FIN220 TUTORIAL
Chapter 2 Financial Statements, Taxes, and Cash Flow
Department of Economics and Finance
College of Business Administration
University of Bahrain
Question
LO1 1. Building a Balance Sheet. Grey Wolf. Inc., has current
assets of $2,090, net fixed assets of $9,830, current liabilities of
$1,710, and long-term debt of $4,520. What is the value of the
shareholders’ equity account for this firm? How much is net
working capital?
LO1 1. Building a Balance Sheet.
Grey Wolf. Inc.
Balance Sheet as of December 31, 2019
Current assets $ 2090 Current liabilities $ 1710
Net fixed assets $ 9830 Long-term debt $ 4520
Total liabilities $ 6230
Shareholders’ equity xxxx
Total assets $ 11,920 Total liabilities and owner’s equity $ 11,920
Shareholders’ equity = Total Assets – Current liabilities – Long-term debt
Shareholders’ equity = $11,920 – 1,710 – 4,520
Shareholders’ equity = $5,690
Net working capital is current assets minus current liabilities, so:
NWC = Current assets – Current liabilities
NWC = $2,090 – 1,710
NWC = $380
Question
LO 2 2. Building an Income Statement. Sidewinder., has sales
of $634,000, costs of $328,000, depreciation expense of $73,000,
interest expense of $38,000, and a tax rate of 21 percent. What is
the net income for this firm?
LO 2 2. Building an Income Statement.
2019 Income Statement
Sales $634,000
Cost of good sold 328,000
Depreciation 73,000
EBIT $233,000
Interest expense 38,000
Taxable income $195,000
Taxes 40,950
Net Income $154,050
Question
LO 2 3. Dividends and Retained Earnings. Suppose the firm in
Problem 2 paid out $68,000 in cash dividends. What is the
addition to retained earnings?
The dividends paid plus the addition to retained earnings must
equal net income, so:
Net income = Dividends + Addition to retained earnings
Addition to retained earnings = $154,050 – 68,000
Addition to retained earnings = $86,050
Question
LO 2 4. Per-Share Earnings and Dividends. Suppose the firm in
Problem 3 had 35,000 shares of common stock outstanding. What is the
earnings per share, or EPS, figure? What is the dividends per share figure?
LO 2 4. Per-Share Earnings and Dividends
Earnings per share 154050/35000 = $4.40
Dividends per share 68000/35000 = $1.94
Question
LO 4 5. Calculating Net Capital Spending. Rotweiler Obedience School’s
December 31, 2018, balance sheet showed net fixed assets of $1,945,000,
and the December 31, 2019, balance sheet showed net fixed assets of
$2,137,000. The company’s 2019 income statement showed a
depreciation expense of $335,000. What was the company’s net capital
spending for 2019?
Net capital spending is the increase in fixed assets, plus
depreciation. Using this relationship, we find:
Net capital spending = NFAend – NFAbeg + Depreciation
Net capital spending = $2,137,000 – 1,945,000 + 335,000
Net capital spending = $527,000
Capital Spending or NCS is used to represent the difference between capital
expenditure (CAPEX) and depreciation. It is also relative to the growth of the
company. A company with the faster growth rate incurs higher net capital
spending than one facing the slower growth rates.
*Cash flow is the measure of total amount of liquid cash that
is moving in and out of the business.
Question
LO 4 6. Cash Flow to Creditors. The December 31, 2018, balance sheet of
Whelan, Inc., showed long-term debt of $1,350,000, and the December 31,
2019, balance sheet showed long-term debt of $1,470,000. The 2019
income statement showed an interest expense of $97,500. What was the
firm’s cash flow to creditors during 2019?
The cash flow to creditors is the interest paid, minus any net new borrowing, so:
Cash flow to creditors = Interest paid – Net new borrowing
Cash flow to creditors = Interest paid – (LTDend – LTDbeg)
Cash flow to creditors = $97,500 – ($1,470,000 – 1,350,000)
Cash flow to creditors = –$22,500
*Cash flow is the measure of total amount of liquid cash that
is moving in and out of the business.
