"Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.doc Solution Manual for Finance Applications and Theory 3rd Edition Cornett Adair NofsingerCHAPTER 2 – REVIEWING FINANCIAL STATEMENTS questionsLG1 1.List and describe the four major financial statements.The four basic financial statements are:1. The balance sheet reports a firm’s assets, liabilities, and equity at a particular point in time.2.The income statement shows the total revenues that a firm earns and the total expenses thefirm incurs to generate those revenues over a specific period of time—generally one year.3.The statement of cash flows shows the firm’s cash flows over a given period of time. Thisstatement reports the amounts of cash the firm generated and distributed during a particular timeperiod. The bottom line on the statement of cash flows?the difference between cash sources anduses?equals the change in cash and marketable securities on the firm’s balance sheet from theprevious year’s balance.4.The statement of retained earnings provides additional details about changes in retainedearnings during a reporting period. This financial statement reconciles net income earned duringa given period minus any cash dividends paid within that period to the change in retainedearnings between the beginning and ending of the period.LG1 2.On which of the four major financial statements (balance sheet, income statement, statement ofcash flows, or statement of retained earnings) would you find the following items?a. earnings before taxes: income statementb. net plant and equipment: balance sheetc. increase in fixed assets: statement of cash flowsd. gross profits: income statement e. balance of retained earnings, December 31, 20xx: statement of retained earnings and balance sheetf. common stock and paid-in surplus: balance sheetg. net cash flow from investing activities: statement of cash flowsh. accrued wages and taxes: balance sheeti. increase in inventory: statement of cash flowsLG13.What is the difference between current liabilities and long-term debt?Current liabilities constitute the firm’s obligations due within one year, including accrued wages andtaxes, accounts payable, and notes payable. Long-term debt includes long-term loans and bonds withmaturities of more than one year.LG1 4.How does the choice of accounting method used to record fixed asset depreciation affectmanagement of the balance sheet?download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docFirm managers can choose the accounting method they use to record depreciation against theirfixed assets. Two choices include the straight-line method and the modified accelerated costrecovery system (MACRS). Companies often calculate depreciation using MACRS when theyfigure the firm’s taxes and the straight-line method when reporting income to the firm’sstockholders. The MACRS method accelerates deprecation, which results in higher deprecationexpenses, lower taxable income, and lower taxes in the early years of a project’s life. Thestraight-line method results in lower depreciation expenses, but also results in higher taxes in theearly years of a project’s life. Firms seeking to lower their cash outflows from tax payments willfavor the MACRS depreciation method.LG1 5.What are the costs and benefits of holding liquid securities on a firm’s balance sheet?The more liquid assets a firm holds, the less likely the firm will be to experience financialdistress. However, liquid assets generate little or no profits for a firm. For example, cash is themost liquid of all assets, but it earns little, if any, return for the firm. In contrast, fixed assets areilliquid, but provide the means to generate revenue. Thus, managers must consider the trade-offbetween the advantages of liquidity on the balance sheet and the disadvantages of having moneysit idle rather than generating profits.LG2 6. Why can the book value and market value of a firm differ?A firm’s balance sheet shows its book (or historical cost) value based on Generally AcceptedAccounting Principles (GAAP). Under GAAP, assets appear on the balance sheet at what thefirm paid for them, regardless of what assets might be worth today if the firm were to sell them.Inflation and market forces make many assets worth more now than they were when the firmbought them. So in most cases, book values differ widely from the market values for the sameassets—the amount that the assets would fetch if the firm actually sold them. For the firm’scurrent assets—those that mature within a year?the book value and market value of anyparticular asset will remain very close. For example, the balance sheet lists cash and marketablesecurities at their market value. Similarly, firms acquire accounts receivable and inventory andthen convert these short-term assets into cash fairly quickly, so the book value of these assets isgenerally close to their market value. LG2 7. From a firm manager’s or investor’s point of view, which is more important?the book value of afirm or the market value of the firm?Balance sheet assets are listed at historical cost. Managers would see little relation between the totalasset value listed on the balance sheet and the current market value of the firm’s assets. Similarly, thestockowners’ equity listed on the balance sheet generally differs from the true market value of theequity—in this case, the market value may be higher or lower than the value listed on the firm’saccounting books. So financial managers and investors often find that balance sheet values are notalways the most relevant numbers.LG3 8. What do we mean by a ?progressive? tax structure ? download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docThe U.S. tax structure is progressive, meaning that the larger the income, the higher the taxesassessed. However, corporate tax rates do not increase in any kind of linear way based on thisprogressive nature: They rise from a low of 15 percent to a high of 39 percent, then drop to 34percent, rise to 38 percent, and finally drop to 35 percent. LG3 9.What is the difference between an average tax rate and a marginal tax rate?You can figure the average tax rate as the percentage of each dollar of taxable income that thefirm pays in taxes. From your economics classes, you can probably guess that the firm’s marginaltax rate is the amount of additional taxes a firm must pay out for every additional dollar oftaxable income it earns.LG3 10.How does the payment of interest on debt affect the amount of taxes the firm must pay?Corporate interest payments appear on the balance sheet as an expense item, so we deduct interestpayments from operating income when the firm calculates taxable income. But, any dividends paidby corporations to their shareholders are not tax deductible. This is one factor that encouragesmanagers to finance projects with debt financing rather than to sell more stock. Suppose one firmuses mainly debt financing and another firm, with identical operations, uses mainly equity financing.The equity-financed firm will have very little interest expense to deduct for tax purposes. Thus, it willhave higher taxable income and pay more taxes than the debt-financed firm. The debt-financed firmwill pay fewer taxes and be able to pay more of its operating income to asset funders, i.e., itsbondholders and stockholders. So even stockholders prefer that firms finance assets primarily withdebt rather than with stock.LG4 11.The income statement is prepared using GAAP. How does this affect the reported revenue andexpense measures listed on the balance sheet?Company accountants must prepare firm income statements following GAAP principles. GAAPprocedures require that the firm recognize revenue at the time of sale, but sometimes thecompany receives the cash before or after the time of sale. Likewise, GAAP counsels the firm toshow production and other expenses on the balance sheet as the sales of those goods take place.So production and other expenses associated with a particular product’s sale only appear on theincome statement (for example, cost of goods sold and depreciation) when that product