CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES

Multiple Choice: Conceptual

38. Which of the following statements is CORRECT?

a. Assets other than cash are expected to produce cash over time, and the amounts of cash they
eventually produce should be exactly the same as the amounts at which the assets are carried on the
books.
b. The primary reason the annual report is important in finance is that it is used by investors when they
form expectations about the firm's future earnings and dividends, and the riskiness of those cash
flows.
c. The annual report is an internal document prepared by a firm's managers solely for the use of its
creditors/lenders.
d. The four most important financial statements provided in the annual report are the balance sheet,
income statement, cash budget, and statement of stockholders' equity.
e. Prior to the Enron scandal in the early 2000s, companies would put verbal information in their annual
reports, along with the financial statements. That verbal information was often misleading, so today
annual reports can contain only quantitative information: audited financial statements.
ANSWER: b

40. Other things held constant, which of the following actions would increase the amount of cash on a
company's balance sheet?
a. The company repurchases common stock.
b. The company pays a dividend.
c. The company issues new common stock.
d. The company gives customers more time to pay their bills.
e. The company purchases a new piece of equipment.
ANSWER: c

44. Below are the 2017 and 2018 year-end balance sheets for Tran Enterprises:

Assets: 2018 2017

Cash $ 200,000 $ 170,000
Accounts receivable 864,000 700,000
Inventories 2,000,000 1,400,000
Total current assets $3,064,000 $2,270,000
Net fixed assets 6,000,000 5,600,000
Total assets $9,064,000 $7,870,000

Liabilities and equity:

Accounts payable $1,400,000 $1,090,000
Notes payable to bank 1,600,000 1,800,000
Total current liabilities $3,000,000 $2,890,000
Long-term debt 2,400,000 2,400,000
Common stock 3,000,000 2,000,000
Retained earnings 664,000 580,000
Total common equity $3,664,000 $2,580,000
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Total liabilities and equity $9,064,000 $7,870,000

The firm has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year, non-callable,
long-term debt in 2017. As of the end of 2018, none of the principal on this debt had been repaid. Assume that
the company's sales in 2017 and 2018 were the same. Which of the following statements must be CORRECT?
a. The firm increased its short-term bank debt in 2018.
b. The firm issued long-term debt in 2018.
c. The firm issued new common stock in 2018.
d. The firm repurchased some common stock in 2018.
e. The firm had negative net income in 2018.
ANSWER: c

45. On its 12/31/18 balance sheet, Barnes Inc showed $510 million of retained earnings, and exactly that same
amount was shown the following year. Assuming that no earnings restatements were issued, which of the
following statements is CORRECT?
a. If the company lost money in 2018, it must have paid dividends.
b. The company must have had zero net income in 2018.
c. The company must have paid out half of its 2018 earnings as dividends.
d. The company must have paid no dividends in 2018.
e. Dividends could have been paid in 2018, but they would have had to equal the earnings for the year.
ANSWER: e

46. Below is the common equity section (in millions) of Timeless Technology's last two year-end balance
sheets:
2018 2017
Common stock $2,000 $1,000
Retained earnings 2,000 2,340
Total common equity $4,000 $3,340

The firm has never paid a dividend to its common stockholders. Which of the following statements is
CORRECT?
a. The company's net income in 2018 was higher than in 2017.
b. The firm issued common stock in 2018.
c. The market price of the firm's stock doubled in 2018.
d. The firm had positive net income in both 2017 and 2018, but its net income in 2018 was lower than it
was in 2017.
e. The company has more equity than debt on its balance sheet.
ANSWER: b

47. Which of the following statements is CORRECT?

a. Typically, a firm's DPS should exceed its EPS.
b. Typically, a firm's net income should exceed its EBIT.
c. If a firm is more profitable than average, we would normally expect to see its stock price exceed its
book value per share.
d. If a firm is more profitable than most other firms, we would normally expect to see its book value per
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 share exceed its stock price, especially after several years of high inflation.
e. The more depreciation a firm has in a given year, the higher its EPS, other things held constant.
ANSWER: C

