Chapter 2, Problem 2CC

1)

Summary Introduction

Case summary:

Company SB manufactures surf boards. It was founded by Person T. Initially, the company was funded by his own family, and hence, there were no detailed financial statements maintained by the company. Presently, the company plans to expand its business by raising equity and debt.

The company hires a financial analyst named Person PW to evaluate the company’s performance. Person PW collects the following information about the company:

Particulars	2013	2014
Sales	$3,334,260	$406,427
Cost of goods sold	$169,969	$214,607
Selling and administrative expenses	$33,425	$43,626
Depreciation	$47,980	$54,230
Interest	$10,442	$11,954
Cash	$24,524	$26,056
Accounts receivable	$17,378	$22,542
Inventory	$36,570	$50,185
Net fixed assets	$211,680	$264,021
Accounts payable	$43,344	$48,090
Short-term notes payable	$19,757	$21,571
Long-term debt	$106,848	$119,976
New equity	$0	$20,160

Characters in the case:

• Company SB
• Person T: Owner of Company SB
• Person PW: Financial analyst

To prepare: The income statement of Company SB for the years2013 and 2014.

Introduction:

The income statement indicates the performance of an organization for a short period. In other words, the income statement helps to determine the income of an organization for a given accounting period.

Answer to Problem 2CC

The net income for 2013 and 2014 is $57,288 and $65,608.

Explanation of Solution

Given information:

The tax rate of Company S is 20 percent. The company pays out 50 percent of the net income as dividend.

Prepare the income statement for 2013:

Income statement for the year 2013
Particulars	Amount	Amount
Net sales		$333,426.00
Less:
Costs	$169,969.00
Selling and administrative expenses	$33,425.00
Depreciation	$47,980.00	$251,374.00
Earnings before interest and taxes		$82,052.00
Less: Interest paid		$10,442.00
Taxable income		$71,610.00
Less: Taxes ($71,610×20%)		$14,322.00
Net income (A)		$57,288.00
Dividends (B) = (A)×50%		$28,644.00
Addition to retained earnings (A)−(B)		$28,644.00

Hence, the net income for 2013 is $57,288.

Prepare the income statement for 2014:

Income statement for the year 2014
Particulars	Amount	Amount
Net sales		$406,427.00
Less:
Costs	$214,607.00
Selling and administrative expenses	$43,626.00
Depreciation	$54,230.00	$312,463.00
Earnings before interest and taxes		$93,964.00
Less: Interest paid		$11,954.00
Taxable income		$82,010.00
Less: Taxes ($98,412×34%)		$16,402.00
Net income (A)		$65,608.00
Dividends (B) = (A)×50%		$32,804.00
Addition to retained earnings (A)−(B)		$32,804.00

Hence, the net income for 2014 is $65,608.

2)

Summary Introduction

To prepare: The balance sheet of Company SB for the year 2013 and 2014

Introduction:

The balance sheet refers to the statement that indicates the financial position of the firm.

Explanation of Solution

Prepare the balance sheet for 2013:

Balance sheet
For the year 2013
Assets	Amount	Liabilities	Amount
Current assets		Current liabilities
Cash	$24,524	Accounts payable	$48,090
Accounts receivable	$17,378	Short-term notes payable	$21,571
Inventory	$36,570	Total	$69,661
Total (A)	$78,472
		Long-term debt	$119,976
Fixed assets
Tangible net fixed assets (B)	$211,680	Shareholders' equity
		Common stock (Balancing figure)	$71,871
		Addition to retained earnings	$28,644.
		Total	$100,515
Total assets (A)+(B)	$290,152	Total liabilities and shareholders' equity	$290,152

Prepare the balance sheet for 2014:

Note: The retained earnings for the year 2014 are the sum of addition to retained earnings of 2013 and the addition to retained earnings of 2014.

Balance sheet
For the year 2014
Assets	Amount	Liabilities	Amount
Current assets		Current liabilities
Cash	$26,056	Accounts payable	$48,090
Accounts receivable	$22,542	Short-term notes payable	$21,571
Inventory	$50,185	Total	$69,661
Total (A)	$98,783
		Long-term debt	$119,976
Fixed assets
Tangible net fixed assets (B)	$264,021	Shareholders' equity
		Common stock (Balancing figure)	$111,719
		Addition to Retained earnings    ($28,644+$32,804)	$61,448
		Total	$173,167
Total assets (A)+(B)	$362,804	Total liabilities and shareholders' equity	$362,804

3)

Summary Introduction

To calculate: The operating cash flow for 2013 and 2014

Answer to Problem 2CC

The operating cash flow for 2013 is $116,710. The operating cash flow for 2014 is $131,792.

Explanation of Solution

Given information:

Refer Part 1 for income statement items for the years 2013 and 2014.

Compute the operating cash flow for 2013:

Operating cash flow for 2013
Particulars	Amount
Earnings before interest and taxes	$83,052
Add: Depreciation	$47,980
	$131,032
Less: Taxes	$14,322
Operating cash flow	$116,710

Hence, the operating cash flow is $116,710.