sells. Ofcourse, just as with the revenue recognition, actual cash outflows incurred with production mayoccur at a very different point in time—usually much earlier than GAAP principles allow thefirm to formally recognize the expenses. Further, income statements contain several noncashentries, the largest of which is depreciation. Depreciation attempts to capture the noncashexpense incurred as fixed assets deteriorate from the time of purchase to the point when thoseassets must be replaced. Let’s illustrate the effect of depreciation: Suppose a firm purchases amachine for $100,000. The machine has an expected life of five years and at the end of those fiveyears, the machine will have no expected salvage value. The firm lays out a $100,000 cashoutflow at the time of purchase. But the entire $100,000 does not appear on the income statementin the year that the firm purchases the machine—in accounting terms, the machine is notexpensed in the year of purchase. Rather, if the firm’s accounting department uses the straight- line depreciation method, it deducts only $100,000/5, or $20,000, each year as an expense. Thisdownload full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.doc$20,000 equipment expense is not a cash outflow for the firm. The person in charge of buying themachine knows that the cash flow occurred at the time of purchase—and it totaled $100,000rather than $20,000. So, figures shown on an income statement may not represent the actual cashinflows and outflows for a firm during a particular period.LG4 12.Why do financial managers and investors find cash flows to be more important than accountingprofit?Financial managers and investors are far more interested in actual cash flows than they are in thesomewhat artificial, backward-looking accounting profit listed on the income statement. This is avery important distinction between the accounting point of view and the finance point of view.Finance professionals know that the firm needs cash, not accounting profit, to pay the firm’sobligations as they come due, to fund the firm’s operations and growth, and to compensate the firm’sultimate owners: its shareholders. Thus, the statement of cash flows is a financial statement thatshows the firm’s cash flows over a given period of time. This statement reports the amounts of cashthat the firm generated and distributed during a particular time period.LG5 13.Which of the following activities result in an increase (decrease) in a firm’s cash?a. decrease fixed assets: increase in cash b. decrease accounts payable: decrease in cash c. pay dividends: decrease in cash d. sell common stock: increase in cash e. decrease accounts receivable: increase in cash f. increase notes payable: increase in cashLG5 14.What is the difference between cash flows from operating activities, cash flows from investingactivities, and cash flows from financing activities?Cash flows from operations are those cash inflows and outflows that result directly fromproducing and selling the firm’s products. These cash flows include: net income, depreciation,and working capital accounts other than cash and operations-related short-term debt. Cash flowsfrom investing activities are cash flows associated with buying or selling of fixed or other long- term assets. This section of the statement of cash flows shows cash inflows and outflows fromlong-term investing activities—most significantly the firm’s investment in fixed assets. Cashflows from financing activities are cash flows that result from debt and equity financingtransactions. These include raising cash by issuing short-term debt, issuing long-term debt,issuing stock, using cash to pay dividends, using cash to pay off debt, and using cash to buy backstock. LG5 15.What are free cash flows for a firm? What does it mean when a firm’s free cash flow is negative?Free cash flows are the cash flows available to pay the firm’s stockholders and debtholders after thefirm has made the necessary working capital investments, fixed asset investments, and developed thedownload full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docnecessary new products to sustain the firm’s ongoing operations. If free cash flow is negative, thefirm's operations produce no cash flows available for investors.download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docLG6 16.What is earnings management?Managers and financial analysts have recognized for years that firms use considerable latitude inusing accounting rules to manage their reported earnings in a wide variety of contexts. Indeed,within the GAAP framework, firms can ?smooth? earnings. That is, firms often take steps toover- or understate earnings at various times. Managers may choose to smooth earnings to showinvestors that firm assets are growing steadily. Similarly, one firm may be using straight-linedepreciation for its fixed assets, while another is using a modified accelerated cost recoverymethod (MACRS), which causes depreciation to accrue quickly. If the firm uses MACRSaccounting methods, its managers write fixed asset values down quickly; thus, assets will havelower book value than if the firm used straight-line depreciation methods. This process ofcontrolling a firm’s earnings is called earnings management.LG6 17.What does the Sarbanes-Oxley Act require of firm managers?The Sarbanes-Oxley Act, passed in June 2002, requires public companies to ensure that theircorporate boards’ audit committees have considerable experience applying generally acceptedaccounting principles (GAAP) for financial statements. The Act also requires that any firm’s seniormanagement must sign off on the financial statements of the firm, certifying the statements asaccurate and representative of the firm’s financial condition during the period covered. If a firm’sboard of directors or senior managers fails to comply with Sarbanes-Oxley (SOX), the firm may bedelisted from stock exchanges. problemsbasic 2-1 Balance Sheet You are evaluating the balance sheet for Goodman’s Bees Corporation.problemsFrom the balance sheet you find the following balances: cash and marketable securities =LG1$400,000, accounts receivable = $1,200,000, inventory = $2,100,000, accrued wages and taxes =$500,000, accounts payable = $800,000, and notes payable = $600,000. Calculate Goodman Bees’net working capital.Net working capital = Current assets –Current liabilities. Goodman’s Bees’ current assets = Cash and marketable securities=$400,000Accounts receivable= 1,200,000Inventory= 2,100,000 Total current assets $3,700,000and current liabilities = Accrued wages and taxes =$500,000 Accounts payable=800,000Notes payable=600,000 Total current liabilities$1,900,000So the firm’s net working capital was $1,800,000 ($3,700,000 – $1,900,000).download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docLG1 2-2 Balance SheetCasello Mowing & Landscaping’s year-end 2015 balance sheet lists currentassets of $435,200, fixed assets of $550,800, current liabilities of $416,600, and long-term debt of$314,500. Calculate Casello’s total stockholders’ equity.Recall the balance sheet identity in Equation 2-1: Assets = Liabilities + Equity. Rearranging this equation:Equity =Assets – Liabilities. Thus, the balance sheets would appear as follows: Book value Book valueAssets Liabilities and EquityCurrent assets $ 435,200 Current liabilities$ 416,600Fixed assets550,800 Long-term debt314,500Stockholders’ equity 254,900Total$ 986,000 Total$ 986,000LG1 2-3 Income StatementThe Fitness Studio, Inc.’s 2015 income statement lists the following incomeand expenses: EBIT = $538,000, interest expense = $63,000, and net income = $435,000. Calculatethe 2015 taxes reported on the income statement.Using the setup of an income statement in Table 2.2:EBIT$538,000 Interest expense-63,000EBT$ 475,000 Taxes -40,000Net income$435,000LG1 2-4 Income StatementThe Fitness Studio, Inc.’s 2015 income statement lists the following incomeand expenses: EBIT = $773,500, interest expense = $100,000, and taxes = $234,500. The firm has nopreferred stock outstanding and 100,000 shares of common stock outstanding. Calculate