AF 3313 – Business Finance

Week 2 Tutorial

Ch2: 3,8,13,14,16

Tutor: YAN Siyuan (Adam)

Question 3

AF 3313 – Business Finance

Question 3
Given information for Klingon company:
Market values (price at trading):
The machinery (fixed assets): $6.5 million
All the current assets: $2.6 million

Book values (recorded in the financial statements):

Net fixed assets: $5.2 million
Current liabilities: $2.4 million
Net working capital: $0.8 million

AF 3313 – Business Finance

Question 3
To find the book value of current assets, we use:
NWC = CA – CL. Rearranging to solve for current assets:
CA = NWC + CL = $0.8M + $2.4M = $3.2M

Book value assets = Book value CA + Book value NFA

= $3.2M + $5.2M
= $8.4M
The market value of current assets and net fixed assets is given, so:
Market value assets = Market value CA + Market value NFA
= $2.6M + $6.5M
= $9.1M

AF 3313 – Business Finance

Question 8

AF 3313 – Business Finance

Question 8
A company borrows money from its creditors and should pay interests in
return.

Cash flow to creditors = Interest paid – Net new borrowing

Cash flow to creditors = $127,000 – (LTDend – LTDbeg)
Cash flow to creditors = $127,000 – ($1,520,000 – 1,450,000)
Cash flow to creditors = $57,000

AF 3313 – Business Finance

Question 13

AF 3313 – Business Finance

Question 13
Question (a)

Interest = Notes Payable * Interest Rate

= $800,000 * 7%
= $56,000

Taxes = Taxable Income * Tax Rate

= $134,000 * 35%
= $46,900

AF 3313 – Business Finance

Question 13
Question (b)
To calculate OCF, we need to do two adjustments on EBIT:
1. Add back depreciation because it is non-cash expense;
2. Subtract taxes because taxes expense is paid in cash.

OCF = EBIT + Depreciation – Taxes

And the operating cash flow is:

OCF = $190,000 + 130,000 – 46,900
OCF = $273,100

AF 3313 – Business Finance

Question 14

AF 3313 – Business Finance

Question 14
Question (a)
To find the OCF, we must firstly
build up the income statement.

OCF = EBIT + Depreciation – Taxes

OCF = $63,800 + 16,500 – 19,180
OCF = $61,120

AF 3313 – Business Finance

Question 14
Question (b)

CF(C) = Interest – Net new LTD

CF(C) = $9,000 – (–$7,100)
CF(C) = $16,100

AF 3313 – Business Finance

Question 14
Question (c)

CF(S) = Dividends – Net new equity

CF(S) = $9,500 – 7,550
CF(S) = $1,950

AF 3313 – Business Finance

Cash Flow
From the balance sheet identity, we know that the value of a firm’s assets
is equal to the value of its liabilities plus the value of its equity. Similarly,
the cash flow from the firm’s assets must equal the sum of the cash flow
to creditors and the cash flow to stockholders (cash flow identity):

CF(A) = CF (C) + CF (S)

CF(A) = OCF – Net capital spending – Change in NWC

Cash flow from assets is also called total cash flow of the firm and it
involves three components: operating cash flow, capital spending and
change in net working capital.

AF 3313 – Business Finance

Question 14
Question (d)
CF(A) ≡ CF(C) + CF(S)
CF(A) = $16,100 + 1,950 = $18,050
CF(A) = OCF – Net capital spending – Change in NWC
Net capital spending = Increase in NFA + Depreciation
Net capital spending = $26,100 + 16,500
Net capital spending = $42,600
Now we can use:
CF(A) = OCF – Net capital spending – Change in NWC
$18,050 = $61,120 – 42,600 – Change in NWC.
Solving for the change in NWC gives $470, meaning the company
increased its NWC by $470.

AF 3313 – Business Finance

Question 16
Shareholders ’ equity represents the difference between the value of the
assets and the debt of the firm. In this sense, it is a residual claim on the
firm ’ s assets.

The market value of shareholders’ equity cannot be negative.

Shareholders’ equity = Max [(TA – TL), 0]

So, if TA is $12,400, equity is equal to $1,500, and if TA is $9,600,

equity is equal to $0.
Thanks for
learning!

AF 3313 – Business Finance