Business Finance Chapter 3

We will concentrate only on the financial statements section of Chapter 3, which includes the balance sheet, income statement, statement of common equity (retained earnings), and statement of cash flows. We will not be covering the sections on cash flows (free cash flows) and taxes.

Last year Rattner Robotics had $5 million in operating income (EBIT). Its depreciation expense was $1 million, its interest expense was $1 million, and its corporate tax rate was 40%. At year-end, it had $14 million in current assets, $3 million in accounts payable, $1 million in accruals, $2 million in notes payable, and $15 million in net plant and equipment. Rattner uses only debt and common equity to fund its operations. (In other words, Rattner has no preferred stock on its balance sheet.) Rattner had no other current liabilities. Assume that Rattner’s only noncash item was depreciation.

1) What was the company’s net income?

Operating income (EBIT) = $5,000,000

EBT=EBIT−Interest Expense

EBT=5,000,000−1,000,000=4,000,000

Tax rate = 40%

Taxes=EBT×40%=4,000,000×0.40=1,600,000

Net Income=EBT−Taxes=4,000,000−1,600,000=2,400,000

$2,400,000 Net Income

Last year Rattner Robotics had $5 million in operating income (EBIT). Its depreciation expense was $1 million, its interest expense was $1 million, and its corporate tax rate was 40%. At year-end, it had $14 million in current assets, $3 million in accounts payable, $1 million in accruals, $2 million in notes payable, and $15 million in net plant and equipment. Rattner uses only debt and common equity to fund its operations. (In other words, Rattner has no preferred stock on its balance sheet.) Rattner had no other current liabilities. Assume that Rattner’s only noncash item was depreciation.

2) What was its net working capital (NWC)?

NWC = Current Assets − Current Liabilities

Current assets = $14,000,000

Notes Payable = $2,000,000

Accounts payable = $3,000,000

Accruals = $1,000,000

Operating Current Liabilities=3,000,000+1,000,000+2,000,000=6,000,000

NWC=14,000,000−6,000,000=8,000,000

Last year Rattner Robotics had $5 million in operating income (EBIT). Its depreciation expense was $1 million, its interest expense was $1 million, and its corporate tax rate was 40%. At year-end, it had $14 million in current assets, $3 million in accounts payable, $1 million in accruals, $2 million in notes payable, and $15 million in net plant and equipment. Rattner uses only debt and common equity to fund its operations. (In other words, Rattner has no preferred stock on its balance sheet.) Rattner had no other current liabilities. Assume that Rattner’s only noncash item was depreciation.

3) What was its net operating working capital (NOWC)?

NOWC=Operating Current Assets−Operating Current Liabilities

• Operating Current Assets = Current assets excluding cash and short-term investments (non-operating items).

• Operating Current Liabilities = Accounts payable + Accruals (exclude notes payable, since that’s financing).

Operating current assets = $14,000,000

• Accounts payable = $3,000,000

• Accruals = $1,000,000

Operating Current Liabilities=3,000,000+1,000,000=4,000,000

NOWC=14,000,000−4,000,000=10,000,000

INCOME STATEMENT Little Books Inc. recently reported $3 million of net income. Its EBIT was $6 million, and its tax rate was 40%. What was its interest expense?

$1,000,000

STATEMENT OF STOCKHOLDERS’ EQUITY In its most recent financial statements, Newhouse Inc. reported $50 million of net income and $810 million of retained earnings. The previous retained earnings were $780 million. How much in dividends were paid to shareholders during the year? Assume that all dividends declared were actually paid.

$20 million

STATEMENT OF CASH FLOWS W.C. Cycling had $55,000 in cash at year-end 2014 and $25,000 in cash at year-end 2015. The firm invested in property, plant, and equipment totaling $250,000. Cash flow from financing activities totaled +$170,000.

1) What was the cash flow from operating activities?

