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CHAPTER 2 Financial Statements, Cash Flow, and Taxes. Balance sheet Income statement Statement of cash flows Accounting income vs. cash flow MVA and EVA Personal taxes Corporate taxes. Balance Sheet: Assets. 2000. 1999. Cash. 7,282. 57,600. AR. 632,160. 351,200. Inventories.

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CHAPTER 2

Financial Statements, Cash Flow,and Taxes

  • Balance sheet

  • Income statement

  • Statement of cash flows

  • Accounting income vs. cash flow

  • MVA and EVA

  • Personal taxes

  • Corporate taxes


Balance Sheet: Assets

2000

1999

Cash

7,282

57,600

AR

632,160

351,200

Inventories

1,287,360

715,200

Total CA

1,926,802

1,124,000

Gross FA

1,202,950

491,000

Less: Deprec.

263,160

146,200

Net FA

939,790

344,800

Total Assets

2,866,592

1,468,800


Liabilities and Equity

2000

1999

Accts payable

524,160

145,600

Notes payable

720,000

200,000

Accruals

489,600

136,000

Total CL

481,600

1,733,760

Long-term debt

1,000,000

323,432

Common stock

460,000

460,000

Retained earnings

(327,168)

203,768

Total equity

132,832

663,768

Total L&E

2,866,592

1,468,800


Income Statement

2000

1999

Sales

5,834,400

3,432,000

COGS

5,728,000

2,864,000

Other expenses

680,000

340,000

(573,600)

228,000

EBITDA

116,960

18,900

Depr. & Amort.

EBIT

(690,560)

209,100

Interest exp.

176,000

62,500

EBT

(866,560)

146,600

Taxes (40%)

(346,624)

58,640

Net income

(519,936)

87,960


Other Data

2000

1999

No. of shares

100,000

100,000

EPS

($5.199)

$0.88

DPS

$0.110

$0.22

Stock price

$2.25

$8.50

Lease pmts

$40,000

$40,000


Statement of Retained Earnings (2000)

Balance of retained

earnings, 12/31/99 $203,768

Add: Net income, 2000 (519,936)

Less: Dividends paid (11,000)

Balance of retained

earnings, 12/31/00 ($327,168)


Statement of Cash Flows (2000)

OPERATING ACTIVITIES

Net income

(519,936)

Add (Sources of cash):

Depreciation

116,960

Increase in A/P

378,560

Increase in accruals

353,600

Subtract (Uses of cash):

Increase in A/R

(280,960)

Increase in inventories

(572,160)

Net cash provided by ops.

(523,936)


L-T INVESTING ACTIVITIES

Investment in fixed assets

(711,950)

FINANCING ACTIVITIES

Increase in notes payable

520,000

Increase in long-term debt

676,568

Payment of cash dividends

(11,000)

Net cash from financing

1,185,568

NET CHANGE IN CASH

(50,318)

Plus: Cash at beginning of year

57,600

Cash at end of year

7,282


What can you conclude about D’Leon’s financial condition from its statement of CFs?

  • Net cash from operations = -$523,936, mainly because of negative NI.

  • The firm borrowed $1,185,568 to meet its cash requirements.

  • Even after borrowing, the cash account fell by $50,318.


Did the expansion create additional net operating profit after taxes (NOPAT)?

NOPAT = EBIT(1 – Tax rate)

NOPAT00 = -$690,560(1 – 0.4)

= -$690,560(0.6)

= -$414,336.

NOPAT99 = $125,460.


What effect did the expansion have on after taxes (NOPAT)?

net operating working capital (NOWC)?

Current

assets

Non-interest

bearing CL

NOWC

= –

NOWC00 = ($7,282 + $632,160 + $1,287,360)

– ($524,160 + $489,600)

= $913,042.

NOWC99 = $842,400.


What effect did the expansion have on capital used in operations?

Operating

capital

= NOWC + Net fixed assets.

= $913,042 + $939,790

= $1,852,832.

= $1,187,200.

Operating

capital00

Operating

capital99


What is your initial assessment of the expansion’s effect on operations?

2000 1999

Sales $5,834,400 $3,432,000

NOPAT ($414,336) $125,460

NOWC $913,042 $842,400

Operating capital $1,852,832 $1,187,200

Net Income ($519,936) $87,960


What effect did the company’s expansion have on its net cash flow and operating cash flow?

