Chapter 2, Problem 26QP

Summary Introduction

To calculate: The cash flow from assets, the cash flow to creditors, and the cash flow to stockholders for the year 2011

Introduction:

The cash flow refers to the difference between the money that comes in and goes out of the firm. The cash flow from assets refers to the difference between the revenues from the sale of assets and the money invested in purchasing the assets

The cash flow to the creditors refers to the interest paid to the creditors minus the net fresh debt borrowed by the company. The cash flow to the stockholders refers to the dividend paid to the shareholders of the company minus the fresh equity raised by the company.

Answer to Problem 26QP

The cash flow from assets for the year 2011 is ($1,886.62). The cash flow to creditors for the year 2011 is ($3,450). The cash flow to stockholders’ for the year 2011 is $1,560.38.

Explanation of Solution

Given information:

Particulars	2010	2011
Sales	$11,573	$12,936
Cost of goods sold	$3,979	$4,707
Other expenses	$946	$824
Depreciation	$1,661	$1,736
Interest	$776	$926
Dividends	$1,411	$1,618
Cash	$6,067	$6,466
Accounts receivable	$8,034	$9,427
Inventory	$14,283	$15,288
Net fixed assets	$50,888	$54,273
Accounts payable	$4,384	$4,644
Short-term notes payable	$1,171	$1,147
Long-term debt	$20,320	$24,696

Prepare the income statement for 2010:

Company T
Income statement for the year 2010
Particulars	Amount	Amount
Net sales		$11,573.00
Less:
Costs	$3,979.00
Other expenses	$946.00
Depreciation	$1,661.00	$6,586.00
Earnings before interest and taxes		$4,987.00
Less: Interest paid		$776.00
Taxable income		$4,211.00
Less: Taxes ($4,211×34%)		$1,431.74
Net income (A)		$2,779.26
Dividends (B)		$1,411.00
Addition to retained earnings (A)−(B)		$1,368.26

Hence, the net income for 2010 is $2,779.26.

Prepare the income statement for 2011:

Company T
Income statement for the year 2011
Particulars	Amount	Amount
Net sales		$12,936.00
Less:
Costs	$4,707.00
Other expenses	$824.00
Depreciation	$1,736.00	$7,267.00
Earnings before interest and taxes		$5,669.00
Less: Interest paid		$926.00
Taxable income		$4,743.00
Less: Taxes ($4,743×34%)		$1,612.62
Net income (A)		$3,130.38
Dividends (B)		$1,618.00
Addition to retained earnings (A)−(B)		$1,512.38

Hence, the net income for 2011 is $3,130.38.

Prepare the balance sheet for 2010:

Company T
Balance sheet
For the year 2010
Assets	Amount	Liabilities	Amount
Current assets		Current liabilities
Cash	$6,067.00	Accounts payable	$4,384.00
Accounts receivable	$8,034.00	Short-term notes payable	$1,171.00
Inventory	$14,283.00	Total	$5,555.00
Total (A)	$28,384.00
		Long-term debt	$20,320.00
Fixed assets
Tangible net fixed assets (B)	$50,888.00	Shareholders' equity
		Common stock (Balance)	$52,028.74
		Addition to Retained earnings	$1,368.26
		Total	$53,397.00
Total assets (A)+(B)	$79,272.00	Total liabilities and shareholders' equity	$79,272.00

Hence, the total assets of Company T is 2010 is $79,272.

Compute the common stock for 2010:

$\begin{array}{c}\text{Common stock}=\left(\begin{array}{l}\text{Total liabilities and}\\ \text{shareholders' equity}\end{array}\right)-\left(\begin{array}{l}\text{Current}\\ \text{liabilities}\end{array}\right)-\left(\begin{array}{l}\text{Long-term}\\ \text{debt}\end{array}\right)-\left(\begin{array}{l}\text{retained}\\ \text{earnings}\end{array}\right)\\ =\$79,272-\$5,555-\$20,320-\$1,368.26\\ =\$52,028.74\end{array}$

Hence, the common stock of Company T for 2010 is $52,028.74.

