Chapter 2, Problem 2M

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

Particulars	2014	2015
Sales	$385,724	$470,172
Cost of goods sold	$196,619	$248,263
Depreciation	$55,506	$62,738
Interest	$12,067	$13,831
Selling and administrative	$38,668	$50,469
Cash	$28,372	$42,865
Accounts receivable	$20,104	$26,078
Inventory	$38,706	$52,057
Net fixed assets	$244,881	$298,350
Accounts payable	$20,143	$34,091
Notes payable	$22,855	$24,955
Long-term debt	$123,607	$140,000
New equity	$0	$15,000

Characters in the case:

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

To prepare: The income statement of Company S for the year 2014 and 2015.

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 2M

The net income for 2014 and 2015 is $58,005 and $66,410 respectively.

Explanation of Solution

Given information:

Particulars	2014	2015
Sales	$385,724	$470,172
Cost of goods sold	$196,619	$248,263
Depreciation	$55,506	$62,738
Interest	$12,067	$13,831
Selling and administrative	$38,668	$50,469
Cash	$28,372	$42,865
Accounts receivable	$20,104	$26,078
Inventory	$38,706	$52,057
Net fixed assets	$244,881	$298,350
Accounts payable	$20,143	$34,091
Notes payable	$22,855	$24,955
Long-term debt	$123,607	$140,000
New equity	$0	$15,000

Prepare the income statement for 2014:

Company S
Income statement for the year 2014
Particulars	Amount	Amount
Net sales		$385,724
Less:
Costs	$196,619
Other expenses	$38,668
Depreciation	$55,506	$290,793
Earnings before interest and taxes		$94,931
Less: Interest paid		$12,067
Taxable income		$82,864
Less: Taxes ($82,864×30%)		$24,859
Net income (A)		$58,005
Dividends (B)=(A)×40%		$23,202
Addition to retained earnings (A)−(B)		$34,803

Hence, the net income for 2014 is $58,005.

Prepare the income statement for 2015:

Company S
Income statement for the year 2015
Particulars	Amount	Amount
Net sales		$470,172
Less:
Costs	$248,263
Other expenses	$50,469
Depreciation	$62,738	$361,470
Earnings before interest and taxes		$108,702
Less: Interest paid		$13,831
Taxable income		$94,871
Less: Taxes ($94,871×30%)		$28,461
Net income (A)		$66,410
Dividends (B)=(A)×40%		$26,564
Addition to retained earnings (A)−(B)		$39,846

Hence, the net income for 2015 is $66,410.

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

Particulars	2014	2015
Sales	$385,724	$470,172
Cost of goods sold	$196,619	$248,263
Depreciation	$55,506	$62,738
Interest	$12,067	$13,831
Selling and administrative	$38,668	$50,469
Cash	$28,372	$42,865
Accounts receivable	$20,104	$26,078
Inventory	$38,706	$52,057
Net fixed assets	$244,881	$298,350
Accounts payable	$20,143	$34,091
Notes payable	$22,855	$24,955
Long-term debt	$123,607	$140,000
New equity	$0	$15,000

Characters in the case:

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

To prepare: The balance sheet of Company S for the year 2014 and 2015.

Introduction:

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

Answer to Problem 2M

The total assets of the company for the year 2014 and 2015 are $332,063 and $419,350 respectively.

Explanation of Solution

Given information:

Particulars	2014	2015
Sales	$385,724	$470,172
Cost of goods sold	$196,619	$248,263
Depreciation	$55,506	$62,738
Interest	$12,067	$13,831
Selling and administrative	$38,668	$50,469
Cash	$28,372	$42,865
Accounts receivable	$20,104	$26,078
Inventory	$38,706	$52,057
Net fixed assets	$244,881	$298,350
Accounts payable	$20,143	$34,091
Notes payable	$22,855	$24,955
Long-term debt	$123,607	$140,000
New equity	$0	$15,000

Prepare the balance sheet for 2014:

