Business Finance FIR 3410
University of Memphis
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This 9 page Class Notes was uploaded by Ashlynn Kuhn on Friday October 23, 2015. The Class Notes belongs to FIR 3410 at University of Memphis taught by Chinmay Jain in Fall. Since its upload, it has received 287 views. For similar materials see /class/228429/fir-3410-university-of-memphis in Finance, Real Estate & Law at University of Memphis.
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Date Created: 10/23/15
CHAPTER 2 FINANCIAL STATEMENTS CASH FLOW AND TAXES Net cash flow Answer e 1 Last year Aldrin Co had negative net cash flow yet its cash on the balance sheet increased What could explain these events a Aldrin issued long term debt b Aldrin repurchased some of its common stock c Aldrin sold some of its assets d Statements a and b are correct e Statements a and c are correct Net cash flow Answer d 2 Which of the following factors could explain why last year Cleaver Energy had negative net cash flow but the cash on its balance sheet increased a The company paid a large dividend b The company had a large depreciation expense c The company repurchased common stock d The company issued new debt e The company made a large investment in new plant and equipment Net cash flow and net income Answer a 3 Kramer Corporation recently announced that its net income was lower than last year However analysts estimate that the company s net cash flow increased What factors could explain this discrepancy a The company s depreciation expense increased b The company s interest expense declined c The company had an increase in its noncash revenues d Statements a and b are correct e Statements b and c are correct Balance sheet Answer c 4 On its 2000 balance sheet Sherman Books had retained earnings equal to 510 million On its 2001 balance sheet retained earnings were also equal to 510 million Which of the following statements is most correct a The company must have had net income equal to zero in 2001 The company did not pay dividends in 2001 c If the company s net income in 2001 was 200 million dividends paid must have also equaled 200 million d If the company lost money in 2001 they must have paid dividends None of the statements above is correct o D Balance sheet and net cash flow Answer c Analysts who follow Sierra Nevada Inc recently noted that the previous year relative to the company s net cash flow was larger but cash on the firm s balance sheet had declined What factors could explain these changes The company sold a division and received cash in return The company cut its dividend The company made a large investment in new plant and equipment Statements a and b are correct Statements b and c are correct Q0 m Changes in depreciation Answer d 6 Assume that a company currently depreciates its fixed assets over 7 years Which of the following would occur if a tax law change forced the company to depreciate its fixed assets over 10 years instead a The company s tax payment would increase b The company s cash position would increase c The company s net income would increase d Statements a and c are correct e Statements b and c are correct Changes in depreciation Answer d 7 Solo Company has been depreciating its fixed assets over 15 years It is Solo s now clear that these assets will only last a total of 10 years accountants have encouraged the firm to revise its annual depreciation to reflect this new information result of this change The company s earnings per share would decrease Which of the following would occur as a a b The company s cash position would increase c The company s EBIT would increase d Statements a and b are correct e All of the statements above are correct Corporate taxes Answer b 8 Your corporation has the following cash flows Operating income 250000 Interest received 10000 Interest paid 45000 Dividends received 20000 Dividends paid 50000 incone tax rate is 40 percent federal and state If the applicable combined and if 70 percent of dividends taxes what is the corporation s tax liability received are exempt from After tax returns 9 After tax returns 10 After tax returns ll 74000 88400 91600 100000 106500 Q0 m Answer I C A corporation can earn 75 percent if it invests in municipal bonds The corporation can also earn 85 percent before tax by investing in preferred stock Assume that the two investments have equal risk What i the break even corporate tax rate that makes the corporation indifferent between the two investments Q0 m LA to l l o0 Answer I C A company with a 35 percent tax rate buys preferred stock in another company The preferred stock has a before tax yield of 8 percent What is the preferred stock s after tax return 1080 520 716 604 630 Q0 m Answer I C Van Dyke Corporation has a corporate tax rate equal to 30 percent The company recently purchased preferred stock in another company The preferred stock has an 8 percent before tax yield What is Van Dyke s after tax yield on the preferred stock Q0 m 1 l 00 o0 Statement of retained earnings 12 of net income million of retained earnings showed 390 million of retained earnings In its recent income statement Smith Software Inc and in its year end balance sheet The previous year What were the total dividends Answer d reported 25 million Smith reported 405 its balance sheet paid to shareholders during the most recent year Q0 m 13 Calcul 14 3500000 5000000 6750000 10000000 11250000 Corporate taxes Griffey Communications recently realized 125000 in operating income The company had dividend income interest Tax on base 6 of bracket Taxable Income Up to 50000 S 0 50000 75000 7500 75000 100000 13750 100000 335000 22250 335000 10000000 113900 income of 25000 and realized 70000 The company s interest expense was 40000 Answer d in 0 on excess above base 15 25 34 39 34 Using the corporate tax schedule above what is Griffey s tax liability Q0 m 45260 53450 27515 34340 33950 ating change in net income Answer c Garfield Industries is expanding its operations throughout the Southeast United States sales ciation interest expense will increase by 150000 will remain at 40 percent If the company s forecast is correct Garfield anticipates that by 1000000 increase by 700000 and much will net income increase or decrease Q0 m No change 40000 increase 60000 increase 100000 increase 180000 increase operating Depreciation expenses the expansion will increase costs excluding depre will rise by 50000 and the company s tax rate how as a result of the expansion Net