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Financial Statements, Cash Flow, and Taxes - Solutions

1.

An increase in a firms debt ratio, with no changes in its sales and operating costs, could
be expected to lower its profit margin on sales.

A.
B.

2.

An increase in the DSO, other things held constant, would generally lead to an increase
in the total assets turnover ratio.

*
3.

*
4.

A.
B.

True
False

True
False

One drawback of economic value added (EVA) as a performance measure is that it


mistakenly assumes that equity capital is free.
A.
B.

True
False

If you look at two firms that are identical from an operational perspective (assets, costs,
sales, etc.), except for their use of debt financing, then the firm with the higher debt ratio
will also have the lower basic earnings power ratio.
A.
B.

True
False

5.

One way to increase economic value added (EVA) is to maintain the same operating
income with less capital.

A.
B.

6.

Given recent changes in the tax laws, the marriage penalty (for a married couple, filing
jointly) no longer exists.

A.
B.

True
False

True
False

7.

The enterprise value of the firm, at least as we have defined it in class, can be
determined by discounting the firms free cash flows by its weighted average cost of
capital.

A.
B.

True
False

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 1 of 73 Pages

8.

*
9.

Because they both are based on NOPAT (or OCF), as well as on the investments made
in the operating assets of the firm, a firm with a negative free cash flow (FCF) will also
have a negative economic value added (EVA).
A.
B.

True
False

A firms dividend policy can have an impact on the value of the firm, since a decrease in
dividends paid out in any year will decrease the firms free cash flow for that year which,
in turn, will reduce the firms enterprise value and the value of the firms stock.
A.
B.

True
False

10.

A decrease in NOPAT does not necessarily lead to a decrease in economic value added
(EVA), since the capital charge may also decrease if the firm has less capital
outstanding.

A.
B.

11.

A decrease in debt (while holding equity constant) will lead to a higher equity-to-value
ratio, a decrease in interest expense, and an increase in the equity multiplier. Therefore,
if a firm decreases its debt we should observe both an increase in return on assets
(ROA) and an increase in return on equity (ROE).

A.
B.

True
False

True
False

12.

A firms economic value added (EVA) will be positive whenever the firms return on
invested capital (ROIC) is greater than its weighted average cost of capital (WACC),
which is the same as when its return on equity (ROE) exceeds the cost of equity (rS).

A.
B.

13.

The first, and most critical, step in constructing a pro forma set of financial statements
using the percent of sales methodology is establishing the sales forecast.

A.
B.

14.

Determining whether a firm's financial position is improving or deteriorating requires


analysis of more than one set of financial statements. Trend analysis is one method of
measuring a firm's performance over time.

True
False

True
False

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 2 of 73 Pages

A.
B.

True
False

15.

Because creditors can foresee, at least to a certain extent, the costs of bankruptcy, they
should charge a higher rate of interest to compensate for the present value of
bankruptcy costs as these expected costs increase.

A.
B.

1.

Assume that a firm has just completed Year 2002 (its second year of operations) and
depreciated its fixed assets on a 20-year straight-line basis. Also assume that the firm
is profitable (positive net income), makes no additional investment in fixed assets
during Year 2003, and that all other factors (sales, other expenses, interest, current
assets and liabilities, etc.) are constant from Year 2002 through Year 2003, but that
there may be changes in the firms equity account. Which of the following would you
most expect to observe, comparing results for Year 2002 to Year 2003, if the firm
changes its depreciable life assumption from 20 years to 10 years for Year 2003?

True
False

A.
B.
C.
D.
E.

2.

A stock analyst has acquired the following information for your company:

Net operating working capital (NOWC) would decrease.


Net operating profit after tax (NOPAT) would increase.
Total operating capital (TOC) would decrease.
Operating cash flow (OCF) would decrease.
Net income (NI) would increase.

Retained earnings on the year-end 2001 balance sheet was $700,000.


Retained earnings on the year-end 2002 balance sheet was $320,000.
The company does not pay dividends.
The company's depreciation expense is its only non-cash expense.
The company has no non-cash revenues.
The company's net cash flow for 2002 was $150,000.

On the basis of this information, select the statement that is most correct.
*

A.
B.
C.
D.
E.

Your company had negative net income in 2002.


Your company had positive net income in 2002, but it was less than its net
income in 2001.
Your company's depreciation expense in 2002 was less than $150,000.
Your companys cash on the balance sheet at the end of 2002 must be lower
than the cash it had on its balance sheet at the end of 2001.
Your companys net cash flow in 2002 must be higher than its net cash flow in
2001.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 3 of 73 Pages

3.

Last year, your firm had positive net cash flow, yet cash on the balance sheet
decreased. Which of the following could explain the firm's financial performance?

A.
B.
C.
D.
E.

4.

Which of the following statements is least correct (most incorrect)?


A.

B.

C.
D.

E.

5.

While the balance sheet can be thought of as a snapshot of the firms financial
position at a point in time, the income statement reports on operations over a
period of time. Because of this, some people will use the average of beginning
and ending balance sheet items when calculating ratios that contain both
balance sheet and income statement data.
If we find the present value of a firms future free cash flows by discounting
these cash flows at the firms weighted average cost of capital (WACC), then
this will be equal to the firms enterprise value or actual worth. If we then
subtract away the market value of the firms debt and other liabilities, then what
we will be left with is the value of the firms equity.
In the United States tax rates are regressive. That is, even though wealthy
taxpayers may face a higher marginal tax rate on their taxable income, their
average tax rate, as a percentage of taxable income, will actually be lower.
It is possible for a firm to be financially healthy even if free cash flows have
been negative for a number of years. In fact, we might expect firms to have
negative free cash flow during the early years (that is, during their start-up
phase), because of low NOPAT and large investments in net operating working
capital and fixed assets.
Regardless of the level of fixed assets and the amount of depreciation
expense, if a firm has no interest expense, than its NI will equal NOPAT and
NCF will equal OCF.

Which of the following is likely to increase the additional funds needed (AFN) in a
given year?
A.
B.
C.
D.
E.

6.

The company issued new common stock.


The company issued new long-term debt.
The company sold off some of its assets.
The company eliminated its dividend.
The company purchased a lot of new fixed assets.

The company reduces its dividend payout ratio.


The companys profit margin increases.
The company decides to reduce its reliance on accounts payable as a form of
financing.
The company is operating well below full capacity.
All of the statements above are correct.

Which of the following statements is most incorrect?

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 4 of 73 Pages

A.
B.
C.

D.

One way to find the total market value of a firms equity is to take the free cash
flows available to the equity shareholders in all future years, and then discount
them back to the present at the shareholders required rate of return.
If the price per share of a firms stock is above the book value per share, then
the market value added will be positive and the market to book ratio will be
greater than 1.0.
One way to find the total market value of a firms equity is to take the free cash
flows available to all investors in all future years, discount them back to the
present at the firms weighted average cost of capital (WACC), and then
subtract away the market value of the firms debt.
If a firm has interest-paying debt in its capital structure, then NOPAT will
always be more than the firms net income, even though NOPAT subtracts
away the total tax that would be paid on the firms operation and does not
consider the interest tax shelter that is created by the debt.
The firms operating cash flow (OCF) for the past year can be calculated as the
change in total operating capital over the year, but this is equivalent to the
change in working capital for the year (total current assets plus total current
liabilities) plus the change in net fixed assets for the year (total gross assets
minus accumulated depreciation).

E.

7.

Which of the following variables is not needed to determine a firms free cash flow?

8.

A.
B.
C.
D.
E.

Which of the following statements is most correct?


A.
B.
C.

D.
E.

9.

net fixed assets


net income
current operating assets
earnings before interest and taxes
tax rate

Personal taxes are of a regressive nature. That is, the lower your income, the
more you pay as a percentage of your taxable income.
Individuals are allowed to deduct 70 percent of any dividend income received
before calculating taxes. That is, they will pay taxes on only 30 percent of the
dividend income received.
The marriage penalty reflects the fact that married couples can be taxed up to
a maximum rate of 43 percent, while individuals have a maximum rate of only
39.6 percent.
Since corporations are allowed to deduct interest before calculating their
taxable income, we say that interest is paid with before-tax dollars.
Corporations are allowed to deduct 70 percent of any dividend they pay out
before calculating taxes. Like interest, this creates a tax shelter for the
corporation.

Which of the following statements concerning valuation is most correct?


A.

A firm that takes on a risky project will increase its value as long as the project
increases expected cash flows in the future.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 5 of 73 Pages

B.
*

C.
D.
E.

10.

Investors will not be willing to purchase the stock of a firm if they expect the
firms cash flow to continually decrease in the future.
One way to determine the value of a firms equity is to first determine the value
of the entire firm (using free cash flows and the weighted average cost of
capital) and then subtract away the value of the firms debt.
One way to determine the value of a firms equity is to find the present value of
the firms operating cash flow (OCF) using the firms weighted average cost of
capital.
Any firm that has equity with a value/price greater than zero will also have
positive market value added and positive economic value added.

You are an analyst following two companies, Company A and Company B. You have
collected the following information:
The two companies have the same total assets.
Company A has a higher total assets turnover than Company B.
Company A has a higher profit margin than Company B.
Company B has a higher inventory turnover ratio than Company A.
Company B has a higher current ratio than Company A.

Select the statement that is most correct.


*

A.
B.
C.
D.
E.

11.

Your companys CFO recently estimated that the companys EVA for the past year was
zero. The companys cost of equity capital is 10 percent, its cost of debt is 6 percent,
and its debt ratio is 40 percent. Select the statement that is most correct.

12.

A.
B.
C.
D.
E.

Company A must have a higher net income.


Company A must have a higher ROE.
Company B must have a higher ROA.
Statements A and B are correct.
Statements A and C are correct.

The companys
The companys
The companys
The companys
The companys
capital.

net income was zero.


net income was negative.
ROA was 10 percent.
ROE was 10 percent.
after-tax operating income was less than the total dollar cost of

Some key financial data and ratios are reported in the table below for Company A and
for its competitor, Company B:
Ratio
Profit margin
ROA
Total assets
BEP

Company A

Company B

4%
9%
$2.0 billion
20%

3%
8%
$1.5 billion
20%

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 6 of 73 Pages

ROE

18%

24%

On the basis of the information above, select the statement that is most correct.

A.
B.
C.
D.
E.

Company A has a higher total assets turnover than Company B.


Company A has a higher debt ratio than Company B.
Company A has higher net income than Company B.
Statements A and B are correct.
All of the statements above are correct.
Ratio

13.

Company A

Company B

Sales
Debt Ratio
EBIT
Net Income

$2.7 billion
0.505
$400 million
$180 million

$4.0 billion
0.667
$300 million
$120 million

TAT

1.350x

2.667x

Select the statement that is most correct.


A.
B.
C.

D.

E.

1.

Any forecast of financial requirements involves determining how much money


the firm will need and is obtained by adding together increases in assets and
spontaneous liabilities and subtracting operating income.
The percent of sales method of forecasting financial needs requires only a
forecast of the firms balance sheet. Although a forecasted income statement
helps clarify the need, it is not essential to the percent of sales method.
Because dividends are paid after taxes from retained earnings, dividends are not
included in the percent of sales method of forecasting.
Financing feedbacks describe the fact that interest must be paid on the debt
used to help finance AFN and dividends must be paid on the shares issued to
raise the equity part of the AFN. These payments would lower the net income
and retained earnings shown in the projected financial statements.
None of the statements above is correct.

Assume that you can purchase $10,000 of State of Florida bonds that have a coupon
rate of 5 percent and will therefore pay you interest of $500 per year. Alternatively,
you can purchase $10,000 of IBM bonds that have a coupon rate of 6.25 percent and
therefore pay you interest of $625 per year. At what tax rate would you be indifferent
between holding the two bonds?
A.
B.
C.
D.
E.

26%
14%
24%
20%
32%

0.05 = (0.0625)(1-T)

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 7 of 73 Pages

1-T = (0.05)/(0.0625) = .80


T = 1 - .80 = 0.20 = 20%

YOU ARE GIVEN THE FOLLOWING INFORMATION FOR PROBLEMS 2 - 4


Income Statement

2001

Sales
Operating Costs
Depreciation

$4,500.00
-$3,600.00
-$400.00

EBIT
Interest (8%)

$500.00
-$160.00

EBT
Taxes (40%)

$340.00
$136.00

Net Income

$204.00

Dividends

$50.00

Addition to RE

2.

2002

$154.00

Balance Sheet

2001

2002

Cash
Inventory
Accounts Receivable

$200.00
$4,000.00
$1,000.00

$300.00
$4,500.00
$1,500.00

Current Assets
Gross Fixed Assets
Less: Depreciation

$5,200.00
$3,000.00
- $600.00

$6,300.00
$4,000.00
- $1,000.00

Net Fixed Assets

$2,400.00

$3,000.00

Total Assets

$7,600.00

$9,300.00

Accounts Payable

$800.00

$1,000.00

Accruals

$700.00

$800.00

Current Liabilities

$1,500.00

$1,800.00

Debt

$1,000.00

$2,000.00

Common Stock
Retained Earnings
Total Liability and Equity

$4,600.00
$500.00
$7,600.00

$4,846.00
$654.00
$9,300.00

Calculate the free cash flow for 2002.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 8 of 73 Pages

A.
B.
C.
D.
E.

-$1,200.00
-$1,400.00
-$1,100.00
-$1,300.00
-$1,000.00

NOPAT = EBIT(1-T) = ($500)(1-.4) = $300


DEP = $400
OCF = NOPAT + DEP = $300 + $400 = $700
NOWC2001 = $5,200 - $1,500 = $3,700
NOWC2002 = $6,300 - $1,800 = $4,500
NFA2001 = $2,400
NFA2002 = $3,000
TOC2001 = NOWC2001 + NFA2001 = $3,700 + $2,400 = $6,100
TOC2002 = NOWC2002 + NFA2002 = $4,500 + $3,000 = $7,500
NIOC = TOC = $7,500 - $6,100 = $1,400
GIOC = NIOC + DEP = $1,400 + $400 = $1,800
FCF = OCF - GIOC = $700 - $1,800 = -$1,100
FCF = NOPAT - NIOC = $300 - $1,400 = -$1,100
3.

Assume that the firm can maintain the same profit margin in 2003 as it has in 2002. If
sales are expected to be $5,000 in 2003, then what must total assets decrease to if the
firm is to achieve an ROA of 7.2533%?
A.
B.
C.
D.
E.

$3,500.00
$3,675.00
$3,125.00
$3,375.00
$3,250.00

PM2003 = PM2002 = $204/$4,500 = 0.045333 = 4.5333%


ROA = .072533 = (PM)(TAT) = (.045333)(TAT)
TAT = .072533 / .045333 = 1.60 = Sales/TA = $5,000/TA
TA = Sales / 1.60 = $5,000 / 1.60 = $3,125

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 9 of 73 Pages

4.

