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FIN CHAP 2 SOL

# FIN CHAP 2 SOL - CHAPTER 2 FINANCE PROBLEMS AND SOLUTIONS...

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CHAPTER 2 FINANCE PROBLEMS AND SOLUTIONS 2-1 INCOME STATEMENT Little Books Inc. recently reported net income of \$3 million. Its operating income (EBIT) was \$6 million, and the company pays a 40 percent tax rate. WHAT WAS THE COMPANY’S INTEREST EXPENSE FOR THE YEAR? [Hint: Divide \$3 million by (1-T) = 0.6 to find taxable income.] NI = \$3,000,000; EBIT = \$6,000,000; T = 40%; Interest = ? Need to set up an income statement and work from the bottom up. EBIT \$6,000,000 Interest 1,000,000 EBT (1 – T) = Net Income EBT (1 - T) = \$3,000,000 EBT \$5,000,000 EBT (1 – .4) = \$3,000,000 EBT = \$3,000,000 0.6 Taxes (40%) 2,000,000 EBT = \$5,000,000 Net Income \$3,000,000 Interest = EBIT EBT = \$6,000,000 - \$5,000,000 = \$1,000,000.

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2-2 NET CASH FLOW Kendall Corners Inc. recently reported net income of \$3.1 million. The company’s depreciation expense was \$500,000. WHAT IS THE COMPANY’S APPROXIMATE NET CASH FLOW? ASSUME THE FIRM HAS NO AMORTIZATION EXPENSE. See page 45 __________________________________________________ Net Income (NI) = \$3,100,000; Depreciation (DEP) = \$500,000; Amortization (AMORT) = 0; Net Cash Flow (NCF) = ? NCF = NI + DEP + AMORT NCF = \$3,100,000 + 500,000 + 0 NCF = \$3,600,000.
2-3 ECONOMIC VALUE ADDED Kordell Company recently reported \$170,000 in operating income (EBIT). The company’s total operating capital is \$800,000. The company’s after-tax cost of that capital is 11.625 percent, and the company is in the 40 percent tax bracket. WHAT IS KORDELL’S EVA? See page 55 ___________________________________ Earnings Before Income and Taxes (EBIT) = \$170,000; Operating capital = \$800,000; After Tax Cost of Capital (k A-T) = 11.625%; Tax Rate (T) = 40%; WHAT IS THE ECONOMIC VALUE ADDED (EVA) = ? EVA is an estimate of a business’s true annual economic profit…it is the residual income that remains after the coast of all capital, including equity capital, has been deducted. It

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