chapter 2 financial statements, taxes, and cash flows
CHAPTER 2 FINANCIAL STATEMENTS, TAXES, AND CASH FLOWS Learning Objectives LO1 LO2 LO3 LO4 LO5
The difference between accounting value (or “book” value) and market value. The difference between accounting income and cash flow. The difference between average and marginal tax rates. How to determine a firm’s cash flow from its financial statements. The basics of Capital Cost Allowance (CCA) and Undepreciated Capital Cost (UCC).
Answers to Concepts Review and Critical Thinking Questions 2.
(LO2) The recognition and matching principles in financial accounting call for revenues, and the costs associated with producing those revenues, to be “booked” when the revenue process is essentially complete, not necessarily when the cash is collected or bills are paid. Note that this way is not necessarily correct; it’s the way accountants have chosen to do it.
4.
(LO4) Depreciation is a noncash deduction that reflects adjustments made in asset book values in accordance with the matching principle in financial accounting. Interest expense is a cash outlay, but it’s a financing cost, not an operating cost.
6.
(LO4) For a successful company that is rapidly expanding, for example, capital outlays will be large, possibly leading to negative cash flow from assets. In general, what matters is whether the money is spent wisely, not whether cash flow from assets is positive or negative.
8.
(LO4) For example, if a company were to become more efficient in inventory management, the amount of inventory needed would decline. The same might be true if it becomes better at collecting its receivables. In general, anything that leads to a decline in ending NWC relative to beginning would have this effect. Negative net capital spending would mean more long-lived assets were liquidated than purchased.
10.
(LO1) Enterprise value is the theoretical takeover price. In the event of a takeover, an acquirer would have to take on the company's debt, but would pocket its cash. Enterprise value differs significantly from simple market capitalization in several ways, and it may be a more accurate representation of a firm's value. In a takeover, the value of a firm's debt would need to be paid by the buyer when taking over a company. This enterprise value provides a much more accurate takeover valuation because it includes debt in its value calculation.
Solutions to Questions and Problems Basic 2.
(LO1) The income statement for the company is: Income Statement Sales $634,000 Costs 305,000 Depreciation 46,000 EBIT $283,000 Interest 29,000 EBT $254,000 Taxes (35%) 88,900
S2-1
Net income 4.
$165,100
(LO1) EPS = Net income / Shares DPS = Dividends / Shares
= $165,100 / 30,000 = $86,000 / 30,000
= $5.50 per share = $2.87 per share
6.
(LO3) Tax bill = 0.165 x $325,000 = $53,625
8.
(LO4) To calculate OCF, we first need the income statement: Income Statement Sales Costs Depreciation EBIT Interest Taxable income Taxes (35%) Net income
$14,200 5,600 1,200 $7,400 680 $6,720 2,352 $4,368
OCF = EBIT + Depreciation – Taxes = $7,400 + 1,200 – 2,352 = $6,248 9.
(LO4) Net capital spending = NFAend – NFAbeg + Depreciation = $5.2M – 4.6M + 875K = $1.475M
10.
(LO4) Change in NWC = NWCend – NWCbeg Change in NWC = (CAend – CLend) – (CAbeg – CLbeg) Change in NWC = ($1,650 – 920) – ($1,400 – 870) Change in NWC = $730 – 530 = $200
12.
(LO4) Cash flow to shareholders = Dividends paid – Net new equity Cash flow to shareholders = $600K – [(Commonend + AREend) – (Commonbeg + AREbeg)] Cash flow to shareholders = $600K – [($885K + 7.7M) – ($860K + 6.9M)] Cash flow to shareholders = $600K – [$8.585M – 7.76M] = –$225K Note, ARE is the additional retained earnings.
Intermediate 13.
(LO4) Cash flow from assets Cash flow from assets Operating cash flow
14.
