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Ch02ToolKit.xlsxChapter
| Tool Kit | Chapter 2 | 10/27/15 | ||||
| Financial Statements, Cash Flow, and Taxes | ||||||
| 2-1 Financial Statements and Reports | ||||||
| The annual report contains a verbal section plus four key statements: the balance sheet, income statement, statement of stockholders' equity, and statement of cash flows. | ||||||
| Our spreadsheets use formulas rather than fixed numbers. For example, the cell for Total assets for the most recent year contains the Sum formula rather than just a fixed number. That way, if the data for any inputs (cash, for instance) change, the spreadsheet will automatically recalculate and provide the correct new value for Total assets. | ||||||
| In financial modeling, it is helpful to users when input data is grouped together, so you should follow this practice in your own models, too. | ||||||
| 2-2 The Balance Sheet | ||||||
| INPUT DATA SECTION: Historical Data Used in the Analysis | ||||||
| 2016 | 2015 | |||||
| Year-end common stock price | $27.00 | $40.00 | ||||
| Year-end shares outstanding (in millions) | 50 | 50 | ||||
| Tax rate | 40% | 40% | ||||
| Weighted average cost of captal (WACC) | 11.0% | 10.5% | ||||
| Figure 2-1 | ||||||
| MicroDrive Inc. December 31 Balance Sheets | ||||||
| (Millions of Dollars) | ||||||
| Assets | 2016 | 2015 | ||||
| Cash and equivalents | $ 50 | $ 60 | ||||
| Short-term investments | - | 40 | ||||
| Accounts receivable | 500 | 380 | ||||
| Inventories | 1,000 | 820 | ||||
| Total current assets | $ 1,550 | $ 1,300 | ||||
| Net plant and equipment | 2,000 | 1,700 | Note: Net plant and equipment is equal to cumulative purchases of fixed assets less cumulative depreciation and cumulative disposed assets. | |||
| Total assets | $ 3,550 | $ 3,000 | ||||
| Liabilities and Equity | ||||||
| Accounts payable | $ 200 | $ 190 | ||||
| Notes payable | 280 | 130 | ||||
| Accruals | 300 | 280 | ||||
| Total current liabilities | $ 780 | $ 600 | ||||
| Long-term bonds | 1,200 | 1,000 | ||||
| Total liabilities | $ 1,980 | $ 1,600 | ||||
| Preferred stock (1,000,000 shares) | 100 | 100 | ||||
| Common stock (50,000,000 shares) | 500 | 500 | ||||
| Retained earnings | 970 | 800 | ||||
| Total common equity | $ 1,470 | $ 1,300 | ||||
| Total liabilities and equity | $ 3,550 | $ 3,000 | ||||
| 2-2 The Income Statement | ||||||
| Figure 2-2 | ||||||
| MicroDrive Income Statements for Years Ending December 31 | ||||||
| (Millions of Dollars, Except for Per Share Data) | ||||||
| 2016 | 2015 | |||||
| Net sales | $ 5,000 | $ 4,760 | ||||
| Costs of goods sold except depreciation | 3,800 | 3,560 | ||||
| Depreciation and amortizationa | 200 | 170 | ||||
| Other operating expenses | 500 | 480 | ||||
| Earnings before interest and taxes (EBIT) | $ 500 | $ 550 | ||||
| Less interest | 120 | 100 | ||||
| Pre-tax earnings | $ 380 | $ 450 | ||||
| Taxes | 152 | 180 | ||||
| Net Income before preferred dividends | $ 228 | $ 270 | ||||
| Preferred dividends | 8 | 8 | ||||
| Net Income available to common stockholders | $ 220 | $ 262 | ||||
| Additional Information | ||||||
| Common dividends | $50 | $48 | ||||
| Addition to retained earnings | $170 | $214 | ||||
| Number of common shares | 50 | 50 | ||||
| Stock price per share | $27 | $40 | ||||
| Per Share Data | ||||||
| Earnings per share, EPSb | $4.40 | $5.24 | ||||
| Dividends per share, DPSc | $1.00 | $0.96 | ||||
| Book value per share, BVPSd | $29.40 | $26.00 | ||||
| Notes: | ||||||
| a MicroDrive has no amortization charges. | ||||||
| b EPS = Net income available to common stockholders Common shares outstanding | ||||||
| c DPS = Dividends paid to common stockholders Common shares outstanding | ||||||
| d BVPS = Total common equity Common shares outstanding | ||||||
| 2-4 Statement of Stockholders’ Equity | ||||||
| The statement of stockholders' equity takes the previous year's balance of common stock, retained earnings, and stockholders' equity and then adds the current year's net income and subtracts dividends paid to common stockholders. The end result is the new balance of common stock, retained earnings, and stockholders' equity. | ||||||
| Figure 2-3 | ||||||
| MicroDrive Inc. Statement of Stockholders' Equity | ||||||
| (Millions of Dollars, Millions of Shares) | ||||||
| Preferred Stock | Common Shares | Common Stock | Retained Earnings | Total Equity | ||
| Balances, Dec. 31, 2015 | $100 | 50 | $500 | $800 | $1,400 | |
| Changes during year: | ||||||
| Net income | $220 | $220 | ||||
| Cash dividends | (50) | (50) | ||||
| Issuance/repurchase of stock | 0 | 0 | 0 | |||
| Balances, Dec. 31, 2016 | $100 | 50 | $500 | $970 | $1,570 | |
| Note: In financial statements, parentheses and red colors denote a negative number. | ||||||
| 2-5 Statement of Cash Flows | ||||||
| Information from the balance sheet and income statement can be used to construct the Statement of Cash Flows, which is shown below for MicroDrive, in millions of dollars. | ||||||