1) $50,000

STATEMENT OF CASH FLOWS W.C. Cycling had $55,000 in cash at year-end 2014 and $25,000 in cash at year-end 2015. The firm invested in property, plant, and equipment totaling $250,000. Cash flow from financing activities totaled +$170,000.

2) If accruals increased by $25,000, receivables and inventories increased by $100,000, and depreciation and amortization totaled $10,000, what was the firm’s net income?

2) $115,000

Which of the following best describes shareholders' equity?

Option A

Equity = what the initial stockholders paid when they bought company shares + the earnings that the company has retained over the years

Option B

Equity = liabilities - assets

Option C

Equity = assets + liabilities

Option D

Equity = paid-in capital - retained earnings

Option A

Emery Mining Inc. recently reported $150,000 of sales, $75,500 of operating costs other than depreciation, and $10,200 of depreciation. The company had $16,500 of outstanding bonds that carry a 7.25% interest rate, and its federal-plus-state income tax rate was 35%. How much was the firm's EBIT?

Option A

$41,017.44

Option B

$74,500.00

Option C

$63,103.75

Option D

$64,300.00

Option D

EBIT = Sales - Operating Costs - Depreciation

EBIT = 150,000 - 75,500 - 10,200

EBIT = 64,300

During 2014, Bascom Bakery paid out $33,525 of common dividends. It ended the year with $197,500 of retained earnings versus the prior year's retained earnings of $159,600. How much net income did the firm earn during the year?

Option A

$82,683

Option B

$78,746

Option C

$86,818

Option D

$74,996

Option E

$71,425

Option E

RE end = RE begin. + NI - Dividends

NI = RE end - RE begin. + Dividends

NI = 71,425

Question 4

Identify which type of activity is described by the following statement:

Fitzi Chemical Co. earns revenue from its cash receipts from royalties.

Option A

Not enough information

Option B

Financing activity

Option C

Operating activity

Option D

Investing activity

Option C

The ______ accounts for all revenues and expenses over an accounting period.

Option A

Income statement

Option B

Balance sheet

Option C

Annual report

Option D

Statement of cash flows

Option A

Brown Office Supplies recently reported $15,500 of sales, $8,250 of operating costs other than depreciation, and $1,750 of depreciation. It had $9,000 of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's interest expense?

Option A

$9000

Option B

$630

Option C

$385

Option D

$1085

Option B

Interest Expense = Bonds Outstanding x Interest Rate

Interest Exepnse = 9,000 × 0.07 = 630

Which major financial statement answers the following question:

Does the firm generate enough funds to support anticipated investment, or does additional outside capital need to be raised?

Option A

Balance sheet

Option B

Annual report

Option C

Income statement

Option D

Statement of cash flows

Option D

Brown Office Supplies recently reported $15,500 of sales, $8,250 of operating costs other than depreciation, and $1,750 of depreciation. It had $9,000 of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's earnings before taxes (EBT)?

Option A

$4,870

Option B

$4,627

Option C

$5,114

Option D

$5,638

Option E

$5,369

Option A

Interest Expense = 9,000 × 0.07 = 630

EBT = Sales - Operating Costs - Depreciation - Interest Expense

EBT = 4,870

Which major financial statement answers the following question:

Can the firm meet all its short-term obligations using its current assets?

Option A

Statement of cash flows

Option B

Statement of retained earnings

Option C

Income statement

Option D

Balance sheet

Option D

Which of the following statements is CORRECT?

Option A

If a company's statements were prepared in accordance with generally accepted accounting principals (GAAP), the market value of the sock equals the book value of the stock as reported on the balance sheet.

Option B

The assets section of a typical company's balance sheet begins with cash, then lists the assets in order in which they will probably be converted to cash, with the longest living assets listed last.

Option C

The balance sheet for a given year tells us how much money the company earned during the year.

Option D

The balance sheet for a given year is designed to give us an idea of what happened to the firm during that year.

Option B

Which of the following is not a primary source of raising money or capital for the firm?

