Solving Income, Cash Flow, and Taxes: A Business Simulation Study

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Georgia Southern University *

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4135

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Finance

Date

Jun 13, 2024

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xlsx

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Uploaded by stephanieekiyor

Therefore, this extra credit allows you to consider some of these real-world complexities INSERT ALL TEAM MEMBER NAMES HERE Stephanie Ekiyor-katimi Problem 1. Income, Cash Flow, Taxes, and Depreciation manufacturing process, more popularly known as 3D printing. Exhibit 1 presents the quarterly operating profit results for Division X while Exhibit 2 presents the Division's Cash Flow Computations. For your convenience, yearly amount columns and a cumulative two-year column have been added. EXHIBIT 1: Net Operating Profit for Division X Division Profitability Quarter Quarter Quarter Quarter Year 1 Quarter Quarter Quarter Quarter % Change Year 2 Cumulative Quarter 1 2 3 4 Totals 5 6 7 8 from Q7 to Q8 Totals Totals 9 Gross Profit Net Revenue (Revenues - Rebates) 0 0 556,304 855,205 1,411,509 1,348,555 4,857,055 8,116,190 9,320,575 14.8% 23,642,375 25,053,884 10,703,682 - Cost of Goods Sold 0 0 (221,773) (338,271) (560,045) (485,805) (1,696,944) (3,035,135) (3,693,037) 21.7% (8,910,921) (9,470,966) (4,493,547) = Gross Profit 0 0 334,531 516,934 851,464 862,750 3,160,111 5,081,055 5,627,538 14,731,454 15,582,918 6,210,136 Expenses Store Leases 0 0 72,000 72,000 144,000 126,000 246,000 283,500 324,500 64,900 980,000 1,124,000 259,600 + Other Operating Expenses: Sales and Service Personnel Expense 0 0 46,474 61,376 107,850 96,364 269,059 332,274 403,544 21.4% 1,101,241 1,209,091 490,101 Brand Promotions 0 0 0 0 0 0 0 7,950 12,840 61.5% 20,790 20,790 20,738 Special Programs 0 0 0 0 0 0 0 50,760 86,940 71.3% 137,700 137,700 148,908 Ad Creation/Revision 0 0 24,000 24,000 48,000 24,000 24,000 6,000 6,000 0.0% 60,000 108,000 6,000 Point of Purchase Display Expenses 0 0 600 600 1,200 1,200 2,000 4,200 6,000 42.9% 13,400 14,600 8,571 Advertising Expenses 0 0 20,596 22,778 43,374 183,862 349,476 457,856 486,150 6.2% 1,477,344 1,520,718 516,192 Internet Marketing Expenses 0 0 3,000 4,000 7,000 12,936 52,033 129,969 92,020 -29.2% 286,958 293,958 65,152 Engineering Cost for New Brands 0 120,000 0 90,000 210,000 60,000 60,000 120,000 30,000 -75.0% 270,000 480,000 7,500 Market Research 88,000 0 20,000 20,000 128,000 20,000 40,000 60,000 60,000 0.0% 180,000 308,000 60,000 Total Other Operating Expenses 88,000 120,000 114,670 222,754 545,424 398,362 796,568 1,169,009 1,183,494 3,547,433 4,092,857 1,323,162 = Total Operating Expenses 88,000 120,000 186,670 294,754 689,424 524,362 1,042,568 1,452,509 1,507,994 4,527,433 5,216,857 1,582,762 Operating Profit Gross Operating Profit (Gross Profit - Operating Expenses) (88,000) (120,000) 147,861 222,180 162,040 338,388 2,117,543 3,628,546 4,119,544 10,204,021 10,366,061 4,627,374 Misc. Income and Expenses + Other Income 0 0 0 0 0 0 0 0 0 0 0 0 - Other Expenses 0 0 0 0 0 0 0 0 0 0 0 0 - Research and Development Costs 0 0 0 0 0 (1,824,930) (739,068) 0 (653,791) (3,217,789) (3,217,789) 0 - Set Up Costs for New Stores 0 (330,000) 0 (146,000) (476,000) (602,000) (218,000) (259,000) (176,000) (1,255,000) (1,731,000) 0 = Net Misc. Income and Expenses 0 (330,000) 0 (146,000) (476,000) (2,426,930) (957,068) (259,000) (829,791) (4,472,789) (4,948,789) 0 Net Operating Profit (NOP) = Net Operating Profit for Division (88,000) (450,000) 147,861 76,180 (313,960) (2,088,542) 1,160,475 3,369,546 3,289,753 5,731,232 5,417,272 4,627,374 EXHIBIT 2: Cash Flow for Division X Division Cash Flow Quarter Quarter Quarter Quarter Year 1 Quarter Quarter Quarter Quarter Year 2 Cumulative 1 2 3 4 Totals 5 6 7 8 Totals Totals Beginning Cash Balance 0 412,000 462,000 1,109,861 0 1,686,040 1,597,498 2,757,973 6,127,519 1,686,040 - + Investment from Corporate Headquarters 500,000 500,000 500,000 500,000 2,000,000 2,000,000 0 0 0 2,000,000 4,000,000 + Net Operating Profit for Division (88,000) (450,000) 147,861 76,180 (313,960) (2,088,542) 1,160,475 3,369,546 3,289,753 5,731,232 5,417,272 + Borrow Emergency Loan from Headquarters 0 0 0 0 0 0 0 0 0 0 0 - Repay Emergency Loan from Headquarters 0 0 0 0 0 0 0 0 0 0 0 Cash Balance, End of Period 412,000 462,000 1,109,861 1,686,040 1,686,040 1,597,498 2,757,973 6,127,519 9,417,272 9,417,272 9,417,272 REQUIRED. 1. Exhibit 1 presents the division's net operating profit as measured by the class simulation. Complete the following schedule to budget the division's net operating profit (NOP) for Quarter 9 given these assumptions: a. In Quarter 9, net Revenue and cost of goods sold will grow at the same rate as they did from Quarter 7 to Quarter 8. b. No miscellaneous income or expenses are expected in Quarter 9. c. Imagine that through innovation & continuous improvements, as well as work-from-home opportunities for the salespeople, the business has made it possible to produce the carbon fiber bikes while reducing further the size of its stores. As store leases expire, the company will lease stores that are approximately half the size of its current stores. This will result in a 20% reduction in lease expense in Quarter 9 over Quarter 8. d. All other operating expenses (other than lease expense) will grow at the same rate as they did from Quarter 7 to Quarter 8 Budgeted Profitability Quarter 9 *Please use excel funtions to calculate rather than inputting into a calculator, for more accurate results Net Revenue (Revenue - Rebates) 10,703,682 as some cells have hidden decimals Less Cost of Goods Sold (4,493,547) = Gross Profit 6,210,136 Less Store Leases 259,600 Less Other Operating Expenses 1,582,762 = Gross Operating Profit 4,627,374 +- Miscellaneous Income and Expenses 0 = Net Operating Profit (NOP) 4,627,374 2. Exhibit 1 presents the division's net operating profit as measured by the class simulation but not net income. Without using numbers, explain the difference between operating income and net income? 