= Cash flow to creditors + Cash flow to shareholders = $80K – 225K = –$145K = –$145K = OCF – Change in NWC – Net capital spending = –$145K = OCF – (–$165K) – 760K = –$145K – 165K + 760K = $450K
(LO4) To find the OCF, we first calculate net income. Income Statement Sales $162,000 Costs 93,000 Depreciation 8,400
S2-2
Other expenses EBIT Interest Taxable income Taxes (38%) Net income
5,100 $55,500 16,500 $39,000 14,820 $24,180
Dividends Additions to RE
$9,400 $14,780
a.
OCF = EBIT + Depreciation – Taxes = $55,500 + 8,400 – 14,820 = $49,080
b.
CFC = Interest – Net new LTD = $16,500 – (–6,400) = $22,900 Note that the net new long-term debt is negative because the company repaid part of its longterm debt.
c.
CFS = Dividends – Net new equity = $9,400 – 7,350 = $2,050
d.
We know that CFA = CFC + CFS, so: CFA = $22,900 + 2,050 = $24,950 CFA is also equal to OCF – Net capital spending – Change in NWC. We already know OCF. Net capital spending is equal to: Net capital spending = Increase in NFA + Depreciation = $12,000 + 8,400 = $20,400 Now we can use: CFA = OCF – Net capital spending – Change in NWC $24,950 = $49,080 – 20,400 – Change in NWC Solving for the change in NWC gives $3,730, meaning the company increased its NWC by $3,730.
16.
(LO1) The balance sheet for the company looks like this: Cash Accounts receivable Inventory Current assets
Balance Sheet $210,000 Accounts payable 149,000 Notes payable 265,000 Current liabilities $624,000 Long-term debt Total liabilities
Tangible net fixed assets Intangible net fixed assets
2,900,000 720,000
Total assets
$4,244,000
Common stock Accumulated ret. earnings Total liab. & owners’ equity
Total liabilities and owners’ equity is: TL & OE = CL + LTD + Common stock + Retained earnings Solving for this equation for equity gives us: Common stock = $4,244,000 – 1,865,000 – 2,040,000 = $339,000
S2-3
$430,000 180,000 $610,000 1,430,000 $2,040,000 ?? 1,865,000 $4,244,000
18.
(LO3) a. Taxes Growth Taxes Income
= 0.165($82,000) = $13,530 = 0.330($8,200,000) = $2,706,000
b. The firms have different marginal tax rates. Corporation Growth pays an additional $1,650 of taxes and in general pays 16.5% of its next dollar of taxable income in taxes. Corporation Income pays $3,300 of taxes and in general pays 33.0% of its next dollar of taxable income in taxes. 19.
(LO2) Income Statement Sales $840,000 COGS 625,000 A&S expenses 120,000 Depreciation 130,000 EBIT –$35,000 Interest 85,000 Taxable income –$120,000 Taxes (35%) 0 Net income –$120,000
a.
20.
b.
OCF = EBIT + Depreciation – Taxes = –$35,000 + 130,000 – 0 = $95,000
c.
Net income was negative because of the tax deductibility of depreciation and interest expense. However, the actual cash flow from operations was positive because depreciation is a non-cash expense and interest is a financing expense, not an operating expense.
(LO4) A firm can still pay out dividends if net income is negative; it just has to be sure there is sufficient cash flow to make the dividend payments. Change in NWC = Net capital spending = Net new equity = 0. (Given) Cash flow from assets = OCF – Change in NWC – Net capital spending Cash flow from assets = $95K – 0 – 0 = $95K Cash flow to shareholders = Dividends – Net new equity = $30K – 0 = $30K Cash flow to creditors = Cash flow from assets – Cash flow to shareholders = $95K – 30K = $65K Cash flow to creditors = Interest – Net new LTD Net new LTD = Interest – Cash flow to creditors = $85K – 65K = $20K
21.
(LO2) a. Income Statement Sales $15,200 Cost of goods sold 11,400 Depreciation 2,700 EBIT $ 1,100 Interest 520 Taxable income $ 580 Taxes (34%) 197 Net income $ 383 b.
