Solutions manual for corporate finance 11th edition by ross

SOLUTIONS MANUAL for Corporate Finance 11th Edition by Ross Download at: http://downloadlink.org/p/solutions-manual-for-corporate-finance-11thedition-by-ross/ TEST BANK for Corporate Finance 11th Edition by Ross Download at http://downloadlink.org/p/test-bank-for-corporate-finance-11th-editionby-ross/

So lution s Manual Corporate Finan ce Ro ss, Westerfield, Jaffe , and Jordan 11 th edition 10/ 20/ 20 15 P repare d by: B rad Jordan Unive rsi ty of K ent ucky Joe Smoli ra B el m ont Universit y

CHAPT ER 2 - 3

CHAPTER 1 INTRODU CTION TO CORPOR ATE FINANCE Answ ers to Concept Q uest i ons 1. In t he cor por at e f or m of owner shi p, t he shar ehol der s ar e t he owner s of t he f irm. T he shar eholders electthedirectorsofthecorporati on, who i n t ur n appoi nt t he f ir m’ s mana ge ment . T hisseparationof ownershipfromcontrolint he cor por at e f or m of or gani zati on i s what ca use sagencyproblemsto exist.Managementmayact i n it s own or someon e el se’ s best int er est s, r at herthanthoseofthe shareholders.Ifsuch events occ ur , t hey may cont r adict t he goal of maximizingthesharepriceofthe equityofthe fi r m.

2. Such or gani zati ons f requent l y pur sue soci al or polit i cal mi ss ions, so many di ff e rent goals are conceivable.Onegoalthatisoftencitedi s revenue mi ni mi zat i on; i .e., provi de what evergoodsand servicesareofferedatthe lowes t possi bl e cost t o soci et y. A bett er appr oachmightbetoobservethat evenanot-for-pr of i t busines s has eq uit y. T hus, one answer i s thattheappropriategoalisto maximizethe val ue of t he equi t y.

3. 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 t he s tat ement i s f alse .

4. 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 these t hi ngs are pr i ced. T her e is t hus an opt i mal l evel of , f or exa mpl e, ethi cal and/or illegal behavior,andtheframeworkofstock val uati on explici tl y i ncludes t hese . At t he ot her extr eme, we coul d ar gue that t hese ar e non -ec onomi c phenomena and ar e best handl ed t hr oughthepolitical process.Aclassic(andhi ghl y r el evant) t hought questi on t hat i ll ust r atesthisdebategoessomething likethis:“Af ir m has es timat ed t hat t he cost of i mpr ovi ng t he safetyofoneofitsproductsis$30 million. However , t he f irm bel i eves t hat i mpr ovi ng t he safetyoftheproductwillonlysave$20 milli on i n pr oduct l i abil it y cl ai ms. W hat shoul d t he f irm do?”

5. 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.

6. 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 i t can i mpr ove t he pr ofi tabi li t y of t he f ir m so t hat the sha re pri ce will exceed$35,thentheyshouldfighttheoff er f rom t he out si de company. If mana gement bel i evesthat thisbidderorotherunidentifiedbi dders wi ll act uall y pay mor e t han $35 per shar e t oacquirethe company,thentheyshouldstill fi ght t he of fer . However , i f t he cur r ent mana gementcannotincrease thevalueofthefirm beyond t he bi d pri ce, and no ot her hi gher bi ds comein,thenmanagementisnot actinginthei nt eres ts of the shar ehol der s by f i ght ing t he offer.Sincecurrentmanagersoftenlose thei r j obs when the cor porat ion i s ac qui red, poorl y moni t or ed mana ger s have an ince nt i ve t o f i ght cor por at e t akeover s i n sit uat i ons s uch a s t hi s.

CHAPT ER 2 - 4

7. W e 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 indi vi dual owner s shoul d r educethenumberof diverseopinionsconcerni ng cor por at e goal s. T he hi gh per cent age of i nst itutionalownershipmight leadtoahigher degr ee of agr ee ment bet ween owner s and mana ger sondecisionsconcerningrisky projects.In addit i on, i nsti tut i ons may be bet ter able to i mplementeffectivemonitoringmechanisms on mana ger s t han ca n i ndi vi dual owner s, bas ed on t he i nst it uti ons’ dee per res our ces and exper iences wi t h t hei r own mana gement .

