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Solutions to End-of-Chapter Three Problems

3-1 From the data given in the problem, we know the following:

Current assets $ 500,000c Accounts payable and accruals $ 100,000e


Net plant and equipment 2,000,000 Notes payable 150,000
Current liabilities $ 250,000d
Long-term debt 750,000
Total common equity 1,500,000
Total assets $2,500,000 Total liabilities and equity $2,500,000b

Note: Superscripts correspond to parts below.

a. Total debt = Short-term debt + Long-term debt


Total debt = $150,000 + $750,000
Total debt = $900,000.

b. We are given that the firms total assets equal $2,500,000. Since both sides of the balance
sheet must equal, total liabilities and equity must equal total assets = $2,500,000.

c. Total assets = Current assets + Net plant and equipment


$2,500,000 = Current assets + $2,000,000
Current assets = $2,500,000 $2,000,000
Current assets = $500,000.

d. Total liabilities and equity = Current liabilities + Long-term debt + Total common equity
$2,500,000 = Current liabilities + $750,000 + $1,500,000
$2,500,000 = Current liabilities + $2,250,000
Current liabilities = $2,500,000 $2,250,000
Current liabilities = $250,000.

e. Current liabilities = Accounts payable and accruals + Notes payable


$250,000 = Accounts payable and accruals + $150,000
Accounts payable and accruals = $250,000 $150,000
Accounts payable and accruals = $100,000.

f. Net working capital = Current assets Current liabilities


Net working capital = $500,000 $250,000
Net working capital = $250,000.

g. Net operating working capital = Current assets (Current liabilities Notes payable)
Net operating working capital = $500,000 ($250,000 $150,000)
Net operating working capital = $400,000.

h. NOWC NWC = $400,000 $250,000


NOWC NWC = $150,000.

The difference between the two is equal to the notes payable balance.

Chapter 3: Financial Statements, Cash Flow, and Taxes Answers and Solutions 1
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3-2 NI = $3,000,000; EBIT = $6,000,000; T = 40%; Interest = ?
Need to set up an income statement and work from the bottom up.

EBIT $6,000,000
Interest 1,000,000 $3,000,000 $3,000,000
EBT $5,000,000 EBT =
(1 T) 0.6
Taxes (40%) 2,000,000
NI $3,000,000

Interest = EBIT EBT = $6,000,000 $5,000,000 = $1,000,000.

3-3 EBITDA $7,500,000 (Given)


Depreciation 2,500,000 Deprec. = EBITDA EBIT = $7,500,000 $5,000,000
EBIT $5,000,000 EBIT = EBT + Int = $3,000,000 + $2,000,000
Interest 2,000,000 (Given) $1,800,000 $1,800,000
EBT $3,000,000
(1 T) 0.6
Taxes (40%) 1,200,000 Taxes = EBT Tax rate
NI $1,800,000 (Given)

3-4 NI = $50,000,000; R/EY/E = $810,000,000; R/EB/Y = $780,000,000; Dividends = ?

R/EB/Y + NI Div = R/EY/E


$780,000,000 + $50,000,000 Div = $810,000,000
$830,000,000 Div = $810,000,000
$20,000,000 = Div.

3-5 MVA = (P0 Number of common shares) BV of common equity


$130,000,000 = $60X $500,000,000
$630,000,000 = $60X
X = 10,500,000 common shares.

3-6 Book value of equity = $35,000,000.


Price per share (P0) = $30.00.
Common shares outstanding = 2,000,000 shares.

Market value of equity = P0 Common shares outstanding


= $30 2,000,000
= $60,000,000.

MVA = Market value of equity Book value of equity


= $60,000,000 $35,000,000
= $25,000,000.

Chapter 3: Financial Statements, Cash Flow, and Taxes Answers and Solutions 2
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Total After -tax %
3-7 EVA = EBIT(1 T) invested cost of
capital capital
EVA = $3,000,000(0.6) [$20,000,000 0.08]
EVA = $1,800,000 $1,600,000
EVA = $200,000.

3-8 Statements b and d will decrease the amount of cash on a companys balance sheet.
Statement a will increase cash through the sale of common stock. Selling stock provides cash
through financing activities. On one hand, Statement c would decrease cash; however, it is also
possible that Statement c would increase cash, if the firm receives a tax refund for taxes paid in
a prior year.

