FIN 3901 Lecture Notes - Lecture 2: Tax Rate, Retained Earnings

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30 Oct 2016

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In ascending order of when due to be paid: liabilities and owners" equity. Assets = liabilities + stockholders" equity: balance sheet identity, liquidity, net working capital. Speed and ease of conversion to cash without significant loss of value. Valuable in avoiding financial distress: debt versus equity. What finance deals with and cares about. Market value- true value, price which assets, liabilities or equity can be actually bought/sold. Kept in company for repurchase, not paid out as dividends. Due to the fact we are on a sliding (progressive) tax rate. Aka effective tax rate avg tax rate: 34% (see breakdown in notes) marginal tax rate: 34% ex. ,000 must pay ,000 x 15% and ,000 x 25% ex. firm earns 4 million in taxable income. Interest expense- goes to debt holder (creditor: cash flow from assets (cffa) = operating cash flow (ocf) - net capital spending (ncs) changes in nwc ( nwc: cash flow from assets (cffa)

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Here is your first question:

Explain what current assets and fixed assets are and give as many examples as you can for each. What is the difference between tangible and intangible assets?

Liabilities and owner's equity are listed on the right-hand side respectively. Liabilities are also classified as current liabilities and long-term liabilities.

Here is your second question:

Explain what current liabilities differ from long-term liabilities and give as many examples as you can for each.

Owner's equity (also known as shareholders' equity, common equity) is the difference between total value of assets and total value of liabilities. That is, if you were to use your assets to pay off the debts, whatever is left over (the residual) would belong to shareholders. That is why they are known as residual claimants. Hence we have the identity;

Assets = Liabilities + Shareholders' equity

Net working capital is simply equal to current assets minus current liabilities. When net working capital is positive, it means cash that will be available over the next 12 months exceeds what must be paid. It is important for a healthy firm to have positive net working capital.

Here is your third question:

A firm has current assets of $100, net fixed assets of $500, short-term debt of $70 and long-term debt of $200. What is shareholders' equity. Construct a balance sheet

for this company. Is net working capital positive or negative? If so by how much? (Hint: You may utilize Example 2.1 on page 24 of the textbook).

Staying Alive in Tough Economic Times

Going broke is an idea that any business hates to think about. However, if you are going to go broke in the United States, it helps to be a large, established company. For example, after the September 11, 2001, terrorist attacks, the government stepped in and saved major air carriers like American and United. More recently quasi-government agencies like Fannie Mae and Freddie Mac received money from the government to stay afloat despite poor practices in the mortgage business. Banks that risked capital on risky investments like derivatives and credit swaps were also beneficiaries of the federal governmentâs largesse. Even automakers whose managers misjudged the market were propped up by government dollars. Which leads us to the question, âWhat if small-business owners run out of cash?â

The simple answer is, itâs goodbye to the business. Thatâs why having enough cash on hand (liquidity) is especially critical for entrepreneurs during economic tough times. Unfortunately, this is no simple task. Liquidity for small companies can change almost immediately due to some unexpected event such as a major customer going out of business or perhaps an unexpected natural catastrophe like a flood. Experts agree that keeping enough liquid assets (like cash and cash equivalents like bonds) to fund the next six months is a good rule of thumb. If you keep a reserve of liquid assets, you have time to work on a remedy if a crisis hits rather than having to close your doors.

Accountants and financial managers also advise small businesses to be particularly aware of three ratios to make sure the business is liquid enough to survive: current ratio, quick ratio, and the debt-to-equity ratio.

Current ratio: current assets divided by current liabilities. Most bankers like the ratio to be at least 2:1.

Quick ratio: cash and receivables divided by current liabilities. This ratio addresses the scary question of whether or not a company can meet its obligations if sales suddenly fall or dry up. A ratio greater than 1:1 is often acceptable.

Debt-to-equity ratio: total liabilities divided by shareholders equity. The higher this ratio is the less likely bankers can deal with you. A ratio below 3:1 is often considered safe for small businesses.

Locating corporate annual reports is easier than it has ever been. AnnualReports.com (Links to an external site.)Links to an external site. hosts a website (www.annualreports.com/ (Links to an external site.)Links to an external site.)[i] containing annual reports for hundreds of corporations. The site is comprehensive and easy to use. You can also find publicly traded companies Annual Report on their websites, usually under "Investor Information".

Go to the website (www.annualreports.com/ (Links to an external site.)Links to an external site. ) and choose one company to research. Use the information given in this report to answer the following questions. (Sometimes the Web address for a location changes. You might need to search to find the exact location mentioned.)

1. What is the name of the company?

2. What is the financial year?

3. Calculate the three financial ratios discussed above and listed below and the additional calculations below. Show your work for the ratios. Provide a link to the Annual Report or source you used for the financial information.

a. What is the current ratio?

b. What is the quick ratio?

c. What is the debt-to-equity ratio?

d. On their Balance Sheet, find their Total Assets. What is the total?

e. On their Balance Sheet, find their Total Liabilities. What is the total?

f. On their Income Statement, find their Total Revenues. What is the total?

g. On their Income Statement, find their Total Income. What is the total?