Compute the operating cash flow for 2014:

Operating cash flow for 2014
Particulars	Amount
Earnings before interest and taxes	$93,964
Add: Depreciation	$54,230
	$148,194
Less: Taxes	$16,402
Operating cash flow	$131,792

Hence, the operating cash flow is $131,792.

4)

Summary Introduction

To calculate: The cash flow from assets

Answer to Problem 2CC

The cash flow from assets for 2014 is $8,701.

Explanation of Solution

Formulae:

The formula to calculate the ending net working capital:

$\text{Ending net working capital}=\text{Ending current assets}-\text{Ending current liabilities}$

The formula to calculate the beginning net working capital:

$\text{Beginning net working capital}=\text{Beginning current assets}-\text{Beginning current liabilities}$

The formula to calculate the change in net working capital:

$\text{Change in net working capital}=\left(\begin{array}{l}\text{Ending net working capital}-\\ \text{Beginning net working capital}\end{array}\right)$

The formula to calculate the cash flow from assets:

$\text{Cash flow from assets}=\left(\begin{array}{l}\text{Operating}\\ \text{cash flow}\end{array}\right)-\left(\begin{array}{l}\text{Change in net}\\ \text{working capital}\end{array}\right)-\left(\begin{array}{l}\text{Net capital}\\ \text{spending}\end{array}\right)$

Compute the net capital spending:

Net capital spending
Particulars	Amount
Ending net fixed assets	$264,021
Less: Beginning net fixed assets	$211,680
	$52,341
Add: Depreciation	$54,230
Net capital spending	$106,571

Hence, the net capital spending is $106,571.

Compute the ending net working capital:

$\begin{array}{c}\text{Ending net working capital}=\text{Ending current assets}-\text{Ending current liabilitie}s\\ =\$98,783-\$69,661\\ =\$29,122\end{array}$

Hence, the ending net working capital is $29,122.

Compute the beginning net working capital:

$\begin{array}{c}\text{Beginning net working capital}=\text{Beginning current assets}\\ -\text{Beginning current liabilities}\\ =\$78,472-\$69,661\\ =\$8,811\end{array}$

Hence, the beginning net working capital is $8,811.

Compute the change in net working capital:

$\begin{array}{c}\text{Change in net working capital}=\left(\begin{array}{l}\text{Ending net working capital}-\\ \text{Beginning net working capital}\end{array}\right)\\ =\$29,122-\$8,811\\ =\$20,311\end{array}$

Hence, the change in net working capital is $20,311.

Compute the cash flow from assets:

The operating cash flow is $131,792,the change in net working capital is $16,502 and the net capital spending is $106,571.

$\begin{array}{c}\text{Cash flow from assets}=\left(\begin{array}{l}\text{Operating}\\ \text{cash flow}\end{array}\right)-\left(\begin{array}{l}\text{Change in net}\\ \text{working capital}\end{array}\right)-\left(\begin{array}{l}\text{Net capital}\\ \text{spending}\end{array}\right)\\ =\$131,792-\$16,520-\$106,571\\ =\$8,701\end{array}$

Hence, the cash flow from assets is $8,701.

5)

Summary Introduction

To calculate: The cash flow to creditors

Answer to Problem 2CC

The cash flow to creditors is −$1,174.

Explanation of Solution

Given information:

Company SB has to pay interest expenses amounting to $11,954. The new net borrowings were $13,128$\left(\$119,976-\$106,848\right)$.

Formula:

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

Compute the cash flow to creditors:

$\begin{array}{c}\text{Cash flow to creditors}=\text{Interest paid}-\text{Net new borrowing}\\ =\$11,954-\$13,128\\ =\left(\$1,174\right)\end{array}$

Hence, the cash flow to creditors is −$1,174.

6)

Summary Introduction

To calculate: The cash flow to stockholders

Answer to Problem 2CC

The cash flow to stockholders is $12,644.

Explanation of Solution

Given information:

Company S paid dividends amounting to $32,804.00. It issued new equity worth $20,160.

Formula:

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

Compute the cash flow to stockholders:

$\begin{array}{c}\text{Cash flow to stockholders'}=\text{Dividends paid}-\text{Net new equity raised}\\ =\$32,804-\$20,160\\ =\$12,644\end{array}$

Hence, the cash flow to stockholders is $12,644.

Summary Introduction

To discuss: The cash flows of the company

Explanation of Solution

The earnings of the company were positive. It also had a positive cash flow from operations. The company paid $12,644 to the stockholders. The cash flow to creditors is negative. Hence, it raised $1,174 from creditors. The investment in net working capital was $20,311. It also invested $106,571 in fixed assets.

Summary Introduction

To discuss: The expansion plans of Person T

Explanation of Solution

Although Company SB has positive cash flow from operating activities, most of it goes for meeting the capital needs. The company is already using its cash flow to build assets. Moreover, it is raising additional capital from creditors through bonds. The expansion plans are risky because of the increased capital spending.