Question: Shortest Way to Answer
Walk me through what happens to each of financial statement after a company buys a factory with debt. For year 1 and 2.
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No.
Personally, I think this is the best way. It's the most structured and probably the quickest RIGHT way. Common note for both answers: start with I/S --> CF/S --> B/S (it flows better and is will be less likely you miss something) I/S: Rev --> NI CF/S: NI --> Change in Cash B/S: Cash --> RE (and should balance!)
Assume: Cost is $100
Year 1. You just bought the factor and you haven't used it: I/S: no change CF/S: CFO - you haven't used it, no change CFI - Capex -100 (outflow) CFF - raise debt +100 (inflow) Total change in cash 0
B/S: A: Cash - no change PP&E + 100 L: Debt + 100 E: no change Balances.
Year 2. You use it for a year Some people prefer if you assume your factory is actually producing stuff (Rev++, COGS++ etc), but I'll just refer to what happens related to the factory itself. Or you can just work your way to EBITDA++ from Rev++ and keep track of the numbers.
Assume (choose convenient numbers, but not TOO convenient): Interest rate of 5% Tax rate of 30% Straight Line Dep @ 10 years
I/S: Dep = 10 Int exp = 5 EBT down 15 (10+5) Tax down 4.5 (15 x 30%) NI down 10.5
CF/S: NI down 10.5 (cash outflow) Dep of 10 (cash inflow, non-cash expense) CFO down 0.5 (outflow) CFI - no change CFF - no change Change in cash 0.5 (outflow)
B/S A: Cash down 0.5 PP&E down 10 A: down 10.5
L: no change
E: RE = RE + NI (down 10.5) Balances.
Lets say this question were asked in an interview... Would you be able to use paper? Like how the hell could you do all that in your head while remembering each item calculated previously..
Because you're supposed to use round numbers, so when you do assumptions don't assume some ridiculous rates and end up with decimals.
Answer per ibankingfaq:
First Year: Income Statement: No depreciation and no interest expense so no change. Cash Flow Statement: No change to net income so no change to cash flow from operations. Just like the previous question, we’ve got a $100 increase in capex so there is a $100 use of cash in cash flow from investing activities. Now, however, in our cash flows from financing section, we’ve got an increase in debt of $100 (source of cash). Net effect is no change to cash. Balance Sheet: No change to cash (asset), PP&E (asset) up $100 and debt (liability) up $100 so we balance.
Second Year: Same depreciation and tax assumptions as previously. Let’s also assume a 10% interest rate on the debt and no debt amortization. Income Statement: Just like the previous question: $20 of depreciation but now we also have $10 of interest expense. Net result is a $18 reduction to net income ($30 x (1 – 40%)). Cash Flow Statement: Net income down $18 and depreciation up $20. No change to cash flow from investing or financing activities (if we assumed some debt amortization, we would have a use of cash in financing activities). Net effect is cash up $2. Balance Sheet: Cash (asset) up $2 and PP&E (asset) down $20 so left side of balance sheet down $18. Retained earnings (shareholders’ equity) down $18 and voila, we are balanced.
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