FIN 201 SOLUTION SET – UNIT ONE

CHAPTER 2

2-1 Balance Sheet You are evaluating the balance sheet for Goodman’s Bees Corporation.
From the balance sheet you find the following balances: cash and marketable securities =
$400,000, accounts receivable = $1,200,000, inventory = $2,100,000, accrued wages and taxes =
$500,000, accounts payable = $800,000, and notes payable = $600,000. Calculate Goodman
Bees’ net working capital.
Net working capital = Current assets - Current liabilities.
Goodman’s Bees’ current assets =

Cash and marketable securities = $400,000

Accounts receivable = 1,200,000

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Inventory = 2,100,000

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Total current assets $3,700,000

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and current liabilities =

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Accrued wages and taxes = $500,000
Accounts payable
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Notes payable = 600,000
Total current liabilities $1,900,000

So the firm’s net working capital was $1,800,000 ($3,700,000 - $1,900,000).

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2-4 Income Statement The Fitness Studio, Inc.’s 2012 income statement lists the following income
and expenses: EBIT = $773,500, interest expense = $100,000, and taxes = $234,500. The firm
has no preferred stock outstanding and 100,000 shares of common stock outstanding. Calculate
the 2012 earnings per share.
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Using the setup of an income statement in Table 2.2:

EBIT $773,500
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Interest expense -100,000

EBT $ 673,500
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Taxes -234,500
Net income $439,000

Thus,
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$439,000
Earnings per share (EPS) = ————— = $4.39 per share
100,000 shares

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2-6 Corporate Taxes Hunt Taxidermy, Inc., is concerned about the taxes paid by the company in
2012. In addition to $42.4 million of taxable income, the firm received $2,975,000 of interest on
state-issued bonds and $1,000,000 of dividends on common stock it owns in Oakdale Fashions,
Inc. Calculate Hunt Taxidermy’s tax liability, average tax rate, and marginal tax rate.

In this case, interest on the state-issued bonds is not taxable and should not be included in taxable income. Further,
the first 70 percent of the dividends received from Hunt Taxidermy is not taxable. Thus, only 30 percent of the
dividends received are taxed, so:

Taxable income = $42,400,000 + (.3)$1,000,000 = $42,700,000

Now Hunt Taxidermy’s tax liability will be:

Tax liability = $6,416,667 + .35 ($42,700,000 - $18,333,333) = $14,945,000

The $1,000,000 of dividend income increased Hunt Taxidermy’s tax liability by $105,000 (.3 x $1,000,000 x .35).

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Hunt Taxidermy’s resulting average tax rate is:

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Average tax rage = $14,945,000/$42,700,000 = 35.00%

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Finally, if Hunt Taxidermy earned $1 more of taxable income, it would pay 35 cents (based upon its tax rate of 35

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percent) more in taxes. Thus, the firm’s marginal tax rate is 35 percent.
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2-7 Statement of Cash Flows Ramakrishnan Inc. reported 2012 net income of $15 million and
depreciation of $2,650,000. The top part of Ramakrishnan, Inc.’s 2012 and 2011 balance sheets
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is listed below (in millions of dollars).

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Current assets: 2012 2011 Current liabilities: 2012 2011

Cash and marketable Accrued wages and
securities $ 20 $ 15 taxes $ 19 $ 18
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Accounts receivable 84 75 Accounts payable 51 45

Inventory 121 110 Notes payable 45 40
Total $225 $200 Total $115 $103
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Calculate the 2012 net cash flow from operating activities for Ramakrishnan, Inc.
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Cash Flows from Operating Activities

Net income $15,000,000
Additions (sources of cash):
Depreciation 2,650,000
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Increase in accrued wages and taxes 1,000,000

Increase in accounts payable 6,000,000
Subtractions (uses of cash):
Increase in accounts receivable -9,000,000
Increase in inventory -11,000,000

Net cash flow from operating activities: $4,650,000

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2-12 Statement of Retained Earnings Use the following information to find dividends paid to
common stockholders during 2012.
2012
Balance of retained earnings, December 31, 2011 $462m.
Plus: Net income for 2012 15m.
Less: Cash dividends paid
Preferred stock $1m.

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Common stock _6m.

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Total cash dividends paid 7m.

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Balance of retained earnings, December 31, 2012 $470m.

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Total cash dividends paid = $470m. - $15m. - $462m. = -$7m. Thus, common stock dividends paid = $7m. - $1m =

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$6m.
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2-16 Market Value versus Book Value Ava’s SpinBall Corp. lists fixed assets of $12 million on its
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balance sheet. The firm’s fixed assets have recently been appraised at $16 million. Ava’s
SpinBall Corp.’s balance sheet also lists current assets at $5 million. Current assets were
appraised at $6 million. Current liabilities’ book and market values stand at $3 million and the
firm’s book and market values of long-term debt are $7 million. Calculate the book and market
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values of the firm’s stockholders’ equity. Construct the book value and market value balance
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sheets for Ava’s SpinBall Corp. (LG2)

Recall the balance sheet identity in Equation 2-1: Assets = Liabilities + Equity. Rearranging this equation: Equity =
Assets – Liabilities. Thus, the balance sheets would appear as follows:
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BOOK MARKET BOOK MARKET

VALUE VALUE VALUE VALUE
Assets Liabilities and Equity
Current assets $ 5m. $ 6m. Current liabilities $ 3m. $ 3m.
Fixed assets 12m. 16m. Long-term debt 7m. 7m.
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Stockholders’ equity 7m. 12m.

