just only 2 questions ,please read the requirment word by word and be careful about the style of the reference(APA) , file 3.1 is for question 2..BTW,please focus the every step

FINANCE SPOTLIGHT YOUR MONEY Accounting is the language of business A firm's financial statements provide a visual representation of the firm that is used to describe the business to investors and others outside the firm as well as to the firm's employees. Consequently, we can think of a firm's financial statements and the various terms used to describe the firm and its operations as the language of business. As such, everyone who becomes a manager, no matter what their area of expertise, needs to know how to 'speak business', and this means knowing how to read and interpret financial statements. For example, when the firm communicates with its bank or the investment analysts who follow the firm's ordinary shares, financial statement results provide the common language. When members of the firm's top management are determining the bonuses to pay at year-end, they look to the firm's financial performance as reflected in the financial statements. Moreover, progressing up the ranks of the firm's management team requires that you develop a broader understanding of the firm and how each of its components fits together. The firm's financial statements provide the key to gaining this knowledge. Objective 1 Describe the content of the four basic financial statements and discuss the importance of financial statement analysis to the financial manager. 3.1 An overview of the firm's financial statements In Chapter 2, we looked at the world of business through the eyes of an investor using security prices from financial markets. In this chapter, we look at the firm from the perspective of the financial analyst by reviewing the firm's financial statements, including the income statement, balance sheet and cash flow statement. Understanding the financial health of a business by reviewing its financial statements is also important to the financial manager whose goal is to determine how to increase the value of the firm. basic financial statements The accounting and financial regulatory authorities mandate the following four types of financial statements: 1 Income statement (also referred to as a statement of comprehensive income or a profit and loss statement) includes the revenue the firm has earned over a specific period of time, usually a quarter of a year or a full year; the expenses it has incurred during the year to earn its revenues; and the profit the firm has earned. 2 Balance sheet (also referred to as a statement of financial position)contains information as of the date of its preparation about the firm's assets (everything of value the company owns), liabilities (the firm's debts) and shareholders' equity (the money invested by the company owners). As such, the balance sheet is a snapshot of the firm's assets, liabilities and owners' equity for a particular date. 3 Cash flow statement (also referred to as a statement of cash flows)reports cash received and cash spent by the firm over a specified period of time, usually a quarter of a year or a full year. Statement of changes in equityprovides a detailed account of the firm's activities in the ordinary and preference share accounts, the retained earnings account and changes to owners' equity that do not appear in the income statement. 4 In this chapter, we review the basic content and format of the income statement, balance sheet and cash flow statement. We do not discuss the statement of changes in equity, as the information we need from this statement can be obtained from the income statement and balance sheet. why study financial statements? Analysing a firm's financial statements can help managers carry out three important tasks: (1) assess current performance, (2) monitor and control operations, and (3) plan and forecast future performance: CHAPTER 3 1 2 3 I Understanding financial statements, taxes and cash flows Financial statement analysis. The basic objective of financial statement analysis is to assess the financial condition of the firm being analysed. In a sense, the analyst performs a financial analysis so he or she can see the firm's financial performance the same way an outside investor would see it. In Chapter 4, we delve into the tools and techniques used in carrying out financial statement analysis. Financial control. Managers use financial statements to monitor and control the firm's operations. The performance of the firm is reported using accounting measures that compare the prices of the firm's products and services with the estimated cost of providing them to buyers. Moreover, the board of directors uses these performance measures to determine executives' bonuses. The company's creditors also use performance measures based on the firm's financial statements to determine whether or not to extend the company's loans. For example, a common restriction included in loan agreements prohibits firms from borrowing more than a specific percentage of their total assets as reflected in the firms' financial statements. Financial forecasting and planning. Financial statements provide a universally understood format for describing a firm's operations. Consequently, financial planning models are typically built using the financial statements as a prototype. We address financial planning in Chapter 17. This chapter focuses on P Principle 3: Cash flows are the source of value. A key issue that we will discuss is the distinction between the earnings numbers that the firm's accountants calculate and the amount of cash that a firm generates from its various lines of business. This difference is a primary source of differentiation between the study of finance and the study of accounting. For example, firms can earn positive accounting earnings while haemorrhaging cash, and can generate positive cash flow while reporting accounting losses. So, a key objective in this chapter for the financial manager involves developing a good understanding of accounting earnings and how they relate to cash flows. what are the accounting principles used to prepare financial statements? Accountants use three fundamental principles when preparing a firm's financial statements: (1) the revenue recognition principle, (2) the matching principle and (3) the historical cost principle. Understanding these principles is critical to a full and complete understanding of what information is reported in a firm's financial statements and how that information is reported. Much of the accounting fraud that has occurred in Australia can be traced back to violations of one or more of these basic principles of accounting. 1 The revenue recognition principle. This principle provides the basis for deciding what revenuethe cumulative dollar amount of goods and services the firm sold to its customers during the periodshould be reported in a particular income statement. The principle states that revenue should be included in the firm's income statement for the period in which (1) its goods and services were exchanged for either cash or accounts receivable (credit sales that have not yet been collected), or (2) the firm has completed what it must do to be entitled to the cash. As a general rule, a sale can be counted only when the goods sold leave the business's premises en route to the customer. The revenue recognition principle guides accountants when it is difficult to determine whether revenues should be reported in one period or another. 2 The matching principle. This principle determines what costs or expenses can be attributed to this period's revenues. Once the firm's revenues for the period have been determined, its accountants then determine the expenses for the period by letting the expenses 'follow' the revenues, so to speak. For example, employees' wages are not recognised when the wages are paid, or when their work is performed, but when the product produced as a result of that work is sold. Therefore, expenses are matched with the revenues they helped to produce. 