Question
LO 4 7. Cash Flow to Stockholders. The December 31, 2018, balance sheet of
Whelan, Inc., showed $120,000 in the common stock account and $2,289,000 in
the additional paid-in surplus account. The December 31, 2019, balance sheet
showed $137,000 and $2,568,000 in the same two accounts, respectively. If the
company paid out $149,500 in cash dividends during 2019, what was the cash
flow to stockholders for the year?
Cash flow to stockholders = Dividends paid – Net new equity
Cash flow to stockholders = Dividends paid – [(Commonend + APISend) – (Commonbeg + APISbeg)]
Cash flow to stockholders = $149,500 – [($137,000 + 2,568,000) – ($120,000 + 2,289,000)]
Cash flow to stockholders = –$146,500
The cash flow to stockholders is the amount of cash that the company pays out to its shareholders. The investors
routinely compare the values of cash flow to stockholders to the total amount of cash flow generated to measure the
dividends potential in future. Given here is the cash flow to stockholders formula to calculate the amount of cash
which needs to be paid. The cash flow to stockholders is the dividends paid minus any new equity raised.
Question
LO 4 8. Calculating Cash Flows. Given the information for Whelan, Inc., in
Problems 10 and 11, suppose you also know that the firm’s net capital
spending for 2019 was $745,000, and that the firm reduced its net
working capital investment by $94,300. What was the firm’s 2019
operating cashflow, or OCF?
We know that cash flow from assets is equal to cash flow to creditors plus cash flow to stockholders. So, cash flow
from assets is:
Cash flow from assets = Cash flow to creditors + Cash flow to stockholders
Cash flow from assets = –$22,500 – 146,500
Cash flow from assets = –$169,000
We also know that cash flow from assets is equal to the operating cash flow minus the change in net working
capital and the net capital spending. We can use this relationship to find the operating cash flow. Doing so, we
find:
Cash flow from assets = OCF – Change in NWC – Net capital spending
–$169,000 = OCF – (–$94,300) – (745,000)
OCF = –$169,000 – 94,300 + 745,000
OCF = $481,700
We know that cash flow from assets is equal to cash flow to creditors plus cash flow to stockholders.
Cash flow analysis is a critical process for both companies and investors. Here is an online cash flow
from assets calculator which helps to calculate the cash flows of the firm.
Question
LO 1 9. Market Values and Book Values. Klingon Widgets, Inc., purchased new
cloaking machinery three years ago for $6 million. The machinery can be sold to the
Romulans today for $4.6 million. Klingon’s current balance sheet shows net fixed assets
of $3.15 million, current liabilities of $830,000, and net working capital of $210,000. If
all the current accounts were liquidated today, the company would receive $950,000
million cash. What is the book value of Klingon’s total assets today? What is the sum of
the market value NWC and the market value of fixed assets?
To find the book value of current assets, we use: NWC = CA – CL. Rearranging to solve for
current assets, we get:
CA = NWC + CL = $210,000 + 830,000 = $1,040,000
The market value of current assets and fixed assets is given, so:
Book value CA = $1,040,000 NWC = $ 950,000
Book value NFA = $3,150,000 Market value NFA = $ 4,600,000
Book value assets = $4,190,000 Total = $ 5,550,000
Question
LO 4 10. Calculating Cash Flows. Weiland Co. shows the following information on its
2019 income statement: sales = $178,000; costs = $103,600; other expenses =
$5,100; depreciation expense = $12,100; interest expense =$8,900; taxes = $12,705;
dividends = $10,143. In addition, you’re told that the firm issued $2,900 in new
equity during 2019 and redeemed $4,000 in outstanding long-term debt.
a. What is the 2019 operating cash flow?
b. What is the 2019 cash flow to creditors?
