Investment in total net operating capital

Responses

Chapter
Tool Kit Chapter 2 10/27/15
Financial Statements, Cash Flow, and Taxes
2-1 Financial Statements and Reports
The annual report contains a verbal section plus four key statements: the balance sheet, income statement, statement of stockholders' equity, and statement of cash flows.
Our spreadsheets use formulas rather than fixed numbers. For example, the cell for Total assets for the most recent year contains the Sum formula rather than just a fixed number. That way, if the data for any inputs (cash, for instance) change, the spreadsheet will automatically recalculate and provide the correct new value for Total assets.
In financial modeling, it is helpful to users when input data is grouped together, so you should follow this practice in your own models, too.
2-2 The Balance Sheet
INPUT DATA SECTION: Historical Data Used in the Analysis
2016 2015
Year-end common stock price $27.00 $40.00
Year-end shares outstanding (in millions) 50 50
Tax rate 40% 40%
Weighted average cost of captal (WACC) 11.0% 10.5%
Figure 2-1
MicroDrive Inc. December 31 Balance Sheets
(Millions of Dollars)
Assets 2016 2015
Cash and equivalents $ 50 $ 60
Short-term investments - 40
Accounts receivable 500 380
Inventories 1,000 820
Total current assets $ 1,550 $ 1,300
Net plant and equipment 2,000 1,700 Note: Net plant and equipment is equal to cumulative purchases of fixed assets less cumulative depreciation and cumulative disposed assets.
Total assets $ 3,550 $ 3,000
Liabilities and Equity
Accounts payable $ 200 $ 190
Notes payable 280 130
Accruals 300 280
Total current liabilities $ 780 $ 600
Long-term bonds 1,200 1,000
Total liabilities $ 1,980 $ 1,600
Preferred stock (1,000,000 shares) 100 100
Common stock (50,000,000 shares) 500 500
Retained earnings 970 800
Total common equity $ 1,470 $ 1,300
Total liabilities and equity $ 3,550 $ 3,000
2-2 The Income Statement
Figure 2-2
MicroDrive Income Statements for Years Ending December 31
(Millions of Dollars, Except for Per Share Data)
2016 2015
Net sales $ 5,000 $ 4,760
Costs of goods sold except depreciation 3,800 3,560
Depreciation and amortizationa 200 170
Other operating expenses 500 480
Earnings before interest and taxes (EBIT) $ 500 $ 550
Less interest 120 100
Pre-tax earnings $ 380 $ 450
Taxes 152 180
Net Income before preferred dividends $ 228 $ 270
Preferred dividends 8 8
Net Income available to common stockholders $ 220 $ 262
Additional Information
Common dividends $50 $48
Addition to retained earnings $170 $214
Number of common shares 50 50
Stock price per share $27 $40
Per Share Data
Earnings per share, EPSb $4.40 $5.24
Dividends per share, DPSc $1.00 $0.96
Book value per share, BVPSd $29.40 $26.00
Notes:
a MicroDrive has no amortization charges.
b EPS = Net income available to common stockholders Common shares outstanding
c DPS = Dividends paid to common stockholders Common shares outstanding
d BVPS = Total common equity Common shares outstanding
2-4 Statement of Stockholders’ Equity
The statement of stockholders' equity takes the previous year's balance of common stock, retained earnings, and stockholders' equity and then adds the current year's net income and subtracts dividends paid to common stockholders. The end result is the new balance of common stock, retained earnings, and stockholders' equity.
Figure 2-3
MicroDrive Inc. Statement of Stockholders' Equity
(Millions of Dollars, Millions of Shares)
Preferred Stock Common Shares Common Stock Retained Earnings Total Equity
Balances, Dec. 31, 2015 $100 50 $500 $800 $1,400
Changes during year:
Net income $220 $220
Cash dividends (50) (50)
Issuance/repurchase of stock 0 0 0
Balances, Dec. 31, 2016 $100 50 $500 $970 $1,570
Note: In financial statements, parentheses and red colors denote a negative number.
2-5 Statement of Cash Flows
Information from the balance sheet and income statement can be used to construct the Statement of Cash Flows, which is shown below for MicroDrive, in millions of dollars.