OCF = EBIT + Depreciation – Taxes = $1,100 + 2,700 – 197 = $3,603
S2-4
c.
Change in NWC
= NWCend – NWCbeg = (CAend – CLend) – (CAbeg – CLbeg) = ($3,850 – 2,100) – ($3,200 – 1,800) = $1,750 – 1,400 = $350
Net capital spending CFA
= NFAend – NFAbeg + Depreciation = $9,700 – 9,100 + 2,700 = $3,300
= OCF – Change in NWC – Net capital spending = $3,603 – 350 – 3,300 = –$47
The cash flow from assets can be positive or negative, since it represents whether the firm raised funds or distributed funds on a net basis. In this problem, even though net income and OCF are positive, the firm invested heavily in both fixed assets and net working capital; it had to raise a net $47 in funds from its shareholders and creditors to make these investments. d.
Cash flow to creditors Cash flow to shareholders
= Interest – Net new LTD = $520 – 0 = $520 = Cash flow from assets – Cash flow to creditors = –$47 – 520 = –$567
We can also calculate the cash flow to shareholders as: Cash flow to shareholders = Dividends – Net new equity Solving for net new equity, we get: Net new equity = $600 – (–567) = $1,167 The firm had positive earnings in an accounting sense (NI > 0) and had positive cash flow from operations. The firm invested $350 in new net working capital and $3,300 in new fixed assets. The firm had to raise $47 from its stakeholders to support this new investment. It accomplished this by raising $1,167 in the form of new equity. After paying out $600 of this in the form of dividends to shareholders and $520 in the form of interest to creditors, $47 was left to meet the firm’s cash flow needs for investment. 22.
(LO4) a. Total assets 2008 Total liabilities 2008 Owners’ equity 2008
= $725 + 2,990 = $3,715 = $290 + 1,580 = $1,870 = $3,715 – 1,870 = $1,845
Total assets 2009 Total liabilities 2009 Owners’ equity 2009
= $785 + 3,600 = $4,385 = $325 + 1,680 = $2,005 = $4,385 – 2,005 = $2,380
b.
NWC 2008 NWC 2009 Change in NWC
= CA08 – CL08 = $725 – 290 = $435 = CA09 – CL09 = $785 – 325 = $460 = NWC09 – NWC08 = $460 – 435 = $25
c.
We can calculate net capital spending as: Net capital spending Net capital spending
= Net fixed assets 2009 – Net fixed assets 2008 + Depreciation = $3,600 – 2,990 + 820 = $1,430
So, the company had a net capital spending cash flow of $1,430. We also know that net capital spending is:
S2-5
Net capital spending $1,430 Fixed assets sold
= Fixed assets bought – Fixed assets sold = $1,500 – Fixed assets sold = $1,500 – 1,430 = $70
To calculate the cash flow from assets, we must first calculate the operating cash flow. The operating cash flow is calculated as follows (you can also prepare a traditional income statement):
d.
24.
EBIT EBT Taxes OCF Cash flow from assets
= Sales – Costs – Depreciation = $9,200 – 4,290 – 820 = $4,090 = EBIT – Interest = $4,090 – 234 = $3,856 = EBT × .35 = $3,856 × .35 = $1,350 = EBIT + Depreciation – Taxes = $4,090 + 820 – 1,350 = $3,560 = OCF – Change in NWC – Net capital spending. = $3,560 – 25 – 1,430 = $2,105
Net new borrowing Cash flow to creditors Net new borrowing Debt retired
= LTD09 – LTD08 = $1,680 – 1,580 = $100 = Interest – Net new LTD = $234 – 100 = $134 = $100 = Debt issued – Debt retired = $300 – 100 = $200
(LO3) Compare the investor’s net receipt if dividends are paid versus what would be received from an income trust distribution: Dividends Income $500,000 Corporate income tax (35%) 175,000 Amount distributed 325,000 Tax on dividends (23%) 74,750 Tax on interest income (48%) Investors’ net receipt $250,250
Income trust distributions $500,000 0 500,000 240,000 $260,000
It appears that investors would benefit from the conversion. For each unit held upon conversion, an investor would gain ($260,000 - $250,250)/10,000 = $0.975. For an investor holding 2,000 units the gain would be = 2,000 ($0.975) = $1,950. Challenge 26.