| Figure 2-4 | ||||||
| MicroDrive Statement of Cash Flows for Year Ending Dec. 31 | ||||||
| (Millions of Dollars) | ||||||
| Operating Activities | 2016 | |||||
| Net Income before preferred dividends | $ 228 | |||||
| Noncash adjustments | ||||||
| Depreciationa | 200 | |||||
| Working capital adjustments | ||||||
| Increase in accounts receivableb | (120) | |||||
| Increase in inventories | (180) | |||||
| Increase in accounts payable | 10 | |||||
| Increase in accruals | 20 | |||||
| Net cash provided (used) by operating activities | $ 158 | |||||
| Investing Activities | ||||||
| Cash used to acquire fixed assetsc | $ (500) | |||||
| Sale of short-term investments | 40 | |||||
| Net cash provided (used) by investing activities | $ (460) | |||||
| Financing Activities | ||||||
| Increase in notes payable | $ 150 | |||||
| Increase in bonds | 200 | |||||
| Payment of common and preferred dividends | (58) | |||||
| Net cash provided (used) by financing activities | $ 292 | |||||
| Summary | ||||||
| Net change in cash and equivalents | $ (10) | |||||
| Cash and securities at beginning of the year | 60 | |||||
| Cash and securities at end of the year | $ 50 | |||||
| Notes: | ||||||
| aDepreciation is a noncash expense that was deducted when calculating net income. It must be added back to show the correct cash flow from operations. | ||||||
| bAn increase in a current asset decreases cash. An increase in a current liability increases cash. For example, inventories increased by $180 million and therefore reduced cash by the same amount. | ||||||
| cThe net increase in fixed assets is $300 million; however, this net amount is after a deduction for the year’s depreciation expense. Depreciation expense must be added back to find the increase in gross fixed assets. From the company’s income statement, we see that the year's depreciation expense is $200 million; thus, expenditures on fixed assets were actually $500 million. | ||||||
| 2-6 Net Cash Flow | ||||||
| 2016 | 2015 | |||||
| Net income | $220.0 | $262.0 | ||||
| Depreciation | $500.0 | $480.0 | ||||
| Net cash flow | $720.0 | $742.0 | ||||
| 2-7 Free Cash Flow: The Cash Flow Available for Distribution to Investors | ||||||
| Net Operating Profit After Taxes | ||||||
| NOPAT is the amount of profit MicroDrive would generate if it had no debt and held no financial assets. | ||||||
| NOPAT = EBIT x (1-T) | ||||||
| 2016 | 2015 | |||||
| Tax rate | 40% | 40% | ||||
| Earnings before interest and taxes (EBIT) | $500 | $550 | ||||
| x (1-T) | 60% | 60% | ||||
| NOPAT | $300 | $330 | ||||
| Net Operating Working Capital | ||||||
| The current assets (CA) used in operations are called operating current assets. Operating CA include the cash needed for operations, accounts receivable and inventories. The current liabilities (CL) that are due to operations are called operating current liabilities. Operating CL include accounts payable and accruals. Net operating working capital (NOWC) is equal to operating CA minus operating CL. NOWC is the net amount that a company's operations tie up in current assets and current liabilities. | ||||||
| Calculating Operating Current Assets | ||||||
| 2016 | 2015 | |||||
| Cash and equivalents | $50 | $60 | ||||
| + Accounts receivable | $500 | $380 | ||||
| +Inventories | $1,000 | $820 | ||||
| Operating current assets | $1,550 | $1,260 | ||||
| Calculating Operating Current Liabilities | ||||||
| 2016 | 2015 | |||||
| Accounts payable | $200 | $190 | ||||
| + Accruals | $300 | $280 | ||||
| Operating current liabilities | $500 | $470 | ||||
| Calculating Net Operating Working Capital | ||||||
| 2016 | 2015 | |||||
| Operating current assets | $1,550 | $1,260 | ||||
| − Operating current liabilities | $500 | $470 | ||||
| Net operating working capital | $1,050 | $790 | ||||
| Total Net Operating Capital (also just called Operating Capital or just Capital) | ||||||
| The Total Net Operating Capital is Net Operating Working Capital plus any long-term fixed assets or net plant, property, and equipment used in operations. | ||||||
| Calculating Total Net Operating Capital | ||||||
| 2016 | 2015 | |||||
| Net operating working capital | $1,050 | $790 | ||||
| + Net plant and equipment | $2,000 | $1,700 | ||||
| Total net operating capital | $3,050 | $2,490 | ||||
| Alternative Calculation of Total Net Operating Capital (also just called Operating Capital) | ||||||
| Total Funds Provided by Investors | ||||||
| 2016 | 2015 | |||||
| Notes payable | $280 | $130 | ||||
| Long-term bonds | $1,200 | $1,000 | ||||
| Preferred stock | $100 | $100 | ||||
| Total common equity | $1,470 | $1,300 | ||||
| Total investor supplied funds | $3,050 | $2,530 | ||||
| Total Funds Provided by Investors for Operations | ||||||
| 2016 | 2015 | |||||
| Total investor supplied capital | $3,050 | $2,530 | ||||
| Less short-term investments | $0 | $40 | ||||
| Total investor-supplied operating capital | $3,050 | $2,490 | ||||
| Free Cash Flow | ||||||