the 2015earnings per share.Using the setup of an income statement in Table 2.2:EBIT$773,500 Interest expense-100,000EBT$ 673,500 Taxes -234,500Net income$439,000Thus, $439,000Earnings per share (EPS) = —————— = $4.39 per share100,000 shares LG1 2-5Income StatementConsider a firm with an EBIT of $850,000. The firm finances its assetswith $2,500,000 debt (costing 7.5 percent) and 400,000 shares of stock selling at $5.00 per share.To reduce firm’s risk associated with this financial leverage, the firm is considering reducing itsdebt by $1,000,000 by selling an additional 200,000 shares of stock. The firm is in the 40 percentdownload full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.doctax bracket. The change in capital structure will have no effect on the operations of the firm.Thus, EBIT will remain at $850,000. Calculate the change in the firm’s EPS from this change incapital structure.The EPS before and after this change in capital structure is illustrated as follows: (Note: Debt dropped by$1,000,000; it did not become $1,000,000)Before capital structure change After capital structure change EBIT$850,000 $850,000- Interest ($2,500,000 x 0.075) 187,500($1,500,000 x 0.075)112,500EBT662,500737,500 - Taxes (40%) 265,000295,000Net income $397,500$442,500 ÷ # of shares 400,000600,000 EPS$0.99375 $0.7375The change in capital structure would decrease the stockholders EPS by $0.25625. LG1 2-6Income StatementConsider a firm with an EBIT of $550,000. The firm finances its assetswith $1,000,000 debt (costing 5.5 percent) and 200,000 shares of stock selling at $12.00 pershare. The firm is considering increasing its debt by $900,000, using the proceeds to buy back75,000 shares of stock. The firm is in the 40 percent tax bracket. The change in capital structurewill have no effect on the operations of the firm. Thus, EBIT will remain at $550,000. Calculatethe change in the firm’s EPS from this change in capital structure. The EPS before and after this change in capital structure is illustrated as follows: Before capital structure change After capital structure change EBIT$550,000 $550,000- Interest ($1,000,000 x 0.055) 55,000($1,900,000 x 0.055) 104,500EBT495,000445,500 - Taxes (40%) 198,000178,200Net income $297,000$267,300 ÷ # of shares 200,000125,000 EPS$1.485 $2.1384The change in capital structure increases the stockholders EPS by $0.6534. LG3 2-7 Corporate Taxes Oakdale Fashions, Inc., had $245,000 in 2015 taxable income. Using thetax schedule in Table 2.3, calculate the company’s 2015 income taxes. What is the average taxrate? What is the marginal tax rate?From Table 2.3, the $245,000 of taxable income puts Oakdale Fashion, Inc. in the 39 percent tax bracket. Thus, Tax liability = Tax on base amount + Tax rate (amount over base):= $22,250 + 0.39 ($245,000 – $100,000) = $78,800Note that the base amount is the maximum dollar value listed in the previous tax bracket. The average tax rate forOakdale Fashions Inc. comes to:$78,800Average tax rate = ———— = $78,800/$245,000 = 32.16%$245,000 download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docIf Oakdale Fashions, Inc. earned $1 more of taxable income, it would pay 39 cents (its tax rate of 39 percent) more intaxes. Thus, the firm’s marginal tax rate is 39 percent.LG3 2-8 Corporate Taxes Hunt Taxidermy, Inc., is concerned about the taxes paid by the companyin 2015. In addition to $42.4 million of taxable income, the firm received $2,975,000 of intereston state-issued bonds and $1,000,000 of dividends on common stock it owns in OakdaleFashions, Inc. Calculate Hunt Taxidermy’s tax liability, average tax rate, and marginal tax rate.In this case, interest on the state-issued bonds is not taxable and should not be included in taxable income. Further,the first 70 percent of the dividends received from Hunt Taxidermy is not taxable. Thus, only 30 percent of thedividends received are taxed, so:Taxable income = $42,400,000 + (0.3)$1,000,000 = $42,700,000Now Hunt Taxidermy’s tax liability will be:Tax liability = $6,416,667 + 0.35 ($42,700,000 – $18,333,333) = $14,945,000The $1,000,000 of dividend income increased Hunt Taxidermy’s tax liability by $105,000 (0.3 x $1,000,000 x 0.35).Hunt Taxidermy’s resulting average tax rate is: Average tax rage = $14,945,000/$42,700,000 = 35.00%Finally, if Hunt Taxidermy earned $1 more of taxable income, it would pay 35 cents (based upon its tax rate of 35percent) more in taxes. Thus, the firm’s marginal tax rate is 35 percent.LG4 2-9 Statement of Cash FlowsRamakrishnan Inc. reported 2015 net income of $15 million anddepreciation of $2,650,000. The top part of Ramakrishnan, Inc.’s 2015 and 2014 balance sheets islisted as follows (in millions of dollars).Current assets: 20152014 Current liabilities: 20152014Cash and marketable Accrued wages andsecurities$20 $15 taxes$19$18Accounts receivable 84 75Accounts payable 51 45 Inventory 121 110Notes payable 4540Total$225 $200 Total $115 $103Calculate the 2015 net cash flow from operating activities for Ramakrishnan, Inc.Cash Flows from Operating Activities Net income $15,000,000 Additions (sources of cash):Depreciation2,650,000Increase in accrued wages and taxes 1,000,000Increase in accounts payable6,000,000 Subtractions (uses of cash):Increase in accounts receivable-9,000,000Increase in inventory -11,000,000Net cash flow from operating activities:$4,650,000LG4 2-10 Statement of Cash FlowsIn 2015, Usher Sports Shop had cash flows from investing activitiesof -$4,364,000 and cash flows from financing activities of -$5,880,000. The balance in the firm’sdownload full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.doccash account was $1,615,000 at the beginning of 2015 and $1,742,000 at the end of the year.Calculate Usher Sports Shop’s cash flow from operations for 2015.Net change in cash and marketable securities = $1,742,000 – $1,615,000 = $127,000Cash flows from operating activities = $10,371,000 Cash flows from investing activities= - 4,364,000Cash flows from financing activities = - 5,880,000Net change in cash and marketable securities=$127,000 LG5 2-11 Free Cash Flow You are considering an investment in Fields and Struthers, Inc., and wantto evaluate the firm’s free cash flow. From the income statement, you see that Fields andStruthers earned an EBIT of $62 million, had a tax rate of 30 percent, and its depreciationexpense was $5 million. Fields and Struthers’ NOPAT gross fixed assets increased by $32million from 2014 to 2015. The firm’s current assets increased by $20 million and spontaneouscurrent liabilities increased by $12 million. Calculate Fields and Struthers’ NOPAT, operatingcash flow, investment in operating capital and free cash flow for 2015.Fields and Struthers’ NOPAT was:NOPAT = EBIT(1 – Tax rate) = $62m(1 – 0.30) = $43.4mOperating cash flow for 2015 was:OCF = NOPAT + Depreciation = $43.4m + $5m = $48.4mInvestment in operating capital for 2015 was:IOC = ?Gross fixed assets + ?Net operating working capital= $32m + ($20m – $12m) = $40 mAccordingly, Fields and Struthers’ free cash flow for 2015 was:FCF = Operating cash flow – Investment in operating capital = $48.4m – $40m = $8.4mIn other words, in 2015, Fields and Struthers had cash flows of $8.4 million available to pay its stockholders anddebtholders. LG5 2-12 Free Cash FlowTater and Pepper Corp. reported free cash flows for 2015 of $39.1 million andinvestment in operating capital of $22.1 million. Tater and Pepper incurred $13.6 million indepreciation expense and paid $28.9 million in taxes on EBIT in 2015. Calculate Tater and Pepper’s2015 EBIT.Tater and Pepper’s free cash flow for 2015 was:FCF = Operating cash flow – Investment in operating capital$39.1m = Operating cash flow – $22.1mSo, operating cash flow = $39.1m + $22.1m = $61.2mTater and Pepper’s operating cash flow was:OCF = EBIT(1 – Tax rate) + Depreciation = EBIT – Taxes on EBIT + Depreciation$61.2m = EBIT – $28.9m + $13.6mSo, EBIT = $61.2m + $28.9m – $13.6m = $76.5mdownload full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docLG1 2-13 Statement of Retained EarningsMr. Husker’s Tuxedos, Corp. began