Solutions Manual

CHAPTER 7

CASH FLOW ANALYSIS

Answer to Questions

1. The only way depreciation generates cash flows for the company is by serving
as a tax shield against reported income. This non-cash deduction may provide
cash flow equal to the tax rate times the depreciation charged. This much in
taxes will be saved, while no cash payments occur.

2. Refer to pages 136 through 138.

3. Refer to page 135.

Answer to Problems

Problem 1 (Statement of Cash Flows)

Cash flow from

Operating activities ₱(817,000) Outflow
Investing activities (2,567,000) Outflow
Financing activities 3,459,000 Inflow
Increase in Cash ₱ 75,000

Cash balance, beginning ₱ 950,000

Cash balance, end 1,025,000
Increase in Cash ₱ 75,000

Note: The problem did not indicate whether the cash flows from investing and
financing activities represented net inflow or outflow. It is assumed that following
normal course of operations, investments will represent usage or outflow of cash and
financing will represent sourcing or inflow of cash. Hence since the cash account
posted a net increase of ₱75,000, operating activities must have used up a net cash
flow of ₱817,000.

Problem 2 (Free Cash Flow)

EBIT ₱62,000,000
Less: Taxes 17,000,000
EAT ₱45,000,000
Add: Depreciation 5,000,000
Operating Cash Flow ₱50,000,000

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 Free Cash Flow = Operating cash flow – Investment in operating capital
= ₱50,000,000 – [₱32,000,000 + (₱20,000,000 −₱12,000,000)]
Free Cash Flow = ₱50,000,000 − ₱40,000,000 = ₱10,000,000

Problem 3 (Free Cash Flow)

Free Cash Flow = Operating cash flow – Investment in operating capital

₱23,000,000 = OCF − ₱13,000,000
OCF = ₱36,000,000

EBIT ₱45,000,000
Less: Taxes 17,000,000
EAT ₱28,000,000
Add: Depreciation 8,000,000
Operating Cash Flow ₱36,000,000

Problem 4 (Statement of Cash Flows)

Notes payable, beginning ₱208,000,000

Payment 23,000,000
Notes payable, end ₱185,000,000

Problem 5 (Free Cash Flow)

GABRIELLE CORPORATION
Income Statement for the Year Ending December 31, 20X4
(In millions of pesos)
20X4
Net sales ₱ 107.1
Less: Cost of goods sold 75.6
Gross profit 31.5
Less: Depreciation 6.0
Earnings before interest and taxes (EBIT) 25.5
Less: Interest --*
Earnings before taxes (EBT) 37.33
Less: Taxes (25%) 9.33
Net income ₱ 28
* No information given relative to Interest.

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Problem 6 (Free Cash Flow)

Mitch’s Petals Galore, Inc.

Statement of Financial Position as of December 31, 20X3 and 20X4
(in millions of pesos)

20X3 20X4
Assets
Current assets:
Cash and marketable securities ₱ 25 ₱ 28
Accounts receivable 65 75
Inventory 100 118
Total 190 221
Fixed assets:
Gross plant and equipment 300 333
Less: Depreciation 40 54
Net plant and equipment 260 279
Other long-term assets 50 50
Total 310 329
Total assets ₱500 ₱550

Liabilities and Equity

Current liabilities:
Accrued wages and taxes ₱ 15 ₱ 17
Accounts payable 50 56
Notes payable 45 45
Total 110 118
Long-term debt: 190 195
Stockholders’ equity:
Preferred stock (5 million shares) 5 5
Common stock and paid-in
surplus (20 million shares) 40 40
Retained earnings 155 192
Total 200 237
Total liabilities and equity ₱500 ₱550

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Problem 7 (Working with Financial Statements)

Garcia’s Health Care, Inc.

