Chapter 2

•Financial Statements, Taxes,

and Cash Flow

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
 Chapter 02 – Index of Sample
Problems
• Slide # 03 - 10 Understanding a balance sheet
• Slide # 11 - 12 Market value versus book value
• Slide # 13 - 18 Understanding an income statement
• Slide # 19 - 20 Earnings per share
• Slide # 21 - 22 Dividends per share
• Slide # 23 - 24 Average tax rate
• Slide # 25 - 26 Marginal tax rate
• Slide # 27 - 28 Operating cash flow
• Slide # 29 - 34 Net capital spending

(index continued on next slide)

Chapter 02 – Index of Sample
Problems
• Slide # 35 - 36 Change in net working capital
• Slide # 37 - 38 Cash flow from assets
• Slide # 39 - 41 Cash flow to creditors
• Slide # 43 - 44 Cash flow to stockholders
3: Understanding a balance sheet

Answer these questions based on the balance sheet shown on

slide # 4. Use 2005 values.

1. What is the amount of the current assets?

2. What is the amount of the long-term assets?
3. What is the amount of the current liabilities?
4. What is the amount of the long-term debt?
5. What is the amount of the stockholders’ equity?

Answers on slide # 5.
4: Understanding a balance sheet

WISDOM, INC.
Balance Sheets
($ in millions)

2004 2005 2004 2005

Assets Liabilities and Owners’ Equity

Cash $ 199 $ 203 Accounts payable $ 219 $ 187

Accounts receivable 436 421 Notes payable 193 546
Inventory 504 497 Total 412 733
Total 1,139 1,121 Long-term debt 470 533
Net fixed assets 1,574 1,633 Total 882 1,266

Common stock and paid

690 650
in surplus
Retained earnings 1,141 838
Total 1,831 1,488
Total assets Total liabilities and
$2,713 $2,754 $2,713 $2,754
owners’ equity
5: Understanding a balance sheet

Answers to questions from slide # 3.

Current assets for 2005  $203m  $421m  $497m

 $1,121m

Long term assets for 2005  $1,633m

Current liabilities for 2005  $187m  $546m

 $733m

Long - term debt for 2005  $533m

Stockholders' equity for 2005  $ 650m  $838m

 $1,488m
6: Understanding a balance sheet

The Dinmore Company has total assets of $6.4 million, current

assets of $2.3 million, current liabilities of $2.5 million and total
liabilities of $4.2 million.

1. What is the amount of the stockholders’ equity?

2. What is the amount of the net working capital?
3. What is the amount of the long-term assets?
4. What is the amount of the long-term debt?

Answers on slides # 7-8.

7: Understanding a balance sheet

Answers to slide # 6.

Stockholders' equity  Total assets - Total liabilities

 $6.4m - $4.2m
 $2.2m

Net working capital  Current assets - Current liabilities

 $2.3m - $2.5m
 - $0.2m
8: Understanding a balance sheet

Answers to slide # 6.

Long - term assets  Total assets - Current assets

 $6.4m - $2.3m
 $4.1m

Long - term liabilities  Total liabilities - Current liabilities

 $4.2m - $2.5m
 $1.7m
 9: Understanding a balance sheet

Your company has current assets of $250 million, total assets of

$395 million and long-term debt of $116 million. The net working
capital is $19 million.

1. What is the amount of the current liabilities?

2. What is the amount of the total equity?

Answers on slide # 10.

10: Understanding a balance sheet

Net working capital  Current assets - Current liabilities

Current liabilities  Current assets - Net working capital
 $250m - $19m
 $231m

Total liabilities  Current liabilities  Long - term liabilities

 $231m  $116m
 $347m

Total equity  Total assets - Total liabilities

 $395m - $347m
 $48m
 11: Market value vs book value

The balance sheet of your firm shows current assets of $214,500

which includes cash of $23,600, accounts receivable of $87,500
and inventory of $103,400. Long-term assets have a book value of
$487,300 which is comprised of a building and some equipment.

You believe you can sell the inventory for $163,900. You expect to
collect only $84,600 of the accounts receivables. You can sell the
equipment for $218,000 and the building for $365,000.