3 The historical cost principle. This principle provides the basis for determining the dollar values the firm reports on the balance sheet. Most assets and liabilities are 41 42 PART 1 I Introduction to financial management reported in the firm's financial statements on the basis of the price the firm paid to acquire them. This price is called the asset's historical cost. This may or may not a equal the price the asset might bring if it were sold today. (Usually it does not.) Remembering these three principles will help you understand what you see in the firm's financial statements and why it is reported that way. Furthermore, having a basic understanding of accounting principles will make you a much more informed user of accounting information and a much better financial analyst. Before you move on to 3.2 Concept Check 3.1 1 Name the four basic financial statements that make up the published financial reports of a firm and describe the basic function of each. 2 what are the three uses of a firm's financial statements for the firm's management? 3 Describe the revenue recognition, matching and historical cost principles as they are applied in the construction of a firm's financial statements. Objective 2 Evaluate firm profitability using the income statement. 3.2 the income statement An income statement, also called a statement of comprehensive income or a profit and loss statement, measures the amount of profit generated by a firm over a given time period (usually a year or a quarter). In its most basic form, the income statement can be expressed as follows: Revenue (or sales) - Expenses = Profit (3-1) Revenue represents the sales for the period. Profit is the difference between the firm's revenue and the expenses the firm incurred in order to generate that revenue for the period. Recall that revenue is determined in accordance with the revenue recognition principle and expenses are then matched to that revenue using the matching principle. income statement of h. j. boswell ltd The typical format for the income statement is shown in Table 3.1 for H. J. Boswell Ltd, a fictitious firm we will use as an example throughout this chapter and Chapter 4. Boswell is a manufacturer of orthopaedic devices and supplies. Its products include hip replacement supplies; knee, shoulder and spinal implants; products used to fix bone fractures; and operating room products. Reading and interpreting Boswell's income statement Recall from equation (3-1) that the income statement contains three basic elements: revenue, expenses and profit. We will use these elements to analyse each of the components of the income statement found in Table 3.1: 1 Revenue: Boswell's revenue totalled $2700 million for the 12-month period ended 31 December 2015. 2 Cost of goods sold: Next, we see that the various expenses the firm incurred in producing revenue are broken down into various sub-categories. For example, the firm spent $2025 million on cost of goods sold, the cost of producing or acquiring the products or services that the firm sold during the period. a There are exceptions to the historical cost principle for recording asset values on the firm's balance sheet. A prime example involves the firm's cash and marketable securities portfolio. These assets are recorded on the balance sheet using the lesser of cost or their current market value. Changing the value of the firm's cash and marketable securities to reflect current market prices is commonly referred to as 'marking to market'. However, the historical cost principle is the guiding rule for determining the value to be recorded on the balance sheet in most cases. CHAPTER 3 table 3.1 I Understanding financial statements, taxes and cash flows H. j. boswell Ltd Income Statement (expressed in $ millions, except per share data) for the year ended 31 December 2015 Sales Cost of goods sold Gross profit Operating expenses: Selling expenses General and administrative expenses Depreciation and amortisation expenses Total operating expenses Operating profit (EBIT, or earnings before interest and tax) Interest expense Profit before tax Tax Net profit $ 2700.00 (2025.00) 675.00 $ (90.00) (67.50) (135.00) (292.50) 382.50 (67.50) 315.00 (110.25) $ 204.75 $ 45.00 90.00 Earnings per share (EPS) Dividends per share $ $ 2.28 0.50 3 Gross profit: Subtracting cost of goods sold from revenue produces an estimate of the firm's gross profit of $675 million. 4 Operating expenses: Next, we examine Boswell's operating expenses (this includes the salaries paid to the firm's administrative staff, the firm's electricity bills, and so forth). One of the operating expense categories is depreciation expense ($135 million for Boswell in 2015). Depreciation expense is a non-cash expense used to allocate the cost of the firm's long-lived assets (such as its plant and equipment) over the useful lives of the assets. For example, suppose that, during 2015, Boswell were to build a new distribution facility in Geelong at a cost of $10 million. The firm would not expense the full $10 million against 2015 revenue, but instead would spread out the costs over many 5 b Operating profit: After deducting $292.50 million in operating expenses, Boswell's operating profit is $382.50 million. The firm's operating profit shows the firm's ability to earn profits from its ongoing operationsbefore it makes interest payments and pays its tax. For our purposes, operating profit will be synonymous c 6 with earnings before interest and tax (EBIT). Interest expense: To this point, we have calculated the profit resulting only from operating the business, without regard for any financing costs, such as the interest paid on money the firm might have borrowed. In this instance Boswell incurred interest expense equal to $67.50 million during 2015. b Although there are many types of depreciation methods that can be used, we restrict our attention in this chapter to a simplified version of straight-line depreciation. Using this method, the total cost of the asset minus any salvage value is divided by the number of years of useful life to calculate annual depreciation. For example, if a piece of equipment is purchased for $125 000 and has a useful life of five years, the annual straight-line depreciation is calculated as $125 000/5 years 5 $25 000. In Chapter 12, we discuss the diminishing value method of depreciation, which is the method required by the Australian Tax Office (ATO) for computing accelerated depreciation. c operating activities Cost of debt financing Additional information: Dividends paid to shareholders during 2015 Number of ordinary shares outstanding (million) years to match the revenue the facility helped create. Income from In practice, a firm may have other income or expenses after operating profit, which are not related to the normal course of business, adding or subtracting these items from operating profit to arrive at EBIT. This distinguishes operating profit (designed to represent the underlying profitability of the firm's operations on an ongoing basis) from the actual profit for the period (before interest and tax). For simplicity, we will ignore such items, and assume that operating profit is equal to EBIT. Cost of corporate income tax Income resulting from operating and financing activities 43 44 PART 1 I Introduction to financial management 7 8 9 Net profit before tax: Now we can subtract Boswell's interest expense of $67.50 million from its operating profit of $382.50 million to determine its net profit before tax (also known as taxable income). Boswell's net profit before tax is $315 million. Tax: Next, we determine the firm's income tax obligation. We will show how to calculate the tax obligation later in this chapter. For now, note that Boswell's income tax obligation is $110.25 million. Net profit: The income statement's bottom line is net profit, which is calculated by subtracting the firm's tax liability of $110.25 million from its net profit before tax of $315 million. This leaves net profit of $204.75 million. Evaluating Boswell's per share earnings and dividends At this point, we have completed the income statement. However, the firm's owners (ordinary shareholders) will