NCF00 = NI + DEP = ($519,936) + $116,960

= ($402,976).

NCF99 = $87,960 + $18,900 = $106,860.

OCF00 = NOPAT + DEP

= ($414,336) + $116,960

= ($297,376).

OCF99 = $125,460 + $18,900

= $144,360.


What was the free cash flow (FCF) for 2000? cash flow and operating cash flow?

FCF = NOPAT – Net capital investment

= -$414,336 – ($1,852,832 – $1,187,200)

= -$414,336 – $665,632

= -$1,079,968.

Is negative free cash flow always a bad

sign?


Economic Value Added (EVA) cash flow and operating cash flow?

Operating IncomeAfter Tax

After-TaxCapital Costs

EVA = –

= –

= NOPAT – After-Tax Cost of Capital

Cost ofCapital Used

Funds Availableto Investors


EVA Concepts cash flow and operating cash flow?

  • In order to generate positive EVA, a firm has to more than just cover operating costs. It must also provide a return to those who have provided the firm with capital.

  • EVA takes into account the total cost of capital, which includes the cost of equity.


What is the company’s EVA? cash flow and operating cash flow?

Assume the firm’s after-tax cost of capital was 11% in 1999

and 13% in 2000.

EVA00 = NOPAT – (A-T cost of capital)(Capital)

= -$414,336 – (0.13)($1,852,832)

= -$414,336 – $240,868

= -$655,204.

EVA99 = $125,460 – (0.11)($1,187,200)

= $125,460 – $130,592

= -$5,132.


Would you conclude that cash flow and operating cash flow?

the expansion increased or

decreased MVA?

Market value

of equity

Equity capital

supplied

MVA = –

During the last year stock price has decreased 73%, so market value of equity has declined. Consequently, MVA has declined.


Leading Creators of Wealth in the U. S. cash flow and operating cash flow?

Market Value Added in 1999

Company Market Value Added

Microsoft $328,257 million

General Electric $285,320 million

Intel $166,902 million

Wal-Mart Stores $159,444 million

Coca-Cola $157,536 million

Merck $153,170 million

Pfizer $148,245 million

Cisco Systems $135,650 million

Lucent Technologies $127,265 million

Bristol-Myers Squibb $119,350 million


Does D’Leon pay its suppliers on time? cash flow and operating cash flow?

  • Probably not.

  • A/P increased 260% over the past year, while sales increased by only 70%.

  • If this continues, suppliers may cut off D’Leon’s trade credit.


Does it appear that D’Leon’s sales price exceeds its cost per unit sold?

  • No, the negative NOPAT and decline in cash position shows that D’Leon is spending more on its operations than it is taking in.


What effect would each of these actions have on D’Leon’s cash account?

1. The company offers 60-day credit terms. The improved terms are matched by its competitors, so sales remain constant.

  • A/R would é

  • Cash would ê


2. Sales double as a result of the cash account?

change in credit terms.

  • Short run: Inventory and fixed assets é to meet increased sales. A/R é , Cash ê. Company may have to seek additional financing.

  • Long-run: Collections increase and the company’s cash position would improve.


How did D’Leon finance its expansion? cash account?

  • D’Leon financed its expansion with external capital.

  • D’Leon issued long-term debt which reduced its financial strength and flexibility.


Would d leon have required external capital if they had broken even in 2000 net income 0
Would D’Leon have required external capital if they had broken even in 2000 (Net Income = 0)?

  • YES, the company would still have to finance its increase in assets.


What happens if d leon depreciates its fixed assets over 7 years as opposed to the current 10 years
What happens if D’Leon depreciates its fixed assets over 7 years (as opposed to the current 10 years)?

  • No effect on physical assets.

  • Fixed assets on balance sheet would decline.

  • Net income would decline.

  • Tax payments would decline.

  • Cash position would improve.


Other policies that affect financial statements
Other policies that affect years (as opposed to the current 10 years)?financial statements

  • Inventory valuation methods.

  • Capitalization of R&D expenses.

  • Policies for funding the company’s retirement plan.


Does the company’s positive stock price ($2.25), in the face of large losses, suggest that investors are irrational?

  • NO, it means that investors expect things to get better in the future.