49. Which of the following factors could explain why Michigan Energy's cash balance increased even though it
had a negative cash flow last year?
a. The company sold a new issue of bonds.
b. The company made a large investment in new plant and equipment.
c. The company paid a large dividend.
d. The company had high depreciation expenses.
e. The company repurchased 20% of its common stock.
ANSWER: a

52. Which of the following statements is CORRECT?

a. The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of
buying or selling fixed assets.
b. The statement of cash flows shows where the firm's cash is located; indeed, it provides a listing of all
banks and brokerage houses where cash is on deposit.
c. The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the
effects of changes in working capital.
d. The statement of cash flows reflects cash flows from operations and from borrowings, but it does not
reflect cash obtained by selling new common stock.
e. The statement of cash flows shows how much the firm's cash, the total of currency, bank deposits,
and short-term liquid securities (or cash equivalents), increased or decreased during a given year.
ANSWER: e

54. Which of the following statements is CORRECT?

a. Most rapidly growing companies have positive free cash flows because cash flows from existing
operations generally exceed fixed asset purchases and changes to net operating working capital.
b. Changes in working capital have no effect on free cash flow.

c. Free cash flow (FCF) is defined as follows:

FCF = EBIT(1 − T) + Depreciation
− Capital expenditures required to sustain operations
− Required changes in net operating working capital.

d. Free cash flow (FCF) is defined as follows:

FCF = EBIT(1 − T) + Capital expenditures.
e. Managers should be less concerned with free cash flow than with accounting net income. Accounting net
income is the "bottom line" and represents how much the firm can distribute to all its investors, both
creditors and stockholders.
ANSWER: c

55. Which of the following statements is CORRECT?

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 a. Actions that increase reported net income will always increase cash flow.
b. One way to increase EVA is to generate the same level of operating income but with less total
invested capital.
c. One drawback of EVA as a performance measure is that it mistakenly assumes that equity capital is
free.
d. One way to increase EVA is to achieve the same level of operating income but with more total
invested capital obtained at a higher cost of capital.
e. If a firm reports positive net income, its EVA must also be positive.
ANSWER: b
RATIONALE: Statement b is true, because the EVA equation: EVA = EBIT(1 − T) − (After-tax cost of
capital %) (Investor-supplied operating capital) implies that lowering the operating
capital, all else equal, lowers capital costs and thus increases EVA.

56. Which of the following statements is CORRECT?

a. MVA stands for market value added, and it is defined as follows:
MVA = (Shares outstanding)(Stock price) + Book value of common equity.
b. The primary difference between EVA and accounting net income is that when net income is
calculated, a deduction is made to account for the cost of common equity, whereas EVA represents
net income before deducting the cost of the equity capital the firm uses.
c. MVA gives us an idea about how much value a firm's management has added during the last year.
d. EVA gives us an idea about how much value a firm's management has added over the firm's life.
e. EVA stands for economic value added, and it is defined as follows:
EVA = NOPAT − (Total invested capital)(AT cost of capital %)
ANSWER: e
RATIONALE: Statement e gives the correct equation for EVA. The other statements are false.

62. Last year, Delip Industries had (1) negative cash flow from operations, (2) a negative free cash flow, and (3)
an increase in cash as reported on its balance sheet. Which of the following factors could explain this situation?
a. The company had a sharp increase in its inventories.
b. The company had a sharp increase in its accrued liabilities.
c. The company sold a new issue of common stock.
d. The company made a large capital investment early in the year.
e. The company had a sharp increase in depreciation expenses.
ANSWER: c

68. Which of the following statements is CORRECT?

a. Dividends paid reduce the net income that is reported on a company's income statement.
b. If a company uses some of its bank deposits to buy short-term, highly liquid marketable securities,
this will cause a decline in its current assets as shown on the balance sheet.
c. If a company issues new long-term bonds to purchase fixed assets during the current year, this will
increase both its reported current assets and current liabilities at the end of the year.
d. Accounts receivable are reported as a current liability on the balance sheet.
e. If a company pays more in dividends than it generates in net income, its retained earnings as reported
on the balance sheet will decline from the previous year's balance.
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ANSWER: e

