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You are on page 1of 73

1.

An increase in a firms debt ratio, with no changes in its sales and operating costs, could

be expected to lower its profit margin on sales.

A.

B.

2.

An increase in the DSO, other things held constant, would generally lead to an increase

in the total assets turnover ratio.

*

3.

*

4.

A.

B.

True

False

True

False

mistakenly assumes that equity capital is free.

A.

B.

True

False

If you look at two firms that are identical from an operational perspective (assets, costs,

sales, etc.), except for their use of debt financing, then the firm with the higher debt ratio

will also have the lower basic earnings power ratio.

A.

B.

True

False

5.

One way to increase economic value added (EVA) is to maintain the same operating

income with less capital.

A.

B.

6.

Given recent changes in the tax laws, the marriage penalty (for a married couple, filing

jointly) no longer exists.

A.

B.

True

False

True

False

7.

The enterprise value of the firm, at least as we have defined it in class, can be

determined by discounting the firms free cash flows by its weighted average cost of

capital.

A.

B.

True

False

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 1 of 73 Pages

8.

*

9.

Because they both are based on NOPAT (or OCF), as well as on the investments made

in the operating assets of the firm, a firm with a negative free cash flow (FCF) will also

have a negative economic value added (EVA).

A.

B.

True

False

A firms dividend policy can have an impact on the value of the firm, since a decrease in

dividends paid out in any year will decrease the firms free cash flow for that year which,

in turn, will reduce the firms enterprise value and the value of the firms stock.

A.

B.

True

False

10.

A decrease in NOPAT does not necessarily lead to a decrease in economic value added

(EVA), since the capital charge may also decrease if the firm has less capital

outstanding.

A.

B.

11.

A decrease in debt (while holding equity constant) will lead to a higher equity-to-value

ratio, a decrease in interest expense, and an increase in the equity multiplier. Therefore,

if a firm decreases its debt we should observe both an increase in return on assets

(ROA) and an increase in return on equity (ROE).

A.

B.

True

False

True

False

12.

A firms economic value added (EVA) will be positive whenever the firms return on

invested capital (ROIC) is greater than its weighted average cost of capital (WACC),

which is the same as when its return on equity (ROE) exceeds the cost of equity (rS).

A.

B.

13.

The first, and most critical, step in constructing a pro forma set of financial statements

using the percent of sales methodology is establishing the sales forecast.

A.

B.

14.

analysis of more than one set of financial statements. Trend analysis is one method of

measuring a firm's performance over time.

True

False

True

False

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 2 of 73 Pages

A.

B.

True

False

15.

Because creditors can foresee, at least to a certain extent, the costs of bankruptcy, they

should charge a higher rate of interest to compensate for the present value of

bankruptcy costs as these expected costs increase.

A.

B.

1.

Assume that a firm has just completed Year 2002 (its second year of operations) and

depreciated its fixed assets on a 20-year straight-line basis. Also assume that the firm

is profitable (positive net income), makes no additional investment in fixed assets

during Year 2003, and that all other factors (sales, other expenses, interest, current

assets and liabilities, etc.) are constant from Year 2002 through Year 2003, but that

there may be changes in the firms equity account. Which of the following would you

most expect to observe, comparing results for Year 2002 to Year 2003, if the firm

changes its depreciable life assumption from 20 years to 10 years for Year 2003?

True

False

A.

B.

C.

D.

E.

2.

A stock analyst has acquired the following information for your company:

Net operating profit after tax (NOPAT) would increase.

Total operating capital (TOC) would decrease.

Operating cash flow (OCF) would decrease.

Net income (NI) would increase.

Retained earnings on the year-end 2002 balance sheet was $320,000.

The company does not pay dividends.

The company's depreciation expense is its only non-cash expense.

The company has no non-cash revenues.

The company's net cash flow for 2002 was $150,000.

On the basis of this information, select the statement that is most correct.

*

A.

B.

C.

D.

E.

Your company had positive net income in 2002, but it was less than its net

income in 2001.

Your company's depreciation expense in 2002 was less than $150,000.

Your companys cash on the balance sheet at the end of 2002 must be lower

than the cash it had on its balance sheet at the end of 2001.

Your companys net cash flow in 2002 must be higher than its net cash flow in

2001.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 3 of 73 Pages

3.

Last year, your firm had positive net cash flow, yet cash on the balance sheet

decreased. Which of the following could explain the firm's financial performance?

A.

B.

C.

D.

E.

4.

A.

B.

C.

D.

E.

5.

While the balance sheet can be thought of as a snapshot of the firms financial

position at a point in time, the income statement reports on operations over a

period of time. Because of this, some people will use the average of beginning

and ending balance sheet items when calculating ratios that contain both

balance sheet and income statement data.

If we find the present value of a firms future free cash flows by discounting

these cash flows at the firms weighted average cost of capital (WACC), then

this will be equal to the firms enterprise value or actual worth. If we then

subtract away the market value of the firms debt and other liabilities, then what

we will be left with is the value of the firms equity.

In the United States tax rates are regressive. That is, even though wealthy

taxpayers may face a higher marginal tax rate on their taxable income, their

average tax rate, as a percentage of taxable income, will actually be lower.

It is possible for a firm to be financially healthy even if free cash flows have

been negative for a number of years. In fact, we might expect firms to have

negative free cash flow during the early years (that is, during their start-up

phase), because of low NOPAT and large investments in net operating working

capital and fixed assets.

Regardless of the level of fixed assets and the amount of depreciation

expense, if a firm has no interest expense, than its NI will equal NOPAT and

NCF will equal OCF.

Which of the following is likely to increase the additional funds needed (AFN) in a

given year?

A.

B.

C.

D.

E.

6.

The company issued new long-term debt.

The company sold off some of its assets.

The company eliminated its dividend.

The company purchased a lot of new fixed assets.

The companys profit margin increases.

The company decides to reduce its reliance on accounts payable as a form of

financing.

The company is operating well below full capacity.

All of the statements above are correct.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 4 of 73 Pages

A.

B.

C.

D.

One way to find the total market value of a firms equity is to take the free cash

flows available to the equity shareholders in all future years, and then discount

them back to the present at the shareholders required rate of return.

If the price per share of a firms stock is above the book value per share, then

the market value added will be positive and the market to book ratio will be

greater than 1.0.

One way to find the total market value of a firms equity is to take the free cash

flows available to all investors in all future years, discount them back to the

present at the firms weighted average cost of capital (WACC), and then

subtract away the market value of the firms debt.

If a firm has interest-paying debt in its capital structure, then NOPAT will

always be more than the firms net income, even though NOPAT subtracts

away the total tax that would be paid on the firms operation and does not

consider the interest tax shelter that is created by the debt.

The firms operating cash flow (OCF) for the past year can be calculated as the

change in total operating capital over the year, but this is equivalent to the

change in working capital for the year (total current assets plus total current

liabilities) plus the change in net fixed assets for the year (total gross assets

minus accumulated depreciation).

E.

7.

Which of the following variables is not needed to determine a firms free cash flow?

8.

A.

B.

C.

D.

E.

A.

B.

C.

D.

E.

9.

net income

current operating assets

earnings before interest and taxes

tax rate

Personal taxes are of a regressive nature. That is, the lower your income, the

more you pay as a percentage of your taxable income.

Individuals are allowed to deduct 70 percent of any dividend income received

before calculating taxes. That is, they will pay taxes on only 30 percent of the

dividend income received.

The marriage penalty reflects the fact that married couples can be taxed up to

a maximum rate of 43 percent, while individuals have a maximum rate of only

39.6 percent.

Since corporations are allowed to deduct interest before calculating their

taxable income, we say that interest is paid with before-tax dollars.

Corporations are allowed to deduct 70 percent of any dividend they pay out

before calculating taxes. Like interest, this creates a tax shelter for the

corporation.

A.

A firm that takes on a risky project will increase its value as long as the project

increases expected cash flows in the future.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 5 of 73 Pages

B.

*

C.

D.

E.

10.

Investors will not be willing to purchase the stock of a firm if they expect the

firms cash flow to continually decrease in the future.

One way to determine the value of a firms equity is to first determine the value

of the entire firm (using free cash flows and the weighted average cost of

capital) and then subtract away the value of the firms debt.

One way to determine the value of a firms equity is to find the present value of

the firms operating cash flow (OCF) using the firms weighted average cost of

capital.

Any firm that has equity with a value/price greater than zero will also have

positive market value added and positive economic value added.

You are an analyst following two companies, Company A and Company B. You have

collected the following information:

The two companies have the same total assets.

Company A has a higher total assets turnover than Company B.

Company A has a higher profit margin than Company B.

Company B has a higher inventory turnover ratio than Company A.

Company B has a higher current ratio than Company A.

*

A.

B.

C.

D.

E.

11.

Your companys CFO recently estimated that the companys EVA for the past year was

zero. The companys cost of equity capital is 10 percent, its cost of debt is 6 percent,

and its debt ratio is 40 percent. Select the statement that is most correct.

12.

A.

B.

C.

D.

E.

Company A must have a higher ROE.

Company B must have a higher ROA.

Statements A and B are correct.

Statements A and C are correct.

The companys

The companys

The companys

The companys

The companys

capital.

net income was negative.

ROA was 10 percent.

ROE was 10 percent.

after-tax operating income was less than the total dollar cost of

Some key financial data and ratios are reported in the table below for Company A and

for its competitor, Company B:

Ratio

Profit margin

ROA

Total assets

BEP

Company A

Company B

4%

9%

$2.0 billion

20%

3%

8%

$1.5 billion

20%

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 6 of 73 Pages

ROE

18%

24%

On the basis of the information above, select the statement that is most correct.

A.

B.

C.

D.

E.

Company A has a higher debt ratio than Company B.

Company A has higher net income than Company B.

Statements A and B are correct.

All of the statements above are correct.

Ratio

13.

Company A

Company B

Sales

Debt Ratio

EBIT

Net Income

$2.7 billion

0.505

$400 million

$180 million

$4.0 billion

0.667

$300 million

$120 million

TAT

1.350x

2.667x

A.

B.

C.

D.

E.

1.

the firm will need and is obtained by adding together increases in assets and

spontaneous liabilities and subtracting operating income.

The percent of sales method of forecasting financial needs requires only a

forecast of the firms balance sheet. Although a forecasted income statement

helps clarify the need, it is not essential to the percent of sales method.

Because dividends are paid after taxes from retained earnings, dividends are not

included in the percent of sales method of forecasting.

Financing feedbacks describe the fact that interest must be paid on the debt

used to help finance AFN and dividends must be paid on the shares issued to

raise the equity part of the AFN. These payments would lower the net income

and retained earnings shown in the projected financial statements.

None of the statements above is correct.

Assume that you can purchase $10,000 of State of Florida bonds that have a coupon

rate of 5 percent and will therefore pay you interest of $500 per year. Alternatively,

you can purchase $10,000 of IBM bonds that have a coupon rate of 6.25 percent and

therefore pay you interest of $625 per year. At what tax rate would you be indifferent

between holding the two bonds?

A.

B.

C.

D.

E.

26%

14%

24%

20%

32%

0.05 = (0.0625)(1-T)

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 7 of 73 Pages

T = 1 - .80 = 0.20 = 20%

Income Statement

2001

Sales

Operating Costs

Depreciation

$4,500.00

-$3,600.00

-$400.00

EBIT

Interest (8%)

$500.00

-$160.00

EBT

Taxes (40%)

$340.00

$136.00

Net Income

$204.00

Dividends

$50.00

Addition to RE

2.

2002

$154.00

Balance Sheet

2001

2002

Cash

Inventory

Accounts Receivable

$200.00

$4,000.00

$1,000.00

$300.00

$4,500.00

$1,500.00

Current Assets

Gross Fixed Assets

Less: Depreciation

$5,200.00

$3,000.00

- $600.00

$6,300.00

$4,000.00

- $1,000.00

$2,400.00

$3,000.00

Total Assets

$7,600.00

$9,300.00

Accounts Payable

$800.00

$1,000.00

Accruals

$700.00

$800.00

Current Liabilities

$1,500.00

$1,800.00

Debt

$1,000.00

$2,000.00

Common Stock

Retained Earnings

Total Liability and Equity

$4,600.00

$500.00

$7,600.00

$4,846.00

$654.00

$9,300.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 8 of 73 Pages

A.

B.

C.

D.

E.

-$1,200.00

-$1,400.00

-$1,100.00

-$1,300.00

-$1,000.00

DEP = $400

OCF = NOPAT + DEP = $300 + $400 = $700

NOWC2001 = $5,200 - $1,500 = $3,700

NOWC2002 = $6,300 - $1,800 = $4,500

NFA2001 = $2,400

NFA2002 = $3,000

TOC2001 = NOWC2001 + NFA2001 = $3,700 + $2,400 = $6,100

TOC2002 = NOWC2002 + NFA2002 = $4,500 + $3,000 = $7,500

NIOC = TOC = $7,500 - $6,100 = $1,400

GIOC = NIOC + DEP = $1,400 + $400 = $1,800

FCF = OCF - GIOC = $700 - $1,800 = -$1,100

FCF = NOPAT - NIOC = $300 - $1,400 = -$1,100

3.

Assume that the firm can maintain the same profit margin in 2003 as it has in 2002. If

sales are expected to be $5,000 in 2003, then what must total assets decrease to if the

firm is to achieve an ROA of 7.2533%?

A.

B.

C.

D.

E.

$3,500.00

$3,675.00

$3,125.00

$3,375.00

$3,250.00

ROA = .072533 = (PM)(TAT) = (.045333)(TAT)

TAT = .072533 / .045333 = 1.60 = Sales/TA = $5,000/TA

TA = Sales / 1.60 = $5,000 / 1.60 = $3,125

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 9 of 73 Pages

4.

Assume that the firm can maintain the same equity multiplier in 2003 as it has in 2002.

If ROA can be increased to 7.2533% in 2003, then what will be the new level of ROE

in 2003?

A.

B.