Figure 2-4
MicroDrive Statement of Cash Flows for Year Ending Dec. 31
(Millions of Dollars)
Operating Activities 2016
Net Income before preferred dividends $ 228
Noncash adjustments
Depreciationa 200
Working capital adjustments
Increase in accounts receivableb (120)
Increase in inventories (180)
Increase in accounts payable 10
Increase in accruals 20
Net cash provided (used) by operating activities $ 158
Investing Activities
Cash used to acquire fixed assetsc $ (500)
Sale of short-term investments 40
Net cash provided (used) by investing activities $ (460)
Financing Activities
Increase in notes payable $ 150
Increase in bonds 200
Payment of common and preferred dividends (58)
Net cash provided (used) by financing activities $ 292
Summary
Net change in cash and equivalents $ (10)
Cash and securities at beginning of the year 60
Cash and securities at end of the year $ 50
Notes:
aDepreciation is a noncash expense that was deducted when calculating net income. It must be added back to show the correct cash flow from operations.
bAn increase in a current asset decreases cash. An increase in a current liability increases cash. For example, inventories increased by $180 million and therefore reduced cash by the same amount.
cThe net increase in fixed assets is $300 million; however, this net amount is after a deduction for the year’s depreciation expense. Depreciation expense must be added back to find the increase in gross fixed assets. From the company’s income statement, we see that the year's depreciation expense is $200 million; thus, expenditures on fixed assets were actually $500 million.
2-6 Net Cash Flow
2016 2015
Net income $220.0 $262.0
Depreciation $500.0 $480.0
Net cash flow $720.0 $742.0
2-7 Free Cash Flow: The Cash Flow Available for Distribution to Investors
Net Operating Profit After Taxes
NOPAT is the amount of profit MicroDrive would generate if it had no debt and held no financial assets.
NOPAT = EBIT x (1-T)
2016 2015
Tax rate 40% 40%
Earnings before interest and taxes (EBIT) $500 $550
x (1-T) 60% 60%
NOPAT $300 $330
Net Operating Working Capital
The current assets (CA) used in operations are called operating current assets. Operating CA include the cash needed for operations, accounts receivable and inventories. The current liabilities (CL) that are due to operations are called operating current liabilities. Operating CL include accounts payable and accruals. Net operating working capital (NOWC) is equal to operating CA minus operating CL. NOWC is the net amount that a company's operations tie up in current assets and current liabilities.
Calculating Operating Current Assets
2016 2015
Cash and equivalents $50 $60
+ Accounts receivable $500 $380
+Inventories $1,000 $820
Operating current assets $1,550 $1,260
Calculating Operating Current Liabilities
2016 2015
Accounts payable $200 $190
+ Accruals $300 $280
Operating current liabilities $500 $470
Calculating Net Operating Working Capital
2016 2015
Operating current assets $1,550 $1,260
− Operating current liabilities $500 $470
Net operating working capital $1,050 $790
Total Net Operating Capital (also just called Operating Capital or just Capital)
The Total Net Operating Capital is Net Operating Working Capital plus any long-term fixed assets or net plant, property, and equipment used in operations.
Calculating Total Net Operating Capital
2016 2015
Net operating working capital $1,050 $790
+ Net plant and equipment $2,000 $1,700
Total net operating capital $3,050 $2,490
Alternative Calculation of Total Net Operating Capital (also just called Operating Capital)
Total Funds Provided by Investors
2016 2015
Notes payable $280 $130
Long-term bonds $1,200 $1,000
Preferred stock $100 $100
Total common equity $1,470 $1,300
Total investor supplied funds $3,050 $2,530
Total Funds Provided by Investors for Operations
2016 2015
Total investor supplied capital $3,050 $2,530
Less short-term investments $0 $40
Total investor-supplied operating capital $3,050 $2,490
Free Cash Flow
MicroDrive's Free Cash Flow calculation is the cash flow actually availabe for distribution to investors after the company has made all necessary investments in fixed assets and working capital to sustain ongoing operations. Free cash flow is equal to NOPAT minus the investment made in total net operating capital. The investment in total net operating capital is equal to the current year's total net operating capital minus the previous year's total net operating capital.
Calculating the Investment in Total Net Operating Capital
2016 2015
Total net operating capital $3,050 $2,490
Investment in total net operating capital $560
Calculating Free Cash Flow
2016
NOPAT $300
− Investment in total net operating capital $560
Free cash flow -$260
Here is an alternative calculation of FCF that is sometimes used in the financial press.
