2 - 1 copyright © 2001 by harcourt, inc.all rights reserved. balance sheet income statement...

2 - 1

Copyright © 2001 by Harcourt, Inc. All rights reserved.

Balance sheetIncome statementStatement of cash flowsAccounting income vs. cash flowMVA and EVAPersonal taxesCorporate taxes

CHAPTER 2Accounting and Finance

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Balance Sheet: Assets

Cash 7,282 57,600AR 632,160 351,200Inventories 1,287,360 715,200 Total CA 1,926,802 1,124,000Gross FA 1,202,950 491,000Less: Deprec. 263,160 146,200 Net FA 939,790 344,800Total Assets 2,866,592 1,468,800

2000 1999

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Liabilities and Equity

2000 1999Accts payable 524,160 145,600Notes payable 720,000 200,000Accruals 489,600 136,000 Total CL 1,733,760 481,600Long-term debt 1,000,000 323,432Common stock 460,000 460,000Retained earnings (327,168) 203,768 Total equity 132,832 663,768Total L&E 2,866,592 1,468,800

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Income Statement

Sales 5,834,400 3,432,000COGS 5,728,000 2,864,000Other expenses 680,000 340,000 EBITDA (573,600) 228,000Depr. & Amort. 116,960 18,900 EBIT (690,560) 209,100Interest exp. 176,000 62,500 EBT (866,560) 146,600Taxes (40%) (346,624) 58,640Net income (519,936) 87,960

2000 1999

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Other Data

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

2000 1999

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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)

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(523,936)

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 353,600Subtract (Uses of cash): Increase in A/R (280,960) Increase in inventories (572,160)

Net cash provided by ops.

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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 57,600Cash at end of year 7,282

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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.

What can you conclude about D’Leon’s financial condition from its

statement of CFs?

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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.

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What effect did the expansion have onnet operating working capital

(NOWC)?

NOWC = –Currentassets

Non-interestbearing CL

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

– ($524,160 + $489,600)= $913,042.

NOWC99 = $842,400.

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

Operatingcapital = NOWC + Net fixed assets.

= $913,042 + $939,790

= $1,852,832.

= $1,187,200.

Operatingcapital00

Operatingcapital99

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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

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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.

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

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?

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Economic Value Added (EVA)

EVA = –

= –

= NOPAT – After-Tax Cost of Capital

Operating IncomeAfter Tax

After-TaxCapital Costs

Funds Availableto Investors

Cost ofCapital Used

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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.

EVA Concepts

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What is the company’s EVA?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.

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Would you conclude that the expansion increased or

decreased MVA?

MVA = – Market value

of equityEquity capital

supplied

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

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Company Market Value AddedMicrosoft $328,257 millionGeneral Electric $285,320 millionIntel $166,902 millionWal-Mart Stores $159,444 millionCoca-Cola $157,536 millionMerck $153,170 millionPfizer $148,245 millionCisco Systems $135,650 millionLucent Technologies $127,265 millionBristol-Myers Squibb $119,350 million

Leading Creators of Wealth in the U. S.Market Value Added in 1999

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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 D’Leon pay its suppliers on time?

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

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

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

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

account?

A/R would Cash would

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2. Sales double as a result of thechange in credit terms.

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

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

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D’Leon financed its expansion with external capital.

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

How did D’Leon finance its expansion?

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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.

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No effect on physical assets.Fixed assets on balance sheet

would decline.Net income would decline.Tax payments would decline.Cash position would improve.

What happens if D’Leon depreciates its fixed assets over 7 years (as opposed

to the current 10 years)?

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Other policies that affect financial statements

Inventory valuation methods.

Capitalization of R&D expenses.

Policies for funding the company’s retirement plan.

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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.

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Why did the stock fall after the dividend was cut?

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.

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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.

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D’Leon received a tax credit of $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.

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INCOME TAXES

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April 2000 Single Individual Tax Rates

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.

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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?

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Calculation of Taxable Income

Salary $45,000

Dividends 3,000

Personal exemptions (2,750)

Deductions (4,850)

Taxable Income $40,400

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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%.

40,400 - 25,750

$7,965 $40,400

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January 2000 Corporate Tax Rates

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.

... ... ...

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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?

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Operating income $100,000Interest income 5,000Taxable dividendincome 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.

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

Taxable vs. Tax-Exempt Bonds

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Exxon bonds at 10% vs. California muni bonds at 7%.

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.

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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?

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If T > 30%, buy tax-exempt munis.If T < 30%, buy corporate bonds.Only high income people should

buy munis.

Implications

2 - 1 copyright © 2001 by harcourt, inc.all rights reserved. balance sheet income statement...

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