C.

D.

E.

11.465%

12.265%

11.865%

12.065%

11.665%

ROE = (ROA)(EM) = (.072533)(1.6909) = .12265 = 12.265%

5.

Assume that you have earned $52,000 from your job this year, have itemized

deductions of $6,000, and are able to deduct your personal exemption of $2,800. Also

assume that you have earned $1,500 in dividend income and another $600 in interest

income. Using the individual tax rate tables in Appendix D (the exam handout),

calculate your average tax rate (taxes paid divided by total taxable income).

A.

B.

C.

D.

E.

21.27%

20.47%

17.37%

19.67%

18.57%

Base Income

Plus: Dividend Income

Plus: Interest Income

Less: Deductions

Les: Exemption

Taxable Income

$52,000

$ 1,500

$ 600

-$ 6,000

-$ 2,800

$45,300

$9,271.50

Average Tax Rate = $9,271.50 / $45,300 = 20.47%

6.

Your firm made $200,000 of EBT during each of the last 10 years and expects to make

the same each year for at least the next 5 years. However, this year the firm incurred

a before-tax loss of $500,000. The firm will claim a tax credit (due to tax carry back) at

the time it files this years income tax return and will receive a check from the U.S.

Treasury. Assuming that the firm has a tax rate of 40 percent on all income (past,

present, and future), determine what the firms expected tax liability will be for the

coming year.

A.

B.

$80,000

$60,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 10 of 73 Pages

C.

D.

E.

$50,000

$70,000

$40,000

Losses can be carried back 2 years and carried forward 15 years. The firm will use

$200,000 of the current loss to shield its income from 2 years ago and $200,000 of the

current loss to shield its income form last year. That will leave the firm with the

remaining $100,000 of current loss to shield its expected income of $200,000 next

year. This will leave the firm with expected taxable income for the coming year of

$100,000 that, at a tax rate of 40 percent, will produce a tax liability of $40,000.

7.

Below is the level of taxable income (EBT) reported by your company over the past

several years:

Year

1997

1998

1999

2000

2001

2002

Taxable Income

$ 350,000

650,000

750,000

250,000

- 1,250,000

750,000

The company was founded in 1997. You may assume that the appropriate corporate

tax rate has been and will continue to be 38 percent. Assume that the company has

taken full advantage of the Tax Code's carry-back and carry-forward provisions (firms

can carry-back two years and carry-forward 20 years), and assume that the current

provisions were applicable in 1997. What was the company's tax liability for 2002?

*

A.

B.

C.

D.

E.

$220,000

$190,000

$250,000

$160,000

$280,000

Carry-back for 1999 and 2000 was $750,000 + $250,000 = $1,000,000

Carry-forward = $1,250,000 - $1,000,000 = $250,000

2002 Taxable Income = $750,000 - $250,000 = $500,000

Taxes Liability = ($500,000)(0.38) = $190,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 11 of 73 Pages

8.

Your firm had $4,000,000 of retained earnings on its balance sheet at the end of 2001.

One year later, at the end of 2002, the firm had $5,250,000 of retained earnings on its

balance sheet. The firm has 750,000 shares of common stock outstanding, and it paid

a dividend of $0.45 per share in 2002. What were the firms earnings per share in

2002?

A.

B.

C.

D.

E.

$2.362 per share

$2.117 per share

$1.426 per share

$1.894 per share

Change in Retained Earnings = $$5,250,000 - $4,000,000 = $1,250,000

Net Income = $337,500 + $1,250,000 = $1,587,500

EPS = $1,587,500 / 750,000 = $2.117 per share

YOU ARE GIVEN THE FOLLOWING INFORMATION FOR PROBLEMS 9 - 11:

Income Statement

Sales

Operating Costs

Depreciation

EBIT

Year 1

Year 2

$1,200.00

-$1,020.00

-$55.00

$125.00

$1,800.00

-$1,440.00

-$155.00

$205.00

Interest

EBT

-$25.00

$100.00

-$124.60

$80.40

Taxes (40%)

-$40.00

-$32.16

Net Income

$60.00

$48.24

Dividends

$40.00

$29.24

Assets

Year 1

Year 2

Cash

Accounts Receivable

$15.00

$200.00

$50.00

$300.00

Inventories

$250.00

$375.00

$465.00

$1,100.00

$725.00

$2,100.00

-$555.00

-$710.00

Current Assets

Gross Plant & Equipment

Less: Depreciation

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 12 of 73 Pages

Total

$545.00

$1,390.00

$1,010.00

$2,115.00

Year 1

Accounts Payable

Notes Payable

$120.00

$50.00

$180.00

$140.00

$80.00

$120.00

Current Liabilities

Long-Term Debt

Common Stock

$250.00

$210.00

$382.00

$440.00

$1,106.00

$382.00

Retained Earnings

$168.00

$187.00

$1,010.00

$2,115.00

Accruals

Total

9.

*

Year 2

Based on the financial statements above, determine the free cash flow for Year 2.

A.

B.

C.

D.

E.

-$436.00

-$882.00

-$534.00

-$727.00

-$689.00

DEP = $155

OCF = NOPAT + DEP = $123 + $155 = $278

NOWCY1 = $465 - $200 = $265

NOWCY2 = $725 - $300 = $425

NFAY1 = $545

NFAY2 = $1,390

TOCY1 = NOWCY1 + NFAY1 = $265 + $545 = $810

TOCY2 = NOWCY2 + NFAY2 = $425 + $1,390 = $1,815

NIOC = TOC = $1,815 - $810 = $1,005

GIOC = NIOC + DEP = $1,005 + $155 = $1,160

FCF = OCF - GIOC = $278 - $1,160 = -$882

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 13 of 73 Pages

Proof:

FCF

- $ 882.00

Interest Payment

- $ 124.60

Interest Tax Shelter +$ 49.84

Dividends

- $ 29.24

Total Needs

- $ 986.00

New Notes Payable +$ 90.00

New L-T Debt

+$ 896.00

Net Effect

$

0

10.

As you can calculate, the firm had $810 of capital employed in Year 1 (notes payable,

long-term debt, common stock, and retained earnings). If the economic value added

(EVA) for Year 1 is -$26.25, then what is the firms weighted average cost of capital

(WACC)?

A.

B.

C.

D.

E.

11.8%

11.4%

12.1%

13.2%

12.5%

EVA = ($125)(1-.4) - ($810)(WACC) = -26.25

WACC = (-$26.25 - $75.00) / (-$810) = (-$101.25) / (-$810) = 12.5%

11.

As you can calculate, in Year 2 the firms profit margin is 2.68%, ROA is 2.2808511%,

and ROE is 8.4780316%. Assume that the firm could have increased its equity

multiplier to 4.50 by issuing debt and using the proceeds to repurchase equity (debt

increases, equity decreases, and the equity multiplier increases) while holding total

assets and total asset turnover constant. What would the firms profit margin have to

have been in order for it to have achieved an ROE of 12.00 percent?

A.

B.

C.

D.

E.

2.875%

3.667%

2.565%

3.133%

3.348%

Currently,

PM = $48.24 / $1,800 = 2.68%

TAT = $1,800 / $2,115 = 0.85106383

ROA = NI / TA = $48.24 / $2,115 = 2.2808511%

ROA = (PM)(TAT) = (.0268)(0.85106383) = 2.2808511%

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 14 of 73 Pages

EM = $2,115 / $569 = 3.717047452

ROE = (PM)(TAT)(EM)

ROE = (.0268) (0.85106383) (3.717047452) = 8.4780316%

New ROE,

12.00% = (PM) (0.85106383) (4.50)

PM = [0.12] / [(0.85106383) (4.50)] = 3.133%

12.

Assume that your company takes on a project that requires it to make an investment in

net operating working capital (NOWC) of $47,250 and an additional investment in

gross fixed assets (GFA), both of these investments being made in Year 0. Assume

that no other investments are required, but that this project will produce free cash

flows, starting in one year, of $19,138.00 per year in all future years (Years 1 through

infinity). The firm has determined that, based on the risk, the weighted average cost of

capital (WACC) for this project is 8 percent and that the net present value (NPV) of this

project is $33,350. Calculate the companys investment in gross fixed assets (GFA) in

Year 0.

A.

B.

C.

D.

E.

$166,437

$187,862

$171,770

$179,294

$158,625

Net Present Value = $33,350 = $239,225 - $47,250 - GFA

GFA = $239,225 - $47,250 - $33,350 = $158,625

13.

Assume that you have earned $48,000 from your job this year, have itemized

deductions of $5,200, and are able to deduct your personal exemption of $2,800. Also

assume that you have earned $1,500 in dividend income, $2,000 in capital gains

income, and another $500 in interest income. Using the individual tax rate tables in

Appendix D (the exam handout), and assuming that capital gains and dividend income

are taxed at 20 percent, calculate your total taxes to be paid.

A.

B.

C.

D.

$8,627.50

$8,457.50

$8,337.50

$8,587.50

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 15 of 73 Pages

E.

$8,767.50

Base Income

Plus: Interest Income

Less: Deductions

Les: Exemption

Taxable Income

$48,000

$ 500

-$ 5,200

-$ 2,800

$40,500

Base Taxes = $3,937.50 + ($14,250.00)(.28) = $3,937.50 + $3,990.00 = $7,927.50

Capital Gains Taxes = ($1,500 + $2,000)(.20) = $700.00

Total Taxes Paid = $7,927.50 + $700.00 = $8,627.50

14.

You have just obtained financial information for the past 2 years for your company.

Income Statement

Sales

Operating costs (excluding depreciation and

amortization)

EBITDA

Depreciation and amortization

Earnings before interest and taxes

Interest

Earnings before taxes

Taxes (40%)

Net income available to common stockholders

Common dividends

Year: 2002

$4,600.0

4,060.0

Year: 2001

$4,000.0

3,550.0

$ 540.0

90.0

$ 450.0

65.0

$ 385.0

154.0

$ 231.0

$ 181.0

$ 450.0

75.0

$ 375.0

60.0

$ 315.0

126.0

$ 189.0

$ 13.2

Balance Sheet

Assets:

Cash and marketable securities

Accounts receivable

Inventories

Total current assets

Net plant and equipment

Total assets

Year: 2002

Accounts payable

Notes payable

Accruals

Total current liabilities

Long-term bonds

Total debt

Common stock (50 million shares)

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Year: 2001

$ 36.0

540.0

540.0

$1,116.0

900.0

$2,016.0

$ 30.0

450.0

600.0

$1,080.0

750.0

$1,830.0

$ 324.0

201.0

216.0

$ 741.0

450.0

$1,191.0

150.0

$ 270.0

155.0

180.0

$ 605.0

450.0

$1,055.0

150.0

Page 16 of 73 Pages

Retained earnings

Total common equity

Total liabilities and equity

675.0

$ 825.0

$2,016.0

625.0

$ 775.0

$1,830.0

A.

B.

C.

D.

E.

$142

$227

$255

$174

$289

= $1,080 - $450 = $630

NOWC2002 = Current assets - Non-interest charging current liabilities

= $1,116 - $540 = $576

NOWC = $576 - $630 = -$54

NFA2001 = $750

NFA2002 = $900

NFA = $900 - $750 = $150

NOPAT2002 = ($450)(1-.4) = $270

FCF2002 = NOPAT2002 - NOWC - NFA = $270 - (-$54) - $150 = $174

15.

Your company recently realized $130,000 in operating income. The company had

interest income of $30,000 and realized $70,000 in dividend income. The company's

interest expense was $50,000.

Taxable Income

Up to $50,000

$50,000-$75,000

$75,000-$100,000

$100,000-$335,000

$335,000-$10,000,000

$10,000,000-$15,000,000

$15,000,000-$18,333,333

Over $18,333,333

Tax on Base of

Bracket

$

0

7,500

13,750

22,250

113,900

3,400,000

5,150,000

6,416,667

Percentage on

Excess Above Base

15%

25

34

39

34

35

38

35

Using the corporate tax schedule above, and assuming that 70 percent of dividend

income is excluded for tax purposes, determine your companys tax liability.

A.

$42,260

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 17 of 73 Pages

B.

C.

D.

E.

$34,340

$47,450

$23,515

$28,950

Operating income

Interest expense

Interest income

Dividend income (30%)*

Taxable income

$130,000

- 50,000

+ 30,000

+ 21,000

$131,000

($70,000)(1-.70) = $21,000

Looking in the tax table above, the base tax amount for the first $100,000 of income is

$22,250

The tax above the base is 39 percent of $31,000 = ($131,000 - $100,000)

= (0.39)($31,000) = $12,090

Your companys total tax liability is $22,250 + $12,090 = $34,340

16.

Your company began operations in 1996. The company's taxable income has been as

follows:

Year

1996

1997

1998

1999

2000

2001

2002

Taxable Income

-$200,000

50,000

75,000

85,000

-90,000

65,000

75,000

Assume the company faced a tax rate of 35 percent each year. Also, assume that the

company has taken full advantage of the Tax Code's carry-back (2 years) and carryforward (20 years) provisions, and assume that the current provisions were applicable

in 1996. Determine what the tax liability is for your company in 2002.

A.

B.

C.

D.

E.

$19,000

$25,000

$21,000

$27,000

$23,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 18 of 73 Pages

The $200,000 loss in 1996 can be carried forward to cover 1997, 1998, and all but

$10,000 of the 1999 income.

$10,000 of the $90,000 loss in 2000 can be carried back to cover that portion of 1999

income not covered by the 1996 loss.

Additionally, the remaining $80,000 of the 2000 loss can be carried forward to cover all

of the 2001 income and $15,000 of the 2002 income.

Thus, taxable income for 2002 is $75,000 - $15,000 = $60,000. Given a 35 percent

tax rate, your companys tax liability is ($60,000)(0.35) = $21,000

17.

