SOLUTIONS MANUAL for Corporate Finance Core Principles and Applications 4th Edition by Ross Download at http://downloadlink.org/p/solutions-manual-for-corporate-finance-coreprinciples-and-applications-4th-edition-by-ross/ TEST BANK for Corporate Finance Core Principles and Applications 4th Edition by Ross Download at http://downloadlink.org/p/test-bank-for-corporate-finance-core-principlesand-applications-4th-edition-by-ross/
End of Chapter Solutions Corporate Finance : Core Principl es and Applications 4th editi on Ross, Weste rfield, Jaffe, and Jordan 06- 08- 201 3
P repared b y Brad J ordan Universit y o f Kentuck y J oe S molira
Belm ont Universit y
CHAPTER 1 INTRODU CTION TO CORPOR ATE FINANCE Answ ers to Concept Q uest i ons 1. T he t hree basi c for ms ar e sol e propri et or shi ps, part nershi ps, and cor porati ons. Some di sa dvantagesof soleproprietorshipsandpart nershi ps ar e: unli mi t ed li abi li t y, l i mi t ed li fe,difficultyintransferring ownership, and hard t o rai se ca pit al f unds. Some advant ages are: si mpl er , les s r egul at i on, t he owners ar e also t he mana ger s, and somet i mes per sonal t ax rat es ar e bett er t han corpor at e t ax r at es . T heprimary disadvantageofthecorporateform i s t he double t axation t o shar ehol ders on distr ibutedearningsand dividends.Someadvant ages i ncl ude: li mi t ed li abi li t y, ea se of t ransf erabili t y, abil it y t o r aise ca pi tal, and unli mi t ed li fe. When a busi ness is start ed, most t ake t he f or m of a sol e pr opri et orshi p or partnership becauseoftherelativesimplici t y of start i ng t hes e f or ms of busi nes ses . 2. T o maxi mi ze t he cur rent mar ket val ue ( sha r e pr ice ) of t he equit y of t he fi r m ( whet her it ’ s publi cl y t r aded or not ) . 3. In t he cor porate f or m of owner shi p, t he shar ehol der s are the owners of t he fi r m. T he shar eholderselect thedirectorsofthecorporat ion, who in t ur n appoint t he f ir m’ s mana ge me nt . Thisseparationof ownershipfromcontrolin the cor por at e f or m of or gani zat i on i s what ca usesagencyproblemstoexist. Managementmay ac t i n i ts own or someone el se’s best i nter est s, ratherthanthoseoftheshareholders. Ifsuch event s occ ur , t hey ma y cont r adi ct t he goal of maxi mi zi ng t he shar e pri ce of t he equit y of t he f i r m. 4. Such or gani zati ons f requent l y pur sue soci al or polit i cal mi ss ions, so many di ff erent goals are conceivable.Onegoalthatisoftencitedi s r evenue mi ni mi zat i on; i .e., pr ov i de what evergoodsand servicesareofferedatthe lowes t possi bl e cost t o soci et y. A bett er appr oachmightbetoobservethat evenanot-for-pr of it busi ness has equit y. T hus, one answer is thattheappropriategoalistomaximize the val ue of t he equi t y. 5. Pre sumabl y, t he curr ent st ock val ue refl ect s t he r isk, t imi ng, and ma gni t ude of al l f ut ure cas hflows, bothshort-termandlong-term.Ifthi s i s c or rec t, t hen the s tat ement i s f alse . 6. An ar gument ca n be made ei ther way. At t he one ext reme, we coul d ar gue t hat i n a mar ket ec onomy, al l of t hese t hi ngs are pri ced. T here i s t hus an opt i mal l evel of , f or exampl e, unethi cal and/ orillegal behavior,andtheframeworkofst ock val uat ion explici tl y i ncl udes t hes e. At theotherextreme,we couldarguethatthesear e non -ec onomi c phenomena and are best handled t hroughthepoliticalprocess. Aclassic(and hi ghl y r elevant ) t hought quest i on t hat il l ustr ates thi s debat e goes somet hi ng l i ke t his: “A f i r m has est i mat ed that t he cost of i mpr ovi ng t he sa f et
y of one of it s pr oduct s is $30 mi l li on. However , t he fi r m bel ieves t hat i mpr ovi ng t he saf et y of t he pr oduct wi ll onl y save $20 mi l li on in productliabilityclaims.Whatshouldthe fi r m do?� 7. T he goal wil l be t he sa me, but t he best cour se of act i on t owar d that goal may be di ff erent becauseof differingsocial,political,and ec onomi c i nst it uti ons.
