FINANCIAL MANAGEMENT

Assignment II

Lecturer:
Ika Pratiwi Simbolon

Group 4:
Eiffelyn Putri Abdikesuma (008201600007)
Giovanni (008201600064)
Jimmy Yaputra (008201600081)
Ni Putu Febby Wulan Bestari (015201400063)
Silvia Sely Grace Gea (008201600062)

President University
Jalan Ki HajarDewantara RT. 2 / RW. 4, Mekarmukti,Cikarang Utara, Bekasi, Jawa Barat 17550, No Telp: 0218910976263,
email: info@president.ac.id website: http://www.president.ac.id

2016/2017
1. Define each of the following terms:
a. Annual Report; balance sheet; income statement
 The four basic statements contained in the annual report are the balance sheet, the
income statement, the statement of stockholders’ equity, and the statement of cash
flows.
 The balance sheet shows assets on the left-hand side and liabilities and equity, or
claims against assets, on the right-hand side. (Sometimes assets are shown at the top
and claims at the bottom of the balance sheet.) The balance sheet may be thought of
as a snapshot of the firm’s financial position at a particular point in time.
 The income statement reports the results of operations over a period of time, and it
shows earnings per share as its “bottom line.”
b. Common stakeholders’ equity, or net worth; retained earnings
 The statement of stockholders’ equity shows the change in retained earnings
between balance sheet dates. Retained earnings represent a claim against assets.
c. Statement of stakeholders’ equity ; statement cash flow
 The statement of cash flows reports the effect of operating, investing, and financing
activities on cash flows over an accounting period.
d. Depreciation; amortization; EBITDA
 Depreciation is an accounting method of allocating the cost of a tangible asset over
its useful life. Businesses depreciate long-term assets for both tax and accounting
purposes.
 Amortization is an accounting term that refers to the process of allocating the cost
of an intangible asset over a period of time.
 Earnings before interest, tax, depreciation and amortization (EBITDA) is a measure
of a company's operating performance. Alternatively, you can also calculate
EBITDA by taking a company's net income and adding back interest, taxes,
depreciation, and amortization
e. Operating current assets; operating current liabilities; net operating capital
 Operating current assets are the current assets that are used to support operations,
such as cash, inventory, and accounts receivable. They do not include short-term
investments.

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  Operating current liabilities are the current liabilities that occur as a natural
consequence of operations, such as accounts payable and accruals. They do not
include notes payable or any other short-term debts that charge interest.
 Net operating working capital is the difference between operating current assets and
operating current liabilities. Thus, it is the working capital acquired with investor-
supplied funds.
 Total net operating capital (which means the same as operating capital and net
operating assets) is the sum of net operating working capital and operating long-term
assets. It is the total amount of capital needed to run the business.
f. Accounting profit; net cash flow; NOPAT; free cash flow
 NOPAT is net operating profit after taxes. It is the after-tax profit a company would
have if it had no debt and no investments in non-operating assets. Because it excludes
the effects of financial decisions, it is a better measure of operating performance than
is net income.
 Net cash flow differs from accounting profit because some of the revenues and
expenses reflected in accounting profits may not have been received or paid out in
cash during the year. Depreciation is typically the largest noncash item, so net cash
flow is often expressed as net income plus depreciation.
 Free cash flow (FCF) is the amount of cash flow remaining after a company makes
the asset investments necessary to support operations. In other words, FCF is the
amount of cash flow available for distribution to investors, so the value of a company
is directly related to its ability to generate free cash flow. FCF is defined as NOPAT
minus the net investment in operating capital.
g. Market Value Added; Economic Value Added
 Market Value Added (MVA) represents the difference between the total market
value of a firm and the total amount of investor-supplied capital. If the market values
of debt and preferred stock equal their values as reported on the financial statements,
then MVA is the difference between the market value of a firm’s stock and the amount
of equity its shareholders have supplied.
 Economic Value Added (EVA) is the difference between after-tax operating profit
and the total dollar cost of capital, including the cost of equity capital. EVA is an
estimate of the value created by management during the year, and it differs

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 substantially from accounting profit because no charge for the use of equity capital is
reflected in accounting profit.
h. Progressive tax; taxable income; marginal and average tax rates
 Progressive tax is the taxing mechanism in which the taxing authority charges more
taxes as the income of the taxpayer increases. A higher tax is collected from the
taxpayers who earn more and lower taxes from taxpayers earning less
 Interest income received by a corporation is taxed as ordinary income; however, 70%
of the dividends received by one corporation from another are excluded from taxable
income.
 Because interest paid by a corporation is a deductible expense whereas dividends are
not, our tax system favors debt over equity financing.
i. Capital gain or loss; tax loss carry back and carry forward
 Ordinary corporate operating losses can be carried back to each of the preceding 2
years and carried forward for the next 20 years in order to offset taxable income in
those years.
 Assets such as stocks, bonds, and real estate are defined as capital assets. If a capital
asset is sold for more than its cost, the profit is called a capital gain; if the asset is
sold for a loss, it is called a capital loss. Assets held for more than a year provide
long-term gains or losses
j. Improper accumulation; S corporation
 S corporations are small businesses that have the limited-liability benefits of the
corporate form of organization yet are taxed as partnerships or proprietorships.
 In the United States, tax rates are progressive—the higher one’s income, the larger
the percentage paid in taxes.

