Chapter 2
Financial Statements, Cash Flow, and Taxes
SOLUTIONS TO END-OF-CHAPTER PROBLEMS
2-1
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
Interest
EBT
Taxes (40%)
NI
$6,000,000
1,000,000
$5,000,000
2,000,000
$3,000,000
EBT =
$3,000,000
$3,000,000

(1  T)
0.6
Interest = EBIT - EBT = $6,000,000 - $5,000,000 = $1,000,000.
2-2
NI = $3,100,000; DEP = $500,000; AMORT = 0; NCF = ?
NCF = NI + DEP and AMORT = $3,100,000 + $500,000 = $3,600,000.
2-3
EBIT = $170,000; Operating capital = $800,000; kA-T = 11.625%; T = 40%;
EVA = ?
EVA =
=
=
=
2-4
EBIT(1 - T) - AT dollar cost of capital
$170,000(1 - 0.4) – ($800,000  0.11625)
$102,000 - $93,000
$9,000.
NI = $50,000,000; R/EY/E = $810,000,000; R/EB/Y = $780,000,000; Dividends = ?
R/EB/Y
+
NI
– Div
$780,000,000 + $50,000,000 – Div
$830,000,000 – Div
$20,000,000
2-5
=
R/EY/E
= $810,000,000
= $810,000,000
=
Div.
EBITDA = $7,500,000; NI = $1,800,000; Int = $2,000,000; T = 40%; DA = ?
EBITDA
DA
EBIT
Int
EBT
Taxes (40%)
NI
$7,500,000
2,500,000
$5,000,000
2,000,000
$3,000,000
1,200,000
$1,800,000
EBITDA – DA = EBIT; DA = EBITDA – EBIT
EBIT = EBT + Int = $3,000,000 + $2,000,000
(Given)
$1,800,000
$1,800,000

(1  T)
0.6
(Given)
Integrated Case: 2 - 1
2-6
EBIT = $750,000; DEP = $200,000; AMORT = 0; 100% Equity; T = 40%; NI = ?; NCF
= ?; OCF = ?
First, determine net income by setting up an income statement:
EBIT
$750,000
Interest
0
EBT
$750,000
Taxes (40%)
300,000
NI
$450,000
NCF = NI + DEP and AMORT = $450,000 + $200,000 = $650,000.
OCF = EBIT(1 - T) + DEP and AMORT = $750,000(0.6) + $200,000 = $650,000.
Note that NCF = OCF because the firm is 100 percent equity financed.
2-7
Statements b, c, and d will all decrease the amount of cash on a company’s
balance sheet, while Statement a will increase cash through the sale of
common stock. This is a source of cash through financing activities.
2-8
a. NOPAT = EBIT(1 – T)
= $4,000,000,000(0.6)
= $2,400,000,000.
b. NCF = NI + DEP and AMORT
= $1,500,000,000 + $3,000,000,000
= $4,500,000,000.
c. OCF = NOPAT + DEP and AMORT
= $2,400,000,000 + $3,000,000,000
= $5,400,000,000.
d. FCF = NOPAT – Net Investment in Operating Capital
= $2,400,000,000 - $1,300,000,000
= $1,100,000,000.
 Total Investor-Supplied   A-T Cost 
e. EVA = NOPAT – 
  of Capital
Operating Capital



= $2,400,000,000 – [($20,000,000,000)(0.10)]
= $400,000,000.
2-9
MVA
$130,000,000
$630,000,000
X
Integrated Case: 2 - 2
=
=
=
=
(P0  Number of common shares)  BV of equity
$60X  $500,000,000
$60X
10,500,000 common shares.
2-10
First, determine the firm’s total operating capital:
Total operating capital = Net operating working capital  Net fixed assets
= $5,000,000  $37,000,000
= $42,000,000.
Now, you can calculate the firm’s EVA:
EVA = EBIT (1  T)  (WACC)(Total operating capital)
= $6,375,000 (1  0.40)  (0.085)($42,000,000)
= $3,825,000  $3,570,000
= $255,000.
=
=
=
=
Beg. R/E  Net income  Dividends
$212,300,000  Net income  $22,500,000
$189,800,000  Net income
$89,100,000.
2-11
Ending R/E
$278,900,000
$278,900,000
Net income
2-12
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
Cash at the beginning of the year
Change in cash
$25,000
55,000
-$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.
b. To determine the firm’s net income for the current year, you must realize
that cash flow from operations is determined by adding sources of cash (such as
depreciation and amortization and increases in accrued liabilities) and
subtracting uses of cash (such as increases in accounts receivable and
inventories) from net income. Since we determined that the firm’s cash
flow from operations totaled $50,000 in part a of this problem, we can
now calculate the firm’s net income as follows:
Increase in
Increase in
Depreciation
NI  and amortization 