| MicroDrive's Free Cash Flow calculation is the cash flow actually availabe for distribution to investors after the company has made all necessary investments in fixed assets and working capital to sustain ongoing operations. Free cash flow is equal to NOPAT minus the investment made in total net operating capital. The investment in total net operating capital is equal to the current year's total net operating capital minus the previous year's total net operating capital. | ||||||
| Calculating the Investment in Total Net Operating Capital | ||||||
| 2016 | 2015 | |||||
| Total net operating capital | $3,050 | $2,490 | ||||
| Investment in total net operating capital | $560 | |||||
| Calculating Free Cash Flow | ||||||
| 2016 | ||||||
| NOPAT | $300 | |||||
| − Investment in total net operating capital | $560 | |||||
| Free cash flow | -$260 | |||||
| Here is an alternative calculation of FCF that is sometimes used in the financial press. | ||||||
| 2016 | FCF = | NOPAT + Depreciation | − | Gross investment in fixed assets | − | Investment in NOWC |
| = | $500.0 | − | $500 | − | $260 | |
| 2016 | FCF = | -$260.0 | ||||
| Uses of Free Cash Flow | ||||||
| 1. After-tax interest payments | ||||||
| 2016 | After-tax interest expense = | (Pre-tax interest expense) x (1-T) | ||||
| = | $120.0 | x | 60% | |||
| = | $72.0 | |||||
| 2. Net repayment of debt | ||||||
| The amount of debt that is repaid is equal to the amount at the beginning of the year minus the amount at the end of the year. This includes notes payable and long-term debt. If the amount of ending debt is less than the beginning debt, the company paid of some of its debt. But if the ending debt is greater than the beginning debt, the company actually borrowed additional funds from creditors. In that case, it would be a negative use of FCF. | ||||||
| 2016 | Repayment to debtholders = | All debt at beginning of year - all debt at end of year | ||||
| = | $1,130.0 | - | $1,480.0 | |||
| = | -$350.0 | |||||
| 3. Total dividend payments | ||||||
| This includes all dividends to preferred stockholders and dividends to common stockholders. | ||||||
| 2016 | Dividends = | Prefered dividends + common dividends | ||||
| = | $8.0 | + | $50.0 | |||
| = | $58.0 | |||||
| 4. Net repurchase of stock | ||||||
| The amount of stock that is repurchased is equal to the amount at the beginning of the year minus the amount at the end of the year. This includes preferred stock and common stock. If the amount of ending stock is less than the beginning stock, the company made net repurchases. But if the ending stock is greater than the beginning stock, the company actually made net issuances. In that case, it would be a negative use of FCF. | ||||||
| 2016 | Repurchase stock = | Preferred stock and common stock at beginning of year - Preferred stock and common stock at end of year | ||||
| = | $600.0 | - | $600.0 | |||
| = | $0.0 | |||||
| 5. Net purchase of short-term investments | ||||||
| The amount of net purchases of ST investments is equal to the amount at the end of the year minus the amount at the beginning of the year. If the amount of ending investments is greater than the beginning investments, the company made net purchases. But if the ending investments are less than the beginning investments, the company actually sold investments. In that case, it would be a negative use of FCF. | ||||||
| 2016 | Purchase ST investments = | ST investents at end of year - ST investments at beginning of year | ||||
| = | $0.0 | - | $40.0 | |||
| = | -$40.0 | |||||
| Summary of uses of FCF | ||||||
| 2016 | ||||||
| 1. After-tax interest payments | $72.0 | |||||
| 2. Net repayment of debt | -$350.0 | |||||
| 3. Total dividend payments | $58.0 | |||||
| 4. Net repurchase of stock | $0.0 | |||||
| 5. Net purchase of short-term investments | -$40.0 | |||||
| Total uses of FCF = | -$260.0 | |||||
| Notice that the total uses of FCF equals the previously calculated value of FCF. | ||||||
| 2-8 Performance Evaluation | ||||||
| The Return on Invested Capital (ROIC) | ||||||
| The Return on Invested Capital tells us the amount of NOPAT per dollar of operating capital. | ||||||
| 2016 | ROIC = | NOPAT | ÷ | Total net operating capital | ||
| $300.00 | ÷ | $3,050 | ||||
| 2016 | ROIC = | 9.84% | ||||
| 2015 | ROIC = | NOPAT | ÷ | Total net operating capital | ||
| $330.00 | ÷ | $2,490 | ||||
| 2015 | ROIC = | 13.25% | ||||
| The Operating Profitability Ratio (OP) | ||||||
| The operating profitability ratio show the amount of NOPAT per dollar of sales. | ||||||
| 2016 | OP = | NOPAT | ÷ | Sales | ||
| $300.00 | ÷ | $5,000 | ||||
| 2016 | OP = | 6.00% | ||||
| 2015 | OP = | NOPAT | ÷ | Sales | ||
| $330.00 | ÷ | $4,760 | ||||
| 2015 | OP = | 6.93% | ||||
| The Capital Requirement Ratio (CR) | ||||||
| The capital requirement ratio show the amount of operating capital that is needed to generate a dollar of sales. | ||||||
| 2016 | CR = | Total net operating capital | ÷ | Sales | ||
| $3,050 | ÷ | $5,000 | ||||
| 2016 | CR = | 61.00% | ||||
