Business 2019, Fall 2004 Assignment 1 Suggested Answers 1. Financial Statements and Cash Flows Answer the following questions using Table 1 and the following information: Operating cash flow in 2002 is 1,140 Cash flow from assets in 2003 is 458 Net capital spending in 2003 is 500 Cash flow to shareholders in 2003 is 200 The tax rate is the same in 2002 and 2003 (a) (10 points) Complete XYZ s income statements and balance sheets. Answer: The completed statements are in Table 2. The calculations for each missing item are shown below. 2002 EBIT and 2003 EBIT: EBIT 02 = 2, 460 846 354 204 = 1, 056 EBIT 03 = 2, 640 960 354 168 = 1, 158 2002 and 2003 Taxable Income (TI): TI 02 = 1, 056 156 = 900 TI 03 = 1, 158 158 = 1, 000 1
2002 and 2003 Taxes: Using the 2002 operating cash flow, we find Taxes 02 = EBIT 02 + DEP 02 OCF 02 = 1, 056 + 354 1, 140 = 270. The tax rate being the same in both years, i.e. taxes paid in 2003 are t = 270 900 = 30%, Taxes 03 = 30% 1, 000 = 300. 2002 and 2003 Net Income and Earnings Retained: NI 02 = 900 270 = 630 ER 02 = 630 250 = 380 NI 03 = 1, 000 300 = 700 ER 03 = 700 275 = 425 2002 Current and Total Assets: CA 02 = 1, 290 + 1, 707 + 3, 033 = 6, 030 TA 02 = 6, 030 + 10, 033 = 16, 063 2002 Liabilities: CL 02 = 750 + 855 = 1, 605 TLE 02 = 16, 063 RE 02 = 16, 063 1, 605 3, 600 1, 000 = 9, 858 2003 Retained Earnings: Add the 2003 earnings retained to accumulated retained earnings in 2002, i.e. ER 03 = 9, 858 + 425 = 10, 283. 2
2003 Common Stock: We know that cash flow to shareholders in 2003 is 200 and dividends paid in that year are 275. Since CF(S) 03 = DIV 03 (CS 03 CS 02 ), common stock in 2003 is CS 03 = 275 200 + 1, 000 = 1, 075. 2003 Long-Term Debt: Cash flow from assets and cash flow to shareholders in 2003 being 458 and 200, respectively, cash flow to bondholders in 2003 is 458 200 = 258. The interest expense in 2003 being 158, debt must have been reduced by 100 and thus the new value for long-term debt is 3, 600 100 = 3, 500. 2003 Current Liabilities: CL 03 = 734 + 914 = 1, 648 2003 Net Fixed Assets: Net capital spending in 2003 being 500 and since NCS 03 = NFA 03 NFA 02 + DEP 03, the value for net fixed assets in 2003 is given by NFA 03 = 500 + 10, 033 354 = 10, 179. 2003 Current Assets and Inventory: Since our 2003 income statement is complete, we can compute the 2003 operating cash flow, which is OCF 03 = EBIT 03 + DEP 03 Taxes 03 = 1, 158 + 354 300 = 1, 212. 3
Using cash flow from assets and net capital spending in 2003, additions to net working capital in 2003 are NWC 03 = OCF 03 NCS 03 CF(A) 03 = 1, 212 500 458 = 254. Net working capital in 2003 is then NWC 03 = NWC 02 + 254 = 6, 030 1, 605 + 254 = 4, 659, which gives CA 03 = NWC 03 + CL 03 = 4, 659 + 1, 648 = 6, 327. Inventory in 2003 is then INV 03 = 6, 327 1, 320 1, 924 = 3, 083. (b) (5 points) What was XYZ s tax rate in 2002 and 2003? Answer: The tax rate in both years is 30%. (c) (10 points) Compute XYZ s 2003 operating cash flow, its 2003 additions to net working capital and its 2003 cash flow to bondholders. Answer: As calculated above, 2003 operating cash flow is 1,212, 2003 additions to net working capital are 254 and 2003 cash flow to bondholders is 258. 2. Statement of Cash Flows Using Unibroue s 2001 statement of cash flows in Table 3, answer the following questions. (a) (5 points) If Unibroue s tax rate was 35.7% in 2001, how much taxes did it record on its 2001 income statement? How much taxes did it actually pay? Answer: Throughout this question, all numbers represent thousands of dollars. Since Net income (NI) = (1 t) Earnings before taxes (EBT), 4
EBT in 2001 was EBT = 609 1.357 = 947. The tax amount recorded on the 2001 income statement was then EBT NI = 947 609 = 338. Since deferred taxes increased by 444 in that years, the actual taxes paid in 2001 were 338 444 = 106. That is, Unibroue received a net tax refund of 106 in 2001. (b) (5 points) What were Unibroue s future income tax liabilities in 2001 if they amounted to $1,804,000 in 2000? Answer: 1, 804 + 444 = 2, 248. (c) (5 points) Calculate Unibroue s 2001 addition to net working capital ( NWC). Answer: This is given by the net change in cach minus the changes in non-cash working capital items on the statement of cash flow, i.e. NWC = 320 336 = 16. (d) (5 points) Calculate Unibroue s 2001 net capital spending (NCS). Answer: 2,068. (e) (5 points) If Unibroue paid $718,000 in interest in 2001 and had no other nonoperating expenses, compute its 2001 cash flow from assets. Answer: Operating cash flow in 2001 is given by Net cash from operations + Interest expense = 2, 885 + 718 = 3, 603, and thus Unibroue s cash flow from assets in 2001 was 3, 603 ( 16) 2, 068 = 1, 551. 5