Statement of Financial Position as of December 31, 20X4 and 20X5
(in millions of pesos)

20X4 20X5
Assets
Current assets:
Cash and marketable securities ₱ 395 ₱ 421
Accounts receivable 1,020 1,109
Inventory 1,581 1,760
Total 2,996 3,290
Fixed assets:
Gross plant and equipment 4,743 5,812
Less: Depreciation 640 840

Net plant and equipment 4,103 4,972

Other long-term assets 790 892
Total 4,893 5,864
Total assets ₱ 7,889 ₱9,154

Liabilities and Equity

Current liabilities:
Accrued wages and taxes ₱ 242 ₱ 316
Accounts payable 791 867
Notes payable 714 872
Total 1,747 2,055
Long-term debt: 3,005 3,090
Stockholders’ equity:
Preferred stock (25 million shares) 60 60
Common stock and paid-in
surplus (200 million shares) 637 637
Retained earnings 2,440 3,312
Total 3,137 4,009
Total liabilities and equity ₱ 7,889 ₱ 9,154

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 Garcia’s Health Care, Inc.
Income Statement for Years Ending December 31, 20X4 and 20X5
(in millions of pesos)

20X4 20X5
Net sales ₱ 4,348 ₱ 4,980
Less: Cost of goods sold 2,135 2,371
Gross profits 2,213 2,609
Less: Depreciation 191 200
Earnings before interest and taxes (EBIT) 2,022 2,409
Less: Interest 285 315
Earnings before taxes (EBT) 1,737 2,094
Less: Taxes 632 ₱ 767
Net income ₱ 1,105 ₱ 1,327
Less: Preferred stock dividends ₱ 60 ₱ 60
Net income available to common
stockholders 1,045 1,267
Less: Common stock dividends 395 395
Addition to retained earnings ₱ 650 ₱ 872
Per (common) share data:
Earnings per share (EPS) ₱ 5.225 ₱ 6.33 (1)
Dividends per share (DPS) ₱ 1.975 ₱ 1.975 (2)
Book value per share (BVPS) ₱ 15.385 ₱ 19.82 (3)
Market value (price) per share (MVPS) ₱22.500 ₱26.850
2004 2005

(1) 1,045M = 5.225 1,267M = 6.335

200M 200M

(2) 395M = 1.975 395M = 1.975

200M 200M

(3) 3,137 – 60 = 15.385 4,009 – 60 = 19.82

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 200M 200M
Garcia’s Health Care, Inc.
Statement of Cash Flows for Year Ending December 31, 20X5
(in millions of pesos)

20X5
A. Cash flows from operating activities
Net income ₱ 1,327
Additions (sources of cash):
Depreciation 200
Increase accrued wages and taxes (316 – 242) 74
Increase in accounts payable (867 – 791) 76

Subtractions (uses of cash):

Increase in accounts receivable (1,109 – 1,020) 89
Increase in inventory (1,760 – 1,581) 179
Net cash flow from operating activities ₱ 1,904

B. Cash flows from investing activities

Subtractions:
Increase fixed assets (5,812 – 4,743) 1,069
Increase in other long-term assets (892 – 790) 102
Net cash flow from investing activities ₱ (1,171)

C. Cash flows from financing activities

Additions:
Increase in notes payable (872 – 714) ₱ 158
Increase in long-term debt (3,090 – 3,005) 85
Increase in common and preferred stock --
Subtractions:
Pay dividends (60 + 395) 455
Net cash flow from financing activities ₱ (212)

D. Net change in cash and marketable securities + ₱26

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 Garcia’s Health Care, Inc.
Statement of Retained Earnings as of December 31, 20X5
(in millions of pesos)

Balance of retained earnings, December 31, 20X4 ₱ 2,440

Plus: Net income for 20X5 1,327
Less: Cash dividends paid
Preferred stock 60
Common stock 395
Total cash dividends paid 455
Balance of retained earnings, December 31, 20X5 ₱ 3,312

Answer to Multiple Choice Questions

1. D 5. A 9. C 13. A
2. C 6. B 10. A 14. B
3. D 7. A 11. B 15. A
4. D 8. D 12. D 16. D

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