During 2010, Raines Umbrella Corp. had sales of $820,000. Cost of goods sold, ad

Question

During 2010, Raines Umbrella Corp. had sales of $820,000. Cost of goods sold, administrative and selling expenses, and depreciation expenses were $575,000, $90,000, and $160,000, respectively. In addition, the company had an interest expense of $100,000 and a tax rate of 35 percent. (Ignore any tax loss carryback or carryforward provisions.) Suppose Raines Umbrella Corp. paid out $57,000 in cash dividends. Is this possible? If spending on net fixed assets and net working capital was zero, and if no new stock was issued during the year, what is the net new long-term debt? Net new long-term debt $

Explanation / Answer

Income Statement Sales $820,000 Less: COGS 575,000 A&S expenses 90,000 Depreciation 160,000 ------------------------------ EBIT –$5,000 less: Interest 100,000 -------------------------------- Taxable income –$105,000 Taxes (35%) 0 ---------------------------------- a. Net income –$105,000 b. OCF = EBIT + Depreciation – Taxes = –$5,000 + 160,000 – 0 = $155,000 A firm can still pay out dividends if net income is negative; it just has to be sure there is sufficient cash flow to make the dividend payments. Change in NWC = Net capital spending = Net new equity = 0. (Given) Cash flow from assets = OCF – Change in NWC – Net capital spending Cash flow from assets = $155,000 – 0 – 0 = $155,000 Cash flow to stockholders = Dividends – Net new equity = $57000– 0 = $57000 Cash flow to creditors = Cash flow from assets – Cash flow to stockholders = $155000 – 57000 = $98,000 Cash flow to creditors = Interest – Net new LTD Net new LTD = Interest – Cash flow to creditors = $100,000 – 98,000 = $2000

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