Why did the stock fall after the dividend was cut
Why did the stock fall after the dividend was cut? face of large losses, suggest that investors are irrational?

  • Management was “signaling” that the firm’s operations were in trouble.

  • The dividend cut lowered expectations for future cash flows, which caused the stock price to decline.


What were some other sources of financing for d leon in 2000
What were some other sources of financing for D’Leon in 2000?

  • Bank loans: Notes payable increased by $520,000.

  • Credit from suppliers: A/P increased by $378,560.

  • Employees: Accruals increased by $353,600.


D leon received a tax credit of 346 624 in 2000
D’Leon received a tax credit of 2000?$346,624 in 2000.

  • This suggests the company paid at least $346,624 in taxes during the past 2 years.

  • If D’Leon’s payments over the past 2 years were less than $346,624 the firm would have had to carry forward the amount of its loss that was not carried back.

  • If the firm did not receive a full refund its cash position would be even worse.



April 2000 Single Individual Tax Rates 2000?

Taxable Income

Tax on Base

Rate*

0 - 25,750

0

15%

25,750 - 62,450

3,862.50

28%

62,450 - 130,250

14,138.50

31%

130,250 - 283,150

35,156.50

36%

Over 283,150

90,200.50

39.6%

*Plus this percentage on the amount over the bracket base.


Assume your salary is $45,000, and you received $3,000 in dividends. You are single, so your personal exemption is $2,750 and your itemized deductions are $4,850.

On the basis of the information above and the April 2000 tax rate schedule, what is your tax liability?


Calculation of Taxable Income dividends. You are single, so your personal exemption is $2,750 and your itemized deductions are $4,850.

Salary

$45,000

Dividends

3,000

Personal exemptions

(2,750)

Deductions

(4,850)

Taxable Income

$40,400


40,400 - 25,750 dividends. You are single, so your personal exemption is $2,750 and your itemized deductions are $4,850.

  • Tax Liability:

    TL = $3,862.50 + 0.28($14,650)

    = $7,964.50 »$7,965.

  • Marginal Tax Rate = 28%.

  • Average Tax Rate:

    Tax rate = = 19.71% »19.7%.

$7,965

$40,400


January 2000 Corporate Tax Rates dividends. You are single, so your personal exemption is $2,750 and your itemized deductions are $4,850.

Taxable Income

Tax on Base

Rate*

0 - 50,000

0

15%

50,000 - 75,000

7,500

25%

75,000 - 100,000

13,750

34%

100,000 - 335,000

22,250

39%

... ... ...

Over 18.3M

6.4M

35%

*Plus this percentage on the amount over the bracket base.


Assume a corporation has $100,000 of taxable income from operations, $5,000 of interest income, and $10,000 of dividend income.

What’s its tax liability?


Operating income operations, $5,000 of interest income, and $10,000 of dividend income.

$100,000

Interest income

5,000

Taxable dividend

income

3,000*

Taxable income

$108,000

Tax = $22,250 + 0.39 ($8,000)

=$25,370.

*Dividends – Exclusion

= $10,000 – 0.7($10,000) = $3,000.


State and local government bonds munis are generally exempt from federal taxes

Taxable vs. Tax-Exempt Bonds operations, $5,000 of interest income, and $10,000 of dividend income.

State and local government bonds (munis) are generally exempt from federal taxes.


  • Exxon bonds at 10% vs. California muni bonds at 7%. operations, $5,000 of interest income, and $10,000 of dividend income.

  • T = Tax rate = 28%.

  • After-tax interest income:

    Exxon = 0.10($5,000) – 0.10($5,000)(0.28)

    = 0.10($5,000)(0.72) = $360.

    CAL = 0.07($5,000) – 0 = $350.


Solve for t in this equation muni yield corp yield 1 t 7 00 10 0 1 t t 30 0

At what tax rate would you be indifferent to muni vs. corp? operations, $5,000 of interest income, and $10,000 of dividend income.

Solve for T in this equation:

Muni yield = Corp Yield(1 – T)

7.00% = 10.0%(1 – T)

T = 30.0%.


Implications operations, $5,000 of interest income, and $10,000 of dividend income.

  • If T > 30%, buy tax-exempt munis.

  • If T < 30%, buy corporate bonds.

  • Only high income people should buy munis.


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