Solutions to End-of-Chapter Three Problems
3-1
From the data given in the problem, we know the following:
Current assets
Net plant and equipment
$ 500,000c
2,000,000
Total assets
$2,500,000
Accounts payable and accruals
Notes payable
Current liabilities
Long-term debt
Total common equity
Total liabilities and equity
$ 100,000e
150,000
$ 250,000d
750,000
1,500,000
$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 firm’s 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
$2,500,000
Current assets
Current assets
=
=
=
=
Current assets + Net plant and equipment
Current assets + $2,000,000
$2,500,000 – $2,000,000
$500,000.
d. Total liabilities and equity
$2,500,000
$2,500,000
Current liabilities
Current liabilities
=
=
=
=
=
Current liabilities + Long-term debt + Total common equity
Current liabilities + $750,000 + $1,500,000
Current liabilities + $2,250,000
$2,500,000 – $2,250,000
$250,000.
e.
Current liabilities
$250,000
Accounts payable and accruals
Accounts payable and accruals
=
=
=
=
Accounts payable and accruals + Notes payable
Accounts payable and accruals + $150,000
$250,000 – $150,000
$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
© 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.
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
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.
3-3
EBITDA
Depreciation
EBIT
Interest
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
3-4
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
=
=
=
=
(Given)
Deprec. = EBITDA – EBIT = $7,500,000 – $5,000,000
EBIT = EBT + Int = $3,000,000 + $2,000,000
(Given)
$1,800 ,000 $1,800 ,000

(1  T)
0.6
Taxes = EBT × Tax rate
(Given)
R/EY/E
$810,000,000
$810,000,000
Div.
= (P0  Number of common shares)  BV of common equity
= $60X  $500,000,000
= $60X
= 10,500,000 common shares.
3-5
MVA
$130,000,000
$630,000,000
X
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
© 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.
3-7
After -tax %
 Total
cost of 
EVA = EBIT(1 – T) – invested 
 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 company’s 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
After-tax % cost of capital
Total invested capital
35%
9%
$15,000,000
Sales
Operating costs (including depreciation)
EBIT
$22,500,000
18,000,000
$ 4,500,000
EVA =
=
=
=
3-11
(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.
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.
Chapter 3: Financial Statements, Cash Flow, and Taxes
Answers and Solutions
3
© 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.
b. 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
accrued  A/R and
liabilitie s
inventory
NI + $10,000 + $25,000 – $100,000
NI – $65,000
NI
NI  Depreciati on 
3-12
I.
3-13
=
CF from
operations
= $50,000
= $50,000
= $115,000.
Statement of Cash Flows
Operating Activities
Net income
Depreciation
NWC
Net cash provided by operating activities
$5,000,000
450,000
0
$5,450,000
II. Long-Term Investing Activities
Additions to property, plant, and equipment
Net cash used in investing activities
($5,500,000)
($5,500,000)
III. Financing Activities
Increase in long-term debt
Payment of common dividends
Net cash provided by financing activities
$1,000,000
(750,000)
$ 250,000
IV. Summary
Net increase in cash (Net sum of I., II., and III.)
Cash at beginning of year
Cash at end of year
$ 200,000
100,000
$ 300,000
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
© 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.
c.
Balances, 12/31/13
2014 Net income
Cash dividends
Addition (Subtraction)
to retained earnings
Balances, 12/31/14
Statement of Stockholders’ Equity, 2014
Common Stock
Retained
Shares
Amount
Earnings
5,000
$50,000
$20,850
22,350
(11,175)
5,000
$50,000
Total Stockholders’
Equity
$70,850
11,175
$82,025
$32,025
d. From Bailey’s 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
Operating costs (excl. Deprec.)
Depreciation
EBIT
Interest
EBT
Taxes (40%)
Net income
3-15
a.
Balances, 12/31/13
2014 Net income
Cash dividends
Addition to RE
Balances, 12/31/14
$12,681,482
6,974,815
880,000
$ 4,826,667
660,000
$ 4,166,667
1,666,667
$ 2,500,000
S – 0.55S – Deprec. = EBIT
$12,681,482  0.55
$800,000  1.10
$4,166,667 + $660,000
$600,000  1.10
$2,500,000/(1  0.4)
$4,166,667  0.40
Common Stock
Shares
Amount
100,000,000
$260,000,000
Retained
Earnings
$1,374,000,000
372,000,000
(146,000,000)
100,000,000
$1,600,000,000
$260,000,000
Total Stockholders’
Equity
$1,634,000,000
226,000,000
$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 don’t 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
© 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.
c. Cash + Equivalents = $15 million.
d. Total current liabilities = $620 million.
3-16
a.
Net operating
= 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
© 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.