71. Last year Besset Company's operations provided a negative cash flow, yet the cash shown on its balance
sheet increased. Which of the following statements could explain the increase in cash, assuming the company's
financial statements were prepared under generally accepted accounting principles (GAAP)?
a. The company repurchased some of its common stock.
b. The company dramatically increased its capital expenditures.
c. The company retired a large amount of its long-term debt.
d. The company sold some of its fixed assets.
e. The company had high depreciation expenses.
ANSWER: d

72. The CFO of Daves Industries plans to have the company issue $300 million of new common stock and use
the proceeds to pay off some of its outstanding bonds that carry a 7% interest rate. Assume that the company,
which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax
rate all remain constant. Which of the following would occur?
a. The company's taxable income would fall.
b. The company's interest expense would remain constant.
c. The company would have less common equity than before.
d. The company's net income would increase.
e. The company would have to pay less taxes.
ANSWER: d

75. Which of the following statements is CORRECT?

a. Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the
company has made the investments in current and fixed assets that are necessary to sustain ongoing
operations.
b. After-tax operating income is calculated as EBIT(1 − T) + Depreciation.
c. Two firms with identical sales and operating costs but with different amounts of debt and tax rates
will have different operating incomes by definition.
d. If a firm is reporting its income in accordance with generally accepted accounting principles, then its
net income as reported on the income statement should be equal to its free cash flow.
e. Retained earnings as reported on the balance sheet represent cash and, therefore, are available to
distribute to stockholders as dividends or any other required cash payments to creditors and
suppliers.
ANSWER: a

Multiple Choice: Problems

77. Bauer Software's current balance sheet shows total common equity of $5,125,000. The company has
530,000 shares of stock outstanding, and they sell at a price of $27.50 per share. By how much do the firm's
market and book values per share differ?
a. $17.83
b. $18.72

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 c. $19.66
d. $20.64
e. $21.67
ANSWER: a
RATIONALE:
Shares outstanding 530,000
Price per share $27.50
Total book common equity $5,125,000
Book value per share = Total book equity/Number of
$9.67
shares
Difference between book and market values $17.83

78. Brown Fashions Inc.'s December 31, 2014, balance sheet showed total common equity of $4,050,000 and
200,000 shares of stock outstanding. During 2014, the firm had $450,000 of net income, and it paid out
$100,000 as dividends. What was the book value per share at 12/31/14, assuming no common stock was either
issued or retired during 2014?
a. $20.90
b. $22.00
c. $23.10
d. $24.26
e. $25.47
ANSWER: b
RATIONALE: 12/31/14 common equity $4,050,000
2014 net income $ 450,000
2014 dividends $ 100,000
2014 addition to retained earnings $ 350,000
12/31/14 common equity $4,400,000
Shares outstanding 200,000
12/31/14 BVPS $22.00

80. Rao Construction recently reported $20.50 million of sales, $12.60 million of operating costs other than
depreciation, and $3.00 million of depreciation. It had $8.50 million of bonds outstanding that carry a 7.0%
interest rate, and its federal-plus-state income tax rate was 40%. What was Rao's operating income, or EBIT, in
millions?
a. $3.21
b. $3.57
c. $3.97
d. $4.41
e. $4.90
ANSWER: e
RATIONALE: Sales $20.50
Operating costs excluding depreciation 12.60
Depreciation 3.00
Operating income (EBIT) $ 4.90

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 Note that operating income is before interest and taxes.

