Financial Statements Taxes and Cash Flow

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Chapter 2: Financial statements, taxes and cash flow

2.1 The balance sheet B/S

1. What is the balance sheet identity?

2. What is liquidity? Why is it important?

3. Explain the difference between book value and market value. Which is more important 

to the financial manager? Why?

4. The Klingon Corporation has NFA with a book value of $700 and an appraised market 

value of $1,000. Net working capital is $400 on the books, but approximately $600 

would be realized if all current accounts were liquidated. Klingon has $500 in long-

term debt, both book value and market value. What is the book value of the equity? 

What is the market value?

5. Prepare a 2009 balance sheet for Bertinlli Corp. based on the following information:

Cash = $195,000; patents and copyrights = $780,000; accounts payable = $405,000; 

accounts receivable = $137,000; tangible net fixed assets = $$2,800,000; inventory = 

$264,000; notes payable = $160,000; accumulated retained earnings = $1,934,000; 

long-term debt = $1,195,300.

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Test Your Knowledge Chapter 2: Financial statements, taxes and cash flow 2.1 The balance sheet B/S 1. What is the balance sheet identity? 2. What is liquidity? Why is it important? 3. Explain the difference between book value and market value. Which is more important to the financial manager? Why? 4. The Klingon Corporation has NFA with a book value of $700 and an appraised market value of $1,000. Net working capital is $400 on the books, but approximately $600 would be realized if all current accounts were liquidated. Klingon has $500 in longterm debt, both book value and market value. What is the book value of the equity? What is the market value? 5. Prepare a 2009 balance sheet for Bertinlli Corp. based on the following information: Cash = $195,000; patents and copyrights = $780,000; accounts payable = $405,000; accounts receivable = $137,000; tangible net fixed assets = $$2,800,000; inventory = $264,000; notes payable = $160,000; accumulated retained earnings = $1,934,000; long-term debt = $1,195,300. 2.2 The income statement 6. What is the income statement equation? 7. Why is accounting income not the same as cash flow? 8. Suppose U.S. had 200 million shares outstanding at the end of 2009. Based on the following table: Net sales $1,509 Cost of goods sold 750 Depreciation 65 EBIT Interest $694 70 EBT (Taxable income) $624 Taxes (34%) 212 Net income 412 Dividends $103 Addition to retained earnings 309 What was the Earnings per share EPS? What were dividends per share DPS? 9. Given the following information for Rosato Pizza Co., calculate the depreciation expense: Sales = $41,000; Costs = $19,500; Addition to retained earnings = $5,100; dividends paid = $1,500; interest expense = $4,500; Tax rate = 35%. 2.3 Cash flow 10. What is the cash flow identity? 11. What are the components of operating cash flow? 12. Why is interest paid not a component of operating cash flow? 13. Dahlia industries had the following operating results for 2009: sales = $22,800; cost of goods sold = $$16,050; depreciation = $4,050; interest = $1,830; dividend = $1,300. At the beginning of the year, net fixed assets were $13,650, current assets were $4,800 and current liabilities were $2,700. At the end of the year, net fixed assets were $16,800, current assets were $5,930 and current liabilities were $3,150. The tax rate for 2009 was 34%. a. What is net income for 2009? b. What is the operating cash flow for 2009? c. What is the cash flow from assets for 2009? Is it possible? Explain. 2.4 Accounting Vs. Finance 14. How is cost of equity in finance treated differently from accounting? 15. Why does the timing of cash flows matter to the financial manager? 16. The cost of equity for any firm is higher than the cost of debt. Why? 17. The matching principle in accounting matches an asset cost and revenue stream over its lifetime. Why is this approach insufficient for the financial manager? CHAPTER 3: Working with financial statements 3.1 Cash Flow and Financial Statements 1. What is a source of cash? Give three examples. 2. What is a use, or application of cash? Give three examples. 3.2 Standardized Financial Statements 3. Why is it necessary often to standardize financial statements? 4. Name two types of standardized statements and describe how each is formed. 5. Standardize the following B/S and fill in the table. Cash A/R Inventory FA Total Assets A/P N/P LTD C/S Retained earnings TL&E 2008 $210 355 507 6,085 7,157 207 1,715 1,987 1,000 2,248 7,157 2009 $215 310 328 6,527 7,380 298 1,427 2,308 1,000 2,347 7,380 2008 2009 Change 100% 100% 0 100% 100% 0 6. Standardize the following I/S and fill in the table. Sales (Revenues) COGS Depreciation EBIT Interest Taxable income Taxes (34%) NI Dividends Addition to retained earnings $2,311 1,344 276 $691 141 $550 187 $363 $121 242 3.3 Ratio Analysis 7. What are the five groups of ratios? Give examples for each. 100% 8. Selected financial data in Saudi Riyal for Hail cement and Najran cement are listed below: Current Assets Fixed assets Total assets Current liabilities Long-term debt Equity Total liabilities Net sales Net income Share price Outstanding shares Hail cement 115,524,000 1,122,148,000 1,334,287,000 135,959,000 236,583,000 961,745,000 372,542,000 159,018,000 50,467,000 SAR23.46 Najran cement 88,265,000 2,493,686,000 2,913,019,000 483,232,000 609,247,000 1,820,540,000 1,092,479,000 631,639,000 198,142,000 SAR 29.08 97,900,000 170,000,000 Compare and contrast between the two corporations using the five ratio categories. 9. Selected financial data in thousands of dollars for the Hunter Corporation are listed below: 2015 2014 Current assets 55 400 Fixed assets 700 600 Total assets 1,200 1,000 Current liabilities 300 200 Long-term debt 200 200 Common equity 700 600 Total liability and equity 1,200 1,000 Net sales 1,500 1,200 Net income 110 100 Shares outstanding 200,000 200,000 Share price $20 $30 Analyze the company using the five ratio categories. 