3-9 Ending R/E= Beg. R/E Net income Dividends


$278,900,000 = $212,300,000 Net income $22,500,000
$278,900,000 = $189,800,000 Net income
Net income = $89,100,000.

3-10 Tax rate 35%


After-tax % cost of capital 9%
Total invested capital $15,000,000

Sales $22,500,000
Operating costs (including depreciation) 18,000,000
EBIT $ 4,500,000

EVA = (EBIT)(1 T) (Total invested capital)(After-tax % cost of capital)


= $4,500,000(0.65) ($15,000,000)(0.09)
= $2,925,000 $1,350,000
= $1,575,000.

3-11 a. From the statement of cash flows the change in cash must equal cash flow from operating
activities plus long-term investing activities plus financing activities. First, we must identify
the change in cash as follows:
Cash at the end of the year $25,000
Cash at the beginning of the year 55,000
Change in cash -$30,000

The sum of cash flows generated from operations, investment, and financing must equal a
negative $30,000. Therefore, we can calculate the cash flow from operations as follows:
CF from operations CF from investing CF from financing = in cash
CF from operations $250,000 $170,000 = -$30,000
CF from operations = $50,000.

Chapter 3: Financial Statements, Cash Flow, and Taxes Answers and Solutions 3
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b. Since we determined that the firms cash flow from operations totaled $50,000 in Part a of
this problem, we can now calculate the firms net income as follows:
Increase in Increase in
NI Depreciati on accrued A/R and = CF from
operations
liabilitie s inventory
NI + $10,000 + $25,000 $100,000 = $50,000
NI $65,000 = $50,000
NI = $115,000.

3-12 Statement of Cash Flows


I. Operating Activities
Net income $5,000,000
Depreciation 450,000
NWC 0
Net cash provided by operating activities $5,450,000

II. Long-Term Investing Activities


Additions to property, plant, and equipment ($5,500,000)
Net cash used in investing activities ($5,500,000)

III. Financing Activities


Increase in long-term debt $1,000,000
Payment of common dividends (750,000)
Net cash provided by financing activities $ 250,000

IV. Summary
Net increase in cash (Net sum of I., II., and III.) $ 200,000
Cash at beginning of year 100,000
Cash at end of year $ 300,000

3-13 a. NOWC2013 = Total CA (Current liabilities Notes payable)


= $59,000 ($20,150 $5,150)
= $44,000.

NOWC2014 = $72,125 ($25,100 $6,700)


= $53,725.

b. FCF2014 = [EBIT(1 T) + Deprec.] [Capital expenditures + NOWC]


= [$39,000(1 0.4) + $5,000] [$8,000 + $9,725]
= $10,675.

Note: To arrive at capital expenditures you add depreciation to the change in net FA, so
Capital expenditures = $5,000 + $3,000 = $8,000.

Chapter 3: Financial Statements, Cash Flow, and Taxes Answers and Solutions 4
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c. Statement of Stockholders Equity, 2014
Common Stock Retained Total Stockholders
Shares Amount Earnings Equity
Balances, 12/31/13 5,000 $50,000 $20,850 $70,850
2014 Net income 22,350
Cash dividends (11,175)
Addition (Subtraction)
to retained earnings 11,175
Balances, 12/31/14 5,000 $50,000 $32,025 $82,025

d. From Baileys 2014 financial statements, you can determine EBIT = $39,000 and Tax rate =
40%. NOWC2014 was calculated in Part a.

Total invested capital2014 = Notes payable + Long-term debt + Common equity


= $6,700 + $15,000 + $82,025
= $103,725.

After-tax % cost of capital = 10% (given in problem)

EVA = EBIT(1 T) (Total invested capital)( After-tax % cost of capital)


= $39,000(0.6) ($103,725)(0.10)
= $23,400 $10,372.50
= $13,027.50.

e. MVA = (P0 Number of shares outstanding) BV of common equity


MVA = ($20 $5,000) $82,025
MVA = $100,000 $82,025
MVA = $17,975.

3-14 Working up the income statement you can calculate the new sales level would be $12,681,482.