3. CCA (10 points) Mississauga Manufacturing Ltd. just invested in some new processing machinery to take advantage of more favourable CCA rates in a new federal budget. The machinery qualifies for 25 percent CCA rate and has an installed cost of $2,500,000. Calculate the CCA and UCC for the first five years. Answer: Please refer to Table 6. 4. CCA and UCC (10 points) Our new computer system cost us $300,000. We expect to sell it in three years for 20 percent of the purchase price. CCA on the computer will be calculated at a 30 percent rate (Class 10). Calculate the CCA and UCC values for three years. What will be the after-tax proceeds from the sale of the system assuming that the asset class is continued? What will be after-tax proceeds from the sale of the system assuming that the asset class is terminated? Assume a 40 percent tax rate. Answer: The CCA and UCC values can be seen in Table 7. If the asset is sold after three years for 20 percent of its initial cost, i.e. $60,000, then the market value of the asset is $64,950 below its UCC. If the asset class is continued, this difference will continue to depreciate as long as the asset class is not terminated. This means that there is no immediate tax consequences and thus the net proceeds from the sale of the asset is simply $60,000. If the asset class is terminated, then the difference between the market value of the asset and its UCC can be claimed against the firm s current income, generating.4 64, 950 = $25, 980 in tax savings. The net proceeds from the sale of the asset is then 60, 000 + 25, 980 = $85, 980. 5. Mini Case Consider the financial information provided in Table 4 for Advanced Manufacturing Corporation. You are a new financial analyst for the company and have been asked 6
to answer a number of questions for senior management in advance of the company s upcoming initial public offering. (a) (5 points) During 2004, the company purchased a number of vehicles falling in CCA class 10 for a total cost of $725,000. All assets previous to this purchase were in class 43. What is the CCA for 2004? What is the value for net fixed assets in 2004? Answer: This company being privately held, all income reporting is for tax purposes and thus CCA and depreciation coincide. The depreciation rate being used for all assets being 30%, the depreciation expense in 2004 is 30% 2, 170, 000 + 30% 725, 000 2 = $759, 750 and thus net fixed assets in 2004 are 2, 170, 000 + 725, 000 759, 750 = $2, 135, 250. (b) (5 points) If the company decides to sell all the vehicles at the end of 2006 for $350,000, what will be the after-tax proceeds from this sale? The tax rate is 35% and assume that the company s net income will be positive in 2006. Answer: At the end of 2006, the vehicles UCC will be (1.3) 3 725, 000 2 + (1.3) 2 725, 000 2 = $301, 962.50. If the vehicles are sold for $350,000, the company will have to pay 35% (350, 000.00 301, 962.50) = $16, 813.13 more taxes since the asset class would then be terminated. The the net proceeds from the sale of the vehicles would then be 350, 000.00 16, 813.13 = $333, 186.87. 7
(c) (10 points) Construct the company s income statements and balance sheets for 2003 and 2004. Answer: Please refer to Table 5. (d) (5 points) For 2004, calculate the cash flow from asset, cash flow to bondholders and cash flow to shareholders. Answer: Operating cash flow in 2004 is OCF = 320, 950 + 759, 750 0 = 438, 800, additions to net working capital are NWC = (1, 200, 200 295, 750) (1, 050, 000 373, 500) = 227, 950 and net capital spending is 725,000. Cash flow from assets is then Cash flow to bondholders is and cash flow to shareholders is 438, 000 227, 950 725, 000 = 514, 150. 55, 450 (407, 500 530, 000) = 177, 950 514, 150 177, 950 = 692, 100. Note that the cash flow to shareholders is equal to net income plus the increase in total equity, i.e. 376, 400 (2, 632, 200 2, 316, 500) = 692, 100. (e) (5 points) For the company s upcoming IPO, management plans to issue 250,000 shares in the company (the current owners plan to take all proceeds from the IPO). Considering the value of owners equity, what is a fair share price? Answer: A fair stock price here would be 2, 632, 200 250, 000 = $10.53. 8
