# Financial Statements learning objectives (Slide 2-2)

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## ANSWER

First the Interest Paid to Creditors comes from the income statement and is \$18,000 for the year. Second, the change in Long-Term Debt reflects an increase or decrease in cash flows to creditors. Here we have a decrease from 2010 to 2011 reflecting a reduction or retirement of debt, a cash flow to creditors:

Decrease in Long-Term Debt 2011 = \$190,000 – \$162,000 = \$28,000

Cash Flow to Creditors for 2011 = \$18,000 + \$28,000 = \$46,000

13. Find the cash flow to owners for 2011 by parts and total, with the parts being dividends paid and increase in borrowing.

## ANSWER

Dividends Paid for 2011 were \$30,000 and the Common Stock account changed from \$130,000 in 2010 to \$180,000 in 2011 for an increase of \$50,000 so we have the following Cash Flow to Owners:

2011 CF to Owners = \$30,000 - \$50,000 = -\$20,000

14. Verify the cash flow identity: cash flow from assets = cash flow to creditors + cash flow to owners.

## ANSWER

\$26,000 ≡ \$46,000 - \$20,000

For problems 15 through 17, obtain the balance sheet, income statement, and statement of cash flow for PepsiCo (ticker symbol PEP) for the most recent year from Yahoo! Finance and answer the following questions.

15. Provide the following amounts for PepsiCo:

a. net income

b. depreciation (see cash flow statement)

c. cash flow from operating activities

d. cash flow from investing activities

e. cash flow from financing activities

f. change in cash and equivalents

## ANSWER: All value in (‘000s)

a. Net Income 2010 is \$6,320,000

b. Depreciation Expense for 2010 is \$2,327,000

c. Cash Flow From Operating Activities is (source) \$8,448,000

d. Cash Flow From Investing Activities is (use) \$7,668,000

e. Cash Flow From Financing Activities is (source) \$1,386,000

f. Change in Cash and Equivalents for 2010 is an increase of \$2,000,000

16. For PepsiCo for the most recent year explain the difference between net income and the change in cash and equivalents. In other words, why is the profit or loss of PepsiCo different from the change in their cash and equivalents account?

## ANSWER:

Pepsi generated \$8.448 billion from operating activities and \$1.386 billion from financing activities for the year and spent only \$7.668 billion investing in new assets. Thus, after adjusting for exchange rate losses of \$166 million, it ended up with an increase in cash of \$2 billion.

17. Using the cash flow statement find the dividends paid to the PepsiCo owners in the most recent year.

## ANSWER:

Dividends in 2010 for PepsiCo were \$2,978,000,000.

For problems 18 through 20, obtain the balance sheet, income statement, and statement of cash flow for Pfizer (ticker symbol PFE) for the most recent year from Yahoo! Finance and answer the following questions.

18. Provide the following amounts for Pfizer:

a. net income

b. depreciation (see cash flow statement)

c. cash flow from operating activities

d. cash flow from investing activities

e. cash flow from financing activities

f. change in cash and equivalents

## ANSWER:

a. Net Income 2010 is negative \$8,257,000

b. Depreciation Expense for 2010 is \$8,487,000

c. Cash Flow From Operating Activities is (source) \$11,454,000

d. Cash Flow From Investing Activities is (use) \$492,000

e. Cash Flow From Financing Activities is (use) \$11,174,000

f. Change in Cash and Equivalents for 2010 is a decrease of \$243,000

19. Explain the difference between net income and the change in cash and equivalents for Pfizer. In other words, why is the profit or loss of Pfizer different from the change in their cash and equivalents account?

## ANSWER:

Pfizer generated over \$11.454 billion in operating activities for the year. It used 0.492 billion for investing in fixed assets and 11.174 billion dollars for financing activities such as paying dividends, buying back stock, and paying off debt, leaving it with a reduction in cash of \$212 million, which after adjusting for a currency translation loss of \$31 million, caused the Cash and equivalents balance to fall by \$243 million.

20. Using the cash flow statement find the dividends paid to the Pfizer owners in the most recent year.

## ANSWER:

Dividends in 2010 paid to Pfizer stockholders \$6,088,000,000.

Solutions to Advanced Problems for Spreadsheet Application

Note: Shaded portions are the inputs provided in the textbook.