want to know how much profit the firm made on a per share basis, or what is called earnings per share. We can calculate earnings per share by dividing the company's net profit by the number of ordinary shares it has outstanding. Because H. J. Boswell Ltd had 90 million shares outstanding in 2015 (see Table 3.1), its earnings per share were $2.28 ($2.28 per share 5 $204.75 million net profit 4 90 million shares). Investors also want to know the amount of dividends a firm pays for each share outstanding, or the dividends per share. In Table 3.1, we see that H. J. Boswell Ltd paid $45 million in dividends during 2015. You can then determine that the firm paid $0.50 in dividends per share ($0.50 5 $45 million total dividends 4 90 million shares outstanding). Connecting the income statement and balance sheet If Boswell earned a net profit of $204.75 million (or $2.28 per share) and paid out only $45 million in dividends ($0.50 in dividends per share), what happened to the $204.75 million 2 $45 million 5 $159.75 million in earnings that were not paid out in dividends? The answer is that this amount was retained and reinvested in the firm. As we will later discuss, in the balance sheet Boswell's retained earnings rise by exactly this amount. Thus, the income statement feeds directly into the balance sheet to record any profit or loss from the firm's operations for the period. interpreting firm profitability using the income statement The first conclusion we can draw from our quick survey of H. J. Boswell Ltd's income statement is that the firm was profitable because its revenue for 2015 exceeded the sum of all its expenses. Furthermore, as we move down the income statement, beginning with the firm's revenue or sales, we can identify three different measures of profit or income. For example, the company's gross profit was $675 million, while its operating profitor earnings before interest and taxwas just $382.5 million, and its net profit was just $204.75 million. It is common practice to divide gross profit, operating profit and net profit by the level of the firm's sales to calculate the firm's gross profit margin, operating profit margin and net profit margin, respectively. For H. J. Boswell Ltd, we calculate each of these profit margins as follows: 1 The gross profit margin is 25% ($675 million of gross profit 4 $2700 million of sales 5 25%). Because the gross profit equals revenue minus the firm's cost of goods sold, the gross profit margin indicates the firm's 'markup' on its cost of goods sold per dollar of sales. Note that the percentage markup is generally expressed as a percentage of the firm's cost of goods sold. That is, the markup percentage equals gross profit divided by cost of goods sold, or $675 million 4 $2025 million 5 33.3%. Because gross profit is 25% of sales and cost of goods is 75% of sales, we can also compute the markup percentage using these percentages; that is, 25% 4 75% 5 33.3%. 2 The operating profit margin is only 14.2% ($382.5 million of operating profit 4 $2700 million of sales 5 14.2%). The operating profit margin is equal to the ratio of operating profit or earnings before interest and tax (EBIT) divided by firm sales. CHAPTER 3 3 I Understanding financial statements, taxes and cash flows The net profit margin is only 7.6% of firm revenue (7.6% 5 $204.75 million of net profit 4 $2700 million of sales). The net profit margin captures the effects of all of the firm's expenses and indicates the percentage of revenue left over after interest and tax have been considered. Notice that as we move down the income statement, calculating different profit margins after incorporating consideration for more categories of expenses, the successive profit margins naturally get smaller and smaller. By comparing these margins to those of similar businesses, we can dissect a firm's performance and identify expenses that are out of line. Because the firm's profit margins are an important indicator of how well the firm is doing financially, managers pay close attention to them, carefully watching for any changes either up or down. They also compare the firm's margins with those of its competitorssomething we will discuss in Chapter 4. iFRS and earnings management In Australia, firms must adhere to a set of accounting principles commonly referred to d as International Financial Report Standards, or IFRS. Even so, there is considerable room for a company's managers to actively influence the firm's reported earnings. Corporate executives have an incentive to manage the firm's earnings, both because their pay depends upon earnings and because investors pay close attention to the firm's quarterly earnings announcements. Executives sometimes 'smooth out' reported earnings, by making choices that, for example, transfer earnings from years when they are abnormally high to future years when earnings would otherwise be low. The specifics of how this is done can be very complex and are beyond the scope of this e book. However, in extreme cases, earnings management can lead to fraudulent efforts to create earnings where none exist. Companies hire accountants to maintain the firm's financial records and prepare the firm's quarterly and annual financial statements. P Principle 5: Individuals respond to incentives serves to remind us that managers may at times find themselves in situations where they would like to be less than forthcoming in describing the firm's financial condition to investors and may be tempted to stretch the rules of financial reporting to disguise the firm's current circumstances. Although the incentive to misreport the firm's financial condition is ever present (remember HIH and OneTel), investors (shareholders) in publicly held companies, whose bonds and/or shares can be bought and sold in the public markets, do not have to depend on the honesty of the firm's accountants for assurance that the firm has followed IFRS. The reason is that public firms are required to have their financial statements audited by an independent accounting firm. The audit of the financial statements provides a verification of the financial statements of the firm and an audit opinion. The audit opinion is intended to provide reasonable assurance that the financial statements are presented fairly, in all material respects, and/or give a true and fair view in accordance with the financial reporting framework. As such, the audit serves to enhance the degree of confidence that investors and others have when they use the financial statements. In essence, the audit by an independent accounting firm serves as a check and balance to control management's incentive to disguise the firm's true financial condition. d IFRS are a set of accounting standards set out by the International Accounting Standards Board (IASB). The IASB and IFRS arose from an attempt to harmonise accounting standards in different countries, which began in 1973. IFRS have now been adopted by all developed countries except the United States and Japan, which use their own Generally Accepted Accounting Principles (GAAP). The Australian equivalent of IFRS, set out by the Australian Accounting Standards Board (AASB), are sometimes referred to as A-IFRS. e If you want to learn more about this and other tools of earnings management (i.e. manipulation), see Howard M. Schilit, Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, 3rd edition (McGraw-Hill, 2010). 