ros3059X_ch02.qxd 12/27/05 05:15 PM Page 37www.mhhe.com/rwj9.Cash Flow to Stockholders and CreditorsCould a company’s cash flow to stockholders benegative in a given year? (Hint: Yes.) Explain how this might come about. What about cash flowto creditors?10.Firm ValuesReferring back to the Viacom example used at the beginning of the chapter, notethat we suggested that Viacom’s stockholders probably didn’t suffer as aresult of the reportedloss. What do you think was the basis for our conclusion?QUESTIONS AND PROBLEMS1.Building a Balance SheetCulligan, Inc., has current assets of $5,000, net fixed assets of$23,000, current liabilities of $4,300, and long-term debt of $13,000. What is the value of theshareholders’ equity account for this firm? How much is net working capital?2.Building an Income StatementRagsdale, Inc., has sales of $527,000, costs of $280,000, depre-ciation expense of $38,000, interest expense of $15,000, and a tax rate of 35 percent. What is thenet income for the firm? Suppose the company paid out $48,000 in cash dividends. What is theaddition to retained earnings?3.Market Values and Book ValuesKlingon Cruisers, Inc., purchased new cloaking machinerythree years ago for $7 million. The machinery can be sold to the Romulans today for $3.2 million.Klingon’s current balance sheet shows net fixed assets of $4,000,000, current liabilities of$2,200,000, and net working capital of $900,000. If all the current assets were liquidated today,the company would receive $2.8 million cash. What is the book value of Klingon’s assets today?What is the market value?4.Calculating TaxesThe Herrera Co. had $273,000 in taxable income. Using the rates fromTable2.3 in the chapter, calculate the company’s income taxes. What is the average tax rate?What is the marginal taxrate?5.Calculating OCFRanney, Inc., has sales of $13,500, costs of $5,400, depreciation expense of$1,200, and interest expense of $680. If the tax rate is 35 percent, what is the operating cashflow, or OCF?6.Calculating Net Capital SpendingGordon Driving School’s 2005 balance sheet showed netfixed assets of $4.2 million, and the 2006 balance sheet showed net fixed assets of $4.7 million.The company’s 2006 income statement showed a depreciation expense of $925,000. What wasGordon’s net capital spending for 2006?7.Building a Balance SheetThe following table presents the long-term liabilities and stock-holders’ equity of Information Control Corp. one year ago:Long-term debtPreferred stockCommon stock ($1 par value)Accumulated retained earningsCapital surplus$60,000,00018,000,00025,000,00089,000,00049,000,000Basic (Questions 1–10)During the past year, Information Control issued 10 million shares of new stock at a total price of$26 million, and issued $8 million in new long-term debt. The company generated $7 million innet income and paid $4 million in dividends. Construct the current balance sheet reflecting thechanges that occurred at Information Control Corp. during the year.8.Cash Flow to CreditorsThe 2005 balance sheet of Anna’s Tennis Shop, Inc., showed long-termdebt of $2.8 million, and the 2006 balance sheet showed long-term debt of $3.1 million. The 2006income statement showed an interest expense of $340,000. What was the firm’s cash flow tocreditors during 2006?37ros3059X_ch02.qxd 12/27/05 05:15 PM Page 38www.mhhe.com/rwj9.Cash Flow to StockholdersThe 2005 balance sheet of Anna’s Tennis Shop, Inc., showed$820,000 in the common stock account and $6.8 million in the additional paid-in surplus account.The 2006 balance sheet showed $855,000 and $7.6 million in the same two accounts, respec-tively. If the company paid out $600,000 in cash dividends during 2006, what was the cash flowto stockholders for the year?10.Calculating Total Cash FlowsGiven the information for Anna’s Tennis Shop, Inc., in the previ-ous two problems, suppose you also know that the firm’s net capital spending for 2006 was$760,000, and that the firm reduced its net working capital investment by $165,000. What was thefirm’s 2006 operating cash flow, or OCF?Intermediate(Questions 11–24)11.Cash FlowsRitter Corporation’s accountants prepared the following financial statements foryear-end 2006.RITTER CORPORATIONIncome Statement2006RevenueExpensesDepreciationNet incomeDividends$50030075____$125$65RITTER CORPORATIONBalance SheetsDecember 312006AssetsCashOther current assetsNet fixed assetsTotal assetsLiabilities and EquityCurrent liabilitiesLong-term debtStockholders’ equityTotal liabilities and equity2005$45145250____$440$7090280____$440$10120150____$280$600220____$280a.Explain the change in cash during the year 2006.b.Determine the change in net working capital in 2006.c.Determine the cash flow generated by the firm’s assets during the year 2006.12.Financial