During 2009, Raines Umbrella Corp. had sales of $744,000. Cost of goods sold, ad

Question

During 2009, Raines Umbrella Corp. had sales of $744,000. Cost of goods sold, administrative and selling expenses, and depreciation expenses were $567,000, $91,000, and $128,000, respectively. In addition, the company had an interest expense of $97,000 and a tax rate of 35 percent. (Ignore any tax loss carryback or carryforward provisions.) Assume Raines Umbrella Corp. paid out $24,000 in cash dividends. 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 firm's net new long-term debt?

Explanation / Answer

For Raines Umbrella Corp, we have

Sales $744,000
Less: Cost of Goods Sold $ 567,000
Administrative and Selling Expense $ 91,000
Depreciation Expense $128,000
EBIT = - $ 42,000
Interest expenses $ 97,000
Taxable Income - $139,000
Tax (35%) = 0
Net loss - $139,000

Operating Cash Flow = EBIT + Depreciation - Tax
-$42,000 + $128,000 - Tax = $86,000

Suppose Raines Umbrella Corp. paid out $24,000 in cash dividends.

If spending on net fixed assets and net working capital was zero, and if no new stock was issued during the year and firm is paying dividends if its net income is negative, in that case

Cash flow to stockholders = Dividends – Net new equity
$24,000 - 0 = $24,000
Cash flow to creditors = Cash flow from assets – Cash flow to stockholders
$86,000 - $ 24,000 = $62,000
Net new Long-term debt = Interest - Cash Flow to Creditors
$97,000 - $ 62,000 = $35,000

Firms net new long-term debt = $ 35,000

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