Company S
Balance sheet
For the year 2014
Assets	Amount	Liabilities	Amount
Current assets:		Current liabilities:
Cash	$28,372	Accounts payable	$20,143
Accounts receivable	$20,104	Notes payable	$22,855
Inventory	$38,706	Total	$42,998
Total(A)	$87,182
		Long-term debt	$123,607
Fixed assets:
Tangible net fixed assets(B)	$244,881	Shareholders' equity:
		Common stock (Balance)	$130,655
		Addition to Retained earnings	$34,803
		Total	$165,458
Total assets (A)+(B)	$332,063	Total liabilities and shareholders' equity	$332,063

Hence, the total assets of Company S is 2014 is $332,063.

Prepare the balance sheet for 2015:

The retained earnings for the year 2015 is the sum of addition to retained earnings of 2014 and the addition to retained earnings of 2015. The common stock of 2015 includes the new equity raised amounting to $15,000.

Company S
Balance sheet
For the year 2015
Assets	Amount	Liabilities	Amount
Current assets:		Current liabilities:
Cash	$42,865	Accounts payable	$34,091
Accounts receivable	$26,078	Notes payable	$24,955
Inventory	$52,057	Total	$59,046
Total (A)	$121,000
		Long-term debt	$140,000
Fixed assets:
Tangible net fixed assets (B)	$298,350	Shareholders' equity:
		Common stock (Balance)	$145,655
		Addition to Retained earnings	$74,649
		Total	$220,304
Total assets (A)+(B)	$419,350	Total liabilities and shareholders' equity	$419,350

Hence, the total assets of Company S are 2015 is $419,350.

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

Particulars	2014	2015
Sales	$385,724	$470,172
Cost of goods sold	$196,619	$248,263
Depreciation	$55,506	$62,738
Interest	$12,067	$13,831
Selling and administrative	$38,668	$50,469
Cash	$28,372	$42,865
Accounts receivable	$20,104	$26,078
Inventory	$38,706	$52,057
Net fixed assets	$244,881	$298,350
Accounts payable	$20,143	$34,091
Notes payable	$22,855	$24,955
Long-term debt	$123,607	$140,000
New equity	$0	$15,000

Characters in the case:

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

To calculate: The operating cash flow for 2014 and 2015.

Answer to Problem 2M

The operating cash flow for 2014 is $125,578. The operating cash flow for 2015 is $142,979.

Explanation of Solution

Given information:

The earnings before interest and taxes is $94,931 and $108,702 for the year 2014 and 2015 respectively. The depreciation is $55,506 and $62,738 for the year 2014 and 2015 respectively. The taxes are $24,859 and $28,461 for the year 2014 and 2015 respectively.

Compute the operating cash flow for 2014:

Company S
Operating cash flow for 2014
Particulars	Amount
Earnings before interest and taxes	$94,931
Add: Depreciation	$55,506
	$150,437
Less: Taxes	$24,859
Operating cash flow	$125,578

Hence, the operating cash flow is $125,578.

Compute the operating cash flow for 2015:

Company S
Operating cash flow for 2015
Particulars	Amount
Earnings before interest and taxes	$108,702
Add: Depreciation	$62,738
	$171,440
Less: Taxes	$28,461
Operating cash flow	$142,979

Hence, the operating cash flow is $142,979.

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

Particulars	2014	2015
Sales	$385,724	$470,172
Cost of goods sold	$196,619	$248,263
Depreciation	$55,506	$62,738
Interest	$12,067	$13,831
Selling and administrative	$38,668	$50,469
Cash	$28,372	$42,865
Accounts receivable	$20,104	$26,078
Inventory	$38,706	$52,057
Net fixed assets	$244,881	$298,350
Accounts payable	$20,143	$34,091
Notes payable	$22,855	$24,955
Long-term debt	$123,607	$140,000
New equity	$0	$15,000

Characters in the case:

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

To calculate: The cash flow from assets.

Answer to Problem 2M

The cash flow from assets for 2015 is $9,002.

