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AFM273 Chapter Notes - Chapter 9: Capital Gains Tax, Leverage (Finance)

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lemonbeetle804
26 Jun 2018
School
University of Waterloo
Department
Accounting & Financial Management
Course
AFM273
Professor
Kenneth Vetzal

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Chapter 9
For t = 1, UCC1 = 0.5 * CapEx
CCAt = UCCt* d
For t >= 2, UCCt = CapEx * (1 – d/2) * (1 – d)( t - 2 )
Unlevered Net Income = (Rev – Costs – CCA) * (1 – t c)
Net Working Capital = Cash + Inventory + Receivables – Payables
Free Cash Flow = [(Rev. – Costs – CCA) * (1 – t c)] + CCA – CapEx – ΔNWC
PVC C A Tax S h i elds = (CapEx * d * tc)/(r+d) * (1 + r/2)/(1+r)
PVL o s t C C A T a x Sh i e l d s = Min(Sale Price or CapEx) * d * t c)/(r+d) * 1/(1+r)t
Capital Gains Tax = ½ * (Sales Price – CapEx) * t c
Post-Sale UCCt + 1 = UCCt + 1 – Minimum of (Sale Price, CapEx)
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For t = 1, ucc 1 = 0. 5 * capex. For t >= 2, ucc t = capex * (1 d/2) * (1 d) ( t - 2 ) Unlevered net income = (rev costs cca) * (1 t c) Net working capital = cash + inventory + receivables payables. Costs cca) * (1 t c)] + cca capex nwc. Pv c c a t a x s h i e l d s = (capex * d * t c)/(r+d) * (1 + r/2)/(1+r) Pv l o s t c c a t a x s h i e l d s = min(sale price or capex) * d * t c)/(r+d) * 1/(1+r) t. Capital gains tax = * (sales price capex) * t c.

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Related Questions

You have just been hired by Internal Business MachinesCorporation (IBM) in their capital budgeting division. Your firstassignment is to determine the free cash flows and NPV of aproposed new type of tablet computer similar in size to an iPad butwith the operating power of a high-end desktop system. Developmentof the new system will initially require an initial capitalexpenditure equal to 10% of IBM’s Property, Plant, and Equipment(PPE) at the end of fiscal year 2014. The project will then requirean additional investment equal to 10% of the initial investmentafter the first year of the project, a 5% increase after the secondyear, and a 1% increase after the third, fourth, and fifth years.The product is expected to have a life of five years. First-yearrevenues for the new product are expected to be 3% of IBM’s totalrevenue for the fiscal year 2014. The new product’s revenues areexpected to grow at 15% for the second year then 10% for the thirdand 5% annually for the final two years of the expected life of theproject. Your job is to determine the rest of the cash flowsassociated with this project. Your boss has indicated that theoperating costs and net working capital requirements are similar tothe rest of the company and that depreciation is straight-line forcapital budgeting purposes. Since your boss hasn’t been much help(welcome to the “real world”!), here are some tips to guide youranalysis: Obtain IBM’s financial statements. (If you really workedfor IBM you would already have this data, but at least you won’tget fired if your analysis is off target.) Download the annualincome statements, balance sheets, and cash flow statements for thelast four fiscal years from Yahoo! Finance (finance.yahoo.com).Enter IBM’s ticker symbol and then go to “financials.” You are nowready to estimate the Free Cash Flow for the new product. Computethe Free Cash Flow for each year using Eq. 8.5: Free Cash Flow =Unlevered Net Incomeî î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î “î ’î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ”î ‘ (Revenues − Costs − Depreciation ) × ( 1 − τ c ) + Depreciation −CapEx − Δ N W C Free Cash Flow=(Revenues−Costs−Depreciation)×(1−τc)︷Unlevered NetIncome+Depreciation−CapEx−ΔNWC Set up the timeline and computationof free cash flow in separate, contiguous columns for each year ofthe project life. Be sure to make outflows negative and inflowspositive. Assume that the project’s profitability will be similarto IBM’s existing projects in 2014 and estimate ( revenues − costs) (revenues−costs) each year by using the 2014 EBITDA/Sales profitmargin. Calculate EBITDA as EBIT + Depreciation EBIT+Depreciationexpense from the cash flow statement. Determine the annualdepreciation by assuming IBM depreciates these assets by thestraight-line method over a 5-year life. Determine IBM’s tax rateby using the income tax rate in 2014. Calculate the net workingcapital required each year by assuming that the level of NWC willbe a constant percentage of the project’s sales. Use IBM’s 2014NWC/Sales to estimate the required percentage. (Use only accountsreceivable, accounts payable, and inventory to measure workingcapital. Other components of current assets and liabilities areharder to interpret and not necessarily reflective of the project’srequired NWC—for example, IBM’s cash holdings.) To determine thefree cash flow, deduct the additional capital investment and thechange in net working capital each year. Use Excel to determine theNPV of the project with a 12% cost of capital. Also calculate theIRR of the project using Excel’s IRR function. Perform asensitivity analysis by varying the project forecasts as follows:Suppose first year sales will equal 2%–4% of IBM’s revenues.Suppose the cost of capital is 10%–15%. Suppose revenue growth isconstant after the first year at a rate of 0%–10%.

