depreciation) when that product sells. Ofcourse, just as with the revenue recognition, actual cash outflows incurred with production mayoccur at a very different point in time—usually much earlier than GAAP principles allow thefirm to formally recognize the expenses. Further, income statements contain several non-cashentries,the largest ofwhichis depreciation. Depreciation attempts to capture the non-cashexpense incurred as fixed assets deteriorate from the time of purchase to the point when thoseassets must be replaced. Let’s illustrate the effect of depreciation: Suppose a firm purchases amachine for $100,000. The machine has an expected life of five years and at the end of those fiveyears, the machine will have no expected salvage value. The firm lays out a $100,000 cashoutflow at the time of purchase. But the entire $100,000 does not appear on the income statementin the year that the firm purchases the machine—in accounting terms, the machine is notexpensedin the year of purchase. Rather, if the firm’s accounting department uses the straight-line depreciation method, it deducts only $100,000/5, or$20,000,each year as an expense. This$20,000 equipment expense is not a cash outflow for the firm. The person in charge of buying themachine knows that the cash flow occurred at the time of purchase—and it totaled $100,000rather than $20,000. So, figures shown on an income statement may not represent the actual cashinflows and outflows for a firm during a particular period.LG2-414.Why do financial managers and investors find cash flowsto be more important than accountingprofit?Financial managers and investors are far more interested in actual cash flows than they are in thesomewhat artificial, backward-looking accounting profit listed on the income statement. This is avery important distinction between the accounting point of view and the finance point of view.Finance professionals know that the firm needs cash, not accounting profit, to pay the firm’sobligations as they come due, to fund the firm’s operations and growth, and to compensate the firm’sultimate owners: its shareholders. Thus, the statement of cash flows is a financial statement thatshows the firm’s cash flows over a given period of time. This statement reports the amounts of cashthat the firm generated and distributed during a particular time period.LG2-515.Which of the following activities result in an increase (decrease) in a firm’s cash?a. Decrease fixed assets–increase in cashb. Decrease accounts payable–decrease in cashc. Pay dividends–decrease in cashd. Sell common stock–increase in cashe. Decrease accounts receivable–increase in cash

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Chapter 2-ReviewingFinancial Statementsf. Increase notes payable–increase in cashLG2-516.What is the difference between cash flowsfrom operating activities, cash flowsfrom investingactivities, and cash flowsfrom financing activities?Cash flows from operations are those cash inflows and outflows that result directly fromproducing and selling the firm’s products. These cash flows include: net income, depreciation,and working capital accounts other than cash and operations-related short-term debt. Cash flowsfrom investing activities are cash flows associated with buying or selling of fixed or other long-term assets. This section of the statement of cash flows shows cash inflows and outflows fromlong-term investing activities—most significantly the firm’s investment in fixed assets. Cashflows from financing activities are cash flows that result from debt and equity financingtransactions. These include raising cash by:issuing short-term debt, issuing long-termdebt,issuing stock, using cash to pay dividends, using cash to pay off debt, and using cash to buy backstock.LG2-517.What are free cash flows for a firm? What does it mean when a firm’s free cash flow is negative?Free cash flows are the cash flows available to pay the firm’s stockholders and debtholders after thefirm has made the necessary working capital investments, fixed asset investments, and developed thenecessary new products to sustain the firm’s ongoing operations. If free cash flow is negative, thefirm's operations produce no cash flows available for investors.LG2-618.What is earnings management?Managers and financial analysts have recognized for years that firms use considerable latitude inusing accounting rules to manage their reported earnings in a wide variety of contexts. Indeed,within the GAAP framework, firms can “smooth” earnings. That is, firms often take steps toover-or understate earnings at various times. Managers may choose to smooth earnings to showinvestors that firm assets are growing steadily. Similarly, one firm may be using straight-linedepreciation for its fixed assets, while another is using a modified accelerated cost recoverymethod (MACRS), which causes depreciation to accrue quickly. If the firm uses MACRSaccounting methods,its managerswrite fixed asset values down quickly; assets will thus havelower book value than if the firm used straight line depreciation methods. This process ofcontrolling a firm’s earnings is called earnings management.LG2-619.What does the Sarbanes-Oxley Act require of firm managers?TheSarbanes-Oxley Act, passed in June 2002, requires public companies to ensure that theircorporate boards’ audit committees haveconsiderable experience applying generally acceptedaccounting principles (GAAP) for financial statements. The Act also requires that any firm’s seniormanagement must sign off on the financial statements of the firm, certifying the statements asaccurate and representative of the firm’s financial condition during the period covered. If a firm’sboard of directors or senior managers fails to comply with Sarbanes-Oxley (SOX), the firm may bedelisted from stock exchanges.

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Chapter 2-ReviewingFinancial Statementsproblemsbasic2-1Balance SheetYou are evaluating the balance sheetfor Goodman’s Bees Corporation.problemsFrom the balance sheet you find the following balances:cash and marketable securities =LG2-1$400,000,accounts receivable = $1,200,000,inventory = $2,100,000,accrued wages and taxes =$500,000,accounts payable = $800,000, andnotes payable = $600,000. Calculate Goodman Bees’net working capital.Net working capital=Current assets-Current liabilities.Goodman’s Bees’current assets =Cash and marketable securities=$400,000Accounts receivable=1,200,000Inventory=2,100,000Total current assets$3,700,000and current liabilities =Accrued wages and taxes=$500,000Accounts payable=800,000Notes payable=600,000Total current liabilities$1,900,000So the firm’s net working capital was $1,800,000 ($3,700,000-$1,900,000).LG2-12-2Balance SheetCaselloMowing & Landscaping’s year-end 2021balancesheet lists currentassets of $435,200, fixed assets of $550,800, current liabilities of $416,600, and long-term debt of$314,500. CalculateCasello’s total stockholders’ equity.Recall the balance sheet identity in Equation 2-1: Assets = Liabilities + Equity.Rearranging this equation: Equity =Assets–Liabilities. Thus, the balance sheets would appear as follows:Book valueBook valueAssetsLiabilities and EquityCurrent assets$ 435,200Currentliabilities$ 416,600Fixed assets550,800Long-term debt314,500Stockholders’ equity254,900Total$ 986,000Total$ 986,000LG2-12-3Income StatementThe Fitness Studio, Inc.’s 2021income statement lists the following incomeand expenses:EBITDA= $650,000,EBIT = $538,000,interest expense = $63,000, andnet income =$435,000. Calculate the 2021taxes reported on the income statement.With $650,000 of EBITDA,The Fitness Studiois allowedto deduct $195,000 ($650,000 x 30 percent) in net interestexpense. The recorded interest expenseof $63,000is under this limit and is thus all tax deductible.EBIT$538,000Interest expense-63,000EBT$475,000