Option A

Assets

Option B

Bonds

Option C

Common stock

Option D

Preferred stock

Option A

Analysts who follow Howe Industries recently noted that, relative to the previous year, the company's net cash provided from operations increased, yet cash as reported on the balance sheet decreased. Which of the following factors could explain this situation?

Option A

The company issued new long-term debt.

Option B

The company sold a division and received cash in return.

Option C

The company made large investments in fixed assets.

Option D

The company issued new common stock.

Option C

Question 13

Identify which type of activity is described by the following statement:

Yum Co. uses cash to repurchase 10% of its common stock.

Option A

Investing activity

Option B

Operating activity

Option C

Financing activity

Option D

Not enough information

Option C

Which of the following items is NOT normally considered to be a current asset?

Option A

Inventory.

Option B

Accounts receivable.

Option C

Short-term, highly-liquid, marketable securities.

Option D

Bonds.

Option E

Cash.

Option D

Gross profit is equal to

Option A

sales minus selling and administrative expenses.

Option B

sales minus cost of goods sold and depreciation expense.

Option C

sales minus cost of goods sold.

Option D

sales minus cost of goods sold and selling and administrative expenses.

Option C

Assume that Cold Goose Metal Works Inc. has 50 million shares of common stock outstanding. Calculate the missing blanks of the balance sheet before answering the following question.

Is the following statement true or false, and why?

Statement 3: The book value per share of Cold Goose's stock in Year 2 was $750.00.

Option A

True, because the per-share book value is calculated by dividing the company's total assets by the number of outstanding shares of common stock.

Option B

True, because the per-share book value is calculated by dividing the company's total common equity by the number of outstanding shares of common stock.

Option C

False, because the per-share book value is calculated by dividing the company's total debt by the number of outstanding shares of common stock.

Option D

False, because the per-share book value is calculated by dividing the company's total assets by the number of outstanding shares of common stock.

Option B

Book value per share = 37,500,000 (common equity) / 5,000,000 (shares outstanding) = $7.50

Bauer Software's current balance sheet shows total common equity of $5,125,000. The company has 530,000 shares of stock outstanding, and they sell at a price of $27.50 per share. By how much do the firm's market and book values per share differ?

Option A

$19.66

Option B

$21.67

Option C

$18.72

Option D

$20.64

Option E

$17.83

Option E

Book value per share = total common equity / shares outstanding

Book value per share = 5,125,000 / 530,000 = 9.669

Difference = market price - book value per share

Difference = 27.50 - 9.669 = 17.83

An item which may be converted to cash within one year or one operating cycle of the firm is classified as a

Option A

current asset.

Option B

current liability.

Option C

long-term liability.

Option D

long-term asset.

Option A

The _____ on the balance sheet shows where the funds of a company come from, and the ______ on the balance sheet shows where the funds of a company go.

Option A

liabilities and assets; equity

Option B

assets; liabities and equity

Option C

liabities; assets and equity

Option D

liabilities and equity; assets

Option D

Which of the following statements is CORRECT?

Option A

The balance sheet gives us a picture of the firm's financial position at a point in time.

Option B

The statement of cash flows tells us how much cash the firm must pay out in interest during the year.

Option C

The income statement gives us a picture of the firm's financial position at a point in time.

Option D

The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget, and the statement of stockholder's equity.

Option A

Which account represents the cumulative earnings of the firm since the firm started, minus dividends paid?

Option A

Paid-in capital

Option B

Accumulated depreciation

Option C

Common stock

Option D

Retained earnings

Option D

Question 22

The _____ has three segments that when analyzed together give an idea of what the company owns and what it owes.

Option A

Annual report

Option B

Balance sheet

Option C

Statement of cash flows

Option D

Statement of retained earnings

Option B

Wu Systems has the following balance sheet. How much net operating working capital does the firm have?

Option A

$675

Option B

$750

Option C

$825

Option B

Operating Current Assets = Cash + A/R + Inventory

Operating Current Assets = 1,300

Operating Current Liab. = Accounts Payable + Accruals

Operating Current Liab. = 550

NOWC = Operating Current Assets - Operating Current Liab.

