Chapter 2

Financial Statements, Cash Flow, and Taxes

ANSWERS TO HOMEWORK QUESTION

2 Net Income is a firm’s accounting profit as reported on its income statement. It is the
earnings available for distribution as dividends to shareholders and to be retained. EBITDA
is earnings before interest, taxes, depreciation, and amortization. It measures the financial
strength of a company, mainly its capacity to service debt. NOPAT, net operating profit after
taxes, is the amount of profit a company would generate if it had no debt and no financial
assets. NOPAT is a better measure of the performance of a company’s operations because
debt lowers income. FCF Free Cash Flow is the cash flow actually available for distribution
to investors after the company has made all investments in fixed assets and working capital
necessary to sustain ongoing operations. It is the most important measure of cash flows
because it shows the exact amount available to all investors. EVA Economic Value Added
represents the residual income that remains after the cost of all capital, including equity
capital, has been deducted.

SOLUTION TO SPREADSHEET PROBLEM

2-15a Net operating working capital
2013 NOWC = Operating current assets – Operating current liabilities
2013 NOWC = $472.500 – $141.750
2013 NOWC = $330.750

2012 NOWC = Operating current assets – Operating current liabilities

2012 NOWC = $450.000 – $135.000
2012 NOWC = $315.000

Total net operating capital

2013 TOC = NOWC + Fixed assets
2013 TOC = $330.750 + $330.750
2013 TOC = $661.500

2012 TOC = NOWC + Fixed assets

2012 TOC = $315.000 + $315.000
2012 TOC = $630.000

Investment in total net operating capital

2013 Inv. In TOC = 2013 TOC – 2012 TOC
2013 Inv. In TOC = $661.500 – $630.000
2013 Inv. In TOC = $31.500

Net operating profit after taxes

2013 NOPAT = EBIT × ( 1 – T )
2013 NOPAT = $99.200 × ( 1 – 40% )
2013 NOPAT = $59.520
 Free cash flow
2013 FCF = NOPAT – Net investment in operating capital
2013 FCF = $59.520 – $31.500
2013 FCF = $28.020

Return on invested capital

2013 ROIC = NOPAT ÷ Total net operating capital
2013 ROIC = $59.520 ÷ $661.500
2013 ROIC = 9,0%

2-15b Market Value Added

MVA = Stock price × # of shares – Total common equity
MVA = $65,00 × 15.000 – $544.538
MVA = $975.000 – $544.538
MVA = $430.462

Economic Value Added

EVA = NOPAT – (Operating Capital × After–tax cost of capital)
EVA = $59.520 – $661.500 × 8%
EVA = $59.520 – $52.920
EVA = $6.600