What is the total book value of your firm? The total market value?
12: Market value vs book value

Book Value Market Value

Current assets $214,500 $272,100

Long-term $487,300 $583,000

assets

Total assets $701,800 $855,100

13: Understanding an income
statement

MALLORY, INC.
2005 Income Statement
($ in millions)
Net sales $2,179
Cost of goods sold
1,806
Depreciation 139
Earnings before interest and taxes ???
Interest paid 48
Earnings before taxes ???
Taxes 63
Net income $ ???

Dividends paid $ 50
Addition to retained earnings $???

Can you find the missing values?

14: Understanding an income
statement

MALLORY, INC.
2005 Income Statement
($ in millions)
Net sales $2,179
Cost of goods sold
1,806
Depreciation 139
Earnings before interest and taxes 234
Interest paid 48
Earnings before taxes 186
Taxes 63
Net income $ 123

Dividends paid $50

Addition to retained earnings $73

Calculations shown on next slide

15: Understanding an income
statement
Earnings before interest and taxes  Net sales - Cost of goods sold - Depreciation
 $2,179m - $1,806m - $139m
 $234m

Earnings before taxes  Earnings before interest and taxes - Interest paid
 $234m - $48m
 $186m

Net income  Earnings before taxes - Taxes

 $186m - $63m
 $123m

Addition to retained earnings  Net income - Dividends

 $123m - $50m
 $73m
16: Understanding an income
statement
FISCHER, INC.
2005 Income Statement
($ in millions)

Net sales $1,067

Cost of goods sold
731
Depreciation 64
Earnings before interest and taxes ???
Interest paid 32
Earnings before taxes ???
Taxes ???
Net income $ ???

Dividends paid $ 35
Addition to retained earnings $ 121

Can you find the missing values?

17: Understanding an income
statement

FISCHER, INC.
2005 Income Statement
($ in millions)
Net sales $1,067
Cost of goods sold 731
Depreciation 64
Earnings before interest and taxes 272
Interest paid 32
Earnings before taxes 240
Taxes – 35% 84
Net income $ 156

Dividends paid $ 35
Addition to retained earnings $121
18: Understanding an income
statement
Net income  Dividends paid  Addition to retained earnings
 $35  $121
 $156

Net income
Earnings before taxes 
1 - Tax rate
$156

1  .35
$156

.65
 $240

Earnings before interest and taxes  Earnings before taxes  Interest paid
 $240  $32
 $272
 19: Earnings per share

Your firm has net income of $210,000. You own 140,000 shares of
stock and are the only stockholder.

What is the amount of your earnings per share?

20: Earnings per share

Net income
Earnings per share 
Number of shares outstanding
$210,000

140,000
 $1.50
 21: Dividends per share

Your firm has net income of $210,000. The number of outstanding

shares of common stock is 140,000. The dividend payout ratio is
40%.

What is the amount of the dividends per share?

22: Dividends per share

Net income  Dividend payout ratio

Dividends per share 
Number of shares outstanding
$210,000  .40

140,000
$84,000

140,000
 $0.60
 23: Average tax rate

Given this tax table, what is the average tax rate for a firm
with taxable income of $160,000?

Taxable Income Tax Rate

0- 50,000 15%

50,001- 75,000 25%

75,001- 100,000 34%

100,001- 335,000 39%

 24: Average tax rate

Taxable Income Tax Rate

$50,000  .15  $ 7,500 0- 50,000 15%

$25,000  .25  $ 6,250

50,001- 75,000 25%
$25,000  .34  $ 8,500
($160,000  $100,000)  .39  $23,400 75,001- 100,000 34%
Total tax  $45,650
100,001- 335,000 39%

Total tax
Average tax rate 
Taxable income
$45,650

$160,000
 .2853125
 28.53%
 25: Marginal tax rate

Given the information below, what is the marginal tax rate

if a firm has taxable income of $160,000?

Taxable Income Tax Rate

0- 50,000 15%

50,001- 75,000 25%

75,001- 100,000 34%

100,001- 335,000 39%

 26: Marginal tax rate

The marginal tax rate for a firm with taxable income of

$160,000 is 39%. The marginal tax rate is the rate that
applies to the next dollar of taxable income earned.

