# 1. Operating, Investment and Financial Cash Flows

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1 1. Operating, Investment and Financial Cash Flows Solutions Problem 1 During 2005, Myears Oil Co. had gross sales of \$1 000,000, cost of goods sold of \$400,000, and general and selling expenses of \$300,000. The interest expense was \$6,000. Nonoperating income was \$66,000, depreciation was \$60,000, and dividends of \$70,000 were paid. (a) What was the NOI? (b) What was the NPBT? (c) What was the NI if the average tax rate was \$10%? (d) If the retained earnings were \$300,000 on December 31, 2004, what will they be on December 31, 2005? Solution (a) Gross sales 1 000,000 - COGS -400,000 Gross profit 600,000 -expenses -300,000 -depreciation -60,000 NOI 240,000 + nonoperating income 66,000 EBIT 306,000 - interest -6,000 (b) NPBT 300,000 - taxes -30,000 (c) NI 270,000 (d) Retained earnings t=0 300,000 + NI 270,000 - dividends -70,000 Retained earnings t=1 500,000 1

2 Problem 2 The balance sheet of the Myears Oil Co. on December 31, 2004, is shown below. During the next year, Myears Oil Co. has gross sales of \$1000,000, sells inventory valued at \$500,000, and manufactures \$800,000 of new inventory. It collects \$700,000 of outstanding accounts receivable and extends new credit in the amount of \$600,000. Accounts payable are decreased by \$120,000. Net income for the period is \$270,000, of which \$70,000 is paid in dividends. During 2005 Myears Oil Co. issued \$50,000 of equity. Long-term debt is increased by \$20,000. Prepaid expenses are increased by \$10,000. For simplicity, assume that none of the other accounts has changed (except cash). (a) Construct the balance sheet as of December 31, (b) Show how fixed assets and net current assets are financed with debt and equity. Cash 100,000 Accounts payable 500,000 Accounts receivable 400,000 Notes payable 200,000 Inventory 500,000 Prepaid expenses 50,000 Current assets 1 050,000 Current liabilities 700,000 Long-term debt 800,000 Net fixed assets 2 000,000 Common equity 1 550,000 Total liabilities and Total assets 3 050,000 stockholders' equity 3 050,000 2

3 Solution (a) (b) Cash is obtained by filling in all other numbers first. Cash 40,000 Accounts payable 380,000 Accounts receivable 300,000 Notes payable 200,000 Inventory 800,000 Prepaid expenses 60,000 Current assets 1 200,000 Current liabilities 580,000 Long-term debt 820,000 Net fixed assets 2 000,000 Common equity 1 800,000 Total liabilities and Total assets 3 200,000 stockholders' equity 3 200,000 Net current assets 620,000 Long-term debt 820,000 Net fixed assets 2 000,000 Common equity 1 800,000 Total assets 2 620,000 Total liabilities 2 620,000 3

4 Problem 3 The records of the Myears Oil Co. Corporation provide more precise data for the period ended December 31, Use cash balance 1/1/2005 = \$100,000. Balance sheet changes Decrease in accounts receivable \$ 100,000 Increase in merchandise inventory -300,000 Increase in prepaid expenses -10,000 Purchase of gross plant and equipment -60,00 Decrease in accounts payable -120,000 Borrowed on a long term note 100,000 Payment of bonds payable in full -80,000 Issued stock 50,000 Net income 270,000 Paid cash dividend -70,000 Change in cash \$ -60,000 Income statement changes Sales revenue \$ 1 000,000 Cost of goods sold -400,000 Depreciation expense -60,000 Remaining expenses -300,000 Income tax 10% -30,000 Nonoperating income (cash from disposal of old drilling rig) 66,000 Interest -6,000 Net income \$ 270,000 (a) Prepare a cash flow statement for the period using indirect approach. (b) Prepare a cash flow statement for the period using direct approach. (c) Calculate FCFF starting from net income, cash flow from operations and net operating income after tax. (d) Calculate FCFE starting from FCFF, net income, cash flow from operations and net operating income after tax. 4

5 Solution (a) Indirect approach Cash inflows (outflows) from operating activities Net income 270,000 + Depreciation expense 60,000 - Increase in merchandise inventory -300,000 - Increase in prepaid expenses -10,000 + Decrease in accounts receivable 100,000 - Decrease in accounts payable -120,000 Adjustments - nonoperating income -66,000 + interest 6,000 Net cash inflow (outflow) from operating activities -60,000 Cash inflows (outflows) from investing activities - Increase in gross plant and investment -60,000 + Nonoperating income (cash from disposal of old drilling rig) 66,000 Net cash inflow (outflow) from investing activities 6,000 Cash inflows (outflows) from financing activities + Issued stock 50,000 - Dividends paid -70,000 + Proceeds from long-term note 100,000 - Retirement of bonds -80,000 - Interest -6,000 Net cash inflow (outflow) from financing activities -6,000 Net increase (decrease) in cash -60,000 Beginning cash balance, 1/1/ ,000 Ending cash balance, 31/12/ ,000 5

6 (b) Direct approach Cash inflows (outflows) from operating activities Cash collected from customers Sales revenue 1 000,000 Decrease in accounts receivable 100, ,000 Payments to suppliers Cost of goods sold -400,000 Increase in merchandise inventory -300,000 Decrease in accounts payable -120, ,000 Gross cash margin 280,000 Remaining expenses -300,000 Cash from operations -20,000 Increase in prepaid expenses -10,000 Taxes -30,000 Net cash inflow (outflow) from operating activities -60,000 6

7 (c) Free cash flows to the firm (FCFF) NI 270,000 +D 60,000 +Interest (1-T) 5,400 - NCA -330,000 FCFF -54,600 OCF -60,000 +NonopInc 66,000 -Interest -6,000 +Interest (1-T) 5,400 FCFF -54,600 NOI (1-T) 216,000 +NonopIn (1-T) 59,400 +D 60,000 - NCA -330,000 FCFF -54,600 Cash -60,000 Tax savings -0,600 Financial flow 6,000 FCFF -54,600 7

8 (d) Free cash flows to equity (FCFE) FCFF -54,600 - Interest (1-T) -5,400 +Net Borrowing 20,000 FCFE -40,000 NI 270,000 +D 60,000 - NCA -330,000 +Net Borrowing 20,000 FCFE -40,000 OCF -60,000 +NonopInc 66,000 -Interest -6,000 +Net Borrowing 20,000 FCFE -40,000 Cash -60,000 -(Issued stock - Dividends paid) 20,000 FCFE -40,000 8

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