Prepare the balance sheet for 2011:

Company T
Balance sheet
For the year 2011
Assets	Amount	Liabilities	Amount
Current assets		Current liabilities
Cash	$6,466.00	Accounts payable	$4,644.00
Accounts receivable	$9,427.00	Short-term notes payable	$1,147.00
Inventory	$15,288.00	Total	$5,791.00
Total (A)	$31,181.00
		Long-term debt	$24,696.00
Fixed assets
Tangible net fixed assets (B)	$54,273.00	Shareholders' equity
		Common stock (Balance)	$52,086.36
		Addition to Retained earnings	$2,880.64
		Total	$54,967.00
Total assets (A)+(B)	$85,454.00	Total liabilities and shareholders' equity	$85,454.00

Hence, the total assets of Company T is 2011 is $85,454.

Compute the retained earnings for 2011:

$\begin{array}{c}\begin{array}{l}\text{Retained earnings}\\ \text{in 2015}\end{array}\}=\text{Retained earnings in 2010}+\text{Addition to retained earnings}\\ =\$1,368.26+\$1,512.38\\ =\$2,880.64\end{array}$

Hence, the retained earnings of Company T for 2011 are $2,880.64.

Compute the common stock for 2011:

$\begin{array}{c}\text{Common stock}=\left(\begin{array}{l}\text{Total liabilities and}\\ \text{shareholders' equity}\end{array}\right)-\left(\begin{array}{l}\text{Current}\\ \text{liabilities}\end{array}\right)-\left(\begin{array}{l}\text{Long-term}\\ \text{debt}\end{array}\right)-\left(\begin{array}{l}\text{retained}\\ \text{earnings}\end{array}\right)\\ =\$85,454-\$5,791-\$24,696-\$2,880.64\\ =\$52,086.36\end{array}$

Hence, the common stock of Company T for 2011 is $52,086.36.

Formulae:

The formula to calculate the net new borrowing and the cash flow to creditors:

$\text{Net new borrowing}=\text{Long-term debt at the end}-\text{Long-term debt at the beginning}$

$\text{Cash flow to creditors}=\text{Interest paid}-\text{Net new borrowing}$

The formula to calculate the new equity raised and the cash flow to stockholders:

$\text{Net new equity raised}=\text{Common equity at the end}-\text{Common equity at the beginning}$

$\text{Cash flow to stockholders'}=\text{Dividends paid}-\text{Net new equity raised}$

The formula to calculate the cash flow from assets:

$\text{Cash flow from assets}=\text{Cash flow to creditors}+\text{Cash flow to stockholders'}$

Compute the net new borrowing at the end of 2011:

The long-term debt in the balance sheet of Company T in 2010 was $20,320. The company had long-term debt worth $24,696 in 2011.

$\begin{array}{c}\text{Net new borrowing}=\text{Long-term debt in 2015}-\text{Long-term debt in 2014}\\ =\$24,696-\$20,320\\ =\$4,376\end{array}$

Hence, the net new borrowing is $4,376.

Compute the cash flow to creditors in 2011:

The interest expense of Company T in 2011 was $926.

$\begin{array}{c}\text{Cash flow to creditors}=\text{Interest paid}-\text{Net new borrowing}\\ =\$926-\$4,376\\ =\left(\$3,450\right)\end{array}$

Hence, the cash flow to creditors is ($3,450).

Compute the net new equity raised in 2011:

The common equity in 2010 is 52,028.74 (Refer to the balance sheet of 2010 in the solution) and the common equity in 2011 is $52,086.36 (Refer to the balance sheet of 2011 in the solution).

$\begin{array}{c}\text{Net new equity raised}=\text{Common equity at the end}-\text{Common equity at the beginning}\\ =\$52,086.36-\$52,028.74\\ =\$57.62\end{array}$

Hence, the net new equity raised is $57.62.

Compute the cash flow to stockholders’ in 2011:

The company paid $1,618 as dividends in the year 2011.

$\begin{array}{c}\text{Cash flow to stockholders'}=\text{Dividends paid}-\text{Net new equity raised}\\ =\$1,618-\$57.62\\ =\$1,560.38\end{array}$

Hence, the cash flow to stockholders’ is $1,560.38.

Compute the cash flow from assets:

$\begin{array}{c}\text{Cash flow from assets}=\text{Cash flow to creditors}+\text{Cash flow to stockholders'}\\ =(\$3,450)+\$1,560.38\\ =\left(\$1,889.62\right)\end{array}$

Hence, the cash flow from assets is ($1,889.62).