MicroDrive Inc. produces memory components for computers and smartphones.

MicroDrive's most recent balance sheet

on the last day of each year.

MicroDrive Inc.
Balance sheet
2013 2012 Increase
Assets
Cash and cash equivalents 50 60 -10
Short-term investments 0 40 -40
Accounts receivable 500 380 120
Inventories 1000 820 180
Total current assets 1550 1300
Net plant and equipment 2000 1700 300
Total assets 3550 3000

Liabilities and Equity

Accounts payable 200 190 10
Accruals 300 280 20
Notes payable 280 130 150
Total current liabilities 780 600
Long-term bonds 1200 1000 200
Total liabilities 1980 1600
Preferred stock (1 million shares) 100 100
Common stock (50 million shares) 500 500 0
Retained earnings 970 800 170
Total common equity 1570 1400
Total liabilities and equity 3550 3000
mputers and smartphones. MicroDrive's most recent balance sheets, which represent "snapshots" of its financial position

MicroDrive Inc.
Income Statements
2013 2012
Sales 5,000 4,760
Cost of goods sold excluding depreciation 3,800 3,560
Depreciation and amortization 200 170
Other operating expenses 500 480
Earnings before interest and taxes 500 550
Less interest expenses 120 100
Earnings before taxes 380 450
Taxes (40%) 152 180
Net income before preferred dividends 228 270
Preferred dividends 8 8
Net income available to common stockholders 220 262

Additional information
Common dividends 50 48
Addition to retained earnings 170 214
Number of common shares 50 50
Stock price per share 27 40

Per share data

Earnings per share, EPS 4.40 5.24
Dividends per share, DPS 1.00 0.96
Book value per share, BVPS 29.40 26.00
WACC 11% 10.50%
represent "snapshots" of its financial position

MicroDrive Inc. MicroDrive Inc.

Statement of cash flows for year 2013 Statement of free cash flows for year 2013
Cash flow from operations Free cash flow generated
Net income 228 Earnings before interest and taxes
Add: Non-cash adjustments less: income taxes @ 40%
Depreciation expense 200 Net operating profit after taxes
Working capital adjustmets plus: Depreciation
Increase in current assets -300 Operating cash flow
Increase in current liabilities 30 less: Investments during the year
Net cash provided by operating activities 158 Net operating working capital 260
Investing activities Fixed assets 500
Cash used to acquire fixed assets -500 Free cash flow generated
Sale of short term investments 40
-460 Distribution of free cash flow
Financing activities Payment to debtholders:
Increase in notes payable 150 Net cost to the company
Increase in long-term debt 200 Principal repayment
Payment of dividends -58
292 Payment to shareholders:
Summary Dividends paid
Net change in cash and equivalents -10 Net stock repurchases
Cash and cash equivalents, Jan. 01, 2013 60
Cash and cash equivalents, Dec. 31, 2013 50 Net purchases of ST investments:
Total

Increase in operating current assets

Increase in operating current liabilities
Increase in NOWC
. MicroDrive Inc.
for year 2013 Sources and uses of capital
2013 2012 2013 2012
500 550 Sources of capital: Uses of capital
200 220 Debt capital Operating current assets
300 330 Notes payable 280 130 Operating current liabilities
200 170 Long-term bonds 1200 1000 NOWC
500 500 Net fixed assets
Shareholders' equity Capital used for operating purposes
Preference capital 100 100 Short-term investments
760 760 Common shares 500 500
-260 -260 Retained earnings 970 800
3050 2530

