Financial Management: Principles & Applications

Chapter 2: Financial Statements, Taxes, and Cash Flows

Study Problems (Set A)

2-1A. (Review of financial statements) Prepare a balance sheet and income statement as of December 31, 2001, for
Belmond, Inc., from the following information.

Inventory $ 6,500
General and administrative expenses 850
Common stock 45,000
Cash 16,550
Operating expenses 1,350
Notes payable 600
Interest expense 900
Depreciation expense 500
Net sales 12,800
Accounts receivable 9,600
Accounts payable 4,800
Long-term debt 55,000
Cost of goods sold 5,750
Buildings and equipment 122,000
Accumulated depreciation 34,000
Taxes 1,440
Retained earnings ?

2-2A. (Review of financial statements) Prepare a balance sheet and income statement as of December 31, 2001, for the
Sharpe Mfg. Co. from the following information.

Accounts receivable $120,000

Machinery and equipment 700,000
Accumulated depreciation 236,000
Notes payable 100,000
Net sales 800,000
Inventory 110,000
Accounts payable 90,000
Long-term debt 160,000
Cost of goods sold 500,000
Operating expenses 280,000
Common stock 320,000
Cash 96,000
Retained earnings›prior year ?
Retained earnings›current year ?

2-3A. (Corporate income tax) Delaney, Inc. sells minicomputers. During the past year, the company's sales were $4
million. The cost of its merchandise sold came to $2 million, cash operating expenses were $400,000, depreciation
expense was $100,000, and the firm paid $150,000 in interest on bank loans. Also, the corporation paid $25,000 in the
form of dividends to its own common stockholders. Calculate the corporation's tax liability.

2-4A. (Corporate income tax) Potts, Inc. had sales of $6 million during the past year. The cost of goods sold amounted to
$3 million. Operating expenses totaled $2.6 million and interest expense was $30,000. Determine the firm's tax liability.

2-5A. (Measuring cash flows) Calculate the free cash flows for Pamplin, Inc., for the year ended December 31, 2001,
both from an operating and a financing perspective. Interpret your results.

Pamplin, Inc., Balance Sheet at 12/31/00 and 12/31/01

Assets
2000 2001
 Cash $ 200 $ 150
Accounts receivable 450 425
Inventory 550 625
Current assets 1,200 1,200
Plant and equipment 2,200 2,600
Less: accumulated depreciation (1,000) (1,200)
Net plant and equipment 1,200 1,400
Total assets $2,400 $2,600

Liabilities and Owners' Equity

2000 2001
Accounts payable $ 200 $ 150
Notes payable›current (9%) 0 150
Current liabilities $ 200 $ 300
Long-term debt 600 600
Owners' equity
Common stock $ 300 $ 300
Paid-in capital 600 600
Retained earnings 700 800
Total owners' equity $1,600 $1,700
Total liabilities and owners' equity $2,400 $2,600

Pamplin, Inc. Income Statement

for years ending 12/31/00 and 12/31/01 ($ in
thousands)

2000 2001
Sales $1,200 $1,450
Cost of goods sold 700 850
Gross profit $ 500 $ 600
Operating expenses 30 40
Depreciation 220 200
Net operating income $ 250 $ 360
Interest expense 50 60
Net income before taxes $ 200 $ 300
Taxes (40%) 80 120
Net income $ 120 $ 180

2-6A. (Measuring cash flows) Calculate the free cash flows for T. P. Jarmon Company for the year ended December 31,
2001, both from an operating and a financing perspective. Interpret your results.

T. P. Jarmon Company Balance Sheets

at 12/31/00 and 12/31/01

Assets
2000 2001
Cash $ 15,000 $ 14,000
Marketable securities 6,000 6,200
Accounts receivable 42,000 33,000
Inventory 51,000 84,000
Prepaid rent 1,200 1,100
Total current assets $115,200 $138,300
Net plant and equipment 286,000 270,000
Total assets $401,200 $408,300
 Liabilities and Equity
2000 2001
Accounts payable $ 48,000 $ 57,000
Notes payable 15,000 13,000
Accruals 6,000 5,000
Total current liabilities $ 69,000 $ 75,000
Long-term debt $160,000 $150,000
Common stockholders' equity $172,200 $183,300
Total liabilities and equity $401,200 $408,300

T. P. Jarmon Company Income Statement

For the Year Ended 12/31/01

Sales $600,000
Less: cost of goods sold 460,000
Gross profits $140,000
Less: expenses
General and administrative $30,000
Interest 10,000
Depreciation 30,000
Total operating expenses $70,000
Earnings before taxes $70,000
Less: taxes 27,100
Net income $42,900
Net income $42,900
Less: cash dividends 31,800
To retained earnings $11,100

2-7A. (Measuring cash flows) Calculate the free cash flows for Abrams Manufacturing Company for the year ended
December 31, 2001, both from an operating and a financing perspective. Interpret your results.