the year 2015 with $256million in retained earnings. The firm earned net income of $33 million in 2015 and paid dividends of$5 million to its preferred stockholders and $10 million to its common stockholders. What is the year- end 2015 balance in retained earnings for Mr. Husker’s Tuxedos?The statement of retained earnings for 2015 is as follows: Balance of retained earnings, December 31, 2014 $256m Plus: Net income for 201533m Less: Cash dividends paidPreferred stock $5mCommon stock 10mTotal cash dividends paid 15mBalance of retained earnings, December 31, 2015 $274mLG1 2-14 Statement of Retained Earnings Use the following information to find dividends paid tocommon stockholders during 2015. Balance of retained earnings, December 31, 2014$462m Plus: Net income for 2015 15m Less: Cash dividends paidPreferred stock$1mCommon stock_6mTotal cash dividends paid 7mBalance of retained earnings, December 31, 2015$470mTotal cash dividends paid = $470m – $15m – $462m = -$7m. Thus, common stock dividends paid = $7m. – $1m = $6m. intermediate 2-15 Balance Sheet Brenda’s Bar and Grill has total assets of $15 million of which $5 million problemsare current assets. Cash makes up 10 percent of the current assets and accounts receivable makes upanother 40 percent of current assets. Brenda’s gross plant and equipment has a book value of $11.5million and other long-term assets have a book value of $500,000. Using this information, what is theLG1 balance of inventory and the balance of depreciation on Brenda Bar and Grill’s balance sheet?Current assets: (in millions) Cash and marketable securities $ 0.5 (0.1 x $5) Accounts receivable 2.0 (0.4 x $5) Inventory step 1. 2.5 ($5 – $0.5 – $2.0) Total$5.0Fixed assets: Gross plant andequipment $11.5 Less: Depreciationstep 4. 2.0 ($11.5 – $9.5)Net plant and equipmentstep 3. $9.5($10.0 – $0.5)Other long-termassets 0.5 Total step 2. $10.0 ($15.0 – $5.0) download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docTotal assets $15.0LG1 2-16 Balance Sheet Glen’s Tobacco Shop has total assets of $91.8 million. Fifty percent of theseassets are financed with debt of which $28.9 million is current liabilities. The firm has no preferredstock but the balance in common stock and paid-in surplus is $20.4 million. Using this informationwhat is the balance for long-term debt and retained earnings on Glen’s Tobacco Shop’s balancesheet?(in millions)Total current liabilities$28.9 Long-term debt:step 3. 17.0 (= $45.9 – $28.9) Total debt:step 2. $45.9 (= 0.5 x $91.8)Stockholders’ equity:Preferred stock $ 0.0Common stock and paid-in surplus20.4 (20 million shares) Retained earningsstep 5.25.5(= $45.9 – $20.4)Totalstep 4$45.9(= $91.8 – $45.9)Total liabilities and equity step 1.$91.8 (= Total Assets)LG2 2-17 Market Value versus Book Value Muffin’s Masonry, Inc’s balance sheet lists net fixed assetas $14 million. The fixed assets could currently be sold for $19 million. Muffin’s current balancesheet shows current liabilities of $5.5 million and net working capital of $4.5 million.If all thecurrent accounts were liquidated today, the company would receive $7.25 million cash after payingthe $5.5 million in current liabilities. What is the book value of Muffin’s Masonry’s assets today?What is the market value of these assets?BOOKMARKET VALUEVALUEAssetsCurrent assetsStep 1. $10m Step 3.$12.75mFixed assets14m 19.00mTotal Step 2. $24m Step 4.$31.75mStep 1. Net working capital (book value) = Current assets (book value) – Current liabilities (book value) = $4.5m = Current assets (book value) – $5.5m => Current assets (book value) = $4.5m + $5.5m = $10mStep 2. Total assets (book value) = $10m + $14m = $24mStep 3. Net working capital (market value) = Current assets (market value) – Current liabilities (market value) = $7.25m = Current assets (market value) – $5.5m => Current assets (market value) = $7.25m + $5.5m = $12.75mStep 4. Total assets (market value) = $12.75m + $19m = $31.75mLG2 2-18Market Value versus Book Value Ava’s SpinBall Corp. lists fixed assets of $12 millionon its balance sheet. The firm’s fixed assets have recently been appraised at $16 million. Ava’sSpinBall Corp.’s balance sheet also lists current assets at $5 million. Current assets wereappraised at $6 million. Current liabilities’ book and market values stand at $3 million and thefirm’s book and market values of long-term debt are $7 million. Calculate the book and marketdownload full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docvalues of the firm’s stockholders’ equity. Construct the book value and market value balancesheets for Ava’s SpinBall Corp. Recall the balance sheet identity in Equation 2-1: Assets = Liabilities + Equity. Rearranging this equation:Equity =Assets – Liabilities. Thus, the balance sheets would appear as follows: BOOK MARKET BOOKMARKET VALUE VALUE VALUE VALUE AssetsLiabilities and EquityCurrent assets $5m $6mCurrent liabilities $ 3m$ 3mFixed assets 12m 16mLong-term debt7m 7mStockholders’ equity 7m 12m Total$17m $22mTotal $17m $22mLG1 2-19 Debt versus Equity FinancingYou are considering a stock investment in one of two firms(NoEquity, Inc., and NoDebt, Inc.), both of which operate in the same industry and haveidentical operating income of $32.5 million. NoEquity, Inc., finances its $65 million in assetswith $64 million in debt (on which it pays 10 percent interest annually) and $1 million in equity.NoDebt, Inc., finances its $65 million in assets with no debt and $65 million in equity. Bothfirms pay a tax rate of 30 percent on their taxable income. Calculate the net income and return onassets for the two firms. NoEquityNoDebtOperating income $32.50m $32.50mLess: Interest($64m x 0.1)6.40m0.00mTaxable income $26.10m $32.50mLess: Taxes (30%) 7.83m 9.75mNet income $18.27m $22.75m Return on assets $18.27m/$65m = 28.11% $22.75m/$65m = 35.00%LG1 2-20 Debt versus Equity FinancingYou are considering a stock investment in one of two firms(AllDebt, Inc., and AllEquity, Inc.), both of which operate in the same industry and haveidentical operating income of $12.5 million. AllDebt, Inc., finances its $25 million in assets with$24 million in debt (on which it pays 10 percent interest annually) and $1 million in equity.AllEquity, Inc., finances its $25 million in assets with no debt and $25 million in equity. Bothfirms pay a tax rate of 30 percent on their taxable income. Calculate the income available to paythe asset funders (the debtholders and stockholders) and resulting return on assets for the twofirms. AllDebt AllEquityOperating income $12.50m $12.50mLess: Interest($24m x 0.1)2.40m0.00mTaxable income $10.10m $12.50mLess: Taxes (30%) 3.03m 3.75mNet income $7.07m $8.75mIncome available for asset funders$9.47m $8.75m(= Operating income – Taxes) Return on assets $9.47m/$25m = 37.88%$8.75m/$25m = 35.00%LG1 2-21 Income Statement You have been given the following information for Corky’s Beddingdownload full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docCorp.: a. Net sales = $11,250,000 b. Cost of goods sold = $7,500,000; c. Other operating expenses = $250,000;d. Addition to retained earnings = $1,000,000; e. Dividends paid to preferred and common stockholders = $495,000; f. Interest expense = $850,000. The firm’s tax rate is 35 percent. Calculate the depreciation expense for Corky’s Bedding Corp. Net sales$11,250,000Less: Cost of goods sold 7,500,000Gross profitsStep 4. $3,750,000Less: Other operating expenses 250,000Earnings before interest, taxes, depreciation, andamortization (EBITDA) Step 5. $3,500,000Less: DepreciationStep 6.350,000 Earnings before interest and taxes (EBIT) Step 3. $3,150,000Less: Interest 850,000Earnings before taxes (EBT) Step 2.