3.4 Using Financial Statement Information 10. What are some uses for financial statement analysis? 11. What are some problems that can come up with financial statement analysis? 12. What is time trend analysis? What is peer group analysis? What is cross-sectional analysis? CHAPTER 3: Working with financial statements 3.1 Cash Flow and Financial Statements 1. What is a source of cash? Give three examples. 2. What is a use, or application of cash? Give three examples. 3.2 Standardized Financial Statements 3. Why is it necessary often to standardize financial statements? 4. Name two types of standardized statements and describe how each is formed. 5. Standardize the following B/S and fill in the table. Cash A/R Inventory FA Total Assets A/P N/P LTD C/S Retained earnings TL&E 2008 $210 355 507 6,085 7,157 207 1,715 1,987 1,000 2,248 7,157 2009 $215 310 328 6,527 7,380 298 1,427 2,308 1,000 2,347 7,380 2008 2009 Change 100% 100% 0 100% 100% 0 6. Standardize the following I/S and fill in the table. Sales (Revenues) COGS Depreciation EBIT Interest Taxable income Taxes (34%) NI Dividends Addition to retained earnings $2,311 1,344 276 $691 141 $550 187 $363 $121 242 3.3 Ratio Analysis 7. What are the five groups of ratios? Give examples for each. 100% 8. Selected financial data in Saudi Riyal for Hail cement and Najran cement are listed below: Current Assets Fixed assets Total assets Current liabilities Long-term debt Equity Total liabilities Net sales Net income Share price Outstanding shares Hail cement 115,524,000 1,122,148,000 1,334,287,000 135,959,000 236,583,000 961,745,000 372,542,000 159,018,000 50,467,000 SAR23.46 Najran cement 88,265,000 2,493,686,000 2,913,019,000 483,232,000 609,247,000 1,820,540,000 1,092,479,000 631,639,000 198,142,000 SAR 29.08 97,900,000 170,000,000 Compare and contrast between the two corporations using the five ratio categories. 9. Selected financial data in thousands of dollars for the Hunter Corporation are listed below: 2015 2014 Current assets 55 400 Fixed assets 700 600 Total assets 1,200 1,000 Current liabilities 300 200 Long-term debt 200 200 Common equity 700 600 Total liability and equity 1,200 1,000 Net sales 1,500 1,200 Net income 110 100 Shares outstanding 200,000 200,000 Share price $20 $30 Analyze the company using the five ratio categories. 3.4 Using Financial Statement Information 10. What are some uses for financial statement analysis? 11. What are some problems that can come up with financial statement analysis? 12. What is time trend analysis? What is peer group analysis? What is cross-sectional analysis? Chapter 5: The time value of money 5.1 Future value and compounding 1. What do we mean by the future value of an investment? 2. What does it mean to compound interest? How does compound interest differ from simple interest? 3. In general, what is the future value of $1 invested at r per period for t periods? 4. Suppose you locate a two-year investment that pays 14% per year. If you invest $325, how much will you have at the end of two years? How much of this is simple interest? How much is compound interest? Answer: $422.37; Total interest is $97.37; Simple interest is $91; Compounding interest is $6.37 5. You have located an investment that pays 12% per year. That rate sounds good to you, so you invest $400. How much will you have in three years? How much in Seven years? How much interest will you have earned? How much of that interest results from compounding? Answer: 4-years is $561.97, Seven-years is $884.27; Interest from compounding is $148.27 5.2 Present value and discounting 6. What do we mean by the present value of an investment? 7. The process of discounting a future amount back to the present is the opposite of doing what? 8. In general, what is the present value of $1 to be received in t periods, assuming a discount rate of r per period? 9. Suppose you need $400 to buy textbooks next year. You can earn 7% on your money. How much do you have to put up today? Answer: $373.83 10. You would like to buy a new car. You have $50,000, but the car costs $68,500. If you can earn 9%, how much do you have to invest today to buy the car in two years? Do you have enough? Assume the price will stay the same. Answer: Need to invest $57,655.08; you are $7,655.08 less 11. Businesses sometimes advertise that “you should come try our product. If you do, we will give you $100 just for coming by” If you read the fine print, what you find out is that they will give you a certificate that will pay you $100 in 25 years or so. If the interest rate is 10% per year, how much are they really giving you today? Answer: They are giving you $9.23 5.3 More about present value and future value 12. Your company proposes to buy an asset for $335. This investment is very safe. You would sell off the asset in three years for $400. You know that you could invest the $335 elsewhere at 10% with very little risk. What do you think of the proposed investment? Answer: This is not good investment. Investing $335 at 10% offers $445.89, while the proposed investment pays only $400. 13. You are considering a one-year investment. If you put up $1,250, you will get back $1,350. What rate is this investment paying? Answer: r = 8% 14. You would like to retire in 50 years as a millionaire. If you have $10,000 today, what rate of return do you need to earn to achieve your goal? Answer: r = 9.65% 15. You have been saving up to buy Alianz insurance company. The total cost will be $10M. You currently have about $2.3M. If you can earn 5% on your money, how long will you have to wait? At 16%, how long must you wait? Answer: At 5%, t = 30 years. At 16%, t = 10 years. 16. During 2003, Sotheby’s sold the Edgar Degas bronze sculpture at auction for a price of $10,311,500. Unfortunately for the previous owner, he had purchased it in 1999 at a price of $12,377,500. What was his annual rate of return on this sculpture? Answer: r = -4.46%
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Running Head: FINANCIAL STATEMENTS, TAXES AND CASH FLOW

