1. Chapter 2: Financial Statements, Cash Flows,
and Taxes
July 15, 2016
Problem 1: Basic Concepts
Calculation of EPS and retained earnings Philagem,
Inc., ended 2009 with a net profit before taxes of
$218,000. The company is subject to a 40% tax rate
and must pay $32,000 in preferred stock dividends
before distributing any earnings on the 85,000
shares of common stock currently outstanding.
a. Calculate Philagem’s 2009 earnings per share
(EPS).
b. If the firm paid common stock dividends of $0.80
per share, how many dollars would go to
retained earnings?
Problem 2: Balance Sheet
Conrad Air, Inc., reported net income of $1,365,000
for the year ended December 31, 2009. Show the
effect of these funds on the firm’s balance sheet for
the previous year in each of the scenarios following
the balance sheet.
a. Conrad paid no dividends during the year
and invested the funds in marketable
securities.
b. Conrad paid dividends totaling $500,000
and used the balance of the net income to
retire (pay off) long-term debt.
c. Conrad paid dividends totaling $500,000
and invested the balance of the net income
in building a new hangar.
d. Conrad paid out all $1,365,000 as dividends
to its stockholders.
Problem 3: Retained Earnings
Cooper Industries, Inc., began 2009 with retained
earnings of $25.32 million. During the year it paid
four quarterly dividends of $0.35 per share to 2.75
million common stockholders. Preferred
stockholders, holding 500,000 shares, were paid two
semiannual dividends of $0.75 per share. The firm
had a net profit after taxes of $5.15 million. Prepare
the statement of retained earnings for the year
ended December 31, 2009.
Problem 4: Income Statement
Hermann Industries is forecasting the following
income statement:
The CEO would like to see higher sales and a
forecasted net income of $2,500,000. Assume that
operating costs (excluding depreciation and
amortization) are 55% of sales and that depreciation
and amortization and interest expenses will increase
by 10%. The tax rate, which is 40%, will remain the
same. What level of sales would generate
$2,500,000 in net income? Construct the income
statement.
Problem 5: Multiple Choice
1. The primary purpose ofa statementofcash flows is to
provide relevant information about
a. Differences between netincome and associated cash
receipts and disbursements.
b. An enterprise’s abilityto generate future positive net
cash flows.
c. The cash receipts and cash disbursements ofan
enterprise during a period.
d. An enterprise’s abilityto meetcash operating needs.
2. Mend Co. purchased a three-month US Treasurybill.
Mend’s policy is to treat as cash equivalents all highly
liquid investments with an original maturityof three months
or less when purchased.How should this purchase be
reported in Mend’s statementofcash flows?
a. As an outflow from operating activities.
b. As an outflow from investing activities.
c. As an outflow from financing activities.
d. Not reported.
3. On September 1,year 1, Canary Co. sold used
equipmentfor a cash amountequaling its carrying amount
for both book and tax purposes.On September 15,year 1,
Canary replaced the equipmentby paying cash and
signing a note payable for new equipment.The cash paid
for the new equipmentexceeded the cash received for the
old equipment.How should these equipmenttransactions
be reported in Canary’s year 1 statementofcash flows?
a. Cash outflow equal to the cash paid less the cash
received.
b. Cash outflow equal to the cash paid and note payable
less the cash received.
c. Cash inflow equal to the cash received and a cash
outflow equal to the cash paid and note payable.
d. Cash inflow equal to the cash received and a cash
outflow equal to the cash paid.
2. Problem 6: Free Cash Flows
The Sanford Software Co. earned $20 million before
interest and taxes on revenues of $60 million last
year. Investment in fixed capital was $12 million, and
depreciation was $8 million. Working capital
investment was $3 million. Sanford expects earnings
before interest and taxes (EBIT), investment in fixed
and working capital, depreciation, and sales to grow
at 12% per year for the next five years. After five
years, the growth in sales, EBIT, and working
capital investment will decline to a stable 4% per
year, and investments in fixed capital and
depreciation will offset each other. Sanford’s tax rate
is 40%. Assume the weighted average cost of
capital (WACC) is 11% during the high growth stage
and 8% during the stable stage. Solve for the Free
Cash Flows from Year 1 onwards.
Problem 7: Cash flows