$2,300,000 Less: Taxes (35%) Net incomeStep 1. $1,495,000 Less: Common and preferred stock dividends$495,000Addition to retained earnings $1,000,000Step 1. Net income = Common and preferred stock dividends + Addition to retained earnings = $495,000 + $1,000,000 = $1,495,000Step 2. EBT (1 – Tax rate) = Net income => EBT = Net income/(1 – Tax rate) = $1,495,000/(1 - 0.35) = $2,300,000 Step 3. EBIT – Interest = EBT => EBIT = EBT + Interest = $2,300,000 + $850,000 = $3,150,000Step 4. Gross profits = Net sales – Cost of goods sold = $11,250,000 – 7,500,000 = $3,750,000Step 5. EBITDA = Gross profits – Other operating expenses = $3,750,000 – 250,000 = $3,500,000Step 6. EBITDA – Depreciation = EBIT => Depreciation = EBITDA – EBIT = $3,500,000 – $3,150,000 = $350,000LG1 2-22 Income Statement You have been given the following information for Moore’s HoneyBeeCorp.:a. Net sales = $32,000,000; b. Gross profits = $18,700,000; c. Other operating expenses = $2,500,000;d. Addition to retained earnings = $4,700,000; e. Dividends paid to preferred and common stockholders = $2,900,000; f. Depreciation expense = $2,800,000.The firm’s tax rate is 35 percent. Calculate the cost of goods sold and the interest expense forMoore’s HoneyBee Corp. Net sales$32,000,000Less: Cost of goods sold Step 1. 13,300,000Gross profits $18,700,000Less: Other operating expenses2,500,000Earnings before interest, taxes, depreciation, andamortization (EBITDA) Step 4. $16,200,000Less: Depreciation2,800,000 download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docEarnings before interest and taxes (EBIT) Step 5. $13,400,000Less: InterestStep 6. 1,707,692Earnings before taxes (EBT) Step 3.$11,692,308 Less: Taxes (35%) Net incomeStep 2. $7,600,000Less: Common and preferred stock dividends $2,900,000Addition to retained earnings $4,700,000Step 1. Net sales – Cost of goods sold = Gross profits => Cost of goods sold = Net sales – Gross Profits =$32,000,000 – $18,700,000 = $13,300,000Step 2. Net income = Common and preferred stock dividends + Addition to retained earnings = $2,900,000 + $4,700,000 = $7,600,000Step 3. EBT (1 – Tax rate) = Net income => EBT = Net income/(1 – Tax rate) = $7,600,000/(1 – 0.35) = $11,692,308 Step 4. EBITDA = Gross profits – Other operating expenses = $18,700,000 – 2,500,000 = $16,200,000Step 5. EBITDA – Depreciation = EBIT = $16,200,000 – $2,800,000 = $13,400,000Step 6. EBIT – Interest = EBT => Interest = EBIT – EBT = $13,400,000 – $11,692,308 = $1,707,692LG1 2-23 Income Statement Consider a firm with an EBIT of $1,000,000. The firm finances itsassets with $4,500,000 debt (costing 8 percent) and 200,000 shares of stock selling at $16.00 pershare. To reduce risk associated with this financial leverage, the firm is considering reducing itsdebt by $2,500,000 by selling additional shares of stock. The firm is in the 40 percent taxbracket. The change in capital structure will have no effect on the operations of the firm. Thus,EBIT will remain at $1,000,000. Calculate the change in the firm’s EPS from this change incapital structure.Number of shares of stock that must be sold to raise $2,500,000:$2,500,000/$16 = 156,250=> number of shares of stock outstanding after refinancing = 200,000 + 156,250 = 356,250The EPS before and after this change in capital structure is illustrated as follows: Before capital structure change After capital structure change EBIT$1,000,000 $1,000,000– Interest ($4,500,000 x 0.08) 360,000($2,000,000 x 0.08)160,000EBT640,000 840,000–Taxes (40%) 256,000 336,000Net income $384,000 $504,000 ÷ # of shares 200,000 356,250 EPS $1.92$1.41The change in capital structure will result in a decrease in the stockholders EPS by $0.50. LG1 2-24 Income StatementConsider a firm with an EBIT of $10,500,000. The firm finances itsassets with $50,000,000 debt (costing 6.5 percent) and 10,000,000 shares of stock selling at$10.00 per share. The firm is considering increasing its debt by $25,000,000, using the proceedsto buy back shares of stock. The firm is in the 40 percent tax bracket. The change in capitalstructure will have no effect on the operations of the firm. Thus, EBIT will remain at$10,500,000. Calculate the change in the firm’s EPS from this change in capital structure. Number of shares of stock that can be repurchased with $25,000,000:download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.doc $25,000,000/$10 = 2,500,000 => number of shares of stock outstanding after refinancing = 10,000,000 – 2,500,000 = 7,500,000The EPS before and after this change in capital structure is illustrated as follows: Before capital structure change After capital structure change EBIT$10,500,000 $10,500,000– Interest ($50,000,000 x 0.065) 3,250,000($75,000,000 x 0.065) 4,875,000EBT7,250,0005,625,000 – Taxes (40%) 2,900,0002,250,000Net income $4,350,000$3,375,000 ÷ # of shares 10,000,0007,500,000 EPS$0.435$0.45The change in capital structure increases the stockholders EPS by $0.015. LG3 2-25 Corporate TaxesThe Dakota Corporation had a 2015 taxable income of $33,365,000from operations after all operating costs but before (1) interest charges of $8,500,000;(2) dividends received of $750,000; (3) dividends paid of $5,250,000; and (4) income taxes.a. Use the tax schedule in Table 2.3 to calculate Dakota’s income tax liability.The first 70 percent of the dividends received is not taxable. Thus, only 30 percent of the dividends received aretaxed, so: Taxable income = $33,365,000 – $8,500,000 + (0.3)$750,000 = $25,090,000Now Dakota Corp.’s tax liability will be:Tax liability = $6,416,667 + 0.35 ($25,090,000 – $18,333,333) = $8,781,500b. What are Dakota’s average and marginal tax rates on taxable income?Dakota Corp.’s average tax rate is: Average tax rate = $8,781,500/$25,090,000 = 35.00%Finally, if Dakota Corp earned $1 more of taxable income, it would pay 35 cents (based on its tax rate of 35 percent)more in taxes. Thus, the marginal tax rate is 35 percent.LG3 2-26 Corporate Taxes Suppose that in addition to $17.85 million of taxable income, TexasTaco, Inc., received $1,105,000 of interest on state-issued bonds and $760,000 of dividends oncommon stock it owns in ArizonaTaco, Inc.a. Use the tax schedule in Table 2.3 to calculate Texas Taco ’s income tax liability. Interest on the state-issued bonds is not taxable and should not be included in taxable income. Further, the first 70percent of the dividends received from Arizona Taco is not taxable. Thus, only 30 percent of the dividends receivedare taxed, so: Taxable income = $17,850,000 + (0.3)$760,000 = $18,078,000Texas Taco’s tax liability will be:Tax liability = $5,150,000 + 0.38 ($18,078,000 – $15,000,000) = $6,319,640download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.doc b. What are Texas Taco’s average and marginal tax rates on taxable income?Texas Taco’s resulting average tax rate is: Average tax rate = $6,319,640/$18,078,000= 34.96%Finally, if Texas Taco earned $1 more of taxable income, it would pay 38 cents (based upon its tax rate of 38percent) more in taxes. Thus, the marginal tax rate is 38 percent.LG5 2-27 Statement of Cash Flows Use the balance sheet and following income statement toconstruct a statement of cash flows for Clancy’s Dog Biscuit Corporation. Clancy ’s Dog Biscuit CorporationBalance Sheet as of December 31, 2015 and 2014(in millions of dollars) 2015 2014 2015 2014AssetsLiabilities & EquityCurrent assets: Current liabilities : Cash and marketableAccrued wages andsecurities$5 $5taxes$10$6Accounts receivable 20 19 Accounts payable 16 15 Inventory36 29 Notes payable 1413Total $61 $53Total $40 $34 Fixed assets: Long-term debt:$57$53Gross plant andequipment $106$88Stockholders’ equity: Less: Depreciation 15 11 Preferred stock (2 million shares)$2 $2 Net plant andCommon stock and equipment $91 $77 paid-in surplus1111 Other long-term (5 million shares) assets 15 15Retained earnings57 45 Total $106 $92Total $70 $58Total assets $167 $145Total liabilities and equity$167 $145 Clancy ’s Dog Biscuit CorporationIncome Statement for Years Ending December 31, 2015 and 2014(in millions of dollars)2015 2014 Net sales $76$80 Less: Cost of goods sold3834 Gross profits $38$46 Less: Other operating expenses 65 Earnings before interest, taxes, depreciation, andamortization (EBITDA)$32$41 Less: Depreciation 44 Earnings before interest and taxes (EBIT) $28$37 Less: Interest 55 Earnings before taxes (EBT)$23$32 Less: Taxes 710 Net income $16$22 download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.doc Less: Preferred stock dividends$1$1 Net income