Sales $12,681,482 S 0.55S Deprec. = EBIT


Operating costs (excl. Deprec.) 6,974,815 $12,681,482 0.55
Depreciation 880,000 $800,000 1.10
EBIT $ 4,826,667 $4,166,667 + $660,000
Interest 660,000 $600,000 1.10
EBT $ 4,166,667 $2,500,000/(1 0.4)
Taxes (40%) 1,666,667 $4,166,667 0.40
Net income $ 2,500,000

3-15 a. Common Stock Retained Total Stockholders


Shares Amount Earnings Equity
Balances, 12/31/13 100,000,000 $260,000,000 $1,374,000,000 $1,634,000,000
2014 Net income 372,000,000
Cash dividends (146,000,000)
Addition to RE 226,000,000
Balances, 12/31/14 100,000,000 $260,000,000 $1,600,000,000 $1,860,000,000

The retained earnings balance on December 31, 2014 is $1,600,000,000. To arrive at this
statement, you must work up the retained earnings column because you dont know the
12/31/13 retained earnings balance.

b. $1,600 million. (Look at retained earnings balance.)

Chapter 3: Financial Statements, Cash Flow, and Taxes Answers and Solutions 5
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c. Cash + Equivalents = $15 million.

d. Total current liabilities = $620 million.

Net operating
3-16 a. = Current assets (Current liabilities Notes payable)
working capital 2013
= $360,000,000 ($201,500,000 $51,500,000)
= $360,000,000 $150,000,000 = $210,000,000.

Net operating
working capital 2014 =$372,000,000 ($247,000,000 $67,000,000)
= $372,000,000 $180,000,000 = $192,000,000.

b. FCF2014 = [EBIT(1 T) + Deprec.] [Cap. expend. + NOWC]


= [$150,000,000(0.6) + $30,000,000] [$80,000,000 $18,000,000]
= [$90,000,000 + $30,000,000] [$80,000,000 $18,000,000]
= $120,000,000 $62,000,000
= $58,000,000.

Note that depreciation must be added to Net P&E to arrive at capital expenditures.

c. The large increase in dividends for 2014 can most likely be attributed to a large increase in
free cash flow from 2013 to 2014, since FCF represents the amount of cash available for
payment to stockholders after the company has made all investments in fixed assets, new
products, and working capital necessary to sustain the business.

Chapter 3: Financial Statements, Cash Flow, and Taxes Answers and Solutions 6
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Solutions to End-of-Chapter Problems

3-1 From the data given in the problem, we know the following:

Current assets $ 500,000c Accounts payable and accruals $ 100,000e


Net plant and equipment 2,000,000 Notes payable 150,000
Current liabilities $ 250,000d
Long-term debt 750,000
Total common equity 1,500,000
Total assets $2,500,000 Total liabilities and equity $2,500,000b

Note: Superscripts correspond to parts below.

a. Total debt = Short-term debt + Long-term debt


Total debt = $150,000 + $750,000
Total debt = $900,000.

b. We are given that the firms total assets equal $2,500,000. Since both sides of the balance
sheet must equal, total liabilities and equity must equal total assets = $2,500,000.

c. Total assets = Current assets + Net plant and equipment


$2,500,000 = Current assets + $2,000,000
Current assets = $2,500,000 $2,000,000
Current assets = $500,000.

d. Total liabilities and equity = Current liabilities + Long-term debt + Total common equity
$2,500,000 = Current liabilities + $750,000 + $1,500,000
$2,500,000 = Current liabilities + $2,250,000
Current liabilities = $2,500,000 $2,250,000
Current liabilities = $250,000.

e. Current liabilities = Accounts payable and accruals + Notes payable


$250,000 = Accounts payable and accruals + $150,000
Accounts payable and accruals = $250,000 $150,000
Accounts payable and accruals = $100,000.

f. Net working capital = Current assets Current liabilities


Net working capital = $500,000 $250,000
Net working capital = $250,000.

g. Net operating working capital = Current assets (Current liabilities Notes payable)
Net operating working capital = $500,000 ($250,000 $150,000)
Net operating working capital = $400,000.

h. NOWC NWC = $400,000 $250,000


NOWC NWC = $150,000.

The difference between the two is equal to the notes payable balance.

Chapter 3: Financial Statements, Cash Flow, and Taxes Answers and Solutions 7
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3-2 NI = $3,000,000; EBIT = $6,000,000; T = 40%; Interest = ?
Need to set up an income statement and work from the bottom up.

EBIT $6,000,000
Interest 1,000,000 $3,000,000 $3,000,000
EBT $5,000,000 EBT =
(1 T) 0.6
Taxes (40%) 2,000,000
NI $3,000,000

Interest = EBIT EBT = $6,000,000 $5,000,000 = $1,000,000.

