Question

During 2018, raines umbrella corp. Had sales of $705,000. Cost of goods sold, administrative and selling expenses, and depreciation expenses were $445,000, $95,000, and $140,000, respectively. In addition, the company had an interest expense of $70,000 and a tax rate of 25 percent. (ignore any tax loss carryforward provisions and assume interest expense is fully deductible.) suppose raines umbrella corp. Paid out $102,000 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? (do not round intermediate calculations.)

Answer 1

Answer: Even though Raines Umbrella Corp has a net loss, its operating cash flow is positive $165,000. This indicates that the company has sufficient cash balance to pay dividends of $102,000.

The net new long-term debt is $7000.

We follow these steps to arrive at the answer:

Calculating Net Income:

 Sales                                                       705000

less:  Cost of goods sold                              -445000

  Administrative and Selling expenses        -95000

  Depreciation                                      -140000

  EBIT                                                        25000

less: Interest                                                        70000

Net loss                                                       -45000

Calculating operating Cash Flow OCF:

$OCF = EBIT + Depreciation - Taxes$

Since Raines has a net loss, there are no taxes. So

$OCF = 25000 + 140000 - 0$

$\mathbf{OCF = 165000}$

Calculation of cash flow from assets:

\mathbf{Cash Flow from assets = OCF + net change in capex spending + change in net working capital}

Since spending on net fixed assets and net working capital is zero,

$\mathbf{Cash Flow from assets = OCF = 165000}$

Calculation of cash flow to stockholders

$\mathbf{Cashflow to stock holders = Dividends paid - net new shares issued}$

$\mathbf{Cashflow to stock holders = 102000 - 0 = 102000}$

Cash flow to creditors:

We determine cash flow to creditors as follows:

$\mathbf{Cashflow to creditors = Interest paid - Net new borrowings}$

$\mathbf{Cashflow to creditors = 70000 - Net new borrowings}$

The Cash Flow identity is given by:

$\mathbf{Cashflow from assets = Cash flow to shareholders + Cashflow to creditors}$

$\mathbf{165000 = 102000 + 70000 - Net new debt}$

$\mathbf{Net new debt = 7000}$