CHAPTER 3

Financial
Statements, Cash
Flow, and Taxes

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 Figure 3.1 A Typical Balance Sheet

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 Table 3.1 Allied Food Products: December 31 Balance Sheets (Millions of
Dollars)

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 Table 3.2 Allied Food Products: Income Statements for Years Ending December
31 (Millions of Dollars, Except for Per-Share Data)

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 Table 3.3 Allied Food Products: Statement of Cash Flows for 2018 (Millions of
Dollars)

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 Table 3.4 Allied Food Products: Statement of Stockholders’ Equity, December 31,
2018 (Millions of Dollars)

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 Free Cash Flow

The amount of cash that could be withdrawn without harming a firm’s ability to
operate and to produce future cash flows.

Net Operating Profit after Tax (NOPAT) The profit a company would generate if it
had no debt and held only operating assets.

• positive level of FCF - enough cash to finance current investments in fixed assets
and working capital.
• negative free cash flow - company does not have sufficient internal funds to finance
investments in fixed assets and working capital, and that it will have to raise new
money in the capital markets in order to pay for these investments.

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 Active Learning: Free Cash Flow

A company has EBIT of $30 million, depreciation of $5 million,

and a 40% tax rate. It needs to spend $10 million on new fixed
assets and $15 million to increase its operating current assets. It
expects its accounts payable to increase by $2 million, its
accruals to increase by $3 million, and its notes payable to
increase by $8 million. The firm’s current liabilities consist of
only accounts payable, accruals, and notes payable. What is its
free cash flow?

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 Active Learning: Free Cash Flow

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 Performance Measures for Evaluating Managers

 Accounting statements are insufficient for

evaluating managers’ performance because they
do not reflect market values.
 Performance Measures
MVA = Difference between market value and book
value of a firm’s common equity.
(P0 x Number of shares) – Book value.
EVA = Estimate of a business’ true economic
profit for a given year.
EBIT(1 – T)–(Total invested capital  Cost of capital)

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 What is the relationship between EVA and MVA?

If EVA is positive, then AT operating

income > cost of capital needed to
produce that income.

Positive EVA on annual basis helps to

ensure MVA is positive.

MVA is applicable to entire firm, while

EVA can be calculated on a divisional
basis as well.

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 Individual Income Tax Rates

● Progressive Tax
– A progressive tax is based on the taxpayer's ability to pay. It imposes a lower tax
rate on low-income earners than on those with a higher income.
– US tax ranges from 10% to 37%

● Proportional Tax/Flat Tax

– A flat tax system applies the same tax rate to every taxpayer regardless of income
bracket.
– Individual Income tax in Kazakhstan is 10%
● Regressive Tax
● A regressive tax is a tax applied uniformly, taking a larger percentage of income
from low-income earners than from high-income earners. 
● A regressive tax is a type of tax that is assessed regardless of income, in which low-
and high-income earners pay the same doll

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 Table 3.6 2017 Corporate Tax Rates

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 Table 3.7 Returns to Investors under Bond and Stock Financing

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