2. What four statement are contained in most annual report?

Annual Report is a vital source of information to the financial world and the one
opportunity in the year to tell shareholders of their Company's record, activity and progress
(Hall, 1975). An annual report complies with legal requirements by providing shareholders
and regulatory authorities with a detailed account of an organization’s operating and
financial performance over its accounting year. According to (Linton, 2010) an annual
report for a corporation normally includes four types of financial statement, such as:
 Balance sheet
A summary of an organization’s financial position. According to Quick MBA, a
balance sheet is useful for evaluating an organization’s ability to meet its long-term
financial commitments. A balance sheet lists all the assets (current assets and fixed

Financial Management – Assignment II |3

 assets) that an organization owns, together with its liabilities, and the equity owned
by various stakeholders.

Assets :
Current Assets : Cash, accounts due for payment, and abilities that can be easily
converted to cash.
Fixed Assets : buildings, equipment or land.

Liabilities:
Taxes, wages, accounts due for settlement and interest.

Equity :
Represents the value of stock owned by stockholders or business owners.

 Income statement
An income statement summarizes the amount of money an organization earned and
the amount it spent during the accounting year. Earnings derive from the revenue
an organization achieves from the sale of products or services, plus any capital
gains. Expenditure refers to the money an organization spends to create revenue,
such as materials, running costs and cost of sales. Deducting expenditure from
revenue provides a figure of net income.
 Cash flow statement
Describe where an organization acquired cash during the accounting period and
how it used the cash during the same period. The cash flow statement analyzes cash
transactions by three categories: operating activities, investing activities and
financing activities. The category of investing activities refers to cash transactions
in buying or selling assets; financing activities includes bank loan, funding through
stock transactions and other forms of credit.
 Equity statement (retained earnings)
Explains changes in the amount of money an organization retains in the business
where this statement shows the owners’ or shareholders’ equity at the beginning of
the period, any investments in the business and the net income for the accounting
period. It also lists any dividends the organization paid to shareholders to arrive at
the closing equity figure.

Financial Management – Assignment II |4

3. Explain the difference between NOPAT and net income. Which is a better measure
of the performance of a company’s operations?
NOPAT (net operating profit after-tax) is the unlevered, after-tax operating cash generated
by a business. It represents the true, normal and recurring profitability of a business
(Trainer, 2012). NOPAT can be said as a profitability measurement that calculates the
theoretical amount of cash that a company could distribute to its shareholders if it had no
debt. In other words, this is the amount of profits that a company makes from its operations
after taxes without regard to interest payments. If the company had no obligations on the
books, it would be able to distribute this entire amount of money to its shareholders at the
end of the year.
 Formula
Calculated by multiplying a company’s operating income by 1 minus the corporate
tax rate.
Net Operating Profit after Tax (NOPAT)
Net Operating Profit after Tax (NOPAT) = Operating Profit x (1 – Tax Rate)

NOPAT = Operating profit X (1 – Tax rate)

If a detailed income statement isn’t available and you can’t figure out the operating
income of the company, you can always calculate the net operating profit after tax
equation using net income by backing out the interest payments like this.
Net Operating Profit after Tax (NOPAT)
Net Operating Profit after Tax (NOPAT) = Net Income + Net Interest X (1 – Tax Rate)

NOPAT = Net Profit + Net Interest X (1 – Tax rate)

According to (Bragg, 2017) net income is the residual amount of earnings after all expenses
have been deducted from sales. Net income also called net profit, is a calculation that
measures the amount of total revenues that exceed total expenses. This is the amount of
money that the company can save for a rainy day, use to pay off debt, invest in new projects,
or distribute to shareholders.

