Chapter 3

3-1 The assets of Dallas & Associates consist entirely of current assets and net plant and equipment,
and the firm has no excess cash. The firm has total assets of $2.5 million and net plant and
equipment equals $2 million. It has notes payable of $150,000, longterm debt of $750,000, and
total common equity of $1.5 million. The firm does have accounts payable and accruals on its
balance sheet. The firm only finances with debt and common equity, so it has no preferred stock
on its balance sheet.

a. What is the company’s total debt?

b. What is the amount of total liabilities and equity that appears on the firm’s balance sheet?

c. What is the balance of current assets on the firm’s balance sheet?

d. What is the balance of current liabilities on the firm’s balance sheet?

e. What is the amount of accounts payable and accruals on its balance sheet? (Hint: Consider this as a
single line item on the firm’s balance sheet.)

f. What is the firm’s net working capital?

g. What is the firm’s net operating working capital?

h. What is the explanation for the difference in your answers to parts f and g?

Total Assets = $2,500,000

Net Plant & Equipment = $2,000,000

Notes Payable = $150,000

Long-Term Debt = $750,000

Total Common Equity = $1,500,000

a. Total Debt = short-term debt + long-term debt

Notes Payable = short-term debt

➔ Total Debt = $150,000 + $750,000 = $900,000

b. Total Assets = Total Liabilities + Total Equity

Total Liabilities & Equity = $2,500,000

c. Net plant & equipment = fixed (long-term) asset

Current Assets = Total Assets - Net plant & equipment

Current Assets = $2,500,000 - $2,000,000 = $500,000

d. Current Liabilities = Total Liabilities - Long-Term Debt

Total Liabilities = Total Liabilities and Equity ($2,500,000) - Equity ($1,500,000) = $1,000,000

Current Liabilities = $1,000,000 - $750,000 = 250,000

e. Current Liabilities [- Notes Payable] = Accounts Payable + Accruals + Notes Payable[-Notes Payable]

Current Liabilities - Notes Payable = Accounts Payable and Accruals

$250,000 - $150,000 = $100,000 = Accounts Payable and Accruals

f. Net Working Capital = current assets - current liabilities

Net Working Capital = $500,000 - $250,000 = $250,000

g. Net Operating Working Capital (NOWC) = Current assets - (Current liabilities - Notes payable)

NOWC = $500,000 - ($250,000 - $150,000) = $500,000 - $100,000 = $400,000

h. Even though both h and g ask you to solve for net working capital, h is asking you to solve for net
operating working capital. This means that questions g is asking you to take into consideration interest-
bearing notes liabilities, which incur interest expense that is included as a financing cost. This additional
cost results in h have a lower net working capital of $250,000. With g, we see that with "free", or non-
interest-bearing, current liabilities the networking operational capital is much higher at $400,000.
3-2 Byron Books Inc. recently reported $13 million of net income. Its EBIT was $20.8 million, and its tax
rate was 35%. What was its interest expense? (Hint: Write out the headings for an income
statement and fill in the known values. Then divide $13 million of net income by (1 2T) 5 0.65 to
find the pretax income. The difference between EBIT and taxable income must be interest expense.
Use this same procedure to complete similar problems.)
𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 $13,000,000
EBT (Earnings Before Tax) = (1−𝑇𝑎𝑥 𝑟𝑎𝑡𝑒) = 1−0.35
= $20,000,000

EBIT + Interest Expense = EBT  Interest Expense = EBIT – EBT = $20,800,000 - $20,000,000 = $800,000

3-3 Patterson Brothers recently reported an EBITDA of $7.5 million and net income of $2.1 million. It
had $2.0 million of interest expense, and its corporate tax rate was 30%. What was its charge for
depreciation and amortization?
𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 $2,100,000
EBT (Earnings Before Tax) = = = $3,000,000
(1−𝑇𝑎𝑥 𝑟𝑎𝑡𝑒) 1−0.3

EBITDA = Depreciation + Amortization + Interest + EBT

 $7,500,000 = Depreciation + Amortization + $2,000,000 + $3,000,000

 Depreciation + Amortization = $7,500,000 - $2,000,000 - $3,000,000 = $2,5000,000

3-4 In its most recent financial statements, Nessler Inc. reported $75 million of net income and $825
million of retained earnings. The previous retained earnings were $784 million. How much in
dividends were paid to shareholders during the year? Assume that all dividends declared were
actually paid.