ROIC 11.86%
72 MVA -120 700
-350 EVA -35.5 68.55
-278

58
0
58
-40
-260

290
30
260
2013 2012

1550 1260
500 470
1050 790
2000 1700
3050 2490
0 40

3050 2530
Molteni Motors Inc. recently reported $6 million of net income. Its EBIT was $13 million, and its tax rate was 40%. W
an income statement, and then fill in the known values. Then divide $6 million net income by 1 − T = 0.6 to find the
taxable income must be the interest expense. Use this procedure to work some of the other problems.)
SOLUTION
Molteni Motors Inc.
Income statement for year _______
Description Amount
Sales revenues
Cost of sales (other than depreciation)
EBITDA
Depreciation and amortisation expense
EBIT 13.00 given
Interest expense 3.00
Profit before tax 10.00
Income tax expense @ 40% 4.00
Profit after tax 6.00 given
n, and its tax rate was 40%. What was its interest expense? (Hint: Write out the headings for
me by 1 − T = 0.6 to find the pre-tax income. The difference between EBIT and
other problems.)
Talbot Enterprises recently reported an EBITDA of $8 million and net income of $2.4 million. It had $2.0 million of in
was its charge for depreciation and amortization?
SOLUTION
Talbot Enterprises
Income statement for year _______
Description Amount
Sales revenues
Cost of sales (other than depreciation)
EBITDA 8.00 GIVEN
Depreciation and amortisation expense 2.00
EBIT 6.00 given
Interest expense 2.00 given
Profit before tax 4.00
Income tax expense @ 40% 1.60
Profit after tax 2.40 given
2.4 million. It had $2.0 million of interest expense, and its corporate tax rate was 40%. What
Kendall Corners Inc. recently reported net income of $3.1 million and depreciation of $500,000. What was its net ca
SOLUTION
Kendall Corners Inc.
Income statement for year _______
Description Amount
Sales revenues
Cost of sales (other than depreciation)
EBITDA
Depreciation and amortisation expense 0.50 given
EBIT
Interest expense
Profit before tax
Income tax expense @ 40%
Profit after tax 3.10 given
Net cash flow = PAT + depreciation 3.60
of $500,000. What was its net cash flow? Assume it had no amortization expense.
In its most recent financial statements, Del-Castillo Inc. reported $70 million of net income and $900 million of reta
million. How much in dividends did the firm pay to shareholders during the year?
SOLUTION
Del-Castillo Inc.
Statement of retained earnings for year ______
Description CC retained earnings
Retained earnings, beginning of year 855.00 given
Net profit for the year 70.00 given
Dividend paid for the year 25.00
Profit after tax 900.00 given
me and $900 million of retained earnings. The previous retained earnings were $855
The Shrieves Corporation has $10,000 that it plans to invest in marketable securities. It is choosing among AT&T bo
5% (but are not taxable), and AT&T preferred stock, with a dividend yield of 6%. Shrieves’s corporate tax rate is 35%
Find the after-tax rates of return on all three securities.
ties. It is choosing among AT&T bonds, which yield 7.5%, state of Florida muni bonds, which yield
Shrieves’s corporate tax rate is 35%, and 70% of the dividends received are tax exempt.
The Moore Corporation has operating income (EBIT) of $750,000. The company’s depreciation expense is $200,000
rate. What is the company’s net income? What is its net cash flow?

SOLUTION
Moore Corporation
Income statement for year _______
Description Amount
Sales revenues
Cost of sales (other than depreciation)
EBITDA
Depreciation and amortisation expense 0.20 given
EBIT 0.75 given
Interest expense - given
Profit before tax 0.75
Income tax expense @ 40% 0.30
Profit after tax 0.45
Net cash flow = PAT + depreciation 0.65
depreciation expense is $200,000. Moore is 100% equity financed, and it faces a 40% tax
BE13e Exercise 2-11 Impact of tax policy on profits and Net CF
The Berndt Corporation expects to have sales of $12 million. Costs other than depreciation are expected t
and depreciation is expected to be $1.5 million. All sales revenues will be collected in cash, and costs othe
must be paid for during the year. Berndt’s federal-plus-state tax rate is 40%. Berndt has no debt.

a. Set up an income statement. What is Berndt’s expected net cash flow?

b. Suppose Congress changed the tax laws so that Berndt’s depreciation expenses doubled. No changes in
What would happen to reported profit and to net cash flow?
c. Now
d. If thissuppose thatcompany,
were your Congress, instead
would youofprefer
doubling Berndt’s
Congress depreciation,
to cause reduced it by 50%. How would p
your depreciation
expense to be doubled or halved? Why?

Solution
Description (a) (b) (c)
Sales 12,000 12,000 12,000
cash costs 9,000 9,000 9,000
Depreciation exp. 1,500 3,000 750
EBIT 1,500 0 2,250
Interest exp 0 0 0
profit before tax 1,500 0 2,250
Income Tax exp @ 40% 600 0 900
Net income 900 0 1,350

Net cashflow 2,400 3,000 2,100

reciation are expected to be 75% of sales,
in cash, and costs other than depreciation
t has no debt.

doubled. No changes in operations occurred.

it by 50%. How would profit and net cash flow be affected?