c. What is the 2019 cash flow to stockholders?
d. If net fixed assets increased by $23,140 during the year, what was the
addition to NWC?
a. To calculate the OCF, we first need to construct an income statement. The income statement starts with
revenues and subtracts costs to arrive at EBIT. We then subtract out interest to get taxable income, and then
subtract taxes to arrive at net income. Doing so, we get:
Income Statement
Sales $178,000
Costs 103,600
Other Expenses 5,100
Depreciation 12,100
EBIT $ 57,200
Interest 8,900
Taxable income $ 48,300
Taxes 12,705
Net income $ 35,595
Dividends $10,143
Addition to retained earnings 25,452
Dividends paid plus addition to retained earnings must equal net income, so:
Net income = Dividends + Addition to retained earnings
Addition to retained earnings = $35,595 – 10,143
Addition to retained earnings = $25,452
So, the operating cash flow is:
OCF = EBIT + Depreciation – Taxes
OCF = $57,200 + 12,100 – 12,705
OCF = $56,595
b. The cash flow to creditors is the interest paid, minus any new borrowing. Since the
company redeemed long-term debt, the net new borrowing is negative. So, the cash
flow to creditors is:
Cash flow to creditors = Interest paid – Net new borrowing
Cash flow to creditors = $8,900 – (–$4,000)
Cash flow to creditors = $12,900
c. The cash flow to stockholders is the dividends paid minus any new equity. So, the
cash flow to stockholders is:
Cash flow to stockholders = Dividends paid – Net new equity
Cash flow to stockholders = $10,143 – 2,900
Cash flow to stockholders = $7,243
d. In this case, to find the addition to NWC, we need to find the cash flow from assets. We can then use
the cash flow from assets equation to find the change in NWC. We know that cash flow from assets is
equal to cash flow to creditors plus cash flow to stockholders. So, cash flow from assets is:
Cash flow from assets = Cash flow to creditors + Cash flow to stockholders
Cash flow from assets = $12,900 + 7,243
Cash flow from assets = $20,143
Net capital spending is equal to depreciation plus the increase in fixed assets, so:
Net capital spending = Depreciation + Increase in fixed assets
Net capital spending = $12,100 + 23,140
Net capital spending = $35,240
Now we can use the cash flow from assets equation to find the change in NWC. Doing so, we find:
Cash flow from assets = OCF – Change in NWC – Net capital spending
$20,143 = $56,595 – Change in NWC – $35,240
Change in NWC = $1,212
Question
LO 1 11. Preparing a Balance Sheet. Prepare a balance sheet for Alaskan
Strawberry Corp. as of December 31, 2019, based on the following
information: cash = $207,000; patents and copyrights = $871,000;
accounts payable = $293,000; accounts receivable = $265,000; tangible
net fixed assets = $5,270,000; inventory = $579,000; notes payable =
$201,000; accumulated retained earnings = $4,676,000; long-term debt =
$1,680,000.
Alaskan Strawberry Corp.
Balance Sheet as of December 31, 2019
Cash $ 207,000 Accounts payable $ 293,000
Accounts Receivable 265,000 Notes payable 201,000
Inventory 579,000 Total current liabilities $ 494,000
Total current assets $ 1,051,000 Long-term debt $ 1,680,000
Tangible net fixed assets $5,270,000 Total liabilities $ 2,174,000
Intangible net fixed assets $ 871,000
Common stock $ xxxxx
Accumulated retained earnings 4,676,000
Total assets $7,192,000 Total liabilities and owner’s equity $ 7,192,000
TL & OE = CL + LTD + Common stock + Retained earnings
Solving for this equation for common stock gives us:
Common stock = $7,192,000 – 4,676,000 – 2,174,000
Common stock = $342,000
Question
LO 4 12. Cash Flow Identity Graffiti Advertising, Inc., reported the
following financial statements for the last two years. Construct the cash
flow identity for the company. Explain what each number means.