2016 FCF = NOPAT + Depreciation − Gross investment in fixed assets − Investment in NOWC
= $500.0 − $500 − $260
2016 FCF = -$260.0
Uses of Free Cash Flow
1. After-tax interest payments
2016 After-tax interest expense = (Pre-tax interest expense) x (1-T)
= $120.0 x 60%
= $72.0
2. Net repayment of debt
The amount of debt that is repaid is equal to the amount at the beginning of the year minus the amount at the end of the year. This includes notes payable and long-term debt. If the amount of ending debt is less than the beginning debt, the company paid of some of its debt. But if the ending debt is greater than the beginning debt, the company actually borrowed additional funds from creditors. In that case, it would be a negative use of FCF.
2016 Repayment to debtholders = All debt at beginning of year - all debt at end of year
= $1,130.0 - $1,480.0
= -$350.0
3. Total dividend payments
This includes all dividends to preferred stockholders and dividends to common stockholders.
2016 Dividends = Prefered dividends + common dividends
= $8.0 + $50.0
= $58.0
4. Net repurchase of stock
The amount of stock that is repurchased is equal to the amount at the beginning of the year minus the amount at the end of the year. This includes preferred stock and common stock. If the amount of ending stock is less than the beginning stock, the company made net repurchases. But if the ending stock is greater than the beginning stock, the company actually made net issuances. In that case, it would be a negative use of FCF.
2016 Repurchase stock = Preferred stock and common stock at beginning of year - Preferred stock and common stock at end of year
= $600.0 - $600.0
= $0.0
5. Net purchase of short-term investments
The amount of net purchases of ST investments is equal to the amount at the end of the year minus the amount at the beginning of the year. If the amount of ending investments is greater than the beginning investments, the company made net purchases. But if the ending investments are less than the beginning investments, the company actually sold investments. In that case, it would be a negative use of FCF.
2016 Purchase ST investments = ST investents at end of year - ST investments at beginning of year
= $0.0 - $40.0
= -$40.0
Summary of uses of FCF
2016
1. After-tax interest payments $72.0
2. Net repayment of debt -$350.0
3. Total dividend payments $58.0
4. Net repurchase of stock $0.0
5. Net purchase of short-term investments -$40.0
Total uses of FCF = -$260.0
Notice that the total uses of FCF equals the previously calculated value of FCF.
2-8 Performance Evaluation
The Return on Invested Capital (ROIC)
The Return on Invested Capital tells us the amount of NOPAT per dollar of operating capital.
2016 ROIC = NOPAT ÷ Total net operating capital
$300.00 ÷ $3,050
2016 ROIC = 9.84%
2015 ROIC = NOPAT ÷ Total net operating capital
$330.00 ÷ $2,490
2015 ROIC = 13.25%
The Operating Profitability Ratio (OP)
The operating profitability ratio show the amount of NOPAT per dollar of sales.
2016 OP = NOPAT ÷ Sales
$300.00 ÷ $5,000
2016 OP = 6.00%
2015 OP = NOPAT ÷ Sales
$330.00 ÷ $4,760
2015 OP = 6.93%
The Capital Requirement Ratio (CR)
The capital requirement ratio show the amount of operating capital that is needed to generate a dollar of sales.
2016 CR = Total net operating capital ÷ Sales
$3,050 ÷ $5,000
2016 CR = 61.00%
2015 CR = Total net operating capital ÷ Sales
$2,490 ÷ $4,760
2015 CR = 52.31%
Market Value Added
Market Value Added is the difference between the market value of MicroDrive's stock and the amount of equity capital supplied by shareholders.
2016 MVA = Stock price x # of shares - Total common equity
= $27.00 x 50 - $1,470
= $1,350 - $1,470
2016 MVA = -$120
2015 MVA = Stock price x # of shares - Total common equity
= $40.00 x 50 - $1,300
= $2,000 - $1,300
2015 MVA = $700
Economic Value Added
Economic Value Added represents MicroDrive's residual income that remains after the cost of all capital, including equity capital, has been deducted.