82. Vasudevan Inc. recently reported operating income of $2.75 million, depreciation of $1.20 million, and had
a tax rate of 40%. The firm's expenditures on fixed assets and net operating working capital totaled $0.6 million.
How much was its free cash flow, in millions?
a. $1.93
b. $2.03
c. $2.14
d. $2.25
e. $2.36
ANSWER: d
RATIONALE: FCF = EBIT(1 − T) + Deprec. − (Capex + ΔNOWC)

EBIT $2.75
Tax rate 40%
Depreciation $1.20
Capex + ΔNOWC $0.60
FCF = $2.25

83. Over the years, O'Brien Corporation's stockholders have provided $20,000,000 of capital, when they
purchased new issues of stock and allowed management to retain some of the firm's earnings. The firm now has
1,000,000 shares of common stock outstanding, and it sells at a price of $38.50 per share. How much value has
O'Brien's management added to stockholder wealth over the years, i.e., what is O'Brien's MVA?
a. $18,500,000
b. $18,870,000
c. $19,247,400
d. $19,632,348
e. $20,024,995
ANSWER: a
RATIONALE Total book value of equity
: Stock price per share
Shares outstanding
Market value of equity = Stock price × Number of shares
MVA = Market value of equity − Book value of equity

84. Wu Systems has the following balance sheet. How much net operating working capital does the firm have?

Cash $ 100 Accounts payable $ 200

Accounts receivable 650 Accruals 350
Inventory 550 Notes payable 350
Current assets $1,300 Current liabilities $ 900
Net fixed assets 1,000 Long-term debt 600
Common equity 300
_____ Retained earnings 500
Total assets $2,300 Total liab. & equity $2,300
a. $675
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 b. $750
c. $825
ANSWER: b
RATIONALE: Cash $ 100 Accounts payable $ 200
Accounts receivable 650 Accruals 350
Inventory 550 Notes payable 350
Current assets $1,300 Current liabilities $ 900
Net fixed assets 1,000 Long-term debt 600
Common equity 300
_____ Retained earnings 500
Total assets $2,300 Total liab. & equity $2,300

Net operating working capital = Current assets − (Current liabilities − Notes payable)
NOWC = $1,300.00 − $550 NOWC = $750

85. Emery Mining Inc. recently reported $150,000 of sales, $75,500 of operating costs other than depreciation,
and $10,200 of depreciation. The company had $16,500 of outstanding bonds that carry a 7.25% interest rate,
and its federal-plus-state income tax rate was 35%. How much was the firm's net income? The firm uses the
same depreciation expense for tax and stockholder reporting purposes.
a. $35,167.33
b. $37,018.24
c. $38,966.57
d. $41,017.44
e. $43,068.31
ANSWER: d
RATIONALE: Bonds $ 16,500
Interest rate 7.25%
Tax rate 35%
Sales $ 150,000
Operating costs excluding depreciation 75,500
Depreciation 10,200
Operating income (EBIT) $64,300.00
Interest charges −1,196.25
Taxable income $63,103.75
Taxes −22,086.31
Net income $41,017.44

86. Last year Almazan Software reported $10.50 million of sales, $6.25 million of operating costs other than
depreciation, and $1.30 million of depreciation. The company had $5.00 million of bonds that carry a 6.5%
interest rate, and its federal-plus-state income tax rate was 35%. This year's data are expected to remain
unchanged except for one item, depreciation, which is expected to increase by $0.70 million. By how much will
net income change as a result of the change in depreciation? The company uses the same depreciation
calculations for tax and stockholder reporting purposes.
a. −$0.432
b. −$0.455
c. −$0.478
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 d. −$0.502
e. −$0.527
ANSWER: b
RATIONALE: This problem can be worked very easily: just multiply the increase in depreciation by (1
− T) to get the decrease in net income:

Change in depreciation $0.700

Tax rate 0.350
Reduction in net income $0.455

We can also get the answer a longer way, which explains things more clearly:

Old New Change

Bonds $ 5.000 $ 5.000 $0.000
Interest rate 0.065 0.065 0.000
Tax rate 0.350 0.350 0.000
Sales $10.500 $10.500 $0.000
Operating costs excluding depreciation $ 6.250 $ 6.250 $0.000
Depreciation $ 1.300 $ 2.000 $0.700
Operating income (EBIT) $ 2.950 $ 2.250 −$0.700
Interest charges $ 0.325 $ 0.325 $0.000
Taxable income $ 2.625 $ 1.925 −$0.700
Taxes $ 0.919 $ 0.674 −$0.245
Net income $ 1.706 $ 1.251 −$0.455