| 2015 | CR = | Total net operating capital | ÷ | Sales | ||
| $2,490 | ÷ | $4,760 | ||||
| 2015 | CR = | 52.31% | ||||
| Market Value Added | ||||||
| Market Value Added is the difference between the market value of MicroDrive's stock and the amount of equity capital supplied by shareholders. | ||||||
| 2016 | MVA = | Stock price | x | # of shares | - | Total common equity |
| = | $27.00 | x | 50 | - | $1,470 | |
| = | $1,350 | - | $1,470 | |||
| 2016 | MVA = | -$120 | ||||
| 2015 | MVA = | Stock price | x | # of shares | - | Total common equity |
| = | $40.00 | x | 50 | - | $1,300 | |
| = | $2,000 | - | $1,300 | |||
| 2015 | MVA = | $700 | ||||
| Economic Value Added | ||||||
| Economic Value Added represents MicroDrive's residual income that remains after the cost of all capital, including equity capital, has been deducted. | ||||||
| 2016 | EVA = | NOPAT | - | Operating Capital x | Weighted average cost of capital | |
| = | $300.00 | - | $3,050 | x | 11% | |
| = | $300.0 | - | $335.5 | |||
| 2016 | EVA = | -$35.5 | ||||
| 2015 | EVA = | NOPAT | - | Operating Capital x | Weighted average cost of capital | |
| = | $330.00 | - | $2,490 | x | 11% | |
| = | $330.0 | - | $261.5 | |||
| 2015 | EVA = | $68.6 | ||||
| Figure 2-6 | ||||||
| Calculating Performance Measures for MicroDrive | ||||||
| (Millions of Dollars) | ||||||
| 2016 | 2015 | |||||
| Calculating NOPAT | ||||||
| EBIT | $500 | $550 | ||||
| x (1 − Tax rate) | 60% | 60% | ||||
| NOPAT = EBIT(1 − T) | $300 | $330 | ||||
| Calculating Net Operating Working Capital (NOWC) | ||||||
| Operating current assets | $1,550 | $1,260 | ||||
| − Operating current liabilities | $500 | $470 | ||||
| NOWC | $1,050 | $790 | ||||
| Calculating Total Net Operating Capital | ||||||
| NOWC | $1,050 | $790 | ||||
| + Net plant and equipment | $2,000 | $1,700 | ||||
| Total net operating capital | $3,050 | $2,490 | ||||
| Calculating Return on Invested Capital (ROIC) | ||||||
| NOPAT | $300 | $330 | ||||
| ÷ Total net operating capital | $3,050 | $2,490 | ||||
| ROIC = NOPAT/Total net operating capital | 9.84% | 13.25% | ||||
| Weighted average cost of capital (WACC) | 11.00% | 10.50% | ||||
| Calculating the Operating Profitability Ratio (OP) | ||||||
| NOPAT | $300 | $330 | ||||
| ÷ Sales | $5,000 | $4,760 | ||||
| OP = NOPAT/Sales | 6.00% | 6.93% | ||||
| Calculating Capital Requirement Ratio (CR) | ||||||
| Total net operating capital | $3,050 | $2,490 | ||||
| ÷ Sales | $5,000 | $4,760 | ||||
| CR = Total net operating capital/Sales | 61.00% | 52.31% | ||||
| Calculating Market Value Added (MVA) | ||||||
| Price per share | $27 | $40 | ||||
| x Number of shares (millions) | 50 | 50 | ||||
| Market value of equity = P x (# of shares) | $1,350 | $2,000 | ||||
| − Book value of equity | $1,470 | $1,300 | ||||
| MVA = Market value − Book value | −$120 | $700 | ||||
| Calculating Economic Value Added (EVA) | ||||||
| Total net operating capital | $3,050.0 | $2,490.0 | ||||
| x Weighted average cost of capital (WACC) | 11.0% | 10.5% | ||||
| Dollar cost of capital | $335.5 | $261.5 | ||||
| NOPAT | $300.0 | $330.0 | ||||
| − Dollar cost of capital | $335.5 | $261.5 | ||||
| EVA = NOPAT – Dollar cost of capital | −$35.5 | $68.6 | ||||
| 2-9 The Federal Income Tax System | ||||||
| This worksheet explores the calculation of corporate income taxes under the federal tax system. By using special Excel functions, we can input a corporate tax schedule into a spreadsheet and then have a cell automatically display a company's tax liability. Either of two procedures can be used, the IF function or the VLOOKUP function. Both functions are explained below, using the data shown in the following tax table. | ||||||
| LOOKUP | ||||||
| There are actually two lookup functions, VLOOKUP for looking up items in vertical columns, and HLOOKUP for looking up things in horizontal rows. Since our tax table is arranged in columns, we use VLOOKUP. | ||||||
| When we use VLOOKUP, Excel first looks down the Column (1) of Table 2-1 below and finds the largest value that does not exceed the firm's taxable income. Next, it looks for the corresponding value in Column (3) of Table 2-1, which is the base amount of the tax. Then, it again looks down Column (1) and finds the corresponding marginal tax rate as shown in Column (4). Then it multiplies the tax rate times the difference between the firm's taxable income and the bottom tax bracket to get the incremental tax. Then it adds the base tax to the incremental tax to get the firm's total tax liability. | ||||||
| We will explain how to use VLOOKUP here, and then we will use it for the calculations below Table 2-1. To get the VLOOKUP formula, click the function wizard, fx, select "Lookup & Reference," and then select VLOOKUP. You will then get a dialog box like the one shown here. | ||||||
