LGIN was founded in 2010 to apply a new technology for the Internet. The company earned a profit of $190,000 in 2010, its first year of operations. Management expects both sales and net income to more than double in each of the next four years. Comparative balance sheets at the end of 2010 and 2011, the company’s first two years of operations, appear below. (Notice that the balances at the end of the current year appear in the right-hand column.)
The following information regarding the company’s operations in 2011 is available in either the company’s income statement or its accounting records:
1. Net income for the year was $562,000. The company has never paid a dividend.
2. Depreciation for the year amounted to $125,000.
3. During the year the company purchased plant assets costing $2,585,000, for which it paid $2,000,000 in cash and financed $585,000 by issuing a long-term note payable. (Much of the cash used in these purchases was provided by short-term borrowing, as described below.)
4. In 2011, LGIN borrowed $1,490,000 against a $5 million line of credit with a local bank. In its balance sheet, the resulting obligations are reported as notes payable (short-term).
5. Additional shares of capital stock (no par value) were issued to investors for $665,000 cash.
a. Prepare a formal statement of cash flows for 2011, including a supplementary schedule of noncash investing and financing activities. (Follow the format illustrated in Exhibit 13–8 . Cash provided by operating activities is to be presented by the indirect method. )
b. Briefly explain how operating activities can be a net use of cash when the company is operating so profitably.
c. Because of the expected rapid growth, management forecasts that operating activities will include an even greater use of cash in the year 2012 than in 2011. If this forecast is correct, does LGIN appear to be heading toward insolvency? Explain.
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