Financial Statements, Taxes and Cash Flow

Student’s name

Course name and number

Instructor’s name

Date submitted

1

FINANCIAL STATEMENTS, TAXES AND CASH FLOW

2

Chapter 2: Financial statements, taxes and cash flow
1
Balance sheet identity is elementary equation which express company’s actual book value. It is
expressed as
𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐿𝑖𝑎𝑏𝑙𝑖𝑡𝑖𝑒𝑠 + 𝑜𝑤𝑛𝑒𝑟 ′ 𝑠 𝑒𝑞𝑢𝑖𝑡𝑦
2
Liquidity is defined as the ease and speed at which can be converted to cash. It is important
because it indicates the likelihood of a company to experience financial distress. For instance,
means less financial distress.
3
Book value is the value of a firm based on its financial statements while market value is the
value of the firm based on the stock market. Market value is more important to the financial
manager because it represent the price one has to pay in order to own part of the business
irrespective of its book value.
4

Assets
NWC
NFA
Total

$400
$700
$1,100

Klingon Corporation
Balance sheets
Market value Vs. Book Value
Book
Market
Book
Liabilities and Shareholders’ equity
$600
LTD $500
$500
$1,000
SE
$600
$1,100
$1,600
Total $1,100
$1,600

Market

FINANCIAL STATEMENTS, TAXES AND CASH FLOW

3

5

Assets ($)
Cash
Account receivable
Inventory
Current assets

195,000
137,000
364,000
696,000

Balance sheet
Owners’ equity and liabilities ($)
Account payable
405,000
Not-payable
160,000
Current liabilities
565,000
Long-term debt
1,195,300
Total liabilities
1,760,300

Tangible net Fixed
assets
Intangible net Fixed
assets

2,800,000
780,000

Common stock

581, 700

Total assets

4,276,000

Retained earnings
Total Owners’ equity
and liabilities

1,934,000
4,276,000

Common stock = 4,276,000 - 1,760,300 - 1,934,000 = $ 581, 700
6
It is a basic equation which forms the basis for income statement. It is expressed as
𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 – 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 = 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒.
7
The basic difference between accounting income and cash flow is the fact that income statement
contains Non-cash Items such as depreciation which does not affect cashflow directly.
8

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 =

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
412
=
= 2.06
𝑁𝑜 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 200

FINANCIAL STATEMENTS, TAXES AND CASH FLOW
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = $ 2.06

𝐷𝑖𝑣𝑖𝑑𝑒𝑑 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 =

𝑇𝑜𝑡𝑎𝑙 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑
103
=
= 0.515
𝑁𝑜 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 200

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = $ 0.515
9
Sales
Costs
EBIDT
Dividends
Interest expense
Tax rate
Addition to retained earnings

$ 41,000
$ 19,500 (-)
$ 21,500
$ 1,500
$ 4,500
35%
$5,100

𝑅𝑒𝑡𝑎𝑖𝑛𝑒𝑑 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠 = 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 – 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠
$5,100 = 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 − $ 1,500
Thus
𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 = $ 6,600
EBIDT = 21,500
EBIT = 6600
Therefore
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 = 21,500 − 6600 = $ 14,900

4

FINANCIAL STATEMENTS, TAXES AND CASH FLOW

5

10
Cash flow identity is a basic equation which denotes the company’s’ cash flow. It is expressed as
𝐶𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 𝑓𝑟𝑜𝑚 𝑎𝑠𝑠𝑒𝑡𝑠 = 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 𝑡𝑜 𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠 + 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 𝑡𝑜 𝑠𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠.
11
Operating cash flow is the cash flow resulting from day-day activities of the business i.e.
producing and selling. It is expressed as
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 = 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡𝑠 𝑎𝑛𝑑 𝑡𝑎𝑥𝑒𝑠 + 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛𝑠 − 𝑇𝑎𝑥𝑒𝑠
12
Interest paid not a ...


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