a.
To determine: The effect of expansion of the after-tax operating income, sales, net income and net operating working capital.
Operating Income:
The operating income refers to that income which is the net income of a business, excluding the financial effects and taxes.
Net Operating Working Capital:
It is a fiscal tool to measure the working liquidity of the business. It is calculated by subtracting the operating current assets which do not include interest from the operating liabilities which also not include interest.
Net Income:
It is the total earnings of the business which is derived from deducting all the interest and taxes from the income.
a.
Explanation of Solution
Calculation of the effect on net income:
The formula to calculate the effect on net income is as follows:
Substitute ($160,176) for net income of 2018 and $87,960 for net income of 2017 in the above formula.
The net income decreases by $248,136.
Calculation of after-tax operating income of 2018,
The after-tax operating income of 2018 is ($78,569).
Calculation of after-tax operating income of 2017,
The after-tax operating income for2017 is $114,149.
Calculation of net-operating working capital of 2018,
The net operating working capital of 2018 is $905,760.
Calculation of net-operating working capital of 2017,
The net operating working capital of 2017 is $784,800.
Conclusion:
Hence, the net operating working capital increases by $120,960 and the net income decreases by $248,136.
b.
To determine: The effect of the expansion on the
Free Cash Flow:
It refers to that cash, which a company can produce after expansion. This is a degree of financial performance of a firm.
b.
Explanation of Solution
Calculation of the effect on the free cash flow:
The formula to calculate the effect on free cash flow of 2016 is as follows:
Substitute ($78,569) for after-tax operating income, $116,960 for depreciation, $711,950 for the capital expenditures and $70,642 for the difference in the net operating working capital in the above formula.
The free cash flow in 2018 is ($794,519).
Hence, the expansion showsnegative cash flow of ($794,519) which means that the shareholder wealth has been destroyed.
c.
To explain: Whether the suppliers were paid on time or not and if not the reasons for the late.
c.
Answer to Problem 20IC
The suppliers were not paid on time and the reasons for this are as follows:
- The accounts payable balance has raised by 260% from the last year.
- The sales balance has raised by only 76%.
- These records of the company demonstrates that the suppliers were not paid on time.
Explanation of Solution
- The suppliers of any company are needed to be paid on time.
- The increased accounts payable and not a high percentage of sales is not a good record for a company.
- If suppliers do not pay on time, the relationship gets strained with them.
- If it exists to be late in paying the suppliers, the suppliers will sue the company and make it as bankrupt.
Thus, the company fails to pay the suppliers on time and the reasons are as mentioned above.
d.
To explain: Whether the sales price increases the costs per unit sold and if that affects the cash balance.
d.
Answer to Problem 20IC
From the income statements, the following conclusions are made:
- It does not look like the sales price exceeds the costs per unit sold.
- As the company is spending much cash than it is earning, the balance in the cash account has reduced.
Explanation of Solution
- The income statement shows the costs at which each unit is sold and also the sales price.
- Any effect on the cash balance and the costs can be known by the income statement.
Hence, the sales price increases the costs per unit sold and the cash account balance has reduced.
e.
To explain: The effect on the cash account and the effect on cash account if the credit policy is changed.
e.
Answer to Problem 20IC
The effect on the cash account in the given situation is as follows:
- By extending the credit terms of the sale, it will take more time to get the money.
- The cash account will reduce and the accounts receivable will increase.
- The inventory and the fixed assets, both can build up.
- The accounts receivable would increase, then the cash will decline.
- When the collections will increase, then the cash would rise.
- In this situation, the company needs to borrow or sell the stock to provide fund for the expansion.
Explanation of Solution
- If the credit policy changes for any company, it surely affects the cash balance.
- If the credit terms are extended, the time for receiving the money also increases.
- The accounts receivable balance rises when the credit term is extended and so the cash balance reduces.
Thus, the cash balance will decrease when the credit policy is changed.
f.
To explain: The imagination of a situation in which the price of sales increases the production cost and selling output.
f.
