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 the 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 J to evaluate the performance of the company. Person J collects the following information about the company:

Particulars	2015	2016
Sales	$400,111	$487,712
Cost of goods sold	$203,963	$257,528
Selling and administrative expenses	$40,110	$52,351
Depreciation	$57,576	$65,076
Interest	$12,530	$14,345
Cash	$29,429	$31,267
Accounts receivable	$20,854	$27,050
Inventory	$43,884	$60,222
Net fixed assets	$254,017	$316,825
Accounts payable	$52,015	$57,708
Short-term notes payable	$23,708	$25,885
Long-term debt	$128,218	$143,971
New equity	$0	$24,192

Characters in the case:

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

To prepare: The income statement of Company S for the year 2015 and 2016.

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 2015 and 2016 is $68,745.60 and $78,729.60 respectively.

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.

Particulars	2015	2016
Sales	$400,111	$487,712
Cost of goods sold	$203,963	$257,528
Selling and administrative expenses	$40,110	$52,351
Depreciation	$57,576	$65,076
Interest	$12,530	$14,345
Cash	$29,429	$31,267
Accounts receivable	$20,854	$27,050
Inventory	$43,884	$60,222
Net fixed assets	$254,017	$316,825
Accounts payable	$52,015	$57,708
Short-term notes payable	$23,708	$25,885
Long-term debt	$128,218	$143,971
New equity	$0	$24,192

Prepare the income statement for 2015:

Company S
Income statement for the year 2015
Particulars	Amount	Amount
Net sales		$400,111.00
Less:
Costs	$203,963.00
Selling and administrative expenses	$40,110.00
Depreciation	$57,576.00	$301,649.00
Earnings before interest and taxes		$98,462.00
Less: Interest paid		$12,530.00
Taxable income		$85,932.00
Less: Taxes ($85,932×20%)		$17,186.40
Net income(A)		$68,745.60
Dividends(B)=(A)×50%		$34,372.80
Addition to retained earnings(A)−(B)		$34,372.80

Hence, the net income for 2015 is $68,745.60.

Prepare the income statement for 2016:

Company S
Income statement for the year 2016
Particulars	Amount	Amount
Net sales		$487,712.00
Less:
Costs	$257,528.00
Selling and administrative expenses	$52,351.00
Depreciation	$65,076.00	$374,955.00
Earnings before interest and taxes		$112,757.00
Less: Interest paid		$14,345.00
Taxable income		$98,412.00
Less: Taxes ($98,412×34%)		$19,682.40
Net income(A)		$78,729.60
Dividends(B)=(A)×50%		$39,364.80
Addition to retained earnings(A)−(B)		$39,364.80

Hence, the net income for 2016 is $78,729.60.

2)

Summary Introduction

Case summary:

Company SB manufactures surf boards. It was founded by Person T. Initially, the company was funded by the 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 J to evaluate the performance of the company. Person J collects the following information about the company:

Particulars	2015	2016
Sales	$400,111	$487,712
Cost of goods sold	$203,963	$257,528
Selling and administrative expenses	$40,110	$52,351
Depreciation	$57,576	$65,076
Interest	$12,530	$14,345
Cash	$29,429	$31,267
Accounts receivable	$20,854	$27,050
Inventory	$43,884	$60,222
Net fixed assets	$254,017	$316,825
Accounts payable	$52,015	$57,708
Short-term notes payable	$23,708	$25,885
Long-term debt	$128,218	$143,971
New equity	$0	$24,192

Characters in the case:

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

To prepare: The balance sheet of Company S for the year 2015 and 2016.

Introduction:

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

Answer to Problem 2CC

The total assets of the company for the year 2015 and 2016 are $348,184 and $435,364 respectively.

Explanation of Solution

Given information:

Particulars	2015	2016
Sales	$400,111	$487,712
Cost of goods sold	$203,963	$257,528
Selling and administrative expenses	$40,110	$52,351
Depreciation	$57,576	$65,076
Interest	$12,530	$14,345
Cash	$29,429	$31,267
Accounts receivable	$20,854	$27,050
Inventory	$43,884	$60,222
Net fixed assets	$254,017	$316,825
Accounts payable	$52,015	$57,708
Short-term notes payable	$23,708	$25,885
Long-term debt	$128,218	$143,971
New equity	$0	$24,192

Prepare the balance sheet for 2015:

Company S
Balance sheet
For the year 2015
Assets	Amount	Liabilities	Amount
Current assets		Current liabilities
Cash	$29,429.00	Accounts payable	$52,015.00
Accounts receivable	$20,854.00	Short-term notes payable	$23,708.00
Inventory	$43,884.00	Total	$75,723.00
Total(A)	$94,167.00
		Long-term debt	$128,218.00
Fixed assets
Tangible net fixed assets(B)	$254,017.00	Shareholders' equity
		Common stock (Balance)	$109,870.20
		Addition to Retained earnings	$34,372.80
		Total	$144,243.00
Total assets(A)+(B)	$348,184.00	Total liabilities and shareholders' equity	$348,184.00

Hence, the total assets of Company S is 2015 is $348,184.

