P1.

Cash Flows Ritter Corporation's accountants prepared the following financial statements
for year-end 2012:
 a. Explain the change in cash during 2012.
 b. Determine the change in net working capital in 2012.
 c. Determine the cash flow generated by the firm's assets during 2012.

RITTER CORPORATION Income Statement 2012

Revenue $750

Expenses 565

Depreciation 90

Net income $ 95

Dividends $ 75

Ritter Corporation Balance sheet December 31

2012 2011
Assets
Cash $ 65 $ 55
Other current assets 170 165
Net fixed assets 390 370
Total assets 625 590
Liabilities and Equity
Accounts payable $ 125 $115
Long-term debt 145 140
Stockholder equity 355 335
Total liabilities and equity 625 590

Solution:

a) Explanation of cash change during 2012:

Cash flow from operating activates:

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 Add: Net profit 95
Add: Depreciation Expense 90
Less: Increase in current assets 5
Less: Decrease in Accounts payable 10

cash from operating activities 170 170

Cash flow from investing activities:-

Investment In fixed assets -90 -90

Cash flow from Financing activities:-

Long term borrowings 5

Dividend paid -75 -70

Net cash flow from all activities 10

Opening cash balance 55

Closing cash balance 65

b) Computation of Change in net working

capital 2012:

2012 2011

Current assets:-

Cash 65 55
Other current assets 170 165

Total Current assets 235 220

Current liabilities:-

Accounts payable 125 115

Total Current liabilities 125 115

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 Working Capital 110 105

Change in Net working capital in 2010 110-105

$5

C) Cash flow generated by firms assets during 2012:

Cash flow generated by firms asset during 2012 = Cash flow from operation= 170

P2. Calculating Total Cash Flows Schwert Corp. shows the following information on its 2012
income statement: sales = $185,000; costs = $98,000; other expenses = $6,700; depreciation
expense = $16,500; interest expense = $9,000; taxes = $19,180; dividends = $9,500. In addition,
you're told that the firm issued $7,550 in new equity during 2012 and redeemed $7,100 in
outstanding long-term debt.

 a. What is the 2012 operating cash flow?

 b. What is the 2012 cash flow to creditors?
 c. What is the 2012 cash flow to stockholders?
 d. If net fixed assets increased by $26,100 during the year, what was the addition to net
working capital (NWC)?

Solution:
A. operating cash flow = EBIT + depreciation
EBIT = sales – cost – other expenses - depreciation
= 185,000 -98,000 – 6,700 -16,500
= 63,800
Operating cash flow = 63,800 + 16,500 -19,180
= 61,120
B. cash flow to creditor = redeemed long term debt + interest
= 7,100 + 9,000
= 16,100
C. cash flow to stock holder = dividends – issued equity
= 9,500 – 7,550
= 1,950
D. Net working capital increase by 26,100.
As net working capital = current assets – current liability and fixed asset is a part of current asset.

P3. Sales and Growth The most recent financial statements for Fontenot Co. are shown here:

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 Income statement Balance statement
Sales $54,000 current assets $ 31000 long-term debt $68000
Costs 39300 fixed assets 118000 equity 81000
Taxable income 14700 total 149000 total 149000
Taxes(34%) 4998
Net income $ 9702
Assets and costs are proportional to sales. The company maintains a constant 30 percent dividend
payout ratio and a constant debt–equity ratio. What is the maximum increase in sales that can be
sustained assuming no new equity is issued?
Solution:
The maximum percentage sales increase without issuing new equity is the sustainable growth
rate.
To calculate the sustainable growth rate, we first need to calculate the ROE,
which is:
ROE = NI / TE
ROE = $9,702 / $81,000
ROE = .1198
The plowback ratio, b, is one minus the payout ratio, so:
b = 1 — .30
b= .70
Now we can use the sustainable growth rate equation to get:
Sustainable growth rate = (ROE x b) / [1 — (ROE x b)]
Sustainable growth rate = [.1198(.70)] / [1 — .1198(.70)]
Sustainable growth rate = .0916 or 9.16%
So, the maximum dollar increase in sales is:
Maximum increase in sales = $54,000(.0916)
Maximum increase in sales = $4,946.4

P4. Calculating EFN The most recent financial statements for Bradley, Inc., are shown here
(assuming no income taxes):
Income statement balance sheet
Sales $ 6500 Assets $ 17400 Debt $8400
Costs 5320 equity 9000
Net income $ 1180 total 17400 total 17400
Assets and costs are proportional to sales. Debt and equity are not. No dividends are paid. Next
year's sales are projected to be $7,280. What is the external financing needed?

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 Solution:
An increase of sales to $7,280 is an increase of:
Sales increase = ($7,280 - 6,500)/ $6,500
Sales increase = .12 or 12%
Assuming costs and assets increase proportionally. the pro forma financial statements will look
like this:
Pro forma income statement Pro forma balance sheet

Sales 7,280 Assets 19,488 Debt 8,400

Costs 5,958 Equity 10,322

Net income 1,322 Total 19,488 Total 18,722

If no dividends are paid. the equity account will increase by the net income so:
Equity = $9,000 + 1,322
Equity = $10,322
So the EFN is:
EFN = Total assets — Total liabilities and equity
EFN = $19,488 – 18,722 = $766

P5. Sustainable Growth Rate The Steiben Company has an ROE of 13.1 percent and a payout
ratio of 40 percent.

 a. What is the company's sustainable growth rate?

 b. Can the company's actual growth rate be different from its sustainable growth rate?
Why or why not?
 c. How can the company increase its sustainable growth rate?

Solution:
A. the sustainable growth is:
sustainable growth rate = ROE x b / 1 – roe x b
where, b = retention ratio = 1 – payout rate = .60
so, the calculation is
Sustainable growth rate = ROE x b / 1 – roe x b
Sustainable growth rate = .1310 x .60 / 1 - .1310 x .60
Sustainable growth rate = .0853 or 8.53
B. yes , it is possible for the sustainable growth rate and the actual growth rate to be different. If
any of the actual parameters in the sustainable growth rate equations different from those who

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 used it to compute the sustainable growth rate, then the actual growth rate will be different from
the sustainable growth rate. Since, in the calculation sustainable growth includes in the
calculation, it can make an impact to change the profit margin and total asset turnover.
C. Doing any of the followings in below, company can increase its growth rate:
 Increase company profit margin, it is most likely by better controlling costs.
 Selling more debt or repurchasing stock can increase the debt to equity ratio.
 Utilize company assets more efficiently like decrease the total assets or sales ratio.
 Company can reduce its dividend payout ratio.
P6. Return on Equity Firm A and Firm B have debt–total asset ratios of 35 percent and 55
percent and returns on total assets of 9 percent and 7 percent, respectively. Which firm has a
greater return on equity?
Solution:
Firm A = 35 x 0.09 = 3.15 (of some unit)
Firm B = 55 x 0.07 = 3.85 (of some unit)
it shows firm B has the greater return on equity.

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