8. T he i ncr eas e i n i nst it uti onal owner shi p of st ock i n the Unit ed St ates and t he gr owi ng ac ti vi smof theselargeshareholdergroupsmayleadt o a r educt i on i n agenc y pr obl ems f or U.S. cor por ationsand amoreefficientmarketforcorpor at e contr ol . However , t h i s may not al ways be the case.Ifthe managersofthemutualfundor pensi on pl an are not conce r ned wit h t he i nt er estsoftheinvestors,the agencyproblemcoul d potent iall y r emai n t he sa me, or even i ncr eas e sincethereisthepossibilityof agencyprobl ems be t wee n the f und and i ts i nvest ors.

9. 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 dese r ves comment . A pr i mar y r easonexecutivecompensationhas grownsodr amat i cal l y i s that compani es have i ncr easi ngl ymovedtostock-basedcompensation. Such move ment 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.Inrecentyears,stockpri ces have soared, so mana ge ment has cl eane d up. Itissometimes arguedthatmuchofthisreward is due t o ri si ng st ock pr i ces i n gene ral , not managerialperformance. Perhapsinthefut ure, exec uti ve compens ati on wi ll be desi gned t orewardonlydifferential performance,i .e., st ock price i ncr eas es in exces s of gener al mar ket i ncr eas es.

10. Ma xi mi zi ng t he curr ent shar e pri ce i s t he sa me as maxi mi zi ng t he f ut ur e shar e pr i ce at any f uture period.Thevalueofashareofstockdepe nds on all of t he f utur e cas h f l ows of company. Another waytolookatthisisthat,barringlar ge ca sh payment s t o shar ehol der s, t he expec ted priceofthe stockmustbehigherinthefuturet han i t i s t oday. Who woul d buy a st ock f or $100 t odaywhenthe sharepriceinoneyearisexpec ted to be $80?

CHAPT ER 2 - 5

CHAPTER 2 ACCOUNT ING STAT EMENTS , TAXES, AND CAS H FLOW Answ ers to Concept s Review and Crit i cal Thi nki ng Q uest ions 1. T rue. Ever y as set ca n be conver t ed t o cas h at some pr ice . However , when we are r eferr i ng to a l iquid asset,theaddedassumptionthatthe asset ca n be qui ckly conver t ed t o cash at or near mar ket val ue i s i mpor t ant .

2. T he r ecogni ti on and mat chi ng pr i nci pl es i n fi nancial ac counti ng ca ll f or revenue s, and t he costs associatedwithproducingthoser evenues , t o be “booked” when t he revenue proce ssisessentially complete,notnecessarily when t he cas h i s col l ected or bi ll s are pai d. Not ethatthiswayisnot necessarilycorrect;it’ s the way ac countants ha ve c hosen t o do it .

3. T he bot t om l ine number shows t he change i n the c as h bal ance on t he bal ance sheet . As s uch, it i s not a us ef ul number f or anal yzi ng a c ompany.

4. T he maj or dif fer ence i s the t rea t ment of i nt er est expens e. T he account i ng stat ement of ca sh f lows treatsinterestasanoperatingcashfl ow, whil e t he fi nanc ial cas h fl ows t r eat i nter estasafinancing cashflow.Thelogicoftheac counti ng st at ement of cas h fl ows i s t hat si nce i nterestappearsonthe incomestatement,whi ch shows t he oper at i ons f or t he peri od, i t i s an operatingcashflow.Inreality, interestisa fi nanci ng expense , whi ch r esult s fr om t he company’ s choice of debt and equi t y. We wi ll have mor e t o sa y about t his i n a later chapt er. When compar i ng t he t wo cas h f low st at ement s, t he financialstatementofcashflowsisamore appr opr i at e mea sur e of the company’ s per f or mance bec ause of it s t r eat ment of int erest .

5. Ma r ket values ca n never be negat i ve. Imagi ne a sha re of st ock sel li ng f or – $20. T hi s woul d mean t hat i f you plac ed an or der f or 100 shares , you would get t he stock along wi t h a check f or $2,000.