2019 Income Statement
Sales $750,727
Cost of good sold 430,821
Selling and administrative 165,676
Depreciation 72,489
EBIT $ 81,741
Interest 25,630
EBT $ 56,111
Taxes 14,028
Net Income $ 42,083
Dividends $ 14,200
Addition to retained earnings 27,883
GRAFFITI ADVERTISING, INC.
Balance Sheet as of December 31, 2018
Cash $ 17,691 Accounts payable $ 12,721
Accounts 25,228 Notes payable 19,149
Receivable
Inventory 18,321 Current liabilities $ 31,870
Current assets $ 61,240 Long-term debt $ 181,000
Net fixed assets $457,454 Owner’s equity $ 305,824
Total assets $518,964 Total liabilities $ 518,694
and owner’s
equity
GRAFFITI ADVERTISING, INC.
Balance Sheet as of December 31, 2019
Cash $ 19,003 Accounts payable $ 13,962
Accounts 28,025 Notes payable 21,872
Receivable
Inventory 30,222 Current liabilities $ 35,834
Current assets $ 77,250 Long-term debt $ 201,900
Net fixed assets $539,679 Owner’s equity $ 379,195
Total assets $616,929 Total liabilities $ 616,929
and owner’s
equity
Cash flow identity:
Cash flow from assets = Cash flow to creditors + Cash flow to stockholders
Cash flow from assets = OCF – Change in NWC – Net capital spending
So, the operating cash flow is:
OCF = EBIT + Depreciation – Taxes
OCF = $81,741 + 72,489 – 14,028
OCF = $140,202
Next, we will calculate the change in net working capital, which is:
Change in NWC = NWCend – NWCbeg
Change in NWC = (CAend – CLend) – (CAbeg – CLbeg)
Change in NWC = ($77,250 – 35,834) – ($61,240 – 31,870)
Change in NWC = $12,046
Now, we can calculate the capital spending. The capital spending is:
Net capital spending = NFAend – NFAbeg + Depreciation
Net capital spending = $539,679 – 457,454 + 72,489
Net capital spending = $154,714
Now, we have the cash flow from assets, which is:
Cash flow from assets = OCF – Change in NWC – Net capital spending
Cash flow from assets = $140,202 – 12,046 – 154,714
Cash flow from assets = –$26,558
The company’s assets generated an outflow of $26,558. The cash flow from operations was
$140,202, and the company spent $12,046 on net working capital and $154,714 on fixed assets.
The cash flow to creditors is:
Cash flow to creditors = Interest paid – New long-term debt
Cash flow to creditors = Interest paid – (Long-term debtend – Long-term debtbeg)
Cash flow to creditors = $25,630 – ($201,900 – 181,000)
Cash flow to creditors = $4,730
Now, the cash flow to stockholders.
New equity = Ending equity – Beginning equity – Addition to retained earnings
New equity = $379,195 – 305,824 – 27,883
New equity = $45,488
Cash flow to stockholders = Dividends paid – Net new equity
Cash flow to stockholders = $14,200 – 45,488
Cash flow to stockholders = –$31,288
Question
LO 4 13. Net Fixed Assets and Depreciation On the balance sheet, the net fixed
assets (NFA) account is equal to the gross fixed assets (FA) account (which records the
acquisition cost of fixed assets) minus the accumulated depreciation (AD) account
(which records the total depreciation taken by the firm against its fixed assets). Using
the fact that NFA = FA − AD, show that the expression given in the chapter for net
capital spending, NFAend − NFAbeg + D (where D is the depreciation expense during the
year), is equivalent to FAend − FAbeg.
Net capital spending = NFAend – NFAbeg + Depreciation
= (NFAend – NFAbeg) + (Depreciation + ADbeg) – ADbeg
= (NFAend – NFAbeg)+ ADend – ADbeg
= (NFAend + ADend) – (NFAbeg + ADbeg)
= FAend – FAbeg