 Formula
Calculated by subtracting total expenses from total revenues.
Net Income
Net Income = Total Revenue – Total Expenses

The difference between NOPAT and net income can be seen from many factors like
definition, use, also from the formula. NOPAT is used for making a comparison between
firms while Net income is used to judge the performance of the company. NOPAT arrives
after deducting tax from operating profit but Net Income arrives after deducting all
expenses, profit, tax and dividends. The company focusses on the calculation of Net Income
for knowing the profitability of the company. Along with that, the stakeholders also easily
understand the net income of the company, as on the basis of it, they will get the dividend.
But NOPAT has its significance in calculating the income of the company if there is no
debt financing as well as to compare two projects or firms. In this way, it primarily
identifies the company’s earnings without interest (Surbhi, 2015).

Financial Management – Assignment II |5

4. What is free cash flow? Why is it the most important measure of cash flow?
Free cash flow (FCF) is a measure of a company's financial performance, represents the
cash that a company is able to generate after spending the money required to maintain or
expand its asset base (Peavler, 2017). FCF is an assessment of the amount of cash a
company generates after accounting for all capital expenditures, such as buildings or
property, plant and equipment. The excess cash is used to expand production, develop new
products, make acquisitions, pay dividends and reduce debt. FCF is important because it
allows a company to pursue opportunities that enhance shareholder value. Usually investors
started looking toward the concept of free cash flow is because it was not as easy to
manipulate as earnings per share or net income.
 Formula
Free Cash Flow
Net Cash Flow from Operation - Capital Expenditures

Net Cash Flow from Operation comes from the statement of cash flows and an increase
in capital expenditures comes from the balance sheet.

5. If you were starting a business, what tax considerations might cause you to prefer to
set it up as a proprietorship or a partnership rather than as a corporation?
Under the 2003 tax law changes, dividends are now taxed as though they were capital gains.
As stated earlier, corporations may deduct interest payments but not dividends when
computing their corporate tax liability, which means that dividends are taxed twice, once at
the corporate level and again at the personal level. (Ehrhardt & Brigham, 2014: 75) While
in a proprietorship or a partnership we only pay the tax once at the individual level.

6. Last year Cole Furnaces had $5 million in operating income (EBIT). The company had
a net depreciation expense of $1 million and an interest expense of $1 million; its
corporate tax rate was 40%. The company has $14 million in operating current assets
and $4 million in operating current liabilities; it has $15 million in net plant and
equipment. It estimates that it has an after-tax cost of capital of 10%. Assume that
Cole’s only noncash item was depreciation.
a) What was the company’s net income for the year?
b) What was the company’s net cash flow?
c) What was the company’s net operating profit after taxes (NOPAT)
d) Calculate net operating working capital and total net operating capital for the
current year.

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e) If total net operating capital in the previous year was $24 million, what was the
company’s free cash flow (FCF) for the year?
f) What was the company’s Economic Value Added (EVA)?

a) EBIT $5,000,000
Less: Interest $1,000,000
EBT $4,000,000
Taxes (40%) $1,600,000
Net income before preferred dividend $2,400,000
Preferred dividend $ 0
Net Income $2,400,000
b) Net cash flow = Net income + Depreciation and amortization
Net cash flow = $2,400,000 + $1,000,000
Net cash flow = $3,400,000
c) NOPAT = EBIT (1 − Tax rate)
NOPAT = $5,000,000 (1 – 0.4)
NOPAT = $5,000,000 (0.6)
NOPAT = $3,000,000
d) NOWC = Operating current assets - Operating current liabilities
NOWC = $14,000,000 - $4,000,000
NOWC = $10,000,000
Total net operating capital = NOWC + operating long-term assets
Total net operating capital = $10,000,000 + $15,000,000
Total net operating capital = $25,000,000
e) Net investment in operating capital
= Total net operating capital this year - Total net operating capital previous year
= $25,000,000 - $24,000,000
= $1,000,000
FCF = NOPAT − Net investment in operating capital
FCF = $3,000,000 - $1,000,000
FCF = $2,000,000
f) Economic Value Added
= Net operating profit after taxes (NOPAT) - After-tax dollar cost of capital used to
support operations

Financial Management – Assignment II |7

 = EBIT (1-Corporate Tax Rate) – (Operating Capital)*(After-Tax Percentage Cost of
Capital)
= $3,000,000 – ($25,000,000*10%)
= $3,000,000 - $2,500,000
= $500,000
7. Little Books Inc. recently reported $3million of net income. Its EBIT was $6million, and
its tax rate was 40%. What was its interest expense? [Hint: write out the headings for
an income statement and fill in the known values. Then divide $3million of net income
by 1 – T = 0.6 to find the pre-tax income. The difference between EBIT and taxable
income must be the interest expense.
 Net income = 3,000,000
 EBIT = 6,000,000
 Tax rate = 40% = 0.04

Interest expense = (X) ????