45 46 PART 1 I Introduction to financial management Checkpoint 3.1 Constructing an income statement Use the following information to construct an income statement for Myer Holdings Ltd (MYR), Australia's largest department 1 store group. Use the scrambled information below to calculate the firm's gross profit, operating profit and net profit for the year ended 26 July 2014 (the last day of its financial year). Calculate the firm's earnings per share and dividends per share. Interest expense Cost of goods sold Operating expenses Shares outstanding $21 906 000 $1 455 066 000 $1 131 922 000 585 253 946 Revenue (sales) Ordinary share dividends Tax $2 747 292 000 $99 470 000 $39 856 000 SteP 1: Picture the problem The income statement can be visualised as a mathematical equation using equation (3-1) as follows: Revenue (or sales) 2 Expenses 5 Profit (3-1) however, this equation belies the level of detail normally included in the income statement. That is, expenses are typically broken down into multiple categories, including cost of goods sold, operating expenses (including such things as selling expenses, administrative expenses and depreciation expenses), finance charges or expenses (interest), and income tax. After subtracting each of these general categories of expenses, a new profit number is calculated. The following template provides a useful guide for reviewing the format of the income statement: Revenue Less: Cost of goods sold equals: Gross profit Less: Operating expenses equals: Operating profit Less: interest expense equals: Profit before tax Less: Tax equals: Net profit SteP 2: Decide on a solution strategy Given the account balances provided, constructing the income statement simply entails substituting the appropriate balances into the template above. SteP 3: Solve Revenue 5 $2 747 292 000 Less: Cost of goods sold 5 $1 455 066 000 equals: Gross profit 5 $1 292 226 000 Less: Operating expenses 5 $1 131 922 000 equals: Operating profit 5 $160 304 000 Less: interest expense 5 $21 906 000 equals: Profit before tax 5 $138 398 000 Less: Tax 5 $39 856 000 equals: Net profit 5 $98 542 000 Earnings per share ($98 542 000 net profit 585 253 946 shares) 5 $0.168 or 16.8 cents Dividends per share ($99 470 000 dividends 585 253 946 shares) 5 $0.170 or 17.0 cents CHAPTER 3 I Understanding financial statements, taxes and cash flows 47 SteP 4: Analyse There are some important observations we can make about Myer's income statement. First, the firm is profitable because it earned a net profit of $98 542 000 over the 2013/14 financial year. Second, the firm distributed more to its shareholders in dividends than it earned in net profit. (we will discuss why this is sometimes the case in Chapter 16Dividend policy.) SteP 5: Check yourself Reconstruct Myer's income statement assuming the firm is able to reduce its cost of goods sold by 10% and that the firm pays tax at a 30% rate. what is the firm's net profit and earnings per share? ANSWeR: $198 733 000 and $0.340 Your turn: For more practice, do related Study Problem 3-1 at the end of this chapter. Before you move on to 3.3 Concept Check 3.2 4 what information can we derive from a firm's income statement? 5 list the entries in the income statement. 6 what does the acronym iFRS stand for? 3.3 corporate tax and dividend imputation In our discussion of the income statement, we simply listed the firm's income tax obligation without further explanation. It is important that the financial manager understand how tax is computed, because tax is a critical factor in determining cash flow ( P Principle 3: Cash flows are the source of value) and consequently in making many financial decisions. The tax rules can be extremely complex, requiring specialised expertise to understand them, so for our purposes we will provide a simplified overview of how corporate income tax is computed. Objective 3 Estimate a firm's liability for corporate income tax and distinguish between a classical taxation system and dividend imputation taxation system. Computing taxable income and company tax payable A corporation's taxable income is often referred to in its income statement as net profit before tax. Net profit before tax is equal to the firm's operating profit less interest expenses. Note that taxable income was item 7 in our earlier description of the firm's income statement. The firm's income tax liability is calculated using its taxable income and the tax rates on corporate income, which we will now discuss. The company tax rate in Australia has been 30% since 2001, but the Federal government intends to cut this to 28.5% from 1 July 2015. Most companies also incur state payroll tax, levied on the wages outlay of employers, which vary from state to state, but they are not relevant to this discussion because they should be included as operating expenses. Dividend imputation In Australia, prior to 1987, dividends received by shareholders in a company were taxed at the shareholder's full marginal tax rate. This meant that company profits were effectively taxed twiceonce at the company tax rate, and then again when paid out as dividends to shareholders. This 'double taxation' of company profits was deemed unfair and against Australia's economic interests, and hence the dividend imputation taxation system was introduced. At the present time, only Australia and New Zealand have full dividend imputation systems for resident shareholders. Some European countries introduced them, but then weakened or abolished them. Some countries, such as the United States, use other means to partially ameliorate the effect of double taxation, such as exempting some dividend income from tax or 48 PART 1 I Introduction to financial management taxing dividends at a concessional rate, while other countries still have full double taxation of company profits distributed as dividends (sometimes referred to as a classical taxation system). Under a dividend imputation system, dividends (if they are paid out of company profits that have been taxed) carry imputation (or franking) credits, and the dividends are referred to as franked dividends. The recipient of a dividend is taxed on the grossed-up value of the dividend, which is calculated by adding the franking credits to the cash dividend received, and then applying the franking credits to reduce the amount of tax actually payable. This has the effect of giving the shareholder credit for the company tax paid by the firm, and the shareholder finishes up paying tax based on the difference between his or her marginal tax rate and the company tax rate. If the shareholder's marginal tax rate is less than the company tax rate, the shareholder receives the difference as a tax credit, which can be offset against other tax payable or refunded in cash by the ATO! Table 3.2 illustrates the difference between the tax liability of the same shareholder (with a marginal tax rate of 45%) under a classical system of taxation and a dividend imputation system. In both scenarios, the firm makes a profit of $100, is taxed at the company tax rate of 30%, and then distributes the remaining $70 as a dividend. Under the classical system, the original $100 has been subject to an effective tax rate of 61.5% (a combination of the company tax rate and the shareholder's marginal tax rate) while under the dividend imputation system, the total tax payable on the $100 profit reflects the shareholder's marginal tax rate of 45%. Table 3.3 illustrates the effect of dividend imputation on shareholders with different personal income tax rates. All three shareholders receive the same $70 in after-tax net profit as was the case in Table 3.2. Based on their personal tax rates, Tom pays net tax of $15 (as was the case under dividend imputation in Table 3.2). Dick has the same personal tax rate as the company tax rate and pays no additional tax, while Harry, by virtue of having a lower personal tax rate than the company tax rate, can offset the 2$15.00 against other tax payable or receive a refund from the tax office. In all of the examples we have discussed so far, we have assumed the dividends are fully franked or carry 100% franking credits. This means that they carry the maximum possible franking credits because the profits out of which they have been paid have been Table 3.2 Comparison between classical and dividend imputation tax systems Classical Dividend imputation Corporate level Net profit before tax Less company tax (30%) Net profit after tax $ 100.00 $ 100.00 (30.00) (30.00) $ 70.00 $ 70.00 $ 70.00 $ 70.00 Shareholder level Dividend received Franking credit Taxable income (grossed-up dividend in the case of the dividend imputation tax system) 3 Marginal tax rate Tax payable, before franking credit Less franking credit Net tax payable 30.00 70.00 100.00 45% 45% 31.50 45.00 (30.00) $ 31.50 $ 15.00 CHAPTER 3 Table 