Total $17m. $22m. Total $17m. $22m.

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2-24 Statement of Cash Flows Use the balance sheet and income statement below to construct a
statement of cash flows for Valium’s Medical Supply Corporation.

Valium’s Medical Supply Corporation

Balance Sheet as of December 31, 2012 and 2011
(in thousands of dollars)
2012 2011 2012 2011
Assets Liabilities & Equity

Current assets: Current liabilities :

Cash and marketable Accrued wages and
securities $ 74 $ 73 taxes
$ 58 $ 45
Accounts receivable 199 189 Accounts payable

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159 145

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Inventory 322 291 Notes payable

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131 131

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Total $ 595 $ 553 Total
$ 348 $ 321

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Fixed assets: rs e Long-term debt: $ 565 $549
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Gross plant and
equipment $1,084 $ 886 Stockholders’ equity:
Less: Depreciation 153 116 Preferred
stock (6 thousand shares) $ 6 $ 6
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Net plant and Common stock and

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equipment $ 931 $ 770 paid-in surplus

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120 120
Other long-term (100 thousand shares)
assets 130 130 Retained earnings 617
457
Total $1,061 $ 900 Total $ 743
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$ 583
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Total assets $1,656 $1,453 Total liabilities and equity $1,656 $1,453
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Valium’s Medical Supply Corporation

Income Statement for Years Ending December 31, 2012 and 2011
(in thousands of dollars)
2012 2011
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Net sales $ 888 $ 798

Less: Cost of goods sold 387 350
Gross profits $ 501 $ 448
Less: Depreciation 37 35
Other operating expenses 48 42
Earnings before interest and taxes (EBIT) $ 416 $ 371
Less: Interest 46 40

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 Earnings before taxes (EBT) $ 370 $ 331
Less: Taxes 129 112
Net income $ 241 $ 219

Less: Preferred stock dividends $ 6 $ 6

Net income available to common stockholders $ 235 $ 213
Less: Common stock dividends 75 75
Addition to retained earnings $ 160 $ 138

Per (common) share data:

Earnings per share (EPS) $2.35 $2.13
Dividends per share (DPS) $0.75 $0.75
Book value per share (BVPS) $7.37 $5.77

Market value (price) per share (MVPS) $8.40 $6.25

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Statement of Cash Flows for Year Ending December 31, 2012

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(in thousands of dollars)

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A. Cash flows from operating activities

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Net income $241
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Additions (sources of cash):
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Depreciation 37
Increase in accrued wages and taxes 13
Increase in accounts payable 14
Subtractions (uses of cash):
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Increase in accounts receivable -10

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Increase in inventory -31

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Net cash flow from operating activities: $264

B. Cash flows from investing activities

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Subtractions:
Increase in fixed assets -$198
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Increase in other long-term assets 0

Net cash flow from investing activities: -$198

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C. Cash flows from financing activities

Additions:
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Increase in notes payable $ 0

Increase in long-term debt 16
Increase in common and preferred stock 0
Subtractions:
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Preferred stock dividends - 6

Common stock dividends -75

Net cash flow from financing activities: -$65

D. Net change in cash and marketable securities $ 1

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 2-34 Free Cash Flow Vinny’s Overhead Construction had free cash flow during 2012 of $25.4
million. The change in gross fixed assets on Vinny’s balance sheet during 2012 was $7.0 million
and the change in net operating working capital was $8.4 million. Using this information, fill in
the blanks on Vinny’s income statement below.

IOC = ΔGross fixed assets + ΔNet operating working capital

=> IOC = $7.0m. + $8.4m. = $15.4m.

FCF = Operating cash flow – Investment in operating capital

=> $25.4m. = OCF – $15.4m.
=> OCF = $25.4m. + $15.4m. = $40.8m.

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OCF = EBIT(1 – Tax rate) + Depreciation

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Using the numbers below: $40.8m. = $43.4m. – ($43.4m x Tax rate) + $10.2m.

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=> $43.4m. + $10.2m. - $40.8m. = $43.4m. x Tax rate
=> Tax rate = ($43.4m. + $10.2m. - $40.8m.)/$43.4m = 29.49%

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Vinny’s Overhead Construction, Corp.
Income Statement for Year Ending December 31, 2012
(in millions of dollars)
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Net sales $ 182.10 Step 1. (= $66.00 + $116.10)

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Less: Cost of goods sold 116.10

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Gross profits $ 66.00

Less: Depreciation 10.20
Other operating expenses 12.40
Earnings before interest and taxes (EBIT) $ 43.40 Step 2. (= $66.00 -
$10.20 - $12.40)
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Less: Interest 4.20 Step 5. (= $43.40 - $39.20)

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Earnings before taxes (EBT) $ 39.20 Step 3. (= $27.64 / (1 –

0.2949)
Less: Taxes (29.49% from above) 11.56 Step 4. (= $39.20 -
$27.64)
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Net income $27.64

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