Transcript CHAPTER 2

2-1
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
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2-2
Balance Sheet: Assets
Cash
AR
Inventories
Total CA
Gross FA
Less: Deprec.
Net FA
Total Assets
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2001
7,282
632,160
1,287,360
1,926,802
1,202,950
263,160
939,790
2,866,592
2000
57,600
351,200
715,200
1,124,000
491,000
146,200
344,800
1,468,800
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Liabilities and Equity
2001
2000
Accts payable
524,160
145,600
Notes payable
636,808
200,000
Accruals
489,600
136,000
Total CL
1,650,568
481,600
Long-term debt
723,432
323,432
Common stock
460,000
460,000
Retained earnings
32,592
203,768
Total equity
492,592
663,768
Total L&E
2,866,592 1,468,800
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Income Statement
Sales
COGS
Other expenses
EBITDA
Depr. & Amort.
EBIT
Interest exp.
EBT
Taxes (40%)
Net income
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2001
2000
6,034,000 3,432,000
5,528,000 2,864,000
519,988
358,672
(13,988)
209,328
116,960
18,900
(130,948)
190,428
136,012
43,828
(266,960)
146,600
(106,784)
58,640
(160,176)
87,960
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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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2-6
Common Sized Balance Sheet: Assets
Cash
AR
Inventories
Total CA
Gross FA
Less: Deprec.
Net FA
Total Assets
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2001
0.25
22.05
44.91
67.22
41.96
9.18
32.78
100.00
2000
3.92
23.91
48.69
76.53
33.43
9.95
23.47
100.00
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Liabilities and Equity
Accts payable
Notes payable
Accruals
Total CL
Long-term debt
Common stock
Retained earnings
Total equity
Total L&E
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2001
18.29
22.21
17.08
57.58
25.24
16.05
1.14
17.18
100.00
2000
9.91
13.62
9.26
32.79
22.02
31.32
13.87
45.19
100.00
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Common Sized Income Statement
Sales
COGS
Other expenses
EBITDA
Depr. & Amort.
EBIT
Interest exp.
EBT
Taxes (40%)
Net income
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2001
100.00
91.61
8.62
-.23
1.94
-2.17
2.25
-4.42
-1.77
-2.65
2000
100.00
83.45
10.45
6.10
.55
5.55
1.28
4.27
1.71
2.56
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Other Data
2001
2000
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
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2 - 10
Statement of Retained Earnings (2001)
Balance of retained
earnings, 12/31/00
Add: Net income, 2001
Less: Dividends paid
Balance of retained
earnings, 12/31/01
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$203,768
(160,176)
(11,000)
$32,592
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Statement of Cash Flows (2001)
OPERATING ACTIVITIES
Net income
Add (Sources of cash):
Depreciation
Increase in A/P
Increase in accruals
Subtract (Uses of cash):
Increase in A/R
Increase in inventories
Net cash provided by ops.
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(160,176)
116,960
378,560
353,600
(280,960)
(572,160)
(164,176)
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L-T INVESTING ACTIVITIES
Investment in fixed assets
(711,950)
FINANCING ACTIVITIES
Increase in notes payable
Increase in long-term debt
Payment of cash dividends
Net cash from financing
436,808
400,000
(11,000)
825,808
NET CHANGE IN CASH
(50,318)
Plus: Cash at beginning of year
Cash at end of year
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57,600
7,282
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What can you conclude about
D’Leon’s financial condition from its
statement of CFs?
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.
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2 - 14
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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2 - 15
What effect did the expansion have on
net operating working capital
(NOWC)?
NOWC =
Current –
assets
Non-interest.
bearing CL
NOWC01 = ($7,282 + $632,160 + $1,287,360)
– ($524,160 + $489,600)
= $913,042.
NOWC00 = $842,400.
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2 - 16
What effect did the expansion have on
capital used in operations?
Operating
capital = NOWC + Net fixed assets.
Operating
= $913,042 + $939,790
capital01
= $1,852,832.
Operating
= $1,187,200.
capital00
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2 - 17
What is your initial assessment of the
expansion’s effect on operations?
Sales
NOPAT
NOWC
Operating capital
Net Income
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2001
2000
$6,034,000
($78,569)
$913,042
$1,852,832
($160,176)
$3,432,000
$114,257
$842,400
$1,187,200
$87,960
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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.
-ORFCF = 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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2 - 20
Economic Value Added (EVA)
Operating Income
After-Tax
EVA =
–
After Tax
Capital Costs
Cost of
= Funds Available –
Capital Used
to Investors
After-Tax
=
NOPAT
–
.
Cost of Capital
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EVA Concepts
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.
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2 - 22
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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2 - 23
Would you conclude that
the expansion increased or
decreased MVA?
Market value Equity capital
MVA = of equity –
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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Leading Creators of Wealth in the U.S.
Market Value Added in 2000
Company
General Electric
Microsoft
Cisco Systems
Intel
Pfizer
Merck
EMC
Oracle
American Int’l Group
Wal-Mart Stores
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Market Value Added
$502,307 million
$388,922 million
$377,883 million
$281,832 million
$260,984 million
$193,348 million
$191,904 million
$180,885 million
$177,982 million
$177,450 million
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Does D’Leon pay its suppliers on time?
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.
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2 - 26
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.
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2 - 27
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 
Cash would 
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2. Sales double as a result of the
change 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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2 - 29
How did D’Leon finance its expansion?
D’Leon financed its expansion with
external capital.
D’Leon issued long-term debt
which reduced its financial strength
and flexibility.
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2 - 30
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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2 - 31
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.
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2 - 32
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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2 - 33
INCOME TAXES
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April 2001 Single Individual Tax Rates
Taxable Income
0 - 26,250
26,250 - 63,550
63,550 - 132,600
132,600 - 288,350
Over 288,350
Tax on Base
Rate*
0
3,937.50
14,381.50
35,787.00
91,857.00
15%
28%
31%
36%
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
Dividends
$45,000
3,000
Personal exemptions
(2,800)
Deductions
(5,150)
Taxable Income
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$40,050
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40,050 - 26,250
Tax Liability:
TL = $3,937.50 + 0.28($13,800)
= $7,801.50  $7,802.
Marginal Tax Rate = 28%.
Average Tax Rate:
$7,802
Tax rate =
= 19.48%  19.5%.
$40,050
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January 2001 Corporate Tax Rates
Taxable Income
0 - 50,000
50,000 - 75,000
75,000 - 100,000
100,000 - 335,000
...
Over 18.3M
Tax on Base
0
7,500
13,750
22,250
...
6.4M
Rate*
15%
25%
34%
39%
...
35%
*Plus this percentage on the amount over the
bracket base.
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2 - 39
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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2 - 40
Operating income
Interest income
Taxable dividend
income
Taxable income
$100,000
5,000
3,000*
$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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Taxable vs. Tax-Exempt Bonds
State and local government bonds
(munis) are generally exempt from
federal taxes.
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2 - 42
 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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2 - 43
At what tax rate would you be
indifferent to muni vs. corp?
Solve for T in this equation:
Muni yield = Corp Yield(1 – T)
7.00% = 10.0%(1 – T)
T = 30.0%.
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Implications
If T > 30%, buy tax-exempt munis.
If T < 30%, buy corporate bonds.
Only high income people should
buy munis.
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