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Chapter 2-ReviewingFinancial StatementsTaxes-40,000Net income$435,000LG2-12-4Income StatementThe Fitness Studio, Inc.’s 2021income statement lists the following incomeand expenses:EBITDA= $923,000,EBIT = $773,500,interest expense = $100,000, andtaxes =$234,500.The firmhas nopreferred stock outstanding and 100,000 shares of common stockoutstanding. Calculate the 2018earnings per share.With $923,000 of EBITDA,The Fitness Studiois allowedto deduct $276,900 ($923,000 x 30 percent) in net interestexpense. The recorded interest expenseof $100,000is under this limit and is thus all tax deductible.EBIT$773,500Interest expense-100,000EBT$673,500Taxes-234,500Net income$439,000Thus,$439,000Earnings per share (EPS) =——————= $4.39 per share100,000sharesLG2-12-5Income StatementConsider a firm with an EBIT of $850,000. The firm finances its assetswith $2,500,000 debt (costing 7.5percentand is all tax deductible) and 400,000 shares of stockselling at $5.00 per share. To reduce firm’s risk associated with this financial leverage, the firmis considering reducing its debt by $1,000,000 by selling an additional 200,000 shares of stock.Thefirm’s tax rate is21percent. The change in capital structure will have no effect on theoperations of the firm. Thus, EBIT will remain at $850,000. Calculate the change in the firm’sEPS from this change in capital structure.The EPS before and after this change in capital structure is illustrated below:Before capital structure changeAfter capital structure changeEBIT$850,000$850,000Less:Interest($2,500,000x 0.075)187,500($1,500,000 x 0.075)112,500EBT662,500737,500Less:Taxes (21%)139,125154,875Net income$523,375$582,625Divide by# of shares400,000600,000EPS$1.3084$0.9710The change in capital structure would decrease the stockholders EPS by $0.3374.LG2-12-6Income StatementConsider a firm with an EBIT of $550,000. The firm finances its assetswith $1,000,000 debt (costing 5.5percentand is all tax deductible) and 200,000 shares of stockselling at $12.00 per share. The firm is considering increasing its debt by $900,000, using theproceeds to buy back 75,000 shares of stock.Thefirm’s tax rate is21 percent.The change incapital structure will have no effect on the operations of the firm. Thus, EBIT will remain at$550,000. Calculate thechangein the firm’s EPS from this change in capital structure.

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Chapter 2-ReviewingFinancial StatementsThe EPS before and after this change in capital structure is illustrated below:Before capital structure changeAfter capital structure changeEBIT$550,000$550,000Less:Interest($1,000,000x 0.055)55,000($1,900,000 x 0.055)104,500EBT495,000445,500Less:Taxes (21%)103,95093,555Net income$391,050$351,945Divide by# of shares200,000125,000EPS$1.9552$2.8156The change in capital structure increases the stockholders EPS by $0.8604.LG2-32-7Corporate TaxesOakdale Fashions, Inc., 2021Income Statement is reported below.2021Net sales (all credit)$565,000Less: Cost of goods sold215,000Gross profits350,000Less: Other operating expenses90,000Earnings before interest, taxes, depreciation, and amortization (EBITDA)260,000Less: Depreciation and amortization15,000Earnings before interest and taxes (EBIT)245,000Less: Interest80,000Earnings before taxes (EBT)165,000Less: TaxesNet income$Determine the firm’s 2021 tax liability, net income, average tax rate, and marginal tax rate.(LG2-3)With $260,000 of EBITDA, Oakdale Fashions is allowed to deduct only $78,000 ($260,000 x 30 percent) of its$80,000 in net interest expense. Thus,Taxable income = EBIT–Allowable interest deduction= $245,000-$78,000 = $167,000Tax liability = 0.21x Taxable income= 0.21($167,000) = $35,070The 30 percent cap on the allowable interest deduction results in an increase inOakdale Fashions’ tax liability of$420 (0.21($80,000-$78,000)).Net income = EBT–Tax liability= $165,000-$35,070 = $129,930Theaveragetax rate for Oakdale Fashions Inc. comes to:$35,070Average tax rate=————= 21.00%$167,000

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Chapter 2-ReviewingFinancial StatementsIf Oakdale Fashions, Inc.earned $1 more of taxable income, it would pay21cents (its tax rate of21percent) more intaxes. Thus, the firm’s marginal tax rate is 21percent.LG2-32-8Corporate TaxesEverybody’s Fitness 2021Income Statement is reported below (inmillions of dollars).2021Net sales (all credit)$885Less: Cost of goods sold440Gross profits445Less: Other operating expenses215Earnings before interest, taxes, depreciation, and amortization(EBITDA)230Less: Depreciation and amortization52Earnings before interest and taxes (EBIT)178Less: Interest75Earnings before taxes (EBT)103Less: TaxesNet income$Determine the firm’s 2021 tax liability, net income, average tax rate, and marginal tax rate.(LG2-3)With $230,000,000 of EBITDA,Everybody’s Fitnessis allowed to deduct only $69,000,000 ($230,000,000 x 30percent) of its $75,000,000 in net interest expense. Thus,Taxable income = EBIT–Allowable interest deduction= $178,000,000-$69,000,000 = $109,000,000Tax liability = 0.21x Taxable income= 0.21($109,000,000) = $22,890,000The 30 percent cap on the allowable interest deduction results in anincrease inEverybody’s Fitness’taxliability of$1,260,000 (0.21($75,000,000-$69,000,000)).Net income = EBT–Tax liability=$103,000,000-$22,890,000 = $80,110,000Theaveragetax rate forEverybody’s Fitnesscomes to:$22,890,000Average tax rate=——————= 21.00%$109,000,000If Oakdale Fashions, Inc.earned $1 more of taxable income, it would pay21cents (its tax rate of21percent) more intaxes. Thus, the firm’s marginal tax rate is 21percent.LG2-32-9Corporate TaxesHunt Taxidermy, Inc.,is concerned about the taxes paid by the companyin 2021. In addition to $42.4million of taxable income, the firm received $2,975,000 of interest

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Chapter 2-ReviewingFinancial Statementson state-issued bonds and $1,000,000 of dividends on common stock it owns in OakdaleFashions, Inc. Calculate Hunt Taxidermy’s tax liability, average tax rate, and marginal tax rate.In this case, interest on the state-issued bonds is not taxable and should not be included in taxable income. Further,the first50percent of the dividends received fromOakdale Fashionsis not taxable. Thus, only50percent of thedividends received are taxed, so:Taxable income = $42,400,000 + (0.5)$1,000,000 = $42,900,000Now Hunt Taxidermy’s tax liability will be:Tax liability =0.21($42,900,000)= $9,009,000The $1,000,000 of dividend income increased Hunt Taxidermy’s tax liability by $105,000 (0.5x $1,000,000 x0.21).HuntTaxidermy’s resulting average tax rate is:Average tax rage = $9,009,000/$42,900,000 =21.00%Finally, if Hunt Taxidermy earned $1 more of taxable income, it wouldpay21cents (based upon its tax rate of21percent) more in taxes.Thus, the firm’s marginal tax rate is21percent.LG2-32-10Corporate TaxesChapman & Power Inc.,is concerned about the taxes paid by thecompany in 2021. In addition to $135,000,000of taxable income, the firm received $15,500,000of interest on state-issued bonds and $12,000,000 of dividends on common stock it owns in HuntTaxidermy.CalculateChapman & Power’s tax liability, average tax rate, and marginal tax rate.In this case, interest on the state-issued bonds is not taxable and should not be included in taxable income. Further,the first50percent of the dividends receivedfromHunt Taxidermyisnot taxable. Thus, only50percent of thedividends received are taxed, so:Taxable income = $135,000,000 + (0.5)$12,000,000 = $141,000,000Now HuntTaxidermy’s tax liability will be:Tax liability =0.21($141,000,000)= $29,610,000The $12,000,000 of dividend income increasedChapman & Power’stax liability by $1,260,000 (0.5x $12,000,000 x0.21). Hunt Taxidermy’s resulting average tax rate is:Average tax rage = $29,610,000/$141,000,000=21.00%Finally, ifChapman & Powerearned $1 more of taxable income, it wouldpay21cents (based upon its tax rate of21percent) more in taxes.Thus, the firm’s marginal tax rate is 21 percent.LG2-42-11Statement of Cash FlowsRamakrishnan Inc. reported 2021net income of $15 million anddepreciation of $2,650,000. The top part of Ramakrishnan, Inc.’s 2021and 2020balance sheets islisted below (in millions of dollars).Current assets:20212020Current liabilities:20212020Cash and marketableAccrued wages andsecurities$ 20$ 15taxes$ 19$ 18Accountsreceivable8475Accounts payable5145Inventory121110Notes payable4540