| For example, suppose we have taxable income of $65,000. We first need to identify the bracket that this is in, then find the amount of tax on the bracket. We can do that by filling out the dialog box for the function arguments. In particular, we set the Lookup_value to $65,000, we set the Table_array to Fedtaxtable, and set the Col_index_num to 3, which is the column in the table that has the amount paid on the base. See the calculations below Table 2-1 for applications of the VLOOKUP function. | ||||||
| Table 2-1 | ||||||
| Corporate Tax Rates for | 2015 | |||||
| If a corporation's taxable income is between | It pays this amount on the base of the bracket | Plus this percentage on the excess over the base | Average tax rate at top of bracket | |||
| (1) | (2) | (3) | (4) | (5) | ||
| $0 | $50,000 | $0 | 15.0% | 15.0% | ||
| $50,000 | $75,000 | $7,500 | 25.0% | 18.3% | ||
| $75,000 | $100,000 | $13,750 | 34.0% | 22.3% | ||
| $100,000 | $335,000 | $22,250 | 39.0% | 34.0% | ||
| $335,000 | $10,000,000 | $113,900 | 34.0% | 34.0% | ||
| $10,000,000 | $15,000,000 | $3,400,000 | 35.0% | 34.3% | ||
| $15,000,000 | $18,333,333 | $5,150,000 | 38.0% | 35.0% | ||
| $18,333,333 | and up | $6,416,667 | 35.0% | 35.0% | ||
| Taxable Income: | $65,000 | |||||
| 1st VLOOKUP to find the base amount of tax: | $ 7,500 | |||||
| 2nd VLOOKUP to find the marginal tax rate: | 25.0% | |||||
| 3rd VLOOKUP to find the marginal income to be taxed: | $ 15,000 | |||||
| Tax on marginal income above the base: | $ 3,750 | |||||
| Total tax liability: | $11,250 | |||||
| Table 2-2 | ||||||
| Apex Corporation: Calculation of $12 million Loss Carry-Back and Amount Available for Carry-Forward | ||||||
| Past Year | Past Year | Curent Year | ||||
| 2014 | 2015 | 2016 | ||||
| Original taxable income | $2,000,000 | $2,000,000 | -$12,000,000 | |||
| Carry-back loss | 2,000,000 | 2,000,000 | ||||
| Adjusted profit | $0 | $0 | ||||
| Taxes previously paid (40%) | 800,000 | 800,000 | ||||
| Difference = Tax refund due | $800,000 | $800,000 | ||||
| Total tax refund received | $1,600,000 | |||||
| Amount of loss carry forward available | ||||||
| Current loss | -$12,000,000 | |||||
| Carry-back losses used | 4,000,000 | |||||
| Carry-forward losses still available | -$8,000,000 | |||||
2-2
| SECTION 2-2 | |
| SOLUTIONS TO SELF-TEST | |
| A firm has $8 million in total assets. It has $3 million in current liabilities, $2 million in long-term debt, and $1 million in preferred stock. What is the reported net worth (i.e., the reported common equity)? | |
| Total assets | $8,000,000 |
| Current liabilities | $3,000,000 |
| Long-term debt | $2,000,000 |
| Preferred stock | $1,000,000 |
| The net worth of shareholders, also called common equity, is equal to the total assets less all liabilities and preferred stock. | |
| Net worth = common equity = | $2,000,000 |
2-3
| SECTION 2-3 | |
| SOLUTIONS TO SELF-TEST | |
| A firm has $2,000,000 million in earnings before taxes. The firm has an interest expense of $300,000 and depreciation of $200,000; it has no amortization. What is its EBITDA? | |
| Earnings before taxes | $2,000,000 |
| Interest | $300,000 |
| Depreciation | $200,000 |
| Amortization | $0 |
| EBITDA stands for earnings before interest, taxes, and depreciation. To calculate EBITDA using the given information, start with earnings before taxes and add back interest, depreciation, and amortization. | |
| EBITDA | $2,500,000 |
| Now suppose a firm has the following information: $7 million in sales, $4 million of costs of goods sold excluding depreciation & amortization, $500,000 of other operating expenses. What is its EBITDA? | |
| Sales | $7,000,000 |
| Costs of goods sold excluding depreciation and amortization | $4,000,000 |
| Other operating expenses | $500,000 |
| EBITDA stands for earnings before interest, taxes, and depreciation. To calculate EBITDA using the given information, start with sales and subtract costs of goods sold (excluding depreciation) and other operating costs: | |
| EBITDA | $2,500,000 |
2-4
| SECTION 2-4 | |
| SOLUTIONS TO SELF-TEST | |
| A firm had a retained earnings balance of $3 million in the previous year. In the current year, its net income is $2.5 million. If it pays $1 million in common dividends in the current year, what it its resulting retained earnings balance? | |
| Previous retained earnings balance | $3,000,000 |
| Current net income | $2,500,000 |
| Common dividends | $1,000,000 |
| This year's addition to retained earnings is the amount of net income not paid out in dividends: | |
| Addition to retained earnings | $1,500,000 |
| The new balance of retained earnings is the previous year's balance plus this year's addition to retained earnings: | |
| Current retained earnings balance | $4,500,000 |
2-5
| SECTION 2-5 | |
| SOLUTIONS TO SELF-TEST | |
| A firm has inventories of $2 million for the previous year and $1.5 million for the current year. What impact does this have on net cash provided by operations? | |
| Previous year's inventories | $2,000,000 |
| Current year's inventories | $1,500,000 |