3-3 EBITDA $7,500,000 (Given)


Depreciation 2,500,000 Deprec. = EBITDA EBIT = $7,500,000 $5,000,000
EBIT $5,000,000 EBIT = EBT + Int = $3,000,000 + $2,000,000
Interest 2,000,000 (Given) $1,800,000 $1,800,000
EBT $3,000,000
(1 T) 0.6
Taxes (40%) 1,200,000 Taxes = EBT Tax rate
NI $1,800,000 (Given)

3-4 NI = $50,000,000; R/EY/E = $810,000,000; R/EB/Y = $780,000,000; Dividends = ?

R/EB/Y + NI Div = R/EY/E


$780,000,000 + $50,000,000 Div = $810,000,000
$830,000,000 Div = $810,000,000
$20,000,000 = Div.

3-5 MVA = (P0 Number of common shares) BV of common equity


$130,000,000 = $60X $500,000,000
$630,000,000 = $60X
X = 10,500,000 common shares.

3-6 Book value of equity = $35,000,000.


Price per share (P0) = $30.00.
Common shares outstanding = 2,000,000 shares.

Market value of equity = P0 Common shares outstanding


= $30 2,000,000
= $60,000,000.

MVA = Market value of equity Book value of equity


= $60,000,000 $35,000,000
= $25,000,000.

Chapter 3: Financial Statements, Cash Flow, and Taxes Answers and Solutions 8
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Total After -tax %
3-7 EVA = EBIT(1 T) invested cost of
capital capital
EVA = $3,000,000(0.6) [$20,000,000 0.08]
EVA = $1,800,000 $1,600,000
EVA = $200,000.

3-8 Statements b and d will decrease the amount of cash on a companys balance sheet.
Statement a will increase cash through the sale of common stock. Selling stock provides cash
through financing activities. On one hand, Statement c would decrease cash; however, it is also
possible that Statement c would increase cash, if the firm receives a tax refund for taxes paid in
a prior year.

3-9 Ending R/E= Beg. R/E Net income Dividends


$278,900,000 = $212,300,000 Net income $22,500,000
$278,900,000 = $189,800,000 Net income
Net income = $89,100,000.

3-10 Tax rate 35%


After-tax % cost of capital 9%
Total invested capital $15,000,000

Sales $22,500,000
Operating costs (including depreciation) 18,000,000
EBIT $ 4,500,000

EVA = (EBIT)(1 T) (Total invested capital)(After-tax % cost of capital)


= $4,500,000(0.65) ($15,000,000)(0.09)
= $2,925,000 $1,350,000
= $1,575,000.

3-11 a. From the statement of cash flows the change in cash must equal cash flow from operating
activities plus long-term investing activities plus financing activities. First, we must identify
the change in cash as follows:
Cash at the end of the year $25,000
Cash at the beginning of the year 55,000
Change in cash -$30,000

The sum of cash flows generated from operations, investment, and financing must equal a
negative $30,000. Therefore, we can calculate the cash flow from operations as follows:
CF from operations CF from investing CF from financing = in cash
CF from operations $250,000 $170,000 = -$30,000
CF from operations = $50,000.

Chapter 3: Financial Statements, Cash Flow, and Taxes Answers and Solutions 9
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b. Since we determined that the firms cash flow from operations totaled $50,000 in Part a of
this problem, we can now calculate the firms net income as follows:
Increase in Increase in
NI Depreciati on accrued A/R and = CF from
operations
liabilitie s inventory
NI + $10,000 + $25,000 $100,000 = $50,000
NI $65,000 = $50,000
NI = $115,000.

3-12 Statement of Cash Flows


I. Operating Activities
Net income $5,000,000
Depreciation 450,000
NWC 0
Net cash provided by operating activities $5,450,000

II. Long-Term Investing Activities


Additions to property, plant, and equipment ($5,500,000)
Net cash used in investing activities ($5,500,000)

III. Financing Activities


Increase in long-term debt $1,000,000
Payment of common dividends (750,000)
Net cash provided by financing activities $ 250,000

IV. Summary
Net increase in cash (Net sum of I., II., and III.) $ 200,000
Cash at beginning of year 100,000
Cash at end of year $ 300,000

3-13 a. NOWC2013 = Total CA (Current liabilities Notes payable)


= $59,000 ($20,150 $5,150)
= $44,000.

