Remains after the cost of all capital including

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remains after the cost of all capital, including equity capital, has been deducted. h. A progressive tax means the higher one’s income, the larger the percentage paid in taxes. Taxable income is defined as gross income less a set of exemptions and deductions which are spelled out in the instructions to the tax forms individuals must file. Marginal tax rate is defined as the tax rate on the last unit of income. Average tax rate is calculated by taking the total amount of tax paid divided by taxable income. i. Capital gain (loss) is the profit (loss) from the sale of a capital asset for more (less) than its purchase price. Ordinary corporate operating losses can be carried backward for 2 years or forward for 20 years to offset taxable income in a given year. 5
j. Improper accumulation is the retention of earnings by a business for the purpose of enabling stockholders to avoid personal income taxes on dividends. An S corporation is a small corporation which, under Subchapter S of the Internal Revenue Code, elects to be taxed as a proprietorship or a partnership yet retains limited liability and other benefits of the corporate form of organization. SOLUTIONS TO END-OF-CHAPTER PROBLEMS 2-5 NI = $3,100,000; DEP = $500,000; AMORT = 0; NCF = ? NCF = NI + DEP and AMORT = $3,100,000 + $500,000 = $3,600,000. 2-10 EBIT = $750,000; DEP = $200,000; 100% Equity; T = 40% NI = ?; NCF = ?; OCF = ? First, determine net income by setting up an income statement: EBIT $750,000 Interest 0 EBT $750,000 Taxes (40%) 300,000 NI $450,000 NCF = NI + DEP = $450,000 + $200,000 = $650,000. 2-12 a. EBIT $1,260 x (1-Tax rate) 60.0% Net operating profit after taxes (NOPAT) $756 6
b. 2013 2012 Cash $550 $500 + Accounts receivable 2,750 2,500 + Inventories 1,650 1,500 Operating current assets $4,950 $4,500 Accounts payable $1,100 $1,000 + Accruals 550 500 Operating current liabilities $1,650 $1,500 Operating current assets $4,950 $4,500 - Operating current liabilities 1,650 1,500 Net operating working capital (NOWC) $3,300 $3,000 c. 2011 2010 Net operating working capital (NOWC) $3,300 $3,000 + Net plant and equipment 3,850 3,500 Total net operating capital $7,150 $6,500 d. 2013 NOPAT $756 - Investment in total net operating capital 650 7
Free cash flow $106 e. 2013 NOPAT $756 ÷ Total net operating capital 7,150 Return on invested capital (ROIC) 10.57% Chapter 3 Analysis of Financial Statements ANSWERS TO END-OF-CHAPTER QUESTONS 3-1 a. A liquidity ratio is a ratio that shows the relationship of a firm’s cash and other current assets to its current liabilities. The current ratio is found by dividing current assets by current liabilities. It indicates the extent to which current liabilities are covered by those assets expected to be converted to cash in the near future. The quick, or acid test, ratio is found by taking current assets less inventories and then dividing by current liabilities. b. Asset management ratios are a set of ratios that measure how effectively a firm is managing its assets. The inventory turnover ratio is COGS divided by inventories. Days sales outstanding is used to appraise accounts receivable and indicates the length of time the firm must wait after making a sale before receiving cash. It is found by dividing receivables by average sales per day. The fixed assets turnover ratio measures how effectively the firm uses its plant and equipment. It is the ratio of sales to net fixed assets. Total assets turnover ratio

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