Answer to Problem 20IC
The situation, where the sales price increases the costs of producing and selling a unit of output, the vast increase in sales volume leads the cash balance to decrease. This situation has the following effects:
- The inventory would build up in this case and so the fixed assets will also increase much before the sales could be raised.
- The accounts receivable will arise in this situation and the cash would decline.
- When the collections will start, then the cash balance will increase.
- To finance the expansion, the company needs to borrow or sell the stock.
Explanation of Solution
- A situation in which the price of the sales is more than the costs of producing and selling the output and the vast increase in the sales volume leads the cash balance to reduce.
- In this situation, it is dramatic that despite high selling price the sales volume has increased.
- The company if has to do the expansion, has to sell or lend the stocks.
Hence,in the given situation the effects are as mentioned above.
g.
To explain: The way in which the expansion program is financed and the way it affects the financial strength of the company.
g.
Answer to Problem 20IC
- The company is financed with external capital instead of internally generated funds.
- The company issued long-term debt rather than the common stock that reduces the financial strength and the flexibility of the company.
Explanation of Solution
- When a company expands, it needs some financing; this financing is done with the external capital instead of internally generated funds.
- When the company finances with the external capital, the company has to bear the interests also.
- But when this financing is done with funds generated internally, the company has not to bear any interests.
Hence, the company is financed with the external capital and it reduces the financial strength of the company.
h.
To explain: The effect of the asset expansion and whether this requires a raise in the external capital.
h.
Answer to Problem 20IC
The effects of the asset expansion are as follows:
- The company has broken in 2018 this means that the sales revenue has equaled the total operating costs and the interest charges.
- In this situation, the firm needs to finance an increase in the assets.
Explanation of Solution
- The asset expansion means that the company is trying to acquire new assets, for this the company needs some way for the financing.
- The expansion of the assets causes the company to experience the shortage of cash, which in turn requires it to raise the external capital.
Hence, in the given situation, the company would have to finance an increase in the assets.
i.
To explain: The effects on the (1) physical stock of assets, (2) the balance sheet account for fixed assets, (3) the company’s reported net income and (4) the cash position of the company.
i.
Answer to Problem 20IC
If the fixed assets are
- (1) The physical stock of assets- There will not be any effect on the physical stock of assets.
- (2) The balance sheet accounts for fixed assets- The balance sheet account for the fixed assets would reduce because the accumulated depreciation will raise as the assets are depreciating for 7 years over 10 years.
- (3) The company’s reported net income- As the depreciation expense will raise, the net income would decrease.
- (4) The cash position of the company- The cash position of the firm will increase, as the tax payments would be reduced.
Explanation of Solution
- If the depreciation year of the assets is reduced, this results in a reduction of the accumulated depreciation.
- When there is less accumulated depreciation, the balance in the depreciation account would reduce.
- This would also result in a declinein net income.
- But, as it will reduce the tax payments, the cash position is improved.
Hence, (1) the physical stock of the assets would have no effect, (2) the balance sheet account would decline, (3) the reported net income would decrease and (4) the cash position will improve.
j.
To explain: The meaning and calculations of the earnings per share, dividends per share and the book value per share and the reason for the market price per share not equal to the book value per share.
j.
Answer to Problem 20IC
The meaning and calculations of the given terms are as follows:
- Earnings per share: The earnings per share refer to that part of the profit of the company which is divided into each of the outstanding shares of the stock of a company. It is computed by dividing the net income by the number of outstanding shares.
- Dividends per share: The dividends per share refer to that sum of declared dividends that is issued by a company for each of the shares which is outstanding. This is the amount of dividend which is received by the shareholders for each number of shares. It is calculated by dividing the amount of dividend from the shares outstanding.
- Book value per share: The book value per share refers to that part of common equity, which is given to each of the shareholders. It is computed by dividing the common equity by the outstanding number of shares.
The market price per share is not equivalent to the book value per share. The market value of a share reflects the profitability that can be earned by the share in the future while book value per share denotes the historic cost of the share.
Explanation of Solution
- The dividends per share, earnings per share and the book value per share are the profitability ratios.