Assume that the firm can maintain the same equity multiplier in 2003 as it has in 2002.
If ROA can be increased to 7.2533% in 2003, then what will be the new level of ROE
in 2003?
A.
B.
C.
D.
E.

11.465%
12.265%
11.865%
12.065%
11.665%

EM2003 = EM2002 = (TA)/(CE) = $9,300 / $5,500 = 1.6909


ROE = (ROA)(EM) = (.072533)(1.6909) = .12265 = 12.265%

5.

Assume that you have earned $52,000 from your job this year, have itemized
deductions of $6,000, and are able to deduct your personal exemption of $2,800. Also
assume that you have earned $1,500 in dividend income and another $600 in interest
income. Using the individual tax rate tables in Appendix D (the exam handout),
calculate your average tax rate (taxes paid divided by total taxable income).
A.
B.
C.
D.
E.

21.27%
20.47%
17.37%
19.67%
18.57%

Base Income
Plus: Dividend Income
Plus: Interest Income
Less: Deductions
Les: Exemption
Taxable Income

$52,000
$ 1,500
$ 600
-$ 6,000
-$ 2,800
$45,300

Taxes = ($26,250)(.15) + ($45,300 - $26,250)(.28) = $3,937.50 + $5,334 =


$9,271.50
Average Tax Rate = $9,271.50 / $45,300 = 20.47%

6.

Your firm made $200,000 of EBT during each of the last 10 years and expects to make
the same each year for at least the next 5 years. However, this year the firm incurred
a before-tax loss of $500,000. The firm will claim a tax credit (due to tax carry back) at
the time it files this years income tax return and will receive a check from the U.S.
Treasury. Assuming that the firm has a tax rate of 40 percent on all income (past,
present, and future), determine what the firms expected tax liability will be for the
coming year.
A.
B.

$80,000
$60,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 10 of 73 Pages

C.
D.
E.

$50,000
$70,000
$40,000

Losses can be carried back 2 years and carried forward 15 years. The firm will use
$200,000 of the current loss to shield its income from 2 years ago and $200,000 of the
current loss to shield its income form last year. That will leave the firm with the
remaining $100,000 of current loss to shield its expected income of $200,000 next
year. This will leave the firm with expected taxable income for the coming year of
$100,000 that, at a tax rate of 40 percent, will produce a tax liability of $40,000.

7.

Below is the level of taxable income (EBT) reported by your company over the past
several years:
Year
1997
1998
1999
2000
2001
2002

Taxable Income
$ 350,000
650,000
750,000
250,000
- 1,250,000
750,000

The company was founded in 1997. You may assume that the appropriate corporate
tax rate has been and will continue to be 38 percent. Assume that the company has
taken full advantage of the Tax Code's carry-back and carry-forward provisions (firms
can carry-back two years and carry-forward 20 years), and assume that the current
provisions were applicable in 1997. What was the company's tax liability for 2002?
*

A.
B.
C.
D.
E.

$220,000
$190,000
$250,000
$160,000
$280,000

The company can carry back its losses for 2 years


Carry-back for 1999 and 2000 was $750,000 + $250,000 = $1,000,000
Carry-forward = $1,250,000 - $1,000,000 = $250,000
2002 Taxable Income = $750,000 - $250,000 = $500,000
Taxes Liability = ($500,000)(0.38) = $190,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 11 of 73 Pages

8.

Your firm had $4,000,000 of retained earnings on its balance sheet at the end of 2001.
One year later, at the end of 2002, the firm had $5,250,000 of retained earnings on its
balance sheet. The firm has 750,000 shares of common stock outstanding, and it paid
a dividend of $0.45 per share in 2002. What were the firms earnings per share in
2002?
A.
B.
C.
D.
E.

$1.698 per share


$2.362 per share
$2.117 per share
$1.426 per share
$1.894 per share

Total Dividend = (750,000)($0.45) = $337,500


Change in Retained Earnings = $$5,250,000 - $4,000,000 = $1,250,000
Net Income = $337,500 + $1,250,000 = $1,587,500
EPS = $1,587,500 / 750,000 = $2.117 per share
YOU ARE GIVEN THE FOLLOWING INFORMATION FOR PROBLEMS 9 - 11:
Income Statement
Sales
Operating Costs
Depreciation
EBIT

Year 1

Year 2

$1,200.00
-$1,020.00
-$55.00
$125.00

$1,800.00
-$1,440.00
-$155.00
$205.00

Interest
EBT

-$25.00
$100.00

-$124.60
$80.40

Taxes (40%)

-$40.00

-$32.16

Net Income

$60.00

$48.24

Dividends

$40.00

$29.24

Assets

Year 1

Year 2

Cash
Accounts Receivable

$15.00
$200.00

$50.00
$300.00

Inventories

$250.00

$375.00

$465.00
$1,100.00

$725.00
$2,100.00

-$555.00

-$710.00

Current Assets
Gross Plant & Equipment
Less: Depreciation

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 12 of 73 Pages

Net Plant & Equipment


Total

Liabilities & Equity

$545.00

$1,390.00

$1,010.00

$2,115.00

Year 1

Accounts Payable
Notes Payable

$120.00
$50.00

$180.00
$140.00

$80.00

$120.00

Current Liabilities
Long-Term Debt
Common Stock

$250.00
$210.00
$382.00

$440.00
$1,106.00
$382.00

Retained Earnings

$168.00

$187.00

$1,010.00

$2,115.00

Accruals

Total
9.
*

Year 2

Based on the financial statements above, determine the free cash flow for Year 2.
A.
B.
C.
D.
E.

-$436.00
-$882.00
-$534.00
-$727.00
-$689.00

NOPAT = (EBIT)(1-T) = ($205)(1-.4) = $123


DEP = $155
OCF = NOPAT + DEP = $123 + $155 = $278
NOWCY1 = $465 - $200 = $265
NOWCY2 = $725 - $300 = $425
NFAY1 = $545
NFAY2 = $1,390
TOCY1 = NOWCY1 + NFAY1 = $265 + $545 = $810
TOCY2 = NOWCY2 + NFAY2 = $425 + $1,390 = $1,815
NIOC = TOC = $1,815 - $810 = $1,005
GIOC = NIOC + DEP = $1,005 + $155 = $1,160
FCF = OCF - GIOC = $278 - $1,160 = -$882

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 13 of 73 Pages

FCF = NOPAT - NIOC = $123 - $1,005 = -$882


Proof:
FCF
- $ 882.00
Interest Payment
- $ 124.60
Interest Tax Shelter +$ 49.84
Dividends
- $ 29.24
Total Needs
- $ 986.00
New Notes Payable +$ 90.00
New L-T Debt
+$ 896.00
Net Effect
$
0
10.

As you can calculate, the firm had $810 of capital employed in Year 1 (notes payable,
long-term debt, common stock, and retained earnings). If the economic value added
(EVA) for Year 1 is -$26.25, then what is the firms weighted average cost of capital
(WACC)?
A.
B.
C.
D.
E.

11.8%
11.4%
12.1%
13.2%
12.5%

EVA = (EBIT)(1-T) - (Capital Employed)(WACC)


EVA = ($125)(1-.4) - ($810)(WACC) = -26.25
WACC = (-$26.25 - $75.00) / (-$810) = (-$101.25) / (-$810) = 12.5%
11.

As you can calculate, in Year 2 the firms profit margin is 2.68%, ROA is 2.2808511%,
and ROE is 8.4780316%. Assume that the firm could have increased its equity
multiplier to 4.50 by issuing debt and using the proceeds to repurchase equity (debt
increases, equity decreases, and the equity multiplier increases) while holding total
assets and total asset turnover constant. What would the firms profit margin have to
have been in order for it to have achieved an ROE of 12.00 percent?
A.
B.
C.
D.
E.

2.875%
3.667%
2.565%
3.133%
3.348%

Currently,
PM = $48.24 / $1,800 = 2.68%
TAT = $1,800 / $2,115 = 0.85106383
ROA = NI / TA = $48.24 / $2,115 = 2.2808511%
ROA = (PM)(TAT) = (.0268)(0.85106383) = 2.2808511%

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 14 of 73 Pages

ROE = NI / CE = $48.24 / $569 = 8.4780316%


EM = $2,115 / $569 = 3.717047452
ROE = (PM)(TAT)(EM)
ROE = (.0268) (0.85106383) (3.717047452) = 8.4780316%
New ROE,
12.00% = (PM) (0.85106383) (4.50)
PM = [0.12] / [(0.85106383) (4.50)] = 3.133%

12.

Assume that your company takes on a project that requires it to make an investment in
net operating working capital (NOWC) of $47,250 and an additional investment in
gross fixed assets (GFA), both of these investments being made in Year 0. Assume
that no other investments are required, but that this project will produce free cash
flows, starting in one year, of $19,138.00 per year in all future years (Years 1 through
infinity). The firm has determined that, based on the risk, the weighted average cost of
capital (WACC) for this project is 8 percent and that the net present value (NPV) of this
project is $33,350. Calculate the companys investment in gross fixed assets (GFA) in
Year 0.
A.
B.
C.
D.
E.

$166,437
$187,862
$171,770
$179,294
$158,625

Present Value of Future Cash Flows = $19,138.00 / 0.08 = $239,225


Net Present Value = $33,350 = $239,225 - $47,250 - GFA
GFA = $239,225 - $47,250 - $33,350 = $158,625

13.

Assume that you have earned $48,000 from your job this year, have itemized
deductions of $5,200, and are able to deduct your personal exemption of $2,800. Also
assume that you have earned $1,500 in dividend income, $2,000 in capital gains
income, and another $500 in interest income. Using the individual tax rate tables in
Appendix D (the exam handout), and assuming that capital gains and dividend income
are taxed at 20 percent, calculate your total taxes to be paid.

A.
B.
C.
D.

$8,627.50
$8,457.50
$8,337.50
$8,587.50

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 15 of 73 Pages

E.

$8,767.50

Base Income
Plus: Interest Income
Less: Deductions
Les: Exemption
Taxable Income

$48,000
$ 500
-$ 5,200
-$ 2,800
$40,500

Base Taxes = ($26,250)(.15) + ($40,500 - $26,250)(.28)


Base Taxes = $3,937.50 + ($14,250.00)(.28) = $3,937.50 + $3,990.00 = $7,927.50
Capital Gains Taxes = ($1,500 + $2,000)(.20) = $700.00
Total Taxes Paid = $7,927.50 + $700.00 = $8,627.50

14.

You have just obtained financial information for the past 2 years for your company.
Income Statement
Sales
Operating costs (excluding depreciation and
amortization)
EBITDA
Depreciation and amortization
Earnings before interest and taxes
Interest
Earnings before taxes
Taxes (40%)
Net income available to common stockholders
Common dividends

Year: 2002
$4,600.0
4,060.0

Year: 2001
$4,000.0
3,550.0

$ 540.0
90.0
$ 450.0
65.0
$ 385.0
154.0
$ 231.0
$ 181.0

$ 450.0
75.0
$ 375.0
60.0
$ 315.0
126.0
$ 189.0
$ 13.2

Balance Sheet
Assets:
Cash and marketable securities
Accounts receivable
Inventories
Total current assets
Net plant and equipment
Total assets

Year: 2002

Liabilities and equity:


Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50 million shares)

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Year: 2001

$ 36.0
540.0
540.0
$1,116.0
900.0
$2,016.0

$ 30.0
450.0
600.0
$1,080.0
750.0
$1,830.0

$ 324.0
201.0
216.0
$ 741.0
450.0
$1,191.0
150.0

$ 270.0
155.0
180.0
$ 605.0
450.0
$1,055.0
150.0

Page 16 of 73 Pages

Retained earnings
Total common equity
Total liabilities and equity

675.0
$ 825.0
$2,016.0

625.0
$ 775.0
$1,830.0

Determine your company's free cash flow for 2002.

A.
B.
C.
D.
E.

$142
$227
$255
$174
$289

NOWC2001 = Current assets - Non-interest charging current liabilities


= $1,080 - $450 = $630
NOWC2002 = Current assets - Non-interest charging current liabilities
= $1,116 - $540 = $576
NOWC = $576 - $630 = -$54
NFA2001 = $750
NFA2002 = $900
NFA = $900 - $750 = $150
NOPAT2002 = ($450)(1-.4) = $270
FCF2002 = NOPAT2002 - NOWC - NFA = $270 - (-$54) - $150 = $174

15.

Your company recently realized $130,000 in operating income. The company had
interest income of $30,000 and realized $70,000 in dividend income. The company's
interest expense was $50,000.
Taxable Income
Up to $50,000
$50,000-$75,000
$75,000-$100,000
$100,000-$335,000
$335,000-$10,000,000
$10,000,000-$15,000,000
$15,000,000-$18,333,333
Over $18,333,333

Tax on Base of
Bracket
$
0
7,500
13,750
22,250
113,900
3,400,000
5,150,000
6,416,667

Percentage on
Excess Above Base
15%
25
34
39
34
35
38
35

Using the corporate tax schedule above, and assuming that 70 percent of dividend
income is excluded for tax purposes, determine your companys tax liability.
A.

$42,260

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 17 of 73 Pages

B.
C.
D.
E.

$34,340
$47,450
$23,515
$28,950

Determine the firm's taxable income:


Operating income
Interest expense
Interest income
Dividend income (30%)*
Taxable income

$130,000
- 50,000
+ 30,000
+ 21,000
$131,000

*Only 30 percent of corporate dividends are included as taxable income =


($70,000)(1-.70) = $21,000
Looking in the tax table above, the base tax amount for the first $100,000 of income is
$22,250
The tax above the base is 39 percent of $31,000 = ($131,000 - $100,000)
= (0.39)($31,000) = $12,090
Your companys total tax liability is $22,250 + $12,090 = $34,340

16.

Your company began operations in 1996. The company's taxable income has been as
follows:
Year
1996
1997
1998
1999
2000
2001
2002

Taxable Income
-$200,000
50,000
75,000
85,000
-90,000
65,000
75,000

Assume the company faced a tax rate of 35 percent each year. Also, assume that the
company has taken full advantage of the Tax Code's carry-back (2 years) and carryforward (20 years) provisions, and assume that the current provisions were applicable
in 1996. Determine what the tax liability is for your company in 2002.

A.
B.
C.
D.
E.

$19,000
$25,000
$21,000
$27,000
$23,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 18 of 73 Pages

The $200,000 loss in 1996 can be carried forward to cover 1997, 1998, and all but
$10,000 of the 1999 income.
$10,000 of the $90,000 loss in 2000 can be carried back to cover that portion of 1999
income not covered by the 1996 loss.
Additionally, the remaining $80,000 of the 2000 loss can be carried forward to cover all
of the 2001 income and $15,000 of the 2002 income.
Thus, taxable income for 2002 is $75,000 - $15,000 = $60,000. Given a 35 percent
tax rate, your companys tax liability is ($60,000)(0.35) = $21,000

17.

