2 - 1 copyright © 2002 by harcourt, inc.all rights reserved. balance sheet income statement...

2 - 1

Copyright © 2002 by Harcourt, Inc. All rights reserved.

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

CHAPTER 2Financial Statements, Cash Flow,

and Taxes

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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

2001 2000

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Liabilities and Equity

2001 2000Accts payable 524,160 145,600Notes payable 636,808 200,000Accruals 489,600 136,000 Total CL 1,650,568 481,600Long-term debt 723,432 323,432Common stock 460,000 460,000Retained earnings 32,592 203,768 Total equity 492,592 663,768Total L&E 2,866,592 1,468,800

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Income Statement

Sales 6,034,000 3,432,000COGS 5,528,000 2,864,000Other expenses 519,988 358,672 EBITDA (13,988) 209,328Depr. & Amort. 116,960 18,900 EBIT (130,948) 190,428Interest exp. 136,012 43,828 EBT (266,960) 146,600Taxes (40%) (106,784) 58,640Net income (160,176) 87,960

2001 2000

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COMMON SIZED FINANCIAL STATEMENTS

To common size the Balance Sheet, divide all accounts by the Total Assets.

To common size the Income Statement, divide all accounts by Total Sales.

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Common Sized Balance Sheet: Assets

Cash 0.25 3.92AR 22.05 23.91Inventories 44.91 48.69 Total CA 67.22 76.53Gross FA 41.96 33.43Less: Deprec. 9.18 9.95 Net FA 32.78 23.47Total Assets 100.00 100.00

2001 2000

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Liabilities and Equity

2001 2000Accts payable 18.29 9.91Notes payable 22.21 13.62Accruals 17.08 9.26 Total CL 57.58 32.79Long-term debt 25.24 22.02Common stock 16.05 31.32Retained earnings 1.14 13.87 Total equity 45.19Total L&E 100.00

17.18 100.00

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Common Sized Income Statement

Sales 100.00 100.00COGS 91.61 83.45Other expenses 8.62 10.45 EBITDA -.23 6.10Depr. & Amort. 1.94 .55 EBIT -2.17 5.55Interest exp. 2.25 1.28 EBT -4.42 4.27Taxes (40%) -1.77 1.71Net income -2.65 2.56

2001 2000

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Other Data

No. of shares 100,000 100,000

EPS ($1.602) $0.88

DPS $0.110 $0.22

Stock price $2.25 $8.50

Lease pmts $40,000 $40,000

2001 2000

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Statement of Retained Earnings (2001)

Balance of retained

earnings, 12/31/00 $203,768

Add: Net income, 2001 (160,176)

Less: Dividends paid (11,000)

Balance of retained

earnings, 12/31/01 $32,592

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(164,176)

Statement of Cash Flows (2001)

OPERATING ACTIVITIES Net income (160,176)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 436,808 Increase in long-term debt 400,000 Payment of cash dividends (11,000) Net cash from financing 825,808

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 = -$164,176, mainly because of negative NI.

The firm borrowed $825,808 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).

NOPAT01 = -$130,948(1 – 0.4)

= -$130,948(0.6)= -$78,569.

NOPAT00 = $114,257.

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What effect did the expansion have onnet operating working capital

(NOWC)?

NOWC = – .Currentassets

Non-interestbearing CL

NOWC01 = ($7,282 + $632,160 + $1,287,360)

– ($524,160 + $489,600)= $913,042.

NOWC00 = $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.

Operatingcapital01

Operatingcapital00

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

Sales $6,034,000 $3,432,000

NOPAT ($78,569) $114,257

NOWC $913,042 $842,400

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

Net Income ($160,176) $87,960

20002001

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

and operating cash flow?

NCF01 = NI + DEP = ($160,176) + $116,960= ($43,216).

NCF00 = $87,960 + $18,900 = $106,860.OCF01 = NOPAT + DEP

= ($78,569) + $116,960= $38,391.

OCF00 = $114,257 + $18,900= $133,157.

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What was the free cash flow (FCF) for 2001?

FCF = OCF – Gross capital investment.

-OR-

FCF = NOPAT – Net capital investment

= -$78,569 – ($1,852,832 – $1,187,200)

= -$78,569 – $665,632

= -$744,201.

Is negative free cash flow always a bad sign?

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Economic Value Added (EVA)

EVA = –

= –

= NOPAT – .

Operating IncomeAfter Tax

After-TaxCapital Costs

Funds Availableto Investors

Cost ofCapital Used

After-TaxCost of Capital

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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

percentage cost of capital was 10% in 2000 and 13% in 2001.

EVA01 = NOPAT – (A-T cost of capital)(Capital)= -$78,569 – (0.13)($1,852,832)= -$78,569 – $240,868= -$319,437.

EVA00 = $114,257 – (0.10)($1,187,200)= $114,257 – $118,720= -$4,463.

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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 AddedGeneral Electric $502,307 millionMicrosoft $388,922 millionCisco Systems $377,883 millionIntel $281,832 millionPfizer $260,984 millionMerck $193,348 millionEMC $191,904 millionOracle $180,885 millionAmerican Int’l Group $177,982 millionWal-Mart Stores $177,450 million

Leading Creators of Wealth in the U.S.Market Value Added in 2000

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Probably not.

A/P increased 260% over the past year, while sales increased by only 76%.

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

2001 (Net Income = 0)?

YES, the company would still have to finance its increase in assets. Looking to the Statement of Cash Flows, we see that the firm made an investment of $711,950 in net fixed assets. Therefore, they would have needed to raise additional funds.

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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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D’Leon received a tax credit of $106,784 in 2001.

This suggests the company paid at least $106,784 in taxes during the past 2 years.

If D’Leon’s payments over the past 2 years were less than $106,784 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 2001 Single Individual Tax Rates

Taxable Income Tax on Base Rate*

0 - 26,250 0 15%26,250 - 63,550 3,937.50 28%63,550 - 132,600 14,381.50 31%132,600 - 288,350 35,787.00 36%Over 288,350 91,857.00 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 $2,800 and your itemized deductions are $5,150.

On the basis of the information above and the April 2001 tax rate schedule, what is your tax liability?

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Calculation of Taxable Income

Salary $45,000

Dividends 3,000

Personal exemptions (2,800)

Deductions (5,150)

Taxable Income $40,050

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Tax Liability:

TL = $3,937.50 + 0.28($13,800)

= $7,801.50 $7,802.Marginal Tax Rate = 28%.Average Tax Rate:

Tax rate = = 19.48% 19.5%.

40,050 - 26,250

$7,802 $40,050

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January 2001 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 Mobil bonds at 10% vs. California muni bonds at 7%.

T = Tax rate = 28%.After-tax interest income:

Exxon Mobil = 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

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