Chapter 3, Problem 17SP

FINANCIAL STATEMENTS, CASH FLOW, AND TAXES Laiho Industries' 2013 and 2014 balance sheets (in thousands of dollars) are shown.

	2014	2013
Cash	$102,850	$ 89,725
Accounts receivable	103,365	85,527
Inventories	38,444	34,982
Total current assets	$244,659	$210,234
Net fixed assets	67,165	42,436
Total assets	$311,824	$252,670
Accounts payable	$ 30,761	$ 23,109
Accruals	30,477	22.656
Notes payable	16,717	14,217
Total current liabilities	$ 77,955	$ 59,982
long term debt	76,264	63,914
Total liabilities	$154,219	$123,896
Common stock	100,000	90,000
Retained earnings	57,605	38,774
Total common equity	$157,605	$128,774
Total liabilities and equity	$311,824	$252,670

1. a. Sales for 2014 were $455,150,000, and EBITDA was 15% of sales. Furthermore, depreciation and amortization were 11% of net fixed assets, interest was $8,575,000, the corporate tax rate was 40%, and Laiho pays 40% of its net income as dividends. Given this information, construct the firm's 2014 income statement.
2. b. Construct the statement of stockholders' equity for the year ending December 31,2014, and the 2014 statement of cash flows.
3. c. Calculate 2013 and 2014 net operating working capital (NOWC) and 2014 free cash flow (FCF).
4. d. If Laiho increased its dividend payout ratio, what effect would this have on corporate taxes paid? What effect would this have on taxes paid by the company's shareholders?
5. e. Assume that the firm's after-tax cost of capital is 105%. What is the firm's 2014 EVA?
6. f. Assume that the firm's stock price is $22 per share and that at year-end 2014 the firm has 10 million shares outstanding. What is the firm's MVA at year-end 2014?

Summary Introduction

To prepare: The income statement of L Industries.

Income statement:

This is a financial statement that shows the net income earned or net loss suffered by a company through reporting all the revenues earned and expenses incurred by the company over a specific period of time.

Retained earnings statement:

This is a financial statement that shows the amount of net income retained by a company at a particular point of time for reinvestment and to pay its debts and obligations. It shows the amount of retained earnings that is not paid as dividends to the shareholders.

Balance sheet:

This is a financial statement that shows the available assets (owner’s equity and outsider’s equity) and owed liabilities from investing and financial activities of a company. This statement reveals the financial health of company.

Statement of cash flows:

This is a financial statement that shows the cash and cash equivalents of a company for a particular period of time. It determines the net changes in cash through reporting the sources and uses of cash due to operating, investing, and financial activities of a company.

Explanation of Solution

Prepare the income statement as shown below.

L Industries Income Statement For the year ended 2014
Particulars	Amounts ($)
Sales	455,150,000
Less: Operating cost $\left(455,150,000\times 0.85\right)$	386,877,500
EBITDA $\left(455,150,000\times 0.15\right)$	68,272,500
Less: Depreciation and amortization $\left(67,165,000\times 0.11\right)$	7,388,150
EBIT	60,884,350
Less: Interests	8,575,000
EBT	52,309,350
Less: Tax $\left(52,309,350\times 0.4\right)$	20,923,740
Net income	31,385,610

Table 1

Conclusion

Hence, the net income of L Industries is $31,385,610.

Summary Introduction

To prepare: The stockholders’ equity and the cash flow statement of L Industries.

Explanation of Solution

Prepare the stockholders’ equity statement as shown below.

L Industries Stockholders’ equity statement For the year ended 2015
Particulars	Amounts ($)	Amounts ($)
Common stock		$1,000,000,000
Retained earnings, 2014	38,774,000
Add: Net income	31,385,610
	$70,159,610
Less: Dividends $\left(31,385,610\times 0.4\right)$	$12,554,244
Retained earnings, 2015		$57,605,366
Total stockholders’ equity		$1, 057,605,366

Table 2

Prepare the statement of the cash flow as shown below.