Pre-tax income = 3,000,000/ (1-T)

3,000,000/0.06 = 5,000,000

EBIT = 6,000,000 – X
X = EBIT – Pre-tax income
X = 6,000,000 – 5,000,000 = 1,000,000
So, the Interest expense is $1,000,000

8. Pearson Brothers recently reported an EBITDA of $7.5 million and net income of $1.8
million. It had $2.0 million of interest expense, and its corporate tax rate was 40%.
What was its charge for depreciation and amortization?

 EBITDA = 7,500,000
 Net income = 1,800,000
 Interest expense = 2,000,000
 Tax rate = 40% = 0.04

EBT = Net income / (1-tax rate)

= 1,800,000/ (1-0.04) = 3,000,000.

Depreciation + Amortization + Interest + EBT = EBITDA

Depreciation + Amortization = EBITDA – Interest expense – EBT
= 7,500,000 – 2,000,000 -3,000,000
= 2,500,000.

So, depreciation and amortization is 2,500,000.

Financial Management – Assignment II |8

 9. The Moore Corporation has operating income (EBIT) of $750,000. The company’s
depreciation expense is $200,000. Moore is 100% equity financed, and it faces a 40%
tax rate. What is the company’s net income? What is its net cash flow?
EBIT: $750,000
Depreciation Expense: $200,000
Interest rate: 40%

EBIT $750,000
Less: Tax 40%
($750,000 x 40%) $300,000
Net Income $450,000

Net Cash Flow = Net Income + Depreciation Expense

Net Cash Flow = $450,000 + $200,000
Net Cash Flow = $650,000

10. Using Rhodes Corporation’s financial statements (shown below), answer the following
questions.

Financial Management – Assignment II |9

a) What is the net operating profit after taxes (NOPAT) for 2010? What are the
amounts of net operating working capital for both years?
b) What are the amounts of total net operating capital for both years?
c) What is the free cash flow for 2010?
d) What is the ROIC for 2010?
e) How much of the FCF did Rhodes use for each of the following purposes: after-
tax interest, net debt repayments, dividends, net stock repurchases, and net
purchases of short-term investments? (Hint: Remember that a net use can be
negative.)

a) NOPAT = EBIT (1 – Tax rate)

= $1,260 million (1 – 0.4)
= $1,260 million (0.6)
= $756 million
Total current assets – Short-term Investment
Operating current assets 2010 $4,950 million
Operating current assets 2009 $4,500 million
Total current liabilities – Notes Payable
F i n a n c i a l M a n a g e m e n t – A s s i g n m e n t I I | 10
 Operating current liabilities 2010 $1,650 million
Operating current liabilities 2009 $1,500 million
NOWC = (Operating current assets – Operating current liabilities)
NOWC for 2010 = $4,950 million - $1,650 million
= $3,300 million

NOWC for 2009 = $4,500 million - $1,500 million

= $3,000 million

b) Operating Capital = NOWC + Net Fixed assets

Operating Capital for 2010 = $3,300 million + $3,850 million
= $7,150 million
Operating Capital for 2009 = $3,000 million + $3,500 million
= $6,500 million

c) Net Investment in operating capital = Operating Capital 2010 – Operating Capital 2009
= $7,150 million - $6,500 million
= $650 million

FCF = NOPAT - Net Investment in operating capital

FCF = $756 million - $650 million
FCF = $106 million

d) ROIC = NOPAT / Total Net Operating Income

= $756 million / $7,150 million
= $10.5%

e) After-tax interest payment = Interest (1 – tax rate)

= $120 Million (1 – 0.4)
= $72 Million
Net reduction in debt
= (Beg. Notes Payable + Beg. Long-term bonds) - (End. Notes Payable + End. Long-
term bonds)
= ($200 + $1,000) - ($384 + $1,100)

F i n a n c i a l M a n a g e m e n t – A s s i g n m e n t I I | 11
= $1,200 - $1,484
= -$284 Million

Dividend payments = Preferred Dividends + Common Dividends

= $0 + $220 Million
= $220 Million

Net Stock Repurchases

= The amount at the beginning of the year - the amount at the end of the year
= (Beg. Common Stock + Beg. Preferred Stock) - (End. Common Stock + End.
Preferred Stock)
= ($4,400 Million + $0) – ($4,312 + $0)
= $88 Million

Net purchases of short-term investments

= The amount at the end of the year - The amount at the beginning of the year
= $110 Million - $100 Million
= $10 Million

After-tax interest payment $72 Million

Net reduction in debt -$284 Million
Dividend payments $220 Million
Net Stock Repurchases $88 Million
Net purchases of short-term investments $10 Million
Total uses of the FCF $106 Million

F i n a n c i a l M a n a g e m e n t – A s s i g n m e n t I I | 12
Bibliography

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