You are given the following end-of-year data for the current year (Year 0) as well as
the forecast for next year (Year 1):
Income Statement

Year 0

Sales
Operating Costs

$4,000.00
-$3,400.00

$4,800.00
-$4,080.00

Depreciation

-$50.00

-$55.00

EBIT

$550.00

$665.00

Interest

-$20.00

-$26.00

EBT

$530.00

$639.00

Taxes (40%)

-$212.00

-$255.60

Net Income

$318.00

$383.40

Assets

Year 0

Year 1

Year 1

Cash
Accounts Receivable

$10.00
$150.00

$15.00
$200.00

Inventories

$200.00

$250.00

$360.00
$1,000.00

$465.00
$1,100.00

-$500.00

-$555.00

$500.00

$545.00

$860.00

$1,010.00

Current Assets
Gross Plant & Equipment
Less: Depreciation
Net Plant & Equipment
Total
Liabilities & Equity

Year 0

Year 1

Accounts Payable
Notes Payable

$90.00
$50.00

$120.00
$50.00

Accruals

$60.00

$80.00

$200.00

$250.00

Current Liabilities

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 19 of 73 Pages

Long-Term Debt
Common Stock

$150.00
$382.00

$210.00
$382.00

Retained Earnings

$128.00

$168.00

Total

$860.00

$1,010.00

Keeping in mind that notes payable are interest bearing obligations and are thus not
part of the firms current operating liabilities (COL), you should now be able to
calculate the firms expected Free Cash Flow (FCF) for Year 1.
Now make the following assumptions:
1.
2.
3.
4.

Free cash flow will grow at a constant rate of 4 percent per year from Year 1
through infinity.
Currently, Year 0, the firm has total book value of debt of $350, and this is a
good approximation of the market value of the debt.
The firms weighted average cost of capital is 9 percent.
The firm has 1,000 shares of stock outstanding.

Given these assumptions, determine what the intrinsic price per share (market value)
of the firms stock should be today.

A.
B.
C.
D.
E.

$7.51
$4.38
$5.63
$6.15
$8.04

NOPAT = (EBIT)(1-T) = ($665)(1-.4) = $399


DEP = $55
OCF = NOPAT + DEP = $399 + $55 = $454
NOWCY1 = $360 - $150 = $210
NOWCY2 = $465 - $200 = $265
NFAY1 = $500
NFAY2 = $545
TOCY1 = NOWCY1 + NFAY1 = $210 + $500 = $710
TOCY2 = NOWCY2 + NFAY2 = $265 + $545 = $810
NIOC = TOC = $810 - $710 = $100
GIOC = NIOC + DEP = $100 + $55 = $155
FCF = OCF - GIOC = $454 - $155 = $299

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 20 of 73 Pages

FCF = NOPAT - NIOC = $399 - $100 = $299


Proof:
FCF
Interest Payment
Interest Tax Shelter
Dividends
Total Needs
New Debt
Net Effect

$299.00
- $ 26.00
+$ 10.40
- $343.40
- $ 60.00
+$ 60.00
$ 0.00

Total market value of the firm at Year 0 = ($299) / (.09 - .04) = $5,980
Total market value of the equity at Year 0 = $5,980 - $350 = $5,630
Intrinsic price per share = $5,630 / 1,000 = $5.63

18.

In addition to taxable earnings from operations of $350,000, your firm has also
received interest income of $27,000, paid interest of $56,000, received dividends of
$19,000, and paid dividends of $93,000. Using the corporate tax table in Appendix D
(end of this exam and you may assume that the average tax rate for the first $100,000
is 22.25% instead of 22.3%), calculate the amount of taxes that the firm will owe.
A.
B.
C.
D.
E.

$102,432
$105,226
$107,812
$110,663
$113,109

Answer: D
Earnings
Interest Received
Interest Paid
Dividends Received
Taxable Income

$350,000
$ 27,000
- $ 56,000
$ 5,700 = ($19,000)(0.30)
$326,700

Taxes = ($100,000)(0.2225) + ($326,700 - $100,000)(0.39)


Taxes = $22,250 + $88,413 = $110,663

19.

Assume that an analyst has examined your company and has estimated that the free
cash flow at the end of the year (Year 1) will be $450 million, that this free cash flow will
grow at a constant rate of 8 percent per year, and that your companys weighted average
cost of capital is 12 percent. If the company currently has debt and preferred stock totaling
$4,500 million (4.5 billion), and if there are 200 million outstanding shares of common

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 21 of 73 Pages

stock, then determine what the intrinsic value of the companys stock should be today
(Year 0) on a per share basis.

A.
B.
C.
D.
E.

$29.25
$35.00
$37.50
$33.75
$31.00

Total Enterprise Value = ($450,000,000) / (.12 - .08) = $11,250,000,000


Value of Stock = $11,250,000,000 - $4,500,000,000 = $6,750,000,000
Price = $6,750,000,000 / 200,000,000 = $33.75

20.

Assume that your company has been given the following projections for the coming
year:
Sales = 20,000 units
Sales price per unit = $10
Variable cost per unit = $7
Fixed costs = $15,000
Bonds outstanding = $43,950
KD on outstanding bonds = 7%
Tax rate = 35%
Shares of common stock outstanding = 10,000 shares
Beta = 1.6
KRF = 8%
KM = 12%
Dividend payout ratio (DPR) = 40%
Return on equity (ROE) = 20%

Based on this information, determine what the current price per share should be.
(Note: you may use the table below to help organize the data.)
Income Statement
Sales
Variable Costs
Fixed Costs
EBIT
Interest
EBT
Taxes
Net Income
Dividends
Per Share

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 22 of 73 Pages

A.
B.
C.
D.
E.

$43.48
$45.42
$39.46
$41.40
$37.44
Income Statement

Sales
Variable Costs
Fixed Costs

$200,000.00
-$140,000.00
-$15,000.00

EBIT

$45,000.00

Interest

-$3,076.50

EBT

$41,923.50

Taxes

-$14,673.23

Net Income

$27,250.28

Dividends

$10,900.11

Per Share

$1.09

Growth Rate = BR = (.60)(.20) = 12%


KS = .08 + (.12 - .08)(1.6) = 14.4%
P0 = $1.09 / (.144 - .12) = $45.42
21.

Assume that a firms optimal capital structure consists of 30% debt at a before-tax cost
of debt (KD) of 6 percent, 10% preferred stock at a cost of preferred (KP) of 8 percent,
and 60% stock at a cost of stock (KS) of 12 percent (you may assume that the firm will
be able to meet all of its equity needs through retained earnings). Now assume that
the firm has $6,500,000 of invested capital, EBIT of $1,125,000, and a tax rate of 40
percent. Based on this information, determine the firms economic value added (EVA).
A.
B.
C.
D.
E.

$80,200
$84,800
$89,400
$82,500
$87,100

WACC = (KD)(1-T)(WD) + (KP)(WP) + (KS)(WS)


WACC = (0.06)*(1 - 0.40)*(0.30) + (0.08)*(0.10) + (.012)*(0.60)
WACC = 0.0108 + 0.008 + 0.072 = 0.0908
EVA = ($1,125,000)*(1 - 0.40) - ($6,500,000)*(0.0908)

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 23 of 73 Pages

EVA = $675,000 - $590,200 = $84,800

22.

Assume that a firms optimal capital structure (investor supplied capital) consists of
$30,000 of debt at a before-tax cost of debt (KD) of 8 percent, $10,000 of preferred
stock at a cost of preferred (KP) of 8 percent, and $60,000 of stock at a cost of stock
(KS) of 14 percent. Also assume that the firms tax rate is 40% and that its EBIT is
$53,750. Given this information, determine the firms EVA.
A.
B.
C.
D.
E.

$22,610
$20,610
$23,610
$21,610
$24,610

WACC = (KD)(1-T)(WD) + (KP)(WP) + (KS)(WS)


WD = $30,000 / $100,000 = 30%
WP = $10,000 / $100,000 = 10%
WS = $60,000 / $100,000 = 60%
WACC = (0.08)*(1-0.4)*(0.30) + (0.08)*(0.10) + (0.14)*(0.60)
WACC = 0.0144 + 0.008 + 0.084 = 0.1064 = 10.64%
EVA = (EBIT)(1-T) - (Capital)(WACC)
EVA = ($53,750)(1-.40) - ($100,000)(.1064) = $21,610

23.

Assume that your company has the following information for the previous year: Net
income = $300; Net operating profit after taxes (NOPAT) = $330; Total assets =
$2,000; and Total net operating capital = $1,500. Also assume that the information for
the current year is: Net income = $510; Net operating profit after taxes (NOPAT) =
$558; Total assets = $2,300; and Total net operating capital = $1,800. Given this
information, determine the free cash flow (FCF) for the current year.
A.
B.
C.
D.
E.

$275
$326
$292
$258
$309

Free cash flow = NOPAT - Net investment in total net operating capital
FCF = $558 - ($1,800 - $1,500) = $558 - $300 = $258

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 24 of 73 Pages

24.

Assume that your firm has just opened for business. The firm is being funded with
investor-supplied capital equal to $20,000,000: liabilities equal to 40 percent of capital
and equity equal to 60 percent of capital. Also assume that creditors require a beforetax rate of return of 8 percent, while stockholders require a 14 percent return. [Based
on this information, and knowing that the tax rate is 40 percent, you should be able to
determine the weighted average cost of capital (WACC) for the firm.] Now assume
that for this first year the firm expects its operations to produce sales of $32,000,000
and EBIT of $4,000,000. [Given this information, you should now be able to calculate
the economic value added expected for the first year.] Finally assume that the firm
expects this EVA to be the same in every future year (a perpetuity). If the WACC is
the correct discount rate to use, determine the market value added by the operations
of this firm.
A.
B.
C.
D.
E.

$3,256,961.35
$3,253,519.24
$3,255,813.95
$3,252,371.87
$3,254,666.61

WACC = (.08)*(1-.4)*(.4) + (.14)*(.6) = 1.92% + 8.4% = 10.32 percent


NOPAT = ($4,000,000.00)*(1-.4) = $2,400,000.00
EVA = $2,400,000 - ($20,000,000.00)*(.1032) = $336,000
MVA = $336,0000 / .1032 = $3,255,813.95
Alternatively,
BV = $20,000,000 (Capital originally supplied by investors)
Enterprise Value = $2,400,000 / .1032 = $23,255,813.95
MVA = $23,255,813.95 - $20,000,000 = $3,255,813.95

YOU ARE GIVEN THE FOLLOWING INFORMATION FOR PROBLEMS 25 - 27:


Income Statement (In Thousands)
Sales
Operating costs
EBITDA
Depreciation
Earnings before interest and taxes
Interest
Earnings before taxes
Taxes (40%)
Net income
Common dividends

Year: 2005
$12,000.00
$9,600.00
$2,400.00
$720.00
$1,680.00
$480.00
$1,200.00
$480.00
$720.00
$360.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Year: 2004
$10,000.00
$8,000.00
$2,000.00
$600.00
$1,400.00
$180.00
$1,220.00
$488.00
$732.00
$366.00

Page 25 of 73 Pages

Balance Sheet (In Thousands)


Assets:
Cash and marketable securities
Accounts receivable
Inventories
Total current assets
Net fixed assets (PP&E)
Total assets
Liabilities and equity:
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (2 million shares)
Retained earnings
Total common equity
Total liabilities and equity
25.

Year: 2005

Year: 2004

$600.00
$4,200.00
$4,800.00
$9,600.00
$7,200.00
$16,800.00

$500.00
$3,500.00
$4,000.00
$8,000.00
$6,000.00
$14,000.00

$840.00
$1,000.00
$600.00
$2,440.00
$3,000.00
$5,440.00
$10,000.00
$1,360.00
$11,360.00
$16,800.00

$700.00
$1,000.00
$500.00
$2,200.00
$800.00
$3,000.00
$10,000.00
$1,000.00
$11,000.00
$14,000.00

Based on the information above, determine how much the firm added to its gross fixed
assets in 2005.
A.
B.
C.
D.
E.

$1,800.00
$1,560.00
$1,920.00
$1,680.00
$2,040.00

NFA = $7,200.00 - $6,000.00 = $1,200.00


GFA = NFA + Depreciation = $1,200.00 + $720.00 = $1,920.00
26.

Assume that during 2004 interest was paid only on notes payable and long-term debt.
Assuming that the interest rate on notes payable was 8 percent, determine the
corresponding interest rate on long-term debt.
A.
B.
C.
D.
E.

12.00%
12.50%
13.00%
12.25%
12.75%

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 26 of 73 Pages

Total Interest = $180.00


Interest on Notes = ($1,000)*(.08) = $80.00
Interest on L-T Debt = $180.00 - $80.00 = $100.00
Interest Rate on L-T Debt = $100.00/ $800.00 = 12.50%
27.

Keeping in mind that notes payable are interest bearing obligations and are thus not
part of the firms current operating liabilities (COL), calculate the firms Free Cash Flow
(FCF) for the Year 2005.
A.
B.
C.
D.
E.

-$1,589.00
-$1,663.00
-$1,626.00
-$1,700.00
-$1,552.00

There are a lot of different ways to solve this problem, simply choose the method you
are most comfortable with.
NOPAT = (EBIT)(1-T) = ($1,680)(1-.4) = $1,008
DEP = $720
OCF = NOPAT + DEP = $1,008 + $720 = $1,728
NOWCY2004 = $8,000 - $1,200 = $6,800
NOWCY2005 = $9,600 - $1,440 = $8,160
NOWC = $8,160 - $6,800 = $1,360
NFAY2004 = $6,000
NFAY2005 = $7,200
NFA = $7,200 - $6,000 = $1,200
GFA = NFA + Depreciation = $1,200 + $720 = $1,920
TOCY2004 = NOWCY2004 + NFAY2005 = $6,800 + $6,000 = $12,800
TOCY2005 = NOWCY2005 + NFAY2005 = $8,160 + $7,200 = $15,360
NIOC = TOC = $15,360 - $12,800 = $2,560
GIOC = NIOC + DEP = $2,560 + $720 = $3,280
FCF = OCF - GIOC = $1,728 - $3,280 = -$1,552
FCF = NOPAT - NIOC = $1,008 - $2,560 = -$1,552
FCF = OCF - NOWC - GFA = $1,728 - $1,360 - $1,920 = -$1,552
Proof:
FCF
Interest Payment
Interest Tax Shelter
Dividends
Total Needs

- $ 1,552
- $ 480
+$ 192
- $ 360
- $ 2,200

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 27 of 73 Pages

New Debt
Net Effect

28.

+$ 2,200
$
0

Assume that in 2005 you have ordinary taxable income of $65,400.00, while your
spouse has ordinary taxable income of $83,250.00. Based on the 2005 tax tables in
the exam handout, determine the dollar amount of your marriage penalty.
A.
B.
C.
D.
E.