C HAP TER 2 B - 2 8. T he goal of mana ge ment should be to maxi mi ze t he shar e pri ce for t he cur rent sharehol ders. If mana ge ment bel i eves t hat it ca n i mpr ove t he pr ofi tabil ity of t he fi r m so t hat t he share pr ice wil l exc eed $35, then t hey shoul d fi ght the off er fr om t he outsi de compan y. If mana ge ment believes t hat t hisbidder orotherunidentifiedbidderswill act ual l y pay mor e t han $35 per shar e t o acquir e t hecompany,then theyshouldstillfightthe off er . However , if t he cur rent mana ge ment ca nnotincreasethevalueofthe firmbeyondthe bi d pri ce , and no ot her hi gher bids come i n, t hen managementisnotactinginthe interestsof the shar ehol ders by f i ght i ng t he off er . Since currentmanagersoftenlosetheirjobswhen t he cor por ati on i s acquir ed, poor l y moni t or ed mana ger s have an i nce nt i ve t o f i ght cor porate t akeovers i n si t uati ons suc h as t his. 9. We would expect agenc y pr oblems t o be l ess sever e i n ot her count ri es , pri mar i l y due t o t he r elatively smallpercentageofindividual owner shi p. Fewer i ndi vi dual owners shoul d r educethenumberof diverseopinionsconcerni ng cor por at e goals. T he hi gh per centage of i nst itutionalownershipmight leadtoahigher degr ee of agr ee ment bet ween owners an d mana ger sondecisionsconcerningrisky projects.In addit ion, i nst itut i ons may be bet t er able to i mplementeffectivemonitoringmechanisms on mana ger s t han can i ndi vi dual owner s, based on t he i nst it uti ons’ dee per r esour ces and experi ences withtheirownmanagement.Theincrease i n i nst it uti onal owner shi p of st ock i n t he UnitedStatesand thegrowingactivismofthes e lar ge shar ehol der gr oups may l ea d t o a reduct i oninagencyproblems forU.S.corporations and a mor e e f fi cient mar ket for cor porate c ont r ol . 10. How much i s t oo much? Who i s wort h mor e, Lar r y Elli son or Tiger Woods? T he si mpl es t ans wer i s t hat t her e is a mar ket f or exe cuti ves j ust as t here i s for all t ypes of l abor . Exec ut ive co mpensationis thepricethatclearsthemarket . T he sa me i s t rue f or at hlet es and per f or mer s. Havingsaidthat,one aspectofexecutive compens ati on deser ves comment . A pr i mar y r ea sonthatexecutivecompensation hasgrownso dramat i cal l y i s t hat companies have i ncrea singl y moved t o st ock -bas ed compens ati on. Such move men t i s obvi ously cons i stent wi t h t he a tt empt t o bett er ali gn st ockholder and mana gement interests.Whenstockpricessoar, mana ge ment clea ns up. It is someti mes ar gued t hatmuchofthis rewardissimplyduetorising st ock pri ces i n gener al , not mana ger ial p erf or mance.Perhapsinthe future,executive compens at i on wi ll be desi gned t o r ewar d onl y di fferentialperformance,i.e.,stock price increa ses i n exce ss of gene r al mar ket increa ses .
CHAPTER 2 FINANCIA L ST ATE MENTS AND CASH FLOW Answ ers to Concept Q uest i ons 1. Liquidit y mea sur es how qui ckl y and easi l y an as set can be convert ed t o ca sh wit hout si gni fi cantloss invalue.It’sdesirableforfirmsto have hi gh l i qui dity so t hat t hey have a l ar ge f ac torofsafetyin meetingshort-termcreditor demands . However , si nce liqui di t y also has an opportunitycostassociated withit-namelyt hat hi gher r et ur ns ca n gene r al l y be f ound by i nves ti ng t he ca sh i nto pr oducti ve as sets - l ow l i qui di t y level s a re als o desir abl e t o the f ir m. It ’ s up t o t he f ir m’ s fi nanci al mana ge ment st af f t o f i nd a rea sonabl e c ompr omi se bet ween these opposi ng nee ds 2. T he r ecogni t ion and mat chi ng pr i nci pl es i n fi nanci al ac counti ng ca ll f or r evenues , and t he costs associatedwithproducingthoser evenues, to be “booked” when t he r evenue proce ssisessentially complete,notnecessarily when t he cash i s coll ect ed or bi ll s ar e pai d. Not ethatthiswayisnot necessarilycorrect;it’ s the way ac countants ha ve c hosen t o do it . 3. T he bot t o m l i ne number shows t he change i n t he cash ba l ance on the balanc e sheet . As s uch, it is not a us ef ul number f or anal yzi ng a c ompany. 4. T he maj or dif f er ence is t he t r eat ment of i nt erest expens e. T he ac counti ng st at ement of ca shflows treatsinterestasanoperatingcashf low, whil e the f inanc ial st atement of cas h fl owstreatsinterestas afinancingcashflow. The logi c of t he ac counti ng st at ement of ca sh fl owsisthatsinceinterestappears onthei ncome st at ement , whi ch shows t he oper ati ons f ortheperiod,itisanoperatingcashflow.In r eal it y, i nteres t is a fi nancing expe nse , which r es ul ts fr om t he company’ s choice of debt/ equi ty.We willhavemoretosayaboutthisinalater chapt er . When compar i ng t he t wo cash flow st atements,the financialstatementofcashfl ows i s a mor e appropr i at e mea sur e of t he compan y’soperating performancebecauseofitstr eat ment of i nt er est . 5. Ma r ket val ues can never be negat i ve. Ima gi ne a shar e of stock se ll i ng f or –$20. This woul d mea n that ifyouplacedanorderfor100shares,you woul d get t he stock al ong wi t h a che ck f or $2,000.How manysharesdoyouwanttobuy?More gene r al l y, beca use of cor por at e and indi vi dualbankruptcy laws,networthforapersonor a cor por at ion ca nnot be negat i ve, i mpl yi ng t hatliabilitiescannotexceed assetsinmar ket val ue. 6. For a succe ssf ul company t hat i s r api dl y expa ndi ng, f or exa mpl e, ca pi t al outl ays wil l be l ar ge,possibly leadingtonegativecashflowfr om as set s. In gene r al, what mat t er s i s whet her themoneyisspent productively,notwhether cas h fl ow fr om as set s i s posit i ve or negat i ve.
7. It ’ s pr obabl y not a good sign f or an es tabli shed comp any, but it woul d be f ai rl y or di nar y f or a st ar t - up, so i t depe nds.