| Inventories are assets that a company owns. When inventories increase (perhaps because the company bought more goods than it sold), cash goes down due to the increase in assets owned by the company. When inventories decrease (perhaps because the company sold more goods than it purchased), cash goes up due to the decrease in assets owned by the company. Therefore the cash flow due to a change in inventories is equal to the previous year's inventories minus the current year's inventories: | |
| Cash flow due to inventories = Previous year's inventories −Current year's inventories | |
| Change in net cash provided by operations | $500,000 |
2-6
| SECTION 2-6 | |
| SOLUTIONS TO SELF-TEST | |
| A firm has net income of $5 million. Assuming that depreciation of $1 million is its only noncash expense, what is the firm’s net cash flow? | |
| Net income | $5,000,000 |
| Depreciation | $1,000,000 |
| Net cash flow = Net income + Noncash expenses | |
| Net cash flow | $6,000,000 |
2-7
| SECTION 2-7 | |
| SOLUTIONS TO SELF-TEST | |
| Suppose a firm has the following information: Sales = $10 million; costs of goods sold (excluding depreciation) = $5 million; depreciation = $1.4 million; other operating expenses = $2 million; interest expense = $1 million. If the tax rate is 25%, what is NOPAT, the net operating profit after taxes? | |
| Sales | $10,000,000 |
| Costs of goods sold (excluding depreciation) | $5,000,000 |
| Depreciation | $1,400,000 |
| Other operating expenses | $2,000,000 |
| Interest expense | $1,000,000 |
| Tax rate | 25% |
| The first step is to calculate the earnings before interest and taxes, EBIT. This is the amount of pre-tax operating earnings. | |
| EBIT = | Sales − Costs of goods sold excluding depreciation − Depreciation − Other operating expenses |
| Notice that interest expense is not subtracted because interest is not an operating expense. | |
| EBIT = pre-tax operating earnings = | $1,600,000 |
| The second step is to calculate NOPAT, which is equal to after-tax operating earnings. | |
| NOPAT = | EBIT (1−T) |
| NOPAT = | $1,200,000 |
| Suppose a firm has the following information: Cash = $500,000; short-term investments = $2.5 million; accounts receivable = $1.2 million, net plant and equipment = $7.8 million. How much is tied up in operating current assets? | |
| Cash | $500,000 |
| Short-term investments | $2,500,000 |
| Accounts receivable | $1,200,000 |
| Inventories | $1,000,000 |
| Net plant and equipment | $4,000,000 |
| Operating current assets are the short-term assets used in operations. They do not include an short-term investments or marketable securities that are not a part of normal operations. They do not include any long-term assets. | |
| Operating CA = | Cash + Accounts receivable + inventories |
| Operating current assets = | $2,700,000 |
| Suppose a firm has the following information: Accounts payable = $1 million; notes payable = $1.1 million; short-term debt = $1.4 million; accruals = $500,000; and long-term bonds = $3 million. What is the amount arising from operating current liabilities? | |
| Accounts payable | $1,000,000 |
| Notes payable | $1,100,000 |
| Short-term debt | $1,400,000 |
| Accruals | $500,000 |
| Long-term bonds | $3,000,000 |
| Operating current liabilities are the short-term liabilities arising from operating acivities. They do not include any form of debt, including notes payable, short-term debt, or long-term bonds. | |
| Operating CL = | Accounts payable + accruals |
| Operating current liabilities = | $1,500,000 |
| Suppose a firm has the following information: Operating current assets = $2.7 million; operating current liabilities = $1.5 million, long-term bonds = $3 million, net plant and equipment = $7.8 million; and other long-term operating assets = $1 million. How much is tied up in net operating working capital? How much is tied up in total net operating capital? | |
| Operating current assets | $2,700,000 |
| Operating current liabilities | $1,500,000 |
| Long-term bonds | $3,000,000 |
| Net plant and equipment | $7,800,000 |
| Other long-term operating assets | $1,000,000 |
| Net operating working capital (NOWC) is the net amount tied up in short-term operating assets after adjusting for the amount arising from short-term operating liabilities. It does not include any cash ties up in long-term assets and it is not adjusted for any cash provided by investors. | |
| Net operating working capital = NOWC = | Operating current assets − Operating current liabilities |
| Net operating working capital = NOWC = | $1,200,000 |
| Total net operating capital includes the net amount tied up in net operating working capital (NOWC) and the amount tied up in all long-term operating assets. It is not adjusted for any cash provided by investors. | |
| Total net operating capital = | Net operating working capital + Net plant and equipment + Other long-term operating assets |
| Total net operating capital = | $10,000,000 |
| A firm’s total net operating capital for the previous year was $2 million. For the current year, its total net operating capital is $2.5 million and its NOPAT is $1.2 million. What is its free cash flow for the current year? | |