$576.00
$522.00
$603.00
$549.00
$630.00

Spouse 1 Tax = $4,090.00 + ($65,400.00 - $29,700.00)*(0.25) = $13,015.00


Spouse 2 Tax = $14,652.50 + ($83,250.00 - $71,950.00)*(0.28) = $17,816.50
Total Tax = $13,015.00 + $17,816.50 = $30,831.50
Married Income = $65,400.00 + $83,250.00 = $148,650.00
Married Tax = $23,317.50 + ($148,650.00 - $119,950)*(0.28) = $31,353.50
Marriage Penalty = $31,353.50 - $30,831.50 = $522.00

YOU ARE GIVEN THE FOLLOWING INFORMATION FOR QUESTIONS 29 - 30:


Income Statement

Year 1

Sales
Operating Costs

$1,000.00
-$850.00

$1,500.00
-$1,275.00

Depreciation

-$50.00

-$60.00

EBIT

$100.00

$165.00

Interest

-$20.00

-$30.00

$80.00

$135.00

Taxes (40%)

-$32.00

-$54.00

Net Income

$48.00

$81.00

EBT

Assets

Year 1

Year 2

Year 2

Cash
Accounts Receivable

$10.00
$150.00

$20.00
$200.00

Inventories

$200.00

$250.00

$360.00
$1,000.00

$470.00
$1,200.00

Current Assets
Gross Plant & Equipment

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 28 of 73 Pages

Less: Depreciation
Net Plant & Equipment
Total
Liabilities & Equity

29.

-$500.00

-$560.00

$500.00

$640.00

$860.00

$1,110.00

Year 1

Year 2

Accounts Payable
Notes Payable

$90.00
$50.00

$150.00
$100.00

Accruals

$60.00

$100.00

Current Liabilities
Long-Term Debt
Common Stock

$200.00
$150.00
$382.00

$350.00
$200.00
$382.00

Retained Earnings

$128.00

$178.00

Total

$860.00

$1,110.00

Assume that investor-supplied capital does not include accounts payable and accruals,
but does include all other liability and equity accounts. Also assume that the firms
weighted average cost of capital (WACC) on its investor-supplied capital was 10.0
percent in Year 1 and 9.5 percent in Year 2. Based on this information, determine by
how much the economic value added (EVA) increased for this firm between Year 1
and Year 2.
A.
B.
C.
D.
E.

$24.70
$27.40
$25.60
$28.30
$26.90

Capital1 = $860.00 - $90.00 - $60.00 = $710.00


Capital2 = $1,110.00 - $150.00 - $100.00 = $860.00
NOPAT1 = ($100.00)*(1-.40) = $60.00
NOPAT2 = ($165.00)*(1-.40) = $99.00
EVA1 = $60.00 - ($710.00)*(.10) = -$11.00
EVA2 = $99.00 - ($860.00)*(.095) = $17.30
Increase = $17.30 - (-$11.00) = $28.30
30.

Keeping in mind that notes payable are interest bearing obligations and are thus not
part of the firms current operating liabilities (COL), calculate the firms Free Cash Flow
(FCF) for Year 2
A.

- $74

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 29 of 73 Pages

B.
C.
D.
E.

- $51
- $99
- $28
- $13

There are a lot of different ways to solve this problem, simply choose the method you
are most comfortable with.
NOPAT = (EBIT)(1-T) = ($165)(1-.4) = $99
DEP = $60
OCF = NOPAT + DEP = $99 + $60 = $159
NOWCY1 = $360 - $150 = $210
NOWCY2 = $470 - $250 = $220
NOWC = $220 - $210 = $10
GFAY1 = $1,000
GFAY2 = $1,200
GFA = $1,200 - $1,000 = $200
NFAY1
NFAY2
NFA
TOCY1
TOCY2

= $500
= $640
= $640 - $500 = $140
= NOWCY1 + NFAY1 = $210 + $500 = $710
= NOWCY2 + NFAY2 = $220 + $640 = $860

NIOC = TOC = $860 - $710 = $150


GIOC = NIOC + DEP = $150 + $60 = $210
FCF = OCF - GIOC = $159 - $210 = -$51
FCF = NOPAT - NIOC = $99 - $150 = -$51
FCF = OCF - NOWC - GFA = $159 - $10 - $200 = -$51
Proof:
FCF
Interest Payment
Interest Tax Shelter
Dividends
Total Needs
New Debt
Net Effect

31.

- $ 51
- $ 30
+$ 12
- $ 31
- $100
+$100
$ 0

Assume that in 2005 your salary was $50,000, that you received dividends and capital
gains of $5,000, and received interest income of $3,500. Also assume that you were
single, your personal tax exemption was $3,000, and your itemized deductions were
$7,000. Based on the 2005 tax tables in the exam handout, and the fact that both
dividends and capital gains are taxed at a 15% rate, calculate the average tax rate that
you paid on your total taxable income.
A.

16.36%

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 30 of 73 Pages

B.
C.
D.
E.

19.28%
17.09%
18.55%
17.82%

Ordinary Taxable Income = $50,000 + $3,500 - $3,000 - $7,000 = $43,500


Ordinary Taxes = $4,090.00 + (.25)*(43,500.00 - $29,700.00) = $7,540.00
Taxes on Dividends ($5,000)*(.15) = $750.00
Total Taxes Paid = $7,540.00 + $750.00 = $8,290.00
Total Taxable Income = $43,500.00 + $5,000.00 = $48,500.00
Average Tax Rate = $8,290.00 / $48,500.00 = 17.09%

32.

Assume that your firm reported net income of $108 million in 2004, while the firm had
sales of $1,100 million and a cost of goods sold of $880 million. Also assume that the
firms corporate tax rate was 40 percent and its interest expense was $40 million. Now
assume that the firms goal is to increase its net income by 25 percent in 2005. It
predicts that the tax rate and cost of goods sold as a percentage of sales will remain
unchanged, while interest expense will increase by 20 percent. Based on this
information, determine the level of sales that the firm will have to generate in 2005 in
order to meet its net income goal.
Income Statement

2005

Sales
Cost of Goods Sold
EBIT
Interest
EBT
Taxes
Net Income
*

A.
B.
C.
D.
E.

$1,293 Million
$1,365 Million
$1,257 Million
$1,329 Million
$1,221 Million

New net income = ($108 million)*(1.25) = $135 million


New Interest Expense = ($40 million)(1.20) = $48 million
Now, work backwards through the income statement:

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 31 of 73 Pages

Income Statement

2005

Sales
Cost of Goods Sold

$1,365
- $1,092

EBIT
Interest

$ 273
-$

EBT
Taxes

$ 225
-$

Net Income

33.

48
90

$ 135

Assume that you are given the income statement and balance sheet (you may assume
that these are market values) for your company listed below. Also assume that the
firms debt is selling at par and that its cost of stock is 14 percent (you may assume that
flotation costs are zero). You should now be able to calculate the weighted average cost
of capital for the firm (go out to at least 6 decimal places). Given this information,
determine the economic value added (EVA) for 2005.
Income Statement

Year: 2005

Sales

$15,000.00

Operating costs

$12,000.00

Earnings before interest and taxes


Interest paid on long-term debt
Earnings before taxes
Taxes (40%)
Net income
Balance Sheet

$3,000.00
$850.00
$2,150.00
$860.00
$1,290.00
Year: 2005

Assets:
Cash and marketable securities

$1,500.00

Accounts receivable

$4,500.00

Inventories

$6,000.00

Total current assets


Property plant and equipment
Total assets

$12,000.00
$7,500.00
$19,500.00

Liabilities and equity:


Long-term Debt

$8,500.00

Total liabilities

$8,500.00

Common stock (1 million shares)

$7,000.00

Retained earnings

$4,000.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 32 of 73 Pages

Total common equity

$11,000.00

Total liabilities and equity

$19,500.00

A.
B.
C.
D.
E.

- $350.00
- $275.00
- $325.00
- $300.00
- $250.00

Since the debt is selling at par, the coupon (interest) rate is equal to the required rate of
return (YTM):
KD = ($850) / ($8,500) = 0.10 = 10.0%
WD = ($8,500) / ($19,500) = 0.4359
WS = ($11,000) / ($19,500) = 0.5641
WACC = (0.10)*(1-.40)*(.4359) + (0.14)*(.5641) = 0.026154 + 0.078974 = 10.5128%
NOPAT = (EBIT)(1-T) = ($3,000.00)(1-.40) = $1,800.00
EVA = $1,800.00 - ($19,500.00)*(0.105128) = $1,800.00 - $2,050 = -$250.00
Decomposition:
EBIT
Taxes
Bondholders
Stockholders
EVA

$3,000.00
- $ 860.00
- $ 850.00
- $1,540.00
- $ 250.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 33 of 73 Pages

YOU ARE GIVEN THE FOLLOWING INFORMATION FOR QUESTIONS 34:

Income Statement (In Millions)

2003

2004

Sales (all on credit; 360-day year)


Operating costs
EBITDA
Depreciation and amortization
Earnings before interest and taxes
Interest (10%)
Earnings before taxes
Taxes (40%)
Net income
Common dividends

4,000.00
-3,400.00
600.00
-100.00
500.00
-110.82
389.18
-155.67
233.51
225.00

4,500.00
-3,825.00
675.00
-120.00
555.00
-123.34
431.66
-172.66
259.00
225.00

Balance Sheet (In Millions)

2003

2004

Assets:
Cash
Accounts receivable
Inventories
Total current assets
Net plant and equipment
Total assets

400.00
333.33
600.00
1,333.33
1,000.00
2,333.33

450.00
375.00
675.00
1,500.00
1,080.00
2,580.00

Liabilities and equity:


Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50 million shares)
Retained earnings
Total common equity
Total liabilities and equity

500.00
658.23
200.00
1,358.23
450.00
1,808.23
400.00
125.10
525.10
2,333.33

562.50
783.40
225.00
1,570.90
450.00
2,020.90
400.00
159.10
559.10
2,580.00

34.

Based on the information above, determine the free cash flow for 2004.

A.
B.
C.
D.
E.

$185.71
$197.24
$173.83
$161.85
$149.49

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 34 of 73 Pages

NOWC2004 = Current assets - Non-interest charging current liabilities


= $1,500.00 - $787.50 = $712.50
NOWC2003 = Current assets - Non-interest charging current liabilities
= $1,333.33 - $700 = 633.33
NOWC = $712.50 - 633.33 = $79.17
NFA2004 = $1,080.00
NFA2003 = $1,000.00
NFA = $1,080.00 - $1,000.00 = $80.00
NOPAT2004 = ($555.00)(1-.4) = $333.00
FCF2004 = NOPAT2004 - NOWC - NFA = $333.00 - $79.17 - $80.00 = $173.83
Proof:

35.

FCF

$173.83

Dividend

-$225.00

Interest

-$123.34

Interest Tax Shelter

$ 49.34

Notes Payable

$125.17

Total

0.00

Assume that single individuals face the following tax schedule:


Taxable Income ($)
$
0 - $ 26,250
$ 26,250 - $ 63,550
$ 63,550 - $132,600
$132,600 - $288,350
Over $288,350

Tax on Base
$
0.00
$ 3,937.50
$14,381.50
$35,787.00
$91,857.00

Tax Rate (on the amount above the base)


15.0%
28.0%
31.0%
36.0%
39.6%

Now assume that you are a single individual and received a salary of $103,750 over
the last year. Also assume that you received $18,000 in dividend income during the
year, interest income of $9,500, have personal exemptions of $2,800, and itemized
deductions of $23,500. If your salary of $103,750 and interest income of $9,500 is
considered to be ordinary income, but your dividends of $18,000 are taxed at only a
15% rate, then calculate your average tax rate on taxable income for the year.
A.
B.

27.45%
21.51%

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 35 of 73 Pages

C.
D.
E.

25.67%
29.08%
23.19%

First, find the ordinary taxable income:


Salary
Interest Income
Personal Exemptions
Itemized Deductions
Ordinary Taxable Income

$103,750
$ 9,500
- $ 2,800
- $ 23,500
$ 86,950

Using the tax table you find that this falls into the 31% marginal bracket, so calculate
taxes as:
Ordinary taxes = $14,381.50 + (0.31)($86,950 - $63,550) = $21,635.50
Now calculate the tax on dividends: Tax = ($18,000)(.15) = $2,700
Total taxes = $21,635.50 + $2,700.00 = $24,335.50
Total taxable income = $86,950 + $18,000 = $104,950
Average tax rate = $24,335.50 / $104,950.00 = 23.19%

36.

Your company reported the following information:


Sales = $20,000,000
Cost of Goods Sold = 60% of Sales
Operating Expenses = 25% of Sales
Interest expense = $180,000
Operating capital = $8 million, originally raised as follows:
Debt = $3 million; Common Stock = $5 million
Current WACC = .1135
Number of Shares of Common Stock = 500,000 shares at $10 par value
Earnings per share = $3.384
Tax rate = 40%
Depreciation = $0 per year
Additional investments in assets needed after Year 0 = $0
Based on this information, you should now be able to determine the economic value
added (EVA). Now make the following assumptions: (1) this EVA will occur every year
forever (a perpetuity), (2) the book value of debt is a good proxy for the market value
of debt, and (3) the intrinsic price per share accurately reflects the current market price
of the firms stock. (Hint: it is a function of what the investors originally paid plus value
that has been added.) Determine the current P/E ratio for this stock.

A.
B.
C.

7.60
7.20
7.80

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 36 of 73 Pages

D.
E.

7.00
7.40

EVA = EBIT(1 - T) - (Operating capital)(After-tax cost of capital).


Sales
Cost of Goods Sold
Operating Expenses
Depreciation
EBIT
Interest
EBT
Taxes
Net Income

$20,000,000
- 12,000,000
- 5,000,000
0
$ 3,000,000
180,000
$ 2,820,000
- 1,128,000
$ 1,692,000

EVA = ($3,000,000)(1-.4) + ($8,000,000)(.1135) = $1,800,000 - $908,000


EVA = $892,000
Value added by EVA = $892,000 / .1135 = $7,859,030.83
Current market value of stock equals starting value plus additional value added:
Current market value = $5,000,000.00 + $7,859,030.83 = $12,859,030.83
Current Price Per Share = $12,859,030.83 / 500,000 = $25.72
P/E Ratio = $25.72 / $3.384 = 7.60
Alternatively,
Since Depreciation = $0, then
OCF = EBIT (1-.4) + $0 = ($3,000,000)(.6) = $1,800,000
Since no additional investment in assets is needed, then
FCF = OCF = $1,800,000
Enterprise value = FCF / WACC = $1,800,000 / .1135 = $15,859,030.83
Intrinsic Value = Enterprise Value minus Value of Debt
Intrinsic Value = $15,859,030.83 - $3,000,000.00 = $12,859,030.83
NOTE:
Although not given, when the capital was originally issued the cost of debt was 6% and
the cost of equity was 16 percent, this gave a WACC of 11.35%.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 37 of 73 Pages

WD = $3,000,000 / $8,000,000 = 37.5%


WS = $5,000,000 / $8,000,000 = 62.5%
WACC = (.06)(1-.4)(.375) + (.16)(.625) = .0135 + .10 = .1135 = 11.35%
However, since value (NPV) has been added, the market weights and the cost of
equity have now changed. Assuming that the cost of debt has stayed at 6%, we now
have the following:
WD = $3,000,000 / $15,859,030.83 = 18.92%
WS = $12,859,030.83 / $15,859,030.83 = 81.08%
WACC = .1135 = (.06)(1-.4)(.1892) + (KS)(.8108)
KS = (.1135 - .0068112) / (.8108) = 13.16%
The required rate went down because there is now less debt (less risk) because the
market value of the equity has increased (positive NPV).

