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# Problem 3-1 BALANCE SHEET

The assets of Dallas and Associates consists entirely of current assets and net plant and
equipment. The firm has total assets of \$2.5 million and net plant and equipment equals \$2
million. It has notes payable of \$150,000, long term 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.

## Compute the following:

a. Total debt
b. Total liabilities and equity
c. Balance of current assets
d. Balance of current liabilities
e. Amounts of accounts payable and accruals
f. Firm’s net working capital
g. Firm’s net operating working capital

3-1 From the data given in the problem, we know the following:

## Current assets \$ 500,000c Accounts payable and accruals \$ 100,000e

Net plant and equipment 2,000,000 Notes payable 150,000
Current liabilities \$ 250,000d
Long-term debt 750,000
Total common equity 1,500,000
Total assets \$2,500,000 Total liabilities and equity \$2,500,000b

## a. Total debt = Short-term debt + Long-term debt

Total debt = \$150,000 + \$750,000
Total debt = \$900,000.

b. We are given that the firm’s total assets equal \$2,500,000. Since both sides of the
balance sheet must equal, total liabilities and equity must equal total assets =
\$2,500,000.

## c. Total assets = Current assets + Net plant and equipment

\$2,500,000 = Current assets + \$2,000,000
Current assets = \$2,500,000 – \$2,000,000
Current assets = \$500,000.

d. Total liabilities and equity = Current liabilities + Long-term debt + Total common equity
\$2,500,000 = Current liabilities + \$750,000 + \$1,500,000
\$2,500,000 = Current liabilities + \$2,250,000
Current liabilities = \$2,500,000 – \$2,250,000
Current liabilities = \$250,000.

## e. Current liabilities = Accounts payable and accruals + Notes payable

\$250,000 = Accounts payable and accruals + \$150,000
Accounts payable and accruals = \$250,000 – \$150,000
Accounts payable and accruals = \$100,000.
f. Net working capital = Current assets – Current liabilities
Net working capital = \$500,000 – \$250,000
Net working capital = \$250,000.

g. Net operating working capital = Current assets – (Current liabilities – Notes payable)
Net operating working capital = \$500,000 – (\$250,000 – \$150,000)
Net operating working capital = \$400,000.

## h. NOWC – NWC = \$400,000 – \$250,000

NOWC – NWC = \$150,000.

The difference between the two is equal to the notes payable balance.
Problem 3-2 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?
HINT: Write out the headings for an income statement account, and fill in the known values.
Then divide \$3 million of net income by (1-T) = 0.6 to find the pretax income. The difference
between EBIT and taxable income must be interest expense. Use this same procedure to
complete similar problems.

## 3-2 NI = \$3,000,000; EBIT = \$6,000,000; T = 40%; Interest = ?

Need to set up an income statement and work from the bottom up.

EBIT \$6,000,000
Interest 1,000,000 \$3,000,000 \$3,000,000

EBT \$5,000,000 EBT = (1  T) 0.6
Taxes (40%) 2,000,000
NI \$3,000,000

## Interest = EBIT – EBT = \$6,000,000 – \$5,000,000 = \$1,000,000.

Problem 3-3 INCOME STATEMENT
Pearson Brothers recently reported an EBITDA of \$7.5 million and net income of \$1.8
million. It had \$2.0 million of interest expense and its corporate tax rate was 40%. What
was its charge for depreciation and amortization?

## 3-3 EBITDA \$7,500,000 (Given)

Depreciation 2,500,000 Deprec. = EBITDA – EBIT = \$7,500,000 – \$5,000,000
EBIT \$5,000,000 EBIT = EBT + Int = \$3,000,000 + \$2,000,000
Interest 2,000,000 (Given) \$1,800,000 \$1,800,000

EBT \$3,000,000 (1  T ) 0.6
Taxes (40%) 1,200,000 Taxes = EBT × Tax rate
NI \$1,800,000 (Given)
Problem 3-4 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.

3-4 NI = \$50,000,000
R/EY/E = \$810,000,000
R/EB/Y = \$780,000,000
Dividends = ?

