P4–5 Classifying inflows and outflows of cash Classify each of the following items as an inflow (I) or an outflow (O) of cash, or as neither (N). LG 2 LG 2 Item Change ($) Item Change ($) Cash +100 Accounts receivable ?700 Accounts payable ?1,000 Net profits +600 Notes payable +500 Depreciation +100 Long-term debt ?2,000 Repurchase of stock +600 Inventory +200 Cash dividends +800 Fixed assets +400 Sale of stock +1,000 P4–6 Finding operating and free cash flows Consider the following balance sheets and selected data from the income statement of Keith Corporation. December 31 Assets 2015 2014 Cash $ 1,500 $ 1,000 Marketable securities 1,800 1,200 Accounts receivable 2,000 1,800 Inventories 2,900 2,800 Total current assets $ 8,200 $ 6,800 Gross fixed assets $29,500 $28,100 Less: Accumulated depreciation 14,700 13,100 Net fixed assets $14,800 $15,000 Total assets $23,000 $21,800 Liabilities and stockholders’ equity Accounts payable $ 1,600 $ 1,500 Notes payable 2,800 2,200 Accruals 200 300 Total current liabilities $ 4,600 $ 4,000 Long-term debt 5,000 5,000 Total liabilities $ 9,600 $ 9,000 Common stock $10,000 $10,000 Retained earnings 3,400 2,800 Total stockholders’ equity $13,400 $12,800 Total liabilities and stockholders’ equity $23,000 $21,800 Keith Corporation Balance Sheets ISBN 1Depreciation expense $1,600 Earnings before interest and taxes (EBIT) 2,700 Interest expense 367 Net profits after taxes 1,400 Tax rate 40% a. Calculate the firm’s net operating profit after taxes (NOPAT) for the year ended December 31, 2015, using Equation 4.1. b. Calculate the firm’s operating cash flow (OCF) for the year ended December 31, 2015, using Equation 4.3. c. Calculate the firm’s free cash flow (FCF) for the year ended December 31, 2015, using Equation 4.4. d. Interpret, compare, and contrast your cash flow estimates in parts b and c. P4–9 Cash budget: Basic Grenoble Enterprises had sales of $50,000 in March and $60,000 in April. Forecast sales for May, June, and July are $70,000, $80,000, and $100,000, respectively. The firm has a cash balance of $5,000 on May 1 and wishes to maintain a minimum cash balance of $5,000. Given the following data, prepare and interpret a cash budget for the months of May, June, and July. (1) The firm makes 20% of sales for cash, 60% are collected in the next month, and the remaining 20% are collected in the second month following sale. LG 4 LG 4 Depreciation expense $1,600 Earnings before interest and taxes (EBIT) 2,700 Interest expense 367 Net profits after taxes 1,400 Tax rate 40% Keith Corporation Income Statement Data (2015) LG 4 ISBN 1-269-86847-0 Principles of Managerial Finance, Fourteenth Edition, by Lawrence J. Gitman and Chad J. Zutter. Published by Prentice Hall. Copyright © 2015 by Pearson Education, Inc. 152 PART 2 Financial Tools (2) The firm receives other income of $2,000 per month. (3) The firm’s actual or expected purchases, all made for cash, are $50,000, $70,000, and $80,000 for the months of May through July, respectively. (4) Rent is $3,000 per month. (5) Wages and salaries are 10% of the previous month’s sales. (6) Cash dividends of $3,000 will be paid in June. (7) Payment of principal and interest of $4,000 is due in June. (8) A cash purchase of equipment costing $6,000 is scheduled in July. (9) Taxes of $6,000 are due in June. P4–15 Pro forma income statement The marketing department of Metroline Manufacturing estimates that its sales in 2016 will be $1.5 million. Interest expense is expected to remain unchanged at $35,000, and the firm plans to pay $70,000 in cash dividends during 2016. Metroline Manufacturing’s income statement for the year ended December 31, 2015, and a breakdown of the firm’s cost of goods sold and operating expenses into their fixed and variable components are given below. a. Use the percent-of-sales method to prepare a pro forma income statement for the year ended December 31, 2016. b. Use fixed and variable cost data to develop a pro forma income statement for the year ended December 31, 2016. c. Compare and contrast the statements developed in parts a and b. Which statement probably provides the better estimate of 2016 income? Explain why. ISBN 1-269-86847-0 Principles of Managerial Finance, Fourteenth Edition, by Lawrence J. Gitman and Chad J. Zutter. Published by Prentice Hall. Copyright © 2015 by Pearson Education, Inc. P4–18 Pro forma balance sheet Peabody & Peabody has 2015 sales of $10 million. It wishes to analyze expected performance and financing needs for 2017, which is 2 years ahead. Given the following information, respond to parts a and b. (1) The percents of sales for items that vary directly with sales are as follows: Accounts receivable, 12% Inventory, 18% Accounts payable, 14% Net profit margin, 3% (2) Marketable securities and other current liabilities are expected to remain unchanged. (3) A minimum cash balance of $480,000 is desired. (4) A new machine costing $650,000 will be acquired in 2016, and equipment costing $850,000 will be purchased in 2017. Total depreciation in 2016 is forecast as $290,000, and in 2017 $390,000 of depreciation