L Industries Cash flow statement For the year ended 2015
Particulars	Amount ($)	Amount ($)
Cash flow from operating activities
Net income $(\$\text{31},\text{385},\text{61}0-\text{366})$		31,385,244
Adjustments
Depreciation and amortization	7,3 88,150
Increase in receivables	-17,838,000
Increase in inventory	-3,462,000
Increase in payables	7,652,000
Increase in accruals	7,821,000
Increase in notes payable	2,500,000	4,061,150
Net cash flow from operating activities (a)		35,446,394
Cash flow from investing activities
Purchase of net fixed assets $\left(67,165,000+7,388,150-42,436,000\right)$	-32,117,150
Net cash flow from investing activities (b)		-32,117,150
Cash flow from financing activities
Proceeds from long term debt	12,350,000
Issue of common stock	10,000,000
Dividend paid	-12,554,244
Net cash flow from financing activities (c)		9,795,756
Net increase in cash and cash equivalents (a + b + c)		13,125,000
Add: Cash and cash equivalents at the beginning of the period		89,725,000
Cash and cash equivalents at the end of the period		102,850,000

Table 3

Conclusion

Hence, the stockholders’ equity and the cash flow statement are prepared as above.

Summary Introduction

To determine: The net operating working capital for the year 2014 and 2015 and the free cash flow of L industries.

Explanation of Solution

Compute the net operating working capital as shown below.

Particulars	2015	2014
Cash	102,850,000	89,725,000
Accounts receivable	103,365,000	85,527,000
Inventories	38,444,000	34,982,000
Total current operating assets (a)	244,659,000	210,234,000
Accounts payable	30,761,000	23,109,000
Accrued expense	30,477,000	22,656,000
Total current operating liabilities (b)	61,238,000	45,765,000
Net operating working capital (a) - (b)	183,421,000	164,469,000

Table 4

Compute the free cash flow as shown below.

Particulars	Amounts ($)	Amounts ($)
EBIT after tax $\left(60,884,350\times \left(1-0.4\right)\right)$		36,530,610
Add: Depreciation and amortization		7,388,150
Less: Change in working capital
Increase in receivables	-17,838,000
Increase in inventory	-3,462,000
Increase in payables	7,652,000
Increase in accruals	7,821,000
Increase in notes payable	2,500,000	3,327,000
Less: Capital expense		32,117,150
Free cash flow		8,474,610

Table 5

Conclusion

Hence, the net operating working capital for the year 2014 and 2015 and the free cash flow of L Industries is calculated as above.

Summary Introduction

To determine: The effect on corporate taxes and the taxes paid by shareholders of the company, on increasing the dividend payout ratio.

Explanation of Solution

On increasing the dividend payout ratio, the corporate taxes would not be affected. It is so because the company did not pay any tax on the dividend distributed to the shareholders. It can be concluded from the income statement that tax is computed on the net income before deducting the dividend paid. Therefore, there is no impact on the corporate tax.

Yes, there would be an impact on the tax paid by the shareholders. The increase in payout ratio will increase the earnings of the shareholder. Therefore, the shareholders’ taxes will increase with the increase in payout ratio.

Conclusion

Hence, there is no impact on the corporate tax and the shareholder taxes will increase with the increase in payout ratio.

Summary Introduction

To determine: The EVA of the L Industries.

Explanation of Solution

Calculate the EVA as shown below:

$\begin{array}{c}\text{EVA}=\left\{\text{EBIT}\left(1-\text{Tax}\right)-\left(\text{Total}\text{operating}\text{capital}\right)\left(\text{After}\text{tax}\text{percentage cost of capital}\right)\right\}\\ =60,884\left(1-0.4\right)-\left(233,869\right)\left(0.105\right)\\ =60,884\left(0.6\right)-\left(233,869\right)\left(0.105\right)\\ =\$11,974\end{array}$

Conclusion

Hence, the EVA is $11,974.

Summary Introduction

To determine: The MVA of the L Industries.

Explanation of Solution

Calculate the MVA as shown below:

$\begin{array}{c}\text{MVA}=\left(\text{Shares outstanding}\right)\left(\text{Stock price}\right)-\left(\text{Total common equity}\right)\\ =\left(10,000,000\right)\left(\$22\right)-\left(157,605\right)\\ =\$219,842,395\end{array}$

Conclusion

Hence, the MVA is $219,842,395.