1. Income Statements Part (A)

 Company A Information Company B Information Units sold 847,000 Units sold 1,388,000 Revenue per unit \$ 16.98 Revenue per unit \$ 11.98 Cost per unit \$ 8.17 Cost per unit \$ 6.69 Fixed costs \$ 1,245,788.00 Fixed costs \$ 1,354,218.00 SG&A costs \$ 785,038.00 SG&A costs \$ 584,431.00 Depreciation Expense \$ 1,489,374.00 Depreciation Expense \$ 1,137,890.00 Interest Expense \$ 501,030.00 Interest Expense \$ 698,540.00 Tax Rate 0.375 Tax Rate 0.375 Income Statement Income Statement Revenue \$ 14,382,060.00 Revenue \$ 16,628,240.00 COGS \$ 6,919,990.00 COGS \$ 9,285,720.00 Gross Margin or Profit \$ 7,462,070.00 Gross Margin or Profit \$ 7,342,520.00 Fixed Costs \$ 1,245,788.00 Fixed Costs \$ 1,354,218.00 SG&A costs \$ 785,038.00 SG&A costs \$ 584,431.00 Depreciation Expense \$ 1,489,374.00 Depreciation Expense \$ 1,137,890.00 EBIT \$ 3,941,870.00 EBIT \$ 4,265,981.00 Interest Expense \$ 501,030.00 Interest Expense \$ 698,540.00 Taxable Income \$ 3,440,840.00 Taxable Income \$ 3,567,441.00 Taxes \$ 1,290,315.00 Taxes \$ 1,337,790.38 Net Income \$ 2,150,525.00 Net Income \$ 2,229,650.63 Operating Cash Flow \$ 4,140,929.00 Operating Cash Flow \$ 4,066,080.63

Company B has the higher Net Income but lower Operating Cash Flow.

Part (B)
 Company A Information Company B Information Units sold 847,000 Units sold 1,179,800 Revenue per unit \$ 16.98 Revenue per unit \$ 14.98 Cost per unit \$ 8.17 Cost per unit \$ 7.89 Fixed costs \$ 1,245,788.00 Fixed costs \$ 1,354,218.00 SG&A costs \$ 785,038.00 SG&A costs \$ 1,168,862.00 Depreciation Expense \$ 1,489,374.00 Depreciation Expense \$ 1,137,890.00 Interest Expense \$ 501,030.00 Interest Expense \$ 698,540.00 Tax Rate 0.375 Tax Rate 0.375 Income Statement Income Statement Revenue \$ 14,382,060.00 Revenue \$ 17,667,505.00 COGS \$ 6,919,990.00 COGS \$ 9,313,577.16 Gross Margin or Profit \$ 7,462,070.00 Gross Margin or Profit \$ 8,353,927.84 Fixed Costs \$ 1,245,788.00 Fixed Costs \$ 1,354,218.00 SG&A costs \$ 785,038.00 SG&A costs \$ 1,168,862.00 Depreciation Expense \$ 1,489,374.00 Depreciation Expense \$ 1,137,890.00 EBIT \$ 3,941,870.00 EBIT \$ 4,692,957.84 Interest Expense \$ 501,030.00 Interest Expense \$ 698,540.00 Taxable Income \$ 3,440,840.00 Taxable Income \$ 3,994,417.84 Taxes \$ 1,290,315.00 Taxes \$ 1,497,906.69 Net Income \$ 2,150,525.00 Net Income \$ 2,496,511.15 Operating Cash Flow \$ 4,140,929.00 Operating Cash Flow \$ 4,332,941.15

Company B’s Net Income and Operating Cash Flow are both higher than those of Company A.