Dividend = Opening retained earnings + Net income – Ending retained earnings

= $784 million + $75 million – $825 million

= $34 million

3-5 Harper Industries has $900 million of common equity on its balance sheet, its stock price is $80 per
share, and its market value added (MVA) is $50 million. How many common shares are currently
outstanding?
𝑀𝑉𝐴+𝐶𝑜𝑚𝑚𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦 $50,000,000+$900,000,000
The number of outstanding common shares = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑠𝑡𝑜𝑐𝑘 𝑝𝑟𝑖𝑐𝑒
= $80
=
11,875,000 shares
3-10 Electronics World Inc. paid out $22.4 million in total common dividends and reported $144.7
million of retained earnings at year-end. The prior year’s retained earnings were $95.5 million.
What was the net income? Assume that all dividends declared were actually paid.

Net income for the current year = (Closing balance of retained earnings - Opening balance of retained
earnings) + Dividends paid for the current year

= ($144,700,000 - $95,500,000) + $22,400,000

= $71,600,000

3-12 Hampton Industries had $39,000 in cash at year-end 2017 and $11,000 in cash at year-end
2018. The firm invested in property, plant, and equipment totaling $210,000. Cash flow from
financing activities totaled +$120,000.
a. What was the cash flow from operating activities?
b. If accruals increased by $15,000, receivables and inventories increased by $50,000, and
depreciation and amortization totaled $25,000, what was the firm’s net income?

a. Cash flow from operating activities

Investment $210,000
Less: Cash flow from financing activities 120,000
Less: Opening cash balance 39,000
Add: Closing cash balance 11,000
Operating cash flow $62,000

b. Net income

Operating cash flow $62,000

Less: Increase in accruals 15,000
Less: Depreciation 25,000
Add: Increase in inventory 50,000
Net income $72,000
 a. Net operating working capital = (Current assets - excess cash) - (current liabilities – notes
payable)

For 2017: NOWC = (71,000 - 14,000) - (20,050 - 5,050) = 42,000

For 2018: NOWC = (83,320 - 15,000) - (25,100 - 7,000) = 50,220

b. EBIT = 44,000

Capital expenditure = Change in net fixed assets + depreciation = (48,000 – 46,000) + 6,000 = 8,000

Change in net operating working capital = 50,220 – 42,000 = 8,220

Free cash flow = EBIT*(1 - t) + Depreciation - Capital expenditure - Change in net operating working
capital

Free cash flow = 44,000 * (1 - 0.4) + 6,000 – 8,000 – 8,220 = 16,180

c. Statement of stockholders’ equity

Common stock
Share Amount Retained Earnings Total
stockholder’s
equity
Balances, 31st 4,000 $40,000 $36,950 $76,950
December 2017
2018 net income $23,190
Less: Cash $13,920
dividend
Balances, 31st 4,000 $40,000 $46,220 $86,220
December 2018

d. EVA = Net operating profits after taxes – Annual dollar cost of capital

= EBIT x ( 1 – Tax rate) – ( Total invested capital x After tax cost of capital)

Total invested capital = 𝑁𝑒𝑡 𝑓𝑖𝑥𝑒𝑑 𝑎𝑠𝑠𝑒𝑡𝑠2018 + 𝑁𝑂𝑊𝐶2018 + 𝐶𝑎𝑠ℎ 𝑎𝑛𝑑 𝑐𝑎𝑠ℎ 𝑒𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡𝑠 = $48,000
+ $50,220 + 15,000 = $113,220

EVA = EBIT x (1 – T) – [Total invested capital x After-tax percentage cost of capital]

= $44,000 x (1 – 40%) – [$113,220 x 10%] = $15,078

e. MVA

MVA = (𝑃0 × 𝑆ℎ𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔) − 𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑚𝑚𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦

𝑃0 stands for price of the stock

MVA = ($25 x 4,000) - $86,220 = $13,780

 a. Statement of stockholders’ equity

Common stock
Share Amount Retained Earnings Total
stockholder’s
equity
Balances, 31st 100,000,000 $260,000,000 $1,374,000,000 $1,634,000,000
December 2017 (1,600,000,000 +
146,000,000 –
372,000,000)
2018 net income $372,000,000 $372,000,000
Less: Cash $146,000,000 $146,000,000
dividend
Balances, 31st 100,000,000 $260,000,000 $1,600,000,000 $1,860,000,000
December 2018

b. Retained earnings = $1,600 million have been reinvested in the firm over the years.
c. The largest check could be Cash & Cash Equivalents = $15 millions
d. All the current liabilities i.e. $620 million will be paid over the next year.