Howmanysharesdoyouwanttobuy?More gener al l y, beca use of corpor ate and i ndi vi dual bankruptcylaws,networthforapersonor a cor por ation ca nnot be negati ve, i mpl yi ng t hatliabilities cannotexceedassetsin market val ue.

6. For a succe ssf ul company t hat i s r api dl y expandi ng, f or exampl e, ca pi tal outlays wi l l belarge, possiblyleadingtonegativecashfl ow fr om as set s. In gene r al , what matt ers is whet herthemoneyis spentwisely,notwhethercash 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 si gn f or an est abl i shed company t o have ne gat i ve ca sh fl ow f rom oper at ions, but i t woul d be f air l y or di nar y f or a st art -u p, so it depe nds.

CHAPT ER 2 - 6

8. For exampl e, i f a company wer e t o b ecome mor e ef fici ent i n i nvent or y mana ge ment , t he amount of i nvent or y nee ded would decl ine. T he s ame mi ght be t rue i f t he c ompany bec omes bet ter at coll ect ing itsreceivables.Ingeneral,anythingt hat l eads t o a dec li ne i n endi ng NWC r el ati ve t o beginning wouldhavethiseffect.Negative net ca pit al spending woul d mea n mor e l ong -l i ved as se ts were l i qui dat ed t han pur chase d.

9. If a company r ai se s mor e mone y f r om se ll i ng st ock than i t pays i n di vi dends i n a par ti cul ar per iod, itscashflowtostockholderswillbene gati ve. If a c o mpany bor r ows mor e t han it pays i n interestand principal,itscashflowto credit or s wi ll be ne gati ve.

10. T he adj ust ment s di sc uss ed wer e pur el y ac counti ng changes ; t hey had no cash flow or mar ketvalue consequencesunlessthenewaccount ing i nf or mat i on caus ed st ockhol der s t o revalue t he asse ts.

Soluti ons t o Q uest ions and P roblem s NOTE: All 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 t hese i nt er medi at e st eps are i ncl udedinthis solutionsmanual,roundingmay appear t o have occurre d. Howev er, t he f i nal answerforeachproblemis foundwithoutroundi ng duri ng any st ep i n the problem.

Basi c 1. T o f i nd owner s’ equi t y, we must cons tr uc t a balanc e shee t as foll ows:

CA NFA

Bal ance Sheet $ 4,900 CL 25,000 LT D OE $29,900 T L & OE

$ 4, 1 00 1 0,3 00 ??

TA $29,9 00 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 $ 29,900.We alsoknowthatTL&OEisequaltocurr 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: Owner s’ equi t y = $ 29,900 –10,300 – 4,1 00 Owner s’ equi t y = $15, 500 And net wor ki ng ca pit al i s cur rent as sets mi nus c ur r ent li abi li ti es, so: NWC = Curr ent asse ts – Cur r ent l iabil it ies NWC = $ 4,900 – 4,100 NWC = $ 800

CHAPT CHAPTER ER22- -7 7

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 Net i ncome

$ 435,000 216,000 40,000 $179 ,000 21,000 $158 ,000 55,300 $102,700

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 = $ 102,700 – 30,000 Addi ti on t o retai ned e ar ni ngs = $ 72,700 3. T o fi nd the book val ue of cur r ent asset s, we use: NWC = CA – CL. Rea r r angi ng t o sol ve f or curr ent as set s, we get: Cur r ent ass et s = Net wor ki ng ca pi tal + Curr ent li abi li ti es Cur r ent ass et s = $800,000 + 2, 400,000 = $3, 200,000 T he mar ket val ue of curr ent as set s and net f i xed a sset s is gi ven, s o: Book val ue CA = $3, Ma r ket value CA = $2,600,000 Book val ue NFA = 200,000 $ Ma r ket value NFA = $6,500,000 5,200,000 Book val ue a ss = $ Ma r ket value ass et = $9, et s 8,400,000 s 100,000 4. T axes = .15($50,000) + .25( $25,000) + .34($25,000) + .39( $ 198 ,000 – 100,000) T axes = $ 60,470 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 = $ 60,470 / $ 198,000 Aver age t ax r at e = .3054, or 30.54% 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 = 39% .

