Chapter 3, Problem 19SP

FINANCIAL STATEMENTS, CASH FLOW, AND TAXES Laiho Industries’s 2017 and 2018 balance sheets (in thousands of dollars) are shown.

	2018	2017
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 2018 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 2018 income statement.
2. b. Construct the statement of stockholders’ equity for the year ending December 31, 2018, and the 2018 statement of cash flows.
3. c. Calculate 2017 and 2018 net operating working capital (NOWC) and 2018 free cash flow (FCF). Assume the firm has no excess cash.
4. d. If Laiho increased its dividend payout ratio, what effect would this have on corporate taxes paid’ What effect would this have on taxis, paid by the company’s shareholders?
5. e. Assume that the firm’s after-tax cost of capital is 10 5%. What is the firm’s 2018 EVA?
6. f. Assume that the firm’s stock price is S22 per share and that at year-end 2018 the firm has 10 million shares outstanding. What is the firm’s MVA at year-end 2018?

Summary Introduction

To prepare: The income statement of company L for 2014.

Financial Statements:

It refer to the statements, which are prepared by the firm at the closure of the accounting period in particular formats and are prescribed in the accounting to show its financial position.

Income Statement:

A part of financial statements that list the income and expenses of the business for an accounting year is called the income statement. It is prepared at the closure of the accounting period to know the profitability of the business.

Explanation of Solution

Given information:

Sales is $455,150,000 for the year 2018.

EBITDA is 15% on sales.

11% of depreciation and amortization on net fixed asset.

Interest is $8,575,000.

40% tax.

40% of the divided on net income.

Calculation on income statement using the spreadsheet is as follows:

Table (1)

Conclusion

Therefore, Company L has a net income of $31,385,610.

Summary Introduction

To prepare: The statement of stockholders’ equity of Company L for 2018.

Statement of stockholders’ equity:

The statement of stockholders’ equity reports the opening and closing balance of stockholder’s equity with the changes incurred during the accounting period.

Statement of cash flow:

The statement of cash flow is a part of fiscal statements those are comprised in the yearly report of a company. It reports the cash generated or used by the business in a specified period.

Explanation of Solution

The calculation of statement of stockholders’ equity using the spreadsheet for the year 2018 is as follows:

Table (2)

The calculation of statement of cash flow using the spreadsheet is as follows:

Table (3)

Summary Introduction

To compute: The net operating working capital for 2017 and 2018, and the free cash flow for 2018.

The net operating working capital:

The current assets and current liabilities of active business operations are known as the operating current assets and the operating current liabilities, respectively. The difference between these two is known as the net operating working capital.

Free Cash Flow:

The performance of a company’s operations is also evaluated by its cash generation abilities. The term used to depict and report that ability is known as the free cash flow. Capital expenditures are deducted from operating cash flow to compute the free cash flow.

Explanation of Solution

The calculation of net operating working capital is as follows:

Given information:

Current assets in 2017 are $210,234,000.

Current liabilities in 2017 are $59,982,000.

Current assets in 2018 are $244,659,000

Current liabilities in 2018 are $77,955,000.

For the year 2017,

The formula to compute the net operating current assets is as follows:

$\text{Operating current assets}=\text{Current assets}-\text{Excess cash}$

Compute the net operating current assets:

$\begin{array}{c}\text{Operating current assets}=\text{Current assets}-\text{Excess cash}\\ =\$210,234,000-0\\ =\$210,234,000\end{array}$

Hence, the net operating current asset is $210,234,000.

For the year 2017,

The formula to compute the net operating current liabilities is as follows:

$\text{Operating current liabilities}=\text{Current liability}-\text{Note payable}$

Compute the net operating current liabilities:

$\begin{array}{c}\text{Operating current liabilities}=\text{Current liability}-\text{Note payable}\\ =\$59,982,000-14,217,000\\ =\$45,765,000\end{array}$

Hence, the net operating current liabilities is $45,765,000.

For the year 2018,

The formula to compute the net operating current assets is as follows:

$\text{Operating current assets}=\text{Current assets}-\text{Excess cash}$

Compute the net operating current assets:

$\begin{array}{c}\text{Operating current assets}=\text{Current assets}-\text{Excess cash}\\ =\$244,659,000-0\\ =\$244,659,000\end{array}$

Hence, the net operating current asset is $244,659,000.

For the year 2018,

The formula to compute the net operating current liabilities is as follows:

$\text{Operating current liabilities}=\text{Current liability}-\text{Note payable}$

Compute the net operating current liabilities:

$\begin{array}{c}\text{Operating current liabilities}=\text{Current liability}-\text{Note payable}\\ =\$77,955,000-16,717,000\\ =\$61,238,000\end{array}$

Hence, the net operating current liabilities is $61,238,000.