(LO1) Cash Accounts receivable Inventory Current assets Net fixed assets Total assets
Cash Accounts receivable Inventory Current assets
Balance sheet as of Dec. 31, 2008 $2,528 Accounts payable 3,347 Notes payable 5,951 Current liabilities $11,826 Long-term debt $21,203 Owners' equity $33,029 Total liab. & equity Balance sheet as of Dec. 31, 2009 $2,694 Accounts payable 3,928 Notes payable 6,370 Current liabilities $12,992 Long-term debt
S2-6
$2,656 488 $3,144 $8,467 21,418 $33,029
$2,683 478 $3,161 $10,290
Net fixed assets Total assets
28.
$2,244 $15,236
Owners' equity Total liab. & equity
1,785 $15,236
2008 Income Statement Sales $4,822.00 COGS 1,668.00 Other expenses 394.00 Depreciation 692.00 EBIT $2,068.00 Interest 323.00 EBT $1,745.00 Taxes (40%) 698.00 Net income $1,047.00
2009 Income Statement Sales $5,390.00 COGS 1,901.00 Other expenses 343.00 Depreciation 723.00 EBIT $2,423.00 Interest 386.00 EBT $2,037.00 Taxes (40%) 814.80 Net income $1,222.20
Dividends Additions to RE
Dividends Additions to RE
$588.00 459.00
$674.00 548.20
(LO3)
DIVIDENDS Dividend Gross up (45%) Federal Tax (29%) Div. Tax Cr. (18.98%) Net Federal Tax Prov. Tax (10%) Div. Tax Cr. (7.40%) Net Provincial Tax Tax Payable
$40,000 18,000 58,000 16,820 -11,008 $5,812 5,800 -4,292 $1,508 $7,320
INTEREST Interest Federal Tax (29%) Prov. Tax (10%) Tax Payable
$20,000 5,800 2,000 $7,800
CAPITAL GAINS Capital Gain Fed. Tax (1/2 x 29%) Prov. Tax (1/2 x10%) Tax Payable
$20,000 2,900 1,000 $3,900
Cash Flow from Dividends = $40,000 - $7,320 = $32,680 Cash Flow from Interest = $20,000 - $7,800 = $12,200 Cash Flow from Capital Gains = $20, 000 - $3,900 = $16,100 Note: A provincial dividend tax credit of 7.40% is assumed. The actual dividend tax rate for an Alberta resident should be verified. 35.
(LO3) a. Federal tax = 0.29($57,000)(0.05) = $826.50 Provincial tax = 0.10($57,000)(0.05) = $285.00 After tax income = $2,850 – $826.50 – $285.00 = $1,738.50 b. Federal tax on dividends = 1.45($25)(250)(0.29 – 0.1898) = $908.06 (rounded) Provincial tax on dividends = 1.45($25)(250)(0.10 – 0.0740) = $235.63 (rounded) After tax income = $25(250) – $908.06 – $235.63 = $5,106.31 Assumes a provincial dividend tax credit of 7.40%. The actual dividend tax credit for an Alberta resident should be verified. c. Federal tax on capital gain = $15(500)(0.5)(0.29) = $1,087.50 Provincial tax on capital gain = $15(500)(0.5)(0.10) = $375 After tax income = $7,500 – $1,087.50 – $375 = $6,037.50
S2-7
36.
(LO3) Carry the ($600) loss in 2006 back 3 years and the remaining loss is carried forward 7 years: (in 1,000's) total carry backs = $116 + $140 + $168 = $424 leaving ($600 – $424) to carry forward which effectively reduces taxable income to zero for all years through 2009. At that time, remaining carryforward is $56.