37.

Below is the level of taxable income (EBT) reported by your company over the past
several years:
Year
1999
2000
2001
2002
2003
2004

Taxable Income
$300,000
$600,000
$750,000
$200,000
-$1,150,000
$800,000

The company was founded in 1999. The corporate tax rate has been and will continue
to be 40 percent. Assume that the company has taken full advantage of the Tax Codes
carry-back, carry-forward provisions, and assume that the current provisions were
applicable in 1999. Determine, after accounting for these provisions, the companys
total tax liability for the 6-year period 1999-2004.

A.
B.
C.
D.
E.

$560,000
$640,000
$600,000
$720,000
$680,000

Year

Adjusted Taxable
Income

1999

$300,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 38 of 73 Pages

2000
2001
2002
2003
2004

$600,000
$0
$0
$0
$600,000

Tax Liability = ($1,500,000)(.40) = $600,000


38.

Corporations face the following corporate tax schedule:


Taxable Income
$0-$50,000
$50,000-$75,000
$75,000-$100,000
$100,000-$335,000
$335,000-$10,000,000
$10,000,000-$15,000,000
$15,000,000-$18,333,333
Over $18,333,333

Tax on Base

Percentage on

of Bracket

Excess above Base

$0
$7,500
$13,750
$22,250
$113,900
$3,400,000
$5,150,000
$6,416,667

15%
25
34
39
34
35
38
35

Assume that your company has $100,000 of taxable income from its operations,
$10,000 of interest income, and $40,000 of dividend income from preferred stock it holds
in other corporations. Determine the companys tax liability.

A.
B.
C.
D.
E.

$30,439
$28,975
$29,778
$30,830
$29,394

Taxable Income
Interest Income
Dividend Income
Total Taxable

$100,000
$ 10,000
$ 12,000 = ($40,000)(.30)
$122,000

Tax Liability = $22,250 + ($22,000)(.39)


Tax Liability = $22,250 + $8,580 = $30,830
39.

Your company has $50,000 that it plans to invest in marketable securities. It is choosing
between corporate bonds that yield 9 percent, municipal bonds that yield 6 percent, and
corporate preferred stock with a dividend yield of 7 percent. Your corporate tax rate is
40 percent, and 70 percent of the preferred stock dividends your company receives are
tax exempt. Assuming that the investments are equally risky and that your company

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 39 of 73 Pages

chooses solely on the basis of after-tax returns. Determine the after-tax rate of return on
the highest yielding security.
*

A.
B.
C.
D.
E.

5.83%
6.16%
6.54%
6.39%
6.82%

Corporate
Municipal
Preferred stock
40.

= (.09)(1-.4)
= 5.40%
= (.06)(1.0)
= 6.00%
= (.07)(1 - (.03(.4)) = 6.16%

A company has just been taken over by new management that believes it can raise
earnings before taxes (EBT) from $897 to $1,200, merely by cutting overtime pay and
reducing cost of goods sold. Prior to the change, the following data applied:
Data

Amount

Total assets
Debt ratio
Tax rate
BEP ratio
EBT
Sales

$10,000
45%
35%
15%
$897
$16,000

These data have been constant for several years, all income is paid out as dividends,
and you may assume that sales, the tax rate, and the balance sheet will remain
constant. Based on this information, determine the firms current cost of debt.

A.
B.
C.
D.
E.

12.6%
13.0%
13.4%
12.8%
13.2%

BEP = 15% = EBIT / Assets EBIT = (.15)($10,000) = $1,500


Interest = EBIT - EBT = $1,500 - $897 = $603
Debt = ($10,000)(.45) = $4,500
Interest Rate = $603 / $4,500 = 13.4%
YOU ARE GIVEN THE FOLLOWING INFORMATION FOR QUESTIONS 41:
Income Statement
Sales
Operating costs (excluding depreciation and

Year: 2004
$15,000.00
$12,000.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Year: 2003
$13,500.00
$10,800.00

Page 40 of 73 Pages

amortization)
EBITDA
Depreciation
Earnings before interest and taxes
Interest
Earnings before taxes
Taxes (35%)
Net income available to common stockholders
Common dividends
Balance Sheet
Assets:
Cash and marketable securities
Accounts receivable
Inventories
Total current assets
Net plant and equipment
Total assets

$3,000.00
$750.00
$2,250.00
$250.00
$2,000.00
$700.00
$1,300.00
$315.00
Year: 2004

Liabilities and equity:


Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50 million shares)
Retained earnings
Total common equity
Total liabilities and equity
41.
*

$2,700.00
$675.00
$2,025.00
$185.00
$1,840.00
$644.00
$1,196.00
$289.80
Year: 2003

$1,500.00
$4,500.00
$6,000.00
$12,000.00
$7,500.00
$19,500.00

$1,350.00
$4,050.00
$5,400.00
$10,800.00
$6,750.00
$17,550.00

$3,000.00
$1,000.00
$2,015.00
$6,015.00
$1,500.00
$7,515.00
$10,000.00
$1,985.00
$11,985.00
$19,500.00

$2,700.00
$350.00
$2,000.00
$5,050.00
$1,500.00
$6,550.00
$10,000.00
$1,000.00
$11,000.00
$17,550.00

Determine your company's free cash flow for 2004.


A.
B.
C.
D.
E.

-$157.50
-$172.50
-$177.50
-$167.50
-$162.50

NOWC2003 = Current assets - Non-interest charging current liabilities


= $10,800 - $4,700 = $6,100
NOWC2004 = Current assets - Non-interest charging current liabilities

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 41 of 73 Pages

= $12,000 - $5,015 = $6,985


NOWC = $6,985 - $6,100 = $885
NFA2003 = $6,750
NFA2004 = $7,500
NFA = $7,500 - $6,750 = $750
GFA = NFA + DEP = $750 + $750 = $1,500
NOPAT2004 = ($2,250)(1-.35) = $1,462.50
OCF2004 = NOPAT2004 + DEP = $1,462.5 + $750 = $2,212.50
FCF2004 = NOPAT2004 - NOWC - NFA = $1,462.50 - $885 - $750 = -$172.50
FCF2004 = OCF2004 - NOWC - GFA = $2,212.50 - $885 - $1,500 = -$172.50
Proof:
FCF
Interest
Tax Shelter
Dividends
Notes Payable
Total
42.

+
+

$172.50
$250.00
$ 87.50
$315.00
$650.00
$ 0.00

Assume that your firm plans to take on a project that will have an infinite life and produce
the free cash flows listed below. Also assume that the $10,000 invested in Year 0 was
supplied by investors as $5,000 of debt, at a before-tax cost of debt of 5 percent, and
$5,000 of equity, at a cost of equity of 12 percent. Finally, you may assume that the
firms tax rate is 40 percent. Given this data, determine the net present value of this
project.

A.
B.
C.

Year

OCF

NOWC

GFA

FCF

0
1
2
3

$0
$1,200
$1,200
$1,200
$1,200
$1,200

-$4,000
$0
$0
$0
$0
$0

-$6,000
$0
$0
$0
$0
$0

-$10,000
$1,200
$1,200
$1,200
$1,200
$1,200

$1,200

$0

$0

$1,200

$3,000
$6,000
$4,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 42 of 73 Pages

D.
E.

$7,000
$5,000

WACC = (.05)(1-.4)(.5) + (.12)(.5) = .015 + .06 = .075 = 7.5%


Enterprise Value = $1,200 / .075 = $16,000
Increase in Value = NPV = $16,000 - $10,000 = $6,000
Alternatively:
EVA = $1,200 - ($10,000)(.75) = $450
NPV = $450 / .075 = $6,000
YOU ARE GIVEN THE FOLLOWING INFORMATION FOR QUESTIONS 43 -44:

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 43 of 73 Pages

Income Statement (In Thousands)


Sales
Operating costs (excluding depreciation and amortization)
EBITDA
Depreciation and amortization
Earnings before interest and taxes
Interest
Earnings before taxes
Taxes (35%)
Net income available to common stockholders
Common dividends

Year: 2005
$18,000.00
$14,400.00
$3,600.00
$900.00
$2,700.00
$540.00
$2,160.00
$756.00
$1,404.00
$340.20

Year: 2004
$15,000.00
$12,000.00
$3,000.00
$750.00
$2,250.00
$250.00
$2,000.00
$700.00
$1,300.00
$315.00

Balance Sheet (In Thousands)


Assets:
Cash and marketable securities
Accounts receivable
Inventories
Total current assets
Net plant and equipment
Total assets

Year: 2005

Year: 2004

Liabilities and equity:


Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50 million shares)
Retained earnings
Total common equity
Total liabilities and equity
43.

Determine the firms free cash flow (FCF) for 2005.

A.
B.
C.
D.
E.

$1,800.00
$5,400.00
$7,200.00
$14,400.00
$9,000.00
$23,400.00

$1,500.00
$4,500.00
$6,000.00
$12,000.00
$7,500.00
$19,500.00

$3,976.00
$2,000.00
$2,860.20
$8,836.20
$2,500.00
$11,336.20
$10,000.00
$2,063.80
$12,063.80
$23,400.00

$3,500.00
$1,000.00
$2,500.00
$7,000.00
$1,500.00
$8,500.00
$10,000.00
$1,000.00
$11,000.00
$19,500.00

-$1,359.80
-$1,257.80
-$1,155.80
-$1,206.80
-$1,308.80

NOWC2004 = Current assets - Non-interest charging current liabilities


= $12,000.00 - $6,000.00 = $6,000.00
NOWC2005 = Current assets - Non-interest charging current liabilities
= $14,400.00 - $6,836.20 = $7,563.80
NOWC = $7,563.80 - $6,000.00 = $1,563.80

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 44 of 73 Pages

NFA2004 = $7,500.00
NFA2005 = $9,000.00
NFA = $9,000.00 - $7,500.00 = $1,500.00
GFA = NFA + DEP = $1,500.00 + $900.00 = $2,400.00
NOPAT2005 = ($2,700.00)(1-.35) = $1,755.00
OCF2005 = NOPAT2005 + DEP = $1,755.00 + $900.00 = $2,655.00
FCF2005 = NOPAT2005 - NOWC - NFA
FCF2005 = $1,755.00 - $1,563.80 - $1,500.00 = -$1,308.80
FCF2005 = OCF2005 - NOWC - GFA
FCF2005 = $2,655.00 - $1,563.80 - $2,400.00 = -$1,308.80
Proof:
FCF
Interest
Tax Shelter
Dividends
Notes Payable
Long-Term Debt
Total
44.

+
+
+

$1,308.80
$ 540.00
$ 189.00
$ 340.20
$1,000.00
$1,000.00
$
0.00

Assuming that a firms invested capital does not include accounts payable or accruals,
and assuming that the firms weighted average cost of capital (WACC) is 11.5%,
determine the firms economic value added (EVA) for 2005.
A.
B.
C.
D.
E.

-$142.73
-$170.26
-$149.84
-$163.02
-$156.95

EVA = (EBIT)(1-T) - (WACC)(Invested Capital)


EVA = ($2,700)(1-.35) - (.115)($23,400 - $6,836.20)
EVA = $1,755.00 - $1,904.84 = -$149.84

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 45 of 73 Pages

45.

Assume that you are single and that your salary for 2004 was $72,146, and that you
received an additional $6,000 in dividends and $4,000 in interest from your
investments (you did not sell any of your investments so you did not incur any capital
gain or loss). Also assume that you claim a personal tax exemption (single filer) of
$3,100 and that your itemized deductions total $13,454. Based on this information,
and knowing that dividends and capital gains are taxed at 15 percent, determine your
total tax liability (amount to be paid) for 2004 (Hint: your tax is $4,000 on your first
$29,050 of ordinary taxable income).
A.
B.
C.
D.
E.

$12,163.50
$12,535.50
$12,976.50
$12,368.50
$12,747.50

Salary
Interest Income
Less: Exemption
Less: Deduction
Ordinary Taxable Income

$72,146.00
$ 4,000.00
-$ 3,100.00
-$13,454.00
$59,592.00

Ordinary Taxes = ($7,150)(.10) + ($21,900)(.15) + ($30,542)(.25)


Ordinary Taxes = $715.00 + $3,285 + $7,635.50 = $11,635.50
Taxes on Dividends = ($6,000)(.15) = $900.00
Total Tax Liability = $11,635.50 + $900.00 = $12,535.50

46.

Assume that the market value of a firms assets is $1,000,000, while the market value
of its capital is as follows: debt = $400,000 at a pre-tax cost of debt (KD) of 8%;
preferred stock = $100,000 at a cost of preferred stock (KP) of 11%; and common
stock = $500,000 at a cost of common stock (KS) of 16%. Assuming that the firms
marginal tax rate is 35%, determine the weighted average cost of capital WACC) for
this firm.
A.
B.
C.
D.
E.

10.98%
11.18%
11.78%
11.38%
11.58%

WACC = (.08)(1-.35)(.40) + (.11)(.10) + (.16)(.50)


WACC = 0.0208 + 0.011 + 0.08 = 11.18%
47.

You are given the following income statement and balance sheet for your company.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 46 of 73 Pages

Income Statement
Sales
Operating costs (excluding depreciation and
amortization)
EBITDA
Depreciation
Earnings before interest and taxes
Interest
Earnings before taxes
Taxes (35%)
Net income available to common stockholders
Common dividends

Year: 2004
$16,000.00
$13,000.00

Year: 2003
$14,500.00
$11,800.00

$3,000.00
$800.00
$2,200.00
$200.00
$2,000.00
$700.00
$1,300.00
$315.00

$2,700.00
$675.00
$2,025.00
$185.00
$1,840.00
$644.00
$1,196.00
$289.80

Balance Sheet
Assets:
Cash and marketable securities
Accounts receivable
Inventories
Total current assets
Net plant and equipment
Total assets

Year: 2004

Liabilities and equity:


Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total debt
Common stock (50 million shares)
Retained earnings
Total common equity
Total liabilities and equity

Year: 2003

$1,600.00
$4,400.00
$6,000.00
$12,000.00
$8,000.00
$20,000.00

$1,350.00
$4,050.00
$5,400.00
$10,800.00
$6,750.00
$17,550.00

$4,000.00
$1,000.00
$2,015.00
$7,015.00
$1,000.00
$8,015.00
$10,000.00
$1,985.00
$11,985.00
$20,000.00

$2,700.00
$350.00
$2,000.00
$5,050.00
$1,500.00
$6,550.00
$10,000.00
$1,000.00
$11,000.00
$17,550.00

Based on this information, determine your company's free cash flow for 2004.
*

A.
B.
C.
D.
E.

$280.00
$295.00
$275.00
$290.00
$285.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 47 of 73 Pages

NOWC2003 = Current assets - Non-interest charging current liabilities


= $10,800 - $4,700 = $6,100
NOWC2004 = Current assets - Non-interest charging current liabilities
= $12,000 - $6,015 = $5,985
NOWC = $5,985 - $6,100 = -$115
NFA2003 = $6,750
NFA2004 = $8,000
NFA = $8,000 - $6,750 = $1,250
GFA = NFA + DEP = $1,250 + $800 = $2,050
NOPAT2004 = ($2,200)(1-.35) = $1,430.00
OCF2004 = NOPAT2004 + DEP = $1,430.00 + $800 = $2,230.00
FCF2004 = NOPAT2004 - NOWC - NFA = $1,430.00 + $115 - $1,250 = $295.00
FCF2004 = OCF2004 - NOWC - GFA = $2,230.00 + $115 - $2,050 = $295.00
Proof:
FCF
Interest
Tax Shelter
Dividends
Debt
Notes Payable
Total
48.