87. On 12/31/14, Hite Industries reported retained earnings of $525,000 on its balance sheet, and it reported that
it had $135,000 of net income during the year. On its previous balance sheet, at 12/31/13, the company had
reported $445,000 of retained earnings. No shares were repurchased during 2014. How much in dividends did
the firm pay during 2014?
a. $49,638
b. $52,250
c. $55,000
d. $57,750
e. $60,638
ANSWER: c
RATIONALE: 12/31/14 RE $525,000
12/31/13 RE 445,000
Change in RE $ 80,000
Net income for 2014 $135,000
Dividends = Net income − Change in RE $ 55,000

88. During 2014, Bascom Bakery paid out $33,525 of common dividends. It ended the year with $197,500 of
retained earnings versus the prior year's retained earnings of $159,600. How much net income did the firm earn
during the year?
a. $71,425
b. $74,996

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 c. $78,746
d. $82,683
e. $86,818
ANSWER: a
RATIONALE: Net income = The change in retained earnings plus the dividends paid:

Current RE $197,500
Previous RE = Current RE − increment 159,600
Change in RE $ 37,900
Plus dividends paid 33,525
= Net income $ 71,425

91. Hartzell Inc. had the following data for 2013, in millions: Net income = $600; after-tax operating income
[EBIT(1 − T)] = $700; and Total assets = $2,000. Information for 2014 is as follows: Net income = $825; after-
tax operating income [EBIT(1 − T)] = $925; and Total assets = $2,500. How much free cash flow did the firm
generate during 2014?
a. $383
b. $425
c. $468
d. $514
e. $566
ANSWER: b
RATIONALE: EBIT(1 − T) 2013 2014 Change = Net invest. in FA + NOWC
Total assets $2,000 $2,500 $500

2014 FCF = EBIT(1 − T) − Net investment in FA + NOWC

2014 FCF = $925 − $500
2014 FCF = $425

92. Shrives Publishing recently reported $10,750 of sales, $5,500 of operating costs other than depreciation, and
$1,250 of depreciation. The company had $3,500 of bonds that carry a 6.25% interest rate, and its federal-plus-
state income tax rate was 35%. During the year, the firm had expenditures on fixed assets and net operating
working capital that totaled $1,550. These expenditures were necessary for it to sustain operations and generate
future sales and cash flows. What was its free cash flow?
a. $1,873
b. $1,972
c. $2,076
d. $2,185
e. $2,300
ANSWER: e
RATIONALE: Bonds $ 3,500.00
Interest rate 6.25%
Tax rate 35.00%

Sales $10,750.00

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 Operating costs excluding depreciation 5,500.00
Depreciation 1,250.00
Operating income (EBIT) $ 4,000.00

Capex + ΔNOWC = $ 1,550.00

Tax rate = 35%

FCF = EBIT(1 − T) + Deprec. − (Capex + ΔNOWC)

FCF = $2,600 + $1,250 − $1,550 Free cash flow = $2,300

94. Hayes Corporation has $300 million of common equity, with 6 million shares of common stock outstanding.
If Hayes' Market Value Added (MVA) is $162 million, what is the company's stock price?
a. $66.02
b. $69.49
c. $73.15
d. $77.00
e. $80.85
ANSWER: d
RATIONALE: Total book value of equity $300,000,000
Shares outstanding 6,000,000
Market Value Added $162,000,000

Market value of equity = Stock price × Number of shares − Total BV of Equity

$162,000,000 = Stock price × 6,000,000 − $300,000,000
Stock price = $77.00

95. Byrd Lumber has 2 million shares of common stock outstanding that sell for $17 a share. If the company has
$40 million of common equity on its balance sheet, what is the company's Market Value Added (MVA)?
a. −$5,415,000
b. −$5,700,000
c. −$6,000,000
d. −$6,300,000
e. −$6,615,000
ANSWER: c
RATIONALE: Total book value of equity $40,000,000
Stock price per share $17.00
Shares outstanding 2,000,000