S2-8
The difference between accounting value (or “book” value) and market value. The difference between accounting income and cash flow. The difference between average and marginal tax rates. How to determine a firm’s cash flow from its financial statements. The basics of Capital Cost Allowance (CCA) and Undepreciated Capital Cost (UCC).
Answers to Concepts Review and Critical Thinking Questions 2.
(LO2) The recognition and matching principles in financial accounting call for revenues, and the costs associated with producing those revenues, to be “booked” when the revenue process is essentially complete, not necessarily when the cash is collected or bills are paid. Note that this way is not necessarily correct; it’s the way accountants have chosen to do it.
4.
(LO4) Depreciation is a noncash deduction that reflects adjustments made in asset book values in accordance with the matching principle in financial accounting. Interest expense is a cash outlay, but it’s a financing cost, not an operating cost.
6.
(LO4) For a successful company that is rapidly expanding, for example, capital outlays will be large, possibly leading to negative cash flow from assets. In general, what matters is whether the money is spent wisely, not whether cash flow from assets is positive or negative.
8.
(LO4) For example, if a company were to become more efficient in inventory management, the amount of inventory needed would decline. The same might be true if it becomes better at collecting its receivables. In general, anything that leads to a decline in ending NWC relative to beginning would have this effect. Negative net capital spending would mean more long-lived assets were liquidated than purchased.
10.
(LO1) Enterprise value is the theoretical takeover price. In the event of a takeover, an acquirer would have to take on the company's debt, but would pocket its cash. Enterprise value differs significantly from simple market capitalization in several ways, and it may be a more accurate representation of a firm's value. In a takeover, the value of a firm's debt would need to be paid by the buyer when taking over a company. This enterprise value provides a much more accurate takeover valuation because it includes debt in its value calculation.
Solutions to Questions and Problems Basic 2.
(LO1) The income statement for the company is: Income Statement Sales $634,000 Costs 305,000 Depreciation 46,000 EBIT $283,000 Interest 29,000 EBT $254,000 Taxes (35%) 88,900
S2-1
Net income 4.
$165,100
(LO1) EPS = Net income / Shares DPS = Dividends / Shares
= $165,100 / 30,000 = $86,000 / 30,000
= $5.50 per share = $2.87 per share
6.
(LO3) Tax bill = 0.165 x $325,000 = $53,625
8.
(LO4) To calculate OCF, we first need the income statement: Income Statement Sales Costs Depreciation EBIT Interest Taxable income Taxes (35%) Net income
$14,200 5,600 1,200 $7,400 680 $6,720 2,352 $4,368
OCF = EBIT + Depreciation – Taxes = $7,400 + 1,200 – 2,352 = $6,248 9.
(LO4) Net capital spending = NFAend – NFAbeg + Depreciation = $5.2M – 4.6M + 875K = $1.475M
10.
(LO4) Change in NWC = NWCend – NWCbeg Change in NWC = (CAend – CLend) – (CAbeg – CLbeg) Change in NWC = ($1,650 – 920) – ($1,400 – 870) Change in NWC = $730 – 530 = $200
12.
(LO4) Cash flow to shareholders = Dividends paid – Net new equity Cash flow to shareholders = $600K – [(Commonend + AREend) – (Commonbeg + AREbeg)] Cash flow to shareholders = $600K – [($885K + 7.7M) – ($860K + 6.9M)] Cash flow to shareholders = $600K – [$8.585M – 7.76M] = –$225K Note, ARE is the additional retained earnings.
Intermediate 13.
(LO4) Cash flow from assets Cash flow from assets Operating cash flow
14.