3.3 I Understanding financial statements, taxes and cash flows 49 Effect of dividend imputation based on different marginal tax rates Dividend received Franking credit Taxable income (grossed-up dividend) 3 Marginal tax rate Tax payable, before franking credit Less franking credit Net tax payable Tom Dick Harry $ 70.00 $ 70.00 $ 70.00 30.00 30.00 30.00 100.00 100.00 100.00 45% 45.00 30% 30.00 15% 15.00 (30.00) (30.00) (30.00) 0 $(15.00) $ 15.00 $ taxed at the full company tax rate. Sometimes, some or all of those profits have not been taxed at the full company tax rate (e.g. because some of the profits have been earned overseas and have not been subject to Australian company tax), and therefore the dividends may be partially franked or unfranked. If a dividend is fully franked (and the company tax rate has been constant since the profits out of which they are paid were made), we can calculate the value of the franking credits, and the value of the grossed-up dividend, without necessarily knowing the value of the franking credit, using the following equation: Cash dividend received Grossed@up dividend = 1 - Company tax rate (3-2) The value of the franking credit is then the difference between the grossed-up dividend and the cash dividend received. We will return to dividend imputation in Chapter 16 when we look at the effect of personal tax on dividend policy. Checkpoint 3.2 Comparison between a classical tax system and a dividend imputation tax system 2 On 11 September 2014, Rio Tinto (RIO) paid a dividend of $1.0309 per share. If you held 100 Rio shares at that time, and your marginal tax rate was 37%, what would your net after-tax dividend have been under (a) a classical tax system and (b) (assuming the dividend was fully franked based on a company tax rate of 30%) a dividend imputation tax system? What would be the effective tax rate that would have been applied to the original company profit, taking into account both corporate tax and personal tax, under each of the two different tax systems? STEP 1: Picture the problem We can solve this problem by completing a table similar to Table 3.2, where we can compare, side by side, the result of this dividend under the two types of tax system. This will give us the net tax payable, allowing us to calculate the after-tax dividend and the effective tax rate applied to the company's profits. The difference between the information provided for Table 3.2 and this problem is that we have not been given the value of the grossed-up dividend or the value of the franking credit, so we will need to calculate the grossed-up dividend using equation 3-2: Grossed@up dividend Cash dividend received 1 - Company tax rate = (3-2) The franking credit will be the difference between the grossed-up dividend and the cash dividend received. (3.2 ConTinuES >>) 50 PART 1 I Introduction to financial management Once we calculate the additional personal tax payable under each system, we can calculate the effective tax rate using the following equation: Effective tax rate = Company tax + Personal tax Pre@tax company profit SteP 2: Decide on a solution strategy Calculate the value of the grossed-up dividend and the franking credits, prepare a table similar to the bottom section of Table 3.2 (shareholder level), complete the table and perform the necessary calculations to determine the effective tax rate on the company profits. SteP 3: Solve Total dividend = No. of shares * Dividend per share = 100 * $1.0309 = $103.09 Cash dividend $103.0 received 9 Grossed@up Dividend 1 - Company tax rate = 1 - 0.3 = $147.27 = Franking credit = Grossed@up dividend - Cash dividend received = $147.27 - $103.09 = $44.18 This means that the company has paid $44.18 in tax, under either system, before paying the dividend of $103.09. $44.18 $38.1 Effective tax 4 = 0.559 or + rate(Classical) 55.9% = $147.27 $44.18 $10.3 Effective tax rate (Dividend 1 + = 0.37 or 37% = imputation) $147.27 Classical Dividend imputation Shareholder level Dividend received Franking credit Taxable income (grossed-up dividend in the case of the dividend imputation tax system) 3 Marginal tax rate Tax payable, before franking credit Less franking credit $103.09 $103.09 44.18 103.09 147.27 37% 37% 38.14 54.49 (44.18) Net tax payable $ 38.14 $ 10.31 Cash dividend received $103.09 $103.09 38.14 10.31 $ 64.95 $ 92.78 Less: Net tax payable After-tax dividend SteP 4: Analyse These results clearly show the difference between the two tax systems. Under a classical tax system, you would pay $27.83 ($38.14 - $10.31 = $27.83) more in tax compared to an imputation system, and the original company profit out of which the dividends were paid would be taxed at an effective 55.9% by the time you receive your after-tax dividend. Under a dividend imputation system, that profit is effectively taxed at 37% - your marginal personal tax rate. SteP 5: Check yourself Recalculate the problem assuming that your marginal tax rate is 25%. ANSWeR: Classical system: After-tax dividend 5 $77.32, effective tax rate 5 47.5%. Dividend imputation system: After-tax dividend 5 $110.45 (cash dividend of $103.09 plus tax credit of $7.36), effective tax rate 5 25%. Your turn: For more practice, do related Study Problems 3-6 and 3-7 at the end of this chapter. CHAPTER 3 I Understanding financial statements, taxes and cash flows 51 Before you move on to 3.4 not equal to the current market value 7 what is meant by the term 'double taxation' of of the firm's company profits? assets; 8 what is the difference between a classical tax consequently, system and a dividend imputation tax system? book value 9 what are franking credits? does not reflect the value of the company if it 3.4 the balance sheet were to be sold The income statement reports the cumulative to another results from operating the business over a period of owner or time, such as one year. By contrast, the balance liquidated by sheet, or statement of financial position, is a selling off the snapshot of the firm's financial position on a individual specific date. In its simplest form, the balance sheet assets it owns. is defined by the following equation: This distinction equity Total assets = Total liabilities + Total shareholders' between Total liabilities represent the total amount of money accounting (or the firm owes its creditors (including the firm's banks book) value and suppliers). Total shareholders' equity refers to the and market difference in the value of the firm's total assets and the valuve is firm's total liabilities recorded in the firm's balance sheet. important for As such, total shareholders' equity refers to the book understanding value of their investment in the firm, which includes both the different the money they invested in the firm to purchase its shares perspectives and the accumulation of past earnings from the firm's taken with operations. The sum of total shareholders' equity and respect to a total liabilities is equal to the firm's total assets, which firm's are the resources owned by the firm. financial In general, IFRS requires that the firm report statements by assets on its balance sheet using the historical cost of accountants acquiring them. Cash and assets held for resale (such and finance as marketable securities) are an exception to the professionals. historical cost principle. These assets are reported in The the balance sheet using the lower of their cost or their accounting current market value, which is the price that an asset approach is to would trade for in a competitive market. Assets whose count or value is expected to decline over time as they are 'account' for used, such as plant and equipment, are adjusted the firm's past downward periodically by depreciating the historical actions, cost. Consequently, the amount recorded on the firm's whereas the balance sheet for net property, plant and equipment financial is equal to the historical cost incurred when the assets manager seeks were purchased less the depreciation accumulated on to understand them. Note that this book value is not intended to the measure the market value of these assets. In fact, book implications of and market