a)
To calculate: The net income for the year 2014.
Introduction:
Cash flow refers to the difference between the cash that comes into the business and the cash that goes out of the business. The following are the different types of cash flows in a corporation:
- Cash flow from assets:
It refers to the difference between the revenues from the sale of assets and the money invested in purchasing the assets.
- Cash flow to creditors:
It refers to the interest paid to the creditors minus the net fresh debt borrowed by the company.
- Cash flow to stockholders:
It refers to the dividend paid to the shareholders of the company minus the fresh equity raised by the company.
a)
Answer to Problem 21QP
Explanation of Solution
Given information:
Company T has sales of $23,730, cost of goods sold of $16,780,
Compute the net income of Company T:
Income statement | ||
Particulars |
Amount ($) |
Amount ($) |
Net sales | $23,730 | |
Less: | ||
Costs | $16,780 | |
Depreciation | $2,840 | $19,620 |
Earnings before interest and taxes | $4,110 | |
Less: Interest paid | $414 | |
Taxable income | $3,696 | |
Less: Taxes ($3696×35%) | $1,294 | |
Net income | $2,402 |
Hence, the net income is $2,402.
b)
To calculate: The operating cash flow for 2014.
b)
Answer to Problem 21QP
Explanation of Solution
Given information:
The earnings before interest and taxes are $4,110 and the taxes are $1,294 (Refer Part (a) of the Answer).
Compute the operating cash flow:
Operating cash flow | |
Particulars |
Amount ($) |
Earnings before interest and taxes | $4,110 |
Add: Depreciation | $2,840 |
$6,950 | |
Less: Taxes | $1,294 |
Operating cash flow | $5,656 |
Hence, the operating cash flow is $5,656.
c)
To calculate: The cash flow from assets for 2014 and the possibility of having negative cash flow from assets
c)
Answer to Problem 21QP
Explanation of Solution
Given information:
At the starting of the year, the company has net fixed assets of $16,560, current assets of $2,940, and current liabilities of $2,592. At the year end, the company has net fixed assets of $18,840, current assets of $3,528, current liabilities of $2,484 and tax at the rate of 35%. Depreciation expense of $2,840
Formulae:
The formula to calculate the ending net working capital:
The formula to calculate the beginning net working capital:
The formula to calculate the changes in net working capital:
The formula to calculate the cash flow from the assets:
Compute the ending net working capital:
Hence, the ending net working capital is $1,044.
Compute the beginning net working capital:
Hence, the beginning net working capital is $348.
Compute the change in net working capital:
Hence, the change in net working capital is $696.
Compute the net capital spending:
Net capital spending | |
Particulars |
Amount ($) |
Ending net fixed assets | $18,840 |
Less: Beginning net fixed assets | $16,560 |
$2,280 | |
Add: Depreciation | $2,840 |
Net capital spending | $5,120 |
Hence, the net capital spending is $5,120.
Compute the cash flow from assets:
The operating cash flow is$5,656(Refer Part (b) of the Answer). The change in net working capital is $696 and the net capital spending is$5,120.
Hence, the cash flow from assets is −$160.
Determine whether the company can have negative cash flow from assets:
The cash flow from assets can be negative. A negative cash flow from assets means that the company borrowed funds to invest in fixed assets. In the given situation, the operating cash flow is positive. However, the cash flow from assets is negative because the company raised additional capital to invest in fixed assets.
d)
To calculate: The cash flow to the creditors and the cash flow to stockholders
d)
Answer to Problem 21QP
Explanation of Solution
Given information:
Company T has interest expenses of $414. There were no debt borrowings in the current year. The cash flow from assets is −$160.
Formulae:
The formula to calculate the cash flow to creditors:
The formula to calculate the cash flow to stock holders:
The formula to calculate the cash flow to stockholders:
Compute the cash flow to creditors:
Hence, the cash flow to creditors is $414.
Compute the cash flow to stockholders:
Hence, the cash flow to stockholders is −$574.
Compute the new equity issued:
Hence, the new equity raised is $1,190.
Final interpretation of the answers in all parts of the Answer:
The operating cash flow and the net income of the company for the year 2014 is positive.
The company had to invest $696 in working capital. It also invested $5,120 for buying new fixed assets. To meet the investment needs, the company raised $1,190 in new equity and the cash flow to stockholders is −$574. It paid $616 as dividend, and interest of $414.
After paying dividends and interest, the company had $160 to meet the investment needs.
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