Transcript IFM7 Chapter 6 - Indiana State University

6-1
CHAPTER 6
Accounting for Financial
Management
Balance sheet
Income statement
Statement of cash flows
Accounting income versus cash flow
MVA and EVA
Personal taxes
Corporate taxes
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6-2
Balance Sheets: Assets
Cash
Short-term inv.
AR
Inventories
Total CA
Gross FA
Less: Depr.
Net FA
Total assets
2001
7,282
0
632,160
1,287,360
1,926,802
1,202,950
263,160
939,790
2,866,592
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2000
9,000
48,600
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
720,000
200,000
Accruals
489,600
136,000
Total CL
1,733,760
481,600
Long-term debt
1,000,000
323,432
Common stock
460,000
460,000
Retained earnings (327,168) 203,768
Total equity
132,832
663,768
Total L&E
2,866,592 1,468,800
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6-4
Income Statement
Sales
COGS
Other expenses
Deprec.
Tot. op. costs
EBIT
Interest exp.
EBT
Taxes (40%)
Net income
2001
2000
5,834,400 3,432,000
5,728,000 2,864,000
680,000
340,000
116,960
18,900
6,524,960 3,222,900
(690,560)
209,100
176,000
62,500
(866,560)
146,600
(346,624)
58,640
(519,936)
87,960
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6-5
Other Data
2001
2000
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
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6-6
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
(519,936)
(11,000)
($327,168)
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Statement of Cash Flows: 2001
OPERATING ACTIVITIES
Net Income
Adjustments:
Depreciation
Change in AR
Change in inventories
Change in AP
Change in accruals
Net cash provided by ops.
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(519,936)
116,960
(280,960)
(572,160)
378,560
353,600
(523,936)
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6-8
L-T INVESTING ACTIVITIES
Investments 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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6-9
What can you conclude about the
company’s financial condition from its
statement of cash flows?
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.
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6 - 10
What effect did the expansion have on
net operating working capital (NOWC)?
Operating
Operating
NOWC =
CA
CL
NOWC01 = ($7,282 + $632,160 + $1,287,360)
- ($524,160 + $489,600)
= $913,042.
NOWC00 = $793,800.
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6 - 11
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
= $1,138,600.
capital00
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6 - 12
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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6 - 13
What is your initial assessment of the
expansion’s effect on operations?
Sales
NOPAT
NOWC
2001
$5,834,400
($414,336)
$913,042
2000
$3,432,000
$125,460
$793,800
Operating capital
$1,852,832
$1,138,600
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6 - 14
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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6 - 15
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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6 - 16
What is the company’s EVA?
Assume the firm’s after-tax cost of
capital (COC) was 11% in 2000
and 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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6 - 17
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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6 - 18
Does the company pay its suppliers
on time?
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.
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6 - 19
Does it appear that the sales price
exceeds the cost per unit sold?
No, the negative NOPAT shows
that the company is spending
more on it’s operations than it is
taking in.
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6 - 20
What effect would each of these
actions have on the 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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6 - 21
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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6 - 22
How was the expansion financed?
The expansion was financed
primarily with external capital.
The company issued long-term debt
which reduced its financial strength
and flexibility.
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6 - 23
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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6 - 24
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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6 - 25
Other policies that
can affect financial statements
Inventory valuation methods.
Capitalization of R&D expenses.
Policies for funding the company’s
retirement plan.
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6 - 26
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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6 - 27
Why did the stock price fall
after 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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6 - 28
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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6 - 29
What is the effect of the $346,624
tax 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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6 - 30
2000 Tax Year Single Individual
Tax Rates
Taxable Income
0 - 26,250
25,620 - 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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6 - 31
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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6 - 32
Calculation of Taxable Income
Salary
Dividends
$45,000
3,000
Personal exemptions
(2,800)
Deductions
(4,550)
Taxable Income
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$40,650
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$40,650 - $26,250
Tax Liability:
TL = $3,937.50 + 0.28($14,400)
= $7,969.50.
Marginal Tax Rate = 28%.
Average Tax Rate:
Tax rate = $9,969.5 = 19.6%.
$40,650
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6 - 34
2000 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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6 - 35
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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6 - 36
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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6 - 37
Taxable versus Tax Exempt Bonds
State and local government bonds
(municipals, or “munis”) are
generally exempt from federal
taxes.
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6 - 38
 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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6 - 39
At what tax rate would you be
indifferent between the muni and the
corporate bonds?
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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6 - 40
Implications
If T > 30%, buy tax exempt munis.
If T < 30%, buy corporate bonds.
Only high income, and hence high
tax bracket, individuals should buy
munis.
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