Cash FlowsThe Stancil Corporation provided the following current information:$7,00018,0002,0003,0001,00023,000Proceeds from short-term borrowingProceeds from long-term borrowingProceeds from the sale of common stockPurchases of fixed assetsPurchases of inventoriesPayment of dividendsDetermine the cash flows from the firm and the cash flows to investors of the firm.38ros3059X_ch02.qxd 12/27/05 05:15 PM Page 39www.mhhe.com/rwj13.Building an Income StatementDuring the year, the Senbet Discount Tire Company had grosssales of $1 million. The firm’s cost of goods sold and selling expenses were $300,000 and$200,000, respectively. Senbet also had notes payable of $1 million. These notes carried aninterest rate of 10 percent. Depreciation was $100,000. Senbet’s tax rate was 35 percent.a.What was Senbet’s net income?b.What was Senbet’s operating cash flow?14.Calculating Total Cash FlowsSchwert Corp. shows the following information on its 2006income statement: sales ϭ$145,000; costs ϭ$86,000; other expenses ϭ$4,900; depreciationexpense ϭ$7,000; interest expense ϭ$15,000; taxes ϭ$12,840; dividends ϭ$8,700. In addition,you’re told that the firm issued $6,450 in new equity during 2006, and redeemed $6,500 inoutstanding long-term debt.a.What is the 2006 operating cash flow?b.What is the 2006 cash flow to creditors?c.What is the 2006 cash flow to stockholders?d.If net fixed assets increased by $5,000 during the year, what was the addition to NWC?15.Using Income StatementsGiven the following information for O’Hara Marine Co., calculatethe depreciation expense: sales ϭ$29,000; costs ϭ$13,000; addition to retained earnings ϭ$4,500; dividends paid ϭ$900; interest expense ϭ$1,600; tax rate ϭ35 percent.16.Preparing a Balance SheetPrepare a 2006 balance sheet for Jarrow Corp. based on the fol-lowing information: cash ϭ$175,000; patents and copyrights ϭ$720,000; accounts payable ϭ$430,000; accounts receivable ϭ$140,000; tangible net fixed assets ϭ$2,900,000; inventory ϭ$265,000; notes payable ϭ$180,000; accumulated retained earnings ϭ$1,240,000; long-termdebt ϭ$1,430,000.17.Residual ClaimsHuang, Inc., is obligated to pay its creditors $3,500 very soon.a.What is the market value of the shareholders’ equity if assets have a market value of $4,300?b.What if assets equal $3,200?18.Marginal versus Average Tax Rates(Refer to Table 2.3.) Corporation Growth has $85,000 intaxable income, and Corporation Income has $8,500,000 in taxable income.a.What is the tax bill for each firm?b.Suppose both firms have identified a new project that will increase taxable income by$10,000. How much in additional taxes will each firm pay? Why is this amount the same?19.Net Income and OCFDuring 2006, Raines Umbrella Corp. had sales of $850,000. Cost ofgoodssold, administrative and selling expenses, and depreciation expenses were $630,000,$120,000, and $130,000, respectively. In addition, the company had an interest expense of $85,000and a tax rate of 35percent. (Ignore any tax loss carry-back or carry-forward provisions.)a.What is Raines’s net income for 2006?b.What is its operating cash flow?c.Explain your results in (a) and (b).20.Accounting Values versus Cash FlowsIn Problem 19, suppose Raines Umbrella Corp. paid out$30,000 in cash dividends. Is this possible? If spending on net fixed assets and net working capi-tal was zero, and if no new stock was issued during the year, what was the change in the firm’slong-term debt account?21.Calculating Cash FlowsCusic Industries had the following operating results for 2006: sales ϭ$12,800; cost of goods sold ϭ$10,400; depreciation expense ϭ$1,900; interest expense ϭ$450;dividends paid ϭ$500. At the beginning of the year, net fixed assets were $9,100, current assetswere $3,200, and current liabilities were $1,800. At the end of the year, net fixed assets were 39ros3059X_ch02.qxd 12/27/05 05:15 PM Page 40www.mhhe.com/rwj$9,700, current assets were $3,850, and current liabilities were $2,100. The tax rate for 2006 was34 percent.a.What is net income for 2006?b.What is the operating cash flow for 2006?c.What is the cash flow from assets for 2006? Is this possible? Explain.d.If no new debt was issued during the year, what is the cash flow to creditors? What is thecash flow to stockholders? Explain and interpret the positive and negative signs of youranswers in (a) through (d).22.Calculating Cash FlowsEnterprises:Consider the following abbreviated financial statements for WestonWESTON ENTERPRISES2006 Income StatementSalesCostsDepreciationInterest paid$8,6004,150800216WESTON ENTERPRISES2005 and 2006 Partial Balance SheetsAssetsCurrent assetsNet fixed assets2005$6502,9002006$7053,400Liabilities and Owners’ EquityCurrent liabilitiesLong-term debt2005$2651,5002006$2901,720a.What is owners’ equity for 2005 and 2006?b.What is the change in net working capital for 2006?c.In 2006, Weston Enterprises purchased $1,500 in new fixed assets. How much in fixed assetsdid Weston Enterprises sell? What is the cash flow from assets for the year? (The tax rate is35 percent.)d.During2006,WestonEnterprisesraised$300innewlong-termdebt.Howmuchlong-termdebtmustWestonEnterpriseshavepaidoffduringtheyear?Whatisthecashflowtocreditors?Use the following information for Ingersoll, Inc., for Problems 23 and 24 (assume the tax rate is34 percent):2005SalesDepreciationCost of goods soldOther expensesInterestCashAccounts receivableShort-term notes payableLong-term debtNet fixed assetsAccounts payableInventoryDividends$4,0185771,3823282692,1072,7894077,05617,6692,2134,9594902006$4,3125781,5692743092,1553,1423828,23218,0912,1465,09653923.Financial Statements2005 and 2006.Draw up an income statement and balance sheet for this company for24.Calculating Cash FlowFor 2006, calculate the cash flow from assets, cash flow to creditors,and cash flow to stockholders.40ros3059X_ch02.qxd 12/27/05 05:15 PM Page 41www.mhhe.com/rwj25.Cash FlowsYou are researching Time Manufacturing and have found the following account-ingstatement of cash flows for the most recent year. You also know that the companypaid$110million in current taxes and had an interest expense of $57 million. Use the accountingstatement of cash flows to construct the financial statement of cash flows.TIME MANUFACTURINGStatement of Cash Flows(in $ millions)OperationsNet incomeDepreciationDeferred taxesChanges in assets and liabilitiesAccounts receivableInventoriesAccounts payableAccrued expensesOtherTotal cash flow from operationsInvesting activitiesAcquisition of fixed assetsSale of fixed assetsTotal cash flow from investing activitiesFinancing activitiesRetirement of long-term debtProceeds from long-term debt salesChange in notes payableDividendsRepurchase of stockProceeds from new stock issueTotal cash flow from financing activitiesChange in cash (on balance sheet)Challenge (Questions 25–27)$19210521Ϫ312419Ϫ102_____$322__________Ϫ$19825_____Ϫ$173__________Ϫ$841296Ϫ94Ϫ1549_____Ϫ$9__________$140__________26.Net Fixed Assets and DepreciationOn the balance sheet, the net fixed assets (NFA) accountis equal to the gross fixed assets (FA) account, which records the acquisition cost of fixedassets, minus the accumulated depreciation (AD) account, which records the total depreciationtaken by the firm against its fixed assets. Using the fact that NFA ϭFA ϪAD, show that theexpression given in the chapter for net capital spending, NFAendϪNFAbegϩD (where D is thedepreciation expense during the year), is equivalent to FAendϪFAbeg.27.Tax RatesRefer to the corporate marginal tax rate information in Table 2.3.a.Why do you think the marginal tax rate jumps up from 34 percent to 39 percent ata taxableincome of $100,001, and then falls back to a 34 percent marginal rate at a taxable income of$335,001?b.Compute the average tax rate for a corporation with exactly $335,001 in taxable income.Does this confirm your explanation in part (a)? What is the average tax rate for a corporationwith exactly $18,333,334? Is the same thing happening here?c.The39percentand38percenttaxratesbothrepresentwhatiscalledatax“bubble.”Supposethegovernmentwantedtolowertheupperthresholdofthe39percentmarginaltaxbracketfrom$335,000to$200,000.Whatwouldthenew39percentbubbleratehavetobe?41ros3059X_ch02.qxd 12/27/05 05:15 PM Page 42www.mhhe.com/rwjS&P PROBLEMSwww.mhhe.com/edumarketinsight1.Marginal and Average Tax RatesDownload the annual income statements for Sharper Image(SHRP). Looking back at Table 2.3, what is the marginal income tax rate for Sharper Image? Usingthe total income tax and the pretax income numbers calculate the average tax rate for SharperImage. Is this number greater than 35 percent? Why or why not?2.Net Working CapitalFind the annual balance sheets for American Electric Power (AEP) andHJHeinz (HNZ). Calculate the net working capital for each company. Is American ElectricPower’s net working capital negative? If so, doesthis indicate potential financial difficulty forthecompany? What about Heinz?3.Per Share Earnings and DividendsFind the annual income statements for Harley-Davidson(HDI), Hawaiian Electric Industries (HE), and Time Warner (TWX). What are the earnings pershare (EPS Basic from operations) for each of these companies? What are the dividends pershare for each company? Why do these companies pay out a different portion of income in theform of dividends?4.Cash Flow IdentityDownload the annual balance sheets and income statements for Landry’sSeafood Restaurants (LNY). Using the most recent year calculate the cash flow identity forLandry Seafood. Explain your