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Chapter 2-ReviewingFinancial StatementsTotal$225$200Total$115$103Calculate the 2021net cash flow from operating activities for Ramakrishnan, Inc.Cash Flows from Operating ActivitiesNet income$15,000,000Additions (sources of cash):Depreciation2,650,000Increase in accrued wages and taxes1,000,000Increase in accounts payable6,000,000Subtractions (uses of cash):Increase in accounts receivable-9,000,000Increase in inventory-11,000,000Net cash flow from operating activities:$4,650,000LG2-42-12Statement of Cash FlowsIn 2021, Usher Sports Shop had cash flows from investing activitiesof-$4,364,000 and cash flows from financing activities of-$5,880,000. The balance in the firm’scash account was $1,615,000 at the beginning of 2021and $1,742,000 at the end of the year.Calculate Usher Sports Shop’s cash flow from operations for 2021.Net change in cash and marketable securities = $1,742,000-$1,615,000 = $127,000Cashflows fromoperatingactivities=$10,371,000Cashflows frominvestingactivities=-4,364,000Cashflows fromfinancingactivities=-5,880,000Netchange incash andmarketablesecurities=$127,000LG2-52-13Free Cash FlowYou are considering an investment in Fields and Struthers, Inc.,and wantto evaluate the firm’s free cash flow. From the income statement, you see that Fields andStruthers earned an EBIT of $62 million,had a tax rate of 30 percent, and its depreciationexpense was $5 million. Fields and Struthers’ gross fixed assets increased by $32 million from2020to 2020. The firm’s current assets increased by $20 million and spontaneous currentliabilities increased by $12 million. Calculate Fields and Struthers’NOPAT,operating cash flow,investment in operating capital,and free cash flow for 2021.Fields and Struthers’NOPAT was:NOPAT = EBIT(1–Tax rate) = $62m.(1–0.21) = $48.98m.Operating cash flowfor 2021was:OCF =NOPAT+ Depreciation= $48.98m.+ $5m.= $53.98m.Investment in operating capital for 2021was:IOC = ΔGross fixed assets + ΔNet operating working capital= $32m. + ($20m.-$12m.) = $40 m.Accordingly, Fields and Struthers’ free cash flow for 2021was:FCF = Operating cash flow–Investment in operating capital= $53.98m.-$40m. = $13.98m.

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Chapter 2-ReviewingFinancial StatementsIn other words, in 2021, Fields and Struthers had cash flows of $13.98million available to pay its stockholders anddebtholders.LG2-52-14Free Cash FlowTater and Pepper Corp. reported free cash flows for 2021of $39.1million andinvestment in operating capital of $22.1million. Tater and Pepper incurred $13.6million indepreciation expense andpaid$28.9million in taxeson EBIT in 2021. Calculate Tater and Pepper’s2021EBIT.Tater and Pepper’s free cash flow for 2021was:FCF = Operating cash flow–Investment in operating capital$39.1m. = Operating cash flow-$22.1m.So, operating cash flow = $39.1m. + $22.1m. =$61.2m.Tater and Pepper’s operating cash flow was:OCF =EBIT(1–Tax rate) + Depreciation =EBIT–Taxeson EBIT+ Depreciation$61.2m. = EBIT–$28.9m. + $13.6m.So, EBIT = $61.2m. + $28.9m.-$13.6m. = $76.5m.LG2-12-15Statement of Retained EarningsMr. Husker’s Tuxedos, Corp. began the year 2021with $256million in retained earnings. The firm earned net income of $33 million in 2021and paiddividends of$5 million to its preferred stockholders and $10 million to its common stockholders. What is the year-end 2021balance in retained earnings for Mr. Husker’s Tuxedos?The statement of retained earnings for 2021is as follows:Balance of retained earnings, December 31, 2020$256m.Plus: Net income for 202133m.Less: Cash dividends paidPreferred stock$5m.Common stock10m.Total cash dividends paid15m.Balance of retained earnings, December 31, 2021$274m.LG2-12-16Statement of Retained EarningsUse the following information to find dividends paid tocommon stockholders during 2021.Balance ofretainedearnings, December 31, 2020$462m.Plus: Netincome for 202115m.Less: CashdividendspaidPreferredstock$1m.Commonstock_6m.Totalcashdividendspaid7m.Balance ofretainedearnings, December 31, 2021$470m.Totalcashdividendspaid = $470m.-$15m.-$462m. =-$7m.Thus, common stock dividends paid = $7m.-$1m =$6m.intermediate2-17Balance SheetMikey’sBar and Grill has total assets of$15 million of which $5 million

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Chapter 2-ReviewingFinancial Statementsproblemsare current assets. Cash makes up 10 percent of the current assets and accounts receivable makes upanother 40 percent of currentassets.Mikey’sgross plant and equipment has a book value of $11.5million and other long-term assets have a book value of $500,000.Using this information, whatis theLG2-1balance of inventory and the balance of depreciation onMikey’sBar and Grill’s balance sheet?Current assets:(in millions)Cash and marketablesecurities$ 0.5(0.1 x $5)Accounts receivable2.0(0.4 x $5)Inventorystep 1.2.5($5-$0.5-$2.0)Total$5.0Fixed assets:Gross plant andequipment$11.5Less: Depreciationstep 4.2.0($11.5-$9.5)Net plant andequipmentstep 3.$9.5($10.0-$0.5)Other long-termassets0.5Totalstep 2.$10.0($15.0-$5.0)Total assets$15.0LG2-12-18Balance SheetSophie’s Tobacco Shop has total assets of $91.8million. Fifty percent of theseassets are financed with debt of which $28.9million is current liabilities. The firm has no preferredstock,but the balance in commonstock and paid-in surplus is $20.4million. Using this informationwhat is the balance for long-term debt and retained earnings onSophie’sTobacco Shop’s balancesheet?(in millions)Total current liabilities$28.9Long-term debt:step 3.17.0(= $45.9-$28.9)Total debt:step 2.$45.9(=0.5 x $91.8)Stockholders’ equity:Preferred stock$ 0.0Common stock andpaid-in surplus20.4(20 million shares)Retained earningsstep 5.25.5(= $45.9-$20.4)Totalstep 4$45.9(= $91.8-$45.9)Total liabilities and equitystep 1.$91.8(= Total Assets)LG2-22-19Market Value versus Book ValueMuffin’s Masonry, Inc’sbalance sheet lists net fixed assetas $14 million. The fixed assets could currently be sold for $19 million. Muffin’s current balancesheet shows current liabilities of $5.5 million and net working capital of $4.5 million. If all thecurrent accounts were liquidated today, the company would receive $7.25 million cash after payingthe$5.5 million incurrentliabilities. What is the book value of Muffin’s Masonry’s assets today?What is the market value of these assets?

