Q-1:Determine historical parameter values for fiscal 1996 and 1997 that relate i

Question

Q-1:Determine historical parameter values for fiscal 1996 and 1997 that relate incremental fixed capital to incremental sales. Assume depreciation is a reasonable estimate of the cost to replace physical capacity and that The May Company has no capitalized interest. Further assume that the amortization portion of “depreciation and amortization” in the cash flow statement is negligible. Treat the disposition of property and equipment as a “negative capital expenditure.”

Q-2 :In converting the 1997 income statement and cash flow statement to a free cash flow basis, you removed the $299 million of interest expense from earnings (and therefore from operating cash flow). You also must adjust the provision for income taxes for the related tax effect. In doing so, the $500 million income tax provision reported under GAAP becomes what amount on a free cash flow basis? (Assume a 39% marginal tax rate and no other adjustments to the income tax provision.)

Explanation / Answer

Q1) Incremental sales in 1996=Sales in 1996- Sales in 1995=11546-10402= 1144

Incremental fixed capital in 1996= Capital Expenditure in 1996- Depreciation expense in 1996 =0-374=-374(..as the depreciation is sole criteria to asses fixed capital with no amortization and capital interest,assume 0 capex as no info on investing activities provided and as per question assumptions)

Ratio(Incremental fixed capital/Incremental sales in 1996)=-374/1144=-32.69%

Incremental sales in 1997=Sales in 1997- Sales in 1996=12352-11546= 806

Incremental fixed capital in 1997= Capital Expenditure in 1997- Depreciation expense in 1997=-0-412=-412

Ratio(Incremental fixed capital/Incremental sales in 1997)=-412/806=-51.11%

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