CHAPT CHAPTER ER22- -8 8

5. T o ca lculate OCF, we fi r st nee d t he i ncome s tat ement: Inco me St at ement Sal es Cost s Depr eci at i on EB IT Int er es t T axable income T axes Net i ncome

$19,800 10,900 2,100 $6,800 1,250 $5,550 2, 220 $3,330

OCF = EB IT + Depr eci at i on – Taxes OCF = $6,800 + 2,100 – 2,220 OCF = $6,680 6. Net capit al spe ndi ng = NFA e nd – NFA be g + Depr eci at ion Net capit al spe ndi ng = $1, 51 0,000 – 1,320,000 + 1 37,000 Net capit al spe ndi ng = $ 327 ,000 7. T he l ong-t er m debt ac count wi ll i ncr ease by $3 0 million,theamountofthenewlong-termdebt i ss ue.

Si nce t he company sol d 5 mi l l ion new shar es of st ock wi t h a $1 p ar val ue, t he common st ock ac count will i ncrea se by $ 5 mi l l i on. T he ca pi tal surpl us ac count wi ll i ncrea se by $ 5 8 mi l l i on,the valueofthenewstocksoldaboveitspar val ue. Since t he company had a net i ncome of $ 8 mi llion, andpaid$1.8millionindividends,the addi ti on t o ret ained ear nings was $ 6.2 mi l l i on,whichwill increasetheaccumulatedretai ned ea rni ngs acc ount . So, t he new l ong -t er m debtandstockholders’ equityportionofthe bal ance s heet wil l be: Long-t er m debt $ 85,000,000 T ot al l ong -t er m debt $ 85,000,000 Shar ehol der s’ equit y Pre ferr ed st ock Common st ock ( $1 par value) Acc umul at ed r et ai ned ea r nings Capi tal sur pl us T ot al equi t y

$ 3,10 0,000 17,000,000 125,2 00,000 114,000,000 $ 259,3 00,000

T ot al Liabil it ies & Equi t y $ 344,3 00,000 8. 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 = $185 ,000 – ( LT De nd – LT Dbe g) Cas h fl ow t o credit or s = $185 ,000 – ( $1, 730 ,000 – 1, 625 ,000) Cas h fl ow t o credit or s = $185 ,000 – 105 ,000 Cas h fl ow t o credit or s = $80,000

CHAPT CHAPTER ER22- -9 9

9. 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 = $ 275,000 – [( Common e nd + APISe nd ) – ( Common be g + AP IS be g)] Cas h fl ow t o stockhol der s = $ 275,000 – [( $ 545 ,000 + 3, 850,000) – ($510,000 + 3, 600,000)] Cashflowtostockholders=$ 275,000 – ($4, 395,000 – 4,100 ,000) Cas h fl ow t o stockhol der s = – $10,000 Not e, APIS is t he addi ti onal pai d -i n sur pl us.

10. Cas h fl ow fr om as se ts = Cash f l ow t o cr edi t or s + Cas h fl ow t o stockhol der s = $ 80 ,000 – 10,000 = $ 70 ,000 Cas h fl ow fr om as se ts = OCF – Change i n NWC – Net capit al spending $70,000 = OCF – ( –$132 ,000) – 975 ,000 Oper at i ng ca sh fl ow = $ 70 ,000 – 132 ,000 + 975 ,000 Oper at i ng ca sh fl ow = $ 913,000 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 income $120 Depr eci at ion 90 Changes i n ot her cur rent ass ets Change i n acc ount s payabl e

(1 5)15

T ot al cash fl ow fr om oper ati ons

$210

I nvesti ng acti vit ies Acqui sit i on of f i xed ass et s $( 110) T ot al cash fl ow fr om i nves ti ng ac ti vi t ies $( 110) Financi ng acti vi ti es Proc eeds of l ong-t er m deb t Di vi dends T ot al cash fl ow fr om f i nanci ng ac ti vi t ies Change i n cash (on bal ance she et ) $ 15

$ (10 9 5) ($85)

CHAPT CHAPTER ER22- 10 10

b. Change i n NWC = NWCe nd – NWCbe g = ( CAe nd – CLe nd ) – ( CAbe g – CLbe g) = [ ( $80 + 185 ) – 1 40] – [( $60 + 1 70) – 1 25) = $1 25 – 105 = $ 20 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 ca pit al spending. So, calculat ing ea ch of t hes e, we fi nd: Oper ati ng cas h f l ow Net i ncome Depr eci at i on Oper at i ng cash fl ow

$ 12090 $ 210 Not e that we c an cal cul at e OCF in t hi s manne r si nce ther e ar e no taxes.

