Homework for Chapter 3 Financial Statements, Cash Flows, and Taxes

VIII. Questions and ro!lems

"#SIC

3.$

"alance sheet% Given the following information about the Elkridge Sporting Goods, Inc., construct a balance sheet for the period ending June 30, 00!. "he firm had cash and marketable securities of # $,%3$, accounts receivables of #&3,'$!, inventor( of #%)',%% , net fi*ed assets of #3 $,& , and other assets of #%3,% $. It had accounts 3,% $, and

pa(ables of #)',!$$, notes pa(ables of #3),&$&, long+term debt of #

common stock of #%$0,000. ,ow much retained earnings does the firm have-

Solution% #ssets .ash /ccounts receivable Inventories "otal current assets 0et fi*ed assets 3ther assets "otal assets "ook Value # $,%3$ &3,'$! %)',%% # 3),00$ 3 $,& %3,% $ #$'&,$$ &ia!ilities /ccounts pa(ables 0otes pa(ables "otal current liabilities 2ong+term debt .ommon stock 4etained earnings "otal liabilities and stockholders5 e6uit( 3.' In(entor) accountin*% 7ifferentiate between 8I83 and 2I83. "ook Value # )',!$$ 3),&$& #%0&,301 3,% $ %$0,000 1',%%! #$'&,$$

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Solution% 8I83 :first in, first out; refers to the practice of firms, when making sales, assuming that the inventor( that came in first :at a lower price; is being sold first. 2I83 :last in, last out; implies that a firm is selling the higher cost, newer inventor( first, leaving the lower cost, older inventor( on the balance sheet.

3.3

In(entor) accountin*% E*plain how the choice of 8I83 versus 2I83 can affect a firm5s balance sheet and income statement.

Solution% 8I83 makes sense during times of rising prices because it allows the firm to eliminate the lower priced inventor( first, resulting in higher profit margin. "his allows the firm to leave higher valued inventor( on the balance sheet. 7uring inflationar( times, a firm using 2I83 would see a lower profit margin and lower values of inventor( on the balance sheet. It is important that an(one who is anal(<ing firms using different accounting methods on inventor( recogni<e the impact on the bottom line :profit margin and net income; and on current assets.

3.+

,arket-(alue accountin*= ,ow does the use of market+value accounting help managers-

Solution% >arket+value accounting of both assets and liabilities allows managers to have a truer picture of their compan(5s financial condition and to do a better ?ob of estimating cash flows that the assets would generate. ,owever, marking+to+market is not as eas(

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as it sounds because of the difficulties involved in coming up with the correct market value of current assets and liabilities.

3..

/orkin* capital= 2aurel Electronics reported the following information at its annual meetings. "he compan( had cash and marketable securities worth #%, 3$,&$$, accounts pa(ables worth #&,%$1,3$', inventor( of #',% %,$11, accounts receivables of #3,&!!,% %, notes pa(able worth #%,%$%,))3, and other current assets of #% %,&$$. @hat is the compan(5s net working capital-

Solution% "otal current assets A #%, 3$,&$$ B #3,&!!,% % B #',% %, $11 B % %,&$$ A #%%,1)),)30 "otal current liabilities A #&,%$1,3$' B #%,%$%,))3 A #$,3%%,0 0 0et working capital A #%%,1)),)30 + #$,3%%,0 0 A 01,1..,1$2

3.1

/orkin* capital= "he financial information for 2aurel Electronics referred to in 9roblem 3.$ is all book value. Suppose marking+to+market reveals that the market value of the firm5s inventor( is 0 percent below its book value and its receivables are $ percent below its book value. "he market value of its current liabilities is identical to the book value. @hat is the firm5s net working capital using market values- @hat is the percent change in net working capital-

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Solution% >arket value of inventor( A #',% %,$11 C 0.!0 A #$,)1', '1 >arket value of receivables A #3,&!!,% % C 0.'$ A # ,)%),01% "otal current assets A #%, 3$,&$$ B # ,)%),01% B #$,)1', '1 B % %,&$$ A #1,)'0, !0 "otal current liabilities A #&,%$1,3$' B #%,%$%,))3 A #$,3%%,0 0 0et working capital A #1,)'0, !0 + #$,3%%,0 0 A 0+,3.3,'12
9ercent .hange = #&,3$1, )0 #),)$),)%0 #),)$),)%0 = 3&.$D

3.4

Income statement% "he 3akland >ills .ompan( has disclosed the following financial information in its annual reports for the period ending >arch 3%, 00!. It produced sales of #%.&$ million, had cost of goods sold to the tune of #!% ,$00, depreciation e*penses of #%'$,000, and interest e*penses of #!1,$'$. /ssume that the firm has a ta* rate of 3$ percent. @hat is the compan(5s net income- Set up an income statement to answer the 6uestion.

Solution% 4evenues .osts EEI"7/ 7epreciation EEI" Interest EE" "a*es :3$D; 0et income #mount #%,&$0.000.00 !% ,$00.00 # )3',$00.00 %'$,000.00 # &) ,$00.00 !1,$'$.00 # 3' ,1 $.00 %30,$ 3.'$ # & ,&0%. $

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3.5

Cash flow= 7escribe the organi<ation of the statement of cash flows.