| Previous year's total net operating capital | $9,300,000 |
| Current year's total net operating capital | $10,000,000 |
| Current year's NOPAT | $1,200,000 |
| First, calculate the investment in total net operating capital. | |
| Investment in total net operating capital = | Current year's total net operating capital − previous year's total net operating capital |
| Investment in total net operating capital = | $700,000 |
| Second, calculate free cash flow. | |
| Free cash flow = | NOPAT − Investment in total net operating capital |
| Free cash flow = | $500,000 |
2-8
| SECTION 2-8 | ||
| SOLUTIONS TO SELF-TEST | ||
| A company has sales of $200 million, NOPAT of $12 million, net income of $8 million, new operating working capital (NOWC) of $10 million, total net operating capital of $100 million, and total assets of $110 million. What is it operating profitability (OP) ratio? Its capital requirment (CF) ratio? Its return on invested capital (ROIC)? | ||
| Sales | $200 | million |
| NOPAT | $12 | million |
| Net income | $8 | million |
| Net operating working capital | $10 | million |
| Total net operating capital | $100 | million |
| Total assets | $110 | million |
| The operating profitability (OP) ratio measures the dollars of operating profit per dollar of sales. | ||
| OP = | NOPAT / Sales | |
| OP = | 6% | |
| The capital requirement (CR) ratio measures the dollars of total net operating capital tied up per dollar of sales. | ||
| CR = | (Total net operating capital) / Sales | |
| CR = | 50% | |
| The return on invested capital (ROIC) measures the dollars of operating profit per dollar of total net operating capital. | ||
| ROIC = | NOPAT / (Total net operating capital) = OP / CR | |
| ROIC = NOPAT / (Total net operating capital) = | 12% | |
| ROIC = OP / CR = | 12.00% | |
| A firm has $100 million in total net operating capital. Its return on invested capital is 14 percent, and its weighted average cost of capital is 10 percent. What is its EVA? | ||
| Total net operating working capital | $100,000,000 | |
| ROIC | 14% | |
| WACC | 10% | |
| Free cash flow = | $4,000,000 |
2-9
| SECTION 2-9 | |
| SOLUTIONS TO SELF-TEST | |
| If a corporation has $85,000 in taxable income, what is its tax liability? | |
| Taxable income | $85,000 |
| Base amount of tax from Table 2-1 | $13,750 |
| Base of tax range | $75,000 |
| Taxable income above range | $10,000 |
| Tax rate in base | 34% |
| Tax liability | $17,150 |
Mini Case Data
| 10/27/15 | |||
| Mini Case Data | |||
| Computron's Income Statement | |||
| 2015 | 2016 | ||
| INCOME STATEMENT | |||
| Net sales | $ 3,432,000 | $ 5,834,400 | |
| Cost of Goods Sold (Except depr. and amort.) | 2,864,000 | 4,980,000 | |
| Other Expenses | 340,000 | 720,000 | |
| Depreciation and amortization | 18,900 | 116,960 | |
| Total Operating Costs | $ 3,222,900 | $ 5,816,960 | |
| Earnings before interest and taxes (EBIT) | $ 209,100 | $ 17,440 | |
| Less interest | 62,500 | 176,000 | |
| Pre-tax earnings | $ 146,600 | $ (158,560) | |
| Taxes (40%) | 58,640 | (63,424) | |
| Net Income | $ 87,960 | $ (95,136) | |
| Dividends | $22,000 | $11,000 | |
| Tax rate | 40% | 40% | |
| Computron's Balance Sheets | |||
| 2015 | 2016 | ||
| Assets | |||
| Cash and equivalents | $ 9,000 | $ 7,282 | |
| Short-term investments | 48,600 | 20,000 | |
| Accounts receivable | 351,200 | 632,160 | |
| Inventories | 715,200 | 1,287,360 | |
| Total current assets | $ 1,124,000 | $ 1,946,802 | |
| Gross fixed assets | $ 491,000 | $ 1,202,950 | |
| Less: Accumulated depreciation | 146,200 | 263,160 | |
| Net plant and equipment | $ 344,800 | $ 939,790 Bart Kreps: Property, Plant and Equipment minus Depreciation |
|
| Total assets | $ 1,468,800 | $ 2,886,592 | |
| Liabilities and equity | |||
| Accounts payable | $ 145,600 | $ 324,000 | |
| Notes payable | 200,000 | 720,000 | |
| Accruals | 136,000 | 284,960 | |
| Total current liabilities | $ 481,600 | $ 1,328,960 | |
| Long-term bonds | $ 323,432 | $ 1,000,000 | |
| Common Stock | 460,000 | 460,000 | |
| Retained Earnings | 203,768 | 97,632 | |
| Total Equity | $ 663,768 | $ 557,632 | |
| Total Liabilites and Equity | $ 1,468,800 | $ 2,886,592 | |
| Computron's Statement of Cash Flows Bart Kreps: The statement of cash flows provides information about cash inflows and outflows during an accounting period. |
|||
| 2016 | |||
| Operating Activities | |||
| Net Income before preferred dividends | $ (95,136) | ||
| Noncash adjustments | |||
| Depreciation and amortization | 116,960 | ||
| Due to changes in working capital | |||
| Change in accounts receivable | (280,960) Bart Kreps: Change is negative because accounts receivable went up in 2001. This means that more sales revenue has been reflected in net income than has been collected in cash. |
||
| Change in inventories | (572,160) Bart Kreps: Inventories went up meaning that Computron used cash to purchase inventories. |
||
