FIN CHAPTER 2 SOL complete

CHAPTER 2   FINANCE  PROBLEMS AND SOLUTIONS

2-1

INCOME STATEMENT        Little Books Inc. recently reported net income of $3 million.  Its operating income (EBIT) was $6 million, and the company pays a 40 percent tax rate.  

WHAT WAS THE COMPANY’S INTEREST EXPENSE FOR THE YEAR? 

 [Hint:  Divide $3 million by (1-T) = 0.6 to find taxable income.]

2-2

NET CASH FLOW        Kendall Corners Inc. recently reported net income of $3.1 million.  The company’s depreciation expense was $500,000.  

WHAT IS THE COMPANY’S APPROXIMATE NET CASH FLOW?  ASSUME THE FIRM HAS NO AMORTIZATION EXPENSE.  See page 45
        

2-3

ECONOMIC VALUE 
ADDED        Kordell Company recently reported $170,000 in operating income (EBIT).  The company’s total operating capital is $800,000.  The company’s after-tax cost of that capital is 11.625 percent, and the company is in the 40 percent tax bracket.  

WHAT IS KORDELL’S EVA?  See page 55
        

2-4

STATEMENT OF RETAINED EARNINGS        In its most recent financial statements, Newhouse Inc. reported $50 million of net income and $810 million of retained earnings.  The previous year, its balance sheet showed $780 million of retained earnings.  

WHAT WERE THE TOTAL DIVIDENDS PAID TO SHAREHOLDERS DURING THE MOST RECENT YEAR?  See pages 38, 41-42

2-5

INCOME STATEMENT        Pearson Brothers recently reported an EDITDA of $7.5 million and $1.8 million of net income.  The company has $2.0 million of interest expense and the corporate tax rate is 40 percent.  

WHAT WAS THE COMPANY’S DEPRECIATION AND AMORTIZATION EXPENSE?

2-6

CASH FLOW        
The Klaven Corporation has operating income (EBIT) of $750,000.  The 
company’s depreciation expense is $200,000.  Klaven is 100 percent equity financed, and it faces a 40 percent tax rate.  Assume that the firm has no amortization expense.  

WHAT ARE ITS NET INCOME, ITS NET CASH FLOW, AND ITS OPERATING CASH FLOW?

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2-7

BALANCE SHEET        WHICH OF THE FOLLOWING ACTIONS WILL, ALL ELSE EQUAL, INCREASE THE AMOUNT OF CASH ON A COMPANY’S BALANCE SHEET?

        a.    The company issues $2 million in new common stock.

        b.    The company invests $3 million in new plant and equipment.

        c.    The company generates negative net income and negative net cash flow during the year.

        d.    The company increases the dividend paid on its common stock.

2-8

CASH FLOW        Bailey Corporation recently reported the following income statement (dollars are in thousands):

        Sales
Operating costs excluding depreciation and amortization
EBITDA
Depreciation and amortization
EBIT
Interest
EBT
Taxes (40%)
Net Income    $14,000,000
  7,000,000
$ 7,000,000
  3,000,000
$ 4,000,000
  1,500,000
$ 2,500,000
  1,000,000
$ 1,500,000
        
        Bailey’s total operating capital is $20 billion and its after-tax cost of capital is 10 percent.  Therefore, Bailey’s total after-tax dollar cost of operating capital is $2 billion.  During the past year, Bailey made a $1.3 billion net investment in its operating capital.

        a.    What is Bailey’s NOPAT for the year?
        b.    What is Bailey’s net cash flow for the year?
        c.    What is Bailey’s operating cash flow for the year?
        d.    What is Bailey’s free cash flow for the year?
        e.    What is Bailey’s EVA for the year?

2-9

MARKET 
VALUE 
ADDED        Henderson Industries has $500 million of common equity on its balance sheet.  The company’s current stock price is $60 per share, and its Market Value Added (MVA) is $130 million.  

HOW MANY SHARES OF THE COMPANY’S STOCK ARE CURRENTLY OUTSTANDING?

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2-10

EVA        The Ronayne Corporation has on its balance sheet $5 million in net operating working capital and $37 million in net fixed assets.  The company’s weighted average cost of capital is 8.5 percent.  The company has the following income statement:

            Sales
Operating costs
EBIT
Interest
EBT
Taxes (40%)
Net income    $25,000,000
18,625,000
$ 6,375,000
  2,325,000
$ 4,050,000
  1,620,000
$ 2,430,000
    
        WHAT IS RONAYNE’S EVA?