Solutions to End-of-Chapter Problems
3-1
From the data given in the problem, we know the following:
Current assets
Net plant and equipment
$ 500,000c
2,000,000
Total assets
$2,500,000
Accounts payable and accruals
Notes payable
Current liabilities
Long-term debt
Total common equity
Total liabilities and equity
$ 100,000e
150,000
$ 250,000d
750,000
1,500,000
$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 firm’s 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
$2,500,000
Current assets
Current assets
=
=
=
=
Current assets + Net plant and equipment
Current assets + $2,000,000
$2,500,000 – $2,000,000
$500,000.
d. Total liabilities and equity
$2,500,000
$2,500,000
Current liabilities
Current liabilities
=
=
=
=
=
Current liabilities + Long-term debt + Total common equity
Current liabilities + $750,000 + $1,500,000
Current liabilities + $2,250,000
$2,500,000 – $2,250,000
$250,000.
e.
Current liabilities
$250,000
Accounts payable and accruals
Accounts payable and accruals
=
=
=
=
Accounts payable and accruals + Notes payable
Accounts payable and accruals + $150,000
$250,000 – $150,000
$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
© 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.
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
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.
3-3
EBITDA
Depreciation
EBIT
Interest
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
3-4
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
=
=
=
=
(Given)
Deprec. = EBITDA – EBIT = $7,500,000 – $5,000,000
EBIT = EBT + Int = $3,000,000 + $2,000,000
(Given)
$1,800 ,000 $1,800 ,000

(1  T)
0.6
Taxes = EBT × Tax rate
(Given)
R/EY/E
$810,000,000
$810,000,000
Div.
= (P0  Number of common shares)  BV of common equity
= $60X  $500,000,000
= $60X
= 10,500,000 common shares.
3-5
MVA
$130,000,000
$630,000,000
X
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
© 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.
3-7
After -tax %
 Total
cost of 
EVA = EBIT(1 – T) – invested 
 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 company’s 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
After-tax % cost of capital
Total invested capital
35%
9%
$15,000,000
Sales
Operating costs (including depreciation)
EBIT
$22,500,000
18,000,000
$ 4,500,000
EVA =
=
=
=
3-11
(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.
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.
Chapter 3: Financial Statements, Cash Flow, and Taxes
Answers and Solutions
9
© 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.
b. 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
accrued  A/R and
liabilitie s
inventory
NI + $10,000 + $25,000 – $100,000
NI – $65,000
NI
NI  Depreciati on 
3-12
I.
3-13
=
CF from
operations
= $50,000
= $50,000
= $115,000.
Statement of Cash Flows
Operating Activities
Net income
Depreciation
NWC
Net cash provided by operating activities
$5,000,000
450,000
0
$5,450,000
II. Long-Term Investing Activities
Additions to property, plant, and equipment
Net cash used in investing activities
($5,500,000)
($5,500,000)
III. Financing Activities
Increase in long-term debt
Payment of common dividends
Net cash provided by financing activities
$1,000,000
(750,000)
$ 250,000
IV. Summary
Net increase in cash (Net sum of I., II., and III.)
Cash at beginning of year
Cash at end of year
$ 200,000
100,000
$ 300,000
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
© 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.
c.
Balances, 12/31/13
2014 Net income
Cash dividends
Addition (Subtraction)
to retained earnings
Balances, 12/31/14
Statement of Stockholders’ Equity, 2014
Common Stock
Retained
Shares
Amount
Earnings
5,000
$50,000
$20,850
22,350
(11,175)
5,000
$50,000
Total Stockholders’
Equity
$70,850
11,175
$82,025
$32,025
d. From Bailey’s 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
Operating costs (excl. Deprec.)
Depreciation
EBIT
Interest
EBT
Taxes (40%)
Net income
3-15
a.
Balances, 12/31/13
2014 Net income
Cash dividends
Addition to RE
Balances, 12/31/14
$12,681,482
6,974,815
880,000
$ 4,826,667
660,000
$ 4,166,667
1,666,667
$ 2,500,000
S – 0.55S – Deprec. = EBIT
$12,681,482  0.55
$800,000  1.10
$4,166,667 + $660,000
$600,000  1.10
$2,500,000/(1  0.4)
$4,166,667  0.40
Common Stock
Shares
Amount
100,000,000
$260,000,000
Retained
Earnings
$1,374,000,000
372,000,000
(146,000,000)
100,000,000
$1,600,000,000
$260,000,000
Total Stockholders’
Equity
$1,634,000,000
226,000,000
$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 don’t 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
© 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.
c. Cash + Equivalents = $15 million.
d. Total current liabilities = $620 million.
3-16
a.
Net operating
= 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
© 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.
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.