Valuation: The Art and Science of Corporate Investment Decisions, Second Edition
A firm’s net income is calculated as the difference in the revenues it recognizes for the period less the expenses it incurred in the process of generating those revenues. The method used to determine what revenues are earned and what expenses have been incurred is determined in accord with the basic rules of accrual, not cash, accounting. Consider the following situation:
§ On March 1, 2010, the Sage Video Store in Tacoma, WA, placed an order for 10 52-inch Sony LCD television sets. The vendor they ordered from gave the firm 60 days to pay the $1,200 cost per set.
§ On April 12, 2010, Mary Griggs came into the Sage Video Store and purchased on of the Sony television sets for $1,950. Part of Mary’s motivation for making the purchase was that she did not have to make a payment for the purchase for six months and did not have to make a down payment either.
a. If Sage ends its first quarter on May 1, how does the sale of the television to Mary impact the firm’s gross profits for the quarter? What is the impact of the sale on the firm’s cash flow?
b. If Mary were to make a 10% cash down payment at the time of the purchase and then not begin making payments for six months, what is the impact of the sale on the firm’s gross profit and cash flow?