values of plant and equipment can differ the financial dramatically. It is important to note that depreciation statements for expense, and consequently the recorded book value of future cash the firm's net plant and equipment, does not account flows and the for P Principle 1: Money has a time value. We will value of the have more to say about this later when we discuss firm. capital-budgeting decisions in Chapters 11-14. Concept Check 3.3 In summary, the balance sheet contains the book value of the firm's assets. Generally, the book value is The balance sheet of h. j. boswell ltd Consider the 2014 and 2015 balance sheets for H. J. Boswell Ltd found in Table 3.4. At the end of 2015, Boswell owned $1971 million in total assets, had debts totalling $1059.75 million, and had total ordinary shareholders' equity of $911.25 million. Assets: The left-hand side of the balance sheet The left-hand side of Boswell's balance sheet lists the firm's assets, which are categorised into current and non-current assets (also referred to as long-term assets or fixed assets). Objective 4 Use the balance sheet to describe a firm's investments in assets and the way it has financed them. 52 PART 1 I Introduction to financial management The distinction between current and non-current assets is simply the time it takes for them to be converted to cash. Current assets Current assets consist of the firm's cash plus other assets the firm expects to convert to cash within 12 months or less. Boswell had current assets of $643.5 million at the end of 2015, which comprise principally its inventories of $378 million (including raw materials used to make the firm's products, goods in process and finished goods that are ready for sale), and its accounts receivable of $162 million, which reflects the value of prior credit sales that have not been collected. Non-current assets Non-current assets are assets that the firm does not expect to sell within one year. These include property, plant and equipment, and other investments that are expected to be held for an extended period of time and frequently cannot be easily converted to cash. Boswell has gross property, plant and equipment totalling $1845 million at the end of 2015. This total represents the combined historical dollar amounts the firm has paid to acquire fixed assets. Net property, plant and equipment is equal to gross property, plant and equipment less accumulated depreciation expense. The latter is the sum of all depreciation expenses deducted in the firm's income statement in previous periods for the property, plant and equipment. Gross property, plant and equipment changes over time as new assets are acquired and others are sold. When a firm purchases a new computer system, for example, it does not immediately report the cost as an expense in its income statement for the period. Instead, the computer system is considered to be an asset and is included on the balance sheet. Then the cost of the computer system is depreciated over time. Some assets, such as land, are not expected to depreciate; these assets are carried on the firm's balance sheet at their original cost until they are sold for a profit or a loss. H. J. Boswell's gross non-current assets for 2014 and 2015 are shown in Table 3.2. In 2014, the firm had $1669.50 million in gross property, plant and equipment. By the end of 2015, this amount had grown to $1845 million. In other words, Boswell acquired an additional $175.5 million in non-current assets during the year (i.e. $1845 million 2 $1669.5 million 5 $175.5 million). In addition, during 2015, the firm's accumulated depreciation expense rose from $382.5 million to $517.5 million. This increase in accumulated depreciation is equal to the amount of depreciation expense for the year (or the $135 million reported in the firm's income statement found in Table 3.1). Thus, Boswell's net non-current assets rose by $40.5 million (the difference in the company's new non-current assets of $175.5 million and the depreciation expense recorded for 2015 of $135 million). Liabilities and shareholders' equity: The right-hand side of the balance sheet We now turn to the right-hand side of the balance sheet in Table 3.4 labelled 'Liabilities and shareholder's equity'. This side of the balance sheet indicates how the firm finances its assets. H. J. Boswell Ltd has borrowed a total of $1059.75 million and raised $911.25 million in equity to finance its total investment in firm assets. Current liabilities Boswell's current liabilities represent the amount that the firm owes to creditors that must be repaid within 12 months or less. Typically, a firm's current liabilities will include accounts payable, which is what the firm owes its suppliers for items purchased for its inventories, and notes payable, which are short-term loans from banks and other creditors. Current liabilities totalled $288 million at the end of 2015. Non-current liabilities The firm also owed $771.75 million in non-current liabilities, such as loans from banks and other lenders that have maturities longer than one year. This also includes bonds sold by the firm in the public markets. CHAPTER 3 table 3.4 I Understanding financial statements, taxes and cash flows 53 H. j. boswell Ltd Balance Sheet ($ millions) 31 December 2015 and 2014 Assets Liabilities and shareholders' equity 2015 2014 Current assets Cash 2015 2014 Current liabilities $ 90.00 $ 94.50 Accounts payable $ 189.00 $ 184.50 Accounts receivable 162.00 139.50 Accrued expenses 45.00 45.00 Inventories 378.00 229.50 Short-term notes 54.00 63.00 13.50 13.50 $ 288.00 $ 292.50 $ 643.50 1845.00 $ 477.00 1669.50 771.75 $ 1059.75 720.00 $ 1012.50 324.00 324.00 Preference shares 45.00 45.00 Retained earnings 542.25 382.50 Total shareholders' equity $ 911.25 $ 751.50 Total liabilities and $ 1971.00 $ 1764.00 Other current assets Total current assets Gross property, plant and equipment Less accumulated depreciation (517.50) (382.50) Net property, plant and equipment $ 1327.50 $ 1287.00 Total assets $ 1971.00 $ 1764.00 Total current liabilities Non-current liabilities Total liabilities Shareholders' equity Ordinary shares shareholders' equity Legend: Assets (the left-hand side of the balance sheet) Current assets: Assets that the firm expects to convert into cash in 12 months or less. Examples include cash, accounts receivable, inventories and other current assets. Cash: Every firm must have some cash on hand at all times because cash expenditures can sometimes exceed cash receipts. Accounts receivable: The amounts owed to the firm by its customers who purchased on credit. Inventories: Raw materials that the firm utilises to build its products; partially completed items or work in process; and finished goods held by the firm for eventual sale. Other current assets: All current assets that do not fall into one of the named categories (cash, accounts receivable, and so forth). Prepaid expenses (e.g. prepayments for insurance premiums) are a common example of an asset in this catch-all category. Gross property, plant and equipment: The sum of the original acquisition prices of property, plant and equipment still owned by the firm. Accumulated depreciation: The sum of all the depreciation expenses charged against the prior year's revenue for fixed assets that the firm still owns. Net property, plant and equipment: The undepreciated value of the firm's property, plant and equipment. Liabilities and shareholders' equity (the right-hand side of the balance sheet) Current liabilities: Liabilities that are due and payable within 12 months or less. Examples include the firm's accounts payable, accrued expenses and short-term notes: Accounts payable: The credit suppliers extended to the firm when it purchased items for its inventories. Accrued expenses: Liabilities that were incurred in the firm's operations but not yet paid. For example, the company's employees might have done work for which they will not be paid until the following week or month. The wages owed by the firm to its employees are recorded as accrued wages. Short-term notes: Debts created by borrowing from a bank or other