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Chapter 2-ReviewingFinancial StatementsBOOKMARKETVALUEVALUEAssetsCurrent assets Step 1.$10m.Step 3.$12.75m.Fixed assets14m.19.00m.TotalStep 2.$24m.Step 4.$31.75m.Step 1. Net working capital (book value) = Current assets (book value)–Current liabilities (book value)= $4.5m. = Current assets (book value)-$5.5m. => Current assets (book value) = $4.5m. + $5.5m. =$10m.Step 2. Total assets (book value) = $10m. + $14m. =$24m.Step 3. Net working capital (market value) = Current assets (market value)–Current liabilities (market value)= $7.25m. = Current assets (market value)-$5.5m. => Current assets (market value) = $7.25m. + $5.5m. =$12.75m.Step 4. Total assets (market value) = $12.75m. + $19m. =$31.75m.LG2-22-20Market Value versus Book ValueAva’s SpinBall Corp. lists fixed assets of $12 millionon its balance sheet. The firm’s fixed assets have recently been appraised at $16 million. Ava’sSpinBall Corp.’s balance sheet also lists current assets at $5 million. Current assets wereappraised at $6 million. Current liabilities’ book and market values stand at $3 million and thefirm’sbook and market values oflong-term debtare$7 million. Calculate the book and marketvalues of the firm’s stockholders’ equity. Construct the book value and market value balancesheets for Ava’s SpinBall Corp.(LG2)Recall the balance sheet identity in Equation 2-1: Assets = Liabilities + Equity. Rearranging this equation:Equity =Assets–Liabilities. Thus, the balance sheets would appear as follows:BOOKMARKETBOOKMARKETVALUEVALUEVALUEVALUEAssetsLiabilities and EquityCurrent assets$ 5m.$ 6m.Current liabilities$ 3m.$ 3m.Fixed assets12m.16m.Long-term debt7m.7m.Stockholders’ equity7m.12m.Total$17m.$22m.Total$17m.$22m.LG2-12-21Debt versus Equity FinancingYou are considering a stock investment in one of two firms(NoEquity, Inc.,andNoDebt, Inc.), both of which operate in the same industry and haveidenticalEBITDA of $37.7 million andoperating income of $32.5 million.NoEquity, Inc.,finances its $65 million in assets with $64 million in debt (on which it pays 10 percent interestannually) and $1 million in equity.NoDebt, Inc., finances its $65 million in assets with no debtand $65 million in equity. Both firms pay a tax rate of21percent on their taxable income.Calculate thenet incomeand return onasset-funders’ investmentfor the two firms.With $37.7 million of EBITDA AllDebt Inc., may deduct up to $11.31 million ($37.7 x 30 percent) of interestexpense for tax purposes. Thus, AllDebt Inc., is allowed to deduct all of its interest expense.NoEquityNoDebtOperating income$32.500m$32.500mLess: Interest($64m. x0.1)6.400m0.000mTaxable income$26.100m$32.500mLess: Taxes (21%)5.481m6.825mNet income$20.619m$25.675m

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Chapter 2-ReviewingFinancial StatementsIncome available for asset funders$10.379m$25.675m(= Operating income-Taxes)Returnonasset-funders’ investment$27.019m/$65m =41.57%$25.675m/$65m = 39.50%LG2-12-22Debt versus Equity FinancingYou are considering a stock investment in one of two firms(AllDebt, Inc.,and AllEquity, Inc.), both of which operate in the same industry and haveidenticalEBITDA of $14.7 million andoperating income of $12.5 million. AllDebt, Inc.,finances its $25 million in assets with $24 million in debt (on which it pays 10 percent interestannually) and $1 million in equity. AllEquity, Inc.,finances its $25 million in assets with no debtand $25 million in equity. Both firms pay a tax rate of21percent on their taxable income.Calculate the income available to pay the asset funders (the debtholders and stockholders) andresulting returnonasset-funders’ investmentforthe two firms.With $14.7 million of EBITDA AllDebt Inc., may deduct up to $4.41 million ($14.7 x 30 percent) of interestexpense for tax purposes. Thus, AllDebt Inc., is allowed to deduct all of its interest expense.AllDebtAllEquityOperating income$12.500m$12.500mLess:Interest($24m. x0.1)2.400m0.000mTaxable income$10.100m$12.500mLess: Taxes (21%)2.121m2.625mNet income$7.979m$9.875mIncome available for asset funders$10.379m$9.875m(=Operating income-Taxes)Return onasset-funders’ investment$10.379m./$25m. =41.516%$9.875m./$25m. = 39.500%LG2-12-23Income StatementYou have been given the following information for Corky’s Bedding Corp.:a. Net sales = $11,250,000.b. Cost of goods sold = $7,500,000.c. Other operating expenses = $250,000.d. Addition toretained earnings = $1,000,000.e. Dividends paid to preferred and common stockholders = $495,000.f. Interest expense = $850,000, all of which is taxdeductible.The firm’s tax rate is 35 percent. Calculate the depreciation expense for Corky’s Bedding Corp.Net sales$11,250,000Less: Cost of goods sold7,500,000Gross profitsStep 4.$3,750,000Less: Otheroperating expenses250,000Earnings before interest, taxes, depreciation, andamortization (EBITDA)Step 5.$3,500,000Less: DepreciationStep6.350,000Earnings before interest and taxes (EBIT)Step 3.$3,150,000Less: Interest850,000Earnings before taxes (EBT)Step 2.$2,300,000Less: Taxes (21%)

