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    Calculating the Net Income and Cash Flows

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    1) XYZ has sales of $100,000 a year, and the sale price will increase with inflation. Inventory valuation is such that the effective cost of goods sold is the purchase price 3 months prior to sale. Depreciation is fixed, and other operating costs are increase proportionately with inflation. The company sells on terms of net 30 and buys inventory on terms of net 60. All other purchases are for cash. Shown below is 1st year of operation with no inflation. Show net income for following year with 10% inflation rate.

    Sales 100,000
    Cost of goods sold 80,000
    Depreciation 5,000
    Other expenses 10,000
    Earnings before tax 5,000
    Tax 1,700
    Net income 3,300


    XYZ started on Dec 31st 1999. The company bought 2 units of inventory initially for $1000 each. The company will sell one unit per inventory each year for $2000 and immediately replace that unit. Depreciation will be $400 per year , labor expenses will be $500 a year in absence of inflation. Sale price and inventory purchase price will increase with inflation. Depreciation will remain fixed and labor expense will lag one year behind inflation due to labor contracts. The company's tax rate is 34%. Assume inflation is 0% in 2000 and 10% a year there after. Using FIFO show net income in 2000, 2001, 2002, 2003. If inventory is purchased for cash and sold cash then what are the annual cash flows for 2000,2001,2002,2003.
    I need brief explanation of COGS calculation as well.

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    Solution Preview

    1. First let's define net income which is the same as net profit. To calculate net income you take gross sales minus cost of goods sold, taxes, interest, depreciation, and other expenses.
    Since the problem is asking to show net income for the following year with a 10% inflation rate you would add 10% to the sales, taxes, depreciation, and other expenses. They already have the current year net income calculated for you which is $3300. They got this by taking sales $100,000 and subtract ...

    Solution Summary

    The solution calculates the net income and cash flows in the given problem.