# 14. Calculating Total Cash Flows.

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1 14. Calculating Total Cash Flows. Greene Co. shows the following information on its 2008 income statement: Sales = \$138,000 Costs = \$71,500 Other expenses = \$4,100 Depreciation expense = \$10,100 Interest expense = \$7,900 Taxes = \$17,760 Dividends = \$5,400. In addition, you're told that the firm issued \$2,500 in new equity during 2008, and redeemed \$3,800 in outstanding long-term debt. a. What is the 2008 operating cash flow? b. What is the 2008 cash flow to creditors? c. What is the 2008 cash flow to stockholders? d. If net fixed assets increased by \$17,400 during the year, what was the addition to NWC? a. To calculate the OCF, we first need to construct an income statement. The income statement starts with revenues and subtracts costs to arrive at EBIT. We then subtract out interest to get taxable income, and then subtract taxes to arrive at net income. Doing so, we get: Income Statement Sales \$138,000 Costs 71,500 Other Expenses 4,100 Depreciation 10,100 EBIT \$52,300 Interest 7,900 Taxable income \$44,400 Taxes 17,760 Net income \$26,640 Dividends \$5,400 Addition to retained earnings 21,240 Page 1

2 Dividends paid plus addition to retained earnings must equal net income, so: Net income = Dividends + Addition to retained earnings Addition to retained earnings = \$26,640 5,400 Addition to retained earnings = \$21,240 So, the operating cash flow is: OCF = EBIT + Depreciation Taxes OCF = \$52, ,100 17,760 OCF = \$44,640 b. The cash flow to creditors is the interest paid, plus any new borrowing. Since the company redeemed long-term debt, the new borrowing is negative. So, the cash flow to creditors is: Cash flow to creditors = Interest paid Net new borrowing Cash flow to creditors = \$7,900 ( \$3,800) Cash flow to creditors = \$11,700 c. The cash flow to stockholders is the dividends paid minus any new equity. So, the cash flow to stockholders is: Cash flow to stockholders = Dividends paid Net new equity Cash flow to stockholders = \$5,400 2,500 Cash flow to stockholders = \$2,900 d. In this case, to find the addition to NWC, we need to find the cash flow from assets. We can then use the cash flow from assets equation to find the change in NWC. We know that cash flow from assets is equal to cash flow to creditors plus cash flow to stockholders. So, cash flow from assets is: Cash flow from assets = Cash flow to creditors + Cash flow to stockholders Cash flow from assets = \$11, ,900 Cash flow from assets = \$14,600 Net capital spending is equal to depreciation plus the increase in fixed assets, so: Net capital spending = Depreciation + Increase in fixed assets Net capital spending = \$10, ,400 Net capital spending = \$27,500 Now we can use the cash flow from assets equation to find the change in NWC. Doing so, we find: \$14,600 = \$44,640 Change in NWC \$27,500 Change in NWC = \$2,540 Page 2

3 21. Calculating Cash Flows. Titan Football Manufacturing had the following operating results for 2008: Sales = \$18,450 Costs = \$13,610 Depreciation expense = \$2,420 Interest expense = \$260 Dividends = \$450. At the beginning of the year: Net fixed assets: \$12,100 Current Assets: \$3,020 Current Liabilities: \$2,260 At the end of the year: Net fixed assets: \$12,700 Current Assets: \$4,690 Current Liabilities: \$2,720 The tax rate for 2008 was 35 percent What is the net income for 2008? What is the operating cash flow for 2008? What is the cash flow from assets for 2008? Is this possible? Explain. If no new debt was issued during the year, what is the cash flow to creditors? What is the cash flow to stockholders? Explain and interpret the positive and negative signs of your answers in (A) through (D). To calculate the OCF, we first need to construct an income statement. The income statement starts with revenues and subtracts costs to arrive at EBIT. We then subtract out interest to get taxable income, and then subtract taxes to arrive at net income. Doing so, we get: Income Statement Sales \$18,450 Cost of goods sold 13,610 Depreciation 2,420 EBIT \$2,420 Interest 260 Taxable income \$2,160 Taxes (35%) 756 Net income \$1,404 Page 3