For 2017,

The formula to compute the net operating working capital is as follows:

$\text{Net Operating Working Capital}=\text{Current Assets}-\text{Current Liabilities}$

Substitute $210,234 for the net operating current assets and $45,765,000 for the net operating current liabilities.

$\begin{array}{c}\text{Net Operating Working Capital}=\$210,234,000-\$45,765,000\\ =\$164,469,000\end{array}$

Hence, the net operating working capital for the year 2017 is $164,469,000.

For 2018,

The formula to compute the net operating working capital is as follows:

$\text{Net Operating Working Capital}=\text{Current Assets}-\text{Current Liabilities}$

Substitute $244,659 for current assets and $77,955 for the current liabilities.

$\begin{array}{c}\text{Net Operating Working Capital}=\$244,659,000-\$61,238,000\\ =\$183,421,000\end{array}$

Hence, the net operating working capital for the year 2018 is $183,421,000.

Calculation of Free cash flow:

Given information:

EBIT is $60,884,358 (refer part a).

The tax rate is 40%.

Depreciation is $7,388,150 (refer part a).

Capital expenditure is $32,117,000 (refer part b).

Increase in the net operating working capital is $18,952,000$\left(\$164,469,000-\$183,421,000\right)$.

The formula to compute the free cash flow is as follows:

$\text{Free Cash Flow}=\left[\begin{array}{l}\text{EBIT}\left(1-\text{Tax Rate}\right)+\text{Depreciation}\\ -\left(\text{Captial Expenditure}+\text{Increase in NOWC}\right)\end{array}\right]$

Substitute $60,884 for EBIT, 40% for tax rate, $7,388 for depreciation, $32,117 for capital expenditure and $18,952,000.

$\begin{array}{c}\text{Free Cash Flow}=\left[\$60,884,358\left(1-0.4\right)+\$7,388,150-\left(\$32,117,000+\$18,952,000\right)\right]\\ =\$36,530,614.8+\$7,388,150-\$51,069,000\\ =-\$7,150,235.2\end{array}$

Hence, the free cash flow for the year 2018 is -$7,150,235.2.

Summary Introduction

To analyze: The effect of increased dividend payment on company’s tax liability and stockholders’ liability.

Dividend Payout Ratio:

The ratio that reflects the dividends paid as the proportion of net income earned by a company during a specified time period is called the dividend payout ratio.

Answer to Problem 19SP

There will be no change in the taxes paid by the company but the stockholders’ tax liability will increase with the increase in the dividend payout.

Explanation of Solution

• The dividend payment is calculated after the tax is calculated. Therefore, there will be no change in the tax amount if the dividend payment is changed.
• The dividend is an income for the stockholders and taxable for them. Therefore their tax liability will increase if the dividend payout is increased.

Conclusion

Therefore, the increased dividend payment will have no change in the company’s tax liability but it will increase the stockholders’ tax liability.

Summary Introduction

To compute: The economic value added (EVA) for 2018.

Explanation of Solution

Given information:

EBIT is 60,884,350.

The capital invested is $250,586,000$\left(\text{Note payable}+\text{Long term debt}+\text{Common equity}\right)$.

The cost of capital is 10.5%.

The formula to compute EVA is as follows:

$\text{EVA}=\text{EBIT }\left(\text{1}-\text{T}\right)-\left(\text{Capital Invested}\times \text{Cost of Capital}\right)$

Substitute $31,386 for the earnings after tax, $157,605 for the capital invested, and 10.5% for the cost of capital.

$\begin{array}{c}\text{EVA}=\text{EBIT }\left(\text{1}-\text{T}\right)-\left(\text{Capital Invested}\times \text{Cost of Capital}\right)\\ \text{EVA}=\$60,884,350\left(\text{1}-40\%\right)-\left(250,586,000\times 10.5\%\right)\\ =\$36,530,610-\$26,311,530\\ =\$10,219,080\end{array}$

Hence, the EVA for the year 2018 is $10,219,080.

Summary Introduction

To compute: The market value added (MVA) for 2018.

Explanation of Solution

Given information:

The market price of a share is $22.

Outstanding shares are 10 million.

Common equity is $157,605,000.

The formula to compute MVA is as follows:

$\text{MVA}=\left(\text{Market Price of Share}\times \text{Outstanding Shares}\right)-\text{Capital Invested}$

Substitute $22 for the market price of the share, $157,605 for the capital invested, and 10,000,000 for the number of shares.

$\begin{array}{c}\text{MVA}=\left(\text{\$22}\times \text{\$10,000,000}\right)-\text{\$157,605,000}\\ =\$220,000,000-\$157,605,000\\ =\$62,395,000\end{array}$

Hence, the MVA for the year 2018 is $62,395,000.