+
+
+

$295.00
$200.00
$ 70.00
$315.00
$500.00
$650.00
$ 0.00

Given the financial statements below, and keeping in mind that notes payable are
interest-bearing securities, determine the firms free cash flow for 2007.

Income Statement (In Thousands)


Sales
Operating costs
EBITDA
Depreciation
Earnings before interest and taxes
Interest (8%)
Earnings before taxes
Taxes (40%)
Net income
Common dividends

Year: 2006
$15,000.00
$9,000.00
$6,000.00
$600.00
$5,400.00
$160.00
$5,240.00
$2,096.00
$3,144.00
$1,282.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Year: 2007
$21,000.00
$12,600.00
$8,400.00
$700.00
$7,700.00
$200.00
$7,500.00
$3,000.00
$4,500.00
$2,452.00

Page 48 of 73 Pages

Balance Sheet (In Thousands)


Assets:
Cash
Accounts receivable
Inventories
Total current assets
Net fixed assets (PP&E)
Total assets
Liabilities and equity:
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total liabilities
Common stock (2 million shares)
Retained earnings
Total common equity
Total liabilities and equity
*

A.
B.
C.
D.
E.

Year: 2006

Year: 2007

$300.00
$3,500.00
$4,000.00
$7,800.00
$6,000.00
$13,800.00

$500.00
$4,348.00
$4,800.00
$9,648.00
$7,000.00
$16,648.00

$1,500.00
$1,000.00
$1,000.00
$3,500.00
$1,000.00
$4,500.00
$6,000.00
$3,300.00
$9,300.00
$13,800.00

$700.00
$1,500.00
$2,100.00
$4,300.00
$1,000.00
$5,300.00
$6,000.00
$5,348.00
$11,348.00
$16,648.00

$2,072
$1,832
$1,592
$1,952
$1,712

NOPAT = (EBIT)(1-T) = ($7,700)(1-.4) = $4,620


DEP = $700
OCF = NOPAT + DEP = $4,620 + $700 = $5,320
NOWC2006 = $7,800 - $2,500 = $5,300
NOWC2007 = $9,648 - $2,800 = $6,848
NOWC = $1,548
NFA2006 = $6,000
NFA2007 = $7,000
NFA = $7,000 - $6,000 = $1,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 49 of 73 Pages

GFA = NFA + DEP = $1,000 + $700 = $1,700


TOC2006 = NOWC2006 + NFA2006 = $5,300 + $6,000 = $11,300
TOC2007 = NOWC2007 + NFA2007 = $6,848 + $7,000 = $13,848
NIOC = TOC = $13,848 - $11,310 = $2,548
GIOC = NIOC + DEP = $2,548 + $700 = $3,248
FCF = OCF - GIOC = $5,320 - $3,248 = $2,072
FCF = NOPAT - NIOC = $4,620 - $2,548 = $2,072
FCF = OCF - NOWC - GFA = $5,320 - $1,548 - $1,700 = $2,072
Proof:
FCF
Interest Payment
Interest Tax Shelter
Dividends
Total Needs
New Notes Payable
New Common Stock
New L-T Debt
Net Effect

$2,072.00
- $ 200.00
+$ 80.00
- $2,452.00
- $ 500.00
+$ 500.00
+$
0.00
+$
0.00
$
0

YOU ARE GIVEN THE FOLLOWING INFORMATION FOR PROBLEMS 49 - 50:


Assume that Firm A is just starting up and has made the projections indicated below.
You may assume that after the initial investment of $200,000 that the firm will make no
other investments in terms of capital expenditures, that there is no depreciation
expense, and that all free cash flows are paid out to the investors and that growth is
therefore zero (i.e., FCF is a perpetuity).
Year
0
1
2
3
4

49.

NOPAT / OCF
$0.00
$28,000.00
$28,000.00
$28,000.00
$28,000.00

$28,000.00

NOWC

NFA / GFA

-$50,000.00
$0.00
$0.00
$0.00
$0.00

$0.00

-$150,000.00
$0.00
$0.00
$0.00
$0.00

$0.00

FCF
-$200,000.00
$28,000.00
$28,000.00
$28,000.00
$28,000.00

$28,000.00

Assume that you calculate that the market value added (MVA) or net present value
(NPV) of this firm is $24,000. Based on this information, determine the economic
value added (EVA) for each year.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 50 of 73 Pages

A.
B.
C.
D.
E.

$6,000
$4,000
$7,000
$5,000
$3,000

MVA = NPV = $24,000 = (FCF / WACC) - Original Cost


MVA = NPV = $24,000 = ($28,000 / WACC) - $200,000
WACC = $28,000 / ($24,000 + $200,000) = 12.50%
EVA = NOPAT - (Capital)*(WACC) = $28,000 - ($200,000)*(.125) = $3,000
MVA = NPV = EVA / WACC = $3,000 / .125 = $24,000
50.

Now, instead of the WACC calculated above, assume that the firm initially raises the
$200,000 of capital by issuing $100,000 of debt at a before-tax cost of debt (rD) of
5.0% (the tax rate is 40%), and $100,000 of equity at a cost of stock (rS) of 13.0%: you
should now be able to calculate the WACC (which may not be the same as in the
problem above), the enterprise value, and the new market value of the firms equity.
Given this market value, and assuming that the firm does not rebalance back to a
50/50 debt equity ratio, but that WACC does remain at its original level, determine
what the new, implied cost of equity must be (HINT1: you can not unlever and relever
beta for this problem; you must use the logic that we discussed and demonstrated in
class. HINT2: work backwards from NOPAT to determine what EBIT must be, and
then work forward to determine, and look at the value of, interest payments versus
dividend payments.)
A.
B.
C.
D.
E.

9.64%
9.28%
9.82%
10.00%
9.46%

WACC = (0.05)*(1-.40)*(50%) + (0.13)*(50%) = 1.50% + 6.50% = 8.0%


Enterprise Value (EV) = $28,000 / .08 = $350,000
MV Equity = Enterprise Value - Debt = $350,000 - $100,000 = $250,000
EBIT = NOPAT / (1-T) = $28,000 / (1 - .40) = $46,666.67
EBIT
Interest
EBT
Taxes
Net Income

$46,666.67
- $ 5,000.00 / .05 = $100,000 (MV of Debt at rD = 5.0%)
$41,666.67
- $16,666.67
$25,000.00 / 0.10 = $250,000 (MV of Equity at rS = 10.0%)

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 51 of 73 Pages

Enterprise Value

$350,000

Therefore, the implied rS is 10.00%


Alternatively,
New WD = $100,000 / $350,000 = 28.57%
New WS = $250,000 / $350,000 = 71.43%
but WACC remains at 8.0%
Therefore,
8.0% = (0.05)*(1-.40)*(28.57%) + (rS)*(71.43%)
rS = (8.0% - 0.857%) / (.7143) = 7.143 / 0.7143 = 10.0%
__________
As we showed in class, if we rebalance so that
Debt = $175,000 (50%)
and
Equity = $175,000(50%)
then
New Interest = ($175,000)*(.05) = $8,750
EBIT
Interest
EBT
Taxes
Net Income

$46,666.67
- $ 8,750.00 / .05 = $175,000
$37,916.67
- $15,166.67
$22,750.00 / 0.13 = $175,000

And we are back to a cost of stock, rS, of 13.0%


51.

Assume that you and your significant other each had total ordinary taxable income of
$75,800 (assume no capital gains or dividend income) and calculated your taxes using
the 2007 Single Tax Rates. Using the 2007 Tax Tables in the exam handout,
determine the amount of the marriage penalty if you had files jointly using the 2007
Married Tax Rates.
A.
B.
C.
D.
E.

$493.00
$293.00
$893.00
$ 93.00
$693.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 52 of 73 Pages

Individual Taxes = $4,386.25 + ($75,800 - $31,850)*(.25) = $15,373.75


Total Individual Taxes = ($15,373.75)*(2) = $30,747.50
Total Income = ($75,800)*(2) = $151,600
Married Taxes = $24,972.50 + ($151,600 - $128,500)*(.28) = $31,440.50
Marriage Penalty = $31,440.50 - $30,747.50 = $693.00

52.

Assume that a firm starts out as an all equity firm with $1,000,000 of equity,
$1,000,000 of assets, and a return on assets (ROA) of 10 percent. Also assume that
management then makes the decision to issue $200,000 of debt, at a before-tax rate
of 5 percent, and use the proceeds to buy back $200,000 of equity. Based on this
information, and assuming that the firms tax rate is 40 percent, determine what the
return on equity (ROE) will be after the buy back.
A.
B.
C.
D.
E.

14.25%
10.50%
13.00%
15.50%
11.75%

Debt / Equity = $200,000 / $800,000 = 2 / 8 = .25


After-tax rD = (.05)*(1-.40) = 3.0%
ROE = ROA (unlevered) + Leverage Effect + Tax Shield on Debt Effect
ROE = 0.10 + (0.10 - 0.05)*(2 / 8) + (0.05 - 0.03)*(2 / 8)
ROE = 0.10 + 0.0125 + 0.005 = 11.75%
Alternatively,
ROA = NI / TA NI = (ROA)*(TA) = (0.10)*($1,000,000) = $100,000
Work backwards up through income statement to get EBIT:
EBIT
Interest
EBT
Taxes
Net Income

$166,667
-$
0
$166,667
-$ 66,667
$100,000

Now add new interest and recalculate net income:


Interest = ($200,000)*(0.05) = $10,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 53 of 73 Pages

EBIT
Interest
EBT
Taxes
Net Income

$166,667
-$ 10,000
$156,667
-$ 62,667
$ 94,000

ROE = NI / CE = $94,000 / $800,000 = 11.75%

YOU ARE GIVEN THE FOLLOWING INFORMATION FOR PROBLEMS 53 - 56:

Income Statement (In Thousands)


Sales
Operating costs
EBITDA
Depreciation
Earnings before interest and taxes
Interest (8%)
Earnings before taxes
Taxes (40%)
Net income
Common dividends

Year: 2006
$25,000.00
$15,000.00
$10,000.00
$1,000.00
$9,000.00
$320.00
$8,680.00
$3,472.00
$5,208.00
$3,318.00

Year: 2005
$22,000.00
$13,200.00
$8,800.00
$880.00
$7,920.00
$320.00
$7,600.00
$3,040.00
$4,560.00
$2,280.00

Balance Sheet (In Thousands)


Assets:
Cash and marketable securities
Accounts receivable
Inventories
Total current assets
Net fixed assets (PP&E)
Total assets

Year: 2006

Year: 2005

Liabilities and equity:


Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total liabilities
Common stock (2 million shares)
Retained earnings
Total common equity
Total liabilities and equity

$750.00
$6,250.00
$7,500.00
$14,500.00
$10,000.00
$24,500.00

$660.00
$5,500.00
$6,600.00
$12,760.00
$8,800.00
$21,560.00

$5,000.00
$2,000.00
$3,750.00
$10,750.00
$2,000.00
$12,750.00
$6,000.00
$5,750.00
$11,750.00
$24,500.00

$4,400.00
$2,000.00
$3,300.00
$9,700.00
$2,000.00
$11,700.00
$6,000.00
$3,860.00
$9,860.00
$21,560.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 54 of 73 Pages

53.

Based on this information, determine the free cash flow (FCF) for 2006.

A.
B.
C.
D.
E.

$3,420,000.00
$3,240,000.00
$3,510,000.00
$3,600,000.00
$3,330,000.00

Change in NWC = ($14,500,000 - $5,000,000 - $3,750,000)


- ($12,760,000 - $4,400,000 - $3,300,000)
Change in NWC = $5,750,000.00 - $5,060,000.00 = $690,000.00
Change in NFA = $10,000,000.00 - $8,800,000.00 = $1,200,000.00
Depreciation = $1,000,000.00 (From Income Statement)
Change in GFA = $1,200,000.00 + $1,000,000.00 = $2,200,000.00
NOPAT = ($9,000,000.00)*(1 - .40) = $5,400,000.00
OCF = $5,400,000.00 + $1,000,000.00 = $6,400,000.00
FCF = $6,400,000.00 - $690,000.00 - $2,200,000.00 = $3,510,000.00
54.

Assume that in 2006 (today) the firms total invested capital can be defined as
$15,750,000 (consisting of $4,000,000 of debt and $11,750,000 of equity; you may
assume that the market value of debt is equal to its book value), and that its weighted
average cost of capital is 10 percent. (Hint: you should now be able to calculate
economic value added (EVA) for 2006.) Now assume that EVA is expected to grow at
a long-run sustainable growth rate of 6 percent each year. Given this information,
determine the present value today (2006) of all future EVAs to be earned by the firm.
A.
B.
C.
D.
E.

$121,635,000
$111,498,750
$101,362,500
$ 91,226,250
$ 81,090,000

Invested Capital = $15,750,000.00 (Given)


WACC = 0.1 (Given)
EVA2006 = $5,400,000 - ($15,750,000)*(0.10) = $3,825,000.00
Growth Rate of EVA = 0.06 (Given)
EVA2007 = ($3,825,000.00)*(1.06) = $4,054,500.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 55 of 73 Pages

Total PV of EVA2006 = $4,054,500.00 / (0.10 - 0.06) = $101,362,500.00


55.