XYZ, Inc. 2003 and 2002 Balance Sheets 2003 2002 Assets Cash 1,320 1,290 Accounts receivable 1,924 1,707 Inventory 3,033 Current assets Net fixed assets 10,033 Total assets Liabilities and Owners Equity Accounts payable 734 750 Accrued expenses 914 855 Current liabilities Long-term debt 3,600 Common stock 1,000 Accum. retained earnings Total liabilities and equity XYZ, Inc. 2003 and 2002 Income Statements 2003 2002 Sales 2,640 2,460 Cost of goods sold 960 846 Depreciation 354 354 Other expenses 168 204 EBIT Interest 158 156 Taxable income Taxes Net income Dividends 275 250 Earnings Retained Table 1: Balance sheets and income statements for Question 1. 9
XYZ, Inc. 2003 and 2002 Balance Sheets 2003 2002 Assets Cash 1,320 1,290 Accounts receivable 1,924 1,707 Inventory 3,083 3,033 Current assets 6,327 6,030 Net fixed assets 10,179 10,033 Total assets 16,506 16,063 Liabilities and Owners Equity Accounts payable 734 750 Accrued expenses 914 855 Current liabilities 1,648 1,605 Long-term debt 3,500 3,600 Common stock 1,075 1,000 Accum. retained earnings 10,283 9,858 Total liabilities and equity 16,506 16,063 XYZ, Inc. 2003 and 2002 Income Statements 2003 2002 Sales 2,640 2,460 Cost of goods sold 960 846 Depreciation 354 354 Other expenses 168 204 EBIT 1,158 1,056 Interest 158 156 Taxable income 1,000 900 Taxes 300 270 Net income 700 630 Dividends 275 250 Earnings Retained 425 380 Table 2: Completed balance sheets and income statements for Question 1. 10
Unibroue, Inc. 2001 Statement of Cash Flows ($000) Operating Activities Net income after taxes 609 Non-cash items Amortization of PP&E 1,637 Amortization of other assets 195 Deferred taxes 444 Net cash from operations 2,885 Changes in non-cash working capital items 336 Cash flow from operating activities 3,221 Investing Activities Short-term investments 361 PP&E (1,939) Other assets (490) Cash flow from investing activities (2,068) Financing Activities Long-term loans 314 Repayment of long-term debt (741) Redemption of shares (406) Cash flow from financing activities (833) Net increase in cash and cash equivalents 320 Cash, beginning of the year 1,394 Cash, end of the year 1,714 Table 3: Statement of Cash Flows for Question 2. 11
Advanced Manufacturing Corporation Financial Data 2003 2004 Sales 700,000 800,000 Cost of goods sold 259,900 280,000 Other expenses 65,000 81,200 Interest 55,000 55,450 Cash 211,000 231,600 Accounts receivable 265,500 285,900 Inventory 573,500 682,700 Accounts payable 373,500 295,750 Long-term debt 530,000 407,500 Net fixed assets 2,170,000 Depreciation 450,000 Table 4: Data for Question 5. Advanced Manufacturing Corporation 2003 and 2004 Balance Sheets 2003 2004 Assets Cash 211,000 231,600 Accounts receivable 265,500 285,900 Inventory 573,500 682,700 Current assets 1,050,000 1,200,200 Net fixed assets 2,170,000 2,135,250 Total assets 3,220,000 3,335,450 Liabilities and Owners Equity Accounts payable 373,500 295,750 Long-term debt 530,000 407,500 Total equity 2,316,500 2,632,200 Total liabilities and equity 3,220,000 3,335,450 Advanced Manufacturing Corporation 2003 and 2004 Income Statements 2003 2004 Sales 700,000 800,000 Cost of goods sold 259,900 280,000 Depreciation 450,000 759,750 Other expenses 65,000 81,200 EBIT (74,900) (320,950) Interest 55,000 55,450 Taxable income (129,900) (376,400) Taxes 0 0 Net income (129,900) (376,400) Table 5: Completed financial statements for Advanced Manufacturing Corporation. 12
Year UCC beg CCA UCC end 1 2,500,000 312,500 2,187,500 2 2,187,500 546,875 1,640,625 3 1,640,625 410,156 1,230,469 4 1,230,469 307,617 922,852 5 922,852 230,713 692,139 Table 6: CCA and UCC for Question 3. Year UCC beg CCA UCC end 1 300,000 45,000 255,000 2 255,000 76,500 178,500 3 178,950 53,550 124,950 Table 7: CCA and UCC for Question 4. 13