C HAP TER 2 B - 2 8. For exampl e, if a company wer e t o bec ome mor e eff ici ent i n i nvent or y mana ge ment , t he amount of i nvent or y nee ded would dec li ne. T he sa me mi ght betrueifitbecomesbetteratcollectingits r ec ei vabl es. In gene r al , anyt hi ng t hat l eads t o a decli ne i n ending NWC r el ati ve to begi nni ng would havethiseffect.Negativenetcapital spendi ng woul d mea n mor e l ong -l i ved as se t s were l iqui dated t han pur chas ed. 9. If a co mpany r ai se s mor e money f r om se l l i ng st ock t han i t pays i n di vi dends i n a par ti cul ar period,its cashflowtostockholderswillbe negati ve. If a comp any bor r ows mor e than i t pays ininterestand principal,itscashflowto credit or s wi ll be ne gati ve. 10. T he adj ust ment s disc usse d wer e pur el y ac count i ng changes ; they had no cas h f low or mar ket val ue cons equences . Soluti ons t o Q uest ions and P roblem s NOTE: Al l end- of - chapter problems were sol ved usi ng a spre adshe et . M any probl ems re qui re mult iple steps.Duetospaceandreadabilityconst rai nt s, when thes e i nt ermediat e st eps are i ncl udedinthissolutions manual,roundingmay appear t o have occ urr ed. Howev er , t he f inal answerforeachproblemisfound withoutroundi ng duri ng any s tep i n t he pr obl em. Basi c 1. T o f i nd owner ’ s equi t y, we must cons tr uct a balanc e shee t as foll ows:
CA NFA TA
Bal ance Sheet $7,300 CL 26,200 LT D OE $33,500 T L & OE
$5,700 12,900 ?? $33,500
We know t hat tot al l i abil it ies and owners’ equit y (T L & OE) must equa l t ot al asset s of $33,500.We alsoknowthatTL&OEisequalto curr ent l iabil it ies pl us l ong -t er m debt pl us owner s’ equit y, so owner s’ equi t y is: OE = $33,500 –12,900 – 5,700 = $14,900 NWC = CA – CL = $7,300 – 5,700 = $1,600 2. T he i ncome s t at ement f or the c ompany i s: Inco me St at Sal es ement Cost s Depr eci at i on IT EB Int er es t EBT T axes ( 35% )
$675,300 297,800 45,100 $332,400 20,700 $311,700 109,095
C HAP TER 2 B - 3 Net i ncome
$202,605
C HAP TER 2 B - 4 One e quat ion f or net i ncome i s: Net i ncome = Divi dends + Addi ti on t o retai ned e ar ni ngs Rea r rangi ng, we get : Addi ti on t o retai ned e ar ni ngs = Net i ncome – Di vi dends Addi ti on t o retai ned e ar ni ngs = $202,605 – 62,000 Addi ti on t o retai ned e ar ni ngs = $140,605 3. T o f i nd t he book val ue of cur r ent as set s, we us e t he NWC equat ion, that i s: NWC = CA – CL Rea r rangi ng t o sol ve f or cur r ent ass et s, we get : CA = NWC + CL CA = $320,000 + 1,400,000 CA = $1,720,000 So, the book val ue bal ance she et wil l be: Book V al ue Balanc e Sheet Cur r ent ass et s Fixe d as set s T ot al asse ts
$1,720,000 4,200,000 $5,920,000
T he mar ket val ue of curr ent as set s i s gi ven, s o t he mar ket val ue balance s heet i s: Ma r ket V al ue Balanc e Sheet Cur r ent ass et s $1,710,000 Fixe d as set s 5,600,000 T ot al asse ts $7,310,000 4. T axes = .15($50,000) + .25( $25,000) + .34($25,000) + .39( $315,000 – 100,000) T axes = $106,100 T he aver age tax rat e i s t he tot al t ax pai d di vi ded by t axabl e i ncome, s o: Aver age t ax r at e = $106,100 / $315,000 Aver age t ax r at e = .3368, or 33.68% T he mar gi nal tax rate i s t he t ax r ate on t he next $1 of ear nings, s o the mar gi nal t ax r ate is 39 per cent .
C HAP TER 2 B - 5 5. To ca lculate OCF, we fi r st nee d t he i ncome s tat ement: Inco me St at ement Sal es $29,200 Cost s 10,400 Depr eci at i on expens e EB IT Int er es t expe nse EBT T axes ( 40% )
1,800 $17,000 1,050 $15,950 6,380
Net i ncome
$ 9,570
Usi ng t he equat i on f or OCF, we get : OCF = EB IT + Depr eci at i on – Taxes OCF = $17,000 + 1,800 – 6,380 OCF = $12,420 6. T he net ca pi tal spe ndi ng i s t he i ncr ease in fi xed as sets, pl us depreci ati on, so: Net capit al spe ndi ng = NFA e nd – NFA be g + Depr e ci at ion Net capit al spe ndi ng = $4,900,000 – 4,100,000 + 385,000 Net capit al spe ndi ng = $1,185,000 7. T he l ong-t er m debt ac count wi l l i ncr ease by $11 mi l l i on, t he amount of t he new l ong -t er m debt i ss ue. Sinc e t he company sol d 4 mi l l i on new shar es of stock wi t h a $1 par val ue, t he common st ock ac count willincreaseby$4million.Thecapital sur plus acc ount wil l i ncr ease by $31 mi ll ion, t hevalueofthe newstocksoldaboveitsparval ue. Si nce the company had a net i ncome of $9.5 mil lion,andpaid$2.8 millionindividends,the addi ti on t o ret ai ned ear ni ngs was $6.7 mi l l ion,whichwillincreasethe accumulatedret ai ned ea rnings ac count. So, t he new l ong -t er m debtandstockholders’equityportion ofthe bal ance sheet wil l be: Long-t er m debt $ 53,0 00,000 T ot al l ong -t er m debt $ 53,000,000 Shar ehol der s’ equit y Pre ferr ed st ock Common st ock ( $1 par value) Capi tal sur pl us Acc umul at ed r et ai ned ea r nings T ot al equi t y $ 119,400,000
$ 3,5000,000 12,700,000 69,000,000 34,200,000