I know it's a lot but they are all small questions related to the same case so I didn't know how to split it into multiple questions. I would really appreciate the help, as I need a way to compare my answers.

Dallas & Associates Financial Statement Preparation & Analysis

You have been hired as a senior financial analyst for Dallas and Associates and you are in charge of preparing the financial statements and presenting an annual analysis at the board meeting.

Overview of Dallas & Associate’s Balance Sheet

The assets of Dallas & Associates in 2017 have both current assets and net plant and equipment. It has total assets of $ 7.5 million and net plan and equipment equals $5 million. Dallas & Associate’s only finances with $2.5 million long-term debt, $500,000 notes payable and total common equity of $3.5 million. The firm does have $400,000 accounts payable and $600,000 accruals on its balance sheet. Now assume the firm’s current assets consist entirely of cash and cash equivalence, account receivables and inventories. If it has 1.5 million cash and cash equivalents and $400,000 account receivables.

Dallas & Associates Income Statement in 2017 (dollars are in millions)

Sales 15

Operating costs excluding depreciation and amortization

 5
EBITDA 10

Depreciation & Amortization

 0.6
EBIT 9.4
Interest 0.4
EBT 9

Taxes (40%)

 3.6

Net Income

Cash Dividends

5.4

2.0

Use the above information to answer the following questions. Make sure to include the calculation steps/ formula.

Questions:

a. Prepare the balance sheet.

Total Assets

Liabilities & Shareholder’s Equity

b. What is the amount of total liabilities and equity that appears on the firm’s balance?

c. What is the amount of current assets?

d. What is the balance of current liabilities?

e. What is the amount of company’s inventory?

f. What is the amount of total liabilities?

g. What is the amount of total debt?

h. What is the amount of total capital?

i. What is the amount of net working capital?

j. What is the amount of net operating working capital?

k. If by the end of 2017, the retained earnings of John and Jon is $2.5 million, what is the amount of paid-in capital?

l. If John & Jon decides to purchase $500,000 market securities by using its cash, how does this action would affect its current asset position?

m. As the Income of Statement shows in 2017 John & Jon actually gave out $2 million cash dividends, what is the amount of retained earnings?

n. What is the amount of operating income?

o. What are the operating margin and the profit margin?

p. What is the average length of time that John & Jon must wait after making a sale before it receives cash?

q. What is the ratio we generally use to estimate a firm’s ability to meet its annual interest payments? And calculate that ratio for John and Jon.

r. What are the fixed assets turnover ratio and the total asset turnover ratio?

s. What is the ratio of total debt to total capital?

t. What is the ratio of return on common equity?