2016 EVA = NOPAT - Operating Capital x Weighted average cost of capital
= $300.00 - $3,050 x 11%
= $300.0 - $335.5
2016 EVA = -$35.5
2015 EVA = NOPAT - Operating Capital x Weighted average cost of capital
= $330.00 - $2,490 x 11%
= $330.0 - $261.5
2015 EVA = $68.6
Figure 2-6
Calculating Performance Measures for MicroDrive
(Millions of Dollars)
2016 2015
Calculating NOPAT
EBIT $500 $550
x (1 − Tax rate) 60% 60%
NOPAT = EBIT(1 − T) $300 $330
Calculating Net Operating Working Capital (NOWC)
Operating current assets $1,550 $1,260
− Operating current liabilities $500 $470
NOWC $1,050 $790
Calculating Total Net Operating Capital
NOWC $1,050 $790
+ Net plant and equipment $2,000 $1,700
Total net operating capital $3,050 $2,490
Calculating Return on Invested Capital (ROIC)
NOPAT $300 $330
÷ Total net operating capital $3,050 $2,490
ROIC = NOPAT/Total net operating capital 9.84% 13.25%
Weighted average cost of capital (WACC) 11.00% 10.50%
Calculating the Operating Profitability Ratio (OP)
NOPAT $300 $330
÷ Sales $5,000 $4,760
OP = NOPAT/Sales 6.00% 6.93%
Calculating Capital Requirement Ratio (CR)
Total net operating capital $3,050 $2,490
÷ Sales $5,000 $4,760
CR = Total net operating capital/Sales 61.00% 52.31%
Calculating Market Value Added (MVA)
Price per share $27 $40
x Number of shares (millions) 50 50
Market value of equity = P x (# of shares) $1,350 $2,000
− Book value of equity $1,470 $1,300
MVA = Market value − Book value −$120 $700
Calculating Economic Value Added (EVA)
Total net operating capital $3,050.0 $2,490.0
x Weighted average cost of capital (WACC) 11.0% 10.5%
Dollar cost of capital $335.5 $261.5
NOPAT $300.0 $330.0
− Dollar cost of capital $335.5 $261.5
EVA = NOPAT – Dollar cost of capital −$35.5 $68.6
2-9 The Federal Income Tax System
This worksheet explores the calculation of corporate income taxes under the federal tax system. By using special Excel functions, we can input a corporate tax schedule into a spreadsheet and then have a cell automatically display a company's tax liability. Either of two procedures can be used, the IF function or the VLOOKUP function. Both functions are explained below, using the data shown in the following tax table.
LOOKUP
There are actually two lookup functions, VLOOKUP for looking up items in vertical columns, and HLOOKUP for looking up things in horizontal rows. Since our tax table is arranged in columns, we use VLOOKUP.
When we use VLOOKUP, Excel first looks down the Column (1) of Table 2-1 below and finds the largest value that does not exceed the firm's taxable income. Next, it looks for the corresponding value in Column (3) of Table 2-1, which is the base amount of the tax. Then, it again looks down Column (1) and finds the corresponding marginal tax rate as shown in Column (4). Then it multiplies the tax rate times the difference between the firm's taxable income and the bottom tax bracket to get the incremental tax. Then it adds the base tax to the incremental tax to get the firm's total tax liability.
We will explain how to use VLOOKUP here, and then we will use it for the calculations below Table 2-1. To get the VLOOKUP formula, click the function wizard, fx, select "Lookup & Reference," and then select VLOOKUP. You will then get a dialog box like the one shown here.
For example, suppose we have taxable income of $65,000. We first need to identify the bracket that this is in, then find the amount of tax on the bracket. We can do that by filling out the dialog box for the function arguments. In particular, we set the Lookup_value to $65,000, we set the Table_array to Fedtaxtable, and set the Col_index_num to 3, which is the column in the table that has the amount paid on the base. See the calculations below Table 2-1 for applications of the VLOOKUP function.