Abrams Manufacturing Balance Sheets

at 12/31/2000 and 12/31/2001

2000 2001
Cash $ 89,000 $100,000
Accounts receivable 64,000 70,000
Inventory 112,000 100,000
Prepaid expenses 10,000 10,000
Plant and equipment 238,000 311,000
Accumulated depreciation (40,000) (66,000)
Total $473,000 $525,000
Accounts payable $ 85,000 $ 90,000
Accrued liabilities 68,000 63,000
Mortgage payable 70,000 0
Preferred stock 0 120,000
Common stock 205,000 205,000
Retained earnings 45,000 47,000
Total liabilities & equity $473,000 $525,000

Abram's Manufacturing Company Income Statement

For the Year Ended 12/31/01

Sales $184,000
Cost of sales 60,000
Gross profit 124,000
Selling, general, and administrative expenses 44,000
Depreciation expense 26,000
 Operating income $ 54,000
Interest expense 4,000
Taxes 16,000
Preferred stock dividends 10,000
Net income $ 24,000

Additional information: The firm paid $22,000 in

common stock dividends during 2001.

2-8A. (Analyzing free cash flows) Following you will find our computation of the free cash flows for Starbucks. Interpret
the information in terms of where cash came from and where it was used.

Starbucks 1999 Free Cash Flows ($ in thousands)

Cash flows from an operating perspective:

After-tax cash flows from operations:

Operating income $156,711
Depreciation 97,797
Earnings before interest, tax, depreciation $254,508
Tax expense $ 62,333
Less change in income tax payable (7,600)
Less change in deferred taxes (13,903)
Cash taxes 40,830
After-tax cash flows from operations $213,678
Other income (losses) 10,532
$224,210
Change in net operating working capital:
Change in cash $ (5,751)
Change in accounts receivable (3,326)
Change in inventories 37,768
Change in other current assets 20,529
Change in current assets $ 49,220
Change in accounts payable $ 1,662
Change in accrued expenses 32,283
Change in noninterest-bearing current debt 33,945
Change in net operating working capital $ 15,275
Change in fixed assets and other assets:
Purchase of fixed assets $257,292
Change in investments 43,334
Change in other assets 7,710
Net cash used for investments $ 308,336
Operating free cash flows $(99,401)
Cash flows from a financing perspective:
Interest expense $ —
Less increase in long-term debt (7,018)
Less increase in short-term debt (30,577)
Plus dividends —
Less increase in common stock (61,806)
Financing free cash flows $(99,401)

2-9A. (Analyzing free cash flows) Following you will find our computation of the free cash flows for Amazon.com.
Interpret the information in terms of where cash came from and where it was used.

Free cash flows from an operating perspective: ($ in thousands)

After-tax cash flows from operations:
Operating income $ (597,683)
Depreciation 251,500
Earnings before interest, tax, depreciation $ (346,183)
 Taxes —
After-tax cash flows from operations $ (346,183)
Other income (losses) (104,388)
$ (450,571)
Change in net operating working capital:
Change in cash $ 332,743
Change in inventories 191,145
Change in other current assets 64,036
Change in current assets $ 587,924
Change in accounts payable 349,753
Change in net operating working capital $ 238,171
Change in fixed assets and other assets:
Purchase of fixed assets $ 472,768
Change in investments 1,101,606
Change in other assets (154,261)
Net cash used for investments $ 1,420,113
Operating free cash flows $(2,108,855)
Free cash flows from a financing perspective:
Interest expense $87,966
Less increase in long-term debt (1,118,198)
Less increase in short-term debt (13,638)
Less increase in other current liabilities (213,969)
Less increase in common stock (851,016)
Financing free cash flows $(2,108,855)

Study Problems (Set B)

2-1B. (Review of financial statements) Prepare a balance sheet and income statement as of December 31, 2001 for the
Warner Company from the following list of items.