C HAP TER 2 B - 6 8. T he cash fl ow t o credit or s is t he i nt erest pai d mi nus the c hange in l ong -t er m debt , so: Cas h fl ow t o credit or s = Int er est pai d – Net new borr owi ng Cas h fl ow t o credit or s = $205,000 – ( LT De nd – LT Dbe g) Cas h fl ow t o credit or s = $205,000 – ( $2,750,000 – 2,600,000) Cas h fl ow t o credit or s = $55,000 9. T he ca sh f low t o st ockhol der s i s the di vi dends pai d minus any new equi t y pur chased by sha r ehol der s, so: Cas h fl ow t o stockhol der s = Di vi dends pai d – Net new equit y Cas h fl ow t o stockhol der s = $350,000 – [( Common e nd + APISe nd ) – ( Common be g + AP IS be g)] Cas h fl ow t o stockhol der s = $350,000 – [( $705,000 + 6,800,000) – ( $670,000 + 5,900,000)] Cashflowtostockholders= –$585,000 Not e: APIS is t he a ddit i onal pai d -i n sur pl us. 10. We know t hat t he ca sh f l ow f r om as se t s must be equal to t he cash f low t o credit ors pl us the cash f low t o st ockhol der s, so: Cas h fl ow fr om as se ts = Cash fl ow t o cr edit ors + Cash f l ow t o st ockhol der s Cas h fl ow fr om as se ts = $55,000 – 585,000 Cas h fl ow fr om as se ts = – $530,000 Now, we ca n use t he rel at ionship bet wee n t he ca sh f low f r om as set s and t he oper at i ng ca sh fl ow, c hange i n net wor ki ng ca pital , and capit al spendi ng t o f i nd t he operati ng ca sh f l ow. Doi ng so, we f i nd: Cas h fl ow fr om as se ts = –$530,000 = OCF – Change i n NWC – Net ca pit al spendi ng – $530,000 = OCF – ( –$85,000) – 810,000 Oper at i ng ca sh fl ow = $195 ,000
C HAP TER 2 B - 7 I nt ermedi ate 11. a. T he account i ng st at ement of ca sh fl ows explai ns the change i n ca sh dur i ng t he yea r . T he ac count ing st at ement of ca sh f l ows will be: Sta tement of ca sh f lows Oper ati ons Net i ncome $157 Depr eci at i on 75 Changes i n ot her cur rent asse t s –34 Change i n account s payable 9 T ot al cash fl ow fr om oper ati ons $207 I nvesti ng acti vit ies Acqui sit i on of f i xed ass et s – $241 T ot al cash fl ow fr om i nves ti ng ac ti vi t ies – $241 Financi ng acti vi ti es Proc eeds of l ong-t er m deb t $70 Di vi dends –22 T ot al cash fl ow fr om f i nanci ng ac ti vi t ies $48 Change i n cash (on bal ance she et ) $ 14 b. T he change in net wor ki ng ca pi tal i s t he endi ng net wor ki ng ca pit al mi nus t he begi nni ng net wor ki ng ca pi tal , so: Change i n NWC = NWCe nd – NWCbe g = ( CAe nd – CLe nd ) – ( CAbe g – CLbe g) = [ ( $90 + 280) – 289] – [( $76 + 246) – 280) = $81 – 42 = $39 c. T o f ind the cas h f low gene r ated by t he fi r m’ s asset s, we nee d t he oper at i ng cash f l ow, and t he capitalspending.Sincetherearenoi nteres t payment s, EBIT i s t he sa me as EBT. Cal cul at ing ea ch of these, we fi nd: Oper ati ng cas h f l ow EBT Depr eci at i on –T axes Oper at i ng cash fl ow
$230 75 73 $232
C HAP TER 2 B - 8 Next , we will cal cul at e t he ca pit al spending, whi ch is: Capi t al spendi ng Ending f i xed ass et s –Begi nni ng f i xed ass et s Depr eci at i on Capit al spe ndi ng
$816 650 75 $241
Now we c an cal cul at e t he cas h fl ow gene rat ed by t he f ir m’ s as set s, whi ch i s:
Cash fl ow from assets Oper at i ng ca sh fl ow $232 –Capit al spe ndi ng 241 –Change i n NWC 39 Cas h fl ow fr om as se ts –$48 Not i ce t hat t he account i ng st at ement of cash fl ows shows a posi ti ve cash fl ow, but t he fi nancialcash flowsshowanegativecashflow.T he fi nancial cas h flow i s a bet t er number f or anal yzi ng t he f i r m’ s per for manc e. 12. T o const r uct t he ca sh fl ow identi t y, we wil l begi n cash f l ow f r om as set s. Cash fl ow f r om as set s is: Cas h fl ow fr om as se ts = OCF – Change i n NWC – Net ca pi tal spe ndi ng So, the oper ati ng ca sh fl ow i s: OCF = EB IT + Depr eci at i on – Taxes OCF = $134,239 + 65,491 – 38,879 OCF = $160,851 Next , we will cal cul at e t he cha nge i n net wor ki ng ca pital which is: Change i n NWC = NWC e nd – NWCbe g Change i n NWC = ( CA e nd – CLe nd ) – ( CAbe g – CLbe g) Change i n NWC = ( $63,790 – 32,258) – ( $55,330 – 28,875) Change i n NWC = $5,077 Now, we c an cal cul at e t he ca pit al spending. T he ca pi tal spendi ng i s: Net capit al spe ndi ng = NFA e nd – NF Abe g + Depr eci ation Net capit al spe ndi ng = $494,573 – 413,311 + 65,491
C HAP TER 2 B - 9 Net capit al spe ndi ng = $146,753 Now, we ha ve t he ca sh f low f r om as set s, whi ch i s: Cas h fl ow fr om as se ts = OCF – Change i n NWC – Net ca pi tal spe ndi ng Cas h fl ow fr om as se ts = $160,851 – 5,077 – 146,753 Cas h fl ow fr om as se ts = $9,021
C HAP TER 2 B 10 T he company gene r at ed $9,021 fr om i ts ass et s. T he ca sh fl ow fr om operati ons was $160,851, and t he company spe nt $5,077 on net wor ki ng ca pi tal and $146,753 i n f ixed ass et s. T he cash fl ow t o credit or s is: Cas h fl ow t o credit or s = Int er est pai d – New long-t er m debt Cas h fl ow t o credit or s = Int er est pai d – ( Long-t er m debt e nd – Long-t er m debt be g) Cas h fl ow t o credit or s = $23,155 – ( $182,400 – 164,200) Cas h fl ow t o credit or s = $4,955 T he ca sh f l ow t o stockhol der s is a li tt le tr i cki er i n t hi s pr oblem. Fir st , we need t o ca l cul at e t henew equitysold.Theequitybalanceincr ease d duri ng t he year . T he onl y way t o i ncr ease t heequitybalance istoaddadditiontoretai ned ear ni ngs or sell equit y. To cal cul ate t he newequitysold,wecanusethe following equati on: New equit y = Endi ng equi ty – Begi nni ng equi t y – Addi ti on t o ret ai ned ear nings New equit y = $343,705 – 275,566 – 57,705 New equit y = $10,434 Wha t happened was t he equi t y account i nc rea sed by $68,139. Of t his increa se, $57,705 ca me f r om addit i on t o r et ained ear ni ngs, so t he remai nder must have bee n the sal e of new equit y. Now we can calculatethecashflowtostockholdersa s: Cas h fl ow t o stockhol der s = Di vi dends pai d – Net new equ it y Cas h fl ow t o stockhol der s = $14,500 – 10,434 Cas h fl ow t o stockhol der s = $4,066 T he company pai d $4,955 to cr edit ors a nd $4,066 t o i ts s t ockhol der s. Final l y, t he ca sh fl ow i denti t y i s: Cas h fl ow fr om as se ts = Cash fl ow t o cr edit ors + Cash f l ow t o st ockhol ders $9,021 = $4,955 + $4,066 T he cash fl ow i dentit y bal ance s, whi ch i s what we expec t . 