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Finance for Technical Management

Fall 2015
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02
Financial Statements, Taxes and Cash flows (Questions
1 to 8 given below)
12 Dec 2015
Kamran Aziz
1099
9 Jan 2016

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Question No. 1
The Functions of Intermediation: Financial intermediation can improve economic
efficiency in at least five ways
1) Facilitating transactions
2) Facilitating portfolio creation
3) Easing household liquidity constraints
4) Spreading risks over time
5) Reducing the problem of asymmetric information.
Financial Intermediaries: Financial institutions can be categorized broadly into four
groups:
Commercial Banks: Deposit-takers
Thrift Institutions: Savings institutions that take deposits and invest mainly in
consumer loans and mortgage loans.
Investment Companies: Mutual funds that pool savings of many individuals and
invest in portfolios of securities..
Pension Funds: Organization that take pension contributions
Insurance Companies: A wide variety of companies that provide insurance coverage
for life, casualty, theft, and medical losses.
Finance Companies: Non-deposit-taking institutions that specialize in consumer
loans, commercial loans and equipment leasing

Question No. 2
Difference Between Operating Cash Flow & Net Cash Flow:
Operating Cash Flow:

The amount of cash flowing in and out of a company.

Operating cash flow is calculated by subtracting its operating expenses from its
revenues. For example, suppose company ABC had revenues of $2 million and

operating expenses of $500,000 in the last fiscal year. Its operating cash flow is $1.5
million. These cash flows are found as follows:
Operating cash flow = EBIT(1-Tax rate) + Depreciation and amortization
Net Cash Flow: It is generally used to calculate and analyze real estate investments.
It looks at the ability of its investments to generate income. It can be calculated by
subtracting a company's operating expenses from its gross operating income. The net
operating income represents the productivity and cash flow of an investment. For
example, suppose company XYZ owns a building that generated a gross operating
income of $1 million and had operating expenses of $250,000 in the last fiscal year.
The net operating income is $750,000, which shows XYZ has positive return rates and
is not losing any money. Relationship between net cash flow and net income can be
expressed as follows:
Net Cash Flow = Net Income Noncash Revenues + Noncash Charges

Question No. 3
Operating Capital & Its Importance:
Operating Capital: Working capital (WC) is a measurement of a company's operating
liquidity. When evaluating a companys overall position and value, analysts often focus
on net operating working capital (NOWC), defined as follows:

Net Operating Working Capital= NOWT = (All Current Assets Required in Operations)
(All Non Interest Bearing Current Liabilities)
Importance of Operating Capital:

Working capital is a daily necessity for

businesses, as they require a regular amount of cash to make routine payments, cover
unexpected costs and purchase basic materials used in production of goods. Working
capital is an easily understandable concept, as it is linked to an individuals cost of
living and, thus, can be understood in a more personal way. Individuals need to collect
money they are owed and maintain a certain amount on a daily basis to cover day-today expenses, bills and other regular expenditures.
Working capital is a prevalent metric for the efficiency, liquidity and overall health of a
company. It is a reflection of the results of various company activities, including

revenue collection, debt management, inventory management and payments to

suppliers. This is because it includes inventory, accounts payable and receivable,
cash, portions of debt due within the period of a year and other short-term accounts.

Question No. 4: Solution

Difference Between NOPAT & Net Income:
Definition of NOPAT
Net Operating Profit after Tax, commonly known as NOPAT is the operating profit of
the organization subsequent to the reduction of tax. It is a tool used by the entity to
calculate the profitability. It helps the companies in reckoning profit, if there is no debt
financing. In case of NOPAT the company cannot claim tax benefit in terms of interest
for its debt financing. It can also be calculated as:
NOPAT = Operating Profit (1 tax rate)
Definition of Net Income
The net earnings (positive amount) remained after deducting all expenses, interest,
taxes and preferred stock dividend from Gross Profit is known as Net Income. It is also
termed as bottom line or net increase in the shareholders equity. A certain percentage
of net income is transferred to Reserves & Surplus and the remaining part is distributed
among the shareholders of the company.
Difference Between NOPAT & Net Income:
1.

NOPAT is used for making a comparison between firms, while Net income is
used to judge the performance of the company.

2.

Tax shield on the interest is not possible in case of NOPAT whereas Tax shield
on interest is available in case of Net Income.

3.

NOPAT is arrived after deducting tax from operating profit. On the other hand,
Net Income is arrived after deducting all expenses, profit, tax and dividends.

Question No. 5
Free Cash Flow & Its Importance:
Free Cash Flow: Free cash flow is the amount of cash a company has in the bank at
any given time, after all of its bills and payables are accounted for. Its a figure that can
be determined on a daily, weekly, monthly, or yearly basis.
FCF = NOPAT Net investment in operating capital
Importance of Free Cash Flow:
1.

FCF is also the foundation of certain types of value investing analysis, such as

discounted cash flow

2.

FCF is a better indicator than the P/E Ratio.

3.

Repay debt holders, that is, pay off some of the debt.

4.

Pay dividends to shareholders.

5.

Repurchase stock from shareholders.

6.

Buy marketable securities or other no operating assets.

Question No. 6

Question No. 7
EBITDA = $ 7.5 Million
Net Income = $ 1.8 Milllion
Interest = $ 2.0 Million
Tax Rate = 40 %
Now as we know
Net Income = EBT Tax Expense
Tax expense = 40 % of EBT
Tax Expense = 0.4 EBT
Putting Values

Net Income = EBT -0.40EBT

Net Income = 0.6 EBT
EBT = Net Income/0.6
EBT = 1.8/0.6
EBT = $ 3 Million
Now
EBIT = EBT + Interest Expense
EBIT = 3 + 2
EBIT = $ 5 Million
Then Dep + Amortization or Say DA will be
DA = EBITDA EBIT
DA = 7.5 5
DA = $ 2.5 Million

Question No. 8
a.

NOPAT = EBIT (1- Tax Rate)

NOPAT = 4 (1.0 0.4)
NOPAT = 4 (0.6)
NOPAT = $ 2.4 Million

b.

NCF = NI + Dep
NCF = 1.5 + 3
NCF = $ 4.5 Million

c.

OCF = NOPAT + Dep

OCF = 2.4 + 3
OCF = $ 5.4 Million

d.

FCF = NOPAT Net Investment in capital

FCF = 2.4 1.3

FCF = $ 1.1 Million
e.

EVA = NOPAT (Total Operating Capital)(After tax cost of capital)

EVA= 2.4 (20)(0.1)
EVA = 2.4 2.0
EVA = $ 0.4 Million