= Cash flow to creditors + Cash flow to shareholders = $80K – 225K = –$145K = –$145K = OCF – Change in NWC – Net capital spending = –$145K = OCF – (–$165K) – 760K = –$145K – 165K + 760K = $450K
(LO4) To find the OCF, we first calculate net income. Income Statement Sales $162,000 Costs 93,000 Depreciation 8,400
S2-2
Other expenses EBIT Interest Taxable income Taxes (38%) Net income
5,100 $55,500 16,500 $39,000 14,820 $24,180
Dividends Additions to RE
$9,400 $14,780
a.
OCF = EBIT + Depreciation – Taxes = $55,500 + 8,400 – 14,820 = $49,080
b.
CFC = Interest – Net new LTD = $16,500 – (–6,400) = $22,900 Note that the net new long-term debt is negative because the company repaid part of its longterm debt.
c.
CFS = Dividends – Net new equity = $9,400 – 7,350 = $2,050
d.
We know that CFA = CFC + CFS, so: CFA = $22,900 + 2,050 = $24,950 CFA is also equal to OCF – Net capital spending – Change in NWC. We already know OCF. Net capital spending is equal to: Net capital spending = Increase in NFA + Depreciation = $12,000 + 8,400 = $20,400 Now we can use: CFA = OCF – Net capital spending – Change in NWC $24,950 = $49,080 – 20,400 – Change in NWC Solving for the change in NWC gives $3,730, meaning the company increased its NWC by $3,730.
16.
(LO1) The balance sheet for the company looks like this: Cash Accounts receivable Inventory Current assets
Balance Sheet $210,000 Accounts payable 149,000 Notes payable 265,000 Current liabilities $624,000 Long-term debt Total liabilities
Tangible net fixed assets Intangible net fixed assets
2,900,000 720,000
Total assets
$4,244,000
Common stock Accumulated ret. earnings Total liab. & owners’ equity
Total liabilities and owners’ equity is: TL & OE = CL + LTD + Common stock + Retained earnings Solving for this equation for equity gives us: Common stock = $4,244,000 – 1,865,000 – 2,040,000 = $339,000
S2-3
$430,000 180,000 $610,000 1,430,000 $2,040,000 ?? 1,865,000 $4,244,000
18.
(LO3) a. Taxes Growth Taxes Income
= 0.165($82,000) = $13,530 = 0.330($8,200,000) = $2,706,000
b. The firms have different marginal tax rates. Corporation Growth pays an additional $1,650 of taxes and in general pays 16.5% of its next dollar of taxable income in taxes. Corporation Income pays $3,300 of taxes and in general pays 33.0% of its next dollar of taxable income in taxes. 19.
(LO2) Income Statement Sales $840,000 COGS 625,000 A&S expenses 120,000 Depreciation 130,000 EBIT –$35,000 Interest 85,000 Taxable income –$120,000 Taxes (35%) 0 Net income –$120,000
a.
20.
b.
OCF = EBIT + Depreciation – Taxes = –$35,000 + 130,000 – 0 = $95,000
c.
Net income was negative because of the tax deductibility of depreciation and interest expense. However, the actual cash flow from operations was positive because depreciation is a non-cash expense and interest is a financing expense, not an operating expense.
(LO4) A firm can still pay out dividends if net income is negative; it just has to be sure there is sufficient cash flow to make the dividend payments. Change in NWC = Net capital spending = Net new equity = 0. (Given) Cash flow from assets = OCF – Change in NWC – Net capital spending Cash flow from assets = $95K – 0 – 0 = $95K Cash flow to shareholders = Dividends – Net new equity = $30K – 0 = $30K Cash flow to creditors = Cash flow from assets – Cash flow to shareholders = $95K – 30K = $65K Cash flow to creditors = Interest – Net new LTD Net new LTD = Interest – Cash flow to creditors = $85K – 65K = $20K
21.
(LO2) a. Income Statement Sales $15,200 Cost of goods sold 11,400 Depreciation 2,700 EBIT $ 1,100 Interest 520 Taxable income $ 580 Taxes (34%) 197 Net income $ 383 b.
OCF = EBIT + Depreciation – Taxes = $1,100 + 2,700 – 197 = $3,603
S2-4
c.