Market value of equity = Stock price × Number of shares $34,000,000

= Market value of equity − Book value of
MVA −$6,000,000
equity

96. Scranton Shipyards has $20 million in total invested operating capital, and its WACC is 10%. Scranton has
the following income statement:

Sales $10.0 million

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Operating costs 6.0 million
Operating income (EBIT) $ 4.0 million
Interest expense 2.0 million
Earnings before taxes (EBT) $ 2.0 million
Taxes (40%) 0.8 million
Net income $ 1.2 million
What is Scranton's EVA?
a. $400,000
b. $420,000
c. $441,000
d. $463,050
e. $486,203
ANSWER: a
RATIONALE: EBIT $4,000,000
Tax rate 40.00%
WACC 10.00%
Total invested capital $20,000,000

EVA = EBIT(1 − T) − (WACC × Total invested capital)

EVA = $2,400,000 − $2,000,000
EVA = $400,000

97. Casey Motors recently reported the following information:

∙ Net income = $600,000.

∙ Tax rate = 40%.
∙ Interest expense = $200,000.
∙ Total invested operating capital employed = $9 million.
∙ After-tax cost of capital = 10%.
What is the company's EVA?
a. −$171,000
b. −$180,000
c. −$189,000
d. −$198,450
e. −$208,373
ANSWER: b
RATIONALE: Net income $600,000
Interest expense $20,000
Total invested operating capital $9,000,000
Tax rate 40%
After-tax cost of capital 10%

EBT = Net income/(1 − T)

EBT = $1,000,000

EBIT = EBT + Interest

EBIT = $1,200,000
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 EVA = EBIT(1 − T) − (WACC × Total invested capital)
EVA = $720,000 − $900,000
EVA = −$180,000

112. Last year, Stewart-Stern Inc. reported $11,250 of sales, $4,500 of operating costs other than depreciation,
and $1,250 of depreciation. The company had $3,500 of bonds outstanding that carry a 6.5% interest rate, and
its federal-plus-state income tax rate was 35%. During last year, the firm had expenditures on fixed assets and
net operating working capital that totaled $2,000. These expenditures were necessary for it to sustain operations
and generate future sales and cash flows. This year's data are expected to remain unchanged except for one item,
depreciation, which is expected to increase by $725. By how much will the depreciation change cause (1) the
firm's net income and (2) its free cash flow to change? Note that the company uses the same depreciation for tax
and stockholder reporting purposes.
a. −$383.84; $206.68
b. −$404.04; $217.56
c. −$425.30; $229.01
d. −$447.69; $241.06
e. −$471.25; $253.75
ANSWER: e
RATIONALE: This problem can be worked very easily--just multiply the increase in depreciation by (1
− T) to get the decrease in net income, and then subtract this value from the change in
depreciation to get the change in free cash flow:

Change in depreciation $725

Tax rate 35.00%
Reduction in net income = Change in Deprec. (1 − Tax rate) −$471.25
Increase in free cash flow = Change in Deprec. − Reduction in NI $253.75

We can also get the answer the long way, which explains things in more detail:

Old New Change

Bonds $ 3,500 $ 3,500 $ 0.00
Interest rate 6.50% 6.50% 0.00
Tax rate 35% 35% 0.00
Capex + NOWC $ 2,000 $ 2,000 $ 0.00

Sales $11,250$11,250 $ 0.00

Operating costs excluding depreciation $ 4,500 $ 4,500 $ 0.00
Depreciation $ 1,250 $ 1,975 $725.00
Operating income (EBIT) $ 5,500 $ 4,775 −$725.00
Interest charges $ 228 $ 228 $ 0.00
Taxable income $ 5,273 $ 4,548 −$725.00
Taxes $ 1,845 $ 1,592 −$253.75
Net income $ 3,427 $ 2,956 −$471.25
Free cash flow = EBIT(1 − T) +
Deprec − [Capex + ΔNOWC] $ 2,825 $ 3,079 $253.75
Check on FCF: ΔFCF = Change in depreciation × Tax
$253.75
rate
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 We like this problem because it illustrates that an increase in depreciation will decrease
the firm's net income yet increase its free cash flow, and cash is king.