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Chapter 2-ReviewingFinancial StatementsNet incomeStep 1.$1,817,000Less: Common and preferred stock dividends$817,000Addition to retained earnings$1,000,000Step 1. Net income = Common and preferred stock dividends + Addition to retained earnings=$817,000 + $1,000,000 =$1,817,000Step 2. EBT (1–Tax rate) = Net income => EBT = Net income/(1–Tax rate) = $1,817,000/(1-0.21) =$2,300,000Step 3. EBIT–Interest = EBT => EBIT = EBT + Interest = $2,300,000 + $850,000 =$3,150,000Step 4. Gross profits = Net sales–Cost of goods sold = $11,250,000–7,500,000 =$3,750,000Step 5. EBITDA = Gross profits–Other operating expenses = $3,750,000–250,000 =$3,500,000Step6.EBITDA–Depreciation= EBIT => Depreciation =EBITDA–EBIT = $3,500,000-$3,150,000 =$350,000LG2-12-24Income StatementYou have been given the following information for Moore’s HoneyBeeCorp.:a. Net sales = $32,000,000.b. Gross profits= $18,700,000.c. Other operating expenses = $2,500,000.d. Addition to retained earnings = $4,700,000.e. Dividends paid to preferred and common stockholders = $2,900,000.f. Depreciation expense = $2,800,000.The firm’s tax rate is 35 percent.The firm’s interest expense is all tax deductible.Calculate thecost of goods sold and the interest expense for Moore’s HoneyBee Corp.Net sales$32,000,000Less: Cost of goods soldStep 1.13,300,000Gross profits$18,700,000Less: Other operating expenses2,500,000Earnings before interest, taxes, depreciation, andamortization (EBITDA)Step 4.$16,200,000Less: Depreciation2,800,000Earnings before interest and taxes (EBIT)Step5.$13,400,000Less: InterestStep 6.1,700,000Earnings before taxes (EBT)Step 3.$11,700,000Less: Taxes (21%)Net incomeStep 2.$9,243,000Less: Common and preferred stock dividends$2,900,000Addition to retained earnings$6,343,000Step 1. Net sales-Cost of goods sold = Gross profits => Cost of goods sold = Net sales–Gross Profits =$32,000,000–$18,700,000 =$13,300,000Step 2. Net income = Common and preferred stock dividends + Addition to retained earnings=$2,900,000 + $6,343,000 =$9,243,000Step 3. EBT (1–Tax rate) = Net income => EBT = Net income/(1–Tax rate) = $9,243,000/(1-0.21) =$11,700,000Step 4. EBITDA = Gross profits–Other operating expenses = $18,700,000–2,500,000 =$16,200,000Step5.EBITDA–Depreciation = EBIT = $16,200,000-$2,800,000 =$13,400,000Step6. EBIT–Interest = EBT => Interest = EBIT-EBT =$13,400,000-$11,7000,000=$1,700,000LG2-12-25Income StatementConsider a firm with anEBITDA of $1,100,000 and anEBIT of$1,000,000. The firm finances its assets with $4,500,000 debt (costing8percent, all of which is

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Chapter 2-ReviewingFinancial Statementstax deductible) and 200,000 shares of stockselling at $16.00 per share.To reduce risk associatedwith this financial leverage, the firm is considering reducing its debt by $2,500,000 by sellingadditional shares of stock. The firm’s tax rateis21percent. The change in capital structure willhave no effect on the operations of the firm. Thus, EBIT will remain at $1,000,000. Calculate thechangein the firm’s EPS from this change in capital structure.With $1,100,000 of EBITDA, the firm may deduct up to $330,000 ($1,100,000 x 30 percent) of interest expense fortax purposes. Thus, given the current capital structure, the firm may deduct only $330,000 of its $360,000interestexpense ($4,500,000x0.08) for tax purposes. Thus,Taxable income = EBIT–Allowable interest deduction= $1,000,000-$330,000 = $670,000Tax liability = 0.21x Taxable income= 0.21($670,000) = $140,700With the proposed change in capital structure, the firm may deduct all of its $160,000($2,000,000x0.08)interestexpensefor tax purposes.Number of shares of stock that must be sold to raise $2,500,000:$2,500,000/$16 = 156,250=> number of shares of stock outstanding after refinancing = 200,000 + 156,250 = 356,250The EPS before and after this change in capital structure is illustrated below:Before capital structure changeAfter capital structure changeEBIT$1,000,000$1,000,000Less:Interest($4,500,000x 0.08)360,000($2,000,000 x 0.08)160,000EBT640,000840,000Less:Taxes (21%)140,700176,400Net income$499,300$663,600Divide by# of shares200,000356,250EPS$2.4965$1.8627The change in capital structurewill result in a decrease inthe stockholders EPS by $0.6338.LG2-12-26Income StatementConsider a firm withanEBITDA of $13,00,000 andan EBIT of$10,500,000. The firmfinances its assets with $50,000,000 debt (costing6.5percent) and10,000,000 shares of stock selling at $10.00 per share.The firm is considering increasing its debtby $25,000,000, using the proceeds to buy back shares of stock.The firm’s tax rateis21 percent.The change in capital structure will have no effect on the operations of the firm. Thus, EBIT willremain at $10,500,000. Calculate thechangein the firm’s EPS from this change in capitalstructure.With $13,000,000 of EBITDA, the firmmay deduct up to $3,900,000 ($13,000,000 x 30 percent) of interest expensefor tax purposes. Thus, given the current capital structure, the firm may deductthe full$3,250,000($50,000,000x0.065) of itsinterest expensefor tax purposes.With the proposed change in capital structure, the firm may deductonly $3,900,000 of its $4,875,000interest expense ($75,000,000x0.065) for tax purposes. Thus,Taxable income = EBIT–Allowable interest deduction= $10,500,000-$3,900,000 = $6,600,000

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Chapter 2-ReviewingFinancial StatementsTax liability = 0.21x Taxable income= 0.21($6,600,000) = $1,386,000Number of shares of stock that can be repurchased with $25,000,000:$25,000,000/$10 = 2,500,000=> number of shares of stock outstanding after refinancing = 10,000,000–2,500,000 = 7,500,000The EPS before and after this change in capital structure is illustrated below:Before capital structure changeAfter capital structure changeEBIT$10,500,000$10,500,000Less:Interest($50,000,000x 0.065)3,250,000($75,000,000 x 0.065)4,875,000EBT7,250,0005,625,000Less:Taxes (21%)1,522,5001,386,000Net income$5,727,500$4,239,000Divide by# of shares10,000,0007,500,000EPS$0.57275$0.56520The change in capital structuredecreases the stockholders EPS by $0.00755.While interest on debt is tax deductibleup to 30 percent of EBITDA, in this case the change in the capital structure causes the firm to hit the tax deductiblecap. The tax benefits of additional debt do not apply once the firm hits the cap, causing debt to no longer be anattractive option from stockholders viewpoint.LG2-32-27Corporate TaxesThe Dakota Corporation had a 2021taxable income of $33,365,000from operations after all operating costs but before(1) interest charges of $8,500,000, all ofwhich is tax deductible;(2) dividends received of $750,000;(3) dividends paid of $5,250,000;and(4) income taxes.The firm’s EBITDA is $tax rateis21 percent.a.Calculate Dakota’s income tax liability.The first50 percent of the dividends received is not taxable. Thus, only50 percent of the dividends received aretaxed, so:Taxable income = $33,365,000-$8,500,000 + (0.5)$750,000 = $25,240,000Now Dakota Corp.’s tax liability will be:Tax liability =0.21($25,240,000)= $5,300,400b. What are Dakota’s average and marginal tax rates on taxable income?Dakota Corp.’s average tax rate is:Average tax rate = $5,300,400/$25,240,000 =21.00%Finally, if Dakota Corp earned $1 more of taxable income, it would pay21cents (basedonits tax rate of21percent)more in taxes.Thus, the marginal tax rate is21percent.LG2-32-26Corporate TaxesSuppose that in addition to $17.85 million of taxable income, TexasTaco, Inc.,received $1,105,000 of interest on state-issued bonds and $760,000 of dividends oncommon stock it owns inArizonaTaco, Inc.a.Calculate Texas Taco’s income tax liability.