NOWC = 1,300 - 550 = 750

During the last year, Dual Purposes Products Co. generated $819 million in cash flow from operating activities and had negative cash flow generated from investing activities (-$448 million). At the end of the first year, Dual Purposes Products Co. had $140 million in cash on its balance sheet, and the firm had $280 million in cash at the end of the second year. What was the firm's cash flow due to financing activities in the second year?

Option A

$288.75 million

Option B

-$231 million

Option C

$173.25 million

Option D

-$115.50 million

Option B

Change in cash = CFO + CFI + CFF

Change in cash = 280 - 140 = 140

140 = 819 + (-448) + CFF

140 = 371 + CFF

CFF = 140 - 371 = -231

Emery Mining Inc. recently reported $150,000 of sales, $75,500 of operating costs other than depreciation, and $10,200 of depreciation. The company had $16,500 of outstanding bonds that carry a 7.25% interest rate, and its federal-plus-state income tax rate was 35%. How much was the firm's net income? The firm uses the same depreciation expense for tax and stockholder reporting purposes.

Option A

$38,966.57

Option B

$41,017.44

Option C

$43,068.31

Option D

$35,167.33

Option E

$37,018.24

Option B

EBIT = 150,000 - 75,500 - 10,200 = 64,300

Interest = 16,500 × 0.0725 = 1,196.25

EBT = 64,300 - 1,196.25 = 63,103.75

Taxes = 63,103.75 × 0.35 = 22,086.3125

Net Income = 63,103.75 - 22,086.3125 = 41,017.4375

Calculate the missing blanks of the balance sheet before answering the following question.

Is the following statement true or false, and why?

Statement 2: On December 31 of Year 2, Cold Goose Metal Works, Inc. had $9,225 million of actual money that it could have spent immediately.

Option A

False, because the funds recorded in Cold Goose's accounts receivable account represents funds that are either cash or can be converted into cash almost immediately.

Option B

False, because Cold Goose's Year 2 cash and equivalents balance is $23,220.

Option C

True, because the funds recorded in Cold Goose's cash and equivalents account represents funds that are either cash or can be converted into cash almost immediately

Option D

True, because Cold Goose's Year 2 cash and equivalents balance is $23,220.

Option C

Cash and Equivalents = 22,500 - 3,375 - 9,900 = 9,225

An increase of $100,000 in inventory would result in a(n)

Option A

Increase of cash flows for investing activities

Option B

Increase of cash flows for financing activities

Option C

decrease of cash flows for operating activities

Option D

decrease of cash flows for financing activities

Option C

Brown Office Supplies recently reported $15,500 of sales, $8,250 of operating costs other than depreciation, and $1,750 of depreciation. It had $9,000 of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's net income?

Option A

$4870

Option B

$1948

Option C

$5500

Option D

$2922

Option D

EBIT = 15,500 - 8,250 - 1,750 = 5,500

Interest = 9,000 × 0.07 = 630

EBT = 5,500 - 630 = 4,870

Tax = 4,870 × 0.40 = 1,948

Net income = 4,870 - 1,948 = 2,922

Question 29

Which of the following is an outflow of cash?

Option A

Profitable operations

Option B

The payment of cash dividends

Option C

The sale of equipment

Option D

The sale of the company's common stock

Option B

Question 30

The _____ provides details about how the flow of funds from operating, investing, and financing activities.

Option A

Balance sheet

Option B

Statement of retained earnings

Option C

Statement of cash flows

Option D

Income statement

Option C

Question 31

W.C. Cycling had $55,000 in cash at year-end 2004 and $25,000 in cash at year-end 2005. Cash flow from long-term investing activities totaled -$250,000, and cash flow from financing activities totaled +$170,000.

What was the cash flow from operating activities?

