Exercise III

Problem 1: The following table shows the income statement of a company. In the next year, sales,
contribution margin, and SG&A expenses each hold the same value as the past year. There is no
extraordinary income or expense in the company that is not related to the core business (i.e., Other
Income is zero for the next year). However, an existing piece of equipment that had an original cost of
$14,000,000 (no salvage value was assumed at the time the original depreciation schedule was created)
is retired in the beginning of the next year with an accumulated depreciation of $10,000,000. In the
beginning of the next year, this old equipment is sold in the market for $4,000,000 and a new piece of
equipment is bought for $21,000,000 and installed. The management of the company determines to use
the same depreciation period of 7 years for the new piece of equipment that it had used for the old
piece of equipment, also assuming the salvage value is zero.

1. What is the operating cash flow and the net cash flow in the past year?
2. How long was the old piece of equipment in service? Is an extraordinary adjustment required
(i.e., is there any Other Income) at the time of its retirement?
3. Complete the income statement for the next year (Assume that the depreciation for all items
other than the new piece of equipment is unchanged; use a straight line depreciation method for
the new equipment).
4. What is the operating cash flow in the next year?
5. What is the net cash flow in the next year?
6. Just given the data for the two years, was the company sound in buying the new piece of
equipment? Why?
7. If the old piece of equipment is sold at $1,000,000 instead of $4,000,000, and assume that you
show the impact of the unrecovered depreciation on the old piece of equipment in Other
Income, what is the value of Other Income in the next year in this case? Does operating cash
flow change?

Income Statement
Past Year Next Year
Revenue $18,232,000 $18,232,000
Allowance for Bad Debt $182,000 $182,000
Net Revenue $18,050,000 $18,050,000
Cost of Goods Sold $12,179,000 $12,179,000
Contribution Margin $5,871,000 $5,871,000
Contribution Margin, % 32.53% 32.53%
Sales, General, and Administrative Expense
All Items except Depreciation $2,796,000 $2,796,000
Depreciation $2,430,000
Operating Income $645,000
Other Income $400,000
Net Income $1,045,000

Operating Cash Flow

Net Cash Flow

1
Problem 2 An abbreviated income statement for Startupco is attached (in $000). Assuming SG&A is
fixed, i.e. it does not increase with sales, what is the break even sales level at which Startupco "covers
the nut".

Sales 1231
Less Allowance for Bad Debt/Warranty 18
Net Revenue 1213
Cost of Goods Sold 486
Contribution Margin 727
SG&A excluding depreciation 1109
Depreciation 420
Operating Income -802
Other Income 0
Net Income -802