Table 2-1
Corporate Tax Rates for 2015
If a corporation's taxable income is between It pays this amount on the base of the bracket Plus this percentage on the excess over the base Average tax rate at top of bracket
(1) (2) (3) (4) (5)
$0 $50,000 $0 15.0% 15.0%
$50,000 $75,000 $7,500 25.0% 18.3%
$75,000 $100,000 $13,750 34.0% 22.3%
$100,000 $335,000 $22,250 39.0% 34.0%
$335,000 $10,000,000 $113,900 34.0% 34.0%
$10,000,000 $15,000,000 $3,400,000 35.0% 34.3%
$15,000,000 $18,333,333 $5,150,000 38.0% 35.0%
$18,333,333 and up $6,416,667 35.0% 35.0%
Taxable Income: $65,000
1st VLOOKUP to find the base amount of tax: $ 7,500
2nd VLOOKUP to find the marginal tax rate: 25.0%
3rd VLOOKUP to find the marginal income to be taxed: $ 15,000
Tax on marginal income above the base: $ 3,750
Total tax liability: $11,250
Table 2-2
Apex Corporation: Calculation of $12 million Loss Carry-Back and Amount Available for Carry-Forward
Past Year Past Year Curent Year
2014 2015 2016
Original taxable income $2,000,000 $2,000,000 -$12,000,000
Carry-back loss 2,000,000 2,000,000
Adjusted profit $0 $0
Taxes previously paid (40%) 800,000 800,000
Difference = Tax refund due $800,000 $800,000
Total tax refund received $1,600,000
Amount of loss carry forward available
Current loss -$12,000,000
Carry-back losses used 4,000,000
Carry-forward losses still available -$8,000,000
2-2
SECTION 2-2
SOLUTIONS TO SELF-TEST
A firm has $8 million in total assets. It has $3 million in current liabilities, $2 million in long-term debt, and $1 million in preferred stock. What is the reported net worth (i.e., the reported common equity)?
Total assets $8,000,000
Current liabilities $3,000,000
Long-term debt $2,000,000
Preferred stock $1,000,000
The net worth of shareholders, also called common equity, is equal to the total assets less all liabilities and preferred stock.
Net worth = common equity = $2,000,000
2-3
SECTION 2-3
SOLUTIONS TO SELF-TEST
A firm has $2,000,000 million in earnings before taxes. The firm has an interest expense of $300,000 and depreciation of $200,000; it has no amortization. What is its EBITDA?
Earnings before taxes $2,000,000
Interest $300,000
Depreciation $200,000
Amortization $0
EBITDA stands for earnings before interest, taxes, and depreciation. To calculate EBITDA using the given information, start with earnings before taxes and add back interest, depreciation, and amortization.
EBITDA $2,500,000
Now suppose a firm has the following information: $7 million in sales, $4 million of costs of goods sold excluding depreciation & amortization, $500,000 of other operating expenses. What is its EBITDA?
Sales $7,000,000
Costs of goods sold excluding depreciation and amortization $4,000,000
Other operating expenses $500,000
EBITDA stands for earnings before interest, taxes, and depreciation. To calculate EBITDA using the given information, start with sales and subtract costs of goods sold (excluding depreciation) and other operating costs:
EBITDA $2,500,000
2-4
SECTION 2-4
SOLUTIONS TO SELF-TEST
A firm had a retained earnings balance of $3 million in the previous year. In the current year, its net income is $2.5 million. If it pays $1 million in common dividends in the current year, what it its resulting retained earnings balance?
Previous retained earnings balance $3,000,000
Current net income $2,500,000
Common dividends $1,000,000
This year's addition to retained earnings is the amount of net income not paid out in dividends:
Addition to retained earnings $1,500,000
The new balance of retained earnings is the previous year's balance plus this year's addition to retained earnings:
Current retained earnings balance $4,500,000
2-5
SECTION 2-5
SOLUTIONS TO SELF-TEST
A firm has inventories of $2 million for the previous year and $1.5 million for the current year. What impact does this have on net cash provided by operations?
Previous year's inventories $2,000,000
Current year's inventories $1,500,000
Inventories are assets that a company owns. When inventories increase (perhaps because the company bought more goods than it sold), cash goes down due to the increase in assets owned by the company. When inventories decrease (perhaps because the company sold more goods than it purchased), cash goes up due to the decrease in assets owned by the company. Therefore the cash flow due to a change in inventories is equal to the previous year's inventories minus the current year's inventories:
Cash flow due to inventories = Previous year's inventories −Current year's inventories
Change in net cash provided by operations $500,000
2-6
SECTION 2-6
SOLUTIONS TO SELF-TEST
A firm has net income of $5 million. Assuming that depreciation of $1 million is its only noncash expense, what is the firm’s net cash flow?