- These ratios help to determine the capacity of a company and help the investor and the user understand the financial status of the company.
- The market price per share is different than the book value per share as both reflect a different value.
Thus, the meaning and calculation of the given terms are as explained above and the market price for one share is not equal to book value per share.
k.
To explain: The tax treatment of (1) the payment of interest and dividends, (2) dividends received and interest earned, (3)
k.
Answer to Problem 20IC
The tax treatment for the given items is as follows:
- (1) Interest and dividends paid: The payment of interest is considered as an expense and is paid out of pre-tax income. So, the payment of interest is tax deductible for a business. The payment of interest is generally not tax-deductible for the individuals, but the exception is limited to home mortgage. The payment of dividends by a business are paid out of after-tax income.
- (2) Interest earned and dividends received: The interest received either by a individual or business is taxable income and is subject to taxes of standard income, except for the local and state government debt interest. The dividends gained are taxed at the rate of capital gains for the individuals. But this sometimes faces double
taxation also. The portion of dividends, which is received by corporations is not included in thetax. - (3) Capital gains: The capital gains for individuals are taxed as ordinary income if it exceeds one year, and is taxed at the capital gains rate if it is held for more than one year. The capital gains for corporations are taxed as ordinary income.
- (4) Tax-loss carry backs and carry forwards: The tax-loss carrybacks and carry forward provisions lets the businesses to utilize a loss in the present year to compensate the profits in the prior years and if losses have not been fully set by previous profits they can be carried forward to compensate the profits in future.
Explanation of Solution
- The tax treatment is different for different kinds of heads.
- The interest paid is not taxed to the individual.
- The interest earned is taxable as per the subject to taxes.
- The dividends are paid after the tax treatment.
- The dividends received are capital gains and are subject to taxes.
Thus, the tax treatment for the given items is as mentioned above.
Want to see more full solutions like this?
Chapter 3 Solutions
Fundamentals of Financial Management (MindTap Course List)
- Amul LLC is a company formed in the year 2000 and listed on the Muscat Securities Exchange. The company has primarily engaged in the manufacture of Milk Chocolates. Recently, the company has expanded its operation by entering into Cool drinks business. As a result, the company is planning to open two more factories in Oman and the Senior manager (finance) Mr. Mohammed Abu has asked to identify the possible sources of funds for the same. As per the estimate submitted by SMA team (Strategic Management Accounting team), the company requires 200,000 OMR to proceed with the proposed investments. By considering the facts and figures given below you are asked to evaluate the proposed capital structure by answering the given questions. Abstract of the Capital structure developed by Mr. Mohammed Abu, CPA Source of capital Amount in OMR Equity share capital( 5000 shares at OMR 10 each) 100,000 Reserve and surplus 20,0000 10% preference shares 40,000 8 % debentures…arrow_forwardRaj Ltd.is a new company that was established on 1st January, 2020 to oversee the production of coronavirus vaccines for Ghana. On 1st July, 2020, Raj Ltd.acquired 75% shares in Harriet Ltd., a pharmaceutical company, to speed up the vaccine production. As anew graduate from UGBS, Raj Ltd.has employed you as their accountant. At a management meeting held, a number of issues were raised about how Raj Ltd.should deal with its transactions and investment in Harriet Ltd. and the need to conduct financial ratio analysis to determine the profitability and sustainability of Harriet Ltd. In a memo to management, provide your views on how the following issues should be addressed.Raj Ltd.is planning to sell 30% of their shares to another company who wants to supportlocal production of the vaccine. How will this transaction affects the preparation of CONVEX Ltd.financial statements for the next accounting period?arrow_forwardTUV Hardware Stores is a major retailer of lumber and building products. They are privately owned but professionally managed. Recently, they took out a bank loan to build a new robotic warehouse. Debt to equity is now .2:1, and the bank has asked for financial statements. They have approached your audit firm to provide some assurance based on your excellent reputation. Each retail store is franchised and there are no corporate-owned stores. In 2020, franchise fees are expected to be $176 million while wholesale sales to stores are expected to be $2,416 million and wholesale sales direct to major builders are expected to be $203 million. Gross profit on wholesale sales is around 5%. The franchise fee goes to such things as store support (training, point of sale inventory, pricing systems) and advertising, and a 20% profit. TUV has operations across Canada with major warehouses in Vancouver, Winnipeg, Brampton, and St. John, New Brunswick. The new warehouse will be built in Kitchener.…arrow_forward