BE14e Exercise 2-12 Free cash flows
Using Rhodes Corporation’s financial statements (shown below), answer the following questions.
a. What is the net operating profit after taxes (NOPAT) for 2013?
b. What are the amounts of net operating working capital for both years?
c. What are the amounts of total net operating capital for both years?
d. What is the free cash flow for 2013?
e. What is the ROIC for 2012?
f. How much of the FCF did Rhodes use for each of the following purposes: after-tax interest, net debt repayments, divid
net stock repurchases, and net purchases of short-term investments? (Hint: Remember that a net use can be negative

Rhodes Corporation
Income Statements
2013 2012
Sales 11,000 10,000
Operating costs excluding depreciation 9,360 8,500
Depreciation 380 360
Earnings before interest and taxes 1,260 1140
Less interest 120 100
Earnings before taxes 1,140 1,040
Taxes (40%) 456 416
Net income available to common stockholder 684 624
Common dividends 220 200

Rhodes Corporation
Statement of retained earnings
2013 2012
Retained earnings, BoY 1000 576
plus: earnings during the year 684 624
less: dividends announced for the year 220 200
Retained earnings, EoY 1464 1000

NOPAT 756 684

NOWC 3300 3000
Total net operating capital 7150 6500
Return on invested capital 10.57% 10.52%
Increase in OC = 650
Free cash flow = NOPAT - delta OC = 106

SUGGESTED SOLUTION

Rhodes Corporation
Modified Balance sheets
31-Dec-13 31-Dec-12 Increase
Sources of capital
Notes payable 384 200
Long-term debt 1100 1000
 Capital provided by lenders 1484 1200
Capital provided by shareholders 5776 5400
Total capital provided by investors 7260 6600

Uses of capital
Cash 550 500
Accounts receivable 2750 2500
Inventories 1650 1500
Operating current assets 4950 4500 450
Less: Operating Current Liabilities
Accounts payable 1100 1000
Accruals 550 500
Operating current liabilities 1650 1500 150
Net operating working capital 3300 3000 300
Add: PPE, net 3850 3500 350
Capital used for operating purposes 7150 6500 650
Capital used for non-optg purposes 110 100 10
Total capital used 7260 6600

Capital provided by shareholders

Common stock 4312 4400
Retained earnings 1464 1000
Total common equity 5776 5400

Statement of changes in Equity

CC RE
Balance as on 31-Dec-2012 4400 1000
Profit earned during year 2013 684
Dividend paid out to shareholders -220
Buyback of equity shares -88
Balance as on 31-Dec-2013 4312 1464
llowing questions.

er-tax interest, net debt repayments, dividends,

Remember that a net use can be negative.)

Rhodes Corporation
Balance sheets
2013 2012
Assets
Cash 550 500
Short-term investments 110 100
Accounts receivable 2750 2500
Inventories 1650 1500
Total current assets 5060 4600
Net plant and equipment 3850 3500
Total assets 8910 8100

Liabilities and Equity

Accounts payable 1100 1000
Accruals 550 500
Notes payable 384 200
Total current liabilities 2034 1700
Long-term debt 1100 1000
Total liabilities 3134 2700
Common stock 4312 4400
Retained earnings 1464 1000
Total common equity 5776 5400
Total liabilities and equity 8910 8100

Rhodes Corporation
Modified Income Statements
2013 2012
Sales 11,000 10,000
Operating costs excluding depreciation 9,360 8,500
Depreciation 380 360
Earnings before interest and taxes 1,260 1,140
Less interest 0 0
Earnings before taxes 1,260 1,140
Taxes (40%) 504 456
Net Operating profit after tax (NOPAT) 756 684

Performance measures
Return on invested capital 10.57% 10.52%
Weighted average cost of capital 10% 10%
EVA = NOPAT - OC * WACC = 41 34
 Rhodes Corporation
Statement of free cash flows for year 2013
Free cash flow from assets
NOPAT for year 2013 756
Add: depreciation 380
Operating cash flow 1136
Less: used internally (note 1) 1030
Free cash flow from the firm 106

Uses of free cash flow

To build up the short-term investments 10
Paid to lenders (note 2) -212
Paid to shareholders (note 3) 308
106

Note 1: profits used internally

For working capital purposes (DNOWC) 300
To buy the fixed assets (D gross PPE) 730
1030
Note 2: Paid to lenders
Interest paid (after-tax basis) -72
NP issued 184
LT debt issued 100
Net received from shareholders 212
Note 3: Paid to shareholders
Dividend paid -220
Stock repurchased -88
Net amount paid to shareholders -308