answer.WHAT’S ON THE WEB?1.Change in Net Working CapitalFind the most recent abbreviated balance sheets for GeneralDynamics at finance.yahoo.com. Enter the ticker symbol “GD,” follow the “Research” link, andthe “Financials” link. Using the two most recent balance sheets, calculate the change in networking capital. What does this number mean?2.Book Values versus Market ValuesThe home page for Coca-Cola Company can be found atwww.coca-cola.com. Locate the most recent annual report, which contains a balance sheet forthe company. What is the book value of equity for Coca-Cola? The market value of a company isthe number of shares of stock outstanding times the price per share. This information can befound at finance.yahoo.comusing the ticker symbol for Coca-Cola (KO). What is the market valueof equity? Which number is more relevant for shareholders?3.Cash Flows to Stockholders and CreditorsCooper Tire and Rubber Company provides financialinformation for investors on its Web site at www.coopertires.com. Follow the “Investor Informa-tion” link and find the most recent annual report. Using the consolidated statements of cashflows, calculate the cash flow to stockholders and the cash flow to creditors.42ros3059X_ch02.qxd 12/27/05 05:15 PM Page 43CASH FLOWS AT WARF COMPUTERS, INC.Warf Computers, Inc., was founded 15 years ago by Nick Warf, a computer programmer. Thesmall initial investment made to start the company was made by Nick and his friends. Over theyears, this same group has supplied the limited additional investment needed by the companyin the form of both equity and short- and long-term debt. Recently the company has developeda virtual keyboard (VK). The VK uses sophisticated artificial intelligence algorithms that allowthe user to speak naturally and have the computer input the text, correct spelling and gram-matical errors, and format the document according to preset user guidelines. The VK even sug-gests alternative phrasing and sentence structure, and it provides detailed stylistic diagnostics.Based on a proprietary, and very advanced, software/hardware hybrid technology, the systemis a full generation beyond what is currently on the market. To introduce the VK, the companywill require significant outside investment.Nick has made the decision to seek this outside financing in the form of new equity investors andbank loans. Naturally, these new investors and the banks will require a detailed financial analysis.Your employer, Angus Jones & Partners, LLC, has asked you to examine the financial statements pro-vided by Nick. Below you will find the balance sheet for the two most recent years and the mostrecent income statement.CLOSING CASEWARF COMPUTERSBalance Sheet(in $ thousands)2006Current assets:Cash and equivalentsAccounts receivableInventoriesOtherTotal current assets2005Current liabilities:Accounts payableNotes payableAccrued expensesTotal current liabilitiesLong-term liabilities:Deferred taxesLong-term debtTotal long-term liabilities20062005$232$20136734232934047_____40_____$975$923$1,630560_____$1,070363_____$1,433_____$263$1976853126______205______$457$455$143$82629______589______$772$671Fixed assets:Property, plant, and equipment$2,105Less accumulated depreciation_____687Netproperty,plant,andequipment$1,418Intangible assets and others406_____Total fixed assets$1,824_____Total assets$2,799_____$2,356_______________Stockholders’ equity:Preferred stock$10$10Common stock7264Capital surplus438399Accumulated retained earnings1,147822Less treasury stockϪ97Ϫ65____________Total equity$1,570______$1,230______Total liabilities and shareholders’ equity$2,799______$2,356__________________43ros3059X_ch02.qxd 12/27/05 05:15 PM Page 44WARF COMPUTERSIncome Statement(in $ thousands)Sales$3,875Cost of goods sold2,286Selling, general, and administrative expense434Depreciation_____127Operating income$1,028Other income_____38Earnings before interest and taxes (EBIT)$1,066Interest expense_____76Pretax income$990Taxes347Current:$286Deferred:$61_____Net income$__________643Addition to retained earnings$325Dividends$318Nick has also provided the following information. During the year, the company raised $94,000 innew long-term debt and retired $54,000 in long-term debt. The company also sold $47,000 in new stockand repurchased $32,000 in stock. The company purchased $629,000 in fixed assets, and sold $111,000in fixed assets.Angus has asked you to prepare the financial statement of cash flows and the accounting state-ment of cash flows. He has also asked you to answer the following questions:1.How would you describe Warf Computers’s cash flows?2.Which cash flows statement more accurately describes the cash flows at the company?3.In light of your previous answers, comment on Nick’s expansion plans.44