Net income $5,000,000
Depreciation $1,000,000
Net cash flow = Net income + Noncash expenses
Net cash flow $6,000,000
2-7
SECTION 2-7
SOLUTIONS TO SELF-TEST
Suppose a firm has the following information: Sales = $10 million; costs of goods sold (excluding depreciation) = $5 million; depreciation = $1.4 million; other operating expenses = $2 million; interest expense = $1 million. If the tax rate is 25%, what is NOPAT, the net operating profit after taxes?
Sales $10,000,000
Costs of goods sold (excluding depreciation) $5,000,000
Depreciation $1,400,000
Other operating expenses $2,000,000
Interest expense $1,000,000
Tax rate 25%
The first step is to calculate the earnings before interest and taxes, EBIT. This is the amount of pre-tax operating earnings.
EBIT = Sales − Costs of goods sold excluding depreciation − Depreciation − Other operating expenses
Notice that interest expense is not subtracted because interest is not an operating expense.
EBIT = pre-tax operating earnings = $1,600,000
The second step is to calculate NOPAT, which is equal to after-tax operating earnings.
NOPAT = EBIT (1−T)
NOPAT = $1,200,000
Suppose a firm has the following information: Cash = $500,000; short-term investments = $2.5 million; accounts receivable = $1.2 million, net plant and equipment = $7.8 million. How much is tied up in operating current assets?
Cash $500,000
Short-term investments $2,500,000
Accounts receivable $1,200,000
Inventories $1,000,000
Net plant and equipment $4,000,000
Operating current assets are the short-term assets used in operations. They do not include an short-term investments or marketable securities that are not a part of normal operations. They do not include any long-term assets.
Operating CA = Cash + Accounts receivable + inventories
Operating current assets = $2,700,000
Suppose a firm has the following information: Accounts payable = $1 million; notes payable = $1.1 million; short-term debt = $1.4 million; accruals = $500,000; and long-term bonds = $3 million. What is the amount arising from operating current liabilities?
Accounts payable $1,000,000
Notes payable $1,100,000
Short-term debt $1,400,000
Accruals $500,000
Long-term bonds $3,000,000
Operating current liabilities are the short-term liabilities arising from operating acivities. They do not include any form of debt, including notes payable, short-term debt, or long-term bonds.
Operating CL = Accounts payable + accruals
Operating current liabilities = $1,500,000
Suppose a firm has the following information: Operating current assets = $2.7 million; operating current liabilities = $1.5 million, long-term bonds = $3 million, net plant and equipment = $7.8 million; and other long-term operating assets = $1 million. How much is tied up in net operating working capital? How much is tied up in total net operating capital?
Operating current assets $2,700,000
Operating current liabilities $1,500,000
Long-term bonds $3,000,000
Net plant and equipment $7,800,000
Other long-term operating assets $1,000,000
Net operating working capital (NOWC) is the net amount tied up in short-term operating assets after adjusting for the amount arising from short-term operating liabilities. It does not include any cash ties up in long-term assets and it is not adjusted for any cash provided by investors.
Net operating working capital = NOWC = Operating current assets − Operating current liabilities
Net operating working capital = NOWC = $1,200,000
Total net operating capital includes the net amount tied up in net operating working capital (NOWC) and the amount tied up in all long-term operating assets. It is not adjusted for any cash provided by investors.
Total net operating capital = Net operating working capital + Net plant and equipment + Other long-term operating assets
Total net operating capital = $10,000,000
A firm’s total net operating capital for the previous year was $2 million. For the current year, its total net operating capital is $2.5 million and its NOPAT is $1.2 million. What is its free cash flow for the current year?
Previous year's total net operating capital $9,300,000
Current year's total net operating capital $10,000,000
Current year's NOPAT $1,200,000
First, calculate the investment in total net operating capital.
Investment in total net operating capital = Current year's total net operating capital − previous year's total net operating capital
Investment in total net operating capital = $700,000
Second, calculate free cash flow.
Free cash flow = NOPAT − Investment in total net operating capital
Free cash flow = $500,000
2-8
SECTION 2-8
SOLUTIONS TO SELF-TEST
A company has sales of $200 million, NOPAT of $12 million, net income of $8 million, new operating working capital (NOWC) of $10 million, total net operating capital of $100 million, and total assets of $110 million. What is it operating profitability (OP) ratio? Its capital requirment (CF) ratio? Its return on invested capital (ROIC)?
