Investment Banking Superday technical question
I had pretty much aced the super day recently at a middle market firm which had brainteasers and technical questions until I was stumped by this question.
If a company lost a lawsuit and the SEC has imposed a $100 million fine, payable $20 million each year, How would it impact the 3 financial statements :
1) on Dec 31st
2) on Jan 1st
Any thoughts on this fellows. I would appreciate confident answers rather than random guesses.
I believe it would just be set under a separate line as it would be considered an extraordinary item.
B/S- Would have a liability listed for the fine and the subsequent cash payments, and accrued interest related to the fine
I/S- Would have it listed out as a loss from lawsuit or a fine and would decrease NI.
CF- Not sure if you would just disclose it in the footnotes or whether it would be part of operating activities.
That's one of the most non-specific answers I've seen on this board.
Assuming that the event occured on or before 12/31 but the cash payout doesn't start until the following 1/1, then:
On 12/31: IS - $100mm loss (NI down $100mm) CFS - NI down $100mm, increase in payable of $100mm (net cash neutral) BS - increase in payable of $100mm, retained earnings down $100mm
On 1/1 (assuming cash payout each year at 1/1): IS - no change CFS - decrease in payable of $20mm ($20mm decrease in cash) BS - decrease in payable of $20mm, decrease in cash of $20mm
monkeynumber 7 thanks for the detailed breakdown...this is what I was actually looking for
note that the above answer excludes taxes; cash flow will actually increase due to shield...etc.
I thought you did not get a tax shield for litigation expenses. The government does not want to offer any benefits for those who break the law/contracts.
I would have guessed no tax shield as well but defer to someone who actually knows.
bump
Don't mean to hijack the thread but I have a technical question too. - What happens to the financial statements and EPS when company issues debt to repurchase stock? I did manage to balance the balance sheet and said that EPS would go up (assume NI doesn't change and total outstanding shares go down since stock is repurchased) but it doesn't seem to be the right answer. Thanks everyone.
Sure, so when the company issues debt to repurchase stock:
IS: No change CFS: Under CFF, cash is up from the debt issuance, but down by the same amount from the stock repurchase. BS: Assets are unchanged. On the other side, liabilities are up from the debt issuance, and under Shareholder's Equity, Treasury Stock is DOWN by the same amount. Thus we are balanced.
For EPS: EPS= (Net Income- dividends) / Shares Outstanding
And your logic on this one is the same as mine. So I'm curious about this too.
That is correct, fines paid are not deductible for tax purposes.
bump anyone has a solution to the above question
ibd_2011
I believe:
Numerator Effect in EPS: NI would decrease by the interest payments due to the issuance of debt NI would need to be changed because it accounts for earnings after interest and taxes. Or you would add back the interest savings from the debt to the tax affected NI Denominator Effect in EPS: Decrease in shares outstanding
So it's just an accounts payable increasing by 100M on 12/31, then decreasing by 20M on 1/1.
Question I have is....why does it appear on the companies IS on 12/31 if it does NOT relate to taxes? To appear on the IS, doesn't a line item have to affect the company's taxes?
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