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Chapter 2-ReviewingFinancial StatementsInterest on the state-issued bonds is not taxable and should not be included in taxable income. Further, the first50percent of the dividends received fromArizonaTaco is not taxable. Thus, only50 percent of the dividends receivedare taxed, so:Taxable income = $17,850,000 + (0.5)$760,000 = $18,230,000Texas Taco’s tax liability will be:Tax liability =0.21($18,230,000) = $3,828,300b. What are Texas Taco’s average and marginal tax rates on taxable income?Texas Taco’s resultingaverage tax rate is:Average tax rate = $3,828,300/$18,230,000=21.00%Finally, if Texas Taco earned $1 more of taxable income, it would pay21cents (based upon its tax rate of21percent) more in taxes.Thus, the marginal tax rate is21percent.LG2-52-29Statement of Cash FlowsUse the balance sheet and income statement below to construct astatement of cash flows for Clancy’s Dog Biscuit Corporation.Clancy’s Dog Biscuit CorporationBalance Sheet as of December 31, 2021and 2020(in millions of dollars)2021202020212020AssetsLiabilitiesandEquityCurrent assets:Current liabilities:Cash and marketableAccrued wages andsecurities$5$5taxes$ 10$6Accounts receivable2019Accounts payable1615Inventory3629Notes payable1413Total$ 61$ 53Total$ 40$ 34Fixed assets:Long-term debt:$ 57$ 53Gross plant andequipment$106$ 88Less:AccumulatedStockholders’ equity:depreciation1511Preferred stock (2 million shares)$2$2Net plant andCommon stock andequipment$ 91$ 77paid-in surplus1111Other long-term(5 million shares)assets1515Retained earnings5745Total$106$ 92Total$ 70$ 58Total assets$167$145Total liabilities and equity$167$145Clancy’s Dog Biscuit CorporationIncome Statement for Years Ending December 31, 2021and 2020(in millions of dollars)20212020Net sales$ 76$ 80Less: Cost of goods sold3835Gross profits$ 38$ 45Less: Other operating expenses65Earnings before interest, taxes, depreciation, and

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Chapter 2-ReviewingFinancial Statementstization (EBITDA)$ 32$ 40Less: Depreciation44Earnings before interest and taxes (EBIT)$ 28$ 36Less: Interest55Earnings before taxes (EBT)$ 23$ 31Less: Taxes57Net income$18$24Less: Preferred stock dividends$ 1$ 1Net income available to common stockholders$17$23Less: Common stock dividends55Addition to retained earnings$12$18Per (common) share data:Earnings per share (EPS)$3.00$4.20Dividends per share (DPS)$1.00$1.00Book value per share (BVPS)$13.60$11.20Market value (price) per share (MVPS)$14.25$14.60SOLUTION:Statement of Cash Flows for Year Ending December 31, 2021(in millions of dollars)2021A. Cashflows fromoperatingactivitiesNet income$18Additions (sources of cash):Depreciation4Increaseaccrued wages and taxes4Increase in accounts payable1Subtractions (uses of cash):Increase in accounts receivable-1Increase in inventory-7Net cash flow from operating activities:$19B. Cashflows frominvestingactivitiesSubtractions:Increase fixed assets-$18Increase in other long-term assets0Net cash flow from investing activities:-$18C. Cashflows fromfinancingactivitiesAdditions:Increase in notes payable$ 1Increase in long-term debt4Increase in common and preferred stock0Subtractions:Preferred stock dividends-1Common stock dividends-5Net cash flowfrom financing activities:-$1D. Netchange incash andmarketablesecurities-$0

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Chapter 2-ReviewingFinancial StatementsLG2-52-30Statement of Cash FlowsUse the balance sheet and income statement below to construct astatement of cash flows for Valium’s Medical Supply Corporation.Valium’s Medical Supply CorporationBalance Sheet as of December 31, 2021and 2020(in thousands of dollars)2021202020212020AssetsLiabilitiesandEquityCurrent assets:Currentliabilities:Cash and marketableAccrued wages andsecurities$74$73taxes$58$45Accounts receivable199189Accounts payable159145Inventory322291Notespayable131131Total$595$553Total$348$ 321Fixed assets:Long-term debt:$565$549Gross plant andequipment$1,084$886Less:AccumulatedStockholders’ equity:depreciation153116Preferred stock (6 thousand shares) $6$6Net plant andCommon stock andequipment$931$770paid-in surplus120120Other long-term(100 thousand shares)assets130130Retained earnings617457Total$1,061$ 900Total$743$583Total assets$1,656$1,453Total liabilities and equity$1,656$1,453Valium’s Medical Supply CorporationIncome Statement for Years Ending December 31, 2021and 2020(in thousands of dollars)20212020Net sales$ 888$ 798Less: Cost of goods sold387350Grossprofits$ 501$ 448Less: Other operating expenses4842Earnings before interest, taxes, depreciation, andamortization (EBITDA)$453$ 406Less: Depreciationand amortization3735Earnings before interest and taxes (EBIT)$ 416$ 371Less: Interest4640Earnings before taxes (EBT)$ 370$ 331Less: Taxes7870Net income$ 292$261Less: Preferred stock dividends$6$6Net income available to common stockholders$ 286$ 255Less: Common stock dividends126126Addition to retained earnings$ 160$ 129Per (common) share data:

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Chapter 2-ReviewingFinancial StatementsEarnings per share (EPS)$2.86$2.55Dividends per share (DPS)$1.26$1.26Book value per share (BVPS)$7.37$5.77Market value (price) per share (MVPS)$8.40$6.25SOLUTION:Statement of Cash Flows for Year Ending December 31, 2021(in thousands of dollars)A. Cashflows fromoperatingactivitiesNet income$292Additions (sources of cash):Depreciationand amortization37Increase inaccrued wages and taxes13Increase in accounts payable14Subtractions (uses of cash):Increase in accounts receivable-10Increase in inventory-31Net cash flow from operating activities:$315B. Cashflows frominvestingactivitiesSubtractions:Increase in fixed assets-$198Increase in other long-term assets0Net cash flow from investing activities:-$198C. Cashflows fromfinancingactivitiesAdditions:Increase in notes payable$0Increase in long-term debt16Increase in common and preferred stock0Subtractions:Preferred stock dividends-6Common stock dividends-126Net cashflow from financing activities:-$116D. Netchange incash andmarketablesecurities$1LG2-52-31Statement of Cash FlowsChris’ Outdoor Furniture, Inc.,has net cash flows fromoperating activities for the last year of $340 million. The income statement shows that netincome is $315 million and depreciation expense is $46 million. During the year, the change ininventory on the balance sheet was $38 million, change in accrued wages and taxes was $15million and change in accounts payable was $20 million. At the beginning of the year thebalance of accounts receivable was $50 million. Calculate the end-of-year balance for accountsreceivable.A. Cashflows fromoperatingactivities(in millions)Net income$315Additions (sources of cash):Depreciation46

