Question

Spongebob and his good friend Patrick Star decide to open a bubble stand. Spongebob and Patrick, long on good ideas but short of capital, ask Mr. Krabs if he is interested in investing in the bubble stand. Mr. Krabs lends the bubble stand $10,000 at interest rate of 10%, interest paid annually. Spongebob purchased a new bubble stand for $10,000, five year useful life, and invests in inventory (bubbles and wands) of $1,000. They maintain an inventory of $1,000 at all times. The bubble stand had an outstanding first year with sales of $20,000. In addition, the bubble stand had a gross margin of 50%, general and administrative expenses were $2,500, and marketing is 10% of sales. The bubble stand paid dividends of $500 to both Spongebob and Patrick. The firm’s tax rate is 30%.

a. What are earnings before interest and taxes?

b. What is net income?

c. What is cash flow from operations?

d. What is free cash flow?

Answer 1

a) EBIT   

Sales = $20000

Cost of goods sold = (10000)

Gross Profit = 10000

General and Administrative expense = (2500)

Marketing Expense = (2000)

EBIT = $5500

b) Net Income   

Sales = $20000

Cost of goods sold = (10000)

Gross Profit = 10000

General and Administrative expense = (2500)

Marketing Expense = (2000)

EBIT = $5500

Interest @10% = (1000)

Depreciation = (2000)

EBT =$2500

Tax @30%   = (750)  

Net Income = $1750

c) Cash flow from operation

Net Income = $1750

Add: Depreciation = 2000

Les: Increase in current asset = (1000)

Cash flow from operation =$2750

d) Free cash flow  

= Operating cash flow - All capital expenditure

= 2750 - 10000 = $-7250