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2/18/2005

Chapter 7. Ch 07-10 Build a Model


Here are the balance sheets as given in the problem: Cumberland Industries December 31 Balance Sheets (in thousands of dollars) 2006 Assets Cash and cash equivalents Short-term investments Accounts Receivable Inventories Total current assets Net fixed assets Total assets Liabilities and equity Accounts payable Accruals Notes payable Total current liabilities Long-term debt Total liabilities Common stock Retained Earnings Total common equity Total liabilities and equity $91,450 $11,400 $103,365 $38,444 $244,659 $67,165 $311,824 2005 $74,625 $15,100 $85,527 $34,982 $210,234 $42,436 $252,670

$30,761 $30,477 $16,717 $77,955 $76,264 $154,219 $100,000 $57,605 $157,605 $311,824

$23,109 $22,656 $14,217 $59,982 $63,914 $123,896 $90,000 $38,774 $128,774 $252,670

a. The companys 2006 sales were $455,150,000, and EBITDA was 15 percent of sales. Furthermore, depreciation amounted to 11 percent of net fixed assets, interest charges were $8,575,000, the state-plusfederal corporate tax rate was 40 percent, and Cumberland pays 40 percent of its net income out in dividends. Given this information, construct Cumberland's 2006 income statement. The input information required for the problem is outlined in the "Key Input Data" section below. Using this data and the balance sheet above, we constructed the income statement shown below. Key Input Data for Cumberland Industries Sales Revenue EBITDA as a percent of sales Depr. as a % of Fixed Assets Tax rate Interest Expense Dividend Payout Ratio $455,150 15% 11% 40% $8,575 40% 2006 $455,150 $386,878 $68,273 2005 $364,120 $321,109 $43,011

Sales Expenses excluding depreciation and amortization EBITDA

Depreciation (Cumberland has no amortization charges) EBIT Interest Expense EBT Taxes (40%) Net Income Common dividends Addition to retained earnings

$7,388 $60,884 $8,575 $52,309 $20,924 $31,386 $12,554 $18,831

$6,752 $36,259 $7,829 $28,430 $11,372 $17,058 $6,823 $10,235

b. Next, construct the firms statement of retained earnings for the year ending December 31, 2006, and then its 2006 statement of cash flows. Statement of Retained Earnings (in thousands of dollars) Balance of Retained Earnings, December 31, 2005 Add: Net Income, 2006 Less: Common dividends paid, 2006 Balance of Retained Earnings, December 31, 2006 Statement of Cash Flows (in thousands of dollars) Operating Activities Net Income Adjustments: Noncash adjustment: Depreciation Due to changes in working capital: Increase in accounts receivable Increase in inventories Increase in accounts payable Increase in accruals Net cash provided by operating activities Investing Activities Cash used to acquire gross fixed assets Financing Activities Decrease in short-term investments Increase in notes payable Increase in long-term debt Increase in common stock Payment of common dividends Net cash provided by financing activities Net increase/decrease in cash Add: Cash balance at the beginning of the year Cash balance at the end of the year $38,774 $31,386 $12,554 $57,605

$31,386

$7,388 -$17,838 -$3,462 $7,652 $7,821 $32,947

-$32,117

$3,700 $2,500 $12,350 $10,000 -$12,554 $15,995 $16,825 $74,625 $91,450

c. Calculate net operating working capital, total net operating capital, net operating profit after taxes, operating cash flow, and free cash flow for 2006.

c. Calculate net operating working capital, total net operating capital, net operating profit after taxes, operating cash flow, and free cash flow for 2006. Net Operating Working Capital Operating current assets $233,259 $172,021 Operating current liabilities $61,238

NOWC06 = = =

NOWC05 = = =

Operating current assets $195,134 $149,369

Operating current liabilities $45,765

Total Net Operating Capital TOC06 = NOWC = $172,021 = $239,186 TOC05 = = = NOWC $149,369 $191,805

+ +

Fixed assets $67,165

+ +

Fixed assets $42,436

Net Operating Profit After Taxes NOPAT06 = EBIT = $60,884 = $36,531 Operating Cash Flow OCF06 = NOPAT = $36,531 = $43,919 Free Cash Flow FCF06 = = = or FCF06 = = = NOPAT $36,531 -$10,850

x x

(1-T) 60%

+ +

Depreciation $7,388

OCF $43,919 -$10,850

Gross investment in operating capital $54,769

Net investment in operating capital $47,381

d. Calculate the firms EVA and MVA for 2006. Assume that Cumberland had 10 million shares outstanding, that the year-end closing stock price was $17.25 per share, and its after-tax cost of capital Additional Input Data Stock price # of shares (in thousands)

$17.25 10,000

A-T cost of capital Market Value Added MVA = Stock price = $17.25 = $172,342,395 Economic Value Added EVA = NOPAT = $36,531 = $7,828

12%

x x

# of shares 10,000,000

Total common equity $157,605

Operating Capital $239,186

x x

After-tax cost of capital 12%