13. Wit h t he i nf or mat i on pr ovided, t he cash f lows f r om t he fi r m are t he ca pi tal spe ndi ng and t he change i n net wor ki ng ca pi tal , so:
Cash fl ows f rom the f i rm Capi tal spe ndi ng –$18,000 Addi ti ons t o NWC 2,300 Cas h fl ows f r om t he f ir m –$17,100
C HAP TER 2 B 11
C HAP TER 2 B 12 And t he ca sh f lows to t he inves t or s of t he f ir m ar e: Cash fl ows t o inve st ors of the fi rm Sal e of long -t er m debt – 15,000 Sal e of common st ock – 2,500 Di vi dends pai d 6,500 Cas h fl ows t o inves t or s of the fi r m –$11,000
14. a. T he i nt er est expens e f or t he company i s t he amount of debt ti mes t he i nteres t r ate on t he debt . So, the i ncome s t atement f or t he c ompany i s: Inco me St at ement
Sal es Cost of goods s ol d Sel li ng expe nse s Depr eci at i on expens e EB IT Int er es t expe nse EBT T axes
$735,000 243,500 138,000 79,000 $274,500 37,200 $237,300 83,055
Net i ncome
$154,245
b.
And t he operati ng ca sh f low i s: OCF = EB IT + Depr eci at i on – Taxes OCF = $274,500 + 79,000 – 83,055 OCF = $270,445 15. T o f i nd t he OCF, we fi rst cal cul at e net ime. nco Inco me St at ement Sal es Cost s Ot her expe nse s Depr eci at i on expens e EB IT Int er es t expe nse EBT T axes
$219,000 96,400 5,300 14,100 $100,200 10,900 $89,300 33,934
Net i ncome
$55,366
Di vi dends Addi ti on t o retai ned e ar ni ngs
$18,500 $36,866
C HAP TER 2 B 13 a. T he oper at i ng ca sh fl ow was: OCF = EB IT + Depr eci at i on – Taxes OCF = $100,200 + 14,100 – 33,934 OCF = $80,366 b. T he cash fl ow t o credit or s is t he i nt erest pai d mi nus a ny net new long -t er m debt , so: CFC = Int er es t – Net new LT D CFC = $10,900 – ( –$9,000) CFC = $19,900 Not e t hat t he net new long-t er m debt i s negati ve because t he company r epai d par t of it s l ong - t er m debt . c. T he cash fl ow t o stockhol der s i s t he di vi dends pai d mi nus a ny net new equit y, or : CFS = Di vi dends – Net new eq uit y CFS = $18,500 – 7,000 CFS = $11,500 d. We know t hat CFA = CFC + CFS, so: CFA = $19,900 + 11,500 = $31,400 CFA i s al so equal t o ( OCF – Net ca pi tal spe ndi ng – Change i n NWC). We alr eady know OCF. Net capit al spe ndi ng i s equal to: Net capit al spe ndi ng = Incr ea se i n NFA + Depr eci at ion Net capit al spe ndi ng = $32,000 + 14,11 Net capit al spe ndi ng = $46,100 Now we c an use: CFA = OCF – Net capit al spendi ng – Change i n NWC $31,400 = $80,366 – $46,100 – Change i n NWC. Solvi ng f or t he change i n NWC gi ves $2,866, mea ning t he company i ncr eas ed i t s NWC by $2,866. 16. T he sol uti on t o t his questi on wor ks t he i ncome s tatement backwar ds. Start ing at t he bott om: Net i ncome = Divi dends + Addi ti ons t o r et ained ear nings Net i ncome = $7,300 + 5,700 Net i ncome = $13,000
Now, l ooki ng at t he income s t at ement : EBT – ( EBT × T ax r at e) = Net i ncome
C HAP TER 2 B 14
C HAP TER 2 B 15 Rec ogni ze t hat EBT × t ax rat e i s t he ca lculati on f or t axes . Sol vi ng t hi s f or EBT yiel ds: EBT = NI / ( 1 – T ax rat e) EBT = $13,000 / ( 1 – .35) EBT = $20,000 Now we c an cal cul at e: EB IT = EBT + Int er est EB IT = $20,000 + 1,950 EB IT = $21,950 T he l ast st ep is t o use: EB IT = Sal es – Costs – Depr eci at i on $21,950 = $53,200 – 27,400 – Deprec iati on Depr eci at i on = $3,850 17. T he bal ance s hee t f or t he company l ooks l i ke t hi s: Cas h Acc ounts rec ei vabl e In vent or y Cur r ent ass et s T angi bl e net f ixed ass et Int s angi bl e ne t fi xed as set s T ot al asse ts
Bal ance $195,000 240,000 Sheet 405,000 $840,000 3,725,000 825,000 $5,390,000
Acc ounts pa yable Not es payabl e Cur r ent l i abil it ies Long-t er m debt T ot al li abi li ti es
$435,000 167,000 $602,000 2,140,000 $2,742,000
Common st ock Acc umul at ed r et . ear ni ngs T ot al li ab. & owner s’ equity
?? 2,035,000 $5,390,000
T ot al li abi li ti es and owner s’ equi t y i s: T L & OE = CL + LT D + Common st ock Solvi ng t hi s equat ion f or equi t y gi ves us: Common st ock = $5,390,000 – 2,742,000 – 2,035,000 Common st ock = $613,000 18. T he mar ket val ue of shar ehol der s’ equi t y ca nnot be negat i ve. A negati ve mar ket val ue i n t hiscase wouldimplythatthecompanywouldpay you t o own t he st ock. T he mar ket value of sha reholders’ equitycanbestatedas:Sharehol der s’ equi t y = Max [( T A – T L) , 0] . So, i f T A i s $14,300,equityis equalto$3,600,andifTAis $9,900, equit y i s equal t o $0. We should not e herethatthebookvalueof shareholders’ equit y ca n be negat i ve.