- Melody Lane Music Company was started by John Ross early in 2018. Initial capital was acquired by issuingshares of common stock to various investors and by obtaining a bank loan. The company operates a retail storethat sells records, tapes, and compact discs. Business was so good during the first year of operations that John isconsidering opening a second store on the other side of town. The funds necessary for expansion will come froma new bank loan. In order to approve the loan, the bank requires financial statements.John asks for your help in preparing the balance sheet and presents you with the following information for theyear ending December 31, 2018:a. Cash receipts consisted of the following:From customers $360,000From issue of common stock 100,000From bank loan 100,000b. Cash disbursements were as follows:Purchase of inventory $300,000Rent 15,000Salaries 30,000Utilities 5,000Insurance 3,000Purchase of equipment and furniture 40,000c. The bank loan was made on March 31, 2018. A…arrow_forwardRichmond, Inc., operates a chain of 44 department stores. Two years ago, the board of directors of Richmond approved a large-scale remodeling of its stores to attract a more upscale clientele. Before finalizing these plans, two stores were remodeled as a test. Linda Perlman, assistant controller, was asked to oversee the financial reporting for these test stores, and she and other management personnel were offered bonuses based on the sales growth and profitability of these stores. While completing the financial reports, Perlman discovered a sizable inventory of outdated goods that should have been discounted for sale or returned to the manufacturer. She discussed the Situation with her management colleagues; the consensus was to ignore reporting this inventory as obsolete because reporting it would diminish the financial results and their bonuses. Required: According to the IMA’s Statement of Ethical Professional Practice, would it be ethical for Perlman not to report the inventory…arrow_forwardNeed help ASAP! This time, imagine you are a recent BCom graduate and have started working for PureMeat Company, a small but successful meat processing business that delivers premium cuts fresh, packaged and frozen to all supermarket chains across both the South and North Islands of New Zealand. PureMeat is currently in the process of evaluating whether to expand its business into Asian countries. The most recent balance sheet at fiscal year end 2021 is as follows: PureMeat Corporation Balance Sheet as at 30 April 2021 Assets $000 Liabilities & Equity $000 Cash 75 Accounts Payable 672 Accounts Receivable 855 Accrued Marketing Expense 9 Inventory 650 Accrued G&A Expense 18 Total Current Assets 1,580 Total Current Debt 699 Fixed Assets 1,957 Long Term Debt 700 Accumulated Depreciation (795) Share capital 950 Net Fixed Assets 1,162 Retained Earnings 393 Total Assets…arrow_forward
- At their last quarterly meeting, the management of Noble Agro Processing & Manufacturing Company, a Public Limited Liability Company incorporated in 2018 to produce assorted Agriculture implements, and processing of Agric aw materials into semi-finished products discussed the future prospects of the Company after the Covid 19 Economic down turn. This was particularly with regards to their plans to extend their sales beyond the frontiers of Ghana and to strive hard to capture at least 20% of the total market share of the industry within the East African sub region by the year 2025. To successfully carry out this aggressive mission, there was the need for inject of fresh capital which management agreed as follows: 1. To issue 400,000 Equity Shares of no par Value at the price of GH¢1.00 per Share 2. 10% Debenture Loan to the tune of GH¢600,000.00 On the basis of the available capital anticipated, management has come out with two possible strategies to enter the East African Market.