Taxable Income Tax Rate

0- 50,000 15%

50,001- 75,000 25%

75,001- 100,000 34%

100,001- 335,000 39%

 27: Operating cash flow

Your firm has sales of $231,800, costs of goods sold of

$187,000, interest expense of $3,600, depreciation expense of
$11,300 and a tax rate of 34%.

What is your operating cash flow?

 28: Operating cash flow

Sales $231,800
COGS 187,000
Depreciation 11,300
EBIT 33,500
Interest 3,600
EBT 29,900
Tax 34% 10,166 Tax  $29,900  .34  $10,166
Net Income $ 19,734

OCF  EBIT  Depreciation – Taxes

 $33,500  11,300 – 10,166
 $34,634
 29: Net capital spending

Your firm has ending net fixed assets of $467,803 and beginning
net fixed assets of $503,498. The depreciation expense for the year
is $59,200.

What is the amount of your net capital spending for the year?
 30: Net capital spending

Net capital spending  Ending net fixed assets - Beginning net fixed assets  Depreciation
 $467,803- $503,498 $59,200
 $23,505
31: Net capital spending

Net fixed assets, beginning $503,498

Less: Depreciation 59,200
Total 444,298
Plus: Net capital spending 23,505
Net fixed assets, ending $467,803
 32: Net capital spending

Your firm has beginning net fixed assets of $678,407 and ending
net fixed assets of $402,398. The depreciation expense for the year
is $75,380.

What is the amount of the net capital spending for the year?
 33: Net capital spending

Net capital spending  Ending net fixed assets - Beginning net fixed assets  Depreciation
 $402,398- $678,407  $75,380
 - $200,629
 34: Net capital spending

Net fixed assets, beginning $678,407

Less: Depreciation 75,380
Total 603,027
Plus: Net capital spending -200,629
Net fixed assets, ending $402,398

In this case, you had net sales of fixed assets.

 35: Change in net working capital

Given the following information what is the change in net working

capital (NWC)?

Beginning Ending
Cash $ 903 $ 789
Accounts receivable 3,298 3,672
Inventory 6,129 5,032
Net fixed assets 11,973 12,530
Accounts payable 1,542 1, 303
Long-term debt 10,200 9,300
36: Change in net working capital

Ending NWC  Ending current assets - Ending current liabilities

 $789  $3,672  $5,032 - $1,303
 $8,190

Beginning NWC  Beginning current assets - Beginnng current liabilities

 $903  $3,298  $6,129 - $1,542
 $8,788

Change in NWC  Ending NWC - Beginning NWC

 $8,190 - $8,788
 -$598
 37: Cash flow from assets

A firm has operating cash flow of $18,500, change in net working

capital of $300 and additions to net capital spending of -$1,200.

What is the amount of the cash flow from assets?

 38: Cash flow from assets

Cash flow from assets  Operating cash flow - Net capital spending - Change in net working capital
 $18,500 - (-$1,200) - $300
 $19,400
39: Cash flow to creditors
 40: Cash flow to creditors

Your firm has long-term debt of $42,900 as of year end. Your

beginning long-term debt was $38,900. During the year, the
company paid a total of $3,500 in interest.

What is the amount your cash flow to creditors?

 41: Cash flow to creditors

Cash flow to creditors  Interest paid - Net new borrowing

 Interest paid - (Ending long - term debt - Beginning long - term debt)
 $3,500 - ($42,900 - $38,900)
 -$500
42: Cash flow to stockholders
 43: Cash flow to stockholders

Your firm has a net income of $136,800 for the year. The dividend
payout ratio is 50%. The balance sheet shows an ending common
stock balance of $800,000 and an ending paid in surplus balance
of $400,000. The beginning common stock balance is $750,000 and
the beginning paid in surplus balance is $350,000.

What is the amount of your cash flow to stockholders?

 44: Cash flow to stockholders

Dividends paid  $136,800  .50  $68,400

CFS  Dividends - Net new equity

 Dividends - (Common stock  paid in surplus)End - (Common stock  paid in surplus)Begin
 $68,400 - ($800,000 $400,000- $750,000- $350,000)
 -$31,600
Chapter 2
• End of Chapter 2

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.