Interview technical - accounting need help
I recently got an interview question and kept on struggling with it, particularly the second part where it doesn't balance. It goes as follows:
You purchase a piece of equipment for $500 using 50% debt and 50% issuing of new stock. Stock share price is $10 with par value of $1. How does this affect the 3 statements.
So obviously I got no effect on Income statement, cash flow statement: capex up by $500 (cash outflow), increase in debt $250 inflow, new shares issued $250 inflow >>> change in cash = $0; Balance sheet: equipment up by $500, debt is up by $250, and shareholders equity is up by $250.
A year later you sell the equipment for $700 in cash. Assume you pay down debt with cash. Assuming an interest expense of 10%. How are the 3 statements affected.
Income Statement: I calculated a gain of $200 and interest expense of $25, making pretax income up by $175, assuming corporate tax rate of 40%. net income was up by $105.
Cash Flow: Net income up by $105, cash inflow of $700, and assume you pay down debt using cash $250 (outflow), I arrive at positive increase in cash flow of $555.
Balance sheet: Cash up by $555, equipment is down by $500, assets are up by $55 liabilities, debt is down by $250...
This is as far as I get, obviously the balance sheet doesn't balance.
I flow everything through and keep on getting an imbalance on the balance sheet here. Please someone help me understand what goes on.
Thanks for your help.
curious about this too
looks like you did everything right except in year 1 you say a cash inflow of $700, but assuming there is no depreciation ( which is what you are doing here), you are booking $200 two times: one in your income statement for profit and in your cash flow statement. your cash inflow should be +500 when you sell and this is what you include in capex for cash flow. if you do that, everything balances. I think that is right...
Your first part is correct, so let's just go to the second part (assuming no depreciation in this case)
IS: Gain on sale = $200 Interest expense = ($25)
Taxes = ($70)Net: $105
CF: Operating activities = $105 Investing activities = $500
Financing activities = ($250)Net change in cash: 355
BS: Cash = $355
PP&E = ($500)Net change in assets = ($145)
Debt = ($250)
Retained earnings = $105Net change in L+S/E = ($145)
Change in investing activities is only $500. The gain on sale of cash is already included in net income, so $700 in investing activities would basically be double counting the proceeds. Also you forgot to include the effects of Net Income on Retained Earnings. I think that's what it is, but someone correct me if I'm wrong.
I think that CF should be presented this way (note that either method shows 355 for net change in cash):
CF: Operating activities = (95) [for tax expense and interest expense] Investing activities = 700 [since it is the actual cash inflow received upon sale]
Financing activities = (250)Net change in cash: 355
thanks for the help
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