You are given the following end-of-year data for the current year (Year 0) as well as

the forecast for next year (Year 1):

Income Statement

Year 0

Sales

Operating Costs

$4,000.00

-$3,400.00

$4,800.00

-$4,080.00

Depreciation

-$50.00

-$55.00

EBIT

$550.00

$665.00

Interest

-$20.00

-$26.00

EBT

$530.00

$639.00

Taxes (40%)

-$212.00

-$255.60

Net Income

$318.00

$383.40

Assets

Year 0

Year 1

Year 1

Cash

Accounts Receivable

$10.00

$150.00

$15.00

$200.00

Inventories

$200.00

$250.00

$360.00

$1,000.00

$465.00

$1,100.00

-$500.00

-$555.00

$500.00

$545.00

$860.00

$1,010.00

Current Assets

Gross Plant & Equipment

Less: Depreciation

Net Plant & Equipment

Total

Liabilities & Equity

Year 0

Year 1

Accounts Payable

Notes Payable

$90.00

$50.00

$120.00

$50.00

Accruals

$60.00

$80.00

$200.00

$250.00

Current Liabilities

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 19 of 73 Pages

Long-Term Debt

Common Stock

$150.00

$382.00

$210.00

$382.00

Retained Earnings

$128.00

$168.00

Total

$860.00

$1,010.00

Keeping in mind that notes payable are interest bearing obligations and are thus not

part of the firms current operating liabilities (COL), you should now be able to

calculate the firms expected Free Cash Flow (FCF) for Year 1.

Now make the following assumptions:

1.

2.

3.

4.

Free cash flow will grow at a constant rate of 4 percent per year from Year 1

through infinity.

Currently, Year 0, the firm has total book value of debt of $350, and this is a

good approximation of the market value of the debt.

The firms weighted average cost of capital is 9 percent.

The firm has 1,000 shares of stock outstanding.

Given these assumptions, determine what the intrinsic price per share (market value)

of the firms stock should be today.

A.

B.

C.

D.

E.

$7.51

$4.38

$5.63

$6.15

$8.04

DEP = $55

OCF = NOPAT + DEP = $399 + $55 = $454

NOWCY1 = $360 - $150 = $210

NOWCY2 = $465 - $200 = $265

NFAY1 = $500

NFAY2 = $545

TOCY1 = NOWCY1 + NFAY1 = $210 + $500 = $710

TOCY2 = NOWCY2 + NFAY2 = $265 + $545 = $810

NIOC = TOC = $810 - $710 = $100

GIOC = NIOC + DEP = $100 + $55 = $155

FCF = OCF - GIOC = $454 - $155 = $299

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 20 of 73 Pages

Proof:

FCF

Interest Payment

Interest Tax Shelter

Dividends

Total Needs

New Debt

Net Effect

$299.00

- $ 26.00

+$ 10.40

- $343.40

- $ 60.00

+$ 60.00

$ 0.00

Total market value of the firm at Year 0 = ($299) / (.09 - .04) = $5,980

Total market value of the equity at Year 0 = $5,980 - $350 = $5,630

Intrinsic price per share = $5,630 / 1,000 = $5.63

18.

In addition to taxable earnings from operations of $350,000, your firm has also

received interest income of $27,000, paid interest of $56,000, received dividends of

$19,000, and paid dividends of $93,000. Using the corporate tax table in Appendix D

(end of this exam and you may assume that the average tax rate for the first $100,000

is 22.25% instead of 22.3%), calculate the amount of taxes that the firm will owe.

A.

B.

C.

D.

E.

$102,432

$105,226

$107,812

$110,663

$113,109

Answer: D

Earnings

Interest Received

Interest Paid

Dividends Received

Taxable Income

$350,000

$ 27,000

- $ 56,000

$ 5,700 = ($19,000)(0.30)

$326,700

Taxes = $22,250 + $88,413 = $110,663

19.

Assume that an analyst has examined your company and has estimated that the free

cash flow at the end of the year (Year 1) will be $450 million, that this free cash flow will

grow at a constant rate of 8 percent per year, and that your companys weighted average

cost of capital is 12 percent. If the company currently has debt and preferred stock totaling

$4,500 million (4.5 billion), and if there are 200 million outstanding shares of common

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 21 of 73 Pages

stock, then determine what the intrinsic value of the companys stock should be today

(Year 0) on a per share basis.

A.

B.

C.

D.

E.

$29.25

$35.00

$37.50

$33.75

$31.00

Value of Stock = $11,250,000,000 - $4,500,000,000 = $6,750,000,000

Price = $6,750,000,000 / 200,000,000 = $33.75

20.

Assume that your company has been given the following projections for the coming

year:

Sales = 20,000 units

Sales price per unit = $10

Variable cost per unit = $7

Fixed costs = $15,000

Bonds outstanding = $43,950

KD on outstanding bonds = 7%

Tax rate = 35%

Shares of common stock outstanding = 10,000 shares

Beta = 1.6

KRF = 8%

KM = 12%

Dividend payout ratio (DPR) = 40%

Return on equity (ROE) = 20%

Based on this information, determine what the current price per share should be.

(Note: you may use the table below to help organize the data.)

Income Statement

Sales

Variable Costs

Fixed Costs

EBIT

Interest

EBT

Taxes

Net Income

Dividends

Per Share

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 22 of 73 Pages

A.

B.

C.

D.

E.

$43.48

$45.42

$39.46

$41.40

$37.44

Income Statement

Sales

Variable Costs

Fixed Costs

$200,000.00

-$140,000.00

-$15,000.00

EBIT

$45,000.00

Interest

-$3,076.50

EBT

$41,923.50

Taxes

-$14,673.23

Net Income

$27,250.28

Dividends

$10,900.11

Per Share

$1.09

KS = .08 + (.12 - .08)(1.6) = 14.4%

P0 = $1.09 / (.144 - .12) = $45.42

21.

Assume that a firms optimal capital structure consists of 30% debt at a before-tax cost

of debt (KD) of 6 percent, 10% preferred stock at a cost of preferred (KP) of 8 percent,

and 60% stock at a cost of stock (KS) of 12 percent (you may assume that the firm will

be able to meet all of its equity needs through retained earnings). Now assume that

the firm has $6,500,000 of invested capital, EBIT of $1,125,000, and a tax rate of 40

percent. Based on this information, determine the firms economic value added (EVA).

A.

B.

C.

D.

E.

$80,200

$84,800

$89,400

$82,500

$87,100

WACC = (0.06)*(1 - 0.40)*(0.30) + (0.08)*(0.10) + (.012)*(0.60)

WACC = 0.0108 + 0.008 + 0.072 = 0.0908

EVA = ($1,125,000)*(1 - 0.40) - ($6,500,000)*(0.0908)

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 23 of 73 Pages

22.

Assume that a firms optimal capital structure (investor supplied capital) consists of

$30,000 of debt at a before-tax cost of debt (KD) of 8 percent, $10,000 of preferred

stock at a cost of preferred (KP) of 8 percent, and $60,000 of stock at a cost of stock

(KS) of 14 percent. Also assume that the firms tax rate is 40% and that its EBIT is

$53,750. Given this information, determine the firms EVA.

A.

B.

C.

D.

E.

$22,610

$20,610

$23,610

$21,610

$24,610

WD = $30,000 / $100,000 = 30%

WP = $10,000 / $100,000 = 10%

WS = $60,000 / $100,000 = 60%

WACC = (0.08)*(1-0.4)*(0.30) + (0.08)*(0.10) + (0.14)*(0.60)

WACC = 0.0144 + 0.008 + 0.084 = 0.1064 = 10.64%

EVA = (EBIT)(1-T) - (Capital)(WACC)

EVA = ($53,750)(1-.40) - ($100,000)(.1064) = $21,610

23.

Assume that your company has the following information for the previous year: Net

income = $300; Net operating profit after taxes (NOPAT) = $330; Total assets =

$2,000; and Total net operating capital = $1,500. Also assume that the information for

the current year is: Net income = $510; Net operating profit after taxes (NOPAT) =

$558; Total assets = $2,300; and Total net operating capital = $1,800. Given this

information, determine the free cash flow (FCF) for the current year.

A.

B.

C.

D.

E.

$275

$326

$292

$258

$309

Free cash flow = NOPAT - Net investment in total net operating capital

FCF = $558 - ($1,800 - $1,500) = $558 - $300 = $258

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 24 of 73 Pages

24.

Assume that your firm has just opened for business. The firm is being funded with

investor-supplied capital equal to $20,000,000: liabilities equal to 40 percent of capital

and equity equal to 60 percent of capital. Also assume that creditors require a beforetax rate of return of 8 percent, while stockholders require a 14 percent return. [Based

on this information, and knowing that the tax rate is 40 percent, you should be able to

determine the weighted average cost of capital (WACC) for the firm.] Now assume

that for this first year the firm expects its operations to produce sales of $32,000,000

and EBIT of $4,000,000. [Given this information, you should now be able to calculate

the economic value added expected for the first year.] Finally assume that the firm

expects this EVA to be the same in every future year (a perpetuity). If the WACC is

the correct discount rate to use, determine the market value added by the operations

of this firm.

A.

B.

C.

D.

E.

$3,256,961.35

$3,253,519.24

$3,255,813.95

$3,252,371.87

$3,254,666.61

NOPAT = ($4,000,000.00)*(1-.4) = $2,400,000.00

EVA = $2,400,000 - ($20,000,000.00)*(.1032) = $336,000

MVA = $336,0000 / .1032 = $3,255,813.95

Alternatively,

BV = $20,000,000 (Capital originally supplied by investors)

Enterprise Value = $2,400,000 / .1032 = $23,255,813.95

MVA = $23,255,813.95 - $20,000,000 = $3,255,813.95

Income Statement (In Thousands)

Sales

Operating costs

EBITDA

Depreciation

Earnings before interest and taxes

Interest

Earnings before taxes

Taxes (40%)

Net income

Common dividends

Year: 2005

$12,000.00

$9,600.00

$2,400.00

$720.00

$1,680.00

$480.00

$1,200.00

$480.00

$720.00

$360.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Year: 2004

$10,000.00

$8,000.00

$2,000.00

$600.00

$1,400.00

$180.00

$1,220.00

$488.00

$732.00

$366.00

Page 25 of 73 Pages

Assets:

Cash and marketable securities

Accounts receivable

Inventories

Total current assets

Net fixed assets (PP&E)

Total assets

Liabilities and equity:

Accounts payable

Notes payable

Accruals

Total current liabilities

Long-term bonds

Total debt

Common stock (2 million shares)

Retained earnings

Total common equity

Total liabilities and equity

25.

Year: 2005

Year: 2004

$600.00

$4,200.00

$4,800.00

$9,600.00

$7,200.00

$16,800.00

$500.00

$3,500.00

$4,000.00

$8,000.00

$6,000.00

$14,000.00

$840.00

$1,000.00

$600.00

$2,440.00

$3,000.00

$5,440.00

$10,000.00

$1,360.00

$11,360.00

$16,800.00

$700.00

$1,000.00

$500.00

$2,200.00

$800.00

$3,000.00

$10,000.00

$1,000.00

$11,000.00

$14,000.00

Based on the information above, determine how much the firm added to its gross fixed

assets in 2005.

A.

B.

C.

D.

E.

$1,800.00

$1,560.00

$1,920.00

$1,680.00

$2,040.00

GFA = NFA + Depreciation = $1,200.00 + $720.00 = $1,920.00

26.

Assume that during 2004 interest was paid only on notes payable and long-term debt.

Assuming that the interest rate on notes payable was 8 percent, determine the

corresponding interest rate on long-term debt.

A.

B.

C.

D.

E.

12.00%

12.50%

13.00%

12.25%

12.75%

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 26 of 73 Pages

Interest on Notes = ($1,000)*(.08) = $80.00

Interest on L-T Debt = $180.00 - $80.00 = $100.00

Interest Rate on L-T Debt = $100.00/ $800.00 = 12.50%

27.

Keeping in mind that notes payable are interest bearing obligations and are thus not

part of the firms current operating liabilities (COL), calculate the firms Free Cash Flow

(FCF) for the Year 2005.

A.

B.

C.

D.

E.

-$1,589.00

-$1,663.00

-$1,626.00

-$1,700.00

-$1,552.00

There are a lot of different ways to solve this problem, simply choose the method you

are most comfortable with.

NOPAT = (EBIT)(1-T) = ($1,680)(1-.4) = $1,008

DEP = $720

OCF = NOPAT + DEP = $1,008 + $720 = $1,728

NOWCY2004 = $8,000 - $1,200 = $6,800

NOWCY2005 = $9,600 - $1,440 = $8,160

NOWC = $8,160 - $6,800 = $1,360

NFAY2004 = $6,000

NFAY2005 = $7,200

NFA = $7,200 - $6,000 = $1,200

GFA = NFA + Depreciation = $1,200 + $720 = $1,920

TOCY2004 = NOWCY2004 + NFAY2005 = $6,800 + $6,000 = $12,800

TOCY2005 = NOWCY2005 + NFAY2005 = $8,160 + $7,200 = $15,360

NIOC = TOC = $15,360 - $12,800 = $2,560

GIOC = NIOC + DEP = $2,560 + $720 = $3,280

FCF = OCF - GIOC = $1,728 - $3,280 = -$1,552

FCF = NOPAT - NIOC = $1,008 - $2,560 = -$1,552

FCF = OCF - NOWC - GFA = $1,728 - $1,360 - $1,920 = -$1,552

Proof:

FCF

Interest Payment

Interest Tax Shelter

Dividends

Total Needs

- $ 1,552

- $ 480

+$ 192

- $ 360

- $ 2,200

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 27 of 73 Pages

New Debt

Net Effect

28.

+$ 2,200

$

0

Assume that in 2005 you have ordinary taxable income of $65,400.00, while your

spouse has ordinary taxable income of $83,250.00. Based on the 2005 tax tables in

the exam handout, determine the dollar amount of your marriage penalty.

A.

B.

C.

D.

E.