available to common stockholders$15$21 Less: Common stock dividends33 Addition to retained earnings$12$18Per (common) share data:Earnings per share (EPS)$3.00$4.20Dividends per share (DPS)$0.60$0.60Book value per share (BVPS)$13.60 $11.20Market value (price) per share (MVPS) $14.25 $14.60 SOLUTION:Statement of Cash Flows for Year Ending December 31, 2015(in millions of dollars)2015A. Cash flows from operating activities Net income $16 Additions (sources of cash):Depreciation4Increase accrued wages and taxes 4Increase in accounts payable1 Subtractions (uses of cash):Increase in accounts receivable-1Increase in inventory -7Net cash flow from operating activities: $17B. Cash flows from investing activities Subtractions:Increase fixed assets -$18Increase in other long-term assets0 Net cash flow from investing activities: -$18C. Cash flows from financing activities Additions:Increase in notes payable$ 1Increase in long-term debt 4Increase in common and preferred stock0 Subtractions:Preferred stock dividends-1Common stock dividends-3 Net cash flow from financing activities: $1 D. Net change in cash and marketable securities -$ 0LG5 2-28 Statement of Cash Flows Use the balance sheet and following income statement toconstruct a statement of cash flows for Valium’s Medical Supply Corporation. Valium ’s Medical Supply CorporationBalance Sheet as of December 31, 2015 and 2014(in thousands of dollars)download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.doc 20152014 20152014AssetsLiabilities & EquityCurrent assets: Current liabilities : Cash and marketableAccrued wages andsecurities$74 $ 73taxes$ 58$ 45Accounts receivable 199189 Accounts payable159 145 Inventory322291 Notes payable131131Total $595 $ 553Total $ 348 $321 Fixed assets: Long-term debt:$ 565 $549 Gross plant andequipment $1,084$ 886Stockholders’ equity: Less: Depreciation153116 Preferred stock (6 thousand shares)$ 6 $ 6 Net plant andCommon stock and equipment $ 931 $ 770 paid-in surplus 120120 Other long-term (100 thousand shares) assets130130Retained earnings 617457 Total $1,061$900Total $ 743 $ 583Total assets $1,656$1,453 Total liabilities and equity $1,656 $1,453 Valium ’s Medical Supply CorporationIncome Statement for Years Ending December 31, 2015 and 2014(in thousands of dollars)2015 2014 Net sales $ 888$ 798 Less: Cost of goods sold 387 350 Gross profits $ 501$ 448 Less: Other operating expenses48 42 Earnings before interest, taxes, depreciation, and amortization (EBITDA)$ 453$ 406 Less: Depreciation and amortization37 35 Earnings before interest and taxes (EBIT) $ 416 $371 Less: Interest46 40 Earnings before taxes (EBT) $370 $331 Less: Taxes129 112 Net income $ 241$ 219Less: Preferred stock dividends$ 6$ 6 Net income available to common stockholders$ 235$ 213 Less: Common stock dividends 75 75 Addition to retained earnings$ 160$ 138Per (common) share data:Earnings per share (EPS)$2.35$2.13Dividends per share (DPS)$0.75$0.75Book value per share (BVPS)$7.37 $5.77Market value (price) per share (MVPS) $8.40 $6.25 Statement of Cash Flows for Year Ending December 31, 2015(in thousands of dollars)download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docA. Cash flows from operating activities Net income $241 Additions (sources of cash):Depreciation and amortization37Increase in accrued wages and taxes 13Increase in accounts payable14 Subtractions (uses of cash):Increase in accounts receivable-10Increase in inventory -31Net cash flow from operating activities: $264B. Cash flows from investing activities Subtractions:Increase in fixed assets -$198Increase in other long-term assets 0 Net cash flow from investing activities: -$198C. Cash flows from financing activities Additions:Increase in notes payable$0Increase in long-term debt16Increase in common and preferred stock 0 Subtractions:Preferred stock dividends -6Common stock dividends -75 Net cash flow from financing activities: -$65 D. Net change in cash and marketable securities $1LG5 2-29 Statement of Cash Flows Chris’ Outdoor Furniture, Inc., has net cash flows fromoperating activities for the last year of $340 million. The income statement shows that netincome is $315 million and depreciation expense is $46 million. During the year, the change ininventory on the balance sheet was $38 million, change in accrued wages and taxes was $15million, and change in accounts payable was $20 million. At the beginning of the year thebalance of accounts receivable was $50 million. Calculate the end-of-year balance for accountsreceivable.A. Cash flows from operating activities (in millions) Net income$315 Additions (sources of cash):Depreciation 46Increase accrued wages and taxes15Increase in accounts payable 20 Subtractions (uses of cash): Increase in accounts receivable -18(=$340 – $315 – $46 – $15 – $20 + $38)Increase in inventory-38Net cash flow from operating activities:$340download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docEnd-of-year balance for accounts receivable = $50m + $18m = $68mLG5 2-30 Statement of Cash Flows Dogs 4 U Corporation has net cash flow from financingactivities for the last year of $34 million. The company paid $178 million in dividends last year.During the year, the change in notes payable on the balance sheet was $39 million, and change in common and preferred stock was $0. The end-of-year balance for long-term debt was $315million. Calculate the beginning-of-year balance for long-term debt.C. Cash flows from financing activities(in millions) Additions:Increase in notes payable$39Increase in long-term debt173(=$34 + $178 – $39)Increase in common and preferred stock 0 Subtractions:Stock dividends-178 Net cash flow from financing activities:$34Beginning-of-year balance for long-term debt = $315m – $173m = $142mLG5 2-31 Free Cash Flow The 2015 income statement for Duffy’s Pest Control shows thatdepreciation expense was $197 million, EBIT was $494 million, and the tax rate was 30 percent.At the beginning of the year, the balance of gross fixed assets was $1,562 million and netoperating working capital was $417 million. At the end of the year, gross fixed assets was $1,803million. Duffy’s free cash flow for the year was $424 million. Calculate the end-of-year balancefor net operating working capital.Duffy’s Pest Control’s operating cash flow was:OCF = EBIT(1 – Tax rate) + Depreciation = ($494m(1 – 0.30) + $197m) = $542.8mDuffy’s Pest Control’s free cash flow for 2015 was:FCF = Operating cash flow – Investment in operating capital$424m = $542.8m – Investment in operating capital=> Investment in operating capital = $542.8m – $424m = $118.8mAccordingly, investment in operating capital for 2015 was:IOC = ?Gross fixed assets + ?Net operating working capital $118.8m = ($1,803m - $1,562m) + (Ending net operating working capital – $417m) => Ending net operating working capital = $118.8m – ($1,803m – $1,562m) + $417m = $294.8mLG5 2-32 Free Cash Flow The 2015 income statement for Egyptian Noise Blasters shows thatdepreciation expense is $85 million, NOPAT is $246 million. At the end of the year, the balanceof gross fixed assets was $655 million. The change in net operating working capital during theyear was $73 million. Egyptian’s free cash flow for the year was $190 million. Calculate thebeginning-of-year balance for gross fixed assets.Egyptian Noise Blasters’ operating cash flow was:OCF = NOPAT + Depreciation == ($246m + $85m) = $331mdownload full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docEgyptian Noise Blasters’ free cash flow for 2015 was:FCF = Operating cash flow – Investment in operating capital$190m = $331m - Investment in operating capital = > Investment in operating capital = $331m – $190m = $141mAccordingly, investment in operating capital for 2015 was:IOC = ?Gross fixed assets + ?Net operating working capital$141m = ($655m – Beginning of year gross fixed assets) + $73m => Beginning of year gross fixed assets = $655m – $141m + $73m = $587mLG1 2-33 Statement of Retained Earnings Thelma and Louie, Inc., started the year with a balanceof retained earnings of $543 million and ended the year with retained earnings