4. Reflect on these calculations. What do they tell you?

Can someone help with this case please, and:

Fill in all the blanks spaces in the spreadsheet for the 2017 column and the 2017 %rev column

Balance the B/S

Answer all questions in full sentence format

Please put in the correct number for forecasted PP&E based on narrative (I highlighted the phrase in the narrative)

Show work for how you calculated the forecasted interest for 2017.

Thank you so much for all your help.

After the financial analysis based on 2016 preliminary estimates was completed, a number of changes were adopted to improve financial and business results for S&S Air during 2016. The customer that awarded the large 40 aircraft order agreed to make interim payments as finished aircraft were delivered (for a price concession). Revenue was revised up slightly due to updated marketing plans. Expenses were trimmed and controls were established that greatly reduced on hand inventory needs. A portion of the line of credit was converted to a 5 year, fixed rate loan. Cash on hand and general liquidity was forecasted to improve to acceptable levels by the end of the year.

Mark and Marie approached Chris about creating a forecast for 2017. They had learned the value of the financial analysis done for 2016 and wanted to get a look at any issues or problems that might be looming in the future. Of particular concern was the continuing need for external funds as the firm continued to grow. The general consensus of Mark and Marie was that S&S Air should realize an increase in revenue of 17% in 2017 from the 2016 results, based on anticipated demand of aircraft. It was felt expenses would change by the same percent of sales as incurred in 2016. However, it was estimated that annual depreciation in 2017 would increase 70% (to a total of $1,075,000), due to the substantial increase in assets that were going to be needed. Finally, Chris said that her banking contract indicted that interest expense should be about 8% of both notes payable and long term debt in 2017.

By the end of 2016, the firm would be operating at capacity; it was estimated that further growth in 2017 would require $6,500,000 (including all depreciation â that is, adding $6.5 million to the 2016 Net PP&E to derive PP&E for 2017) in plant upgrades and additions to meet anticipated production volume. Everyone felt that all other asset categories (including cash) and current liabilities (including the line of credit) would change by percent of revenue. Both owners were concerned about where any needed external financing would come from. Neither was interested in raising any further equity, and agreed that they would likely secure long term financing for any external funds needed. The plan was to pay dividends totaling $400,000 in 2017.

Chris knew that a key exhibit would be the forecast mode. She planned to set up the model so that a key input would be the sales growth forecast. The âplugâ to reconcile the balance sheet would be long term debt.

Q U E S T I O N S (please use full sentences)

1) Completed forecast model. Fill in all blanks for the 2017 and 2017 % of rev columns.

2) Compare PM, ROA, and ROE from 2016 to 2017. Why the differences?

3) Compare debt ratios from 2016 to 2017. Why the differences?

4) Compare total asset turnover from 2016 to 2017. Why the difference? What observations can you make regarding capacity utilization from 2016 to 2017?

5) Estimate the maximum revenue possible given the new level of assets in 2017, based on TATO in 2016 (at full capacity).

6) If COGS could be decreased by 1% of revenue, how much increase in EBIT would result? Express the change in EBIT in both dollar terms and % change.

7) Do a DuPont analysis on S&S Air for both 2016 and 2017. If the owners asked you for any issues or concerns about the basic results forecasted for 2017, what would you tell them? Consider operating, investing, and financing issues.

7a) Operating comments:

7b) Investing comments:

7c) Financing comments:

Income statement	2016	% rev			2017	% rev
Sales	$21,566,000	100.0%		17%%
COGS	14,786,000	68.6%	% of rev	68.6%
Other expenses	2,375,000	11.0%	% of rev	11.0%
Depreciation	625,000	2.9%	given	1,075,000
EBIT	3,780,000	17.5%	calc
Interest	437,000	2.0%	given	8.0%
Taxable income	3,343,000	15.5%	calc
Taxes (40%)	1,337,200	6.2%	calc TI * tax rate	40.0%
Net income	2,005,800	9.3%	calc
Dividends	375,000	1.7%	given	400,000
Add to RE	1,630,800	7.6%	calc

B A L A N C E S H E E T
	2016	% rev			2017	%
Current Assets
Cash	425,000	2.0%	% of rev	2.0%
Accounts rec.	855,000	4.0%	% of rev	4.0%
Inventory	689,000	3.2%	% of rev	3.2%
Total CA	1,969,000	9.1%	calc
Fixed assets
Net PP&E	9,873,000	45.8%	given	6,500,000
Total Assets	11,842,000	54.9%	calc

Current Liabilities
Accounts Payable	727,000	3.4%	% of rev	3.4%
Notes Payable	1,467,000	6.8%	% of rev	6.8%
Total CL	2,194,000	10.2%	calc
Long-term debt	2,908,800	13.5%	PLUG
TOTAL CL + LTL	5,102,800

Shareholder Equity
Common stock	120,000	0.6%	no change
Retained earnings	6,619,200	30.7%	+2017 RE
Total Equity	6,739,200	31.2%	calc

Total L&E	11,842,000	54.9%	calc

Ratio Analysis
	2016	2017
PM
ROA
ROE
Debt / Equity
Debt / Total Assets
Equity Multiplier
Total Asset TO

Thank you

FIN 3901 Lecture Notes - Lecture 2: Tax Rate, Retained Earnings

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