lending source that must be repaid in 12 months or less. Non-current liabilities (or long-term debt ): All debts of the firm that are due and payable more than 12 months in the future. A 25-year mortgage loan used to purchase land or buildings is an example of a non-current liability. If the firm has issued bonds, the portion of those bonds that is not due and payable in the coming 12 months is also included in non-current liabilities. Shareholders' equity: This comprises various types of equity, including ordinary shares, preference shares, retained earnings and possibly reserves, such as general reserve or asset revaluation reserve. All of this equity, except preference shares, belongs to the ordinary shareholders, who are the residual owners of a business. They receive whatever income is left over after the firm has paid all of its expenses (including preference dividends). In the event the firm is liquidated, the ordinary shareholders receive only what is left overbut never lose more than they investedafter the firm's other financial obligations have been paid. 54 PART 1 I Introduction to financial management Shareholders' equity To understand the shareholders' equity account, we need to know how accountants construct this account. Specifically, it is broken down into the following components: 1 The amount the company received from selling shares to investors. This amount will be shown as ordinary shares or preference shares in the balance, depending on the type of shares that have been issued (and there may be multiple types of preference shares and other hybrid securities). 2 The amount of the firm's retained earnings. Retained earnings are the portion of net profit that has been retained (i.e. not paid in dividends) from prior years' operations. Boswell has retained a total of $542.25 million over the course of its existence. 3 Reserves. Sometimes (although not shown in Table 3.4), there may be reserves of various kinds, such as general reserve or an asset revaluation reserve. The ordinary shareholders are the residual owners of everything listed under 'Shareholders' equity' except the preference shares. In effect, shareholders' equity is equal to the sum of the amount received for ordinary shares and preference shares plus retained earnings plus reserves. Shareholders' Amount received for ordinary Retained + + Reserves earnings equity and preference shares = (3-4) Alternatively, shareholders' equity can be thought of as the difference between total assets and total liabilities. For example, if some of your company's assets (such as land) increased in value over time, then the value of the company's assets would increase accordingly. Thus, in order for the balance sheet to balance, shareholders' equity must increase, and that is done through an increase in shareholders' equity (specifically, by an increase in the asset revaluation reserve. In effect, Shareholders' equity Total = assets Total - liabilities (3-5) Firm liquidity and net working capital The liquidity of an asset refers to the speed with which the asset can be converted into cash without loss of value. Obviously, the firm's bank account is perfectly liquid because it consists of cash that can be readily spent. However, other types of assets are less liquid because they are more difficult to sell and convert into cash. We can also think in terms of the liquidity of the firm as a whole; that is, the firm's ability to regularly convert its current assets (principally accounts receivable and inventories) into cash so that it can pay its bills on time. This is a function of both the liquidity of the firm's current assets and the size of the bills the firm must pay. A common way to assess a firm's overall liquidity therefore involves comparing its current assets to its current liabilities. This simple measure of the firm's liquidity is its net working capital, the difference between the firm's current assets and current liabilities. Net working Current Current capital = assets - liabilities (3-6) Graphically, this is presented in Figure 3.1. Recall that current assets are those assets that the firm expects to be able to convert to cash within a period of one year or less, and current liabilities are those debts the firm owes that must be paid within one year. Consequently, a firm with current assets much larger than its current liabilities is in a good position to repay its debts on time and is consequently very liquid. Lenders frequently focus on the amount of net working capital as an important indicator of a firm's ability to repay its loans. CHAPTER 3 I Understanding financial statements, taxes and cash flows 55 Figure 3.1 the balance sheet The balance sheet represents a snapshot of the firm. Specifically, it lists the assets the firm has acquired, classified as current and non-current (or long-term, or fixed) assets, as well as the sources of financing the firm has used to finance the acquisition of its assets. Net working capital is an important measure of a firm's ability to pay its bills on time and is equal to the difference in the dollar amount of current assets (assets the firm expects to convert to cash within the year) and current liabilities (debts the firm must repay within the year). Shareholders' equity is the total investment of the firm's owners in the firm and is equal to the difference in total assets and total liabilities. TOTAL LIABILITIES + SHAREHOLDERS' EQUITY TOTAL ASSETS Current liabilities: Current assets: Cash Accounts receivable Inventories Other current assets Net working capital Current assets - Current liabilities Long-term (fixed) assets: Accounts payable Short-term debt (notes payable) Other current liabilities Long-term liabilities: Long-term debt Shareholders' equity: Net property, plant and equipment Other long-term assets TOTAL ASSETS Ordinary shares Preference shares Retained earnings Reserves TOTAL LIABILITIES AND EQUITY For H. J. Boswell Ltd, net working capital for year-end 2015 is computed as follows, using information from Table 3.4: Current assets Less: Current liabilities Equals: Net working capital $643 500 000 288 000 000 $355 500 000 Debt and equity financing The right-hand side of the firm's balance sheet reveals the sources of the money used to finance the purchase of the firm's assets listed on the left-hand side of the balance sheet. 56 PART 1 I Introduction to financial management It shows how much was borrowed (debt financing) and how much was provided by the firm's owners (equity financing), either through the sale of equity to investors or through the retention of prior years' earnings. Debt and equity, as you will recall from Chapter 2, differ with regard to how the holders of these types of securities get paid and the priority of their respective claims in the event the firm were to become bankrupt, because debt security holders or lenders get paid first. They typically receive periodic interest payments up until the maturity of the debt, at which time the principal must be repaid. Equity securities, on the other hand, do not mature, and although equity security holders may receive dividends, there is no contractual or pre-determined dividend payment (for example, Apple did not pay any dividends between 1995 and 2012). Another key difference between debt and equity is the fact that debt holders are paid before equity holders in the event of bankruptcy. It is often said that equity holders have the residual claim on income. This simply means that they have a claim on any income that is left over after paying the firm's obligations. This income is either paid to them in the form of dividends, used to buy back outstanding shares or added to their investment in the firm when the firm reinvests the retained earnings. Checkpoint 3.3 Constructing a balance sheet Construct a balance sheet for Myer Holdings Ltd (MYR) using the following list of jumbled accounts for 26 July 2014 3 (the last day of its financial year). Identify the firm's total assets and net working capital. Net property, plant and equipment Cash Current liabilities Inventories Other non-current assets $502 881 000 73 564 000 530 