…arrow_forwardPlant Universe Ltd (PUL) trades in the buying and selling of flowers and has several branches within your country. Recently the company has seen a rapid increase in demand of its products across all branches and is therefore in need of additional financing to adequately boost its inventory. The corporate banking head of Bank One Ltd is requesting a full set of financial statements to ensure that granting the loan to PUL would be financially feasible during a period when many businesses are facing financial challenges.arrow_forwardCONVEX Ltd. is a new company that was established on 1st January, 2020 to oversee the production of coronavirus vaccines for Ghana. On 1st July, 2020, CONVEX Ltd. acquired 75% shares in CONCAVE Ltd., a pharmaceutical company, to speed up the vaccine production. As a new graduate from UGBS, CONVEX Ltd. has employed you as their accountant. At a management meeting held, a number of issues were raised about how CONVEX Ltd. should deal with its transactions and investment in CONCAVE Ltd. and the need to conduct financial ratio analysis to determine the profitability and sustainability of CONCAVE Ltd. In a memo to management, provide your views on how the following issues should be addressed. Issue CCONVEX Ltd. is planning to sell 30% of their shares to another company who wants to support local production of the vaccine. How will this transaction affects the preparation of CONVEX Ltd.financial statements for the next accounting period? Issue DAssuming you have done the financial ratio…arrow_forward
- CONVEX Ltd. is a new company that was established on 1st January, 2020 to oversee the production of coronavirus vaccines for Ghana. On 1st July, 2020, CONVEX Ltd. acquired 75% shares in CONCAVE Ltd., a pharmaceutical company, to speed up the vaccine production. As a new graduate from UGBS, CONVEX Ltd. has employed you as their accountant. At a management meeting held, a number of issues were raised about how CONVEX Ltd. should deal with its transactions and investment in CONCAVE Ltd. and the need to conduct financial ratio analysis to determine the profitability and sustainability of CONCAVE Ltd. In a memo to management, provide your views on how the following issues should be addressed. Issue A At the meeting, executive members could not agree on whether CONVEX Ltd. should prepare and present both separate and consolidated financial statements. Some of the executive members raised issues that CONVEX Ltd. does not need to prepare consolidated financial statements because it is simply…arrow_forwardCONVEX Ltd. is a new company that was established on 1st January, 2020 to oversee the production of coronavirus vaccines for Ghana. On 1st July, 2020, CONVEX Ltd. acquired 75% shares in CONCAVE Ltd., a pharmaceutical company, to speed up the vaccine production. As a new graduate from UGBS, CONVEX Ltd. has employed you as their accountant. At a management meeting held, a number of issues were raised about how CONVEX Ltd. should deal with its transactions and investment in CONCAVE Ltd. and the need to conduct financial ratio analysis to determine the profitability and sustainability of CONCAVE Ltd. In a memo to management, provide your views on how the following issues should be addressed. Issue Assuming there is the need for CONVEX Ltd. to prepare consolidated financial statements and CONCAVE Ltd. has presented its separate financial statement to CONVEX Ltd., comment on how the following transactions between CONVEX Ltd. and CONCAVE Ltd. will be accounted for in the consolidated…arrow_forwardCONVEX Ltd. is a new company that was established on 1st January, 2020 to oversee the production of coronavirus vaccines for Ghana. On 1st July, 2020, CONVEX Ltd. acquired 75% shares in CONCAVE Ltd., a pharmaceutical company, to speed up the vaccine production. As a new graduate from UGBS, CONVEX Ltd. has employed you as their accountant. At a management meeting held, a number of issues were raised about how CONVEX Ltd. should deal with its transactions and investment in CONCAVE Ltd. and the need to conduct financial ratio analysis to determine the profitability and sustainability of CONCAVE Ltd. In a memo to management, provide your views on how the following issues should be addressed. Issue AAt the meeting, executive members could not agree on whether CONVEX Ltd. should prepare and present both separate and consolidated financial statements. Some of the executive members raised issues that CONVEX Ltd. does not need to prepare consolidated financial statements because it is simply an…arrow_forward
- Financial AccountingAccountingISBN:9781337272124Author:Carl Warren, James M. Reeve, Jonathan DuchacPublisher:Cengage Learning
- Fundamentals Of Financial Management, Concise Edi...FinanceISBN:9781337902571Author:Eugene F. Brigham, Joel F. HoustonPublisher:Cengage Learning