2. Balance Sheets (Part A)

 Reach Manufacturing 2010 2011 Change Verification Assets: Current Assets Cash \$ 23,000.00 \$ 26,000.00 \$ 3,000.00 \$ 3,000.00 Marketable Securities \$ 62,000.00 \$ 58,000.00 \$ (4,000.00) \$ (4,000.00) Accounts Receivable \$ 518,000.00 \$ 796,000.00 \$ 278,000.00 \$ 278,000.00 Inventory \$ 639,000.00 \$ 910,000.00 \$ 271,000.00 \$ 271,000.00 Total Current Assets \$ 1,242,000.00 \$ 1,790,000.00 \$ 548,000.00 \$ 548,000.00 Long-term Assets Fixed Assets \$ 4,387,000.00 \$ 4,975,000.00 \$ 588,000.00 \$ 588,000.00 Accumulated Depreciation \$(1,009,000.00) \$(1,364,000.00) \$ (355,000.00) \$ (355,000.00) Intangible Assets \$ 465,000.00 \$ 431,000.00 \$ (34,000.00) \$ (34,000.00) Total Long-Term Assets \$ 3,843,000.00 \$ 4,042,000.00 \$ 199,000.00 \$ 199,000.00 TOTAL ASSETS \$ 5,085,000.00 \$ 5,832,000.00 \$ 747,000.00 \$ 747,000.00 Liabilities: Current Liabilities Accounts Payable \$ 419,000.00 \$ 679,000.00 \$ 260,000.00 \$ 260,000.00 Notes Payable \$ 390,000.00 \$ 210,000.00 \$ (180,000.00) \$ (180,000.00) Total Current Liabilities \$ 809,000.00 \$ 889,000.00 \$ 80,000.00 \$ 80,000.00 Long-Term Liabilities Long-Term Debt \$ 3,540,000.00 \$ 3,912,000.00 \$ 372,000.00 \$ 372,000.00 TOTAL LIABILITIES \$ 4,349,000.00 \$ 4,801,000.00 \$ 452,000.00 \$ 452,000.00 Owner’ Equity: Common Stock \$ 330,000.00 \$ 330,000.00 \$ - \$ - Retained Earnings \$ 406,000.00 \$ 701,000.00 \$ 295,000.00 \$ 295,000.00 TOTAL OWNER’s EQUITY \$ 736,000.00 \$ 1,031,000.00 \$ 295,000.00 \$ 295,000.00 TOTAL LIAB. AND O.E. \$ 5,085,000.00 \$ 5,832,000.00 \$ 747,000.00 \$ 747,000.00

Part (B)
 PART B: 2010 2011 Change Net Working Capital \$ 433,000.00 \$ 901,000.00 \$ 468,000.00 Capital Spending 2011 Fixed Assets \$ 4,975,000.00 plus 2011 Intangible Assets \$ 431,000.00 minus 2010 Fixed Assets \$ 4,387,000.00 minus 2010 Intangible Assets \$ 465,000.00 Change In Capital Spending \$ 554,000.00 Cash Flow From Assets: OCF \$ 389,000.00 minus increase in NWC \$ 468,000.00 minus increase in capital sp. \$ 554,000.00 Cash Flow From Assets \$ (633,000.00)

Solutions to Mini-Case Questions

Hudson Valley Realty

This case focuses on the interpretation rather than the preparation of financial statements. Students should understand how the statements are important for outside stakeholders who need to make decisions concerning a company. The case reinforces the chapter’s emphasis on cash flow rather than accrual-based measures of income. The statements are loosely based on Ethan Allen Co., but have been modified to eliminate complexities that are not important at this level.

1. Look at Vermont Heritage’s sales revenue, EBIT, and net income over the three-year period. Would you classify it as a growing, diminishing, or a stable company?

Sales were up a little in 2010, down a little in 2011. Overall, sales are trendless. EBIT and net income also remain remarkably stable, indicating that the company can adjust expenses as a response to falling sales. The company appears to be stable, but not growing.

2. Look at Vermont Heritage’s expense accounts, cost of goods sold, and selling and administrative expenses. Do they seem to be roughly proportional to sales? Do any of these categories seem to be growing out of control?

Cost of goods sold decreases when sales decrease, which suggests that sales revenue is responding to lower volume. Selling and administrative expenses are increasing relative to sales, and this is a matter for some concern. Perhaps the company is making an extra marketing effort to increase sales.

3. Depreciation expense is the same for all three years. What does that tell you about Vermont Heritage’s growth?

It is highly unusual for depreciation expense to remain the same, at least when the figures are rounded to millions, for three years in a row. It would suggest that the company is not selling off assets, but neither is it investing in new assets. At most, it is replacing assets as needed.

4. Look at Vermont Heritage’s EBIT, interest expense, and debt accounts (current liabilities, long-term debt, and other liabilities) over the three-year period. Comparing debt to equity, do you think the company seems to have excessive debt? Would you expect the company to have any problems meeting its interest payments?

Interest expense is minimal compared to EBIT, which shows that the company is in a strong financial position. Vermont Heritage has been using surplus cash to reduce long-term liabilities over the last few years. The company is now almost entirely equity-financed.

5. Dividends have increased as a percentage of net income. Why do you think the company decided to pay out more of its earnings to shareholders?