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Chapter 2-ReviewingFinancial StatementsIncrease accrued wages and taxes15Increase in accounts payable20Subtractions (uses of cash):Increase in accounts receivable-18 (=$340-$315-$46-$15-$20+$38)Increase in inventory-38Net cash flow from operating activities:$340End-of-year balanceforaccounts receivable = $50m. +$18m. = $68m.LG2-52-32Statement ofCash FlowsDogs 4 U Corporation has net cash flow from financingactivities for the last year of $34million. The company paid $178million in dividends last year.During the year, the change in notes payable on the balancesheetwas $39million, and change incommon and preferred stock was $0.The end-of-year balance for long-term debt was $315million.Calculate the beginning-of-year balance for long-term debt.C. Cashflows fromfinancingactivities(in millions)Additions:Increase in notes payable$ 39Increase in long-term debt173(=$34+$178-$39)Increase in common and preferred stock0Subtractions:Stock dividends-178Net cash flow from financing activities:$34Beginning-of-yearbalance for long-term debt = $315m.-$173m = $142m.LG2-52-31Free Cash FlowThe 2021income statement for Duffy’s Pest Control shows thatdepreciation expensewas$197 million, EBITwas$440million, and the tax ratewas21percent.At the beginning of the year, the balance of gross fixed assets was $1,562 million and netoperating working capital was $417 million. At the end of the year,gross fixed assets was $1,803million. Duffy’s free cash flow for the year was $424 million. Calculate the end-of-year balancefor net operating working capital.Duffy’s Pest Control’s operating cash flow was:OCF = EBIT(1–Tax rate)+ Depreciation= ($440m.(1-0.21)+ $197m.) = $544.6m.Duffy’s Pest Control’s free cash flow for2021was:FCF = Operating cash flow–Investment in operating capital$424m. = $544.6m.-Investment in operating capital=> Investment in operating capital = $544.6m.-$424m. =$120.6m.Accordingly, investment in operating capital for 2021was:IOC = ΔGross fixed assets + ΔNet operating working capital$120.6m. = ($1,803m.-$1,562m.) + (Ending net operating working capital-$417m.)=> Ending net operating working capital = $120.6m.-($1,803m.-$1,562m.) + $417m. = $296.6m.LG2-52-34Free Cash FlowThe 2021income statement for Egyptian Noise Blasters shows thatdepreciation expense is $85million,NOPAT is $246million. At the end of the year, the balance

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Chapter 2-ReviewingFinancial Statementsgross fixed assets was $655 million. The change in net operating working capital during theyear was $73 million. Egyptian’s free cash flow for the year was $190 million. Calculate thebeginning-of-year balance for gross fixed assets.Egyptian Noise Blasters’ operating cash flow was:OCF =NOPAT+ Depreciation== ($246m.+ $85m.) = $331m.Egyptian Noise Blasters’ free cash flow for 2021was:FCF = Operating cash flow–Investment in operating capital$190m. = $331m.-Investment in operating capital= > Investment in operating capital = $331m.-$190m. = $141m.Accordingly, investment in operating capital for 2021was:IOC = ΔGross fixed assets + ΔNet operating working capital$141m. = ($655m.–Beginning of year gross fixed assets) + $73m.=> Beginning of year gross fixed assets = $655m.-$141m. +$73m. = $587m.LG2-12-35Statement of Retained EarningsThelma and Louie, Inc., started the year with a balanceof retained earnings of $543 million and ended the year with retained earnings of $589 million.The company paid dividends of $35 million to the preferred stockholders and $88 million tocommon stockholders. Calculate Thelma and Louie’s net income for the year.Statement of Retained Earnings as of December 31, 2021(in millions of dollars)Balance of retained earnings, December 31, 2020$543Plus: Net income for 2021169(= $589 + $123-$543)Less: Cash dividends paidPreferred stock$35Common stock88Total cash dividends paid123Balance of retained earnings, December 31, 2021$589LG2-12-36Statement of Retained EarningsJamaica Tours, Inc.,started the year with a balance ofretained earnings of $1,780million. The company reported net income for the year of $284million andpaid dividends of $17 million to the preferred stockholders and $59 million tocommon stockholders. Calculate Jamaica Tour’s end-of-year balance in retained earnings.Statement ofRetained Earnings as of December 31, 2018(in millions of dollars)Balance of retained earnings, December 31, 2017$1,780Plus: Net income for 2018284Less: Cash dividends paidPreferred stock$17Common stock59Total cash dividends paid76Balance of retained earnings, December 31, 2018$1,988

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Chapter 2-ReviewingFinancial Statementsadvanced2-37Income StatementListed below is the 2021income statement for Tom and Sue Travels,Inc.problemsLG2-1Tom and Sue Travels, Inc.Income Statement for Year Ending December 31, 2021(in millions of dollars)Net sales$16.500Less: Cost of goods sold7.100Gross profits9.400Less: Otheroperating expenses3.200Earnings before interest, taxes, depreciation, andamortization (EBITDA)6.200Less: Depreciation2.900Earnings before interest and taxes (EBIT)3.300Less: Interest0.950Earnings before taxes (EBT)2.350Less: Taxes0.495Net income$ 1.855The CEO of Tom and Sue’s wants the company to earn a net income of $2.250 million in 2022.Cost of goods sold is expected to be 60percent ofnet sales, depreciation and other operatingexpenses arenot expected to change,interest expense is expected to increase to $1.416million,and the firm’s tax rate will be21percent. Calculate the net sales needed to produce net incomeof $2.250 million.Tom and Sue Travels, Inc.Income Statement for Year Ending December 31, 2022(in millions of dollars)Net salesStep5.$25.910Less: Cost of goods soldStep 6.15.546Gross profitsStep 4.10.364Less: Other operating expenses3.200Earnings before interest, taxes, depreciation, andamortization (EBITDA)Step 3.7.164Less: Depreciation2.900Earnings before interest and taxes (EBIT)Step 2.4.264Less: Interest1.416Earnings before taxes (EBT)Step 1.3.214Less: TaxesNet income$ 2.250Step 1.EBT (1-t) = Net income = $2.250m = EBT (1-0.21) => EBT = $2.250m./(1-0.21) =$2.848m.Step 2. EBIT = EBT + Interest = $2.848m. + $1.416m. = $4.264m.Step 3.EBITDA= EBIT + Depreciation = $4.264m. + $2.900m. = $7.164mStep4. Gross profits = EBITDA+Other operating expenses= $7.164m. +$3.200m.= $10.364mStep 4. Net sales = Gross profits/(1-Cost of goods sold percent) = $10.364m./(1-0.6) = $25.910m.

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Chapter 2-ReviewingFinancial StatementsStep 5. Cost of goods sold = Net sales–Gross profits = $25.910m.-$10.364 = $15.546m.LG2-12-38Income StatementYou have been given the following information forPattyCake’sAthletic Wear Corp. for the year 2021:a. Net sales = $38,250,000.b. Cost of goods sold = $22,070,000.c. Other operating expenses = $5,300,000.d. Addition to retained earnings = $2,195,500.e. Dividends paid to preferred and common stockholders = $1,912,000.f. Interest expense = $1,785,000.g.The firm’s tax rate is21percent.In 2022:h.net sales are expected to increase by $9.75 million.i. Cost of goods sold is expectedto be60 percent of net sales.j. Depreciationandother operating expenses areexpected to be the same as in 2021.k. Interest expense is expected to be $2,004,367.l. The tax rate is expected to be21percent of EBT.m. Dividends paid to preferred and common stockholders will not change.Calculate the addition to retained earnings expected in 2022.Income Statement for Year Ending December 31, 2021(in millions of dollars)Net sales$38,250,000Less: Cost of goods sold22,070,000Gross profits16,180,000Less: Other operating expenses5,300,000Earnings before interest, taxes, depreciation, andamortization (EBITDA)10,880,000Less: Depreciation$10,880,000-$6,984,3673,895,633Earnings before interest and taxes (EBIT)$5,199,367+ $1,785,0006,984,367Less: Interest1,785,000Earnings before taxes (EBT)$4,107,500 / (1-0.21)5,199,367Less: TaxesNet income$4,107,500Less: Preferred and common stock dividends$1,912,000Addition to retained earnings$2,195,500IncomeStatement for Year Ending December 31, 2022(in millions of dollars)Net sales (all credit)$38,250,000 + $9,750,000$48,000,000Less: Cost of goods sold0.6 x $48,000,00028,800,000Gross profits19,200,000Less: Other operating expenses5,300,000