Sales $200 million
NOPAT $12 million
Net income $8 million
Net operating working capital $10 million
Total net operating capital $100 million
Total assets $110 million
The operating profitability (OP) ratio measures the dollars of operating profit per dollar of sales.
OP = NOPAT / Sales
OP = 6%
The capital requirement (CR) ratio measures the dollars of total net operating capital tied up per dollar of sales.
CR = (Total net operating capital) / Sales
CR = 50%
The return on invested capital (ROIC) measures the dollars of operating profit per dollar of total net operating capital.
ROIC = NOPAT / (Total net operating capital) = OP / CR
ROIC = NOPAT / (Total net operating capital) = 12%
ROIC = OP / CR = 12.00%
A firm has $100 million in total net operating capital. Its return on invested capital is 14 percent, and its weighted average cost of capital is 10 percent. What is its EVA?
Total net operating working capital $100,000,000
ROIC 14%
WACC 10%
Free cash flow = $4,000,000
2-9
SECTION 2-9
SOLUTIONS TO SELF-TEST
If a corporation has $85,000 in taxable income, what is its tax liability?
Taxable income $85,000
Base amount of tax from Table 2-1 $13,750
Base of tax range $75,000
Taxable income above range $10,000
Tax rate in base 34%
Tax liability $17,150
Mini Case Data
10/27/15
Mini Case Data
Computron's Income Statement
2015 2016
INCOME STATEMENT
Net sales $ 3,432,000 $ 5,834,400
Cost of Goods Sold (Except depr. and amort.) 2,864,000 4,980,000
Other Expenses 340,000 720,000
Depreciation and amortization 18,900 116,960
Total Operating Costs $ 3,222,900 $ 5,816,960
Earnings before interest and taxes (EBIT) $ 209,100 $ 17,440
Less interest 62,500 176,000
Pre-tax earnings $ 146,600 $ (158,560)
Taxes (40%) 58,640 (63,424)
Net Income $ 87,960 $ (95,136)
Dividends $22,000 $11,000
Tax rate 40% 40%
Computron's Balance Sheets
2015 2016
Assets
Cash and equivalents $ 9,000 $ 7,282
Short-term investments 48,600 20,000
Accounts receivable 351,200 632,160
Inventories 715,200 1,287,360
Total current assets $ 1,124,000 $ 1,946,802
Gross fixed assets $ 491,000 $ 1,202,950
Less: Accumulated depreciation 146,200 263,160
Net plant and equipment $ 344,800 $ 939,790
Bart Kreps: Property, Plant and Equipment minus Depreciation
Total assets $ 1,468,800 $ 2,886,592
Liabilities and equity
Accounts payable $ 145,600 $ 324,000
Notes payable 200,000 720,000
Accruals 136,000 284,960
Total current liabilities $ 481,600 $ 1,328,960
Long-term bonds $ 323,432 $ 1,000,000
Common Stock 460,000 460,000
Retained Earnings 203,768 97,632
Total Equity $ 663,768 $ 557,632
Total Liabilites and Equity $ 1,468,800 $ 2,886,592
Computron's Statement of Cash Flows
Bart Kreps: The statement of cash flows provides information about cash inflows and outflows during an accounting period.
2016
Operating Activities
Net Income before preferred dividends $ (95,136)
Noncash adjustments
Depreciation and amortization 116,960
Due to changes in working capital
Change in accounts receivable (280,960)
Bart Kreps: Change is negative because accounts receivable went up in 2001. This means that more sales revenue has been reflected in net income than has been collected in cash.
Change in inventories (572,160)
Bart Kreps: Inventories went up meaning that Computron used cash to purchase inventories.
Change in accounts payable 178,400
Bart Kreps: This is positive because accounts payable went up. Computron bought on credit from suppliers and did not dispense cash.
Change in accruals 148,960
Bart Kreps: Accruals increased in 2001. Cash flow is positive because it recognizes an increased expense prior to the payment of cash.
Net cash provided by operating activities $ (503,936)
Investing activities
Cash used to acquire fixed assets $ (711,950)
Bart Kreps: Make sure to add back annual Depreciation to Net PP&E.