Prepare the balance sheet for 2016:

The retained earnings for the year 2016 is the sum of addition to retained earnings of 2015 and the addition to retained earnings of 2016. The common stock of 2016 includes the new equity raised amounting to $24,192.

Company S
Balance sheet
For the year 2016
Assets	Amount	Liabilities	Amount
Current assets		Current liabilities
Cash	$31,267.00	Accounts payable	$57,708.00
Accounts receivable	$27,050.00	Short-term notes payable	$25,885.00
Inventory	$60,222.00	Total	$83,593.00
Total(A)	$118,539.00
		Long-term debt	$143,971.00
Fixed assets
Tangible net fixed assets (B)	$316,825.00	Shareholders' equity
		Common stock (Balance)	$134,062.40
		Addition to Retained earnings	$73,737.60
		Total	$207,800.00
Total assets(A)+(B)	$435,364.00	Total liabilities and shareholders' equity	$435,364.00

Hence, the total assets of Company S are 2016 is $435,364.

3)

Summary Introduction

Case summary:

Company SB manufactures surf boards. It was founded by Person T. Initially, the company was funded by the 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 J to evaluate the performance of the company. Person J collects the following information about the company:

Particulars	2015	2016
Sales	$400,111	$487,712
Cost of goods sold	$203,963	$257,528
Selling and administrative expenses	$40,110	$52,351
Depreciation	$57,576	$65,076
Interest	$12,530	$14,345
Cash	$29,429	$31,267
Accounts receivable	$20,854	$27,050
Inventory	$43,884	$60,222
Net fixed assets	$254,017	$316,825
Accounts payable	$52,015	$57,708
Short-term notes payable	$23,708	$25,885
Long-term debt	$128,218	$143,971
New equity	$0	$24,192

Characters in the case:

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

To calculate: The operating cash flow for 2015 and 2016.

Answer to Problem 2CC

The operating cash flow for 2015 is $139,032. The operating cash flow for 2016 is $158,151.

Explanation of Solution

Given information:

The earnings before interest and taxes is $98,462 and $112,757 for the year 2015 and 2016 respectively. The depreciation is $57,576 and $65,076 for the year 2015 and 2016 respectively. The taxes are $17,186 and $19,682 for the year 2015 and 2016 respectively.

Compute the operating cash flow for 2015:

Company S
Operating cash flow for 2015
Particulars	Amount
Earnings before interest and taxes	$98,642
Add: Depreciation	$57,576
	$156,218
Less: Taxes	$17,186
Operating cash flow	$139,032

Hence, the operating cash flow is $139,032.

Compute the operating cash flow for 2016:

Company S
Operating cash flow for 2016
Particulars	Amount
Earnings before interest and taxes	$112,757
Add: Depreciation	$65,076
	$177,833
Less: Taxes	$19,682
Operating cash flow	$158,151

Hence, the operating cash flow is $158,151.

4)

Summary Introduction

Case summary:

Company SB manufactures surf boards. It was founded by Person T. Initially, the company was funded by the 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 J to evaluate the performance of the company. Person J collects the following information about the company:

Particulars	2015	2016
Sales	$400,111	$487,712
Cost of goods sold	$203,963	$257,528
Selling and administrative expenses	$40,110	$52,351
Depreciation	$57,576	$65,076
Interest	$12,530	$14,345
Cash	$29,429	$31,267
Accounts receivable	$20,854	$27,050
Inventory	$43,884	$60,222
Net fixed assets	$254,017	$316,825
Accounts payable	$52,015	$57,708
Short-term notes payable	$23,708	$25,885
Long-term debt	$128,218	$143,971
New equity	$0	$24,192

Characters in the case:

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

To calculate: The cash flow from assets

Answer to Problem 2CC

The cash flow from assets for 2016 is $13,765.