Change in NWC
= NWCend – NWCbeg = (CAend – CLend) – (CAbeg – CLbeg) = ($3,850 – 2,100) – ($3,200 – 1,800) = $1,750 – 1,400 = $350
Net capital spending CFA
= NFAend – NFAbeg + Depreciation = $9,700 – 9,100 + 2,700 = $3,300
= OCF – Change in NWC – Net capital spending = $3,603 – 350 – 3,300 = –$47
The cash flow from assets can be positive or negative, since it represents whether the firm raised funds or distributed funds on a net basis. In this problem, even though net income and OCF are positive, the firm invested heavily in both fixed assets and net working capital; it had to raise a net $47 in funds from its shareholders and creditors to make these investments. d.
Cash flow to creditors Cash flow to shareholders
= Interest – Net new LTD = $520 – 0 = $520 = Cash flow from assets – Cash flow to creditors = –$47 – 520 = –$567
We can also calculate the cash flow to shareholders as: Cash flow to shareholders = Dividends – Net new equity Solving for net new equity, we get: Net new equity = $600 – (–567) = $1,167 The firm had positive earnings in an accounting sense (NI > 0) and had positive cash flow from operations. The firm invested $350 in new net working capital and $3,300 in new fixed assets. The firm had to raise $47 from its stakeholders to support this new investment. It accomplished this by raising $1,167 in the form of new equity. After paying out $600 of this in the form of dividends to shareholders and $520 in the form of interest to creditors, $47 was left to meet the firm’s cash flow needs for investment. 22.
(LO4) a. Total assets 2008 Total liabilities 2008 Owners’ equity 2008
= $725 + 2,990 = $3,715 = $290 + 1,580 = $1,870 = $3,715 – 1,870 = $1,845
Total assets 2009 Total liabilities 2009 Owners’ equity 2009
= $785 + 3,600 = $4,385 = $325 + 1,680 = $2,005 = $4,385 – 2,005 = $2,380
b.
NWC 2008 NWC 2009 Change in NWC
= CA08 – CL08 = $725 – 290 = $435 = CA09 – CL09 = $785 – 325 = $460 = NWC09 – NWC08 = $460 – 435 = $25
c.
We can calculate net capital spending as: Net capital spending Net capital spending
= Net fixed assets 2009 – Net fixed assets 2008 + Depreciation = $3,600 – 2,990 + 820 = $1,430
So, the company had a net capital spending cash flow of $1,430. We also know that net capital spending is:
S2-5
Net capital spending $1,430 Fixed assets sold
= Fixed assets bought – Fixed assets sold = $1,500 – Fixed assets sold = $1,500 – 1,430 = $70
To calculate the cash flow from assets, we must first calculate the operating cash flow. The operating cash flow is calculated as follows (you can also prepare a traditional income statement):
d.
24.
EBIT EBT Taxes OCF Cash flow from assets
= Sales – Costs – Depreciation = $9,200 – 4,290 – 820 = $4,090 = EBIT – Interest = $4,090 – 234 = $3,856 = EBT × .35 = $3,856 × .35 = $1,350 = EBIT + Depreciation – Taxes = $4,090 + 820 – 1,350 = $3,560 = OCF – Change in NWC – Net capital spending. = $3,560 – 25 – 1,430 = $2,105
Net new borrowing Cash flow to creditors Net new borrowing Debt retired
= LTD09 – LTD08 = $1,680 – 1,580 = $100 = Interest – Net new LTD = $234 – 100 = $134 = $100 = Debt issued – Debt retired = $300 – 100 = $200
(LO3) Compare the investor’s net receipt if dividends are paid versus what would be received from an income trust distribution: Dividends Income $500,000 Corporate income tax (35%) 175,000 Amount distributed 325,000 Tax on dividends (23%) 74,750 Tax on interest income (48%) Investors’ net receipt $250,250
Income trust distributions $500,000 0 500,000 240,000 $260,000
It appears that investors would benefit from the conversion. For each unit held upon conversion, an investor would gain ($260,000 - $250,250)/10,000 = $0.975. For an investor holding 2,000 units the gain would be = 2,000 ($0.975) = $1,950. Challenge 26.
