Cash Flow and Taxes Financial Statements: Things to Keep in Mind Backward vs. Forward Looking Book Values vs. Market Values Accounting Numbers vs. Cash Flows Tax Deductible vs. Taxable Notes to Financial Statements 51 Taxes Average vs. Marginal Tax Rates Corporate Taxes: Capital Gains Taxed as ordinary income Dividends Received If own < 20%, can exclude 70% If own > 20% but < 80%, can exclude 80% If own > 80%, can exclude 100% Interest 52
53 2015 Corporate Tax Rates Assume a corporation has $100,000 of taxable income from operations, $5,000 of interest income, and $10,000 of dividend income. What is its tax liability? 54 Operating Assets Operating Assets = Necessary to operate the firm Operating Current Assets Usually cash, accounts receivable, and inventories Operating Long-Term Assets Operating Current Liabilities= NOT capital that investors provide Usually accounts payable and accruals 55
Nonoperating Assets Nonoperating Assets = NOT necessary to operate the firm Out of the control of management Examples: cash or marketable securities Investments in other companies Land 56 Operating Capital Net Operating Working Capital = Operating Current Assets Operating Current Liabilities For example: (cash + accounts receivable + inventories) (accounts payable + accruals) Total Net Operating Capital = Net Operating Working Capital + Operating Long-Term Assets 57 Net Operating Profit After Taxes (NOPAT) NOPAT = 58 Features/Uses: Ignores Can compare companies with different capital structures Gives Profit from Operations
59 Free Cash Flow (FCF) FCF = Cash flow available to investors after necessary investment in fixed assets and working capital 60 Net Investment vs. Gross Investment Net Investment in Operating Capital = Change in Operating Capital Gross Investment in Operating Capital = Net Investment in Operating Capital + Depreciation 61 Free Cash Flow (FCF)
Free Cash Flow (FCF) 62 Free Cash Flow (FCF) 63 Uses of Free Cash Flow (FCF) 1. 2. 3. 4. 5. 64
Market Value Added (MVA) MVA= Over life of a company Market value of stock equity supplied by shareholders Market Value Book Value (price per share) x (# shares) total equity Total market value of firm total capital 65 Market Value Added (MVA) 66 Economic Value Added (EVA) EVA = Over period of time Measures economic profit Can be applied to divisions NOPAT After-tax cost of capital used to support operations EBIT (1-t) (Operating Capital) x (WACC) 67
FCF, MVA, and EVA for Home Depot What do we need? 68 Where do we find it? What are FCF, MVA, and EVA? Chapter 2 Suggested Problems Concept Questions 6 and 8 (2, 5, and 7 done in Orientation 1) Questions and Problems 4, 5, 6, 10, 16, 17, and 18 (1, 2, and 3 done in Orientation 1) Calculate FCF, EVA, and MVA for Home Depot 69
Balance Sheet December 31 Assets: 2015 2014 Cash 7,282 9,000 Short-term Investments 20,000 48,600 Accounts Receivable 632,160 351,200 Inventories 1,287,360 715,200 Total Current Assets 1,946,802 1,124,000 Gross Fixed Assets 1,202,950 491,000 Less: Depreciation 263,160 146,200 Net Fixed Assets 939,790 344,800 Total Assets 2,886,592 1,468,800 Balance Sheet December 31 Liabilities and Equity: 2015 2014 Accounts Payable 324,000 145,600 Notes Payable 720,000 200,000 Accrued Expenses 284,960 136,000 Total Current 1,328,960 481,600 Liabilities Long-term Debt 1,000,000 323,432 Common Stock 460,000 460,000 Retained Earnings 97,632 203,768 Total Equity 557,632 663,768 Total Liabilities & Equity 2,886,592 1,468,800
Income Statement For Year Ended December 31 2015 2014 Sales 5,834,400 3,432,000 Cost of Goods Sold (COGS) 4,980,000 2,864,000 Other Expenses 720,000 340,000 Depreciation 116,960 18,900 Total Operating Costs 5,816,960 3,222,900 EBIT 17,440 209,100 Interest Expense 176,000 62,500 EBT (158,560) 146,600 Taxes (40%) (63,424) 58,640 Net Income (95,136) 87,960 Statement of Cash Flows For Year Ended December 31, 2015 Operating Activities: Net Income (95,136) Adjustments: Depreciation and Amortization 116,960 Change in Accounts Receivable (280,960) Change in Inventories (572,160) Change in Accounts Payable 178,400 Change in Accrued Expenses 148,960 Net Cash Provided by Operating Acts. (503,936)
Statement of Cash Flows For Year Ended December 31, 2015 Investing Activities : Cash Used to Acquire Fixed Assets (711,950) Statement of Cash Flows For Year Ended December 31, 2015 Financing Activities: Change in Short-term Investments 28,600 Change in Notes Payable 520,000 Change in Long-term Debt 676,568 Payment of Cash Dividends (11,000) Net Cash Provided by Financing Activities 1,214,168 Net Change in Cash (1,718) Cash at Beginning of Year 9,000 Cash at End of Year 7,282