Explanation of Solution

Formulae:

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

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

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

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

Compute the net capital spending:

Company S
Net capital spending
Particulars	Amount
Ending net fixed assets	$316,825
Less: Beginning net fixed assets	$254,017
	$62,808
Add: Depreciation	$65,076
Net capital spending	$127,884

Hence, the net capital spending is $127,884.

Compute the ending net working capital:

$\begin{array}{c}\text{Ending net working capital}=\text{Ending current assets}-\text{Ending current liabilities}\\ =\$118,539-\$83,593\\ =\$34,946\end{array}$

Hence, the ending net working capital is $34,946.

Compute the beginning net working capital:

$\begin{array}{c}\text{Beginning net working capital}=\text{Beginning current assets}-\text{Beginning current liabilities}\\ =\$94,167-\$75,723\\ =\$18,444\end{array}$

Hence, the beginning net working capital is $18,444.

Compute the change in net working capital:

$\begin{array}{c}\text{Change in net working capital}=\left(\begin{array}{l}\text{Ending net working capital}-\\ \text{Beginning net working capital}\end{array}\right)\\ =\$34,946-\$18,444\\ =\$16,502\end{array}$

Hence, the change in net working capital is $16,502.

Compute the cash flow from assets:

The operating cash flow is $158,151. The change in net working capital is $16,502, and the net capital spending is $127,884.

$\begin{array}{c}\text{Cash flow from assets}=\left(\begin{array}{l}\text{Operating}\\ \text{cash flow}\end{array}\right)-\left(\begin{array}{l}\text{Change in net}\\ \text{working capital}\end{array}\right)-\left(\begin{array}{l}\text{Net capital}\\ \text{spending}\end{array}\right)\\ =\$158,151–\$16,502–\$127,884\\ =\$13,765\end{array}$

Hence, the cash flow from assets is $13,765.

5)

Summary Introduction

Case summary:

Company SB manufactures surf boards. It was founded by Person T. Initially, the company was funded by the 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 J to evaluate the performance of the company. Person J collects the following information about the company:

Particulars	2015	2016
Sales	$400,111	$487,712
Cost of goods sold	$203,963	$257,528
Selling and administrative expenses	$40,110	$52,351
Depreciation	$57,576	$65,076
Interest	$12,530	$14,345
Cash	$29,429	$31,267
Accounts receivable	$20,854	$27,050
Inventory	$43,884	$60,222
Net fixed assets	$254,017	$316,825
Accounts payable	$52,015	$57,708
Short-term notes payable	$23,708	$25,885
Long-term debt	$128,218	$143,971
New equity	$0	$24,192

Characters in the case:

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

To calculate: The cash flow to creditors.

Answer to Problem 2CC

The cash flow to creditors is ($1,408).

Explanation of Solution

Given information:

Company S had to pay interest expenses amounting to $14,345. The new net borrowings were $15,753$(\$143,971-\$128,218)$.

Formula:

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

Compute the cash flow to creditors:

$\begin{array}{c}\text{Cash flow to creditors}=\text{Interest paid}-\text{Net new borrowing}\\ =\$14,345-\$15,753\\ =\left(\$1,408\right)\end{array}$

Hence, the cash flow to creditors is ($1,408).

6)

Summary Introduction

Case summary:

Company SB manufactures surf boards. It was founded by Person T. Initially, the company was funded by the 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 J to evaluate the performance of the company. Person J collects the following information about the company:

Particulars	2015	2016
Sales	$400,111	$487,712
Cost of goods sold	$203,963	$257,528
Selling and administrative expenses	$40,110	$52,351
Depreciation	$57,576	$65,076
Interest	$12,530	$14,345
Cash	$29,429	$31,267
Accounts receivable	$20,854	$27,050
Inventory	$43,884	$60,222
Net fixed assets	$254,017	$316,825
Accounts payable	$52,015	$57,708
Short-term notes payable	$23,708	$25,885
Long-term debt	$128,218	$143,971
New equity	$0	$24,192

Characters in the case:

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

To calculate: The cash flow to stockholders.

Answer to Problem 2CC

The cash flow to stockholders is $15,173.

Explanation of Solution

Given information:

Company S paid dividends amounting to $39,364.8. It issued new equity worth $24,192.

Formula:

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

Compute the cash flow to stockholders:

$\begin{array}{c}\text{Cash flow to stockholders'}=\text{Dividends paid}-\text{Net new equity raised}\\ =\$39,364.8-\$24,192\\ =\$15,173\end{array}$

Hence, the cash flow to stockholders is $15,173.

Summary Introduction

To discuss: The expansion plans of Person T

Explanation of Solution

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