Depreciation $ 66,000
Cash 225,000
Long-term debt 334,000
Sales 573,000
Accounts payable 102,000
General and administrative expenses 79,000
Buildings and equipment 895,000
Notes payable 75,000
Accounts receivable 153,000
Interest expense 4,750
Accrued expenses 7,900
Common stock 289,000
Cost of goods sold 297,000
Inventory 99,300
Taxes 50,500
Accumulated depreciation 263,000
Prepaid expenses 14,500
Taxes payable 53,000
Retained earnings 262,900

2-2B. (Review of financial statements) Prepare a balance sheet and income statement as of December 31, 2001, for the
Sabine Mfg. Co. from the following list of items. Ignore income taxes and interest expense.

Accounts receivable $150,000

Machinery and equipment 700,000
Accumulated depreciation 236,000
Notes payable›current 90,000
Net sales 900,000
 Inventory 110,000
Accounts payable 90,000
Long-term debt 160,000
Cost of goods sold 550,000
Operating expenses 280,000
Common stock 320,000
Cash 90,000
Retained earnings›prior year ?
Retained earnings›current year ?

2-3B. (Corporate income tax) Cook, Inc., sells minicomputers. During the past year, the company's sales were $3.5
million. The cost of its merchandise sold came to $2 million, and cash operating expenses were $500,000; depreciation
expense was $100,000, and the firm paid $165,000 in interest on bank loans. Also, the corporation paid $25,000 in
dividends to its own common stockholders. Calculate the corporation's tax liability.

2-4B. (Corporate income tax) Rose, Inc. had sales of $7 million during the past year. The cost of goods sold amounted to
$4 million. Operating expenses totaled $2.6 million and interest expense was $40,000. Determine the firm's tax liability.

2-5B. (Measuring cash flows) Calculate the free cash flows for the J. B. Chavez Corporation for the year ended
December 31, 2001, both from an operating and a financing perspective. Interpret your results.

J. B. Chavez Corporation, Balance Sheet

at 12/31/00 and 12/31/01 ($000)

Assets
12/31/00 12/31/01
Cash $ 225 $ 175
Accounts receivable 450 430
Inventory 575 625
Current assets $1,250 $1,230
Plant and equipment $2,200 $2,500
Less: accumulated depreciation (1,000) (1,200)
Net plant and equipment $1,200 $1,300
Total assets $2,450 $2,530

Liabilities and Owners' Equity

12/31/00 12/31/01
Accounts payable $ 250 $ 115
Notes payable›current (9%) 0 115
Current liabilities $ 250 $ 230
Bonds $ 600 $ 600
Owners' equity
Common stock $ 300 $ 300
Paid-in capital 600 600
Retained earnings 700 800
Total owners' equity $1,600 $1,700
Total liabilities and owners' equity $2,450 $2,530

J. B. Chavez Corporation, Income Statement

for the years ending 12/31/00 and 12/31/01 ($000)

2000 2001
Sales $1,250 $1,450
Cost of goods sold 700 875
Gross profit $ 550 $ 575
Operating expenses 30 45
Depreciation $ 220 $ 200
 Net operating income $ 300 $ 330
Interest expense 50 60
Net income before taxes $ 250 $ 270
Taxes (40)%) 100 108
Net income $ 150 $ 162

2-6B. (Measuring cash flows) Calculate the free cash flows for RPI, Inc., for the year ended December 31, 2001, both
from an operating and a financing perspective. Interpret your results.

RPI, Inc., Balance Sheets

for 12/31/00 and 12/31/01

Assets
2000 2001
Cash $ 16,000 $ 17,000
Marketable securities 7,000 7,200
Accounts receivable 42,000 38,000
Inventory 50,000 93,000
Prepaid rent 1,200 1,100
Total current assets $116,200 $156,300
Net plant and equipment 286,000 290,000
Total assets $402,200 $446,300

Liabilities and Stockholders' Equity

2000 2001
Accounts payable $ 48,000 $ 55,000
Notes payable 16,000 13,000
Accruals 6,000 5,000
Total current liabilities $ 70,000 $ 73,000
Long-term debt $160,000 $150,000
Common stockholders' equity $172,200 $223,300
Total liabilities and equity $402,200 $446,300

RPI, Inc., Income Statement

For the Year Ended 12/31/01

Sales $700,000
Less: cost of goods sold 500,000
Gross profits $200,000
Less: operating and interest expenses
General and administrative $50,000
Interest 10,000
Depreciation 30,000
Total expenses $90,000
Profit before taxes $110,000
Less: taxes 27,100
Net income available
to common stockholders $ 82,900
Less: cash dividends 31,800
Change in retained earnings $ 51,100

2-7B.(Measuring cash flows) Calculate the free cash flows for the Cameron Company for the year ended December 31,
2001, both from an operating and a financing perspective. Interpret your results.

