Cff302.ppt

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Copyright © 2002 by Harcourt, Inc. All rights reserved.
Balance sheet
Income statement
Statement of cash flows
Accounting income vs. cash flow
MVA and EVA
Personal taxes
Corporate taxes
CHAPTER 2
Financial Statements, Cash Flow,
and Taxes

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Balance Sheet: Assets
Cash 7,282 57,600
AR 632,160 351,200
Inventories 1,287,360 715,200
Total CA 1,926,802 1,124,000
Gross FA 1,202,950 491,000
Less: Deprec. 263,160 146,200
Net FA 939,790 344,800
Total Assets 2,866,592 1,468,800
2001 2000

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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 6,034,000 3,432,000
COGS 5,528,000 2,864,000
Other expenses 519,988 358,672
EBITDA (13,988) 209,328
Depr. & Amort. 116,960 18,900
EBIT (130,948) 190,428
Interest exp. 136,012 43,828
EBT (266,960) 146,600
Taxes (40%) (106,784) 58,640
Net income (160,176) 87,960
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 353,600
Subtract (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 57,600
Cash 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 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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What effect did the expansion have on
capital used in operations?
Operating
capital = NOWC + Net fixed assets.
= $913,042 + $939,790
= $1,852,832.
= $1,187,200.
Operating
capital01
Operating
capital00

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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
2000
2001

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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 Income
After Tax
After-Tax
Capital Costs
Funds Available
to Investors
Cost of
Capital Used
After-Tax
Cost 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 equity
Equity 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 Added
General Electric $502,307 million
Microsoft $388,922 million
Cisco Systems $377,883 million
Intel $281,832 million
Pfizer $260,984 million
Merck $193,348 million
EMC $191,904 million
Oracle $180,885 million
American Int’l Group $177,982 million
Wal-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 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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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 $100,000
Interest income 5,000
Taxable dividend
income 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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