of $589 million.The company paid dividends of $35 million to the preferred stockholders and $88 million tocommon stockholders. Calculate Thelma and Louie’s net income for the year.Statement of Retained Earnings as of December 31, 2015(in millions of dollars) Balance of retained earnings, December 31, 2014$543 Plus: Net income for 2015 169 (= $589 + $123 – $543) Less: Cash dividends paidPreferred stock$35Common stock88Total cash dividends paid123Balance of retained earnings, December 31, 2015$589LG1 2-34 Statement of Retained Earnings Jamaica Tours, Inc., started the year with a balance ofretained earnings of $1,780 million. The company reported net income for the year of $284million and paid dividends of $17 million to the preferred stockholders and $59 million tocommon stockholders. Calculate Jamaica Tour’s end-of-year balance in retained earnings.Statement of Retained Earnings as of December 31, 2015(in millions of dollars) Balance of retained earnings, December 31, 2014$1,780 Plus: Net income for 2015284 Less: Cash dividends paidPreferred stock$17Common stock59Total cash dividends paid 76Balance of retained earnings, December 31, 2015$1,988advanced2-35 Income Statement Listed is the 2015 income statement for Tom and Sue Travels, Inc.problems LG1Tom and Sue Travels, Inc.Income Statement for Year Ending December 31, 2015 (in millions of dollars)download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.doc Net sales $16.500 Less: Cost of goods sold7.100 Gross profits 9.400 Less: Other operating expenses 3.200 Earnings before interest, taxes, depreciation, andamortization (EBITDA) 6.200 Less: Depreciation2.900 Earnings before interest and taxes (EBIT)3.300 Less: Interest 0.950 Earnings before taxes (EBT)2.350 Less: Taxes 0.705 Net income$ 1.645The CEO of Tom and Sue’s wants the company to earn a net income of $2.250 million in 2016.Cost of goods sold is expected to be 60 percent of net sales, depreciation and other operatingexpenses are not expected to change, interest expense is expected to increase to $1.050 million,and the firm’s tax rate will be 30 percent. Calculate the net sales needed to produce net incomeof $2.250 million. Tom and Sue Travels, Inc.Income Statement for Year Ending December 31, 2016(in millions of dollars) Net salesStep 5. $25.910 Less: Cost of goods sold Step 6. 15.546 Gross profits Step 4. 10.364 Less: Other operating expenses 3.200 Earnings before interest, taxes, depreciation, andamortization (EBITDA)Step 3. 7.164 Less: Depreciation2.900 Earnings before interest and taxes (EBIT) Step 2. 4.264 Less: Interest 1.050 Earnings before taxes (EBT) Step 1. 3.214 Less: TaxesNet income$ 2.250 Step 1. EBT (1-t) = Net income = $2.250m = EBT (1 – 0.3) => EBT = $2.250m/(1 – 0.3) = $3.214mStep 2. EBIT = EBT + Interest = $3.214m + $1.050m = $4.264mStep 3. EBITDA = EBIT + Depreciation = $4.264m + $2.900m = $7.164mStep 4. Gross profits = EBITDA + Other operating expenses = $7.164m + $3.200m = $10.364mStep 4. Net sales = Gross profits/(1 – Cost of goods sold percent) = $10.364m/(1 – 0.6) = $25.910mStep 5. Cost of goods sold = Net sales – Gross profits = $25.910m – $10.364 = $15.546mLG1 2-36 Income Statement You have been given the following information for PattyCake’sAthletic Wear Corp. for the year 2015: a. Net sales = $38,250,000; b. Cost of goods sold = $22,070,000;c. Other operating expenses = $5,300,000;d. Addition to retained earnings = $1,195,500;download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.doce. Dividends paid to preferred and common stockholders = $1,912,000;f. Interest expense = $1,785,000; g. The firm’s tax rate is 30 percent; h. In 2016, net sales are expected to increase by $9.75 million;i. Cost of goods sold is expected to be 60 percent of net sales;j. Depreciation and other operating expenses are expected to be the same as in 2015;k. Interest expense is expected to be $2,004,286;l. The tax rate is expected to be 30 percent of EBT; m. Dividends paid to preferred and common stockholders will not change. Calculate the addition to retained earnings expected in 2016.Income Statement for Year Ending December 31, 2015(in millions of dollars)Net sales$38,250,000Less: Cost of goods sold 22,070,000Gross profits16,180,000Less: Other operating expenses5,300,000Earnings before interest, taxes, depreciation, and amortization (EBITDA) 10,880,000Less: Depreciation$10,880,000 – $6,224,2864,655,714Earnings before interest and taxes (EBIT)$4,439,286 + $1,785,0006,224,286Less: Interest1,785,000Earnings before taxes (EBT)$3,107,500 / (1 – 0.3) 4,439,286Less: TaxesNet income$3,107,500 Less: Preferred and common stock dividends $1,912,000Addition to retained earnings $1,195,500 Income Statement for Year Ending December 31, 2016(in millions of dollars)Net sales (all credit)$38,250,000 + $9,750,000 $48,000,000 Less: Cost of goods sold0.6 x $48,000,00028,800,000 Gross profits19,200,000 Less: Other operating expenses5,300,000 Earnings before interest, taxes, depreciation, andamortization (EBITDA)13,900,000 Less: Depreciation 4,655,714 Earnings before interest and taxes (EBIT) 9,244,286 Less: Interest2,004,286 Earnings before taxes (EBT)7,240,000 Less: Taxes (30%) 2,172,000 Net income$5,068,000Less: Preferred and common stock dividends$1,912,000 Addition to retained earnings$3,156,000download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docLG5 2-37 Free Cash Flow Rebecky’s Flowers 4U, Inc., had free cash flows during 2015 of $43million, NOPAT of $85 million, and depreciation of $14 million. Using this information, fill inthe blanks on Rebecky’s balance sheet that follows.Rebecky’s operating cash flow for 2015 was:OCF = NOPAT + Depreciation = ($85m + $14m) = $99mRebecky’s free cash flow was:FCF = Operating cash flow – Investment in operating capital$43m = $99m – Investment in operating capitalSo, Investment in operating capital = $99m – $43m = $56mIOC = ?Gross fixed assets + ?Net operating working capital $56m = ($333m – $300m) + ?Net operating working capital=> ?Net operating working capital = $56m – ($333m – $300m) = $23m?Net operating working capital = $23m = ?Current assets – ?Current liabilities$23m = ($221m – $190m) – ?Current liabilities => ?Current liabilities = ($221m – $190m) – $23m = $8m=> 2015 Current liabilities = $110m + $8m = $118mand 2015 Current liabilities = Accrued wages and taxes + Accounts payable + Notes payable $118m =$17m + Accounts payable + $45m => Accounts payable = $118m – $17m – $45m = $56m=> Long-term debt = $550m– - $118m – $237m = $195m Rebecky ’s Flowers 4U, Inc.Balance Sheet as of December 31, 2015 and 2014(in millions of dollars) 2015 2014 2015 2014AssetsLiabilities & EquityCurrent assets: Current liabilities : Cash and marketableAccrued wages andsecurities$28 $25taxes$17$15Accounts receivable 75 65 Accounts payable 56 50Inventory118 100 Notes payable 4545Total $221 $190Total $118 $110 Fixed assets: Long-term debt:$195$190Gross plant andequipment $333 $300Stockholders’ equity: Less: Depreciation 54 40 Preferred stock (5 million shares)$5 $ 5 Net plant andCommon stock and equipment $279 $260 paid-in surplus4040 Other long-term (20 million shares) assets 50 50Retained earnings192 155 Total $329 $310Total $237 $200Total assets $550 $500Total liabilities and equity$550 $500LG5 2-38 Free Cash Flow Vinny’s Overhead Construction had free cash flow during 2015 of $25.4million. The change in gross fixed assets on Vinny’s balance sheet during 2015 was $7.0 milliondownload full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docand the change in net operating working capital was $8.4 million. Using this information, fill inthe blanks on Vinny’s income statement that follows. IOC = ?Gross fixed assets + ?Net operating working capital=>IOC = $7.0m + $8.4m = $15.4mFCF = Operating cash flow – Investment in operating capital=>$25.4m = OCF – $15.4m=>OCF = $25.4m + $15.4m = $40.8mOCF = EBIT(1 – Tax rate) + Depreciation Using the following numbers:$40.8m = $43.4m – ($43.4m x Tax rate) + $10.2m=>$43.4m + $10.2m – $40.8m = $43.4m x Tax rate=> Tax rate = ($43.4m + $10.2m – $40.8m)/$43.4m = 29.49%Vinny ’s Overhead