$576.00

$522.00

$603.00

$549.00

$630.00

Spouse 2 Tax = $14,652.50 + ($83,250.00 - $71,950.00)*(0.28) = $17,816.50

Total Tax = $13,015.00 + $17,816.50 = $30,831.50

Married Income = $65,400.00 + $83,250.00 = $148,650.00

Married Tax = $23,317.50 + ($148,650.00 - $119,950)*(0.28) = $31,353.50

Marriage Penalty = $31,353.50 - $30,831.50 = $522.00

Income Statement

Year 1

Sales

Operating Costs

$1,000.00

-$850.00

$1,500.00

-$1,275.00

Depreciation

-$50.00

-$60.00

EBIT

$100.00

$165.00

Interest

-$20.00

-$30.00

$80.00

$135.00

Taxes (40%)

-$32.00

-$54.00

Net Income

$48.00

$81.00

EBT

Assets

Year 1

Year 2

Year 2

Cash

Accounts Receivable

$10.00

$150.00

$20.00

$200.00

Inventories

$200.00

$250.00

$360.00

$1,000.00

$470.00

$1,200.00

Current Assets

Gross Plant & Equipment

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 28 of 73 Pages

Less: Depreciation

Net Plant & Equipment

Total

Liabilities & Equity

29.

-$500.00

-$560.00

$500.00

$640.00

$860.00

$1,110.00

Year 1

Year 2

Accounts Payable

Notes Payable

$90.00

$50.00

$150.00

$100.00

Accruals

$60.00

$100.00

Current Liabilities

Long-Term Debt

Common Stock

$200.00

$150.00

$382.00

$350.00

$200.00

$382.00

Retained Earnings

$128.00

$178.00

Total

$860.00

$1,110.00

Assume that investor-supplied capital does not include accounts payable and accruals,

but does include all other liability and equity accounts. Also assume that the firms

weighted average cost of capital (WACC) on its investor-supplied capital was 10.0

percent in Year 1 and 9.5 percent in Year 2. Based on this information, determine by

how much the economic value added (EVA) increased for this firm between Year 1

and Year 2.

A.

B.

C.

D.

E.

$24.70

$27.40

$25.60

$28.30

$26.90

Capital2 = $1,110.00 - $150.00 - $100.00 = $860.00

NOPAT1 = ($100.00)*(1-.40) = $60.00

NOPAT2 = ($165.00)*(1-.40) = $99.00

EVA1 = $60.00 - ($710.00)*(.10) = -$11.00

EVA2 = $99.00 - ($860.00)*(.095) = $17.30

Increase = $17.30 - (-$11.00) = $28.30

30.

Keeping in mind that notes payable are interest bearing obligations and are thus not

part of the firms current operating liabilities (COL), calculate the firms Free Cash Flow

(FCF) for Year 2

A.

- $74

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 29 of 73 Pages

B.

C.

D.

E.

- $51

- $99

- $28

- $13

There are a lot of different ways to solve this problem, simply choose the method you

are most comfortable with.

NOPAT = (EBIT)(1-T) = ($165)(1-.4) = $99

DEP = $60

OCF = NOPAT + DEP = $99 + $60 = $159

NOWCY1 = $360 - $150 = $210

NOWCY2 = $470 - $250 = $220

NOWC = $220 - $210 = $10

GFAY1 = $1,000

GFAY2 = $1,200

GFA = $1,200 - $1,000 = $200

NFAY1

NFAY2

NFA

TOCY1

TOCY2

= $500

= $640

= $640 - $500 = $140

= NOWCY1 + NFAY1 = $210 + $500 = $710

= NOWCY2 + NFAY2 = $220 + $640 = $860

GIOC = NIOC + DEP = $150 + $60 = $210

FCF = OCF - GIOC = $159 - $210 = -$51

FCF = NOPAT - NIOC = $99 - $150 = -$51

FCF = OCF - NOWC - GFA = $159 - $10 - $200 = -$51

Proof:

FCF

Interest Payment

Interest Tax Shelter

Dividends

Total Needs

New Debt

Net Effect

31.

- $ 51

- $ 30

+$ 12

- $ 31

- $100

+$100

$ 0

Assume that in 2005 your salary was $50,000, that you received dividends and capital

gains of $5,000, and received interest income of $3,500. Also assume that you were

single, your personal tax exemption was $3,000, and your itemized deductions were

$7,000. Based on the 2005 tax tables in the exam handout, and the fact that both

dividends and capital gains are taxed at a 15% rate, calculate the average tax rate that

you paid on your total taxable income.

A.

16.36%

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 30 of 73 Pages

B.

C.

D.

E.

19.28%

17.09%

18.55%

17.82%

Ordinary Taxes = $4,090.00 + (.25)*(43,500.00 - $29,700.00) = $7,540.00

Taxes on Dividends ($5,000)*(.15) = $750.00

Total Taxes Paid = $7,540.00 + $750.00 = $8,290.00

Total Taxable Income = $43,500.00 + $5,000.00 = $48,500.00

Average Tax Rate = $8,290.00 / $48,500.00 = 17.09%

32.

Assume that your firm reported net income of $108 million in 2004, while the firm had

sales of $1,100 million and a cost of goods sold of $880 million. Also assume that the

firms corporate tax rate was 40 percent and its interest expense was $40 million. Now

assume that the firms goal is to increase its net income by 25 percent in 2005. It

predicts that the tax rate and cost of goods sold as a percentage of sales will remain

unchanged, while interest expense will increase by 20 percent. Based on this

information, determine the level of sales that the firm will have to generate in 2005 in

order to meet its net income goal.

Income Statement

2005

Sales

Cost of Goods Sold

EBIT

Interest

EBT

Taxes

Net Income

*

A.

B.

C.

D.

E.

$1,293 Million

$1,365 Million

$1,257 Million

$1,329 Million

$1,221 Million

New Interest Expense = ($40 million)(1.20) = $48 million

Now, work backwards through the income statement:

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 31 of 73 Pages

Income Statement

2005

Sales

Cost of Goods Sold

$1,365

- $1,092

EBIT

Interest

$ 273

-$

EBT

Taxes

$ 225

-$

Net Income

33.

48

90

$ 135

Assume that you are given the income statement and balance sheet (you may assume

that these are market values) for your company listed below. Also assume that the

firms debt is selling at par and that its cost of stock is 14 percent (you may assume that

flotation costs are zero). You should now be able to calculate the weighted average cost

of capital for the firm (go out to at least 6 decimal places). Given this information,

determine the economic value added (EVA) for 2005.

Income Statement

Year: 2005

Sales

$15,000.00

Operating costs

$12,000.00

Interest paid on long-term debt

Earnings before taxes

Taxes (40%)

Net income

Balance Sheet

$3,000.00

$850.00

$2,150.00

$860.00

$1,290.00

Year: 2005

Assets:

Cash and marketable securities

$1,500.00

Accounts receivable

$4,500.00

Inventories

$6,000.00

Property plant and equipment

Total assets

$12,000.00

$7,500.00

$19,500.00

Long-term Debt

$8,500.00

Total liabilities

$8,500.00

$7,000.00

Retained earnings

$4,000.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 32 of 73 Pages

$11,000.00

$19,500.00

A.

B.

C.

D.

E.

- $350.00

- $275.00

- $325.00

- $300.00

- $250.00

Since the debt is selling at par, the coupon (interest) rate is equal to the required rate of

return (YTM):

KD = ($850) / ($8,500) = 0.10 = 10.0%

WD = ($8,500) / ($19,500) = 0.4359

WS = ($11,000) / ($19,500) = 0.5641

WACC = (0.10)*(1-.40)*(.4359) + (0.14)*(.5641) = 0.026154 + 0.078974 = 10.5128%

NOPAT = (EBIT)(1-T) = ($3,000.00)(1-.40) = $1,800.00

EVA = $1,800.00 - ($19,500.00)*(0.105128) = $1,800.00 - $2,050 = -$250.00

Decomposition:

EBIT

Taxes

Bondholders

Stockholders

EVA

$3,000.00

- $ 860.00

- $ 850.00

- $1,540.00

- $ 250.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 33 of 73 Pages

2003

2004

Operating costs

EBITDA

Depreciation and amortization

Earnings before interest and taxes

Interest (10%)

Earnings before taxes

Taxes (40%)

Net income

Common dividends

4,000.00

-3,400.00

600.00

-100.00

500.00

-110.82

389.18

-155.67

233.51

225.00

4,500.00

-3,825.00

675.00

-120.00

555.00

-123.34

431.66

-172.66

259.00

225.00

2003

2004

Assets:

Cash

Accounts receivable

Inventories

Total current assets

Net plant and equipment

Total assets

400.00

333.33

600.00

1,333.33

1,000.00

2,333.33

450.00

375.00

675.00

1,500.00

1,080.00

2,580.00

Accounts payable

Notes payable

Accruals

Total current liabilities

Long-term bonds

Total debt

Common stock (50 million shares)

Retained earnings

Total common equity

Total liabilities and equity

500.00

658.23

200.00

1,358.23

450.00

1,808.23

400.00

125.10

525.10

2,333.33

562.50

783.40

225.00

1,570.90

450.00

2,020.90

400.00

159.10

559.10

2,580.00

34.

Based on the information above, determine the free cash flow for 2004.

A.

B.

C.

D.

E.

$185.71

$197.24

$173.83

$161.85

$149.49

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 34 of 73 Pages

= $1,500.00 - $787.50 = $712.50

NOWC2003 = Current assets - Non-interest charging current liabilities

= $1,333.33 - $700 = 633.33

NOWC = $712.50 - 633.33 = $79.17

NFA2004 = $1,080.00

NFA2003 = $1,000.00

NFA = $1,080.00 - $1,000.00 = $80.00

NOPAT2004 = ($555.00)(1-.4) = $333.00

FCF2004 = NOPAT2004 - NOWC - NFA = $333.00 - $79.17 - $80.00 = $173.83

Proof:

35.

FCF

$173.83

Dividend

-$225.00

Interest

-$123.34

$ 49.34

Notes Payable

$125.17

Total

0.00

Taxable Income ($)

$

0 - $ 26,250

$ 26,250 - $ 63,550

$ 63,550 - $132,600

$132,600 - $288,350

Over $288,350

Tax on Base

$

0.00

$ 3,937.50

$14,381.50

$35,787.00

$91,857.00

15.0%

28.0%

31.0%

36.0%

39.6%

Now assume that you are a single individual and received a salary of $103,750 over

the last year. Also assume that you received $18,000 in dividend income during the

year, interest income of $9,500, have personal exemptions of $2,800, and itemized

deductions of $23,500. If your salary of $103,750 and interest income of $9,500 is

considered to be ordinary income, but your dividends of $18,000 are taxed at only a

15% rate, then calculate your average tax rate on taxable income for the year.

A.

B.

27.45%

21.51%

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 35 of 73 Pages

C.

D.

E.

25.67%

29.08%

23.19%

Salary

Interest Income

Personal Exemptions

Itemized Deductions

Ordinary Taxable Income

$103,750

$ 9,500

- $ 2,800

- $ 23,500

$ 86,950

Using the tax table you find that this falls into the 31% marginal bracket, so calculate

taxes as:

Ordinary taxes = $14,381.50 + (0.31)($86,950 - $63,550) = $21,635.50

Now calculate the tax on dividends: Tax = ($18,000)(.15) = $2,700

Total taxes = $21,635.50 + $2,700.00 = $24,335.50

Total taxable income = $86,950 + $18,000 = $104,950

Average tax rate = $24,335.50 / $104,950.00 = 23.19%

36.

Sales = $20,000,000

Cost of Goods Sold = 60% of Sales

Operating Expenses = 25% of Sales

Interest expense = $180,000

Operating capital = $8 million, originally raised as follows:

Debt = $3 million; Common Stock = $5 million

Current WACC = .1135

Number of Shares of Common Stock = 500,000 shares at $10 par value

Earnings per share = $3.384

Tax rate = 40%

Depreciation = $0 per year

Additional investments in assets needed after Year 0 = $0

Based on this information, you should now be able to determine the economic value

added (EVA). Now make the following assumptions: (1) this EVA will occur every year

forever (a perpetuity), (2) the book value of debt is a good proxy for the market value

of debt, and (3) the intrinsic price per share accurately reflects the current market price

of the firms stock. (Hint: it is a function of what the investors originally paid plus value

that has been added.) Determine the current P/E ratio for this stock.

A.

B.

C.

7.60

7.20

7.80

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 36 of 73 Pages

D.

E.

7.00

7.40

Sales

Cost of Goods Sold

Operating Expenses

Depreciation

EBIT

Interest

EBT

Taxes

Net Income

$20,000,000

- 12,000,000

- 5,000,000

0

$ 3,000,000

180,000

$ 2,820,000

- 1,128,000

$ 1,692,000

EVA = $892,000

Value added by EVA = $892,000 / .1135 = $7,859,030.83

Current market value of stock equals starting value plus additional value added:

Current market value = $5,000,000.00 + $7,859,030.83 = $12,859,030.83

Current Price Per Share = $12,859,030.83 / 500,000 = $25.72

P/E Ratio = $25.72 / $3.384 = 7.60

Alternatively,

Since Depreciation = $0, then

OCF = EBIT (1-.4) + $0 = ($3,000,000)(.6) = $1,800,000

Since no additional investment in assets is needed, then

FCF = OCF = $1,800,000

Enterprise value = FCF / WACC = $1,800,000 / .1135 = $15,859,030.83

Intrinsic Value = Enterprise Value minus Value of Debt

Intrinsic Value = $15,859,030.83 - $3,000,000.00 = $12,859,030.83

NOTE:

Although not given, when the capital was originally issued the cost of debt was 6% and

the cost of equity was 16 percent, this gave a WACC of 11.35%.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 37 of 73 Pages

WS = $5,000,000 / $8,000,000 = 62.5%

WACC = (.06)(1-.4)(.375) + (.16)(.625) = .0135 + .10 = .1135 = 11.35%

However, since value (NPV) has been added, the market weights and the cost of

equity have now changed. Assuming that the cost of debt has stayed at 6%, we now

have the following:

WD = $3,000,000 / $15,859,030.83 = 18.92%

WS = $12,859,030.83 / $15,859,030.83 = 81.08%

WACC = .1135 = (.06)(1-.4)(.1892) + (KS)(.8108)

KS = (.1135 - .0068112) / (.8108) = 13.16%

The required rate went down because there is now less debt (less risk) because the

market value of the equity has increased (positive NPV).

