4. What is Free Cash Flow? 5.

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1 Chapter 4 Class Notes Cash Flows and Planning 1. Why do we have things like depreciation? Smooths income Imagine 3 years of steady income and then a big purchase. What happens if we write off the entire asset? 2. Why are managers more interested in Cash flow than profits? Difference between accounting and finance Would managers want CF sooner or later? How can they get it sooner? 3. What is operating cash flow? Cash generated from running the business. Critical to success 4. What is Free Cash Flow? 5. After a business has done everything they are going to do Business; invest in ST assets, invest in LT assets Funds left for investors Who are the investors of a company? Don t forget the creditors 6. What is the difference between long-term and short-term financial plans? Short-term is cash related Long-term is asset related Both in the end are designed to help us predict the need to get funds from outside the firm. 7. What is the pro forma process? The process of forecasting financial statements in the future. Does not use the double entry journal system so the balance sheet will not balance Deficit means we need money from outside the firm Surplus means we have extra cash What should you do with a surplus?

2 8. Calculate the following: a. What is depreciable basis? Cost + installation costs b. I am going to replace a 5-year MACRS asset purchased 4 years ago. The asset had an original depreciable basis of 65,000. What is the depreciation schedule that I have been using for this asset? CB: cash Flows New Project Depreciable Basis Depreciation New Old Taxes 1 $ - $ 13,000 MACRS Life 2 $ - $ 20,800 Project Life 3 $ - $ 12,350 4 $ - $ 7,800 Alternative Project 5 $ - $ 7,800 Depreciable Basis $65,000 6 $ - $ 3,250 MACRS Life 5 7 $ - $ - Year Purchased (ago) 4 8 $ - $ - How much depreciation is left? c. The new asset was purchased for $75,000. It costs $2,000 to ship the asset to my facility and $4,000 to install. The IRS has classified this asset as a 5 year MACRS asset. What does the depreciation schedule look like? New Project Depreciable Basis $81,000 Depreciation New Old Taxes 1 $ 16,200 $ 13,000 MACRS Life 5 2 $ 25,920 $ 20,800 Project Life 3 $ 15,390 $ 12,350 4 $ 9,720 $ 7,800 Alternative Project 5 $ 9,720 $ 7,800 Depreciable Basis $65,000 6 $ 4,050 $ 3,250 MACRS Life 5 7 $ - $ - Year Purchased (ago) 4 8 $ - $ - $7,800 d. This year I expect to have taxable income of $750,000. What is the depreciation taken on the old asset for the past year? e. What is the tax that I would expect to pay if I did not buy the new asset? Tax on $750,000 Tax = 113,900 + (750, ,000) *.34 = 113, ,100 = 255,000

3 f. What would be the difference in taxable income if I had purchased the new asset? Difference in depr = 16,200 7,800 = 8,400 Tax decrease = 8400 *.34 = 2,856 g. What is the new tax if I did make the exchange? 252,144 h. What is the book value of the old asset? 11,050 i. How do you use the book value information? Book value = the accounting value of the asset If you sell the asset the price you sell for the BV determines profit

4 9. Determine the free cash flow information for the following company. FCF calculation Keith Corporation Balance Sheets Assets Cash and Mkt Securities 3,300 2,200 Accounts Receivable 2,000 1,800 Inventory 2,900 2,800 Total Current Assets 8,200 6,800 Gross Fixed Assets 29,500 28,100 Acc. Depreciation 14,700 13,100 Net Fixed Assets 14,800 15,100 Total Assets 23,000 21,800 Liabilities and Equity Accounts Payable 1,600 1,500 Notes Payable 2,800 2,200 Accruals Total Current Liabilities 4,600 4,000 Long-term Debt 5,000 5,000 Total Liabilities 9,600 9,000 Common Stock 10,000 10,000 Retained Earnings 3,400 2,800 Common Equity 13,400 12,800 Total Liability and Equity 23,000 21,800 Keith Corporation Income Information Depreciation 1,600 EBIT 2,700 Interest Expense 367 Dividends Paid 800 NPM 1,400 Tax Rate 40%

5 Year 2012 Net Income Non-Cash Expenses $1,600 CFAT Taxes ($) (not deferred) $933 EBIT $2,700 OCF CA (beg) $6,800 NCAI CA (end) (change) $8,200 NFAI A/P and Accruals (beg) $1,800 A/P and Accruals (end) (change) $1,800 FCF Fixed Assets (beg) $15,100 Fixed Assets (end) change $14,800 CF Firm OCF (if given) CF Creditors Total Equity (beg) $12,800 CF Shareholders Total Equity (end) change $13,400 Dividends $800 DO Not Include N/P as a Current Liability! Assume it is long term. Total LT Debt and N/P (beg) $7,200 Total LT Debt and N/P (end) chang $7,800 Interest Expense $367 Lawrence Byerly PhD 2013 Research (50 points) Offline Homework (40 points)

