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ECO359-07MiDA

# ECO359-07MiDA - DEPARTMENT OF ECONOMICS UNIVERSITY OF...

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D EPARTMENT OF E CONOMICS U NIVERSITY OF T ORONTO ECO359 – Financial Economics II Summer 2007 Midterm: July 24 Solutions Instructions : This is a closed book test. A formula sheet is attached to the test. You are allowed the use of a calculator . Show all your work otherwise you will not get full cre dit. Only written re-grade requests submitted with a completely unaltered exam paper can be considered. You have 2 hours. Good Luck! NAME: _____________________________________________ ID#: _____________________________________________ 1 _______________ (15 points) 2 _______________ (20 points) 3 _______________ (15 points) 4 _______________ (20 points) 5 _______________ (15 points) Total _____________ (80 points)

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2 Problem 1: [15 points] ABC Inc. has released the following information on their income statement for year 2006: Sales \$12,200 Cost of Goods Sold \$9,000 Depreciation expense \$1,600 Interest expense \$200 Dividends/Share \$0.15 per share Tax rate 34% Furthermore, it was also reported that at the start of beginning of the year, ABC had \$8,000 in net fixed assets, current assets were \$2,000, and current liabilities were \$1,500. At the end of the year, net fixed assets were \$8,400, current assets were \$3,100, and current liabilities were \$1,800. During the year, the firm redeemed \$100 in outstanding long-term debt. The total number of shares outstanding in the year was 2,000 shares. a) [5 points] Find the net income and the operating cash flows in 2006. b) [5 points] Find ABC’s cash flow from assets. c) [5 points] Find the Net New Equity Raised by ABC in 2006. Solution: 1. (a) We need the income statement to to estimate Tax, NI, EBIT, and Dividends paid : Income statement for 2006 Sales \$12,200 Cost of good sold 9,000 Depreciation 1,600 EBIT \$1,600 Interest 200 Taxable income \$1,400 Taxes (34%) 476 Net income \$924 Dividends \$300 Retained earnings \$624 Total Dividends paid = 0.15 x 2,000 = \$300
3 b) We should calculate OCF, NCS (net capital spending), and Δ NWC as follows: Δ OCF = EBIT + Dep. – T = \$1,600 + 1,600 – 476 = \$2,724 NWC = NWCend – NWCbeg = (CAend – CLend) – (CAbeg – CLbeg) = (\$3,100 – 1,800) – (\$2,000 – 1,500) = \$800 Net Capital Spending (NCS) = Δ Net fixed Assets + Dep. = [\$8,400 – 8,000] + 1,600 = \$2,000 => So, TCF (total cash flow) = FCF (Free cash Flow) = OCF – Δ NWC – NCS = \$2,724 – 800 – 2,000 = –\$76 c) The net income and OCF are positive, but the firm invested heavily in both fixed assets and net working capital => it had to raise a net \$76 in funds from its stockholders and creditors to make these investments. Cash flow to creditors = interest – net new LTD = \$200 – (– \$100) = \$300 Cash flow to stockholders = TCF – cash flow to creditors = –\$76 – 300 = –\$376 But, Cash flow to stockholders = dividends – net new equity raised; => net new equity raised = \$300 – (–376) = \$676 The firm: Invested \$800 in new net working capital and \$2,000 in new fixed assets Raised \$76 from its stakeholders to support this new investment.

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