C HAP TER 2 B 19. a. T axes Growt h = .15( $50,000) + .25( $25,000) + .34( $8,000) = $16,470 16 T axes Income = .15( $50,000) + . 25( $25,000) + .34( $25,000) + .39( $235,000) + .34( $8,300,000 – 335,000) = $2,822,000
C HAP TER 2 B 17 b.
20. a.
Each f ir m has a mar gi nal tax rat e of 34 per ce nt on the next $10,000 of taxa bl e income, des tpihei t er di ff er ent aver age tax rat es, so bot h f ir ms wil l pay an a d di ti onal $3,400 i n taxes. T he i ncome s t at ement f or the c ompany i s: Inco me St at ement Sal es $735,000 Cost s 525,000 Admi ni st rati ve a nd sell i ng expe nses 126,000 Depr eci at i on expens e 82,000 EB IT $ 2,000 Int er es t expe nse 64,000 EBT – $62,000 T axes 0 Net i ncome – $62,000
b. OCF = EB IT + Depr eci at i on – Taxes OCF = $2,000 + 82,000 – 0 OCF = $84,000 c. Net i ncome was negat i ve bec ause of t he t ax deducti bili t y of depr eciati on and i nt er est expens e. However , t he act ual ca sh flow f r om oper at i ons was posi ti ve beca use depr eciati on i s a non -ca sh expe nse a nd i nt er est is a f i nanc i ng expens e, not an operat ing expe nse. 21. A f i r m ca n st il l pay out divi dends if net i ncome i s negat i ve; it j ust has t o be sure t her e i s suff ici ent c as h f l ow t o make t he di vi dend pa yment s. Change i n NWC = Net capit al spe ndi ng = Net new equi t y = 0. ( Gi ven) Cas h fl ow fr om as se ts = OCF – Change i n NWC – Net ca pi tal spe ndi ng Cas h fl ow fr om as se ts = $84,000 – 0 – 0 = $84,000 Cas h fl ow t o stockhol der s = Di vi dends – Net new equi t y Cas h fl ow t o stockhol der s = $43,000 – 0 = $43,000 Cas h fl ow t o credit or s = Cash fl ow fr om as se ts – Cash f l ow t o st ockhol der s Cas h fl ow t o credit or s = $84,000 – 43,000 Cas h fl ow t o credit or s = $41,000 Cas h fl ow t o credit or s is al so:
Cas h fl ow t o credit or s = Int er est – Net new LT D So: Net new LT D = Int eres t – Cas h fl ow t o credit or s Net new LT D = $64,000 – 41,000 Net new LT D = $23,000
C HAP TER 2 B 18
C HAP TER 2 B 19 22. a. T he i ncome s t at ement i s: Inco me St at ement Sal es $34,300 Cost of goods s ol d Depr eci at i on EB IT Int er es t T axable income T axes ( 40% ) Net i ncome b.
c.
OCF OCF OCF
21,200 3,560 $ 9,540 810 $ 8,730 3,492 $ 5,238
= EBIT + Depr eci at ion – = $9,540 + 3,560 – 3,492 Taxes = $9,608
Change i n NWC = NWCe nd – NWCbe g = ( CAe nd – CLe nd ) – ( CAbe g – CLbe g) = ( $5,940 – 3,720) – ( $5,260 – 3,520) = $480 Net capit al spe ndi ng = NFAe nd – NFAbe g + Depr ec i at i on = $27,390 – 21,160 + 3,560 = $9,790 CFA = OCF – Change i n NWC – Net capit al spending = $9,608 – 480 – 9,790 = –$662 T he cash f l ow f r om as set s can be posi ti ve or negat i ve, si nce it repres ent s whet her the fi rmraised fundsordistributedfundsonanet basi s. In t hi s pr oblem, e ven t hough net i ncomeandOCFare positive,thefirminvest ed hea vi l y i n bot h f ixed ass et s and net wor ki ngcapital;ithadtoraisea net$662infunds fr om i t s st ockhol der s and cr edi tor s t o ma ke t hes e i nves t ment s.
