Chapter 3
Understanding Financial Statements,
Taxes, and Cash Flows

3-1. To find the net income, we must subtract all relevant expenses from revenues: cost of goods sold, operating expenses, interest, and taxes. Following the template from Checkpoint 3.1, we find the following for Sandifer Manufacturing Company:

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Sandifer was able to generate $438,750 in net income from its sales of $4.5M. The $438,750 is now available to pay out to shareholders (dividends), and/or to reinvest in the business (retained earnings).

3-2. We just learned (in Problem 3-1) that Sandifer has $438,750 to allocate to dividends and reinvestment. If it chooses to reinvest $50,000, then it will have ($438,750 − $50,000) ’ $388,750 to pay out as dividends (a [$388,750/$438,750] ’ 88.6% payout ratio).

3-3. Marifield Steel Fabrication earned net income of $500,000, then paid out a dividend of $300,000. This left ($500,000 − $300,000) ’ $200,000 to be retained by the firm to finance growth.

However, earnings per share is based on net income, not reinvested earnings. Thus, the firm’s EPS is:

[pic] 3-4. Barrington Enterprises earned $4M in taxable income. Using the corporate tax rates given in Section 3.3 of the chapter, we find the following:

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Barrington’s total tax liability is $1,360,000, for an average tax rate of ($1,360,000/$4,000,000) ’ 34%.

The chart above is very close to that in Section 3.3. However, we will explain the entries, using the calculations for bracket #3 (highlighted in the chart) as an example:

Bracket #3 is shown in the text to apply to taxable income between $75,001 through $100,000. Thus, the bracket applies to $25,000, which is what we have entered in the “(marginal) taxable income” column. The “cumulative income taxed” column shows $100,000, meaning that when we have moved