Chapter 3 PRE and HW - without PowerPoint Notes

Net working capital

The difference between current assets and current liabilities

Net worth

Capital supplied by common stockholders and represent ownership

Annual report

A report issued annually by a corporation to its stockholders. It contains basic financial statements as well as management's analysis of the firm's past operations and future prospects.

Total liabilities

Equals total debt plus the company's "free" liabilities.

(1) cash flows (2) cash flows (3) cash

Management's goal is to maximize the firm's stock price. The value of any asset, including a share of stock, is based on the *(1) *the asset is expected to produce. Therefore, managers strive to maximize the *(2) *available to investors. The statement of cash flows shows how much *(3) *a firm is generating. It is divided into four parts: (1) Operating activities, (2) Long-Term Investing activities, (3) Financing activities, and (4) Summary.

Free cash flow (FCF)

The amount of cash that could be withdrawn without harming a firm's ability to operate and to produce future cash flows.

Income Statement

A report summarizing a firm's revenues, expenses, and profits during a reporting period, generally a quarter or a year.

Dividends

Changes in stockholders' equity during an accounting period are reported in the statement of stockholders' equity. Changes in stockholders' equity can come from new stock issues, stock repurchases, net income, and ___________ paid.

Net operating working capital

Equal to current assets less the difference between current liabilities and notes payable

Statement of Cash Flows

A report that shows how items that affect the balance sheet and income statement affect the firm's cash flows.

Total debt

Includes a company's short-term and long-term interest-bearing liabilities.

B 12/31/15 RE $472,500 12/31/14 RE $445,000 Change in RE $27,500 Net income for 2015 $135,000 Dividends = Net income - Change in RE $107,500

On 12/31/15, Hite Industries reported retained earnings of $472,500 on its balance sheet, and it reported that it had $135,000 of net income during the year. On its previous balance sheet, at 12/31/14, the company had reported $445,000 of retained earnings. No shares were repurchased during 2015. How much in dividends did the firm pay during 2015? a. $117,175 b. $107,500 c. $131,150 d. $96,750 e. $121,475

(1) Operating income (2) Earnings per share (EPS) (3) balance sheet (4) dividends

The income statement reports on operations over a period of time. Companies' operating performances can be compared by looking at each firm's EBIT, often referred to as *(1) *. A typical stockholder focuses on the bottom line of the income statement, *(2) *. The income statement is tied to the *(3) *through the retained earnings account. Net income minus *(4) *paid is equal to the retained earnings for the year, and this amount is added to the cumulative retained earnings from prior years to obtain the year-end retained earnings balance.

D

Which of the following items cannot be found on a firm's balance sheet under current liabilities? a. Accrued wages. b. Short-term notes payable to the bank. c. Accrued payroll taxes. d. Cost of goods sold. e. Accounts payable.

Balance Sheet

A statement of a firm's financial position at a specific point in time.

Statement of Stockholder's Equity

A statement that shows by how much a firm's equity changed during the year and why this change occurred.

D

Below is the common equity section (in millions) of Timeless Technology's last two year-end balance sheets: 2015 2014 Common stock 2,000 1,000 Retained earnings 2,000 2,340 Total common equity $4,000 $3,340 The firm has never paid a dividend to its common stockholders. Which of the following statements is CORRECT? a. The firm had positive net income in both 2014 and 2015, but its net income in 2015 was lower than it was in 2014. b. The company has more equity than debt on its balance sheet. c. The market price of the firm's stock doubled in 2015. d. The firm issued common stock in 2015. e. The company's net income in 2015 was higher than in 2014.

B EBIT(1 - T) 2014 2015 Change = Net invest. in FA + NOWC Total assets $2,000 $2,500 $500 2015 FCF = EBIT(1 - T) - Net investment in FA + NOWC 2015 FCF = $1475 - $500 2015 FCF = $975

Hartzell Inc. had the following data for 2014, in millions: Net income = $600; after-tax operating income (EBIT (1-T)) = $700; and Total assets = $2,000. Information for 2015 is as follows: Net income = $825; after-tax operating income (EBIT (1-T)) = $725; and Total assets = $2,500. How much free cash flow did the firm generate during 2015? a. $198 b. $225 c. $176 d. $191 e. $169

Annual report

The focus on financial statements in finance is how managers and investors interpret and use them. A firm's __________ contains both verbal and quantitative information. The quantitative information consists of four financial statements: (1) Balance Sheet, (2) Income Statement, (3) Statement of Cash Flows, and (4) Statement of Stockholders' Equity.