37.

Below is the level of taxable income (EBT) reported by your company over the past

several years:

Year

1999

2000

2001

2002

2003

2004

Taxable Income

$300,000

$600,000

$750,000

$200,000

-$1,150,000

$800,000

The company was founded in 1999. The corporate tax rate has been and will continue

to be 40 percent. Assume that the company has taken full advantage of the Tax Codes

carry-back, carry-forward provisions, and assume that the current provisions were

applicable in 1999. Determine, after accounting for these provisions, the companys

total tax liability for the 6-year period 1999-2004.

A.

B.

C.

D.

E.

$560,000

$640,000

$600,000

$720,000

$680,000

Year

Adjusted Taxable

Income

1999

$300,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 38 of 73 Pages

2000

2001

2002

2003

2004

$600,000

$0

$0

$0

$600,000

38.

Taxable Income

$0-$50,000

$50,000-$75,000

$75,000-$100,000

$100,000-$335,000

$335,000-$10,000,000

$10,000,000-$15,000,000

$15,000,000-$18,333,333

Over $18,333,333

Tax on Base

Percentage on

of Bracket

$0

$7,500

$13,750

$22,250

$113,900

$3,400,000

$5,150,000

$6,416,667

15%

25

34

39

34

35

38

35

Assume that your company has $100,000 of taxable income from its operations,

$10,000 of interest income, and $40,000 of dividend income from preferred stock it holds

in other corporations. Determine the companys tax liability.

A.

B.

C.

D.

E.

$30,439

$28,975

$29,778

$30,830

$29,394

Taxable Income

Interest Income

Dividend Income

Total Taxable

$100,000

$ 10,000

$ 12,000 = ($40,000)(.30)

$122,000

Tax Liability = $22,250 + $8,580 = $30,830

39.

Your company has $50,000 that it plans to invest in marketable securities. It is choosing

between corporate bonds that yield 9 percent, municipal bonds that yield 6 percent, and

corporate preferred stock with a dividend yield of 7 percent. Your corporate tax rate is

40 percent, and 70 percent of the preferred stock dividends your company receives are

tax exempt. Assuming that the investments are equally risky and that your company

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 39 of 73 Pages

chooses solely on the basis of after-tax returns. Determine the after-tax rate of return on

the highest yielding security.

*

A.

B.

C.

D.

E.

5.83%

6.16%

6.54%

6.39%

6.82%

Corporate

Municipal

Preferred stock

40.

= (.09)(1-.4)

= 5.40%

= (.06)(1.0)

= 6.00%

= (.07)(1 - (.03(.4)) = 6.16%

A company has just been taken over by new management that believes it can raise

earnings before taxes (EBT) from $897 to $1,200, merely by cutting overtime pay and

reducing cost of goods sold. Prior to the change, the following data applied:

Data

Amount

Total assets

Debt ratio

Tax rate

BEP ratio

EBT

Sales

$10,000

45%

35%

15%

$897

$16,000

These data have been constant for several years, all income is paid out as dividends,

and you may assume that sales, the tax rate, and the balance sheet will remain

constant. Based on this information, determine the firms current cost of debt.

A.

B.

C.

D.

E.

12.6%

13.0%

13.4%

12.8%

13.2%

Interest = EBIT - EBT = $1,500 - $897 = $603

Debt = ($10,000)(.45) = $4,500

Interest Rate = $603 / $4,500 = 13.4%

YOU ARE GIVEN THE FOLLOWING INFORMATION FOR QUESTIONS 41:

Income Statement

Sales

Operating costs (excluding depreciation and

Year: 2004

$15,000.00

$12,000.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Year: 2003

$13,500.00

$10,800.00

Page 40 of 73 Pages

amortization)

EBITDA

Depreciation

Earnings before interest and taxes

Interest

Earnings before taxes

Taxes (35%)

Net income available to common stockholders

Common dividends

Balance Sheet

Assets:

Cash and marketable securities

Accounts receivable

Inventories

Total current assets

Net plant and equipment

Total assets

$3,000.00

$750.00

$2,250.00

$250.00

$2,000.00

$700.00

$1,300.00

$315.00

Year: 2004

Accounts payable

Notes payable

Accruals

Total current liabilities

Long-term bonds

Total debt

Common stock (50 million shares)

Retained earnings

Total common equity

Total liabilities and equity

41.

*

$2,700.00

$675.00

$2,025.00

$185.00

$1,840.00

$644.00

$1,196.00

$289.80

Year: 2003

$1,500.00

$4,500.00

$6,000.00

$12,000.00

$7,500.00

$19,500.00

$1,350.00

$4,050.00

$5,400.00

$10,800.00

$6,750.00

$17,550.00

$3,000.00

$1,000.00

$2,015.00

$6,015.00

$1,500.00

$7,515.00

$10,000.00

$1,985.00

$11,985.00

$19,500.00

$2,700.00

$350.00

$2,000.00

$5,050.00

$1,500.00

$6,550.00

$10,000.00

$1,000.00

$11,000.00

$17,550.00

A.

B.

C.

D.

E.

-$157.50

-$172.50

-$177.50

-$167.50

-$162.50

= $10,800 - $4,700 = $6,100

NOWC2004 = Current assets - Non-interest charging current liabilities

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 41 of 73 Pages

NOWC = $6,985 - $6,100 = $885

NFA2003 = $6,750

NFA2004 = $7,500

NFA = $7,500 - $6,750 = $750

GFA = NFA + DEP = $750 + $750 = $1,500

NOPAT2004 = ($2,250)(1-.35) = $1,462.50

OCF2004 = NOPAT2004 + DEP = $1,462.5 + $750 = $2,212.50

FCF2004 = NOPAT2004 - NOWC - NFA = $1,462.50 - $885 - $750 = -$172.50

FCF2004 = OCF2004 - NOWC - GFA = $2,212.50 - $885 - $1,500 = -$172.50

Proof:

FCF

Interest

Tax Shelter

Dividends

Notes Payable

Total

42.

+

+

$172.50

$250.00

$ 87.50

$315.00

$650.00

$ 0.00

Assume that your firm plans to take on a project that will have an infinite life and produce

the free cash flows listed below. Also assume that the $10,000 invested in Year 0 was

supplied by investors as $5,000 of debt, at a before-tax cost of debt of 5 percent, and

$5,000 of equity, at a cost of equity of 12 percent. Finally, you may assume that the

firms tax rate is 40 percent. Given this data, determine the net present value of this

project.

A.

B.

C.

Year

OCF

NOWC

GFA

FCF

0

1

2

3

$0

$1,200

$1,200

$1,200

$1,200

$1,200

-$4,000

$0

$0

$0

$0

$0

-$6,000

$0

$0

$0

$0

$0

-$10,000

$1,200

$1,200

$1,200

$1,200

$1,200

$1,200

$0

$0

$1,200

$3,000

$6,000

$4,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 42 of 73 Pages

D.

E.

$7,000

$5,000

Enterprise Value = $1,200 / .075 = $16,000

Increase in Value = NPV = $16,000 - $10,000 = $6,000

Alternatively:

EVA = $1,200 - ($10,000)(.75) = $450

NPV = $450 / .075 = $6,000

YOU ARE GIVEN THE FOLLOWING INFORMATION FOR QUESTIONS 43 -44:

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 43 of 73 Pages

Sales

Operating costs (excluding depreciation and amortization)

EBITDA

Depreciation and amortization

Earnings before interest and taxes

Interest

Earnings before taxes

Taxes (35%)

Net income available to common stockholders

Common dividends

Year: 2005

$18,000.00

$14,400.00

$3,600.00

$900.00

$2,700.00

$540.00

$2,160.00

$756.00

$1,404.00

$340.20

Year: 2004

$15,000.00

$12,000.00

$3,000.00

$750.00

$2,250.00

$250.00

$2,000.00

$700.00

$1,300.00

$315.00

Assets:

Cash and marketable securities

Accounts receivable

Inventories

Total current assets

Net plant and equipment

Total assets

Year: 2005

Year: 2004

Accounts payable

Notes payable

Accruals

Total current liabilities

Long-term bonds

Total debt

Common stock (50 million shares)

Retained earnings

Total common equity

Total liabilities and equity

43.

A.

B.

C.

D.

E.

$1,800.00

$5,400.00

$7,200.00

$14,400.00

$9,000.00

$23,400.00

$1,500.00

$4,500.00

$6,000.00

$12,000.00

$7,500.00

$19,500.00

$3,976.00

$2,000.00

$2,860.20

$8,836.20

$2,500.00

$11,336.20

$10,000.00

$2,063.80

$12,063.80

$23,400.00

$3,500.00

$1,000.00

$2,500.00

$7,000.00

$1,500.00

$8,500.00

$10,000.00

$1,000.00

$11,000.00

$19,500.00

-$1,359.80

-$1,257.80

-$1,155.80

-$1,206.80

-$1,308.80

= $12,000.00 - $6,000.00 = $6,000.00

NOWC2005 = Current assets - Non-interest charging current liabilities

= $14,400.00 - $6,836.20 = $7,563.80

NOWC = $7,563.80 - $6,000.00 = $1,563.80

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 44 of 73 Pages

NFA2004 = $7,500.00

NFA2005 = $9,000.00

NFA = $9,000.00 - $7,500.00 = $1,500.00

GFA = NFA + DEP = $1,500.00 + $900.00 = $2,400.00

NOPAT2005 = ($2,700.00)(1-.35) = $1,755.00

OCF2005 = NOPAT2005 + DEP = $1,755.00 + $900.00 = $2,655.00

FCF2005 = NOPAT2005 - NOWC - NFA

FCF2005 = $1,755.00 - $1,563.80 - $1,500.00 = -$1,308.80

FCF2005 = OCF2005 - NOWC - GFA

FCF2005 = $2,655.00 - $1,563.80 - $2,400.00 = -$1,308.80

Proof:

FCF

Interest

Tax Shelter

Dividends

Notes Payable

Long-Term Debt

Total

44.

+

+

+

$1,308.80

$ 540.00

$ 189.00

$ 340.20

$1,000.00

$1,000.00

$

0.00

Assuming that a firms invested capital does not include accounts payable or accruals,

and assuming that the firms weighted average cost of capital (WACC) is 11.5%,

determine the firms economic value added (EVA) for 2005.

A.

B.

C.

D.

E.

-$142.73

-$170.26

-$149.84

-$163.02

-$156.95

EVA = ($2,700)(1-.35) - (.115)($23,400 - $6,836.20)

EVA = $1,755.00 - $1,904.84 = -$149.84

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 45 of 73 Pages

45.

Assume that you are single and that your salary for 2004 was $72,146, and that you

received an additional $6,000 in dividends and $4,000 in interest from your

investments (you did not sell any of your investments so you did not incur any capital

gain or loss). Also assume that you claim a personal tax exemption (single filer) of

$3,100 and that your itemized deductions total $13,454. Based on this information,

and knowing that dividends and capital gains are taxed at 15 percent, determine your

total tax liability (amount to be paid) for 2004 (Hint: your tax is $4,000 on your first

$29,050 of ordinary taxable income).

A.

B.

C.

D.

E.

$12,163.50

$12,535.50

$12,976.50

$12,368.50

$12,747.50

Salary

Interest Income

Less: Exemption

Less: Deduction

Ordinary Taxable Income

$72,146.00

$ 4,000.00

-$ 3,100.00

-$13,454.00

$59,592.00

Ordinary Taxes = $715.00 + $3,285 + $7,635.50 = $11,635.50

Taxes on Dividends = ($6,000)(.15) = $900.00

Total Tax Liability = $11,635.50 + $900.00 = $12,535.50

46.

Assume that the market value of a firms assets is $1,000,000, while the market value

of its capital is as follows: debt = $400,000 at a pre-tax cost of debt (KD) of 8%;

preferred stock = $100,000 at a cost of preferred stock (KP) of 11%; and common

stock = $500,000 at a cost of common stock (KS) of 16%. Assuming that the firms

marginal tax rate is 35%, determine the weighted average cost of capital WACC) for

this firm.

A.

B.

C.

D.

E.

10.98%

11.18%

11.78%

11.38%

11.58%

WACC = 0.0208 + 0.011 + 0.08 = 11.18%

47.

You are given the following income statement and balance sheet for your company.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 46 of 73 Pages

Income Statement

Sales

Operating costs (excluding depreciation and

amortization)

EBITDA

Depreciation

Earnings before interest and taxes

Interest

Earnings before taxes

Taxes (35%)

Net income available to common stockholders

Common dividends

Year: 2004

$16,000.00

$13,000.00

Year: 2003

$14,500.00

$11,800.00

$3,000.00

$800.00

$2,200.00

$200.00

$2,000.00

$700.00

$1,300.00

$315.00

$2,700.00

$675.00

$2,025.00

$185.00

$1,840.00

$644.00

$1,196.00

$289.80

Balance Sheet

Assets:

Cash and marketable securities

Accounts receivable

Inventories

Total current assets

Net plant and equipment

Total assets

Year: 2004

Accounts payable

Notes payable

Accruals

Total current liabilities

Long-term bonds

Total debt

Common stock (50 million shares)

Retained earnings

Total common equity

Total liabilities and equity

Year: 2003

$1,600.00

$4,400.00

$6,000.00

$12,000.00

$8,000.00

$20,000.00

$1,350.00

$4,050.00

$5,400.00

$10,800.00

$6,750.00

$17,550.00

$4,000.00

$1,000.00

$2,015.00

$7,015.00

$1,000.00

$8,015.00

$10,000.00

$1,985.00

$11,985.00

$20,000.00

$2,700.00

$350.00

$2,000.00

$5,050.00

$1,500.00

$6,550.00

$10,000.00

$1,000.00

$11,000.00

$17,550.00

Based on this information, determine your company's free cash flow for 2004.