NOWC2014 = $72,125 ($25,100 $6,700)


= $53,725.

b. FCF2014 = [EBIT(1 T) + Deprec.] [Capital expenditures + NOWC]


= [$39,000(1 0.4) + $5,000] [$8,000 + $9,725]
= $10,675.

Note: To arrive at capital expenditures you add depreciation to the change in net FA, so
Capital expenditures = $5,000 + $3,000 = $8,000.

Chapter 3: Financial Statements, Cash Flow, and Taxes Answers and Solutions 10
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c. Statement of Stockholders Equity, 2014
Common Stock Retained Total Stockholders
Shares Amount Earnings Equity
Balances, 12/31/13 5,000 $50,000 $20,850 $70,850
2014 Net income 22,350
Cash dividends (11,175)
Addition (Subtraction)
to retained earnings 11,175
Balances, 12/31/14 5,000 $50,000 $32,025 $82,025

d. From Baileys 2014 financial statements, you can determine EBIT = $39,000 and Tax rate =
40%. NOWC2014 was calculated in Part a.

Total invested capital2014 = Notes payable + Long-term debt + Common equity


= $6,700 + $15,000 + $82,025
= $103,725.

After-tax % cost of capital = 10% (given in problem)

EVA = EBIT(1 T) (Total invested capital)( After-tax % cost of capital)


= $39,000(0.6) ($103,725)(0.10)
= $23,400 $10,372.50
= $13,027.50.

e. MVA = (P0 Number of shares outstanding) BV of common equity


MVA = ($20 $5,000) $82,025
MVA = $100,000 $82,025
MVA = $17,975.

3-14 Working up the income statement you can calculate the new sales level would be $12,681,482.

Sales $12,681,482 S 0.55S Deprec. = EBIT


Operating costs (excl. Deprec.) 6,974,815 $12,681,482 0.55
Depreciation 880,000 $800,000 1.10
EBIT $ 4,826,667 $4,166,667 + $660,000
Interest 660,000 $600,000 1.10
EBT $ 4,166,667 $2,500,000/(1 0.4)
Taxes (40%) 1,666,667 $4,166,667 0.40
Net income $ 2,500,000

3-15 a. Common Stock Retained Total Stockholders


Shares Amount Earnings Equity
Balances, 12/31/13 100,000,000 $260,000,000 $1,374,000,000 $1,634,000,000
2014 Net income 372,000,000
Cash dividends (146,000,000)
Addition to RE 226,000,000
Balances, 12/31/14 100,000,000 $260,000,000 $1,600,000,000 $1,860,000,000

The retained earnings balance on December 31, 2014 is $1,600,000,000. To arrive at this
statement, you must work up the retained earnings column because you dont know the
12/31/13 retained earnings balance.

b. $1,600 million. (Look at retained earnings balance.)

Chapter 3: Financial Statements, Cash Flow, and Taxes Answers and Solutions 11
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c. Cash + Equivalents = $15 million.

d. Total current liabilities = $620 million.

Net operating
3-16 a. = Current assets (Current liabilities Notes payable)
working capital 2013
= $360,000,000 ($201,500,000 $51,500,000)
= $360,000,000 $150,000,000 = $210,000,000.

Net operating
working capital 2014 =$372,000,000 ($247,000,000 $67,000,000)
= $372,000,000 $180,000,000 = $192,000,000.

b. FCF2014 = [EBIT(1 T) + Deprec.] [Cap. expend. + NOWC]


= [$150,000,000(0.6) + $30,000,000] [$80,000,000 $18,000,000]
= [$90,000,000 + $30,000,000] [$80,000,000 $18,000,000]
= $120,000,000 $62,000,000
= $58,000,000.

Note that depreciation must be added to Net P&E to arrive at capital expenditures.

c. The large increase in dividends for 2014 can most likely be attributed to a large increase in
free cash flow from 2013 to 2014, since FCF represents the amount of cash available for
payment to stockholders after the company has made all investments in fixed assets, new
products, and working capital necessary to sustain the business.

Chapter 3: Financial Statements, Cash Flow, and Taxes Answers and Solutions 12
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Chapter 3: Financial Statements, Cash Flow, and Taxes Answers and Solutions 13
2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.