| Change in accounts payable | 178,400 Bart Kreps: This is positive because accounts payable went up. Computron bought on credit from suppliers and did not dispense cash. |
||
| Change in accruals | 148,960 Bart Kreps: Accruals increased in 2001. Cash flow is positive because it recognizes an increased expense prior to the payment of cash. |
||
| Net cash provided by operating activities | $ (503,936) | ||
| Investing activities | |||
| Cash used to acquire fixed assets | $ (711,950) Bart Kreps: Make sure to add back annual Depreciation to Net PP&E. |
||
| Change in short-term investments | 28,600 Bart Kreps: Short term investments went down in 2001. Computron received cash through the sale or maturity of these assets. |
||
| Net cash provided by investing activities | $ (683,350) | ||
| Financing Activities | |||
| Change in notes payable | $ 520,000 Bart Kreps: Notes payable went up in 2001. Computron received cash from creditors. |
||
| Change in long-term debt | 676,568 Bart Kreps: Long term debt went up in 2001. Computron received cash from creditors. |
||
| Payment of cash dividends | (11,000) Bart Kreps: Computron used cash to pay dividends to shareholders. |
||
| Net cash provided by financing activities | $ 1,185,568 | ||
| Net change in cash and equivilents | $ (1,718) | ||
| Cash and securities at beginning of the year | 9,000 | ||
| Cash and securities at end of the year | $ 7,282 | ||
| Corporate Tax Rates | |||
| If a corporation's taxable income is between: | It pays this amount on the base of the bracket: | Plus this percentage on the excess over the base | |
| (1) | (2) | (3) | (4) |
| $0 | $50,000 | $0 | 15.0% |
| $50,000 | $75,000 | $7,500 | 25.0% |
| $75,000 | $100,000 | $13,750 | 34.0% |
| $100,000 | $335,000 | $22,250 | 39.0% |
| $335,000 | $10,000,000 | $113,900 | 34.0% |
| $10,000,000 | $15,000,000 | $3,400,000 | 35.0% |
| $15,000,000 | $18,333,333 | $5,150,000 | 38.0% |
| $18,333,333 | and up | $6,416,667 | 35.0% |
Web 2A
| 10/27/15 | ||||
| Web Extension 2A: Tool Kit for Individual Taxes | ||||
| Individual Tax Table for the 2015 Tax Year | ||||
| If an individual's | He/she pays this | Plus this percentage | Average tax | |
| taxable income | amount on the | on the excess | rate at | |
| is between: | base of the bracket | over the base | top of bracket | |
| (1) | (2) | (3) | (4) | (5) |
| $0 | $9,225 | $0.00 | 10.0% | 10.0% |
| $9,225 | $37,450 | $922.50 | 15.0% | 13.8% |
| $37,450 | $90,750 | $5,156.25 | 25.0% | 20.4% |
| $90,750 | $189,300 | $18,481.25 | 28.0% | 24.3% |
| $189,300 | $411,500 | $46,075.25 | 33.0% | 29.0% |
| $411,500 | $413,200 | $119,401.25 | 35.0% | 35.0% |
| $413,200 | and up | $119,996.25 | 39.6% | 39.6% |
| High-Income Average Tax Rates for Individuals | ||||
| Income | Average Tax Rate | |||
| $1,000,000 | 32.5% | |||
| $10,000,000 | 34.8% | |||
| Married (Joint Return) Tax Table for the 2015 Tax Year | ||||
| If a couple's | It pays this | Plus this percentage | Average tax | |
| taxable income | amount on the | on the excess | rate at | |
| is between: | base of the bracket | over the base | top of bracket | |
| (1) | (2) | (3) | (4) | (5) |
| $0 | $18,450 | $0.00 | 10.0% | 10.0% |
| $18,450 | $74,900 | $1,845.00 | 15.0% | 13.8% |
| $74,900 | $151,200 | $10,312.50 | 25.0% | 19.4% |
| $151,200 | $230,450 | $29,387.50 | 28.0% | 22.4% |
| $230,450 | $411,500 | $51,577.50 | 33.0% | 27.1% |
| $411,500 | $464,850 | $111,324.00 | 35.0% | 35.0% |
| $464,850 | and up | $129,996.50 | 39.6% | 39.6% |
| High-Income Average Tax Rates for Joint Returns | ||||
| Income | Average Tax Rate | |||
| $1,000,000 | 31.7% | |||
| $10,000,000 | 34.7% | |||
| Other Tax Data: | ||||
| Exemption per person = | $4,000 | |||
| Capital gains rate (most investments and most taxpayers) = | 15% | |||
| Standard deduction (individual) = | $6,300 | |||
| Standard deduction (married filing joint) = | $12,600 | |||
| Rate on social security (OASDI, payroll)= | 6.2% | |||
| Rate on social security (OASDI, self-employed)= | 12.4% | |||
| Rate on medicare (payroll) = | 1.45% | |||
| Rate on medicare (self-employed) = | 2.90% | |||
| Example | ||||
| Find the tax, the marginal tax rate, and the average tax rate for the following situation. | ||||
| Taxable Income: | $40,000 | |||
| Base taxable income: | $37,450.00 | |||
| Base tax: | $5,156.25 | |||
| Marginal tax rate: | 25.0% | |||
| Tax: | $5,793.75 | |||
| Average tax rate: | 14.5% | |||
| Suppose the person in the previous example receives a $1,000 raise. What are the additional income taxes and combined social security and medicare taxes (assume the person is not self-employed). | ||||
| Pay raise: | $1,000 | |||
| Additional income tax: | $250 | |||
| Additional Social Security and Medicare tax: | $76.50 | |||
| Total after-tax raise: | $673.50 | |||
| Example | ||||
| After-tax Yield on Municipal Bonds | ||||
| Tax rate on individual | 39.60% | |||
| Rate on municipal bond | 5.50% | |||
| Rate needed on corporate bond | 9.11% | |||
| Total after-tax raise: | $0.25 | |||