*

A.

B.

C.

D.

E.

$280.00

$295.00

$275.00

$290.00

$285.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 47 of 73 Pages

= $10,800 - $4,700 = $6,100

NOWC2004 = Current assets - Non-interest charging current liabilities

= $12,000 - $6,015 = $5,985

NOWC = $5,985 - $6,100 = -$115

NFA2003 = $6,750

NFA2004 = $8,000

NFA = $8,000 - $6,750 = $1,250

GFA = NFA + DEP = $1,250 + $800 = $2,050

NOPAT2004 = ($2,200)(1-.35) = $1,430.00

OCF2004 = NOPAT2004 + DEP = $1,430.00 + $800 = $2,230.00

FCF2004 = NOPAT2004 - NOWC - NFA = $1,430.00 + $115 - $1,250 = $295.00

FCF2004 = OCF2004 - NOWC - GFA = $2,230.00 + $115 - $2,050 = $295.00

Proof:

FCF

Interest

Tax Shelter

Dividends

Debt

Notes Payable

Total

48.

+

+

+

$295.00

$200.00

$ 70.00

$315.00

$500.00

$650.00

$ 0.00

Given the financial statements below, and keeping in mind that notes payable are

interest-bearing securities, determine the firms free cash flow for 2007.

Sales

Operating costs

EBITDA

Depreciation

Earnings before interest and taxes

Interest (8%)

Earnings before taxes

Taxes (40%)

Net income

Common dividends

Year: 2006

$15,000.00

$9,000.00

$6,000.00

$600.00

$5,400.00

$160.00

$5,240.00

$2,096.00

$3,144.00

$1,282.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Year: 2007

$21,000.00

$12,600.00

$8,400.00

$700.00

$7,700.00

$200.00

$7,500.00

$3,000.00

$4,500.00

$2,452.00

Page 48 of 73 Pages

Assets:

Cash

Accounts receivable

Inventories

Total current assets

Net fixed assets (PP&E)

Total assets

Liabilities and equity:

Accounts payable

Notes payable

Accruals

Total current liabilities

Long-term bonds

Total liabilities

Common stock (2 million shares)

Retained earnings

Total common equity

Total liabilities and equity

*

A.

B.

C.

D.

E.

Year: 2006

Year: 2007

$300.00

$3,500.00

$4,000.00

$7,800.00

$6,000.00

$13,800.00

$500.00

$4,348.00

$4,800.00

$9,648.00

$7,000.00

$16,648.00

$1,500.00

$1,000.00

$1,000.00

$3,500.00

$1,000.00

$4,500.00

$6,000.00

$3,300.00

$9,300.00

$13,800.00

$700.00

$1,500.00

$2,100.00

$4,300.00

$1,000.00

$5,300.00

$6,000.00

$5,348.00

$11,348.00

$16,648.00

$2,072

$1,832

$1,592

$1,952

$1,712

DEP = $700

OCF = NOPAT + DEP = $4,620 + $700 = $5,320

NOWC2006 = $7,800 - $2,500 = $5,300

NOWC2007 = $9,648 - $2,800 = $6,848

NOWC = $1,548

NFA2006 = $6,000

NFA2007 = $7,000

NFA = $7,000 - $6,000 = $1,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 49 of 73 Pages

TOC2006 = NOWC2006 + NFA2006 = $5,300 + $6,000 = $11,300

TOC2007 = NOWC2007 + NFA2007 = $6,848 + $7,000 = $13,848

NIOC = TOC = $13,848 - $11,310 = $2,548

GIOC = NIOC + DEP = $2,548 + $700 = $3,248

FCF = OCF - GIOC = $5,320 - $3,248 = $2,072

FCF = NOPAT - NIOC = $4,620 - $2,548 = $2,072

FCF = OCF - NOWC - GFA = $5,320 - $1,548 - $1,700 = $2,072

Proof:

FCF

Interest Payment

Interest Tax Shelter

Dividends

Total Needs

New Notes Payable

New Common Stock

New L-T Debt

Net Effect

$2,072.00

- $ 200.00

+$ 80.00

- $2,452.00

- $ 500.00

+$ 500.00

+$

0.00

+$

0.00

$

0

Assume that Firm A is just starting up and has made the projections indicated below.

You may assume that after the initial investment of $200,000 that the firm will make no

other investments in terms of capital expenditures, that there is no depreciation

expense, and that all free cash flows are paid out to the investors and that growth is

therefore zero (i.e., FCF is a perpetuity).

Year

0

1

2

3

4

49.

NOPAT / OCF

$0.00

$28,000.00

$28,000.00

$28,000.00

$28,000.00

$28,000.00

NOWC

NFA / GFA

-$50,000.00

$0.00

$0.00

$0.00

$0.00

$0.00

-$150,000.00

$0.00

$0.00

$0.00

$0.00

$0.00

FCF

-$200,000.00

$28,000.00

$28,000.00

$28,000.00

$28,000.00

$28,000.00

Assume that you calculate that the market value added (MVA) or net present value

(NPV) of this firm is $24,000. Based on this information, determine the economic

value added (EVA) for each year.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 50 of 73 Pages

A.

B.

C.

D.

E.

$6,000

$4,000

$7,000

$5,000

$3,000

MVA = NPV = $24,000 = ($28,000 / WACC) - $200,000

WACC = $28,000 / ($24,000 + $200,000) = 12.50%

EVA = NOPAT - (Capital)*(WACC) = $28,000 - ($200,000)*(.125) = $3,000

MVA = NPV = EVA / WACC = $3,000 / .125 = $24,000

50.

Now, instead of the WACC calculated above, assume that the firm initially raises the

$200,000 of capital by issuing $100,000 of debt at a before-tax cost of debt (rD) of

5.0% (the tax rate is 40%), and $100,000 of equity at a cost of stock (rS) of 13.0%: you

should now be able to calculate the WACC (which may not be the same as in the

problem above), the enterprise value, and the new market value of the firms equity.

Given this market value, and assuming that the firm does not rebalance back to a

50/50 debt equity ratio, but that WACC does remain at its original level, determine

what the new, implied cost of equity must be (HINT1: you can not unlever and relever

beta for this problem; you must use the logic that we discussed and demonstrated in

class. HINT2: work backwards from NOPAT to determine what EBIT must be, and

then work forward to determine, and look at the value of, interest payments versus

dividend payments.)

A.

B.

C.

D.

E.

9.64%

9.28%

9.82%

10.00%

9.46%

Enterprise Value (EV) = $28,000 / .08 = $350,000

MV Equity = Enterprise Value - Debt = $350,000 - $100,000 = $250,000

EBIT = NOPAT / (1-T) = $28,000 / (1 - .40) = $46,666.67

EBIT

Interest

EBT

Taxes

Net Income

$46,666.67

- $ 5,000.00 / .05 = $100,000 (MV of Debt at rD = 5.0%)

$41,666.67

- $16,666.67

$25,000.00 / 0.10 = $250,000 (MV of Equity at rS = 10.0%)

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 51 of 73 Pages

Enterprise Value

$350,000

Alternatively,

New WD = $100,000 / $350,000 = 28.57%

New WS = $250,000 / $350,000 = 71.43%

but WACC remains at 8.0%

Therefore,

8.0% = (0.05)*(1-.40)*(28.57%) + (rS)*(71.43%)

rS = (8.0% - 0.857%) / (.7143) = 7.143 / 0.7143 = 10.0%

__________

As we showed in class, if we rebalance so that

Debt = $175,000 (50%)

and

Equity = $175,000(50%)

then

New Interest = ($175,000)*(.05) = $8,750

EBIT

Interest

EBT

Taxes

Net Income

$46,666.67

- $ 8,750.00 / .05 = $175,000

$37,916.67

- $15,166.67

$22,750.00 / 0.13 = $175,000

51.

Assume that you and your significant other each had total ordinary taxable income of

$75,800 (assume no capital gains or dividend income) and calculated your taxes using

the 2007 Single Tax Rates. Using the 2007 Tax Tables in the exam handout,

determine the amount of the marriage penalty if you had files jointly using the 2007

Married Tax Rates.

A.

B.

C.

D.

E.

$493.00

$293.00

$893.00

$ 93.00

$693.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 52 of 73 Pages

Total Individual Taxes = ($15,373.75)*(2) = $30,747.50

Total Income = ($75,800)*(2) = $151,600

Married Taxes = $24,972.50 + ($151,600 - $128,500)*(.28) = $31,440.50

Marriage Penalty = $31,440.50 - $30,747.50 = $693.00

52.

Assume that a firm starts out as an all equity firm with $1,000,000 of equity,

$1,000,000 of assets, and a return on assets (ROA) of 10 percent. Also assume that

management then makes the decision to issue $200,000 of debt, at a before-tax rate

of 5 percent, and use the proceeds to buy back $200,000 of equity. Based on this

information, and assuming that the firms tax rate is 40 percent, determine what the

return on equity (ROE) will be after the buy back.

A.

B.

C.

D.

E.

14.25%

10.50%

13.00%

15.50%

11.75%

After-tax rD = (.05)*(1-.40) = 3.0%

ROE = ROA (unlevered) + Leverage Effect + Tax Shield on Debt Effect

ROE = 0.10 + (0.10 - 0.05)*(2 / 8) + (0.05 - 0.03)*(2 / 8)

ROE = 0.10 + 0.0125 + 0.005 = 11.75%

Alternatively,

ROA = NI / TA NI = (ROA)*(TA) = (0.10)*($1,000,000) = $100,000

Work backwards up through income statement to get EBIT:

EBIT

Interest

EBT

Taxes

Net Income

$166,667

-$

0

$166,667

-$ 66,667

$100,000

Interest = ($200,000)*(0.05) = $10,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 53 of 73 Pages

EBIT

Interest

EBT

Taxes

Net Income

$166,667

-$ 10,000

$156,667

-$ 62,667

$ 94,000

Sales

Operating costs

EBITDA

Depreciation

Earnings before interest and taxes

Interest (8%)

Earnings before taxes

Taxes (40%)

Net income

Common dividends

Year: 2006

$25,000.00

$15,000.00

$10,000.00

$1,000.00

$9,000.00

$320.00

$8,680.00

$3,472.00

$5,208.00

$3,318.00

Year: 2005

$22,000.00

$13,200.00

$8,800.00

$880.00

$7,920.00

$320.00

$7,600.00

$3,040.00

$4,560.00

$2,280.00

Assets:

Cash and marketable securities

Accounts receivable

Inventories

Total current assets

Net fixed assets (PP&E)

Total assets

Year: 2006

Year: 2005

Accounts payable

Notes payable

Accruals

Total current liabilities

Long-term bonds

Total liabilities

Common stock (2 million shares)

Retained earnings

Total common equity

Total liabilities and equity

$750.00

$6,250.00

$7,500.00

$14,500.00

$10,000.00

$24,500.00

$660.00

$5,500.00

$6,600.00

$12,760.00

$8,800.00

$21,560.00

$5,000.00

$2,000.00

$3,750.00

$10,750.00

$2,000.00

$12,750.00

$6,000.00

$5,750.00

$11,750.00

$24,500.00

$4,400.00

$2,000.00

$3,300.00

$9,700.00

$2,000.00

$11,700.00

$6,000.00

$3,860.00

$9,860.00

$21,560.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 54 of 73 Pages

53.

Based on this information, determine the free cash flow (FCF) for 2006.

A.

B.

C.

D.

E.

$3,420,000.00

$3,240,000.00

$3,510,000.00

$3,600,000.00

$3,330,000.00

- ($12,760,000 - $4,400,000 - $3,300,000)

Change in NWC = $5,750,000.00 - $5,060,000.00 = $690,000.00

Change in NFA = $10,000,000.00 - $8,800,000.00 = $1,200,000.00

Depreciation = $1,000,000.00 (From Income Statement)

Change in GFA = $1,200,000.00 + $1,000,000.00 = $2,200,000.00

NOPAT = ($9,000,000.00)*(1 - .40) = $5,400,000.00

OCF = $5,400,000.00 + $1,000,000.00 = $6,400,000.00

FCF = $6,400,000.00 - $690,000.00 - $2,200,000.00 = $3,510,000.00

54.

Assume that in 2006 (today) the firms total invested capital can be defined as

$15,750,000 (consisting of $4,000,000 of debt and $11,750,000 of equity; you may

assume that the market value of debt is equal to its book value), and that its weighted

average cost of capital is 10 percent. (Hint: you should now be able to calculate

economic value added (EVA) for 2006.) Now assume that EVA is expected to grow at

a long-run sustainable growth rate of 6 percent each year. Given this information,

determine the present value today (2006) of all future EVAs to be earned by the firm.

A.

B.

C.

D.

E.

$121,635,000

$111,498,750

$101,362,500

$ 91,226,250

$ 81,090,000

WACC = 0.1 (Given)

EVA2006 = $5,400,000 - ($15,750,000)*(0.10) = $3,825,000.00

Growth Rate of EVA = 0.06 (Given)

EVA2007 = ($3,825,000.00)*(1.06) = $4,054,500.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 55 of 73 Pages

55.

As you can calculate, the firms return on equity (ROE) was 44.32 percent in 2006.

Assume now that the firm can maintain the same profit margin (NI / Sales) and equity

multiplier (TA/CE) in 2007 as it had in 2006. Also assume that sales will increase to

$30,000,000 in 2007. Given this information, determine the level of total assets that

the firm must have in 2007 if its return on equity (ROE) is to increase to 56.86 percent.

(Hint: use the Du Pont relationship of ROE = (PM)*(TAT)*(EM))

A.

B.

C.

D.

E.