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Chapter 2-ReviewingFinancial StatementsEarnings before interest, taxes, depreciation, andamortization (EBITDA)13,900,000Less: Depreciation3,895,633Earnings before interest and taxes (EBIT)10,004,367Less: Interest2,004,367Earnings before taxes (EBT)8,000,000Less: Taxes (21%)1,680,000Net income$6,320,000Less: Preferred and common stock dividends$1,912,000Addition to retained earnings$4,408,000LG2-52-39Free Cash FlowRebecky’s Flowers 4U, Inc.,had free cash flowsduring 2021of $43million,NOPATof $85million, and depreciation of $14 million. Using this information, fill inthe blanks onRebecky’s balance sheet below.Rebecky’s operating cash flow for 2021was:OCF =NOPAT+ Depreciation = ($85m. + $14m.) = $99m.Rebecky’s free cash flow was:FCF = Operating cash flow–Investment in operating capital$43m. = $99m.-Investment in operating capitalSo, Investment in operating capital = $99m.-$43m. = $56m.IOC = ΔGross fixed assets + ΔNet operating working capital$56m. = ($333m.-$300m.) + ΔNet operating working capital=> ΔNet operating working capital = $56m.-($333m.-$300m.) = $23m.ΔNet operating working capital = $23m.=∆Current assets-∆Current liabilities$23m. = ($221m.-$190m.)-∆Current liabilities=>∆Current liabilities = ($221m.-$190m.)-$23m. = $8m.=>2021Current liabilities = $110m. + $8m. =$118m.and 2021Current liabilities = Accrued wages and taxes + Accounts payable + Notes payable$118m. =$17m. + Accounts payable + $45m.=> Accounts payable = $118m.-$17m.-$45m. =$56m.=>Long-term debt= $550m.-$118m.-$237m. =$195m.Rebecky’s Flowers 4U, Inc.Balance Sheet as of December 31, 2021and 2020(in millions of dollars)2021202020212020AssetsLiabilitiesandEquityCurrent assets:Current liabilities:Cash and marketableAccrued wages andsecurities$ 28$ 25taxes$ 17$ 15Accounts receivable7565Accounts payable5650Inventory118100Notes payable4545Total$221$190Total$118$110Fixed assets:Long-term debt:$195$190Gross plant andequipment$333$300

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Chapter 2-ReviewingFinancial StatementsLess:AccumulatedStockholders’ equity:depreciation5440Preferred stock (5 millionshares)$5$5Net plant andCommon stock andequipment$279$260paid-in surplus4040Other long-term(20 million shares)assets5050Retained earnings192155Total$329$310Total$237$200Total assets$550$500Total liabilities and equity$550$500LG2-52-38Free Cash FlowVinny’s Overhead Construction had free cash flow during 2021of $25.4million. The change in gross fixed assets onVinny’s balance sheet during 2021was $7.0 millionand the change in netoperating working capital was $8.4million. Using this information, fill inthe blanks onVinny’s income statement below.IOC = ΔGross fixed assets + ΔNet operating working capital=>IOC = $7.0m. + $8.4m. = $15.4m.FCF = Operating cash flow–Investment in operating capital=>$25.4m. =OCF–$15.4m.=>OCF= $25.4m.+$15.4m. = $40.8m.OCF = EBIT(1–0.21)+ DepreciationUsing the numbers below: $40.8m. =EBIT(1–0.21)+ $10.2m.=>EBIT=($40.8m.-$10.2m.)/(1–0.21) = $38.73mVinny’s Overhead Construction, Corp.Income Statement for Year Ending December 31, 2021(inmillions of dollars)Net sales$ 182.10Step 1.(=$66.00 + $116.10)Less: Cost of goods sold116.10Gross profits$66.00Less: Other operating expenses17.07Step 7.(=$66.00-$48.93)Earnings before interest, taxes, depreciation, andamortization (EBITDA)48.93Step 6.(=$38.73 + $10.20)Less: Depreciation10.20Earnings before interest and taxes (EBIT)$38.73Step 2.(fromabove)Less: Interest3.73Step5.(=$38.73-$35.00)Earnings before taxes (EBT)$35.00Step3.(= $27.65/ (1–0.21)Less: Taxes (21% from above)7.35Step4. (= $35.00-$27.65)Net income$27.65research it!Reviewing Financial StatementsGo the web site of Wal-Mart Stores, Inc. atwww.walmartstores.comand get the latestfinancial statements from the annual report using the following steps.

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Chapter 2-ReviewingFinancial StatementsGo to Wal-Mart Stores, Inc.’s Web site atwww.walmartstores.com.Click on Investors, thenselectAnnual Reports; next choose Annual Reports& Proxies. This will bring the file onto yourcomputer thatcontains the relevant data. Locate the total assets, total equity, net sales, netincome, dividends paid, cash flows from operating activities, and cash flows from investingactivities for the last two years. How have these items changed over the last two years?SOLUTION: The solution will vary with the year annual report is accessed. However, theannual report for each year summarizes the financial information necessary to evaluate keyinformation used by firm managers, who make financial decisions, and by investors, who decidewhether or not to invest in the firm.

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Chapter 2-ReviewingFinancial Statementsintegratedmini-case: Working with Financial StatementsShownbelow are partial financial statements for Garners’ Platoon Mental Health Care, Inc. Fill in theblanks on the four financial statements.Garners’Platoon Mental Health Care, Inc.Balance Sheet as of December 31, 2021and 2020(in millions of dollars)2021202020212020AssetsLiabilitiesandEquityCurrentassets:Current liabilities:Cash and marketableAccrued wages andsecurities$ 421$____taxes$316$242Accounts receivable____1,020Accounts payable867791Inventory1,7601,581Notes payable____714Total$3,290$____Total$2,055$1,747Fixed assets:Long-term debt:$3,090$____Gross plant andequipment$____$4,743Less:AccumulatedStockholders’ equity:depreciation840640Preferred stock (30million shares) $60$60Net plant andCommon stock andequipment$4,972$____paid-in surplus637___Other long-termassets____790(200 million shares)Total$5,864$4,893Retained earnings3,3122,440Total$4,009$3,137Total assets$____$7,889Total liabilities and equity$9,154$7,889Garners’Platoon Mental Health Care, Inc.Income Statement for Years Ending December 31, 2021and 2020(in millions of dollars)20212020Net sales$4,980$Less: Cost of goods sold2,035Gross profits$2,734$2,313Less: Other operating expenses125100Earnings before interest, taxes, depreciation, andamortization (EBITDA)2,6092,213Less: Depreciation200191Earnings before interest and taxes (EBIT)$2,409$Less: Interest(21 percent)285Earnings before taxes (EBT)$2,094$1,737Less: Taxes_____Net income$1,654$1,372

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