Option A

$55,000

Option B

-$30,000

Option C

-$80,000

Option D

$50,000

Option D

Change cash = Cash flow operating + cash flow investing + cash flow financing

25,000 - 55,000 = Cash flow operating + (-250,000) + 170,000

-30,000 = Cash flow operating - 80,000

Cash flow operating = 50,000

Question 32

Identify which type of activity is described by the following statement:

A company buys some common stock in its supplier's firm with its extra cash.

Option A

Operating activity

Option B

Financing activity

Option C

Investing activity

Option D

Not enough information

Option C

Missing from table:

Total common equity

2014; $3,664,000, 2013; $2,580,000

Total liabilities and equity

2014; $9,064,000, 2013; $7,870,000

The firm has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year, non-callable, long-term debt in 2013. As of the end of 2014, none of the principal on this debt had been repaid. Assume that the company's sales in 2013 and 2014 were the same. Which of the following statements must be CORRECT?

Option A

The firm issued new common stock in 2014.

Option B

The firm repurchased some common stock in 2014.

Option C

The firm increased its short-term bank debt in 2014.

Option D

The firm issued long-term debt in 2014.

Option A

The ______ is published once a year and provides stockholders with details about the company's performance and financial condition

Option A

Annual report

Option B

Statement of retained earnings

Option C

Balance sheet

Option D

Statement of cash flows

Option A

Identify which type of activity is described by the following statement:

A company records a loss of $70,000 on the sale of its outdated inventory.

Option A

Financing activity

Option B

Operating activity

Option C

Investing activity

Option D

Not enough information

Option B

Which of the following statements is CORRECT?

Option A

Dividends do not show up in the statement of cash flows because dividends are considered to be a financing activity, not an operating activity.

Option B

In the statement of cash flows, a decrease in accounts payable is subtracted from net income in the operating activities section.

Option C

In the statement of cash flows, a decrease in accounts receivable is subtracted from net income in the operating activities section.

Option D

In the statement of cash flows, depreciation is subtracted from net income in the operating activities section.

Option B

Brown Office Supplies recently reported $15,500 of sales, $8,250 of operating costs other than depreciation, and $1,750 of depreciation. It had $9,000 of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's EBIT (earnings before interests and taxes)?

Option A

$4870

Option B

$2922

Option C

$1948

Option D

$5500

Option D

EBIT = sales - operating costs - depreciation

EBIT = 15,500 - 8,250 - 1,750

EBIT = 5,500

NOW Inc. released its annual results and financial statements. Grace is reading the summary in the business pages of today's paper. In its annual report, NOW Inc. reported a net income of $200 million. Last year, the company reported a retained earnings balance of $544 million, whereas this year it increased to $640 million. How much was paid out in dividends this year?

Option A

$3 million

Option B

$296 million

Option C

$104 million

Option D

$525 million

Option C

Ending RE = Beginning RE + NI - Dividends

640 = 544 + 200 - Dividends

640 = 744 - Dividends

Dividends = 744 - 640 = 104

Calculate the missing blanks of the balance sheet before answering the following question.

Is the following statement true or false, and why?

Statement 1: Cold Goose's pool of relatively liquid assets, which are available to support the company's current and future sales, decreased from Year 1 to Year 2.

Option A

False, because Cold Goose's total current asset balance actually increased from $18,000 million to $22,500 million between Year 1 and Year 2.

Option B

True, because Cold Goose's total current liabilities decreased by $4,500 million between Year 1 and Year 2.

Option C

False, because Cold Goose's total current asset balance decreased from $22,500 million to $18,000 million between Year 1 and Year 2.

Option D

True, because Cold Goose's total current asset balance actually decreased from $18,000 million to $22,500 million between Year 1 and Year 2.

Option A

Total Current Assets

Year 1 = 18,000

Year 2 = 22,500

Increase, not a decrease

Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet?

Option A

The company pays a dividend.

Option B

The company gives customers more time to pay their bills.

Option C

The company repurchases common stock.

Option D

The company issues new common stock.

Option D