As you can calculate, the firms return on equity (ROE) was 44.32 percent in 2006.
Assume now that the firm can maintain the same profit margin (NI / Sales) and equity
multiplier (TA/CE) in 2007 as it had in 2006. Also assume that sales will increase to
$30,000,000 in 2007. Given this information, determine the level of total assets that
the firm must have in 2007 if its return on equity (ROE) is to increase to 56.86 percent.
(Hint: use the Du Pont relationship of ROE = (PM)*(TAT)*(EM))

A.
B.
C.
D.
E.

$22,917,834.77
$24,187,602.22
$21,648,067.31
$25,457,369.68
$26,727,137.15

Current
Profit Margin = $5,208,000 / $25,000,000 = 0.20832
TAT = $25,000,000 / $24,500,000 = 1.020408163
ROA = (0.20832)*(1.020408163) = 0.212571429
Alternatively: ROA = $5,208,000 / $24,500,000 = 0.212571429
EM = $24,500,000 / $11,650,000 = 2.085106383
ROE = (0.20832)*(1.020408163)*(2.085106383) = 0.443234043
Alternatively: ROE = $5,280,00 / $11,750,000 = 0.443234043
New ROE (Given) = 0.5686
Implied TAT = ROE / (PM)*(EM) = .5686 / ((.20832)*(2.085106383)) =
1.309024186
Sales (Given) = $30,000,000.00
Implied TA = Sales / TAT = $30,000,000 / 1.309024186 = $22,917,834.77
56.

Assume that only 80 percent of the firms sales are sold on credit and create an
account receivable. Using a 365-day year, determine the days sales outstanding
(DSO) for 2006.
A.
B.
C.
D.
E.

133.02 days
190.00 days
152.08 days
114.06 days
171.04 days

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 56 of 73 Pages

Credit Sales = ($25,000,000)*(.80) = $20,000,000


Credit Sales Per Day = $20,000,000 / 365 = $54,794.52
DSO = $6,250,000 / ($54,794.52) = 114.06 days

YOU ARE GIVEN THE FOLLOWING INFORMATION FOR PROBLEMS 57 - 58:


Assume that Firm A is just starting up and has made the projections indicated below.
You may assume that after the initial investment of $500,000 that the firm will make no
other investments in terms of capital expenditures, that there is no depreciation
expense, and that all free cash flows are paid out to the investors and that growth is
therefore zero (i.e., FCF is a perpetuity).
Year
0
1
2
3
4

57.

NOPAT / OCF
$0.00
$77,720.00
$77,720.00
$77,720.00
$77,720.00

$77,720.00

NOWC
-$100,000.00
$0.00
$0.00
$0.00
$0.00

$0.00

NFA / GFA
-$400,000.00
$0.00
$0.00
$0.00
$0.00

$0.00

FCF
-$500,000.00
$77,720.00
$77,720.00
$77,720.00
$77,720.00

$77,720.00

Assume that you calculate that the market value added (MVA) or net present value
(NPV) of this firm is $36,000. Based on this information, determine the economic
value added (EVA) for each year.
A.
B.
C.
D.
E.

$4,090
$5,220
$5,020
$5,320
$5,120

MVA = NPV = $36,000 = (FCF / WACC) - Original Cost


MVA = NPV = $36,000 = ($77,720 / WACC) - $500,000
WACC = $77,720 / ($36,000 + $500,000) = 14.50%
EVA = NOPAT - (Capital)*(WACC) = $77,720 - ($500,000)*(.145) = $5,220
MVA = NPV = EVA / WACC = $5,220 / .145 = $36,000
58.

Now, instead of the WACC calculated above, assume that the firm initially raises the
$500,000 of capital by issuing $200,000 of debt at a before-tax cost of debt (rD) of
5.0% (the tax rate is 40%), and $300,000 of equity at a cost of stock (rS) of 20.0%: you

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 57 of 73 Pages

should now be able to calculate the WACC (which may not be the same as in the
problem above), the enterprise value, and the new market value of the firms equity.
Given this market value, and assuming that the firm does not rebalance back to a 2/3
debt equity ratio, but that WACC does remain at its original level, determine what the
new, implied cost of equity must be (HINT1: you can not unlever and relever beta for
this problem; you must use the logic that we discussed and demonstrated in class.
HINT2: work backwards from NOPAT to determine what EBIT must be, and then work
forward to determine, and look at the value of, interest payments versus dividend
payments.)

A.
B.
C.
D.
E.

16.97%
18.08%
17.34%
18.45%
17.71%

WACC = (0.05)*(1-.40)*(40%) + (0.20)*(60%) = 1.20% + 12.00% = 13.20%


Enterprise Value (EV) = $77,720 / .132 = $588,787.88
MV Equity = Enterprise Value - Debt = $588.787.88 - $200,000 = $388,787.88
EBIT = NOPAT / (1-T) = $77,720 / (1 - .40) = $129,533.33
EBIT
Interest
EBT
Taxes
Net Income

$129,533.33
- $ 10,000.00 / .0500 = $200,000.00 (MV of Debt at rD = 5.0%)
$119,533.33
- $ 47,813.33
$ 71,720.00 / .1845 = $388,787.88 (MV of Equity at rS = 18.45%)

Enterprise Value

$588,787.88

Therefore, the implied rS is 18.45%


Alternatively,
New WD = $200,000.00 / $588,787.88 = 33.9680905%
New WS = $388,787.88 / $588,787.88 = 66.0319095%
but WACC remains at 8.0%
Therefore,
13.2% = (0.05)*(1-.40)*(33.9680905%) + (rS)*(66.0319095%)
rS = (13.2% - 1.0190427%) / (.660319095)
rS = 12.1809573% / 0.660319095 = 18.45%
__________

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 58 of 73 Pages

As we showed in class, if we rebalance so that


Debt = $235,515.15 (40%)
and
Equity = $353,272.73 (60%)
then
New Interest = ($235,515.15)*(.05) = $11,775.76
EBIT
Interest
EBT
Taxes
Net Income

$129,533.33
- $ 11,775.76 / .0500 = $235,515.15 (MV of Debt at rD = 5.0%)
$117,757.57
- $ 47,103.03
$ 70,654.54 / .2000 = $353,272.73 (MV of Equity at rS = 20.00%)

Enterprise Value

$588,787.88

And we are back to a cost of stock, rS, of 20.0%


59.

Assume that an all equity firm has assets of $20,000 and a return on assets (ROA) of
13.00 percent. And that the firm makes the decision to replace 1/2 of its equity with
debt that has a before-tax cost of 8 percent Assuming that the firms tax rate is 40
percent, calculate the firms ROE after the debt has been issued and equity has been
repurchased. (HINT: Think about leverage and tax shelter effects of using debt that we
demonstrated in class.)
A.
B.
C.
D.
E.

20.20%
21.70%
20.70%
22.20%
21.20%

This problem can be solved without knowing the firms income statement or how much
it has in total assets.
AT rD = (8.00%)(1-.40) = 4.80%
As discussed in class, after the issue and repurchase, the remaining equity
shareholders will benefit from both a leverage effect and a tax shelter effect:
ROE = ROA + Leverage Effect + Tax Shelter Effect
ROE = 13.00% + (13.00% - 8.00%)(1.0) + (8.00% - 4.80%)(1.0)
ROE = 13.00% + 5.00% + 3.20% = 21.20%
Alternatively,
Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 59 of 73 Pages

Since you were given total assets, you can also work backwards to get ROE:
ROA = 13.00% = NI / $20,000
NI = ($20,000)*(.13) = $2,600
Interest = ($10,000)*(.08) = $800
Assets/Income

Without
Debt

Assets
Debt (1/2)
Equity (1/2)

$20,000.00
$
0.00
$20,000.00

EBIT
Interest (8%)
EBT
Taxes (40%)
Net Income

$
$
$
-$
$

ROA
ROE

60.

4,333.33
0.00
4,333.33
1,733.33
2,600.00

With
Debt
$20,000.00
$10,000.00
$10,000.00
$
-$
$
-$
$

13.00%
13.00%

4,333.33
800.00
3,533.33
1,413.33
2,120.00
10.60%
21.20%

Assume that in 2006 (today) a firm had EBIT of $9,000,000, a tax rate of 40 percent,
and that the firms total invested capital could be defined as $20,450,000 (consisting of
$8,000,000 of debt and $12,450,000 of equity), and that its weighted average cost of
capital is 12 percent. (Hint: you should now be able to calculate economic value
added (EVA) for 2006.) Now assume that EVA is expected to grow at a long-run
sustainable growth rate of 4 percent each year. Given this information, determine the
present value today (2006) of all future EVAs to be earned by the firm.
A.
B.
C.
D.
E.

$38,161,000
$38,572,000
$38,298,000
$38,709,000
$38,435,000

Invested Capital = $20,450,000 (Given)


WACC = 0.12 (Given)
EVA2006 = ($9,000,000)*(1-.40) - ($20,450,000)*(0.12) = $2,946,000
Growth Rate of EVA = 0.04 (Given)
EVA2007 = ($2,946,000)*(1.04) = $3,063,840

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 60 of 73 Pages

Total PV of EVA2006 = $3,063,840 / (0.12 - 0.04) = $38,298,000


61.

Assume that your company is 60 percent equity financed (40 percent debt financed).
Given the following information, calculate the return on equity (ROE).
Data

Amount

EBIT
Sales
Interest Rate
Dividend payout ratio
Total assets turnover
Tax rate

A.
B.
C.
D.
E.

$6,000
$35,000
0.06
40%
0.70 x
40%

9.20%
9.50%
9.40%
9.30%
9.60%

TAT = 0.75

= Sales / TA TA = Sales / TAT = $35,000 / 0.70 = $50,000

Debt = ($50,000)*(.40) = $20,000


Equity = ($50,000)*(.60) = $30,000
Interest Expense = ($20,000)*(0.06) = $1,200
EBIT
Interest
EBT
Taxes
Net Income

$6,000
-$1,200
$4,800
-$1,920
$2,880

ROE = $2,880 / $30,000 = 9.60%


62.

We discussed in class how the return on equity for a levered firm can be a function of
the return on assets of an equivalent unlevered firm, a leverage effect, and a tax
shelter effect. Assume that a firm starts out as an all equity firm with $10,000,000 of
common equity, $10,000,000 of assets, and a return on assets (ROA) of 14 percent.
Also assume that management makes the decision to issue $2,000,000 of debt (the
firms cost of debt is 8 percent), and to then use the proceeds to buy back $2,000,000
of common equity. Based on this information, and assuming that the firms tax rate is
40 percent, determine what the return on equity (ROE) will be after the buy back.
A.
B.

15.05%
17.55%

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 61 of 73 Pages

C.
D.
E.

12.55%
16.30%
13.80%

Debty / Equity = $2,000,000 / $8,000,000 = .25


ROA = 14.0% (Given)
rD = 8.0% (Given)
After-tax rD = (8.0%)*(1-.40) = 4.,80%
Interest Expense = ($2,000,000)*(.08) = $160,000
Debt does create a leverage and a tax shelter effect, so
ROE = ROA (unlevered) + Leverage Effect + Tax Shelter Effect
ROE = 0.14 + (0.14 - 0.08)*(.25) + (0.08 - 0.048)*(.25)
ROE = 0.14 + 0.015 + 0.008 = 16.30%
Alternatively,
ROA = NI / TA NI = (ROA)*(TA) = (0.14)*($10,000,000) = $1,400,000
Work backwards up through income statement to get EBIT:
EBIT
Interest
EBT
Taxes
Net Income

$2,333,333
-$
0
$2,333,333
- $ 933,333
$1,400,000

Now consider the interest payment:


Interest Expense = ($2,000,000)*(0.08) = $160,000
EBIT
Interest
EBT
Taxes
Net Income

$2,333,333
- $ 160,000
$2,173,333
- $ 869,333
$1,304,000

NEW ROE = $1,304,000 / $8,000,000 = 16.30%


63.

Assume that Firm A is an all-equity firm with total assets of $2,000 and the following
distribution of EBIT for the coming year:

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 62 of 73 Pages

Firm A
(Unlevered)
Probability
EBIT
Interest
EBT
Taxes (40%)
Net Income
BEP
ROA
ROE

Economy
Bad
30.00%
$200.00
$0.00
$200.00
-$80.00
$120.00
10.00%
6.00%
6.00%

Average
40.00%
$240.00
$0.00
$240.00
-$96.00
$144.00
12.00%
7.20%
7.20%

Good
30.00%
$280.00
$0.00
$280.00
-$112.00
$168.00
14.00%
8.40%
8.40%

As you can calculate, the variance of the ROE distribution is 0.008640 percent
(standard deviation of 0.92516 percent). Now assume that the firm plans to issue
$500 of debt, at an interest rate of 5 percent, and use the proceeds to repurchase
equity (you may ignore potential impacts on price and assume that the firm will then
have $1,500 of equity). Given this information, determine the expected ROE of the
resulting ROE distribution.

A.
B.
C.
D.
E.

9.60%
11.60%
10.60%
12.60%
8.60%

The new distribution will look like the following:


Firm A
(Levered)
Probability
EBIT
Interest
EBT
Taxes (40%)
Net Income
BEP
ROA
ROE

Economy
Bad

Average

Good

30.00%

40.00%

30.00%

$200.00
-$25.00
$175.00
-$70.00
$105.00
10.00%
5.25%
7.00%

$240.00
-$25.00
$215.00
-$86.00
$129.00
12.00%
6.45%
8.60%

$280.00
-$25.00
$255.00
-$102.00
$153.00
14.00%
7.65%
10.20%

Expected ROE = (7.00%)(.30) + (8.60%)(.40) + (10.20%)(.30)


Expected ROE = 2.10% + 3.44% + 3.06% = 8.60%
Alternatively, since the values for ROE and the probabilities are symmetrical around
the middle value, we know that the expected ROE must be 8.60%.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 63 of 73 Pages

64.

Assume that Firm A is an all-equity firm with total assets of $2,000 and the following
distribution of EBIT for the coming year:
Firm A
(Unlevered)
Probability
EBIT
Interest
EBT
Taxes (40%)
Net Income
BEP
ROA
ROE

Economy
Bad
30.00%
$300.00
$0.00
$300.00
-$120.00
$180.00
15.00%
9.00%
9.00%

Average

Good

40.00%
$340.00
$0.00
$340.00
-$136.00
$204.00
17.00%
10.20%
10.20%

30.00%
$380.00
$0.00
$380.00
-$152.00
$228.00
19.00%
11.40%
11.40%

As you can calculate, the variance of the ROE distribution is 0.008640 percent
(standard deviation of 0.92516 percent). Now assume that the firm plans to issue
$500 of debt, at an interest rate of 5 percent, and use the proceeds to repurchase
equity (you may ignore potential impacts on price and assume that the firm will then
have $1,500 of equity). Given this information, determine the expected ROE of the
resulting ROE distribution.

A.
B.
C.
D.
E.

9.60%
11.60%
10.60%
12.60%
8.60%

The new distribution will look like the following:


Firm A
(Levered)
Probability
EBIT
Interest
EBT
Taxes (40%)
Net Income
BEP
ROA
ROE

Economy
Bad

Average

Good

30.00%
$300.00
-$25.00
$275.00
-$110.00
$165.00
15.00%
8.25%
11.00%

40.00%
$340.00
-$25.00
$315.00
-$126.00
$189.00
17.00%
9.45%
12.60%

30.00%
$380.00
-$25.00
$355.00
-$142.00
$213.00
19.00%
10.65%
14.20%

Expected ROE = (11.00%)(.30) + (12.60%)(.40) + (14.20%)(.30)


Expected ROE = 3.30% + 5.04% + 4.26% = 12.60%
Alternatively, since the values for ROE and the probabilities are symmetrical around
the middle value, we know that the expected ROE must be 12.60%.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 64 of 73 Pages

65.