$22,917,834.77

$24,187,602.22

$21,648,067.31

$25,457,369.68

$26,727,137.15

Current

Profit Margin = $5,208,000 / $25,000,000 = 0.20832

TAT = $25,000,000 / $24,500,000 = 1.020408163

ROA = (0.20832)*(1.020408163) = 0.212571429

Alternatively: ROA = $5,208,000 / $24,500,000 = 0.212571429

EM = $24,500,000 / $11,650,000 = 2.085106383

ROE = (0.20832)*(1.020408163)*(2.085106383) = 0.443234043

Alternatively: ROE = $5,280,00 / $11,750,000 = 0.443234043

New ROE (Given) = 0.5686

Implied TAT = ROE / (PM)*(EM) = .5686 / ((.20832)*(2.085106383)) =

1.309024186

Sales (Given) = $30,000,000.00

Implied TA = Sales / TAT = $30,000,000 / 1.309024186 = $22,917,834.77

56.

Assume that only 80 percent of the firms sales are sold on credit and create an

account receivable. Using a 365-day year, determine the days sales outstanding

(DSO) for 2006.

A.

B.

C.

D.

E.

133.02 days

190.00 days

152.08 days

114.06 days

171.04 days

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 56 of 73 Pages

Credit Sales Per Day = $20,000,000 / 365 = $54,794.52

DSO = $6,250,000 / ($54,794.52) = 114.06 days

Assume that Firm A is just starting up and has made the projections indicated below.

You may assume that after the initial investment of $500,000 that the firm will make no

other investments in terms of capital expenditures, that there is no depreciation

expense, and that all free cash flows are paid out to the investors and that growth is

therefore zero (i.e., FCF is a perpetuity).

Year

0

1

2

3

4

57.

NOPAT / OCF

$0.00

$77,720.00

$77,720.00

$77,720.00

$77,720.00

$77,720.00

NOWC

-$100,000.00

$0.00

$0.00

$0.00

$0.00

$0.00

NFA / GFA

-$400,000.00

$0.00

$0.00

$0.00

$0.00

$0.00

FCF

-$500,000.00

$77,720.00

$77,720.00

$77,720.00

$77,720.00

$77,720.00

Assume that you calculate that the market value added (MVA) or net present value

(NPV) of this firm is $36,000. Based on this information, determine the economic

value added (EVA) for each year.

A.

B.

C.

D.

E.

$4,090

$5,220

$5,020

$5,320

$5,120

MVA = NPV = $36,000 = ($77,720 / WACC) - $500,000

WACC = $77,720 / ($36,000 + $500,000) = 14.50%

EVA = NOPAT - (Capital)*(WACC) = $77,720 - ($500,000)*(.145) = $5,220

MVA = NPV = EVA / WACC = $5,220 / .145 = $36,000

58.

Now, instead of the WACC calculated above, assume that the firm initially raises the

$500,000 of capital by issuing $200,000 of debt at a before-tax cost of debt (rD) of

5.0% (the tax rate is 40%), and $300,000 of equity at a cost of stock (rS) of 20.0%: you

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 57 of 73 Pages

should now be able to calculate the WACC (which may not be the same as in the

problem above), the enterprise value, and the new market value of the firms equity.

Given this market value, and assuming that the firm does not rebalance back to a 2/3

debt equity ratio, but that WACC does remain at its original level, determine what the

new, implied cost of equity must be (HINT1: you can not unlever and relever beta for

this problem; you must use the logic that we discussed and demonstrated in class.

HINT2: work backwards from NOPAT to determine what EBIT must be, and then work

forward to determine, and look at the value of, interest payments versus dividend

payments.)

A.

B.

C.

D.

E.

16.97%

18.08%

17.34%

18.45%

17.71%

Enterprise Value (EV) = $77,720 / .132 = $588,787.88

MV Equity = Enterprise Value - Debt = $588.787.88 - $200,000 = $388,787.88

EBIT = NOPAT / (1-T) = $77,720 / (1 - .40) = $129,533.33

EBIT

Interest

EBT

Taxes

Net Income

$129,533.33

- $ 10,000.00 / .0500 = $200,000.00 (MV of Debt at rD = 5.0%)

$119,533.33

- $ 47,813.33

$ 71,720.00 / .1845 = $388,787.88 (MV of Equity at rS = 18.45%)

Enterprise Value

$588,787.88

Alternatively,

New WD = $200,000.00 / $588,787.88 = 33.9680905%

New WS = $388,787.88 / $588,787.88 = 66.0319095%

but WACC remains at 8.0%

Therefore,

13.2% = (0.05)*(1-.40)*(33.9680905%) + (rS)*(66.0319095%)

rS = (13.2% - 1.0190427%) / (.660319095)

rS = 12.1809573% / 0.660319095 = 18.45%

__________

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 58 of 73 Pages

Debt = $235,515.15 (40%)

and

Equity = $353,272.73 (60%)

then

New Interest = ($235,515.15)*(.05) = $11,775.76

EBIT

Interest

EBT

Taxes

Net Income

$129,533.33

- $ 11,775.76 / .0500 = $235,515.15 (MV of Debt at rD = 5.0%)

$117,757.57

- $ 47,103.03

$ 70,654.54 / .2000 = $353,272.73 (MV of Equity at rS = 20.00%)

Enterprise Value

$588,787.88

59.

Assume that an all equity firm has assets of $20,000 and a return on assets (ROA) of

13.00 percent. And that the firm makes the decision to replace 1/2 of its equity with

debt that has a before-tax cost of 8 percent Assuming that the firms tax rate is 40

percent, calculate the firms ROE after the debt has been issued and equity has been

repurchased. (HINT: Think about leverage and tax shelter effects of using debt that we

demonstrated in class.)

A.

B.

C.

D.

E.

20.20%

21.70%

20.70%

22.20%

21.20%

This problem can be solved without knowing the firms income statement or how much

it has in total assets.

AT rD = (8.00%)(1-.40) = 4.80%

As discussed in class, after the issue and repurchase, the remaining equity

shareholders will benefit from both a leverage effect and a tax shelter effect:

ROE = ROA + Leverage Effect + Tax Shelter Effect

ROE = 13.00% + (13.00% - 8.00%)(1.0) + (8.00% - 4.80%)(1.0)

ROE = 13.00% + 5.00% + 3.20% = 21.20%

Alternatively,

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 59 of 73 Pages

Since you were given total assets, you can also work backwards to get ROE:

ROA = 13.00% = NI / $20,000

NI = ($20,000)*(.13) = $2,600

Interest = ($10,000)*(.08) = $800

Assets/Income

Without

Debt

Assets

Debt (1/2)

Equity (1/2)

$20,000.00

$

0.00

$20,000.00

EBIT

Interest (8%)

EBT

Taxes (40%)

Net Income

$

$

$

-$

$

ROA

ROE

60.

4,333.33

0.00

4,333.33

1,733.33

2,600.00

With

Debt

$20,000.00

$10,000.00

$10,000.00

$

-$

$

-$

$

13.00%

13.00%

4,333.33

800.00

3,533.33

1,413.33

2,120.00

10.60%

21.20%

Assume that in 2006 (today) a firm had EBIT of $9,000,000, a tax rate of 40 percent,

and that the firms total invested capital could be defined as $20,450,000 (consisting of

$8,000,000 of debt and $12,450,000 of equity), and that its weighted average cost of

capital is 12 percent. (Hint: you should now be able to calculate economic value

added (EVA) for 2006.) Now assume that EVA is expected to grow at a long-run

sustainable growth rate of 4 percent each year. Given this information, determine the

present value today (2006) of all future EVAs to be earned by the firm.

A.

B.

C.

D.

E.

$38,161,000

$38,572,000

$38,298,000

$38,709,000

$38,435,000

WACC = 0.12 (Given)

EVA2006 = ($9,000,000)*(1-.40) - ($20,450,000)*(0.12) = $2,946,000

Growth Rate of EVA = 0.04 (Given)

EVA2007 = ($2,946,000)*(1.04) = $3,063,840

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 60 of 73 Pages

61.

Assume that your company is 60 percent equity financed (40 percent debt financed).

Given the following information, calculate the return on equity (ROE).

Data

Amount

EBIT

Sales

Interest Rate

Dividend payout ratio

Total assets turnover

Tax rate

A.

B.

C.

D.

E.

$6,000

$35,000

0.06

40%

0.70 x

40%

9.20%

9.50%

9.40%

9.30%

9.60%

TAT = 0.75

Equity = ($50,000)*(.60) = $30,000

Interest Expense = ($20,000)*(0.06) = $1,200

EBIT

Interest

EBT

Taxes

Net Income

$6,000

-$1,200

$4,800

-$1,920

$2,880

62.

We discussed in class how the return on equity for a levered firm can be a function of

the return on assets of an equivalent unlevered firm, a leverage effect, and a tax

shelter effect. Assume that a firm starts out as an all equity firm with $10,000,000 of

common equity, $10,000,000 of assets, and a return on assets (ROA) of 14 percent.

Also assume that management makes the decision to issue $2,000,000 of debt (the

firms cost of debt is 8 percent), and to then use the proceeds to buy back $2,000,000

of common equity. Based on this information, and assuming that the firms tax rate is

40 percent, determine what the return on equity (ROE) will be after the buy back.

A.

B.

15.05%

17.55%

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 61 of 73 Pages

C.

D.

E.

12.55%

16.30%

13.80%

ROA = 14.0% (Given)

rD = 8.0% (Given)

After-tax rD = (8.0%)*(1-.40) = 4.,80%

Interest Expense = ($2,000,000)*(.08) = $160,000

Debt does create a leverage and a tax shelter effect, so

ROE = ROA (unlevered) + Leverage Effect + Tax Shelter Effect

ROE = 0.14 + (0.14 - 0.08)*(.25) + (0.08 - 0.048)*(.25)

ROE = 0.14 + 0.015 + 0.008 = 16.30%

Alternatively,

ROA = NI / TA NI = (ROA)*(TA) = (0.14)*($10,000,000) = $1,400,000

Work backwards up through income statement to get EBIT:

EBIT

Interest

EBT

Taxes

Net Income

$2,333,333

-$

0

$2,333,333

- $ 933,333

$1,400,000

Interest Expense = ($2,000,000)*(0.08) = $160,000

EBIT

Interest

EBT

Taxes

Net Income

$2,333,333

- $ 160,000

$2,173,333

- $ 869,333

$1,304,000

63.

Assume that Firm A is an all-equity firm with total assets of $2,000 and the following

distribution of EBIT for the coming year:

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 62 of 73 Pages

Firm A

(Unlevered)

Probability

EBIT

Interest

EBT

Taxes (40%)

Net Income

BEP

ROA

ROE

Economy

Bad

30.00%

$200.00

$0.00

$200.00

-$80.00

$120.00

10.00%

6.00%

6.00%

Average

40.00%

$240.00

$0.00

$240.00

-$96.00

$144.00

12.00%

7.20%

7.20%

Good

30.00%

$280.00

$0.00

$280.00

-$112.00

$168.00

14.00%

8.40%

8.40%

As you can calculate, the variance of the ROE distribution is 0.008640 percent

(standard deviation of 0.92516 percent). Now assume that the firm plans to issue

$500 of debt, at an interest rate of 5 percent, and use the proceeds to repurchase

equity (you may ignore potential impacts on price and assume that the firm will then

have $1,500 of equity). Given this information, determine the expected ROE of the

resulting ROE distribution.

A.

B.

C.

D.

E.

9.60%

11.60%

10.60%

12.60%

8.60%

Firm A

(Levered)

Probability

EBIT

Interest

EBT

Taxes (40%)

Net Income

BEP

ROA

ROE

Economy

Bad

Average

Good

30.00%

40.00%

30.00%

$200.00

-$25.00

$175.00

-$70.00

$105.00

10.00%

5.25%

7.00%

$240.00

-$25.00

$215.00

-$86.00

$129.00

12.00%

6.45%

8.60%

$280.00

-$25.00

$255.00

-$102.00

$153.00

14.00%

7.65%

10.20%

Expected ROE = 2.10% + 3.44% + 3.06% = 8.60%

Alternatively, since the values for ROE and the probabilities are symmetrical around

the middle value, we know that the expected ROE must be 8.60%.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 63 of 73 Pages

64.

Assume that Firm A is an all-equity firm with total assets of $2,000 and the following

distribution of EBIT for the coming year:

Firm A

(Unlevered)

Probability

EBIT

Interest

EBT

Taxes (40%)

Net Income

BEP

ROA

ROE

Economy

Bad

30.00%

$300.00

$0.00

$300.00

-$120.00

$180.00

15.00%

9.00%

9.00%

Average

Good

40.00%

$340.00

$0.00

$340.00

-$136.00

$204.00

17.00%

10.20%

10.20%

30.00%

$380.00

$0.00

$380.00

-$152.00

$228.00

19.00%

11.40%

11.40%

As you can calculate, the variance of the ROE distribution is 0.008640 percent

(standard deviation of 0.92516 percent). Now assume that the firm plans to issue

$500 of debt, at an interest rate of 5 percent, and use the proceeds to repurchase

equity (you may ignore potential impacts on price and assume that the firm will then

have $1,500 of equity). Given this information, determine the expected ROE of the

resulting ROE distribution.

A.

B.

C.

D.

E.

9.60%

11.60%

10.60%

12.60%

8.60%

Firm A

(Levered)

Probability

EBIT

Interest

EBT

Taxes (40%)

Net Income

BEP

ROA

ROE

Economy

Bad

Average

Good

30.00%

$300.00

-$25.00

$275.00

-$110.00

$165.00

15.00%

8.25%

11.00%

40.00%

$340.00

-$25.00

$315.00

-$126.00

$189.00

17.00%

9.45%

12.60%

30.00%

$380.00

-$25.00

$355.00

-$142.00

$213.00

19.00%

10.65%

14.20%

Expected ROE = 3.30% + 5.04% + 4.26% = 12.60%

Alternatively, since the values for ROE and the probabilities are symmetrical around

the middle value, we know that the expected ROE must be 12.60%.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 64 of 73 Pages

65.

