CHAPTER 2 FINANCIAL STATEMENT, TAXES & CASH FLOW

I. True/ False

1. Net working capital equals to current assets minus current liabilities.

A. True

B. False

2. Equity holders get the first claim to the firm's cash flow

A. True

B. False

3. Retained earnings refer to the portion of a corporation's profits that are paid out to

shareholders

A. True

B. False

4. Depreciation is a noncash item, which is an expense charged against revenues that do

not directly affect cash flow

A. True

B. False

5. Cash flow from assets involves three components: operating cash flow, capital
spending, and change in net working capital

A. True

B. False

II. Short answer

1. Under standard accounting rules, a decrease in depreciation expense will

decrease net income and decrease the cash flow from asset? Why or why not?

Net Cash Flow = Net Income + Depreciation Expense

=> A decrease in depreciation expense will decrease net income and decrease the cash
flow from asset

2. Why might the revenue and cost figures shown on a standard income statement
not be representative of the actual cash inflows and outflows that occurred during
a period?

=> The recognition and matching principle

The recognition principle shows that revenue is recognized at the time of sale, which
need not be the same as the time of collection. The matching principle indicates that
revenues is first recognized by the recognition principle and then match those revenues
with the costs associated with producing them.

Therefore, income statement may not be at all representative of the actual cash inflows
and outflows

3. What makes net income be different from operating cash flow?

• Net Income is the result of revenues minus the expenses, taxes, and costs
of goods sold (COGS).

• Operating cash flow is the cash generated from operations, or revenues,

less operating expenses.

=> Revenues

4. If a company’s cash flow from asset is negative for a specific period. Does it
signal that this company is in a good or bad financial position?

A company’s cash flow from asset includes operating cash flow (OCF) so negative cash
flow from operating activities is a warning signal for the enterprise.

III. Multiple Choice Question

1. What is the balance sheet?

A. A financial statement showing a firm's accounting value on a particular date

B. A financial statement showing a firm's accounting value over a period of time

C. A financial statement showing a firm's cash flow over a period of time

D. A financial statement showing a firm's revenue & expenses over a period of time

2. What is the income statement?

A. A financial statement summarizing a firm’s performance over a period of time

B. A financial statement summarizing a firm’s performance on a particular date

C. A financial statement showing a firm's cash flow over a period of time

D. A financial statement showing a firm's accounting value on a particular date

Information for question 3 & 4

3. What is the NWC of the firm given the information above?

A. 50

B. 40 Net working capital = Current assets –

Current liabilities = 100 - 70
C. 30

D. 10

4. What is the Shareholders’ Equity given the information above?

A. 300

B. 330 Shareholders’ equity = Total liabilities and

shareholders’ equity – Current liabilities – Long-term debt =
C. 350 600 – 70 - 200

D. 400

5. What is not included in Current Assets?

A. Account receivables
B. Inventory

C. Cash & cash equivalent

D. Account payables

6. What would be the first thing reported on an income statement?

A. Revenue/Sales

B. Operating Expense

C. Interest expense

D. Taxes

7. Gross profit is calculated as:

A. Total sales - cost of goods sold - selling, general and administrative expenses -

depreciation and amortization

B. Total sales - cost of goods sold - selling, general and administrative expenses

C. Total sales - cost of goods sold

D. None of the above

8. In 2021, Firm A has done a great job and yielded a net income of 500,000 USD. The

company decides to give back to its shareholders 200,000 USD. What is the addition to
retained earning?

A. 100,000 USD

B. 200,000 USD Retained earnings = Net income – Dividend paid =

500 – 200
C. 300,000 USD

D. 400,000 USD

9. Use the following information for Firm B incorporated:

Assets $200 million

Shareholder Equity $100 million

Sales $300 million

Net Income $15 million

Interest Expense $2 million

If Firm B’s stock is currently trading at $24.00 and Firm B has 25 million shares

outstanding, then Firm B's market-to-book ratio is closest to:

A. 0.24

B. 4

C. 6

D. 30

10. How to calculate Cash flow from assets:

A. Operating cash flow + Net capital spending - Change in net working capital (NWC)

B. Operating cash flow - Net capital spending + Change in net working capital (NWC)

C. Operating cash flow - Net capital spending - Change in net working capital (NWC)

D. Operating cash flow + Net capital spending + Change in net working capital (NWC)

IV. Excersice

1. Papa Roach Exterminators, Inc., has sales of $586,000, costs of $247,000,

depreciation expense of $43,000, interest expense of $32,000, and a tax rate of 35
percent. What is the net income for this firm?

Papa Roach Exterminators, Inc.

Income statement
Sales $586,000
Costs 247,000
Depreciation 43,000
Earning before interest and tax (EBIT) $296,000
Interest expense 32,000
Taxable income $264,000
Taxes 92,400
Net income $171,600
Taxes = Taxable income x 0,35 = 264,000 x 0,35 = 92,400
2. So Long, Inc., has sales of $27,500, costs of $13,280, depreciation expense of
$2,300, and interest expense of $1,105. If the tax rate is 35 percent, what is the
operating cash flow, or OCF?