B

Which of the following statements is CORRECT? a. If a company issues new long-term bonds to purchase fixed assets during the current year, this will increase both its reported current assets and current liabilities at the end of the year. b. If a company pays more in dividends than it generates in net income, its retained earnings as reported on the balance sheet will decline from the previous year's balance. c. If a company uses some of its bank deposits to buy short-term, highly liquid marketable securities, this will cause a decline in its current assets as shown on the balance sheet. d. Dividends paid reduce the net income that is reported on a company's income statement. e. Accounts receivable are reported as a current liability on the balance sheet.

D The marginal tax rate is the tax rate applicable to the last unit of a person's income. Since taxable income is $174,750, the marginal tax rate is shown in Column 3 for the income bracket that includes the taxable income amount - which is 28.0%. Taxable income is $174,750, so the federal tax liability is calculated as follows: Federal tax liability = $29,387.50 + (($174,750 - $151,200) × 0.28) Federal tax liability = $29,387.50 + $6,594.00 = $35,981.50 $35,981.50 was the tax paid and $174,750 is the taxable income, so their average tax rate is calculated as follows: Average tax rate = Tax paid/Taxable income Average tax rate = $35,981.50/$174,750 Average tax rate = 20.59%

Alan and Sara Winthrop are a married couple who file a joint income tax return. They have two children, so they claim a total of 4 exemptions. In addition, they have legitimate itemized deductions totaling $25,750. Their total income from wages is $216,500. Assume the following tax table is applicable: Married Couples Filing Joint Returns If Your Taxable You Pay This Plus This Percentage Average Tax Rate Income Is Amount on the on Excess over at the Top of Bracket Base of the Bracket the Base Up to $18,450 $ 0 10.0% 10.0% $18,450-$74,900 1,845.00 15.0 13.8 $74,900-$151,200 10,312.50 25.0 19.4 $151,200-$230,450 29,387.50 28.0 22.4 $230,450-$411,500 51,577.50 33.0 27.1 $411,500-$464,850 111,324.00 35.0 28.0 Over $464,850 129,996.50 39.6 39.6 What is their average tax rate? a. 19.15% b. 18.94% c. 16.68% d. 20.59% e. 17.71%

B Tax rate 40% EBT After Unused Carry-Forward Forward Carryable Year Taxable Income Used Applied Amount 2011 -$5,500,000 $0 $0 $5,500,000 2012 $1,000,000 $1,000,000 $0 $4,500,000 2013 $2,000,000 $2,000,000 $0 $2,500,000 2014 $3,000,000 $2,500,000 $500,000 $0 2015 $5,000,000 $0 $5,000,000 $0 2014 Tax liability = EBT × Tax rate 2014 Tax liability = $200,000

Appalachian Airlines began operating in 2011. The company lost money the first year but has been profitable ever since. The company's taxable income (EBT) for its first five years is listed below. Each year the company's corporate tax rate has been 40%. Year Taxable Income 2011 -$5,500,000 2012 $1,000,000 2013 $2,000,000 2014 $3,000,000 2015 $5,000,000 Assume that the company has taken full advantage of the Tax Code's carry-back, carry-forward provisions and that the current provisions were applicable in 2011. How much did the company pay in taxes in 2014? a. $212,000 b. $200,000 c. $206,000 d. $224,000 e. $176,000

C

Assume that Congress recently passed a provision that will enable Bev's Beverages Inc. (BBI) to double its depreciation expense for the upcoming year but will have no effect on its sales revenue or the tax rate. Prior to the new provision, BBI's net income was forecasted to be $4 million. Which of the following best describes the impact of the new provision on BBI's financial statements versus the statements without the provision? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes. a. The provision will increase the company's tax payments. b. The provision will increase the firm's operating income (EBIT). c. Net fixed assets on the balance sheet will decrease. d. The provision will reduce the company's cash flow. e. The provision will increase the company's net income.