d. Cas h fl ow t o credit or s = Int er es t – Net new LT D = $810 – 0 = $810 Cas h fl ow t o stockhol der s = Cash f l ow f r om as set s – Cas h fl ow t o credit or s = –$662 – 810 = –$1,472 We can al so calculat e t he cas h fl ow to st ockhol der s as: Cas h fl ow t o stockhol der s = Di vi dends – Net new equi t y Solvi ng f or net new equi t y, we get :
Net new equit y = $1,750 – ( –1,472) = $3,222
C HAP TER 2 B 20
C HAP TER 2 B 21 T he f ir m had posit i ve ea rnings i n an ac counti ng se nse ( NI > 0) and had posit i ve cas h fl ow f rom operations.Thefirminvested$480in new net wor ki ng ca pi t al and $9,790 i n new f i xedassets. Thefirmhadtoraise$662fromit s st akehol ders t o suppor t t hi s new i nvest ment.Itaccomplished thisbyraising $3,222 i n t he f or m of new equi t y. Af ter payi ng out$1,750ofthisintheformof dividendsto sharehol d ers and $810 in t he f or m of i nt eres t tocreditors,$662waslefttomeetthe firm’ s cas h f l ow nee ds f or inves t ment . 23. a. T ot al asse ts 2013 = $888 + 4,320 = $5,208 T ot al li abi li ti es 2013 = $396 + 2,400 = $2,796 Owner s’ equi t y 2013 = $5,208 – 2,796 = $2,412 T ot al asse ts 2014 = $954 + 4,560 = $5,514 T ot al li abi li ti es 2014 = $432 + 2,580 = $3,012 Owner s’ equi t y 2014 = $5,514 – 3,012 = $2,502 b. NWC 2013 = CA2013 – CL2013 = $888 – 396 = $492 NWC 2014 = CA2014 – CL2014 = $954 – 432 = $522 Change i n NWC = NWC2014 – NWC2013 = $522 – 492 = $30 c. We can cal cul at e net ca pi t al spendi ng as: Net capit al spe ndi ng = Net f i xed asset s 2014 – Net fi xed as set s 2013 + Deprec iati on Net capit al spe ndi ng = $4,560 – 4,320 + 1 ,116 Net capit al spe ndi ng = $1,356 So, t he company had a net ca pit al spending ca sh f l ow of $1,356. We al so know that net ca pi t al spe ndi ng i s: Net capit al spe ndi ng = Fi xed asse ts bought – Fixed a sse ts s ol d $1,356 = $2,280 – Fixed ass et s sold Fixe d as set s sold = $2,280 – 1,356 Fixe d as set s sold = $924 T o ca lculate t he cash fl ow f r om as set s, we must f ir st ca lculat e t he oper at i ng cash fl ow. T he oper at ing ca sh f low i s cal cul ated as foll ows ( you ca n al so pr epare a t radit ional i ncome st at eme nt ): EB IT = Sal es – Costs – Depr eci at i on EB IT = $13,080 – 5,616 – 1,116
EB IT = $6,348 EBT = EBIT – Int er est EBT = $6,348 – 468 EBT = $5,880 T axes = EBT .35 T axes = $5,880 .35 T axes = $2,058
C HAP TER 2 B 22
C HAP TER 2 B 23 OCF = EB IT + Depr eci at i on – Taxes OCF = $6,348 + 1,116 – 2,058 OCF = $5,406 Cas h fl ow fr om as se ts = OCF – Change i n NWC – Net ca pi tal spe ndi ng. Cas h fl ow fr om as se ts = $5,406 – 30 – 1,356 Cas h fl ow fr om as se ts = $4,020 d. Net new bor rowi ng = LT D2014 – LT D2013 Net new bor rowi ng = $2,580 – 2,400 Net new bor rowi ng = $180 Net new bor rowi ng = $180 = Debt i ssued – Debt r et ir ed Debt reti red = $528 – 180 Debt reti red = $348 Cas h fl ow t o credit or s = Int er est – Net new LT D Cas h fl ow t o credit or s = $468 – 180 Cas h fl ow t o credit or s = $288
24. Cas h Acc ounts rec ei vabl e In vent or y Cur r ent ass et s
Bal ance s heet as of Dec. 31, 2013 $17,804 Acc ount s pa yabl e 23,569 41,906 Long-t er m debt $83,279
$22,790 59,625
Net fi xed as sets
$149,305 Owner s' equi t y
T ot al asse ts
$232,584 T ot al li ab. & equit y
150,169 $232,584
Bal ance s heet as of Dec. 31, 2014 $18,213 Acc ount s pa yabl e
$21,366
Cas h Acc ounts rec ei vabl e In vent or y Cur r ent ass et s
26,553 43,063 Long-t er m debt $87,829
Net fi xed as sets
$152,867 Owner s' equi t y
T ot al asse ts
$240,696 T ot al li ab. & equit y
69,563
149,767 $240,696
C HAP TER 2 B 24 2013 Income St at ement 2014 Income St at ement Sal es $33,950.00 Sal es $36,439.00 COGS 11,681.00 COGS 13,260.00 Ot her expe nse s 2,769.00 Ot her expe nse s 2,314.00 Depr eci at i on 4,875.00 Depr eci at i on 4,882.00 EB IT $14,625.00 EB IT $15,983.00 Int er es t 1,749.00 Int er es t 2,618.00 EBT $12,876.00 EBT $13,365.00 T axes ( 35% ) 4,506.60 T axes ( 35% ) 4,677.75 Net i ncome $8,369.40 Net i ncome $8,687.25 Di vi dends Addi ti ons t o RE
$4,139.00 $4,230.40
Di vi dends Addi ti ons t o RE