Comparative Balance Sheets for December 31, 2000,

and December 31, 2001, for the Cameron Company
2000 2001
Cash $ 89,000 $ 70,000
Accounts receivable 64,000 70,000
 Inventory 102,000 80,000
Prepaid expenses 10,000 10,000
Total current assets $265,000 $230,000
Plant and equipment $238,000 $301,000
Accumulated depreciation (40,000) (66,000)
Total assets $463,000 $465,000
Accounts payable $ 85,000 $ 80,000
Accrued liabilities 68,000 63,000
Total current liabilities $153,000 $143,000
Mortgage payable 60,000 0
Preferred stock 0 70,000
Common stock 205,000 205,000
Retained earnings 45,000 47,000
Total debt and equity $463,000 $465,000

Cameron's 2001 income statement is as follows:

Sales
$204,000
Cost of sales 84,000
Gross profit $120,000
Selling, general, and
administrative expenses 17,000
Depreciation expense 26,000
Operating income $ 77,000
Interest expense 5,000
Taxes 30,000
Preferred stock dividends 8,000
Net income $ 34,000

Additional information: The firm paid $32,000 in

common stock dividends during 2001.

2-8B. (Analyzing free cash flows) Following you will find our computation of the free cash flows for Ben & Jerry's Ice
Cream. Interpret the information in terms of where cash came from and where it was used.

BEN & JERRY'S FREE CASH FLOWS ($ IN THOUSANDS)

Cash flows from an operating perspective:

After-tax cash flows from operations:
Operating income $13,129
Depreciation 9,202
Earnings before interest, tax, depreciation $22,331
Tax expense $ 1,823
Less change in income tax payable 1,215
Less change in deferred taxes (4,174)
Cash taxes $ 4,782
After-tax cash flows from operations 17,549
Other income (losses) (6,596)
$10,953
Change in net operating working capital:
Change in cash $ (638)
Change in accounts receivable 7,495
Change in inventories 847
Change in other current assets (2,666)
Change in current assets $ 5,038
Change in accounts payable $ 5,456
Change in accrued expenses 517
Change in noninterest-bearing current debt $ 5,973
Change in net operating working capital $ (935)
Change in fixed assets and other assets:
Purchase of fixed assets $ (757)
 Change in investments (103)
Change in other assets 3,060
Net cash used for investments $ 2,200
Operating free cash flows $ 9,688
Cash flows from a financing perspective:
Interest expense $ 1,634
Plus decrease in long-term debt 3,822
Less increase in short-term debt (361)
Plus dividends —
Plus decrease in common stock 4,593
Financing free cash flows $ 9,688

2-9B. (Analyzing free cash flows) Following you will find our computation of the free cash flows for iVillage. Interpret
the information in terms of where cash came from and where it was used.

iVILLAGE CASH FLOWS ($ IN THOUSANDS)

Cash flows from an operating perspective:

After-tax cash flows from operations:
Operating income $ (97,324)
Depreciation 29,312
Earnings before interest, tax, depreciation $ (68,012)
Cash taxes —
After-tax cash flows from operations (68,012)
Other income (losses) 4,323
$ (63,689)
Change in net operating working capital:
Change in cash $ 76,680
Change in accounts receivable 3,472
Change in inventories 2,332
Change in other current assets 2,478
Change in current assets $ 84,962
Change in accounts payable $ 4,657
Change in noninterest-bearing current debt 4,657
Change in net operating working capital $ 80,305
Change in fixed assets and other assets:
Purchase of fixed assets $ 31,971
Change in investments 178,108
Change in other assets 250
Net cash used for investments $ 210,329
Operating free cash flows $ (354,323)
Cash flows from a financing perspective:
Interest expense $ —
Dividends 23,612
Plus decrease in short-term debt 137
Less increase in other current liabilities (9,609)
Less increase in common stock (368,463)
Financing free cash flows $ (354,323)