D

Below are the 2014 and 2015 year-end balance sheets for Tran Enterprises: Assets: 2015 2014 Cash $ 200,000 $ 170,000 Accounts receivable 864,000 700,000 Inventories 2,000,000 1,400,000 Total current assets $3,064,000 $2,270,000 Net fixed assets 6,000,000 5,600,000 Total assets $9,064,000 $7,870,000 Liabilities and equity: Accounts payable $1,400,000 $1,090,000 Notes payable to bank 1,600,000 1,800,000 Total current liabilities $3,000,000 $2,890,000 Long-term debt 2,400,000 2,400,000 Common stock 3,000,000 2,000,000 Retained earnings 664,000 580,000 Total common equity $3,664,000 $2,580,000 Total liabilities and equity $9,064,000 $7,870,000 The firm has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year, non-callable, long-term debt in 2014. As of the end of 2015, none of the principal on this debt had been repaid. Assume that the company's sales in 2014 and 2015 were the same. Which of the following statements must be CORRECT? a. The firm issued long-term debt in 2015. b. The firm repurchased some common stock in 2015. c. The firm increased its short-term bank debt in 2015. d. The firm issued new common stock in 2015. e. The firm had negative net income in 2015.

D Taxable income $90,000 Interest income $5,000 Dividend income $30,000 Dividend exclusion % 70% Total taxable income = Taxable income + Interest income + Taxable dividend income Total taxable income = Taxable income + Interest income + Dividend income (1-Dividend exclusion %) Total taxable income = $54,000 Taxable Income Tax on Base of Bracket % on Excess above Base $0 $0 15% $50,000 7,500 25% $75,000 13,750 34% $100,000 22,250 3 9% $335,000 113,900 34% $10,000,000 3,400,000 35% $15,000,000 5,150,000 38% $18,333,333 6,416,667 35% Tax on base = $22,250 Tax on excess base = $1,560 Tax liability = $23,810

Corporations face the following tax schedule: Taxable Income Tax on Base of Bracket Percentage on Excess above Base Up to $50,000 $0 15% $50,000-$75,000 7,500 25 $75,000-$100,000 13,750 34 $100,000-$335,000 22,250 39 $335,000-$10,000,000 113,900 34 $10,000,000-$15,000,000 3,400,000 35 $15,000,000-$18,333,333 5,150,000 38 Over $18,333,333 6,416,667 35 Company Z has $90,000 of taxable income from its operations, $5,000 of interest income, and $30,000 of dividend income from preferred stock it holds in other corporations. What is Company Z's tax liability? Assume a 70% dividend exclusion for tax on dividends. a. $18,096 b. $22,620 c. $19,762 d. $23,810 e. $21,429

(1) liquidity (2) receivable (3) current liabilities (4) interest-bearing (5) total debt (6) net working capital (7) net operating working capital (8) net worth

The balance sheet shows the firm's assets and claims against those assets. In other words, assets are equal to liabilities and equity. Assets are shown in order of their *(1) *and claims are listed in the order of when they must be paid. Current assets include cash and their equivalents, accounts *(2) * and inventory, while long-term assets are those whose useful lives exceed one year. Liabilities are divided into *(3) *and long-term debt. We differentiate between total debt and total liabilities. A company's total debt includes both its short-term and long-term *(4) *liabilities. Total liabilities equal *(5) *plus the company's "free" liabilities. *(6) *is the difference between current assets and current liabilities, while *(7) *is equal to current assets less the difference between current liabilities and notes payable. *(8) *is capital supplied by common stockholders and represents ownership.

(1) accounting (2) free (3) operating working capital (4) internal (5) capital

The focus on traditional financial statements is *(1) *data rather than cash flow. However, cash flow is important to investors, managers, and stock analysts. Therefore, decision makers and security analysts need to modify financial statement data provided to them. An important modification is the concept of free cash flow (FCF). Many analysts regard FCF as being the single and most important number that can be developed from the income statements, even more important than net income. The equation for free cash flow is: FCF = (EBIT(1 - T) + Depreciation and amortization) - (Capital expenditures + ΔNet operating working capital) *(2) *cash flow is the cash flow actually available for payments to all investors (stockholders and debtholders) after the company has made investments in fixed assets, new products, and *(3) *. A negative FCF means that the company does not have sufficient *(4) *funds to finance its investments in fixed assets and working capital, and that it will have to raise new money in the *(5) *markets to pay for these investments. Negative FCF is not always bad. If FCF is negative because after-tax operating income is negative this is bad, because the company is probably experiencing operating problems. Exceptions to this might be startup companies, companies incurring significant expenses to launch a new product line, and high-growth companies—with large capital investments.