Finance and Value Creation

11/23/2018 Capella: Corporate Finance: Core Principles and Applications

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Book Values versus Market Values Under standard accounting rules, it is possible for a company’s liabilities to exceed its assets. When this occurs, the owners’ equity is negative. Can this happen with market values? Why or why not?

Cash Flow from Assets Suppose a company’s cash flow from assets was negative for a particular period. Is this necessarily a good sign or a bad sign?

Operating Cash Flow Suppose a company’s operating cash flow was negative for several years running. Is this necessarily a good sign or a bad sign?

Net Working Capital and Capital Spending Could a company’s change in net working capital be negative in a given year? (Hint: Yes.) Explain how this might come about. What about net capital spending?

Cash Flow to Stockholders and Creditors Could a company’s cash flow to stockholders be negative in a given year? (Hint: Yes.) Explain how this might come about. What about cash flow to creditors?

Firm Values Referring back to the Microsoft example used at the beginning of the chapter, note that we suggested that Microsoft’s stockholders probably didn’t suffer as a result of the reported loss. What do you think was the basis for our conclusion?

QUESTIONS AND PROBLEMS

Basic (Questions 1–10)

1. Building a Balance Sheet Burnett, Inc., has current assets of $6,800, net fixed assets of $29,400, current liabilities of $5,400, and long-term debt of $13,100. What is the value of the shareholders’ equity account for this firm? How much is net working capital?

2. Building an Income Statement Bradds, Inc., has sales of $528,600, costs of $264,400, depreciation expense of $41,700, interest expense of $20,700, and a tax rate of 35 percent. What is the net income for the firm? Suppose the company paid out $27,000 in cash dividends. What is the addition to retained earnings?

3. Market Values and Book Values Klingon Cruisers, Inc., purchased new cloaking machinery three years ago for $7 million. The machinery can be sold to the Romulans today for $5.3 million. Klingon’s current balance sheet shows net fixed assets of $3.9 million, current liabilities of $1.075 million, and net working capital of $320,000. If all the current accounts were liquidated today, the company would receive $410,000 cash. What is the book value of Klingon’s total assets today? What is the sum of the market value of NWC and market value of assets?

4. Calculating Taxes The Alexander Co. had $328,500 in taxable income. Using the rates from Table 2.3 in the chapter, calculate the company’s income taxes. What is the average tax rate? What is the marginal tax rate?

11/23/2018 Capella: Corporate Finance: Core Principles and Applications

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5. Calculating OCF Timsung, Inc., has sales of $30,700, costs of $11,100, depreciation expense of $2,100, and interest expense of $1,140. If the tax rate is 40 percent, what is the operating cash flow, or OCF?

6. Calculating Net Capital Spending Busch Driving School’s 2016 balance sheet showed net fixed assets of $3.75 million, and the 2017 balance sheet showed net fixed assets of $4.45 million. The company’s 2017 income statement showed a depreciation expense of $395,000. What was the company’s net capital spending for 2017?

7. Building a Balance Sheet The following table presents the long-term liabilities and stockholders’ equity of Information Control Corp. one year ago:

Long-term debt $37,000,000

Preferred stock 2,100,000

Common stock ($1 par value) 8,900,000

Capital surplus 41,000,000

Accumulated retained earnings 75,300,00

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During the past year, the company issued 4 million shares of new stock at a total price of $26 million, and issued $9.5 million in new long-term debt. The company generated $15.3 million in net income and paid $3.1 million in dividends. Construct the current balance sheet reflecting the changes that occurred on the company’s balance sheet during the year.

8. Cash Flow to Creditors The 2016 balance sheet of Maria’s Tennis Shop, Inc., showed long-term debt of $2.4 million, and the 2017 balance sheet showed long-term debt of $2.53 million. The 2017 income statement showed an interest expense of $187,000. What was the firm’s cash flow to creditors during 2017?

9. Cash Flow to Stockholders The 2016 balance sheet of Maria’s Tennis Shop, Inc., showed $540,000 in the common stock account and $5.6 million in the additional paid-in surplus account. The 2017 balance sheet showed $595,000 and $6.18 million in the same two accounts, respectively. If the company paid out $270,000 in cash dividends during 2017, what was the cash flow to stockholders for the year?

10. Calculating Total Cash Flows Given the information for Maria’s Tennis Shop, Inc., in the previous two problems, suppose you also know that the firm’s net capital spending for 2017 was $640,000, and that the firm reduced its net working capital investment by $65,000. What was the firm’s 2017 operating cash flow, or OCF?

Intermediate (Questions 11–25)

11. Cash Flows Ritter Corporation’s accountants prepared the following financial statements for year- ends.

RITTER CORPORATION Income Statement

2017

Revenue $1,068

Expenses 745

Depreciation      77

EBT $   246

Tax      98

Net income $   148

Dividends $     40

RITTER CORPORATION Balance Sheets

December 31

  2016 2017

Assets

Cash $ 81 $ 93

Other current assets 253 265

Net fixed assets     690     824

  Total assets $1,024 $1,182

11/23/2018 Capella: Corporate Finance: Core Principles and Applications

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Liabilities and Equity

Accounts payable $ 295 $ 301

Long-term debt 0 44

Stockholders’ equity     729    837

  Total liabilities and equity $1,024 $1, 182

a. Explain the change in cash during the year 2017. b. Determine the change in net working capital in 2017. c. Determine the cash flow generated by the firm’s assets during the year 2017.

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