Corporate Finance

Exercises
Topic 2: Financial Statements Taxes and Cash Flow
 Questions
1. Calculating OCF. Hammett, Inc., has sales of $34,630, costs of $10,340,
depreciation expense of $2,520, and interest expense of $1,750. If the tax
rate is 35 percent, what is the operating cash flow, or OCF?
2. Rotweiler Obedience School's December 31, 2013, balance sheet showed
net fixed assets of $1,635,000, and the December 31, 2014, balance sheet
showed net fixed assets of $1,976,000. The company's 2014 income
statement showed a depreciation expense of $305,000. What was
Rotweiler's net capital spending for 2014?
3. The December 31, 2013, balance sheet of Maria's Tennis Shop, Inc., showed
current assets of $1,045 and current liabilities of $960. The December 31,
2014, balance sheet showed current assets of $1,310 and current liabilities
of $1,090. What was the company's 2014 change in net working capital, or
NWC?
Questions

4. During the year, Belyk Paving Co. had sales of $2,600,000. Cost of
goods sold, administrative and selling expenses, and depreciation
expense were $1,535,000, $465,000, and $520,000, respectively. In
addition, the company had an interest expense of $245,000 and a tax
rate of 35 percent. (Ignore any tax loss carryback or carryforward
provisions.)
a. What is Belyk's net income?
b. What is its operating cash flow?
c. Explain your results in (a) and (b).
Suggested Solutions
1. To calculate the OCF, we first need to construct an income
statement. The income statement starts with revenues and
subtracts costs to arrive at EBIT. We then subtract out interest to
get taxable income, and then subtract taxes to arrive at net
income. Doing so, we get:
Income Statement
Sales $34,630
Costs 10,340
Depreciation 2,520
EBIT $21,770
Interest 1,750
Taxable income $20,020
Taxes (35%) 7,007
Net income $13.013

OCF = EBIT + Depreciation – Taxes

OCF = $21,770 + 2,520 – 7,007
OCF = $17,283
Suggested Solutions
2. Answer

Net capital spending is the increase in fixed assets, plus depreciation. Using this relationship, we find:

Net capital spending = NFAend – NFAbeg + Depreciation

Net capital spending = $1,976,000 – 1,635,000 + 305,000
Net capital spending = $646,000

3. Answer
The change in net working capital is the end of period net working capital minus the beginning of period
net working capital, so:

Change in NWC = NWCend – NWCbeg

Change in NWC = (CAend – CLend) – (CAbeg – CLbeg)
Change in NWC = ($1,310 – 1,090) – (1,045 – 960)
Change in NWC = $135
Suggested Solutions
4. Answer
a.
The income statement starts with revenues and subtracts costs to arrive at EBIT. We then subtract interest
to get taxable income, and then subtract taxes to arrive at net income. Doing so, we get:

Income Statement
Sales $2,600,000
Cost of goods sold 1,535,000
Other expenses 465,000
Depreciation 520,000
EBIT $ 80,000
Interest 245,000
Taxable income –$165,000
Taxes (35%) 0
Net income –$165,000

The taxes are zero since we are ignoring any carryback or carryforward provisions.
Suggested Solutions
4. Answer

b. The operating cash flow for the year was:

OCF = EBIT + Depreciation – Taxes

OCF = $80,000 + 520,000 – 0
OCF = $600,000

c. Net income was negative because of the tax deductibility of depreciation and interest expense.
However, the actual cash flow from operations was positive because depreciation is a non-cash
expense and interest is a financing, not an operating, expense.