## R/EB/Y + NI – Div = R/EY/E

\$780,000,000 + \$50,000,000 – Div = \$810,000,000
\$830,000,000 – Div = \$810,000,000
\$20,000,000 = Div.
Problem 3-5 MVA
Henderson Industries has \$500 million of common equity on its balance sheet, its stock
price is \$60 per share and its market value added is \$130 million. How many common
shares are currently outstanding?

## 3-5 MVA = (P0  Number of common shares)  BV of common equity

\$130,000,000 = \$60X  \$500,000,000
\$630,000,000 = \$60X
X = 10,500,000 common shares.
Problem 3-6 MVA
Over the years, McLaughlin Corporation’s stockholders have provided \$35,000,000 of capital
when they purchased new issues of stock and allowed management to retain some of the
firm’s earnings. The firm now has 2,000,000 shares of common stock outstanding , and the
shares sell at a price of \$30 per share. How much value has McLaughlin’s management
added to stockholder wealth over the years, that is, what is McLaughlin’s MVA?

## 3-6 Book value of equity = \$35,000,000.

Price per share (P0) = \$30.00.
Common shares outstanding = 2,000,000 shares.

## Market value of equity = P0 × Common shares outstanding

= \$30 × 2,000,000
= \$60,000,000.

## MVA = Market value of equity – Book value of equity

= \$60,000,000 – \$35,000,000
= \$25,000,000.
Prob. 3-7 EVA
Briton Industries has operating income for the year of \$3,000,000 and a 40% tax rate. Its
total invested capital is \$20,000,000 and its after tax percentage cost of capital is 8%. What
is the firm’s EVA?

 Total After-tax %
3-7 EVA = EBIT(1 – T) – invested  cost of 
 capital capital 
EVA = \$3,000,000(0.6) – [\$20,000,000 × 0.08]
EVA = \$1,800,000 – \$1,600,000
EVA = \$200,000.
Prob. 3-9 BALANCE SHEET
Which of the following actions are most likely to directly increase cash as shown on a firm’s

## a. It issues \$2 million of new common stock

Statement a will increase cash through the sale of common stock. Selling stock
provides cash through financing activities.

## b. It buys new plant and equipment at a cost of \$3 million

Statements b will decrease the amount of cash on a company’s balance sheet.

## c. It reports a large loss for the year.

Statement c would decrease cash; however, it is also possible that Statement c
would increase cash, if the firm receives a tax refund for taxes paid in a prior year.

## d. It increases the dividends paid on its common stock

Statements d will decrease the amount of cash on a company’s balance sheet.
Prob. 3-10 STATEMENT OF STOCKHOLDERS EQUITY
Computer World Inc. paid out \$22.5 million in total common dividends and reported \$278.9
million of retained earnings at year-end. The prior year’s retained earnings were \$212.3
million. What was the net income? Assume that all dividends declared were actually paid

## Ending R/E = Beg. R/E  Net income  Dividends

\$278,900,000 = \$212,300,000  Net income  \$22,500,000
\$278,900,000 = \$189,800,000  Net income
Net income = \$89,100,000.
Prob. 3-12 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 flows from
financing activities totaled + \$170,000.

## a. what was the cash flow from operating activities?

b. 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?

3-12 a. From the statement of cash flows the change in cash must equal cash flow from
operating activities plus long-term investing activities plus financing activities. First, we
must identify the change in cash as follows:
Cash at the end of the year \$25,000
– Cash at the beginning of the year – 55,000
Change in cash -\$30,000

The sum of cash flows generated from operations, investment, and financing must equal
a negative \$30,000. Therefore, we can calculate the cash flow from operations as
follows:
CF from operations  CF from investing  CF from financing =  in cash
CF from operations  \$250,000  \$170,000 = -\$30,000
CF from operations = \$50,000.

b. Since we determined that the firm’s cash flow from operations totaled \$50,000 in Part a
of this problem, we can now calculate the firm’s net income as follows:
Increase in Increase in
NI  Depreciation  accrued  A/R and = CF from
liabilities operations
inventory
NI + \$10,000 + \$25,000 – \$100,000 = \$50,000
NI – \$65,000 = \$50,000
NI = \$115,000.