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	$298,350
Less: Beginning net fixed assets	$244,881
	$53,469
Add: Depreciation	$62,738
Net capital spending	$116,207

Hence, the net capital spending is $116,207.

Compute the ending net working capital:

$\begin{array}{c}\text{Ending net working capital}=\text{Ending current assets}-\text{Ending current liabilities}\\ =\$121,000-\$59,046\\ =\$61,954\end{array}$

Hence, the ending net working capital is $61,954.

Compute the beginning net working capital:

$\begin{array}{c}\text{Beginning net working capital}=\text{Beginning current assets}-\text{Beginning current liabilities}\\ =\$87,182-\$42,998\\ =\$44,184\end{array}$

Hence, the beginning net working capital is $44,184.

Compute the change in net working capital:

$\begin{array}{c}\text{Change in net working capital}=\left(\begin{array}{l}\text{Ending net working capital}-\\ \text{Beginning net working capital}\end{array}\right)\\ =\$61,954-\$44,184\\ =\$17,770\end{array}$

Hence, the change in net working capital is $17,770.

Compute the cash flow from assets:

The operating cash flow is $142,979. The change in net working capital is $17,770, and the net capital spending is $116,207.

$\begin{array}{c}\text{Cash flow from assets}=\left(\begin{array}{l}\text{Operating}\\ \text{cash flow}\end{array}\right)-\left(\begin{array}{l}\text{Change in net}\\ \text{working capital}\end{array}\right)-\left(\begin{array}{l}\text{Net capital}\\ \text{spending}\end{array}\right)\\ =\$142,979–\$17,770–\$116,207\\ =\$9,002\end{array}$

Hence, the cash flow from assets is $9,002.

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

Particulars	2014	2015
Sales	$385,724	$470,172
Cost of goods sold	$196,619	$248,263
Depreciation	$55,506	$62,738
Interest	$12,067	$13,831
Selling and administrative	$38,668	$50,469
Cash	$28,372	$42,865
Accounts receivable	$20,104	$26,078
Inventory	$38,706	$52,057
Net fixed assets	$244,881	$298,350
Accounts payable	$20,143	$34,091
Notes payable	$22,855	$24,955
Long-term debt	$123,607	$140,000
New equity	$0	$15,000

Characters in the case:

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

To calculate: The cash flow to creditors.

Answer to Problem 2M

The cash flow to creditors is ($2,562).

Explanation of Solution

Given information:

Company S had to pay interest expenses amounting to $13,831. The new net borrowings were $16,393$(\$140,000-\$123,607)$.

Formula:

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

Compute the cash flow to creditors:

$\begin{array}{c}\text{Cash flow to creditors}=\text{Interest paid}-\text{Net new borrowing}\\ =\$13,831-\$16,393\\ =\left(\$2,562\right)\end{array}$

Hence, the cash flow to creditors is ($2,562).

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

Particulars	2014	2015
Sales	$385,724	$470,172
Cost of goods sold	$196,619	$248,263
Depreciation	$55,506	$62,738
Interest	$12,067	$13,831
Selling and administrative	$38,668	$50,469
Cash	$28,372	$42,865
Accounts receivable	$20,104	$26,078
Inventory	$38,706	$52,057
Net fixed assets	$244,881	$298,350
Accounts payable	$20,143	$34,091
Notes payable	$22,855	$24,955
Long-term debt	$123,607	$140,000
New equity	$0	$15,000

Characters in the case:

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

To calculate: The cash flow to stockholders.

Answer to Problem 2M

The cash flow to stockholders is ($2,562).

Explanation of Solution

Given information:

Company S paid dividends amounting to $26,564. It issued new equity worth $15,000.

Formula:

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

Compute the cash flow to stockholders:

$\begin{array}{c}\text{Cash flow to stockholders'}=\text{Dividends paid}-\text{Net new equity raised}\\ =\$26,564-\$15,000\\ =\$11,564\end{array}$

Hence, the cash flow to stockholders is $11,564.

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.