3. Which amount (gross operating profit or net operating profit) would be more useful (i.e., relevant) for making decisions requiring predictions of future division income and cash flow? 4. Many decisions (e.g., capital budgeting, firm valuation models, etc.) require cash flow estimates. Exhibit 2 presents the division's cash flow as measured by the class simulation. Notice that the net operating profit amounts from Exhibit 1 increased the division's cash flows by the same amount. In what way did the simulation simplify how things would really work - What key assumption about the division's revenues and expenses made this possible? The simulation assumed that every dollar earned in profit immediately translated into a dollar of cash inflow, and every dollar spent on expenses immediately translated into a dollar of c 5. As you can see, operating income values do not include income taxes. Ignoring income taxes in important decisions can lead to poor results. Assuming the appropriate combined federal/state/local tax rate is 36%, compute the division's cumulative (i.e., two year total) gross operating profit on an after-tax basis. 6. According to the simulation, each division was given $4,000,000 in investment capital and this directive: "Your division should be generating a profit from its operations and contributing towards the overhead and profit of the corporation as a whole. Within 8 quarters, you are expected to earn enough profit to more than pay back the initial investment to Headquarters." If we are operating in the real world rather than a simplified simulation, did Division X really meet the expectations of Corporate Headquarters? Explain. 7. The division currently leases its retail space. Thanks to the new 3D printing manufacutring process, the average square footage requirement of the division's retail stores is now much much smaller. Thus, the division is considering purchasing retail space rather than leasing it. Without using numbers, explain the impact on the division's operating income, annual net cash flow (exclusive of taxes), and taxes assuming the division purchases retail space rather than leasing it. IMPACT ON (Enter "Increase," "Decrease," or "No Impact" in the 9 boxes) Net Cash Flow Income Taxes Eliminating the store lease payments Increase Increase Decrease Recording depreciation on purchased stores Decrease Decrease Decrease Purchase price of new stores No impact Decrease No impact we do things to simplify reality in order to help you learn without true complexity and detail. The simulation you completed for class simplified certain rea 1. Assumed income = cash and 2. ignored taxes From the simulation . A large, international bicycle firm has decided to enter a new segment of the business. It has recently licensed the technology to build carbon fiber bikes using an additive Operating income, also known as operating profit, reflects the revenue generated from a company's core business operations minus the expenses directly associated with those operations. These expenses typically include costs such as raw materials, labor, and overhead. Operating income excludes non-operating revenue and expenses, such as interest income, interest expenses, and taxes. Net income represents the total profit or loss of a company after accounting for all revenues, expenses, gains, and losses, including both operating and non-operating items. It takes into account not only the operating performance of the company but also factors in other income sources, such as interest and expenses on interest payments on debt and taxes. Net operating profit is generally more useful and relevant than gross operating profit when making decisions requiring predictions. Gross operating profit represents the profit generated from core business operations before deducting operating expenses, such as wages, rent, utilities, and depreciation. While gross operating profit provides insights into the efficiency and profitability of a company's primary business activities, it does not account for all expenses associated with running the business. Net operating profit takes into account all operating expenses, including both variable and fixed costs, such as salaries, utilities, marketing expenses, and depreciation. Net operating profit provides a clearer understanding of the profitability of a company's core business operations. It reflects the amount of profit that remains after covering all costs directly related to running the business. we need to adjust the operating income values for income taxes using the appropriate tax rate of 36%. 3,467,055 In the real world, Division X met the expectations of Corporate Headquarters based on the information provided in the simulation. According to the simulation, Division X received a total investment of $4,000,000 from Corporate Headquarters and was expected to generate a profit from its operations within 8 quarters to more than pay back the initial investment. From the cash flow data provided in exhibit 2, Division X achieved this goal. The cumulative cash balance at the end of the two years was $9,417,272. This indicates that Division X could generate sufficient profits to repay the initial investment of $4,000,000 to Corporate Headquarters within the specified timeframe. Operating Income

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