u. Assume between 2016 and 2017, net operating working capital has increased by $500,000, calculate John & Jon’s free cash flow. (Hint: use this formula. FCF = [EBIT (1-T) +Depreciation & Amortization] – [Capital Expenditures + Change on Net Operating Working Capital])

v. Now after you present your analysis on the meeting, the CEO would like to see higher sales and a forecasted net income of $10.8 million. Assume that operating costs (excluding depreciation and amortization) are still one third of sales and that depreciation and amortization and interest expenses will increase by 10%. The tax rate which is 40%, will remain the same. What level of sales would generate $10.8 million in net income?

THANK YOU!

I need Answers to Question from P - V!

I know it's a lot but they are all small questions related to the same case so I didn't know how to split it into multiple questions. I would really appreciate the help, as I need a way to compare my answers.

Dallas & Associates Financial Statement Preparation & Analysis

You have been hired as a senior financial analyst for Dallas and Associates and you are in charge of preparing the financial statements and presenting an annual analysis at the board meeting.

Overview of Dallas & Associate’s Balance Sheet

The assets of Dallas & Associates in 2017 have both current assets and net plant and equipment. It has total assets of $ 7.5 million and net plan and equipment equals $5 million. Dallas & Associate’s only finances with $2.5 million long-term debt, $500,000 notes payable and total common equity of $3.5 million. The firm does have $400,000 accounts payable and $600,000 accruals on its balance sheet. Now assume the firm’s current assets consist entirely of cash and cash equivalence, account receivables and inventories. If it has 1.5 million cash and cash equivalents and $400,000 account receivables.

Dallas & Associates Income Statement in 2017 (dollars are in millions)

Sales 15

Operating costs excluding depreciation and amortization

 5
EBITDA 10

Depreciation & Amortization

 0.6
EBIT 9.4
Interest 0.4
EBT 9

Taxes (40%)

 3.6

Net Income

Cash Dividends

5.4

2.0

Use the above information to answer the following questions. Make sure to include the calculation steps/ formula.

Questions:

a. Prepare the balance sheet.

Total Assets

Liabilities & Shareholder’s Equity

b. What is the amount of total liabilities and equity that appears on the firm’s balance?

c. What is the amount of current assets?

d. What is the balance of current liabilities?

e. What is the amount of company’s inventory?

f. What is the amount of total liabilities?

g. What is the amount of total debt?

h. What is the amount of total capital?

i. What is the amount of net working capital?

j. What is the amount of net operating working capital?

k. If by the end of 2017, the retained earnings of John and Jon is $2.5 million, what is the amount of paid-in capital?

l. If John & Jon decides to purchase $500,000 market securities by using its cash, how does this action would affect its current asset position?

m. As the Income of Statement shows in 2017 Dallas associates actually gave out $2 million cash dividends, what is the amount of retained earnings?

n. What is the amount of operating income?

o. What are the operating margin and the profit margin?

p. What is the average length of time that Dallas associates must wait after making a sale before it receives cash?

q. What is the ratio we generally use to estimate a firm’s ability to meet its annual interest payments? And calculate that ratio for Dallas associates.

r. What are the fixed assets turnover ratio and the total asset turnover ratio?

s. What is the ratio of total debt to total capital?

t. What is the ratio of return on common equity?

u. Assume between 2016 and 2017, net operating working capital has increased by $500,000, calculate Dallas & Associates free cash flow. (Hint: use this formula. FCF = [EBIT (1-T) +Depreciation & Amortization] – [Capital Expenditures + Change on Net Operating Working Capital])

v. Now after you present your analysis on the meeting, the CEO would like to see higher sales and a forecasted net income of $10.8 million. Assume that operating costs (excluding depreciation and amortization) are still one third of sales and that depreciation and amortization and interest expenses will increase by 10%. The tax rate which is 40%, will remain the same. What level of sales would generate $10.8 million in net income?

THANK YOU!