So Long, Inc.
Income statement
Sales $27,500
Costs 13,280
Depreciation 2,300
Earning before interest and tax (EBIT) $11,920
Interest expense 1,105
Taxable income $10,815
Taxes 3,785
Net income $7,030
Taxes = Taxable income x 0,35 = 10,815 x 0,35 = 3,785

OCF = EBIT + Depreciation – Taxes = 11,920 + 2,300 – 3,785 = $10,435

3. Jetson Spacecraft Corp. shows the following information on its 2009 income
statement: sales = $196,000; costs = $104,000; other expenses = $6,800;
depreciation expense = $9,100; interest expense = $14,800; taxes = $21,455;
dividends = $10,400. In addition, you’re told that the firm issued $5,700 in new
equity during 2009 and redeemed $7,300 in outstanding long-term debt.

a. What is the 2009 operating cash flow?

b. What is the 2009 cash flow to creditors?

c. What is the 2009 cash flow to stockholders?

d. If net fixed assets increased by $27,000 during the year, what was the addition
to NWC?

Jetson Spacecraft Corp.

Income statement
Sales $196,000
Costs 104,000
Other expenses 6,800
Depreciation 9,100
Earning before interest and tax (EBIT) $76,100
Interest expense 14,800
Taxable income $61,300
Taxes 21,455
Net income $39,845
a. 2009 operating cash flow:
OCF = EBIT + Depreciation – Taxes = 76,100 + 9,100 – 21,455 = $63,745
b. 2009 cash flow to creditors
CFC = Interest – Net new LTD = 14,800 – (-7,300) = $22,100
c. 2009 cash flow to stockholders
CFS = Dividends – Net new equity = 10,400 – 5,700 = $4,700
d. The addition to NWC
CFA (Cash flow from assets) = CFC + CFS = 22,100 + 4,700 = $26,800
CFA = OCF – Net capital spending – NWC
Net capital spending = Net fixed assets + Depreciation = 27,000 +9,100 = $36,100
NWC = OCF - Net capital spending – CFA = 63,745 – 36,100 – 26,800 = $845

4. Prepare a 2009 balance sheet for Bertinelli Corp. based on the following
information: cash = $195,000; patents and copy- rights = $780,000; accounts
payable = $405,000; accounts receivable = $137,000; tangible net fixed assets =
$2,800,000; inventory = $264,000; notes payable = $160,000; accumulated retained
earnings = $1,934,000; long-term debt = $1,195,300.

Bertinelli Corp.
Balance sheet
Assets
Cash 195,000
Patents and copyrights 780,000
Accounts receivable 137,000
Tangible net fixed assets 2,800,000
Inventory 264,000
Total assets 4,176,000
Liabilities
Accounts payable 405,000
Notes payable 160,00
Long-term debt 1,195,300
Total liabilities 1,760,300
Shareholders’ equity
Accumulated retained earnings 1,934,000
Total shareholders’ equity 1,934,000
5. Dahlia Industries had the following operating results for 2009: sales = $22,800;
cost of goods sold = $16,050; depreciation expense = $4,050; interest expense =
$1,830; dividends paid = $1,300. At the beginning of the year, net fixed assets were
$13,650, current assets were $4,800, and current liabilities were $2,700.

At the end of the year, net fixed assets were $16,800, current assets were $5,930,
and current liabilities were $3,150. The tax rate for 2009 was 34 percent.

a. What is net income for 2009?

b. What is the operating cash flow for 2009?

c. What is the cash flow from assets for 2009? Is this possible? Explain.

d. If no new debt was issued during the year, what is the cash flow to creditors?

What is the cash flow to stockholders? Explain and interpret the positive and
negative signs of your answers in (a) through (d).

a. Net income for 2009

Net income = (Sales – Cost of goods sold – Depreciation – Interest) x (1 –
Tax rate)
= (22,800 – 16,050 – 4,050 – 1,830) x (1- 0.34)
= $584.1
b. The operating cash flow for 2009
OCF = Net income + Depreciation + Interest x (1- Tax rate)
= 584.1 + 4,050 + 1,830 x (1 – 0.34)
= $5,841.9
c. The cash flow from assets for 2009
Net capital spending = Net fixed assets (end) – Net fixed assets (beginning)
+ Depreciation
= 16,800 – 13,650 + 4,050
= $7,200
Change in NWC = Current assets (end) – Current Liabilities (end) – Current
assets (beginning) – Current liabilities (beginning)
= (5,930 – 3,150) – (4,800 – 2,700)
= $680
CFA = 5,841.9 – 7,200 – 680 = $- 2,038.1 <0
d. The cash flow to creditors
CFC = Interest paid – Ner new borrowing
= $1,830
The cash flow to stockholders
CFS = Dividends – Net new equity raised
= $1,300