will be taken. (5) Accruals are expected to rise to $500,000 by the end of 2017. (6) No sale or retirement of long-term debt is expected. (7) No sale or repurchase of common stock is expected. (8) The dividend payout of 50% of net profits is expected to continue. (9) Sales are expected to be $11 million in 2016 and $12 million in 2017. (10) The December 31, 2015, balance sheet follows. Assets Liabilities and stockholders’ equity Cash $ 400 Accounts payable $1,400 Marketable securities 200 Accruals 400 Accounts receivable 1,200 Other current liabilities 80 Inventories 1,800 Total current liabilities $1,880 Total current assets $3,600 Long-term debt 2,000 Net fixed assets 4,000 Total liabilities 3,880 Total assets $7,600 Common equity 3,720 Total liabilities and stockholders’ equity $7,600 Peabody & Peabody Balance Sheet December 31, 2015 ($000) a. Prepare a pro forma balance sheet dated December 31, 2017. b. Discuss the financing changes suggested by the statement prepared in part a. P5–2 Future value calculation Without referring to the preprogrammed function on your financial calculator, use the basic formula for future value along with the given interest rate, r, and the number of periods, n, to calculate the future value of $1 in each of the cases shown in the following table. Case Interest rate, r Number of periods, n A 12% 2 B 6 3 C 9 2 D 3 4 P5–6 Time value As part of your financial planning, you wish to purchase a new car exactly 5 years from today. The car you wish to purchase costs $14,000 today, and your research indicates that its price will increase by 2% to 4% per year over the next 5 years. a. Estimate the price of the car at the end of 5 years if inflation is (1) 2% per year and (2) 4% per year. b. How much more expensive will the car be if the rate of inflation is 4% rather than 2%? c. Estimate the price of the car if inflation is 2% for the next 2 years and 4% for 3 years after that. P5–14 Time value An Iowa state savings bond can be converted to $100 at maturity 6 years from purchase. If the state bonds are to be competitive with U.S. savings bonds, which pay 8% annual interest (compounded annually), at what price must the state sell its bonds? Assume no cash payments on savings bonds prior to redemption. P5–22 Retirement planning Hal Thomas, a 25-year-old college graduate, wishes to retire at age 65. To supplement other sources of retirement income, he can deposit $2,000 each year into a tax-deferred individual retirement arrangement (IRA). The IRA will earn a 10% return over the next 40 years. a. If Hal makes annual end-of-year $2,000 deposits into the IRA, how much will he have accumulated by the end of his sixty-fifth year? b. If Hal decides to wait until age 35 to begin making annual end-of-year $2,000 deposits into the IRA, how much will he have accumulated by the end of his sixty-fifth year? c. Using your findings in parts a and b, discuss the impact of delaying making deposits into the IRA for 10 years (age 25 to age 35) on the amount accumulated by the end of Hal’s sixty-fifth year. d. Rework parts a, b, and c, assuming that Hal makes all deposits at the beginning, rather than the end, of each year. Discuss the effect of beginning-of-year deposits on the future value accumulated by the end of Hal’s sixty-fifth year. P5-29 Value of a single amount versus a mixed stream Gina Vitale has just contracted to sell a small parcel of land that she inherited a few years ago. The buyer is willing to pay $24,000 at the closing of the transaction or will pay the amounts shown in the following table at the beginning of each of the next 5 years. Because Gina doesn’t really need the money today, she plans to let it accumulate in an account that earns 7% annual interest. Given her desire to buy a house at the end of 5 years after closing on the sale of the lot, she decides to choose the payment alternative—$24,000 single amount or the mixed stream of payments in the following table—that provides the higher future value at the end of 5 years. Which alternative will she choose? Mixed stream Beginning of year Cash flow 1 $ 2,000 2 4,000 3 6,000 4 8,000 5 10,000 P5–39 Compounding frequency and time value You plan to invest $2,000 in an individual retirement arrangement (IRA) today at a nominal annual rate of 8%, which is expected to apply to all future years. LG 5 LG 5 LG 5 LG 5 Principles of Managerial Finance, Fourteenth Edition, by Lawrence J. Gitman and Chad J. Zutter. Published by Prentice Hall. Copyright © 2015 by Pearson Education, Inc. 214 PART 2 Financial Tools a. How much will you have in the account at the end of 10 years if interest is compounded (1) annually, (2) semiannually, (3) daily (assume a 365-day year), and (4) continuously? b. What is the effective annual rate (EAR) for each compounding period in part a? c. How much greater will your IRA balance be at the end of 10 years if interest is compounded continuously rather than annually? d. How does the compounding frequency affect the future value and effective annual rate for a given deposit? Explain in terms of your findings in parts a through c.