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Copyright © 2002 South-Western
Balance sheet Income statementStatement of cash flowsAccounting income versus cash flowMVA and EVAPersonal taxesCorporate taxes
CHAPTER 6Accounting for Financial
Management
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Copyright © 2002 South-Western
2001 2000 Cash 7,282 9,000Short-term inv. 0 48,600AR 632,160 351,200Inventories 1,287,360 715,200 Total CA 1,926,802 1,124,000Gross FA 1,202,950 491,000Less: Depr. 263,160 146,200 Net FA 939,790 344,800Total assets 2,866,592 1,468,800
Balance Sheets: Assets
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Copyright © 2002 South-Western
1,733,760
Liabilities and Equity
2001 2000Accts payable 524,160 145,600Notes payable 720,000 200,000Accruals 489,600 136,000 Total CL 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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Copyright © 2002 South-Western
(519,936)
Income Statement
Sales 5,834,400 3,432,000COGS 5,728,000 2,864,000Other expenses 680,000 340,000Deprec. 116,960 18,900 Tot. op. costs 6,524,960 3,222,900 EBIT (690,560) 209,100Interest exp. 176,000 62,500 EBT (866,560) 146,600Taxes (40%) (346,624) 58,640Net income 87,960
2001 2000
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Copyright © 2002 South-Western
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
2001 2000
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Copyright © 2002 South-Western
Statement of Retained Earnings (2001)
Balance of retained
earnings, 12/31/00 $203,768
Add: Net income, 2001 (519,936)
Less: Dividends paid (11,000)
Balance of retained
earnings, 12/31/01 ($327,168)
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Copyright © 2002 South-Western
Statement of Cash Flows: 2001
OPERATING ACTIVITIESNet Income (519,936)Adjustments: Depreciation 116,960 Change in AR (280,960) Change in inventories (572,160) Change in AP 378,560 Change in accruals 353,600 Net cash provided by ops. (523,936)
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Copyright © 2002 South-Western
L-T INVESTING ACTIVITIESInvestments in fixed assets (711,950)
FINANCING ACTIVITIES Change in s-t investments 48,600 Change in notes payable 520,000 Change in long-term debt 676,568 Payment of cash dividends (11,000)Net cash from financing 1,234,168 Sum: net change in cash (1,718)Plus: cash at beginning of year 9,000 Cash at end of year 7,282
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Copyright © 2002 South-Western
Net cash from operations = -$523,936, mainly because of negative net income.
The firm borrowed $1,185,568 and sold $48,600 in short-term investments to meet its cash requirements.
Even after borrowing, the cash account fell by $1,718.
What can you conclude about the company’s financial condition from its
statement of cash flows?
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Copyright © 2002 South-Western
What effect did the expansion have on net operating working capital (NOWC)?
NOWC01 = ($7,282 + $632,160 + $1,287,360)
- ($524,160 + $489,600)= $913,042.
NOWC00 = $793,800.
= -Operating
CAOperating
CLNOWC
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Copyright © 2002 South-Western
What effect did the expansion have on capital used in operations?
= NOWC + Net fixed assets.
= $913,042 + $939,790
= $1,852,832.
= $1,138,600.
Operatingcapital01
Operatingcapital00
Operatingcapital
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Copyright © 2002 South-Western
Did the expansion create additional net operating profit after taxes (NOPAT)?
NOPAT = EBIT(1 - Tax rate)
NOPAT01 = -$690,560(1 - 0.4)
= -$690,560(0.6)= -$414,336.
NOPAT00 = $125,460.
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Copyright © 2002 South-Western
What is your initial assessment of the expansion’s effect on operations?
2001 2000
Sales $5,834,400 $3,432,000
NOPAT ($414,336) $125,460
NOWC $913,042 $793,800
Operating capital $1,852,832 $1,138,600
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Copyright © 2002 South-Western
What effect did the company’s expansion have on its net cash flow
and operating cash flow?
NCF01 = NI + DEP = -$519,936 + $116,960= -$402,976.
NCF00 = $87,960 + $18,900 = $106,860.
OCF01 = NOPAT + DEP= -$414,336 + $116,960= -$297,376.