6 Chapter 4 Web exercise In Yahoo finance Go to Competitors (10) Who are the company s primary competitors (name and ticker)? 1) 2) 3) How does your company compare to the revenues, gross margin, PE and EPS of the competitors and the industry? Go to Analyst opinion (3) How do the analyst s feel about this company? Go to Analyst Estimates (10) What are the next year s estimates for Revenue EPS PE (under growth estimates) How does the company stack up against the industry and the sector? What does this relationship show? Go to Basic chart (this chart shows how your company s prices have moved historically. You can also compare it to an index and another company Click the S&P index box and type in the ticker symbol for one of your company s competitors above. Choose the big chart and the 1 year chart.

7 Copy and paste chart into this word document. (5) (5) How has your company s prices moved relative to the index and the competitor? Now go back and switch the chart to the 5yr chart. Now compare to the index and competitor. (5) Calculate the CFAT OCF and FCF for the company in your web exercise for the last 2 years. (use Free Cash Flow Calculation) Get the data from the annual financial statements you downloaded. Find the financial statements at yahoo finance under the statement links for your company. Copy and paste special the worksheet below your explanation. Type in the answers. (10) OCF FCF CFAT Year before Last year Explain the differences between the numbers if any. (5)

8 Use the textbook problems at the end of the chapter for this assignment. (15 points) 1) The Laramie Company is considering the purchase of two new machines for their production line. Create the depreciation tables for the two assets. Use the CB Cash Flow worksheet. (5 points) a. Drill Press is a 7 year MACRS asset with a cost of 25,000. It will take $10,000 to install the drill press. i. Depreciable basis = 35,000 ii. Insert table from worksheet b. The fork lift is a 5 year MACRS asset, which has an installed cost of $44,000. i. Insert table. Depreciation New 1 $ 4,900 2 $ 8,750 3 $ 6,300 4 $ 4,200 5 $ 3,150 6 $ 3,150 7 $ 3,150 8 $ 1,400 Depreciation New 1 $ 8,800 2 $ 14,080 3 $ 8,360 4 $ 5,280 5 $ 5,280 6 $ 2,200 7 $ - 8 $ - 2) The Zombie Express Company has an estimated pre-tax income of $750,000. They are considering purchasing a new piece of 5 year MACRS machinery that has an installed cost of $900,000. (Use the Cash Flow Calc spreadsheet) (5 points) a. What is the current tax liability prior to the purchase? $255,000 b. What is the depreciation expense for year one for the purchase? $180,000 c. What is the new pre-tax income after the purchase? $570,000 d. What is the new tax liability? $193,800 e. What is the net income pre-purchase? $495,000 f. What is the net income post-purchase? $376,200

9 3) Use the financial statements below to solve the following question. (Use the FCF Calc worksheet) (15 points) Zebra Corporation Balance Sheets Assets Cash and Mkt Securities Accounts Receivable Inventory Total Current Assets Gross Fixed Assets Acc. Depreciation Net Fixed Assets Total Assets Liabilities and Equity Accounts Payable Notes Payable Accruals Total Current Liabilities Long-term Debt Total Liabilities Common Stock ,000 Retained Earnings Common Equity Total Liability and Equity

10 Zebra Corporation Income Information Depreciation EBIT Interest Expense 3980 Dividends Paid NPM Tax Rate 40% a. CFAT b. OCF c. FCF d. Explain the differences between the answers in b and c. Year 2012 Net Income Non-Cash Expenses $12,103 CFAT Taxes ($) (not deferred) $25,319 EBIT $67,278 OCF CA (beg) $35,681 NCAI CA (end) (change) $38,291 NFAI A/P and Accruals (beg) $26,411 A/P and Accruals (end) (change) $29,082 FCF Fixed Assets (beg) $107,493 Fixed Assets (end) change $114,353 CF Firm OCF (if given) CF Creditors Total Equity (beg) $73,161 CF Shareholders Total Equity (end) change $74,597 Dividends $14,700 DO Not Include N/P as a Current Liability! Assume it is long term. Total LT Debt and N/P (beg) $43,602 Total LT Debt and N/P (end) chang $48,965 Interest Expense $3,980 Lawrence Byerly PhD 2013

Preparing the Statement of Cash Flows. Interpreting the Statement

Preparing the Statement of Cash Flows The statement of cash flows for a given period is developed using the income statement for the period, along with the beginning- and end-of-period balance sheets.