During 2014, Raines Umbrella Corp. had sales of $830,000. Cost of goods sold, ad

Question

During 2014, Raines Umbrella Corp. had sales of $830,000. Cost of goods sold, administrative and selling expenses, and depreciation expenses were $575,000, $125,000, and $145,000, respectively. In addition, the company had an interest expense of $80,000 and a tax rate of 35 percent. (Ignore any tax loss carryback or carryforward provisions.)

Suppose Raines Umbrella Corp. paid out $59,000 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 was the net new long-term debt?

During 2014, Raines Umbrella Corp. had sales of $830,000. Cost of goods sold, administrative and selling expenses, and depreciation expenses were $575,000, $125,000, and $145,000, respectively. In addition, the company had an interest expense of $80,000 and a tax rate of 35 percent. (Ignore any tax loss carryback or carryforward provisions.)

Explanation / Answer

Profit before tax (PBT) = Sales - Cost of goods sold - Administrative expense - Selling expense - Depreciation - Interest expense

= $830,000 - $575,000 - $125,000 - $145,000 - $80,000

= -$95,000

Since the firm incurred PBT loss of $95,000, so no tax would be charged and Profit after tax (PAT) would -$95,000.

Now, Cash accrual = PAT + Depreciation

= -$95,000 + $145,000

= $50,000

Now, it would be impossible to pay $59,000 as cash dividends with only $50,000 of cash accrual. So, the firm has to raise the deficit through new long-term debt.

Therefore, Net new long-term debt = Cash dividend - Cash accrual

= $59,000 - $50,000

= $9,000

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