OCF00 = $125,460 + $18,900= $144,360.
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Copyright © 2002 South-Western
What was the free cash flow (FCF)for 2001?
FCF = NOPAT - Net capital investment
= -$414,336 - ($1,852,832 - $1,138,600)
= -$414,336 - $714,232
= -$1,128,568.
How do you suppose investors reacted?
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Copyright © 2002 South-Western
What is the company’s EVA?Assume the firm’s after-tax cost of
capital (COC) was 11% in 2000and 13% in 2001.
EVA01 = NOPAT- (COC)(Capital)= -$414,336 - (0.13)($1,852,832)= -$414,336 - $240,868= -$655,204.
EVA00 = $125,460 - (0.11)($1,138,600)= $125,460 - $125,246= $214.
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Copyright © 2002 South-Western
Would you concludethat the expansion increased or
decreased MVA?
MVA = - .
During the last year stock price has decreased 73%, so market value of equity has declined. Consequently, MVA has declined.
Equity capitalsupplied
Market valueof equity
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Copyright © 2002 South-Western
Probably not.
A/P increased 260% over the past year, while sales increased by only 70%.
If this continues, suppliers may cut off trade credit.
Does the company pay its suppliers on time?
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Copyright © 2002 South-Western
No, the negative NOPAT shows that the company is spending more on it’s operations than it is taking in.
Does it appear that the sales price exceeds the cost per unit sold?
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Copyright © 2002 South-Western
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 the cash account?
A/R would Cash would
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Copyright © 2002 South-Western
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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Copyright © 2002 South-Western
The expansion was financed primarily with external capital.
The company issued long-term debt which reduced its financial strength and flexibility.
How was the expansion financed?
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Copyright © 2002 South-Western
Would external capital have been required if they had broken even in
2001 (Net income = 0)?
Yes, the company would still have to finance its increase in assets.
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Copyright © 2002 South-Western
What happens if fixed assets are depreciated 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.
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Copyright © 2002 South-Western
Other policies thatcan affect financial statements
Inventory valuation methods.
Capitalization of R&D expenses.
Policies for funding the company’s retirement plan.
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Copyright © 2002 South-Western
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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Copyright © 2002 South-Western
Why did the stock price fallafter the dividend was cut?
Management was “signaling” that the firm’s operations were in trouble.
The dividend cut lowered investors’ expectations for future cash flows, which caused the stock price to decline.
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Copyright © 2002 South-Western
What were some other sources of financing used in 2001?
Selling financial assets: Short term investments decreased by $48,600.
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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Copyright © 2002 South-Western
What is the effect of the $346,624tax credit received in 2001.
This suggests the company paid at least $346,624 in taxes during the past 2 years.
If the 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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Copyright © 2002 South-Western
2000 Tax Year Single IndividualTax Rates
Taxable Income Tax on Base Rate*
0 - 26,250 0 15%25,620 - 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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Copyright © 2002 South-Western
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 $4,550.
On the basis of the information above and the 2000 tax year tax rate schedule, what is your tax liability?
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Copyright © 2002 South-Western
Calculation of Taxable Income
Salary $45,000
Dividends 3,000
Personal exemptions (2,800)
Deductions (4,550)
Taxable Income $40,650
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Copyright © 2002 South-Western
Tax Liability:
TL = $3,937.50 + 0.28($14,400)
= $7,969.50.Marginal Tax Rate = 28%.Average Tax Rate:
Tax rate = = 19.6%.
$40,650 - $26,250
$9,969.5 $40,650
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Copyright © 2002 South-Western
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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Copyright © 2002 South-Western
Assume a corporation has $100,000 of taxable income from operations, $5,000
of interest income, and $10,000 of dividend income.
What is its tax liability?
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Copyright © 2002 South-Western
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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Copyright © 2002 South-Western
State and local government bonds (municipals, or “munis”) are generally exempt from federal taxes.
Taxable versus Tax Exempt Bonds
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Copyright © 2002 South-Western
Exxon bonds at 10% versus 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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Copyright © 2002 South-Western
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 between the muni and the
corporate bonds?