Chapter 2, Problem 2M

1)

Summary Introduction

To prepare: The income statement of Company SB for the years 2010 and 2011.

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.

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	2010	2011
Sales	$ 163,849	$ 206,886
Cost of goods sold	$   23,643	$   35,721
Depreciation	$   46,255	$   52,282
Interest	$   10,056	$   11,526
Selling and administrative	$   33,223	$   42,058
Cash	$   41,786	$   47,325
Accounts receivable	$ 204,068	$ 248,625
Inventory	$ 321,437	$ 391,810
Net fixed assets	$   16,753	$   21,732
Accounts payable	$   19,046	$   20,796
Notes payable	$ 103,006	$ 116,334
Long-term debt	$   32,255	$   43,381
New equity	$          0	$   20,500

Characters in the case:

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

Answer to Problem 2M

The net income for 2010 and 2011are $54,443 and $63,246 respectively.

Explanation of Solution

Given information:

Particulars	2010	2011
Sales	$ 163,849	$ 206,886
Cost of goods sold	$   23,643	$   35,721
Depreciation	$   46,255	$   52,282
Interest	$   10,056	$   11,526
Selling and administrative	$   33,223	$   42,058
Cash	$   41,786	$   47,325
Accounts receivable	$ 204,068	$ 248,625
Inventory	$ 321,437	$ 391,810
Net fixed assets	$   16,753	$   21,732
Accounts payable	$   19,046	$   20,796
Notes payable	$ 103,006	$ 116,334
Long-term debt	$   32,255	$   43,381
New equity	$          0	$   20,500

Prepare the income statement for 2010:

Company S
Income statement for the year 2010
Particulars	Amount	Amount
Net sales		$ 321,437
Less:
Costs	163,849
Other expenses	33,223
Depreciation	46,255	$243,327
Earnings before interest and taxes		$   78,110
Less: Interest paid		10,056
Taxable income		$   68,054
Less: Taxes ($68,054×20%)		$13,611
Net income (A)		$   54,443
Dividends (B)=(A)×50%		$   27,222
Addition to retained earnings (A)−(B)		$   27,222

Hence, the net income for 2010 is $54,443.

Prepare the income statement for 2011:

Company S
Income statement for the year 2011
Particulars	Amount	Amount
Net sales		$ 391,810
Less:
Costs	206,886
Other expenses	42,058
Depreciation	52,282	$301,226
Earnings before interest and taxes		$   90,584
Less: Interest paid		11,526
Taxable income		$   79,058
Less: Taxes ($79,058×20%)		15,812
Net income (A)		$   63,246
Dividends (B)=(A)×50%		$   31,623
Addition to retained earnings (A)−(B)		$   31,623

Hence, the net income for 2011 is $63,426.

2)

Summary Introduction

To prepare: The balance sheet of Company SB for the years 2010 and 2011.

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 2010 and 2011are $276,719 and $349,459 respectively.

Explanation of Solution

Given information:

Particulars	2010	2011
Sales	$ 163,849	$ 206,886
Cost of goods sold	$   23,643	$   35,721
Depreciation	$   46,255	$   52,282
Interest	$   10,056	$   11,526
Selling and administrative	$   33,223	$   42,058
Cash	$   41,786	$   47,325
Accounts receivable	$ 204,068	$ 248,625
Inventory	$ 321,437	$ 391,810
Net fixed assets	$   16,753	$   21,732
Accounts payable	$   19,046	$   20,796
Notes payable	$ 103,006	$ 116,334
Long-term debt	$   32,255	$   43,381
New equity	$          0	$   20,500

Prepare the balance sheet for 2010:

Company S
Balance sheet
For the year 2010
Assets	Amount	Liabilities	Amount
Current assets		Current liabilities
Cash	$23,643	Accounts payable	$41,786
Accounts receivable	$16,753	Notes payable	$19,046
Inventory	$32,255	Total	$60,832
Total (A)	$72,651
		Long-term debt	$ 103,006
Fixed assets
Tangible net fixed assets (B)	$ 204,068	Shareholders' equity
		Owners' equity	$ 112,881
Total assets (A)+(B)	$276,719	Total liabilities and shareholders' equity	$276,719

Note: The sum of the current liabilities and long term debt is subtracted from the total liabilities and shareholders’ equity to compute the owners’ equity.

Hence, the total assets of Company SBin 2010are $276,719.

Prepare the balance sheet for 2011:

The common stock of 2011 includes the new equity raised, amounting to $20,500.