881 000 376 763 000 949 323 000 Accounts receivable Non-current liabilities Shareholders' equity Accounts payable $ 30 133 000 508 370 000 893 413 000 428 066 000 SteP 1: Picture the problem The firm's balance sheet can be visualised as a mathematical equation using equation (3-3) as follows: Total assets = Total liabilities + Total shareholders' equity (3-3) just as with the income statement equation, this equation belies the level of detail normally included in the firm's balance sheet. The following template shows how to construct the balance sheet: Current assets Cash Accounts receivable Inventories Other current assets Total current assets Current liabilities Accounts payable Short-term debt (notes payable) Other current liabilities Total current liabilities Non-current liabilities Long-term debt Non-current assets Gross property, plant and equipment Less: Accumulated depreciation Net property, plant and equipment Other long-term assets Total non-current assets Total assets Shareholders' equity Ordinary shares Preference shares Retained earnings Total equity Total liabilities and shareholders' equity CHAPTER 3 I Understanding financial statements, taxes and cash flows 57 SteP 2: Decide on a solution strategy Given the account balances provided, constructing the balance sheet simply entails substituting the appropriate balances into the template found above. SteP 3: Solve Current assets Non-current assets Total assets $ 480 460 000 1 452 204 000 $1 932 664 000 Current liabilities Non-current liabilities Shareholders' equity Total liabilities and equity $ 530 881 000 508 370 000 893 413 000 $1 932 664 000 Total assets = Current assets + Non@current assets = $480 460 000 + $1 452 204 000 = $1 932 664 000 Net working capital = Current assets - Current liabilities = $480 460 000 - $530 881 000 = - 00 $50 421 0 SteP 4: Analyse There are some important observations we can make about Myer's balance sheet. First, the firm has invested a total of $1 932 664 000 in assets which have been financed using current liabilities of $530 881 000, $508 370 000 in non-current liabilities and $893 413 000 in owner-supplied funds. Second, the firm has $480 460 000 tied up in current assets and $530 881 000 in current liabilities, leaving the firm with a net working capital position of $480 460 000 2 $530 881 000 5 2$50 421 000. The latter suggests that the firm will be unable to pay its current liabilities. however, the nature of Myer's business is that the vast majority of its sales are for cash, rather than on credit, and therefore it has very little in the way of accounts receivable (which are normally a significant part of a firm's current assets). The cash generated is considered sufficient to pay current liabilities as and when they fall due. This is typical of Myer's business modelits net working capital was 2$49 million in 2013. SteP 5: Check yourself Reconstruct Myer's balance sheet to reflect the repayment of $50 million in short-term debt using a like amount of the firm's cash. what is the balance for total assets and net working capital? ANSWeR: $1 882 664 000 and 2$50 421 000 respectively. Your turn: For more practice, do related Study Problems 3-10 and 3-11 at the end of this chapter. book values, historical costs and market values The different objectives of the accountants who prepare financial statements and the financial managers who interpret those statements are perhaps nowhere more apparent than in the comparison of book values based on historical costs and market values. Moreover, the difference between an asset's book value and its current market value can be very significant. For example, the book values of current assets are generally very close to their market values. By contrast, the book and market values of fixed assets can differ substantially. For example, in June 2014, JB Hi-Fi Ltd (JBH) had total assets (book value) of $860 million; 4 however, the market value of its liabilities plus equity totalled more than $2 billion. There are two reasons for book and market values to be different. First, over time, inflation greatly affects the cost of fixed assets. For example, when Boswell purchased land for one of its plant sites in 2005, the price of the parcel of land was $3.2 million. By 2015, the value of the land had risen to over $8 million; however, on Boswell's balance sheet, the land continues to be valued at its historical cost. The second reason for a difference in book and market values is that the firm adjusts the book value of its fixed assets (other than land) downward each year as it depreciates them. This depreciation expense represents the firm's acknowledgement of the fact that fixed assets wear out and the cost of the wear must be accounted for in determining the profits the firm earns. For example, if Boswell were to pay $25 000 for a new forklift truck in 2015 that it expected to depreciate over five years toward a zero salvage value, the truck would have a book value in 2015 equal to its cost, but this book value would decline by Question 2 [Calculation-based]: The Income Statement [Chapter 3 Study Questions 3.2 and Study Problems 3.1, 3.2, 3.3] (Refer to Example on page 46 of Textbook) Construct an Income Statement. Use an Excel spreadsheet and/or tables Show all workings. Part 1 At the end of its third year of operations, the Sandifer Manufacturing Company ha $4,500,000 in revenue; $3,375,000 in cost of goods sold; $450,000 in operating expenses, which included a depreciation expense of a tax liability equal to 30% of the firm's taxable income. a. Construct an Income Statement with the above data. b. What is the net profit of the firm for the year? c. Explain how net profit differs from gross profit and operating profit? d. Analyse the data and outcome. What information can we derive from Sandifer' Part 2 Continued from Part 1: Sandifer Manufacturing Company (from the previous p $50,000 of its earnings back in the firm. How much profit is left for the payment of a cash dividend to Sandifer's sharehold Criteria Content Knowledge Measures of Excellence / There is an excellent standard of analysis and the responses demonstra appreciation of the key concepts, principles and / or formulae. Evidence / Support / Referencing The source of formulae, examples, figures and tables have been appropria Referencing accurate - per APA Reference Guide. Presentation Responses have been presented in a superior manner i.e comparisons, tables, neat, separators have been used to present numbers, workings are shown in headings have been used to categorise elements of the answers. Correct gra and punctuation. Question 3: [Calculation-based] Financial Analysis [Chapter 4 Study Questions 4.4 and 4.10; Study Problems 4.5 and 4.8] Use an Excel spreadsheet and/or tables to present your calculations. Sho Part 1 Liquidity Analysis Calculation: The King Carpet Company has $3, 000, $12,000,000 in current assets. The firm's current liabilities equal $6,000,000 suc equals 2. The company's managers want to reduce the firm's cash holdings to $1 in cash to expand the firm's truck fleet, and using $1,500,000 in cash to retire a s decisions is the issue of liquidity. a. What does the term liquidity mean in the context of the firm's financial con b. What financial ratios can you use to analyse and assess liquidity? c. If they carry this plan through, demonstrate the effect on the firm's current d. How we can we determine whether The King Carpet Company is more or le Part 2 Profitability Analysis Calculation: The Allen Corporation had sales in 2015 o $42 million and total liabilities of $20 million. The annual interest rate on the com rate is 30%. The operating profit margin is 12%. a. Compute the firm's 2015 operating profit and net profit. b. How would you determine if the frim was achieving reasonable profit marg c. Calculate the firm's return on assets and return on equity (hint: you can a paid on all of the firm's liabilities) and describe what aspect of the measuring. Criteria Content Knowledge Measures of Excellence / There is an excellent standard of analysis and the responses demonstra appreciation of the key co