What effect did the expansion have on sales, after-tax operating income, net operating working capital (NOWC), and net income?

1. What effect did the expansion have on sales, after-tax operating income, net operating working capital (NOWC), and net income?

2. What effect did the companys expansion have on its free cash flow?

3. DLeon purchases materials on 30-day terms, meaning that it is supposed to pay for purchases within 30 days of receipt. Judging from its 2019 balance sheet, do you think that DLeon pays suppliers on time? Provide an explanation and include a discussion about what problems might occur if suppliers are not paid in a timely manner.

4. DLeon spends money for labor, materials, and fixed assets (depreciation) to make productsand spends still more money to sell those products. Then the firm makes sales that result in receivables, which eventually result in cash inflows. Does it appear that DLeons sales price exceeds its costs per unit sold? How does this affect the cash balance?

5. Suppose DLeons sales manager told the sales staff to start offering 60-day credit terms rather than the 30-day terms now being offered. DLeons competitors react by offering similar terms, so sales remain constant. What effect would this have on the cash account? How would the cash account be affected if sales doubled as a result of the credit policy change?

6. Can you imagine a situation in which the sales price exceeds the cost of producing and selling a unit of output, yet a dramatic increase in sales volume causes the cash balance to decline? Explain.

7. Did DLeon finance its expansion program with internally generated funds (additions to retained earnings plus depreciation) or with external capital? How does the choice of financing affect the companys financial strength?

8. Refer to Tables IC 3.2 and IC 3.4. Suppose DLeon broke even in 2019 in the sense that sales revenues equaled total operating costs plus interest charges. Would the asset expansion have caused the company to experience a cash shortage that required it to raise external capital? Explain.

9. The new tax law calls for immediate expensing of certain qualified business assets rather than depreciating them over a longer time period. How will that affect

   • (1)

     a companys physical stock of assets,

   • (2)

     a firms balance sheet account for fixed assets,

   • (3)

     a companys reported net income, and

   • (4)

     a companys cash position?

   In your responses, assume that the same depreciation method is used for stockholder reporting and for tax calculations and that the accounting change has no effect on assets physical lives.

10. Explain how earnings per share, dividends per share, and book value per share are calculated and what they mean. Why does the market price per share not equal the book value per share?

11. Explain briefly the tax treatment of

    • (1)

      interest and dividends paid,

    • (2)

      interest earned and dividends received,

    • (3)

      capital gains, and

    • (4)

      tax loss carryforwards.

    How might each of these items affect DLeons taxes?

Table IC 3.1 Balance Sheets 2019 2018 $ 57,600 351,200 715,200 $1,124,000 344,800 $1,468,800 Assets Cash- $ 7,282 Accounts receivable 632,160 Inventories 1,287,360 Total current assets $1,926,802 Net fixed assets 939,790 Total assets $2,866,592 Liabilities and Equity Accounts payable $ 524,160 Accruals 489,600 Notes payable 636,808 Total current liabilities $1,650,568 Long-term debt 723,432 Common stock (100,000 shares) 460,000 Retained earnings 32,592 Total equity $ 492,592 Total liabilities and equity $2,866,592 Assume that all cash is excess cash; i.e., this cash is not needed for operating purposes. $ 145,600 136,000 200,000 $ 481,600 323,432 460,000 203,768 $ 663,768 $1,468,800 Table IC 3.2 Income Statements 2019 2018 + Sales Cost of goods sold Other expenses Total operating costs excluding depreciation and amortization Depreciation and amortization EBIT Interest expense EBT Taxes (259) Net income $6,126,796 5,528,000 519,988 $6,047,988 116,960 ($ 38,152) 122,024 ($ 160,176) 0 ($ 160,176) $3,432,000 2,864,000 358,672 $ 3,222,672 18,900 $ 190,428 43,828 $ 146,600 36,650 $ 109,950 EPS ($ 1.602) $ 1.100 DPS $ 0.110 $ 0.275 Book value per share $ 4.926 $ 6.638 Stock price $ 2.25 $ 8.50 Shares outstanding 100,000 100,000 Tax rate 25.00% 25.00% Lease payments $ 40,000 $ 40,000 Sinking fund payments 0 0 D'Leon Inc's annual gross receipts have been less than $25 million for the past three years, so it's exempt from the interest expense deduction limitation. The 2019 net operating loss (NOL) can be carried forward indefinitely to lower taxable income and taxes in future years, but no tax credit (refund) is received in the current year. Refer back to Section 3-9, where we demonstrated how tax loss carryforwards are handled. Table IC 3.3 Statement of Stockholders' Equity, 2019 Common Stock + Shares Amount Total Stockholders' Equity $ 663,768 100,000 $460,000 Retained Earnings $ 203,768 (160,176) (11,000) Balances, December 31, 2018 2019 Net Income Cash dividends Addition (subtraction) to retained earnings Balances, December 31, 2019 (171,176) $492,592 100,000 $460,000 $ 32592 $ 32,592 Table IC 3.4 Statement of Cash Flows, 2019 Operating Activities Net income Depreciation and amortization Increase in accounts payable Increase in accruals Increase in accounts receivable Increase in inventories Net cash provided by operating activities Investing Activities Additions to property, plant, and equipment Net cash used in investing activities ($ 160,176) 116,960 378,560 353,600 (280,960) (572,160) ($ 164,176) ($ 711,950) ($ 711,950) Financing Activities Increase in notes payable Increase in long-term debt Payment of cash dividends Net cash provided by financing activities $ 436,808 400,000 (11,000) $ 825,808 Summary Net decrease in cash Cash at beginning of year Cash at end of year ($ 50,318) 57,600 $ 7,282