We discussed in class how the return on equity for a levered firm can be a function of
the return on assets of an equivalent unlevered firm, a leverage effect, and a tax
shelter effect. Assume that a firm starts out as an all equity firm with $10,000,000 of
common equity, $10,000,000 of assets, and a return on assets (ROA) of 12 percent.
Also assume that management makes the decision to issue $2,000,000 of debt (the
firms cost of debt is 8 percent), and to then use the proceeds to buy back $2,000,000
of common equity. Based on this information, and assuming that the firms tax rate is
40 percent, determine what the return on equity (ROE) will be after the buy back.
A.
B.
C.
D.
E.

15.05%
17.55%
12.55%
16.30%
13.80%

Debty / Equity = $2,000,000 / $8,000,000 = .25


ROA = 12.0% (Given)
rD = 8.0% (Given)
After-tax rD = (8.0%)*(1-.40) = 4.,80%
Interest Expense = ($2,000,000)*(.08) = $160,000
Debt does create a leverage and a tax shelter effect, so
ROE = ROA (unlevered) + Leverage Effect + Tax Shelter Effect
ROE = 0.12 + (0.12 - 0.08)*(.25) + (0.08 - 0.048)*(.25)
ROE = 0.12 + 0.01 + 0.008 = 13.80%
Alternatively,
ROA = NI / TA NI = (ROA)*(TA) = (0.12)*($10,000,000) = $1,200,000
Work backwards up through income statement to get EBIT:
EBIT
Interest
EBT
Taxes
Net Income

$2,000,000
-$
0
$2,000,000
- $ 800,000
$1,200,000

Now consider the interest payment:


Interest Expense = ($2,000,000)*(0.08) = $160,000
EBIT

$2,000,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 65 of 73 Pages

Interest
EBT
Taxes
Net Income

- $ 160,000
$1,840,000
- $ 736,000
$1,104,000

NEW ROE = $1,104,000 / $8,000,000 = 13.80%

66.

Assume that an all equity firm has assets of $12,000 and a return on assets (ROA) of
14.50 percent. And that the firm makes the decision to replace 1/3 of its equity with
debt that has a before-tax cost of 9 percent (note: this will give a D/E ratio of = 0.50
). Assuming that the firms tax rate is 40 percent, calculate the firms ROE after the
debt has been issued and equity has been repurchased. (HINT: Think about leverage
and tax shelter effects of using debt that we demonstrated in class.)
A.
B.
C.
D.
E.

18.30%
21.30%
19.05%
20.55%
19.80%

This problem can be solved without knowing the firms income statement or how much
it has in total assets.
AT rD = (9.00%)(1-.40) = 5.40%
As discussed in class, after the issue and repurchase, the remaining equity
shareholders will benefit from both a leverage effect and a tax shelter effect:
ROE = ROA + Leverage Effect + Tax Shelter Effect
ROE = 14.50% + (14.50% - 9.00%)(1/2) + (9.00% - 5.40%)(1/2)
ROE = 14.50% + 2.75% + 1.80% = 19.05%
Alternatively,
Since you were given total assets, you can also work backwards to get ROE:
ROA = 14.50% = NI / $12,000
NI = ($12,000)*(.1450) = $1,740
Interest = ($4,000)*(.09) = $360
Assets/Income

Without
Debt

Assets
Debt (1/3)
Equity (2/3)

$12,000.00
$
0.00
$12,000.00

With
Debt
$12,000.00
$ 4,000.00
$ 8,000.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 66 of 73 Pages

EBIT
Interest (8%)
EBT
Taxes (40%)
Net Income

$
$
$
-$
$

ROA
ROE

2,900.00
0.00
2,900.00
1,160.40
1,740.00

$
-$
$
-$
$

14.50%
14.50%

2,900.00
360.00
2,540.00
1,016.00
1,524.00
12.70%
19.05%

YOU ARE GIVEN THE FOLLOWING INFORMATION FOR PROBLEMS 67 - 70:

Income Statement
Sales
Operating Costs
Depreciation
EBIT
Interest (6%)
EBT
Taxes (40%)
Net Income

2006
$4,000,000.00

$600,800.00

Dividends
Addition to RE
Balance Sheet

2007
$6,500,000.00
-$4,550,000.00
-$350,000.00
$1,600,000.00
-$72,000.00
$1,528,000.00
-$611,200.00
$916,800.00
$279,300.00
$637,500.00

2006

2007

Cash
Inventory
Accounts Receivable
Current Assets
Gross Fixed Assets
Less: Depreciation
Net Fixed Assets
Total Assets

$80,000.00
$1,600,000.00
$1,200,000.00
$2,880,000.00
$3,000,000.00
-$900,000.00
$2,100,000.00
$4,980,000.00

$130,000.00
$2,600,000.00
$1,950,000.00
$4,680,000.00
$3,500,000.00
-$1,250,000.00
$2,250,000.00
$6,930,000.00

Accounts Payable
Accruals

$1,000,000.00
$300,000.00

$1,625,000.00
$487,500.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 67 of 73 Pages

Current Liabilities
Debt
Common Stock
Retained Earnings
Total Liability and
Equity
67.

$1,300,000.00
$700,000.00
$2,000,000.00
$980,000.00

$2,112,500.00
$1,200,000.00
$2,000,000.00
$1,617,500.00

$4,980,000.00

$6,930,000.00

Based on the information above, determine the free cash flow (FCF) for 2007.
A.
B.
C.
D.
E.

- $184,250
- $169,750
- $154,250
- $177,500
- $162,000

There are a lot of different ways to solve this problem, simply choose the method you
are most comfortable with.
NOPAT = (EBIT)(1-T) = ($1,600,000)(1-.4) = $960,000
DEP = $350,000
OCF = NOPAT + DEP = $960,000 + $350,000 = $1,310,000
NOWCY2006 = $2,880,000 - $1,300,000 = $1,580,000
NOWCY2007 = $4,680,000 - $2,112,500 = $2,567,500
NOWC = $2,567,500 - $1,580,000 = $987,500
NFAY2006 = $2,100,000
NFAY2007 = $2,250,000
NFA = $2,250,000 - $2,100,000 = $150,000
GFA = NFA + Depreciation = $150,000 + $350,000 = $500,000
GFAY2006 = $3,000,000
GFAY2007 = $3,500,000
GFA = $3,500,000 - $3,000,000 = $500,000
TOCY2006 = NOWCY2006 + NFAY2006 = $1,580,000 + $2,100,000 = $3,680,000
TOCY2007 = NOWCY2007 + NFAY2007 = $2,567,500 + $2,250,000 = $4,817,500
NIOC = TOC = $4,817,500 - $3,680,000 = $1,137,500
GIOC = NIOC + DEP = $1,137,500 + $350,000 = $1,487,500
FCF = OCF - GIOC = $1,310,000 - $1,487,500 = -$177,500
FCF = NOPAT - NIOC = $960,000 - $1,137,500 = -$177,500
FCF = OCF - NOWC - GFA = $1,310,000 - $987,500 - $500,000 = -$177,500

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 68 of 73 Pages

Proof:
FCF
Interest Payment
Interest Tax Shelter
Dividends
Total Needs
New Debt
Net Effect
68.

- $ 177,500
- $ 72,000
+$ 28,800
- $ 279,300
- $ 500,000
+$ 500,000
$
0

Assume that the firm had total invested capital (total investor-supplied operating
capital) for 2007 of $4,817,500 and a weighted average cost of capital of 11 percent.
Given this information, determine the economic value added (EVA) for 2007.
A.
B.
C.
D.
E.

$340,500
$370,200
$400,150
$430,075
$460,750

EVA = NOPAT - (TIC)*(WACC)


NOPAT = (EBIT)*(1-T) = ($1,600,000)*(.60) = $960,000
EVA = $960,000 - ($4,817,500)*(.11) = $430,075
69.

Assuming that all sales were on credit, and using a 365-day year, determine the daily
sales outstanding (DSO) for 2007.
A.
B.
C.
D.
E.

110.00 days
109.50 days
109.00 days
108.50 days
108.00 days

Credit Sales = $6,500,000 (Given)


Daily Credit Sales = $6,500,000 / 365 = $17,808.22
A/R = $1,950,000 (Given)
DSO = $1,950,000 / $17,808.22 = 109.50 days
70.

As you can calculate, in 2006 the firms profit margin was 15.02%, total asset turnover
was 0.80321285, and the equity multiplier was 1.67114094. In 2007, the profit margin
went down slightly, but the total asset turnover and the equity multiplier went up.
Determine what the return on equity would have been for the firm in 2007 if it had been
able to maintain a profit margin of 15.02%, while keeping all other variables for 2007
the same, such as the firms total asset turnover and equity multiplier.

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 69 of 73 Pages

A.
B.
C.
D.
E.

26.9883%
24.0183%
22.5333%
25.5033%
21.0483%

Equity2007 = $2,000,000 + $1,617,500 = $3,617,500


TAT2007 = $6,500,000 / $6,930,000 = 0.937950938
EM2007 = $6,930,000 / $3,617,500 = 1.915687630
New ROE2007 = (.1502)*(0.937950938)*(1.915687630) = 26.9883%
Alternatively,
New Net Income2007 = ($6,500,000)*(.1502) = $976,300
New ROE2007 = $967,300 / $3,617,500 = 26.9883%
YOU ARE GIVEN THE FOLLOWING INFORMATION FOR PROBLEMS 71 - 74:

Income Statement
Sales
Operating Costs
Depreciation
EBIT
Interest (6%)
EBT
Taxes (40%)
Net Income

2006
$4,000,000.00

$540,800.00

Dividends
Addition to RE
Balance Sheet
Cash
Inventory
Accounts Receivable
Current Assets
Gross Fixed Assets

2007
$6,000,000.00
-$4,200,000.00
-$370,000.00
$1,430,000.00
-$54,000.00
$1,376,000.00
-$550,400.00
$825,600.00
$205,600.00
$620,000.00

2006
$80,000.00
$1,600,000.00
$1,200,000.00
$2,880,000.00
$3,000,000.00

2007
$120,000.00
$2,400,000.00
$1,800,000.00
$4,320,000.00
$3,700,000.00

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 70 of 73 Pages

Less: Depreciation
Net Fixed Assets
Total Assets

-$900,000.00
$2,100,000.00
$4,980,000.00

-$1,270,000.00
$2,430,000.00
$6,750,000.00

Accounts Payable
Accruals

$1,200,000.00
$300,000.00

$1,800,000.00
$450,000.00

Current Liabilities
Debt
Common Stock
Retained Earnings
Total Liability and
Equity

$1,500,000.00
$500,000.00
$2,000,000.00
$980,000.00

$2,250,000.00
$900,000.00
$2,000,000.00
$1,600,000.00

$4,980,000.00

$6,750,000.00

71.

Based on the information above, determine the free cash flow (FCF) for 2007.

A.
B.
C.
D.
E.

- $185,250
- $169,750
- $154,250
- $177,500
- $162,000

There are a lot of different ways to solve this problem, simply choose the method you
are most comfortable with.
NOPAT = (EBIT)(1-T) = ($1,430,000)(1-.4) = $858,000
DEP = $370,000
OCF = NOPAT + DEP = $858,000 + $370,000 = $1,228,000
NOWCY2006 = $2,880,000 - $1,500,000 = $1,380,000
NOWCY2007 = $4,320,000 - $2,250,000 = $2,070,000
NOWC = $2,070,000 - $1,380,000 = $690,000
NFAY2006 = $2,100,000
NFAY2007 = $2,430,000
NFA = $2,430,000 - $2,100,000 = $330,000
GFA = NFA + Depreciation = $330,000 + $370,000 = $700,000
GFAY2006 = $3,000,000
GFAY2007 = $3,700,000
GFA = $3,700,000 - $3,000,000 = $700,000
TOCY2006 = NOWCY2006 + NFAY2006 = $1,380,000 + $2,100,000 = $3,480,000
TOCY2007 = NOWCY2007 + NFAY2007 = $2,070,000 + $2,430,000 = $4,500,000

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 71 of 73 Pages

NIOC = TOC = $4,500,000 - $3,480,000 = $1,020,000


GIOC = NIOC + DEP = $1,020,000 + $370,000 = $1,390,000
FCF = OCF - GIOC = $1,228,000 - $1,390,000 = -$162,000
FCF = NOPAT - NIOC = $858,000 - $1,020,000 = -$162,000
FCF = OCF - NOWC - GFA = $1,228,000 - $690,0000 - $700,000 = -$162,000
Proof:
FCF
Interest Payment
Interest Tax Shelter
Dividends
Total Needs
New Debt
Net Effect

- $ 162,000
- $ 54,000
+$ 21,600
- $ 205,600
- $ 400,000
+$ 400,000
$
0

72.

Assume that the firm had total invested capital (total investor-supplied operating
capital) for 2007 of $4,500,000 and a weighted average cost of capital of 11.5 percent.
Given this information, determine the economic value added (EVA) for 2007.

A.
B.
C.
D.
E.

$340,500
$370,200
$400,150
$430,075
$460,750

EVA = NOPAT - (TIC)*(WACC)


NOPAT = (EBIT)*(1-T) = ($1,430,000)*(.60) = $858,000
EVA = $858,000 - ($4,500,000)*(.115) = $340,500
73.

Assuming that all sales were on credit, and using a 360-day year, determine the daily
sales outstanding (DSO) for 2007.
A.
B.
C.
D.
E.

110.00 days
109.50 days
109.00 days
108.50 days
108.00 days

Credit Sales = $6,000,000 (Given)


Daily Credit Sales = $6,000,000 / 360 = $16,666.67
A/R = $1,800,000 (Given)

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 72 of 73 Pages

DSO = $1,800,000 / $16,666.67 = 108.00 days


74.

As you can calculate, in 2006 the firms profit margin was 13.52%, total asset turnover
was 0.80321285, and the equity multiplier was 1.67114094. In 2007, the profit margin
went up slightly, as well as the total asset turnover and the equity multiplier.
Determine what the return on equity would have been for the firm in 2007 if it had been
maintained a profit margin of 13.52%, while keeping all other variables for 2007 the
same, such as the firms total asset turnover and equity multiplier.
A.
B.
C.
D.
E.

26.9883%
24.0183%
22.5333%
25.5033%
21.0483%

Equity2007 = $2,000,000 + $1,600,000 = $3,600,000


TAT2007 = $6,000,000 / $6,750,000 = 0.888888889
EM2007 = $6,750,000 / $3,600,000 = 1.875
New ROE2007 = (.1352)*(0.888888889)*(1.875) = 22.5333%
Alternatively,
New Net Income2007 = ($6,000,000)*(.1352) = $811,200
New ROE2007 = $811,200 / $3,600,000 = 22.5333%

Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions

Page 73 of 73 Pages