113. Watson Oil recently reported (in millions) $8,250 of sales, $5,750 of operating costs other than
depreciation, and $650 of depreciation. The company had $3,200 of outstanding bonds that carry a 5% interest
rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate
future sales and cash flows, the firm was required to make $1,250 of capital expenditures on new fixed assets
and to invest $300 in net operating working capital. By how much did the firm's net income exceed its free cash
flow?
a. $718
b. $756
c. $796
d. $836
e. $878
ANSWER: c
RATIONALE: Bonds $3,200
Interest rate 5%
Tax rate 35%
Required capital expenditures (fixed assets) $1,250
Required addition to net operating working capital $300

Sales $8,250.00
Operating costs excluding depreciation 5,750.00
Depreciation 650.00
Operating income (EBIT) $1,850.00
Interest charges 160.00
Taxable income (EBT) $1,690.00
Taxes 591.50
Net income $1,098.50

FCF = EBIT(1 − T) + Deprec. − Capex − ΔNOWC

FCF = $1,202.50 + $650 − $1,250 − -$300 = $302.50
Difference between net income and FCF = $796.00

114. For 2014, Bargain Basement Stores reported $11,500 of sales and $5,000 of operating costs (including
depreciation). The company has $20,500 of total invested capital, the weighted average cost of that capital (the
WACC) was 10%, and the federal-plus-state income tax rate was 40%. What was the firm's Economic Value
Added (EVA), i.e., how much value did management add to stockholders' wealth during 2014?
a. $1,670
b. $1,758
c. $1,850
d. $1,943
e. $2,040
ANSWER: c
RATIONALE: WACC 10.00%
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 Total invested capital $20,500
Sales $11,500
Operating costs including depreciation $5,000
Tax rate 40%

EBIT = Sales − Operating costs

EBIT = $6,500

EVA = EBIT(1 − T) − (WACC × Total invested capital)

EVA = $3,900 − $2,050
EVA = $1,850

Problems:

1. W.C. Cycling had $55,000 in cash at year-end 2017 and $25,000 in cash at year-end 2018. Cash flow from
long-term investing activities totaled ($250,000), and cash flow from financing activities totaled +$170,000.
a. What was the cash flow from operating activities?
b. If accruals increased by $25,000, receivables and inventories increased by $100,000, and depreciation
and amortization totaled $10,000, what was the firm’s net income?
Answer:
a. From the statement of cash flows the change in cash must equal cash flow from operating activities
plus long-term investing activities plus financing activities. First, we must identify the change in
cash as follows:
Cash at the end of the year $25,000
– Cash at the beginning of the year – 55,000
Change in cash -$30,000

The sum of cash flows generated from operations, investment, and financing must equal a negative
$30,000. Therefore, we can calculate the cash flow from operations as follows:
CF from operations  CF from investing  CF from financing =  in cash
CF from operations  $250,000  $170,000 = -$30,000
CF from operations = $50,000.

b. Since we determined that the firm’s cash flow from operations totaled $50,000 in Part a of this
problem, we can now calculate the firm’s net income as follows:
Increase in Increase in
NI  Depreciation  accrued  A/R and CF from
= operations
liabilitie s inventory
NI + $10,000 + $25,000 – $100,000 = $50,000
NI – $65,000 = $50,000
NI = $115,000.
2.

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Answer:

Working up the income statement you can calculate the new sales level would be $12,681,482.

Sales $12,681,482 S – 0.55S – Deprec. = EBIT

Operating costs (excl. Deprec.) 6,974,815 $12,681,482  0.55
Depreciation 880,000 $800,000  1.10
EBIT $ 4,826,667 $4,166,667 + $660,000
Interest 660,000 $600,000  1.10
EBT $ 4,166,667 $2,500,000/(1  0.4)
Taxes (40%) 1,666,667 $4,166,667  0.40
Net income $ 2,500,000

3.

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Answer:

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