Construction, Corp.Income Statement for Year Ending December 31, 2015(in millions of dollars)Net sales$ 182.10 Step 1. (= $66.00 + $116.10) Less: Cost of goods sold116.10 Gross profits$ 66.00 Less: Other operating expenses12.40 Earnings before interest, taxes, depreciation, and amortization (EBITDA)53.60 Less: Depreciation10.20 Earnings before interest and taxes (EBIT)$ 43.40 Step 2. (= $66.00 – $10.20 – $12.40) Less: Interest 4.20 Step 5. (= $43.40 – $39.20) Earnings before taxes (EBT) $ 39.20 Step 3. (= $27.64 / (1 – 0.2949) Less: Taxes (29.49% from above)11.56 Step 4. (= $39.20 – $27.64) Net income $27.64research it! Reviewing Financial StatementsGo the website of Wal-Mart Stores, Inc. at www.walmartstores.comand get the latest financialstatements from the annual report using the following steps. Go to Wal-Mart Stores, Inc.’s website at www.walmartstores.com. Click on Investors, thenselect Financial Information; next choose Annual Reports; finally, click on the most recent date.This will bring the file onto your computer that contains the relevant data. Locate the total assets,total equity, net sales, net income, dividends paid, cash flows from operating activities, and cashflows from investing activities for the last two years. How have these items changed over the lasttwo years?SOLUTION:The solution will vary with the year annual report that is accessed. However, theannual report for each year summarizes the financial information necessary to evaluate keyinformation used by firm managers, who make financial decisions, and by investors, who decidewhether or not to invest in the firm.download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docintegrated mini-case: Working with Financial StatementsShownare partial financial statements for Garners’ Platoon Mental Health Care, Inc. Fill in theblanks on the four financial statements. Garners ’ Platoon Mental Health Care, Inc. Balance Sheet as of December 31, 2015 and 2014 (in millions of dollars) 20152014 2015 2014AssetsLiabilities & EquityCurrent assets: Current liabilities : Cash and marketable Accrued wages and securities$421 $____taxes$ 316$ 242 Accounts receivable____ 1,020 Accounts payable 867791 Inventory1,760 1,581 Notes payable ____ 714Total $3,290 $____ Total$2,055 $1,747 Fixed assets:Long-term debt:$3,090$____Gross plant and equipment $____$4,743Stockholders’ equity: Less: Depreciation840640 Preferred stock (30 million shares)$ 60$60Net plant andCommon stock and equipment $4,972 $____ paid-in surplus637___Other long-term assets ____790 (200 million shares)Total $5,864 $4,893 Retained earnings3,312 2,440Total $4,009$3,137 Total assets $____ $7,889Total liabilities and equity $9,154 $7,889Garners ’ Platoon Mental Health Care, Inc.Income Statement for Years Ending December 31, 2015 and 2014(in millions of dollars)2 0152014 Net sales $4,980$ Less: Cost of goods sold 2,035Gross profits$2,734 $2,313 Less: Other operating expenses125 100 Earnings before interest, taxes, depreciation, and amortization (EBITDA) 2,6092,213 Less: Depreciation 200 191 Earnings before interest and taxes (EBIT)$2,409 $ Less: Interest285 Earnings before taxes (EBT) $2,094$1,737 Less: Taxes _____ Net income $1,327$1,105download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.docLess: Preferred stock dividends$ 60$ Net income available to common stockholders$1,267$1,045 Less: Common stock dividends395 395 Addition to retained earnings$ 872$____ Per (common) share data:Earnings per share (EPS)$____$____Dividends per share (DPS)$____$____Book value per share (BVPS)$____$____Market value (price) per share (MVPS) $26.850$22.500Garners ’ Platoon Mental Health Care, Inc.Statement of Cash Flows for Year Ending December 31, 2015(in millions of dollars)A. Cash flows from operating activities Net income $___ Additions (sources of cash):Depreciation___Increase in accrued wages and taxes___Increase in accounts payable ___ Subtractions (uses of cash):Increase in accounts receivable___Increase in inventory___Net cash flow from operating activities:$___B. Cash flows from investing activities Subtractions:Increase in fixed assets$ ___Increase in other long-term assets___ Net cash flow from investing activities:$ ___C. Cash flows from financing activities Additions:Increase in notes payable $___Increase in long-term debt___ Increase in common and preferred stock ___ Subtractions:Dividends ___ Net cash flow from financing activities:$___download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.doc D. Net change in cash and marketable securities$ 26Garners ’ Platoon Mental Health Care, Inc.Statement of Retained Earnings as of December 31, 2015(in millions of dollars) Balance of retained earnings, December 31, 2014$2,440 Plus: Net income for 2015 _____ Less: Cash dividends paidPreferred stock$____Common stock_____ Total cash dividends paid_____ Balance of retained earnings, December 31, 2015$____ SOLUTION:Garners ’ Platoon Mental Health Care, Inc. Balance Sheet as of December 31, 2015 and 2014 (in millions of dollars) 20152014 2015 2014AssetsLiabilities & EquityCurrent assets: Current liabilities : Cash and marketable Accrued wages and securities$421 $_395taxes$ 316$ 242 Accounts receivable1,1091,020 Accounts payable 867791 Inventory1,760 1,581 Notes payable _872 714Total $3,290 $2,996 Total$2,055 $1,747 Fixed assets:Long-term debt:$3,090 $3,005Gross plant and equipment $5,812$4,743Stockholders’ equity: Less: Depreciation840640 Preferred stock (25 million shares)$ 60$60Net plant andCommon stock and equipment $4,972 $4,103 paid-in surplus637637Other long-term assets892790 (200 million shares)Total $5,864 $4,893 Retained earnings3,312 2,440Total $4,009$3,137 Total assets $9,154 $7,889Total liabilities and equity $9,154 $7,889Garners ’ Platoon Mental Health Care, Inc.Income Statement for Years Ending December 31, 2015 and 2014(in millions of dollars)2015 2014download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.doc Net sales $4,980 $4,348 Less: Cost of goods sold2,246 2,035Gross profits$2,734$2,313 Less: Other operating expenses125 100 Earnings before interest, taxes, depreciation, and amortization (EBITDA) 2,609 2,213 Less: Depreciation 200191 Earnings before interest and taxes (EBIT) $2,409$ 2,022Less: Interest315285 Earnings before taxes (EBT)$2,094$1,737 Less: Taxes767 632 Net income $1,327$1,105Less: Preferred stock dividends$ 60$ 60Net income available to common stockholders$1,267$1,045 Less: Common stock dividends 395 395 Addition to retained earnings$ 872$ 650 Per (common) share data:Earnings per share (EPS) $ 6.335$5.225Dividends per share (DPS)$1.975$1.975Book value per share (BVPS)$19.745 $15.385Market value (price) per share (MVPS) $26.850 $22.500Garners ’ Platoon Mental Health Care, Inc.Statement of Cash Flows for Year Ending December 31, 2015(in millions of dollars) A. Cash flows from operating activities Net income $1,327 Additions (sources of cash):Depreciation 200Increase in accrued wages and taxes74Increase in accounts payable 76 Subtractions (uses of cash):Increase in accounts receivable-89Increase in inventory -179Net cash flow from operating activities:$1,409B. Cash flows from investing activities Subtractions:Increase in net fixed assets $-1,069Increase in other long-term assets-102 Net cash flow from investing activities: $-1,171C. Cash flows from financing activities Additions:Increase in notes payable$158Increase in long-term debt85 Increase in common and preferred stock 0download full file at http://testbankcafe.com Solution Manual for Finance Applications and Theory 3rd Edition CornettAdair Nofsinger.doc Subtractions:Dividends455 Net cash flow from financing activities:$ -212D. Net change in cash and marketable securities $ 26Garners ’ Platoon Mental Health Care, Inc.Statement of Retained Earnings as of December 31, 2015(in millions of dollars) Balance of retained earnings, December 31, 2014$2,440 Plus: Net income for 2015 1,327 Less: Cash dividends paidPreferred stock$60Common stock395 Total cash dividends paid$455Balance of retained earnings, December 31, 2014$3,312 download full file at http://testbankcafe.com "