Change in short-term investments 28,600
Bart Kreps: Short term investments went down in 2001. Computron received cash through the sale or maturity of these assets.
Net cash provided by investing activities $ (683,350)
Financing Activities
Change in notes payable $ 520,000
Bart Kreps: Notes payable went up in 2001. Computron received cash from creditors.
Change in long-term debt 676,568
Bart Kreps: Long term debt went up in 2001. Computron received cash from creditors.
Payment of cash dividends (11,000)
Bart Kreps: Computron used cash to pay dividends to shareholders.
Net cash provided by financing activities $ 1,185,568
Net change in cash and equivilents $ (1,718)
Cash and securities at beginning of the year 9,000
Cash and securities at end of the year $ 7,282
Corporate Tax Rates
If a corporation's taxable income is between: It pays this amount on the base of the bracket: Plus this percentage on the excess over the base
(1) (2) (3) (4)
$0 $50,000 $0 15.0%
$50,000 $75,000 $7,500 25.0%
$75,000 $100,000 $13,750 34.0%
$100,000 $335,000 $22,250 39.0%
$335,000 $10,000,000 $113,900 34.0%
$10,000,000 $15,000,000 $3,400,000 35.0%
$15,000,000 $18,333,333 $5,150,000 38.0%
$18,333,333 and up $6,416,667 35.0%
Web 2A
10/27/15
Web Extension 2A: Tool Kit for Individual Taxes
Individual Tax Table for the 2015 Tax Year
If an individual's He/she pays this Plus this percentage Average tax
taxable income amount on the on the excess rate at
is between: base of the bracket over the base top of bracket
(1) (2) (3) (4) (5)
$0 $9,225 $0.00 10.0% 10.0%
$9,225 $37,450 $922.50 15.0% 13.8%
$37,450 $90,750 $5,156.25 25.0% 20.4%
$90,750 $189,300 $18,481.25 28.0% 24.3%
$189,300 $411,500 $46,075.25 33.0% 29.0%
$411,500 $413,200 $119,401.25 35.0% 35.0%
$413,200 and up $119,996.25 39.6% 39.6%
High-Income Average Tax Rates for Individuals
Income Average Tax Rate
$1,000,000 32.5%
$10,000,000 34.8%
Married (Joint Return) Tax Table for the 2015 Tax Year
If a couple's It pays this Plus this percentage Average tax
taxable income amount on the on the excess rate at
is between: base of the bracket over the base top of bracket
(1) (2) (3) (4) (5)
$0 $18,450 $0.00 10.0% 10.0%
$18,450 $74,900 $1,845.00 15.0% 13.8%
$74,900 $151,200 $10,312.50 25.0% 19.4%
$151,200 $230,450 $29,387.50 28.0% 22.4%
$230,450 $411,500 $51,577.50 33.0% 27.1%
$411,500 $464,850 $111,324.00 35.0% 35.0%
$464,850 and up $129,996.50 39.6% 39.6%
High-Income Average Tax Rates for Joint Returns
Income Average Tax Rate
$1,000,000 31.7%
$10,000,000 34.7%
Other Tax Data:
Exemption per person = $4,000
Capital gains rate (most investments and most taxpayers) = 15%
Standard deduction (individual) = $6,300
Standard deduction (married filing joint) = $12,600
Rate on social security (OASDI, payroll)= 6.2%
Rate on social security (OASDI, self-employed)= 12.4%
Rate on medicare (payroll) = 1.45%
Rate on medicare (self-employed) = 2.90%
Example
Find the tax, the marginal tax rate, and the average tax rate for the following situation.
Taxable Income: $40,000
Base taxable income: $37,450.00
Base tax: $5,156.25
Marginal tax rate: 25.0%
Tax: $5,793.75
Average tax rate: 14.5%
Suppose the person in the previous example receives a $1,000 raise. What are the additional income taxes and combined social security and medicare taxes (assume the person is not self-employed).
Pay raise: $1,000
Additional income tax: $250
Additional Social Security and Medicare tax: $76.50
Total after-tax raise: $673.50
Example
After-tax Yield on Municipal Bonds
Tax rate on individual 39.60%
Rate on municipal bond 5.50%
Rate needed on corporate bond 9.11%
Total after-tax raise: $0.25