FIN 310 - Chapter 2 Questions - Answers
FIN 310 - Chapter 2 Questions - Answers
FIN 310 - Chapter 2 Questions - Answers
A. Liquidity measures the speed and ease with which assets can be converted to cash
without significant loss of value, and fortress balance sheets are especially liquid.
B. Even though depreciation is not a cash expense, it affects taxes, and corporations prefer
to depreciate assets using accelerated over straight line methods for tax purposes.
C. The marginal tax rate is the tax rate payable on the next dollar earned and is always
higher than the average tax rate.
D. Operating Cash Flow is generated from utilizing existing assets after deducting interest
expense
FALSE: Interest expense is not deducted for Operating Cash Flow
(b) Calculate the net capital expenditures for 2010. Briefly discuss or interpret it.
(c) Calculate the investment in working capital for 2010. Briefly discuss or interpret it.
(d) Calculate the Free Cash Flow From Assets for 2010. Briefly discuss or interpret it.
First calculate EBIT = Sales COGS SGA Depreciation = $19,570 9,460 2,130 = $7,980
Taxable Income subtracts interest expense: $7,980 1,620 = $6,360
Taxes at 35% of Taxable Income are 35% * 6,360 = $2,226
Net Income = Taxable Income Taxes = $6,360 2, 226 = $4,134
OCF = EBIT + Depreciation Taxes = $7,980 + 2,130 2,226 = $7,884
This positive Operating Cash Flow represents cash flowing into the company from current
operations.
Q2.P9. (5 points) Rotweiler Obedience Schools December 31, 2009 balance sheet showed net
fixed assets of $1,725,000 and the December 31, 2010 balance sheet showed net fixed asset of
$2,040,000. The companys 2010 income statement showed a depreciation expense of $321,000.
What was Rotweilers net capital spending for 2010? Does that represent cash flowing into or
flowing out of the company?
Q2.P10. (5 points) The December 31, 2009 balance sheet of Annas Tennis Shop, Inc., showed
current assets of $1,015 and current liabilities of $870. The December 31, 2010 balance sheet
showed current assets of $1,230 and current liabilities of $905. What was the companys 2010
change in net working capital? Does that represent cash flowing into or flowing out of the
company?
The change in net working capital is the end of period net working capital minus the beginning
of period net working capital:
NWC = $325 145 = $180 in 2010
This positive change in net working capital represents cash flowing out of the company to invest
in current operating assets.
Ch2.KP8. (8 points) Last year, Drumor, Inc. earned $20.4m. This year it has sales of $81.3m,
costs of goods sold of $60.7m, depreciation expense of $18.5m, and interest expense of $4.1m. If
the tax rate is 35%, what is its net income? What is its operating cash flow? Does that represent
cash flowing into or flowing out of the company?
First calculate EBIT = Sales COGS SGA Depreciation = $81.3 60.7 18.5 = $2.1m
Taxable Income subtracts interest expense: $2.1 4.1 = $2.0m
Taxes at 35% of Taxable Income are 35% * 2.0 = $0.7m, which is a refund and fully
recoverable immediately because Drumor earned a substantial profit last year.
Net Income = Taxable Income Taxes = $2.0 $0.7 = $1.3m
OCF = EBIT + Depreciation Taxes = 2.1 + 18.5 0.7 = +$21.3m
This positive Operating Cash Flow represents cash flowing into the company from current
operations. Even though net income is negative, depreciation is non-cash and taxes in this case
provided a refund.
Ch2.KP9. (5 points) Drumors current balance sheet showed net fixed assets of $160.4m and its
balance sheet last year showed net fixed asset of $174.3m. The companys income statement this
year showed a depreciation expense of $18.5m . What was Drumors net capital spending for the
current year? Does that represent cash flowing into or flowing out of the company?
b) Combined, how much did the firm spend in 2013 on new investments in both net working
capital and in net capital expenditures?
c) Calculate the firms Free Cash Flows from assets. Briefly discuss or interpret it. AND briefly
discuss how it was either paid for or used (hint in this case: if its Free Cash Flows were negative,
what balance(s) increased, or if its FCFs were positive, what decreased?)
The firms operating cash flow from existing assets generated $66m, and combined with its $8m
recovered investment in assets for future operations, its Free Cash Flows, available to be paid to
investors, amounted to $74m.
FCF = OCF (CapEx + NWA) = 66 (8) = +74
Of that amount, $6m was paid in interest on debt and $2m was paid in dividends to equity
holders. The remainder $66m reduced the debt balance and/or the common & paid-in equity: The
debt balance actually decreased by $54m and the equity balance decreased by $12m. Not only
did this firm pay interest to debt holders and dividends to equity holders, this firm paid down its
debt balance a lot and even (depending on accounting conventions) bought back some shares.
Ch2.Hwk4b. (12 points) Roscoe's purchased new machinery three years ago for $1.8 million.
The machinery can be sold to Stewart's today for $1.2 million. Roscoe's current balance sheet
shows net fixed assets of $840,000, current liabilities of $348,000, and net working capital of
$144,000. If all the current assets were liquidated today, the company would receive $476,000
cash. What is the book value of the firm's assets today? What is the market value? If these values
are not the same, briefly discuss why they differ.
The purchase price of the machinery has been depreciated to $840,000 on the current balance
sheet
Since NWC = CA CL, CA = NWC + CL = $144,000 + $348,000 = $492,000
Book value = $840,000 + $492,000 = $1,332,000
Market value = $1,200,000 + $476,000 = $1,676,000
The market value of assets is their current liquidation or sale value, which must always be
positive.
Market values can be higher or lower than book values, which generally reflect their historical
costs.
2.T76. (6 points) Caldweiler & Co. owes a total of $21,684 in taxes for this year. The taxable
income is $72,000. If the firm earns $100 more in income, it will owe an additional $36 in taxes.
a) What will its average tax rate be on income of $72,100?
b) What is its marginal tax rate? Briefly compare these tax rates.
Marginal tax rate = $36 / $100 = 36%
The marginal tax rate is the tax on the next increment of income and is larger than the average
tax rate.