accrued
A/R and
liabilities
inventory
NI + $10,000 + $25,000 - $100,000
NI - $65,000
NI
CF from
= operations
= $50,000
= $50,000
= $115,000.
Integrated Case: 2 - 3
2-13
Working up the income statement you can calculate the new sales level would
be $12,681,482.
Sales
Operating costs (excl. D&A)
EBITDA
Depr. & amort.
EBIT
Interest
EBT
Taxes (40%)
Net income
2-14
$5,706,667/(1  0.55)
$12,681,482  0.55
$4,826,667 + $880,000
$800,000  1.10
$4,166,667 + $660,000
$600,000  1.10
$2,500,000/(1  0.4)
$4,166,667  0.40
$12,681,482
6,974,815
$ 5,706,667
880,000
$ 4,826,667
660,000
$ 4,166,667
1,666,667
$ 2,500,000
a. Because we’re interested in net cash flow
stockholders, we exclude common dividends paid.
available
to
common
CF02 = NI available to common stockholders + Depreciation and amortization
= $364 + $220 = $584 million.
The net cash flow number is larger than net income by the current year’s
depreciation and amortization expense, which is a noncash charge.
b. Balance of RE, December 31, 2001
Add: NI, 2002
Less: Div. paid to common stockholders
Balance of RE, December 31, 2002
$1,302
364
(146)
$1,520
The RE balance on December 31, 2002 is $1,520 million.
c. $1,520 million.
d. Cash + Marketable securities = $15 million.
e. Total current liabilities = $620 million.
2-15
a.
Sales revenues
Costs except deprec. and amort. (75%)
EBITDA
Depreciation and amortization
EBT
Taxes (40%)
Net income
Add back deprec. and amort.
Net cash flow
Income Statement
$12,000,000
9,000,000
$ 3,000,000
1,500,000
$ 1,500,000
600,000
$
900,000
1,500,000
$ 2,400,000
b. If depreciation and amortization doubled, taxable income would fall to
zero and taxes would be zero. Thus, net income would decrease to zero,
but net cash flow would rise to $3,000,000. Menendez would save $600,000
in taxes, thus increasing its cash flow:
CF = T(Depreciation and amortization) = 0.4($1,500,000) = $600,000.
Integrated Case: 2 - 4
c. If depreciation and amortization were halved, taxable income would rise
to $2,250,000 and taxes to $900,000. Therefore, net income would rise to
$1,350,000, but net cash flow would fall to $2,100,000.
d. You should prefer to have higher depreciation and amortization charges
and higher cash flows. Net cash flows are the funds that are available
to the owners to withdraw from the firm and, therefore, cash flows should
be more important to them than net income.
e. In the situation where depreciation and amortization doubled, net income
fell by 100 percent. Since many of the measures banks and investors use
to appraise a firm’s performance depend on net income, a decline in net
income could certainly hurt both the firm’s stock price and its ability
to borrow. For example, earnings per share is a common number looked at
by banks and investors, and it would have declined by 100 percent, even
though the firm’s ability to pay dividends and to repay loans would have
improved.
2-16
This involves setting up the income statement and working from the bottom up.
Sales Revenue*
Cost of Goods Sold (60%)
EBITDA
Deprec. and amort.
EBIT
Interest
EBT
Taxes (40%)
NI
* Sales Revenue - COGS
Revenue - 0.6(Revenue)
0.4 Revenue
Revenue
2-17
=
=
=
=
$2,500,000
1,500,000
$1,000,000
500,000
$ 500,000
100,000
$ 400,000
160,000
$ 240,000
EBITDA
$1,000,000
$1,000,000
$2,500,000.
2,500,000  0.6
EBITDA = EBIT + DEP and AMORT
(Given)
EBIT = EBT + Interest
(Given)$240,000
$240,000
EBT =

(1  T)
0.6
(Given)$240,000
$240,000

(1  T)
0.6
a. NOPAT = EBIT(1 - T)
= $150,000,000(0.6)
= $90,000,000.
Net operating
Non-interest charging
b. working capital = Current assets - current liabilities
01
= $360,000,000 - ($90,000,000 + $60,000,000)
= $210,000,000.
Net operating
working capital02 = $372,000,000 - $180,000,000 = $192,000,000.
Net plant
Net operating
c. Operating capital01 = and equipment  working capital
= $250,000,000 + $210,000,000
= $460,000,000.
Integrated Case: 2 - 5
Operating capital02 = $300,000,000 + $192,000,000
= $492,000,000.
d. FCF = NOPAT - Net investment in operating capital
= $90,000,000 - ($492,000,000 - $460,000,000)
= $58,000,000.
e. The large increase in dividends for 2002 can most likely be attributed to
a large increase in free cash flow from 2001 to 2002, since FCF
represents the amount of cash available to be paid out to stockholders
after the company has made all investments in fixed assets, new products,
and operating working capital necessary to sustain the business.
Integrated Case: 2 - 6