25. OCF = EB IT + Depr eci at i on – Taxes OCF = $15,983 + 4,882 – 4,677.75 OCF = $16,187.25 Change i n NWC = NWC e nd – NWCbe g = ( CA – CL) e nd – ( CA – CL) be g Change i n NWC = ( $87,829 – 21,366) – ( $83,279 – 22,790) Change i n NWC = $5,974 Net capit al spe ndi ng = NFA e nd – NF Abe g + Depr eci at ion Net capit al spe ndi ng = $152,867 – 149,305 + 4,882 Net capit al spe ndi ng = $8,444 Cas h fl ow fr om as se ts = OCF – Cha nge i n NWC – Net ca pi tal spe ndi ng Cas h fl ow fr om as se ts = $16,187.25 – 5,974 – 8,444 Cas h fl ow fr om as se ts = $1,769.25 Cas h fl ow t o credit or s = Int er est – Net new LT D Net new LT D = LT De nd – LT Dbe g Cas h fl ow t o credit or s = $2,618 – ($69,563 – 59,625 ) Cas h fl ow t o credit or s = –$7,320 Net new equit y = Common st ocke nd – Co mmon st ockbe g Common st ock + Ret ai ned ea r ni ngs = T ot al owners’ equi t y Net new equit y = ( OE – RE) e nd – ( OE – RE) be g Net new equit y = OEe nd – OEbe g + REbe g – REe nd REe nd = REb eg + Addi t i ons to RE Net new equit y = OEe nd – OEbe g + REbe g – ( REbe g + Addi ti ons t o RE 2014) Net new equit y = OEe nd – OEbe g – Addi t i ons t o RE 2014 Net new equit y = $149,767 – 150,169 – 4,130.25 Net new equit y = –$4,532.25 Cas h fl ow t o stockhol der s = Di vi dends – Net new equi t y
$4,557.00 4,130.25
Cas h fl ow t o stockhol der s = $4,557 – ( – $4,532.25) Cas h fl ow t o stockhol der s = $9,089.25
C HAP TER 2 B 25
C HAP TER 2 B 26 As a check, ca sh f l ow f r om as set s i s $1,769.25. Cas h fl ow fr om as se ts = Cash fl ow fr om cr edit ors + Cash fl ow t o st ockhol der s Cas h fl ow fr om as se ts = –$7,320 + 9,089.25 Cas h fl ow fr om as se ts = $1,769.25 Chal lenge 26. We wi ll begi n by cal cul ati ng t he oper at ing ca sh fl ow. Fi r st , we need t he EBIT , which can be cal cul at ed as: EB IT = Net i ncome + Current t axes + Def er r ed t axes + Int er es t EB IT = $321 + 185 + 34 + 96 EB IT = $636 Now we c an cal cul at e t he oper at i ng cash fl ow as: Oper ati ng cas h f l ow Ear nings be f or e i nter est and t axes Depr eci at i on – Cur rent t axes Oper at i ng cash fl ow
$636 177 231 $628
T he net ca pi t al spe ndi ng is found i n t he i nvest i ng acti vi ti es port ion of t he account i ng st atement of cash f l ows, so: Net capi tal spe ndi ng Acqui si ti on of fi xed asset s – Sal e of f i xed ass et s Capit al spe ndi ng
$332 42 $290
T he net wor ki ng ca pit al ca sh f l ows ar e all f ound i n t he oper at ions cash fl ow se ct i on of t he accounting statementofcashflows.However, instea d of cal cul ati ng t he net wor ki ng ca pi tal cashflowsasthe changeinnetworkingcapital , we must cal cul at e ea ch it em i ndi vi dual l y. Doi ng so, we f i nd: Net worki ng capi t al cash flow Cas h $27 Acc ount s rec ei vabl e 52 In vent or i es – 41 Acc ount s pa yabl e – 33 Acc r ued e xpenses 17 Ot her –4 NWC cas h fl ow $18
C HAP TER 2 B 27 Except f or t he i nt er est expense and not es payabl e, t he ca sh f low t o credit or s i s f ound i n the f i nanci ng ac ti vi t ies of t he ac counti ng st at ement of ca sh fl ows. T he int er est expense fr om t he i ncome st atement i s gi ven, so: Cash fl ow t o cr edit ors Int er es t Ret ir ement of debt Debt ser vi ce – Procee ds f rom sa l e of l ong -t er m debt T ot al
$96 195 $291 105 $186
And we c an f i nd t he c ash flow t o st ockhol der s i n t he f inanc ing se cti on of t he acc ount ing st atement of ca sh f l ows. T he ca sh f low to st ockhol der s was: Cash fl ow t o stock hol ders Di vi dends Repur chas e of st ock Cas h to st ockhol der s – Procee ds f rom new st ock i ss ue T ot al
$158 26 $184 – 50 $134
27. Net capit al spe ndi ng = NFAe nd – NFAbe g + Depr ec i ati on = ( NFAe nd – NFAbe g) + ( Depr eci at i on + AD be g) – ADbe g = ( NFAe nd – NFAbe g) + ADe nd – AD be g = ( NFAe nd + ADe nd ) – ( NFAbe g + ADbe g) = FAe nd – FAbe g 28. a.
b.
T he tax bubbl e ca use s average t ax r at es t o ca tch up t o mar gi nal t ax r at es, thus elimi nat i ng t heage advant t axof l ow mar gi nal r ates f or hi gh i ncome c or por ati ons. Ass umi ng a t axa bl e i ncome of $335,001, t he t axes wil l be: T axes = .15($50,000) + .25( $25,000) + .34($25,000) + .39( $235,000) T axes = $113,900 Aver age t ax r at e = $113,900 / $335,000 Aver age t ax r at e = .34 or 34% T he mar gi nal tax rate on t he ne xt doll ar of i ncome i s 34 perce nt . For cor porate t axabl e i ncome l evel s gr ea t er t han $18,333,334, aver age t ax r at es ar e equal to mar gi nal t ax r at es . T axes = .34($10,000,000) + .35( $5,000,000) + .38( $3,333,334) T axes = $6,416,667
C HAP TER 2 B 28 Aver age t ax r at e = $6,416,667 / $18,333,334 Aver age t ax r at e = .35, or 35% T he mar gi nal tax r ate on t he next dol l ar of income i s 35 perce nt . For cor porate taxa ble income l evel s over $18,333,334, aver age t ax rat es ar e a gai n equal t o mar gi nal t ax r at es . c.
T axes $68,000 X( $100,000) X X
= .34( $200,000) = $68,000 = .15( $50,000) + .25( $25,000) + .34( $25,000) + X ($100,000) = $68,000 – 22,250 = $45,750 = $45,750 / $100,000 = .4575, or 45.75%
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C HAP TER 2 B 29
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