4 The operating cash flow for the year was: OCF = EBIT + Depreciation Taxes OCF = \$2, , = \$4,084 To calculate the cash flow from assets, we also need the change in net working capital and net capital spending. The change in net working capital was: Change in NWC = NWC end NWC beg Change in NWC = (CA end CL end ) (CA beg CL beg ) Change in NWC = (\$4,690 2,720) (\$3,020 2,260) Change in NWC = \$1,210 And the net capital spending was: Net capital spending = NFA end NFA beg + Depreciation Net capital spending = \$12,700 12, ,420 Net capital spending = \$3,020 So, the cash flow from assets was: Cash flow from assets = \$4,084 1,210 3,020 Cash flow from assets = \$146 The cash flow from assets can be positive or negative, since it represents whether the firm raised funds or distributed funds on a net basis. In this problem, even though net income and OCF are positive, the firm invested heavily in both fixed assets and net working capital; it had to raise a net \$146 in funds from its stockholders and creditors to make these investments. The cash flow from creditors was: Cash flow to creditors = Interest Net new LTD Cash flow to creditors = \$260 0 Cash flow to creditors = \$260 Rearranging the cash flow from assets equation, we can calculate the cash flow to stockholders as: Cash flow from assets = Cash flow to stockholders + Cash flow to creditors \$146 = Cash flow to stockholders + \$260 Cash flow to stockholders = \$406 Page 4

5 23. Cash Flow Identity. Find Your Way Back, Inc., reported the following financial statements for the last two years. Construct the cash flow identity for the company Income Statement Sales 706,500 Cost of goods sold 342,531 Selling & administrative 155,916 Depreciation 68,220 EBIT 139,833 Interest 24,120 EBT 115,713 Taxes 40,499 Net income 75,214 Dividends 12,000 Addition to retained earnings 63,214 FIND YOUR WAY BACK, INC. Balance Sheet as of December 31, 2007 Cash 16,650 Accounts payable 11,880 Accounts receivable 23,742 Notes payable 18,135 Inventory 17,242 Current liabilities 30,015 Current assets 57,634 Long-term debt 171,000 Net fixed assets 430,533 Owners equity 287,152 Total assets 488,167 Total liabilities and owners' equity 488,167 FIND YOUR WAY BACK, INC. Balance Sheet as of December 31, 2008 Cash 17,883 Accounts payable 13,140 Accounts receivable 26,374 Notes payable 20,583 Inventory 28,443 Current liabilities 33,723 Current assets 72,700 Long-term debt 190,000 Net fixed assets 507,888 Owners equity 356,865 Total assets 580,588 Total liabilities and owners' equity 580,588 Page 5

6 To construct the cash flow identity, we will begin cash flow from assets. Cash flow from assets is: So, the operating cash flow is: OCF = EBIT + Depreciation Taxes OCF = \$139, ,220 40,499 OCF = \$167,554 Next, we will calculate the change in net working capital which is: Change in NWC = NWC end NWC beg Change in NWC = (CA end CL end ) (CA beg CL beg ) Change in NWC = (\$72,700 33,723) (\$57,634 30,015) Change in NWC = \$11,358 Now, we can calculate the net capital spending. The net capital spending is: Net capital spending = NFA end NFA beg + Depreciation Net capital spending = \$507, , ,220 Net capital spending = \$145,575 Now, we have the cash flow from assets, which is: Cash flow from assets = \$167,554 11, ,575 Cash flow from assets = \$10,621 The company generated \$10,621 in cash from its assets. The cash flow from operations was \$167,554, and the company spent \$11,358 on net working capital and \$145,575 in fixed assets. The cash flow to creditors is: Cash flow to creditors = Interest paid New long-term debt Cash flow to creditors = Interest paid (Long-term debt end Long-term debt beg ) Cash flow to creditors = \$24,120 (\$190, ,000) Cash flow to creditors = \$5,120 The cash flow to stockholders is a little trickier in this problem. First, we need to calculate the new equity sold. The equity balance increased during the year. The only way to increase the equity balance is to add addition to retained earnings or sell equity. To calculate the new equity sold, we can use the following equation: Page 6

7 New equity = Ending equity Beginning equity Addition to retained earnings New equity = \$356, ,152 63,214 New equity = \$6,499 What happened was the equity account increased by \$69,713. \$63,214 of this came from addition to retained earnings, so the remainder must have been the sale of new equity. Now we can calculate the cash flow to stockholders as: Cash flow to stockholders = Dividends paid Net new equity Cash flow to stockholders = \$12,000 6,499 Cash flow to stockholders = \$5,501 The company paid \$5,120 to creditors and \$5,501 to stockholders. Finally, the cash flow identity is: Cash flow from assets = Cash flow to creditors + Cash flow to stockholders \$10,621 = \$5,120 + \$5,501 The cash flow identity balances, which is what we expect. Page 7

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