We discussed in class how the return on equity for a levered firm can be a function of

the return on assets of an equivalent unlevered firm, a leverage effect, and a tax

shelter effect. Assume that a firm starts out as an all equity firm with $10,000,000 of

common equity, $10,000,000 of assets, and a return on assets (ROA) of 12 percent.

Also assume that management makes the decision to issue $2,000,000 of debt (the

firms cost of debt is 8 percent), and to then use the proceeds to buy back $2,000,000

of common equity. Based on this information, and assuming that the firms tax rate is

40 percent, determine what the return on equity (ROE) will be after the buy back.

A.

B.

C.

D.

E.

15.05%

17.55%

12.55%

16.30%

13.80%

ROA = 12.0% (Given)

rD = 8.0% (Given)

After-tax rD = (8.0%)*(1-.40) = 4.,80%

Interest Expense = ($2,000,000)*(.08) = $160,000

Debt does create a leverage and a tax shelter effect, so

ROE = ROA (unlevered) + Leverage Effect + Tax Shelter Effect

ROE = 0.12 + (0.12 - 0.08)*(.25) + (0.08 - 0.048)*(.25)

ROE = 0.12 + 0.01 + 0.008 = 13.80%

Alternatively,

ROA = NI / TA NI = (ROA)*(TA) = (0.12)*($10,000,000) = $1,200,000

Work backwards up through income statement to get EBIT:

EBIT

Interest

EBT

Taxes

Net Income

$2,000,000

-$

0

$2,000,000

- $ 800,000

$1,200,000

Interest Expense = ($2,000,000)*(0.08) = $160,000

EBIT

$2,000,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 65 of 73 Pages

Interest

EBT

Taxes

Net Income

- $ 160,000

$1,840,000

- $ 736,000

$1,104,000

66.

Assume that an all equity firm has assets of $12,000 and a return on assets (ROA) of

14.50 percent. And that the firm makes the decision to replace 1/3 of its equity with

debt that has a before-tax cost of 9 percent (note: this will give a D/E ratio of = 0.50

). Assuming that the firms tax rate is 40 percent, calculate the firms ROE after the

debt has been issued and equity has been repurchased. (HINT: Think about leverage

and tax shelter effects of using debt that we demonstrated in class.)

A.

B.

C.

D.

E.

18.30%

21.30%

19.05%

20.55%

19.80%

This problem can be solved without knowing the firms income statement or how much

it has in total assets.

AT rD = (9.00%)(1-.40) = 5.40%

As discussed in class, after the issue and repurchase, the remaining equity

shareholders will benefit from both a leverage effect and a tax shelter effect:

ROE = ROA + Leverage Effect + Tax Shelter Effect

ROE = 14.50% + (14.50% - 9.00%)(1/2) + (9.00% - 5.40%)(1/2)

ROE = 14.50% + 2.75% + 1.80% = 19.05%

Alternatively,

Since you were given total assets, you can also work backwards to get ROE:

ROA = 14.50% = NI / $12,000

NI = ($12,000)*(.1450) = $1,740

Interest = ($4,000)*(.09) = $360

Assets/Income

Without

Debt

Assets

Debt (1/3)

Equity (2/3)

$12,000.00

$

0.00

$12,000.00

With

Debt

$12,000.00

$ 4,000.00

$ 8,000.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 66 of 73 Pages

EBIT

Interest (8%)

EBT

Taxes (40%)

Net Income

$

$

$

-$

$

ROA

ROE

2,900.00

0.00

2,900.00

1,160.40

1,740.00

$

-$

$

-$

$

14.50%

14.50%

2,900.00

360.00

2,540.00

1,016.00

1,524.00

12.70%

19.05%

Income Statement

Sales

Operating Costs

Depreciation

EBIT

Interest (6%)

EBT

Taxes (40%)

Net Income

2006

$4,000,000.00

$600,800.00

Dividends

Addition to RE

Balance Sheet

2007

$6,500,000.00

-$4,550,000.00

-$350,000.00

$1,600,000.00

-$72,000.00

$1,528,000.00

-$611,200.00

$916,800.00

$279,300.00

$637,500.00

2006

2007

Cash

Inventory

Accounts Receivable

Current Assets

Gross Fixed Assets

Less: Depreciation

Net Fixed Assets

Total Assets

$80,000.00

$1,600,000.00

$1,200,000.00

$2,880,000.00

$3,000,000.00

-$900,000.00

$2,100,000.00

$4,980,000.00

$130,000.00

$2,600,000.00

$1,950,000.00

$4,680,000.00

$3,500,000.00

-$1,250,000.00

$2,250,000.00

$6,930,000.00

Accounts Payable

Accruals

$1,000,000.00

$300,000.00

$1,625,000.00

$487,500.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 67 of 73 Pages

Current Liabilities

Debt

Common Stock

Retained Earnings

Total Liability and

Equity

67.

$1,300,000.00

$700,000.00

$2,000,000.00

$980,000.00

$2,112,500.00

$1,200,000.00

$2,000,000.00

$1,617,500.00

$4,980,000.00

$6,930,000.00

Based on the information above, determine the free cash flow (FCF) for 2007.

A.

B.

C.

D.

E.

- $184,250

- $169,750

- $154,250

- $177,500

- $162,000

There are a lot of different ways to solve this problem, simply choose the method you

are most comfortable with.

NOPAT = (EBIT)(1-T) = ($1,600,000)(1-.4) = $960,000

DEP = $350,000

OCF = NOPAT + DEP = $960,000 + $350,000 = $1,310,000

NOWCY2006 = $2,880,000 - $1,300,000 = $1,580,000

NOWCY2007 = $4,680,000 - $2,112,500 = $2,567,500

NOWC = $2,567,500 - $1,580,000 = $987,500

NFAY2006 = $2,100,000

NFAY2007 = $2,250,000

NFA = $2,250,000 - $2,100,000 = $150,000

GFA = NFA + Depreciation = $150,000 + $350,000 = $500,000

GFAY2006 = $3,000,000

GFAY2007 = $3,500,000

GFA = $3,500,000 - $3,000,000 = $500,000

TOCY2006 = NOWCY2006 + NFAY2006 = $1,580,000 + $2,100,000 = $3,680,000

TOCY2007 = NOWCY2007 + NFAY2007 = $2,567,500 + $2,250,000 = $4,817,500

NIOC = TOC = $4,817,500 - $3,680,000 = $1,137,500

GIOC = NIOC + DEP = $1,137,500 + $350,000 = $1,487,500

FCF = OCF - GIOC = $1,310,000 - $1,487,500 = -$177,500

FCF = NOPAT - NIOC = $960,000 - $1,137,500 = -$177,500

FCF = OCF - NOWC - GFA = $1,310,000 - $987,500 - $500,000 = -$177,500

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 68 of 73 Pages

Proof:

FCF

Interest Payment

Interest Tax Shelter

Dividends

Total Needs

New Debt

Net Effect

68.

- $ 177,500

- $ 72,000

+$ 28,800

- $ 279,300

- $ 500,000

+$ 500,000

$

0

Assume that the firm had total invested capital (total investor-supplied operating

capital) for 2007 of $4,817,500 and a weighted average cost of capital of 11 percent.

Given this information, determine the economic value added (EVA) for 2007.

A.

B.

C.

D.

E.

$340,500

$370,200

$400,150

$430,075

$460,750

NOPAT = (EBIT)*(1-T) = ($1,600,000)*(.60) = $960,000

EVA = $960,000 - ($4,817,500)*(.11) = $430,075

69.

Assuming that all sales were on credit, and using a 365-day year, determine the daily

sales outstanding (DSO) for 2007.

A.

B.

C.

D.

E.

110.00 days

109.50 days

109.00 days

108.50 days

108.00 days

Daily Credit Sales = $6,500,000 / 365 = $17,808.22

A/R = $1,950,000 (Given)

DSO = $1,950,000 / $17,808.22 = 109.50 days

70.

As you can calculate, in 2006 the firms profit margin was 15.02%, total asset turnover

was 0.80321285, and the equity multiplier was 1.67114094. In 2007, the profit margin

went down slightly, but the total asset turnover and the equity multiplier went up.

Determine what the return on equity would have been for the firm in 2007 if it had been

able to maintain a profit margin of 15.02%, while keeping all other variables for 2007

the same, such as the firms total asset turnover and equity multiplier.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 69 of 73 Pages

A.

B.

C.

D.

E.

26.9883%

24.0183%

22.5333%

25.5033%

21.0483%

TAT2007 = $6,500,000 / $6,930,000 = 0.937950938

EM2007 = $6,930,000 / $3,617,500 = 1.915687630

New ROE2007 = (.1502)*(0.937950938)*(1.915687630) = 26.9883%

Alternatively,

New Net Income2007 = ($6,500,000)*(.1502) = $976,300

New ROE2007 = $967,300 / $3,617,500 = 26.9883%

YOU ARE GIVEN THE FOLLOWING INFORMATION FOR PROBLEMS 71 - 74:

Income Statement

Sales

Operating Costs

Depreciation

EBIT

Interest (6%)

EBT

Taxes (40%)

Net Income

2006

$4,000,000.00

$540,800.00

Dividends

Addition to RE

Balance Sheet

Cash

Inventory

Accounts Receivable

Current Assets

Gross Fixed Assets

2007

$6,000,000.00

-$4,200,000.00

-$370,000.00

$1,430,000.00

-$54,000.00

$1,376,000.00

-$550,400.00

$825,600.00

$205,600.00

$620,000.00

2006

$80,000.00

$1,600,000.00

$1,200,000.00

$2,880,000.00

$3,000,000.00

2007

$120,000.00

$2,400,000.00

$1,800,000.00

$4,320,000.00

$3,700,000.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 70 of 73 Pages

Less: Depreciation

Net Fixed Assets

Total Assets

-$900,000.00

$2,100,000.00

$4,980,000.00

-$1,270,000.00

$2,430,000.00

$6,750,000.00

Accounts Payable

Accruals

$1,200,000.00

$300,000.00

$1,800,000.00

$450,000.00

Current Liabilities

Debt

Common Stock

Retained Earnings

Total Liability and

Equity

$1,500,000.00

$500,000.00

$2,000,000.00

$980,000.00

$2,250,000.00

$900,000.00

$2,000,000.00

$1,600,000.00

$4,980,000.00

$6,750,000.00

71.

Based on the information above, determine the free cash flow (FCF) for 2007.

A.

B.

C.

D.

E.

- $185,250

- $169,750

- $154,250

- $177,500

- $162,000

There are a lot of different ways to solve this problem, simply choose the method you

are most comfortable with.

NOPAT = (EBIT)(1-T) = ($1,430,000)(1-.4) = $858,000

DEP = $370,000

OCF = NOPAT + DEP = $858,000 + $370,000 = $1,228,000

NOWCY2006 = $2,880,000 - $1,500,000 = $1,380,000

NOWCY2007 = $4,320,000 - $2,250,000 = $2,070,000

NOWC = $2,070,000 - $1,380,000 = $690,000

NFAY2006 = $2,100,000

NFAY2007 = $2,430,000

NFA = $2,430,000 - $2,100,000 = $330,000

GFA = NFA + Depreciation = $330,000 + $370,000 = $700,000

GFAY2006 = $3,000,000

GFAY2007 = $3,700,000

GFA = $3,700,000 - $3,000,000 = $700,000

TOCY2006 = NOWCY2006 + NFAY2006 = $1,380,000 + $2,100,000 = $3,480,000

TOCY2007 = NOWCY2007 + NFAY2007 = $2,070,000 + $2,430,000 = $4,500,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 71 of 73 Pages

GIOC = NIOC + DEP = $1,020,000 + $370,000 = $1,390,000

FCF = OCF - GIOC = $1,228,000 - $1,390,000 = -$162,000

FCF = NOPAT - NIOC = $858,000 - $1,020,000 = -$162,000

FCF = OCF - NOWC - GFA = $1,228,000 - $690,0000 - $700,000 = -$162,000

Proof:

FCF

Interest Payment

Interest Tax Shelter

Dividends

Total Needs

New Debt

Net Effect

- $ 162,000

- $ 54,000

+$ 21,600

- $ 205,600

- $ 400,000

+$ 400,000

$

0

72.

Assume that the firm had total invested capital (total investor-supplied operating

capital) for 2007 of $4,500,000 and a weighted average cost of capital of 11.5 percent.

Given this information, determine the economic value added (EVA) for 2007.

A.

B.

C.

D.

E.

$340,500

$370,200

$400,150

$430,075

$460,750

NOPAT = (EBIT)*(1-T) = ($1,430,000)*(.60) = $858,000

EVA = $858,000 - ($4,500,000)*(.115) = $340,500

73.

Assuming that all sales were on credit, and using a 360-day year, determine the daily

sales outstanding (DSO) for 2007.

A.

B.

C.

D.

E.

110.00 days

109.50 days

109.00 days

108.50 days

108.00 days

Daily Credit Sales = $6,000,000 / 360 = $16,666.67

A/R = $1,800,000 (Given)

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 72 of 73 Pages

74.

As you can calculate, in 2006 the firms profit margin was 13.52%, total asset turnover

was 0.80321285, and the equity multiplier was 1.67114094. In 2007, the profit margin

went up slightly, as well as the total asset turnover and the equity multiplier.

Determine what the return on equity would have been for the firm in 2007 if it had been

maintained a profit margin of 13.52%, while keeping all other variables for 2007 the

same, such as the firms total asset turnover and equity multiplier.

A.

B.

C.

D.

E.

26.9883%

24.0183%

22.5333%

25.5033%

21.0483%

TAT2007 = $6,000,000 / $6,750,000 = 0.888888889

EM2007 = $6,750,000 / $3,600,000 = 1.875

New ROE2007 = (.1352)*(0.888888889)*(1.875) = 22.5333%

Alternatively,

New Net Income2007 = ($6,000,000)*(.1352) = $811,200

New ROE2007 = $811,200 / $3,600,000 = 22.5333%

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 73 of 73 Pages

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