Company S
Balance sheet
For the year 2011
Assets	Amount	Liabilities	Amount
Current assets		Current liabilities
Cash	$   35,721	Accounts payable	$   47,325
Accounts receivable	21,732	Notes payable	20,796
Inventory	43,381	Total	$   68,121
Total (A)	$ 100,834
		Long-term debt	$ 116,334
Fixed assets
Tangible net fixed assets (B)	$ 248,625	Shareholders' equity
	Owners' equity	$ 165,004
Total assets (A)+(B)	$349,459	Total liabilities and shareholders' equity	$349,459

Note: The owners’ equity is computed by adding the owners’ equity for the year 2010, in addition to the retained earnings in the income statement of 2011 and the given new equity.

Hence, the total assets of Company SB in 2011are $349,459.

3)

Summary Introduction

To calculate: The operating cash flow for 2010 and 2011.

Introduction:

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

Answer to Problem 2M

The operating cash flow for 2010 is $110,754. The operating cash flow for 2011 is $127,054.

Explanation of Solution

Given information:

The earnings before interest and taxes is $78,110 and $90,584 for the years 2010 and 2011 respectively. The depreciation is $46,255and $52,282 for the years 2010 and 2011 respectively. The taxes are $13,611 and $15,812 for the years 2010 and 2011 respectively.

Compute the operating cash flow for 2010:

Company S
Operating cash flow for 2010
Particulars	Amount
Earnings before interest and taxes	$78,110
Add: Depreciation	$46,255
	$124,365
Less: Taxes	$13,611
Operating cash flow	$110,754

Hence, the operating cash flow is $110,754.

Compute the operating cash flow for 2011:

Company S
Operating cash flow for 2011
Particulars	Amount
Earnings before interest and taxes	$90,584
Add: Depreciation	$52,282
	$142,866
Less: Taxes	$15,812
Operating cash flow	$127,054

Hence, the operating cash flow is $127,054.

4)

Summary Introduction

To calculate: The cash flow from assets.

Introduction:

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

Answer to Problem 2M

The cash flow from assets for 2011 is $9,321.

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	$248,625
Less: Beginning net fixed assets	$204,068
	$44,557
Add: Depreciation	$52,282
Net capital spending	$96,839

Hence, the net capital spending is $96,839.

Compute the ending net working capital:

$\begin{array}{c}\text{Ending net working capital}=\text{Ending current assets}-\text{Ending current liabilities}\\ =\$100,834-\$68,121\\ =\$32,713\end{array}$

Hence, the ending net working capital is $32,713.

Compute the beginning net working capital:

$\begin{array}{c}\text{Beginning net working capital}=\text{Beginning current assets}-\text{Beginning current liabilities}\\ =\$72,651-\$60,832\\ =\$11,819\end{array}$

Hence, the beginning net working capital is $11,819.

Compute the change in net working capital:

$\begin{array}{c}\text{Change in net working capital}=\left(\begin{array}{l}\text{Ending net working capital}-\\ \text{Beginning net working capital}\end{array}\right)\\ =\$32,713-\$11,819\\ =\$20,894\end{array}$

Hence, the change in net working capital is $20,894.

Compute the cash flow from assets:

The operating cash flow is $127,054. The change in net working capital is $20,894, and the net capital spending is $96,839.

$\begin{array}{c}\text{Cash flow from assets}=\left(\begin{array}{l}\text{Operating}\\ \text{cash flow}\end{array}\right)-\left(\begin{array}{l}\text{Change in net}\\ \text{working capital}\end{array}\right)-\left(\begin{array}{l}\text{Net capital}\\ \text{spending}\end{array}\right)\\ =\$127,054–\$20,894–\$96,839\\ =\$9,321\end{array}$

Hence, the cash flow from assets is $9,321.

5)

Summary Introduction

To calculate: The cash flow to creditors.

Introduction:

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

Answer to Problem 2M

The cash flow to creditors is ($1,802).

Explanation of Solution

Given information:

Company S had to pay interest expenses amounting to $11,526. The new net borrowings were $13,328 $(\$116,334-\$103,006)$.

Formula:

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

Compute the cash flow to creditors:

$\begin{array}{c}\text{Cash flow to creditors}=\text{Interest paid}-\text{Net new borrowing}\\ =\$11,526-\$13,328\\ =\left(\$1,802\right)\end{array}$

Hence, the cash flow to creditors is ($1,802).

6)

Summary Introduction

To calculate: The cash flow to stockholders.

Introduction:

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

Answer to Problem 2M

The cash flow to stockholders is ($11,123).

Explanation of Solution

Given information: Company SB paid dividends amounting to $31,623. It issued new equity worth $20,500.

Formula:

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

Compute the cash flow to stockholders:

$\begin{array}{c}\text{Cash flow to stockholders'}=\text{Dividends paid}-\text{Net new equity raised}\\ =\$31,623-\$20,500\\ =\$11,123\end{array}$

Hence, the cash flow to stockholders is $11,123.