income 15 Operating and net cash flows 16 Retained earnings 17 Answer d Moose Industries faces the following tax schedule Tax on base of bracket Ol l EXCESS Taxable income above base Up to 50000 0 15 50000 75000 7500 25 75000 100000 13750 34 100000 335000 22250 39 335000 10000000 113900 34 10000000 15000000 3400000 35 15000000 18333333 5150000 38 Over 18333333 6416667 35 Last year the company realized 10000000 in operating income EBTT Tts annual interest expense is 1500000 What was the company s net income for the year 3450175 4385100 5100000 5610000 8386100 Q0 m Answer I a Brooks Sisters operating income EBTT is 500000 The company s tax rate is 40 percent and its operating cash flow is 450000 The company s interest expense is 100000 What is the company s net cash flow Assume that depreciation is the only non cash item in the firm s financial statements a 390000 b 550000 c 600000 d 950000 e 1050000 Answer b New Hampshire Services reported 23 million of retained earnings on its 2000 balance sheet In 2001 the company lost money its net income was 500000 negative 500000 Despite the loss the company still paid a 100 per share dividend The company s earnings per share for 2001 were 250 negative 250 What was the level of retained earnings on the company s 2001 balance sheet a 1 2 million b 16 million c 18 million d 2 6 million e 2 8 million Solution 1 Net cash flow Answer e Long term debt is a source of cash Companies issue debt to get more cash Therefore statement a is true If the company repurchases common stock it must use cash to pay for the repurchases So cash on the balance sheet would decrease Therefore statement b is false If the company sold assets total assets would be unchanged but there would e an increase in cash and a decrease in other assets Therefore statement c is true Since statements a and c are both true the correct choice is statement e 2 Net cash flow Answer d The correct answer is statement d NCF NT Depreciation and Amortization If the company pays a large dividend it is a use of cash so cash on the balance sheet decreases Therefore statement a is incorrect If the company has a large depreciation expense it makes NCF less negative Depreciation is a non cash charge so it will not affect cash on the balance sheet Therefore statement b is incorrect Repurchasing common stock is a use of cash so cash on the balance sheet decreases Therefore statement c is incorrect If the company issues debt NCF can still be negative but cash on the balance sheet will increase The company sells bonds It receives cash for the bonds and gives the investors paper with a promise to pay in return Therefore statement d could explain a negative NCF while cash on the balance sheet increases A large investment in new plant and equipment is a use of cash so cash on the balance sheet decreases Therefore statement e is incorrect 3 Net cash flow and net income Answer a 4 Balance sheet Answer c Statement c is correct the others are false Simply because the change in retained earnings between the two years was zero doesn t mean that net income was zero Remember Beginning retained earnings Net income Dividends Ending retained earnings JUst because the change in retained earnings was zero doesn t mean that dividends were zero 5 Balance sheet and net cash flow Answer c NCF NT DEP If the company had sold a division and received cash cash on the firm s balance sheet would have increased Therefore statement a is false If the company cut its dividend it would have more cash left over from net income so cash on the firm s balance sheet would have increased Therefore statement b is false If the company made a large investment in new plant and equipment it would have larger depreciation expense so net cash flow would increase In addition it had to pay for the equipment somehow so cash on the balance sheet would decline Therefore statement c is true Because statements a and b are false statements d and e must also be false 6 Changes in depreciation Answer d Statements a and c are correct therefore statement d is the correct choice Statement b is incorrect The company would be paying more in 10 11 12 13 taxes a cash decrease expense Thus the company s cash position would Changes in depreciation Answer d Statement a is correct because an increase in depreciation would lower net income and consequently EPS Statement b is also correct because Solo will pay less taxes because depreciation is higher Therefore statement d is the correct choice Statement c is incorrect Depreciation expense would increase hence EBIT would fall Corporate taxes Answer b Operating income 250000 Interest received 10000 Interest paid 45000 Dividends received taxable 6000 Taxable income 221000 Taxable dividends 20000030 6000 Taxes 04221000 88400 After tax returns Answer c 70 of the preferred stock dividends are not taxable thus we need to solve the following for T the tax rate 75 85 851 07T 1 255T T 039 2 3922 After tax returns Answer c Remember only 30 percent of the dividends are taxable After tax return 8 7 8 X 035 X 03 716 After tax returns Answer c After tax yield o0 l l 100 00 o0 Statement of retained earnings Answer d N1 25000000 REyE 405000000 REBY 390000000 Dividends REBY N1 7 Div REWE 390000000 25000000 Div 405000000 415000000 Div 405000000 10000000 Div Corporate taxes Answer d Determine the firm s taxable income Operating income 125000 14 15 16 17 Interest expense 40000 Interest income 25000 Dividend income 30 21000 Taxable income 131000 Only 30 percent of corporate dividends are included as taxable income 030 X 70000 21000 Looking this up in the tax table above the base tax amount is 22250 and the tax above the base is 39 percent of 31000131000 100000 039 X 31000 12090 Griffey s total tax liability is 22250 12090 34340 Calculating change in net income Answer c Set up an income statement Sales 1000000 Oper costs excl depr 700000 EBITDA 300000 Depreciation 50000 EBIT 250000 Interest 150000 EBT 100000 Taxes 40000 Taxes 04100000 40000 Net income 60000 Net income Answer d EBIT 10000000 Interest 1500000 EBT 8500000 Tax 2890000 113900 8500000 335000034 NI Operating and net cash flows Answer I a NCF NI DEP EBIT 500000 Given Interest 100000 Given EBT 400000 Taxes 40 160000 Given NI 240 00 Operating cash flow EBIT1 T DEP 450000 50000006 DEP 150000 DEP NCF 240000 150000 390000 Retained earnings Answer b EPS NIshares For 2001 250 500000Shares Shares 500000 250 200000 Dividends paid in 2001 100 X 200000 200000
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