Ch 02-20 Build a Model Solution						2/22/2001
Chapter 2. Solution for Ch 02-20 Build a Model
Here are the balance sheets as given in the problem:
Cumberland Industries December 31 Balance Sheets
(in thousands of dollars)
				2001	2000
Assets
Cash and cash equivalents				$91,450	$74,625
Short-term investments				$11,400	$15,100
Accounts Receivable				$103,365	$85,527
Inventories				$38,444	$34,982
Total current assets				$244,659	$210,234
Fixed assets				$67,165	$42,436
Total assets				$311,824	$252,670
Liabilities and equity
Accounts payable				$30,761	$23,109
Accruals				$30,477	$22,656
Notes payable				$16,717	$14,217
Total current liabilities				$77,955	$59,982
Long-term debt				$76,264	$63,914
Total liabilities				$154,219	$123,896
Common stock				$100,000	$90,000
Retained Earnings				$57,605	$38,774
Total common equity				$157,605	$128,774
Total liabilities and equity				$311,824	$252,670
a. The company’s sales for 2001 were $455,150,000, and EBITDA was 15 percent of sales. Furthermore,
depreciation amounted to 11 percent of net fixed assets, interest charges were $8,575,000, the
state-plus-federal corporate tax rate was 40 percent, and Cumberland pays 40 percent of its net income
out in dividends. Given this information, construct Cumberland's 2001 income statement.
The input information required for the problem is outlined in the "Key Input Data" section below. Using
this data and the balance sheet above, we constructed the income statement shown below.
Key Input Data for Cumberland Industries
Sales Revenue			$455,150
EBITDA as a percent of sales			15%
Depr. as a % of Fixed Assets			11%
Tax rate			40%
Interest Expense			$8,575
Dividend Payout Ratio			40%
				2001	Put the pointer on E51 to see
Sales				$455,150	the note indicated by the little
Expenses excluding depreciation and amortization				Start with EBITDA and then calculate expenses $386,878	red tic mark.
EBITDA				$68,273
Depreciation (Cumberland has no amortization charges)				$7,388
EBIT				$60,884
Interest Expense				$8,575
EBT				$52,309
Taxes (40%)				$20,924
Net Income				$31,386
Common dividends				$12,554
Addition to retained earnings				$18,831
b. Next, construct the firm’s statement of retained earnings for the year ending December 31, 2001, and
then its 2001 statement of cash flows.
Statement of Retained Earnings
(in thousands of dollars)
Balance of Retained Earnings, December 31, 2000				$38,774
Add: Net Income, 2001				$31,386
Less: Common dividends paid, 2001				($12,554)
Balance of Retained Earnings, December 31, 2001				$57,605
Statement of Cash Flows
(in thousands of dollars)
Operating Activities
Net Income				$31,386
Adjustments:
Noncash adjustment:
Depreciation				$7,388
Due to changes in working capital:
Increase in accounts receivable				An increase in accounts receivable from 2000 to 2001 reduces the net cash provided by operating activities -$17,838
Increase in inventories				An increase in Inventory from 2000 to 2001 reduces the net cash provided by operation activities -$3,462
Increase in accounts payable				$7,652
Increase in accruals				$7,821
Net cash provided by operating activities				$32,947
Investing Activities
Cash used to acquire fixed assets				Remember, to calculate cash used to acquire fixed assets, we must include depreciation, i.e., assets purchased are equal to the increase in net assets plus depreciation. -$32,117
Financing Activities
Decrease in short-term investments				$3,700
Increase in notes payable				$2,500
Increase in long-term debt				$12,350
Increase in common stock				$10,000
Payment of common dividends				-$12,554
Net cash provided by financing activities				$15,995
Net increase/decrease in cash				$16,825
Add: Cash balance at the beginning of the year				$74,625
Cash balance at the end of the year				$91,450
c. Calculate net operating working capital, total operating capital, net operating profit after taxes, operating
cash flow, and free cash flow for 2001.
Net Operating Working Capital
NOWC01 =	Operating current assets	-	Operating current liabilities
=	Short-Term Investments are not part of current operating assets $233,259		Notes Payable are not part of current operating liabilities $61,238
=	$172,021
NOWC00 =	Operating current assets	-	Operating current liabilities
=	$195,134		$45,765
=	$149,369
Total Operating Capital
TOC01 =	NOWC	+	Fixed assets
=	$172,021	+	$67,165
=	$239,186
TOC00 =	NOWC	+	Fixed assets
=	$149,369	+	$42,436
=	$191,805
Net Operating Profit After Taxes
NOPAT01 =	EBIT	x	( 1 - T )
=	$60,884	x	60%
=	$36,531
Operating Cash Flow
OCF01 =	NOPAT	+	Depreciation
=	$36,531	+	$7,388
=	$43,919
Free Cash Flow
FCF01 =	OCF	-	Gross investment in operating capital
=	$43,919	-	Change in total operating capital plus Depreciation $54,769
=	-$10,850
or
FCF01 =	NOPAT	-	Net investment in operating capital
=	$36,531	-	Change in total operating capital. $47,381
=	-$10,850
d. Calculate the firm’s EVA and MVA for 2001. Assume that Laiho had 10 million shares outstanding, that
the year-end closing stock price was $17.25 per share, and its after-tax cost of capital was 12 percent.
Additional Input Data
Stock price		$17.25
# of shares (in thousands)		10,000
A-T cost of capital		12%
Market Value Added
MVA =	Stock price	x	# of shares	-	Total common equity
=	$17.25	x	10,000	-	$157,605
=	$14,895
Economic Value Added
EVA =	NOPAT	-	Operating Capital x		After-tax cost of capital
=	$36,531	-	$239,186	x	12%
=	$7,828
The firm's market value exceeds its book value by $14.895 million. This means that management has added this
much to shareholder value over the company's history. It would have to be compared to the MVA of other
companies before declaring the performance good, bad, or indifferent.
EVA shows how much value management has added during the latest year. The $7.828 million appears to be
pretty good, but again, industry comparisons would be helpful. We discuss such comparisons in Chapter 3.