(LO1) Cash Accounts receivable Inventory Current assets Net fixed assets Total assets
Cash Accounts receivable Inventory Current assets
Balance sheet as of Dec. 31, 2008 $2,528 Accounts payable 3,347 Notes payable 5,951 Current liabilities $11,826 Long-term debt $21,203 Owners' equity $33,029 Total liab. & equity Balance sheet as of Dec. 31, 2009 $2,694 Accounts payable 3,928 Notes payable 6,370 Current liabilities $12,992 Long-term debt
S2-6
$2,656 488 $3,144 $8,467 21,418 $33,029
$2,683 478 $3,161 $10,290
Net fixed assets Total assets
28.
$2,244 $15,236
Owners' equity Total liab. & equity
1,785 $15,236
2008 Income Statement Sales $4,822.00 COGS 1,668.00 Other expenses 394.00 Depreciation 692.00 EBIT $2,068.00 Interest 323.00 EBT $1,745.00 Taxes (40%) 698.00 Net income $1,047.00
2009 Income Statement Sales $5,390.00 COGS 1,901.00 Other expenses 343.00 Depreciation 723.00 EBIT $2,423.00 Interest 386.00 EBT $2,037.00 Taxes (40%) 814.80 Net income $1,222.20
Dividends Additions to RE
Dividends Additions to RE
$588.00 459.00
$674.00 548.20
(LO3)
DIVIDENDS Dividend Gross up (45%) Federal Tax (29%) Div. Tax Cr. (18.98%) Net Federal Tax Prov. Tax (10%) Div. Tax Cr. (7.40%) Net Provincial Tax Tax Payable
$40,000 18,000 58,000 16,820 -11,008 $5,812 5,800 -4,292 $1,508 $7,320
INTEREST Interest Federal Tax (29%) Prov. Tax (10%) Tax Payable
$20,000 5,800 2,000 $7,800
CAPITAL GAINS Capital Gain Fed. Tax (1/2 x 29%) Prov. Tax (1/2 x10%) Tax Payable
$20,000 2,900 1,000 $3,900
Cash Flow from Dividends = $40,000 - $7,320 = $32,680 Cash Flow from Interest = $20,000 - $7,800 = $12,200 Cash Flow from Capital Gains = $20, 000 - $3,900 = $16,100 Note: A provincial dividend tax credit of 7.40% is assumed. The actual dividend tax rate for an Alberta resident should be verified. 35.
(LO3) a. Federal tax = 0.29($57,000)(0.05) = $826.50 Provincial tax = 0.10($57,000)(0.05) = $285.00 After tax income = $2,850 – $826.50 – $285.00 = $1,738.50 b. Federal tax on dividends = 1.45($25)(250)(0.29 – 0.1898) = $908.06 (rounded) Provincial tax on dividends = 1.45($25)(250)(0.10 – 0.0740) = $235.63 (rounded) After tax income = $25(250) – $908.06 – $235.63 = $5,106.31 Assumes a provincial dividend tax credit of 7.40%. The actual dividend tax credit for an Alberta resident should be verified. c. Federal tax on capital gain = $15(500)(0.5)(0.29) = $1,087.50 Provincial tax on capital gain = $15(500)(0.5)(0.10) = $375 After tax income = $7,500 – $1,087.50 – $375 = $6,037.50
S2-7
36.
(LO3) Carry the ($600) loss in 2006 back 3 years and the remaining loss is carried forward 7 years: (in 1,000's) total carry backs = $116 + $140 + $168 = $424 leaving ($600 – $424) to carry forward which effectively reduces taxable income to zero for all years through 2009. At that time, remaining carryforward is $56.
S2-8