Solution% "he statement of cash flows identifies the cash inflows and cash outflows of the firms for a specified period. "his allows one to estimate the net cash flows from operations. "his financial statement is organi<ed to report the cash flows resulting from the three basic activities in an( firmFoperating, investing, and financing. See E*hibit 3.& for an e*ample. "he cash flows from operations are the results of netting all revenues and e*penses that result from the operating activities of the firm. Eu(ing and selling a firm5s assets lead to cash flows from investing activities. Cash flows from financing activities arise from the firm borrowing from its investors andGor making pa(ments to its lenders and shareholders.

3.3

Cash flows= 7uring 00!, "owson 4ecording .ompan( increased its investment in marketable securities b( #3),!&$, funded fi*ed assets ac6uisitions of #%01,&$$, and had marketable securities of #%&, %$ mature. @hat is the net cash used in investing activities-

Solution% 2ong+"erm Investing /ctivities 0et propert(, e6uipment, and other assets 0et ac6uisitions and dispositions Investments in marketable securities 0et cash used in investing activities 3.$2 #:%01,&$$.00; 0.00 : ,)30.00; #:%3 ,0!$.00;

Cash flows= .austic .hemicals identified the following cash flows as significant in its meeting with anal(sts. 7uring the (ear, it had repaid e*isting debt of #3% ,0!0 and raised

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additional debt capital of #)$0,000. It also repurchased stock in the open market for a total of #&$, $0. @hat is the net cash provided b( financing activities-

Solution% 8inancing /ctivities 2oan repa(ment Increase in long+term debt 9urchase of treasur( stock 0et cash provided b( financing activities 3.$$

#:3% ,0!0; )$0,000 :&$, $0; # 1 ,)'0

Cash flow= Identif( and e*plain the noncash e*penses that a firm ma( incur.

Solution% / firm ma( have several items on its income statement that did not result in an( cash outflow to the firm. "he two largest are depreciation e*penses and amorti<ation e*penses. 3ther noncash e*penses include deferred ta*es, wages, and depletion charges, which is similar to depreciation and used for natural resource assets. 9repaid e*penses also fit into this categor( as the( represent e*penses to the firm that are (et to be paid out.

3.$'

Tax% 7efine average ta* rate and marginal ta* rate.

Solution% "he a(era*e tax rate is defined as the total ta*es paid divided b( ta*able income. "he mar*inal tax rate, meanwhile, represents the ta* rate that is paid on the last dollar of income earned, or the rate that will be paid on the ne*t dollar earned.

3.$3

Tax= @hat is the relevant ta* rate to use when making financial decisions- E*plain wh(.
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Solution% >anagers need to use the marginal ta* rate for making financial decisions. "his is because an( additional cash flows that result from a firm5s new pro?ects will be ta*ed at the marginal ta* rate. "hus, this is the appropriate rate to use.

3.$+

Tax= >an< 9ropert( >anagement .ompan( announced that in the (ear ended June 30, 00!, its earnings before ta*es amounted to #%,&'!,13). .alculate its ta*es using E*hibit 3.).

Solution% Earnings before ta* A #%,&'!,13) Tax Tax rate %$D $ 3& 31 3& 3$ 3! 3$ Income #0 to #$0,000 $0,00% '$,000 '$,00% %00,000 %00,00% 33$,000 33$,00% %0,000,000 %0,000,00% %$,000,000 %$,000,00% %!,333,333 >ore than #%!,333,333 "otal ta*es pa(able # ',$00.00 ), $0.00 !,$00.00 1%,)$0.00 3!!,13!. &

#$0 ,!3!. &

I6T78,79I#T7

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3.$.

"alance sheet= "im 7(e, the chief financial officer of Elackwell /utomotive, Inc., is putting together this (ear5s financial statements. ,e has gathered the following information. "he firm had a cash balance of # 3,0%$, accounts pa(able of #%)3, $', common stock of #3%3, 11, retained earnings of #$% ,%$1, inventor( of # % ,&&&, goodwill and other assets e6ual to #'!,)$), net plant and e6uipment of #'%%, $), and short+term notes pa(able of # %,%%$. It also has accounts receivables of #%&%, other current assets of #%%, /utomotive have3. @hat amount of long+term debt does Elackwell ! and

Solution%
&ia!ilities and Stockholders: #ssets .ash and marketable securities /ccounts receivable Inventories 3ther current assets "otal current assets 0et plant and e6uipment Goodwill and other assets # 3,0%$ 7;uit) /ccounts pa(able and accruals 0otes pa(able "otal current liabilities 2ong+term debt "otal liabilities .ommon stock 4etained earnings "otal common e6uit( "otal liabilities and stockholders5 e6uit( # %)3, $' %,%%$ # %!&,3' $15,2'' # 3$ ,31& 3%3, 11 $% ,%$1 # ! $,&$! #%,%'',!$

%&%, $! % ,&&& %%, 3 # 3!',1&0 '%%, $) '!,)$)

"otal assets

#%,%'',!$

3.$1

"alance sheet= 4efer to the information for Elackwell /utomotive in 9roblem 3.%$. @hat level of working capital does Elackwell /utomotive have-

Solution% 0et working capital A "otal current assets H "otal current liabilities

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#3!',1&0 H #%!&,3' A 0'23,.15

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