Solution - Chapter 2

Solution_Chapter 2
NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this solutions
manual, rounding may appear to have occurred. However, the final answer for each problem is found
without rounding during any step in the problem.
Basic
1. To find owners’ equity, we must construct a balance sheet as follows:
Balance Sheet
CA $ 5,400 CL $ 4,100
NFA 28,100 LTD 10,600
OE ??
TA $33,500 TL & OE $33,500
We know that total liabilities and owners’ equity (TL & OE) must equal total assets of $33,500.
We also know that TL & OE is equal to current liabilities plus long-term debt plus owners’ equity,
so owners’ equity is:
Owners’ equity = $33,500 – 10,600 – 4,100

Owners’ equity = $18,800
And net working capital (NWC) is:

NWC = CA – CL
NWC = $5,400 – 4,100
NWC = $1,300
2. The income statement for the company is:
Income Statement
Sales $742,000
Costs 316,000
Depreciation 39,000
EBIT $387,000
Interest 34,000
EBT $353,000
Taxes (21%) 74,130
Net income $278,870
3. One equation for net income is:
Net income = Dividends + Addition to retained earnings
Rearranging, we get:
Addition to retained earnings = Net income – Dividends = $278,870 – 125,000 = $153,870
4. EPS = Net income/Shares = $278,870/75,000 = $3.72 per share
DPS = Dividends/Shares = $125,000/75,000 = $1.67 per share
5. Taxes = .10($9,875) + .12($40,125 – 9,875) + .22($85,525 – 40,125) + .24($163,300 – 85,525)

+ .32($189,000 – 163,300)
Taxes = $41,495.50
The average tax rate is the total tax paid divided by taxable income, so:
Average tax rate = $41,495.50/$189,000

Average tax rate = .2196, or 21.96%
The marginal tax rate is the tax rate on the next $1 of earnings, so the marginal tax rate is 32 percent.
6. To calculate OCF, we first need the income statement:
Income Statement
Sales $49,800
Costs 23,700
Depreciation 2,300
EBIT $23,800
Interest 1,800
Taxable income $22,000
Taxes (22%) 4,840
Net income $17,160
OCF = EBIT + Depreciation – Taxes
OCF = $23,800 + 2,300 – 4,840
OCF = $21,260
7. Net capital spending = NFAend – NFAbeg + Depreciation

Net capital spending = $3,100,000 – 2,300,000 + 327,000
Net capital spending = $1,127,000
8. Change in NWC = NWCend – NWCbeg

Change in NWC = (CAend – CLend) – (CAbeg – CLbeg)
Change in NWC = ($5,970 – 3,240) – ($5,320 – 2,510)
Change in NWC = $2,730 – 2,810
Change in NWC = –$80
9. Cash flow to creditors = Interest paid – Net new borrowing

Cash flow to creditors = Interest paid – (LTDend – LTDbeg)
Cash flow to creditors = $305,000 – ($2,660,000 – 2,250,000)
Cash flow to creditors = –$105,000
10. Cash flow to stockholders = Dividends paid – Net new equity

Cash flow to stockholders = Dividends paid – [(Common end + APISend) – (Commonbeg + APISbeg)]
Cash flow to stockholders = $654,000 – [($965,000 + 5,040,000) – ($780,000 + 4,780,000)]
Cash flow to stockholders = $209,000
Note, APIS is the additional paid-in surplus.
11. Cash flow from assets = Cash flow to creditors + Cash flow to stockholders
= –$105,000 + 209,000 = $104,000
Cash flow from assets = $104,000 = OCF – Change in NWC – Net capital spending
= $104,000 = OCF – (–$55,000) – 1,500,000
Operating cash flow = $104,000 – 55,000 + 1,500,000

Operating cash flow = $1,549,000
Intermediate
14. The solution to this question works the income statement backwards. Starting at the bottom:
Net income = Dividends + Addition to retained earnings = $2,370 + 6,800 = $9,170
Now, looking at the income statement:
EBT – EBT × Tax rate = Net income
Recognize that EBT × Tax rate is the calculation for taxes. Solving this for EBT yields:
EBT = NI/(1 – Tax rate) = $9,170/(1 – .22) = $11,756
Now you can calculate:

EBIT = EBT + Interest = $11,756 + 5,300 = $17,056
The last step is to use:
EBIT = Sales – Costs – Depreciation

$17,056 = $76,800 – 36,900 – Depreciation
Depreciation = $22,844
17. Income Statement

Sales $865,000
COGS 535,000
A&S expenses 125,000
Depreciation 170,000
EBIT $35,000
Interest 90,000
Taxable income –$55,000
Taxes (25%) 0
a. Net income –$55,000
b. OCF = EBIT + Depreciation – Taxes

OCF = $35,000 + 170,000 – 0
OCF = $205,000
c. Net income was negative because of the tax deductibility of depreciation and interest expense.
However, the actual cash flow from operations was positive because depreciation is a non-cash
expense and interest is a financing expense, not an operating expense.

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Solution_Chapter 2

1. To find owners’ equity, we must construct a balance sheet as follows:

Owners’ equity = $33,500 – 10,600 – 4,100

And net working capital (NWC) is:

2. The income statement for the company is:

3. One equation for net income is:

Net income = Dividends + Addition to retained earnings

Addition to retained earnings = Net income – Dividends = $278,870 – 125,000 = $153,870

4. EPS = Net income/Shares = $278,870/75,000 = $3.72 per share

DPS = Dividends/Shares = $125,000/75,000 = $1.67 per share

5. Taxes = .10($9,875) + .12($40,125 – 9,875) + .22($85,525 – 40,125) + .24($163,300 – 85,525)

Average tax rate = $41,495.50/$189,000

6. To calculate OCF, we first need the income statement:

7. Net capital spending = NFAend – NFAbeg + Depreciation

8. Change in NWC = NWCend – NWCbeg

9. Cash flow to creditors = Interest paid – Net new borrowing

10. Cash flow to stockholders = Dividends paid – Net new equity

Note, APIS is the additional paid-in surplus.

Operating cash flow = $104,000 – 55,000 + 1,500,000

Net income = Dividends + Addition to retained earnings = $2,370 + 6,800 = $9,170

Now, looking at the income statement:

EBT – EBT × Tax rate = Net income

EBT = NI/(1 – Tax rate) = $9,170/(1 – .22) = $11,756

Now you can calculate:

The last step is to use:

EBIT = Sales – Costs – Depreciation

17. Income Statement

b. OCF = EBIT + Depreciation – Taxes

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