The company has paid off most of its debt and seems to have limited growth opportunities at the present time, so it is appropriately returning cash to the stockholders.

6. Compare current assets with current liabilities. Would you expect Vermont Heritage to have any problems meeting its short-term obligations?

Current assets are approximately 10 times current liabilities, implying that the company is highly liquid. Excess liquidity may imply inefficiency, but since Peter Cortland is only concerned with safety, it is a good thing from his point of view.

7. Overall, do you think Vermont Heritage will be a relatively safe tenant for Hudson Valley’s building?

Vermont Heritage should be a very safe and stable tenant for Hudson Valley’s building. Although it doesn’t seem to be growing rapidly, it has very low debt, stable profits, excellent liquidity, and low interest obligations.

Additional Problems with Solutions

1. Balance Sheet. Chuck Enterprises has current assets of \$300,000, and total assets of \$750,000. It also has current liabilities of \$125,000, common equity of \$250,000, and retained earnings of \$85,000. How much long-term debt and fixed assets does the firm have?

## ANSWER (Slides 2-23 to 2-24)

Current Assets + Fixed Assets = Total Assets

\$300,000+Fixed Assets = \$750,000

Fixed Assets = \$750,000 - \$300,000 = \$400,000

Total Assets = Current Liabilities + Long-term debt + Common equity + Retained Earnings

\$750,000 = \$125,000 + Long-term debt + \$250,000 + 85,000

Long-term debt = \$750,000 - \$125,000-\$250,000 - \$85,000

Long-term debt = \$290,000

2. Income Statement. The Top Class Company had revenues of \$925,000in 2011. Its operating expenses (excluding depreciation) amounted to \$325,000, depreciation charges were \$125,000, and interest costs totaled \$55,000. If the firm pays a marginal tax rate of 34 percent, calculate its net income after taxes.

## ANSWER (Slides 2-25 to 2-26)

Revenues \$925,000

Less operating expenses 325,000

= EBITDA 600,000

Less depreciation 125,000

= EBIT 475,000

Less interest expenses 55,000

= Taxable Income 420,000

Less taxes (34%) 142,800

= Net Income after taxes 277,200

3. Retained Earnings: The West Hanover Clay Co. had, at the beginning of the fiscal year, November 1, 2010, retained earnings of \$425,000. During the year ended October 31, 2011, the company generated net income after taxes of \$820,000 and paid out 35 percent of its net income as dividends. Construct a statement of retained earnings and compute the year-end balance of retained earnings.

## ANSWER (Slides 2-27 to 2-28)

Statement of Retained Earnings for the year ended October 31, 2011

Balance of Retained Earnings, November 1, 2010 \$425,000

Add: Net income after taxes, October 31, 2011 \$820,000

Less: Dividends paid for the year ended October 31, 2011 \$287,000

Balance of Retained Earnings, October 31, 2011 \$958,000

4. Working Capital: D.K. Imports Incorporated reported the following information at its last annual meeting:

Cash and cash equivalents = \$1,225,000; Accounts payables = \$3,200,000

Inventory = \$625,000; Accounts receivables = \$3,500,000;

Notes payables = \$1,200,000; other current assets = \$125,000;

Calculate the company’s net working capital.

## ANSWER (Slides 2-29 to 2-30)

Net Working Capital = Current Assets - Current Liabilities

(Cash & Cash Equivalents + Accts. Rec. + Inventory + other current assets) - (Accounts payables + Notes Payables)

(\$1,225,000+\$3,500,000+\$625,000+\$125,000) - (\$3,200,000+\$1,200,000)

\$5,475,000 - \$4,400,000

Net Working Capital \$1,075,000

5. Cash Flow from Operating Activities. The Mid-American Farm Products Corporation provided the following financial information for the quarter ending September 30, 2011:

Depreciation and amortization - \$75,000

Net Income - \$225,000

Increase in receivables - \$ 95,000

Increase in inventory - \$69,000

Increase in accounts payables - \$80,000

Decrease in marketable securities - \$34,000.

What is the cash flow from operating activities generated during this quarter by the firm?

## ANSWER (Slides 2-31 to 2-32)

Net Income \$225,000

Add depreciation and amortization 75,000

Add decrease in marketable securities 34,000

Add increase in accounts payables 80,000

Less increase in accounts receivables 95,000

Less increase in inventory 69,000

Cash flow from operating activities \$250,000

©2013 Pearson Education, Inc. Publishing as Prentice Hall

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