Capi t al spendi ng Ending f i xed ass et s $ 405 Begi nni ng f i xed a sset s – 385 Depr eci at i on 90 Capit al spe ndi ng $110 Now we c an cal cul at e t he cas h fl ow gene rat ed by t he f ir m’ s a ss et s, whi ch i s:

Cash fl ow from assets Oper at i ng ca sh fl ow $ 210 Capi tal spe ndi ng – 110 Change i n NWC –20 Cas h fl ow fr om as set s $ 80 12. 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 spendi 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 Addi ti ons t o NWC Cas h fl ows f r om t he f ir m

$( 2 7,000) ( 2,3 $( 00) 2 9,3 00) 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 Sal e of common st ock Di vi dends pai d Cas h fl ows t o i nves t or s of t he f ir m

$( 17, 800) ( 5,000) 1 5,2 $(00 7,6 00)

CHAPT CHAPTER ER22- 11 11

13. 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 cost s Depr eci at i on EB IT $ 95,000 Int er es t T axable income T axes Net i ncome

$925 ,000 490 ,000 220,000 120,000 29,600 $ 65,400 22,890 $ 42,510

b. And t he operati ng ca sh f low i s: OCF = EB IT + Depr eci at i on – Taxes OCF = $ 95,000 + 1 20,000 – 22,890 OCF = $ 192,110 14. T o f i nd t he OCF, we fi rst cal cul at e net i ncome.

Inco me St at ement Sal es $215,000 Cost s 117 ,000 Ot her expe nse s 6, Depr eci at i on 18,400 700 EB IT $72,900 Int er es t 10,000 T axable income $62,900 T axes 25,370 Net i ncome $37,530 Di vi dends $9,500 Addi ti ons t o RE $28,030 a. OCF = EB IT + Depr eci at i on – Taxes OCF = $ 72,900 + 1 8,400 – 25,370 OCF = $6 5,930 b. CFC = Int er es t – Net new LT D CFC = $ 10 ,000 – ( –$7, 200) CFC = $1 7,200 Not e that t he net new l ong-t er m debt i s negat i ve beca use t he c ompany r epai d par t of it s l ong - t er m debt . c. CFS = Di vi dends – Net new equit y

CHAPT CHAPTER ER22- 12 12 CFS = $9,500 – 8,10 0 CFS = $1, 400

CHAPT CHAPTER ER22- 13 13

d. We know t hat CFA = CFC + CFS, so: CFA = $1 7,200 + 1, 400 = $18, 600 CFA i s al so equal t o OCF – Net capit al spendi ng – Change i n NWC. We a lr 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 = $2 8,400 + 1 8,4 00 Net capit al spe ndi ng = $4 6,800 Now we c an use: CFA = OCF – Net capit al spendi ng – Change i n NWC $18,600 = $6 5,930 – 46,800 – Change i n NWC Solvi ng f or t he change i n NWC gi ves $ 530, mea ni ng the c ompany i ncr eas ed it s NWC by $ 530.

15. 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 on t o ret ai ned ear ni ngs Net i ncome = $1, 670 + 5,200 Net i ncome = $ 6,870 Now, l ooki ng at t he income s t at ement : EBT – ( EBT × T ax r at e) = Net i ncome 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 – Tax rat e) EBT = $6, 870 / (1 – .40) EBT = $11,450 Now we c an cal cul at e: EB IT = EBT + Int er est EB IT = $ 11,450 + 1,8 5 0 EB IT = $ 13,300 T he l ast st ep is t o use: EB IT = Sal es – Costs – Depr eci at i on $13,300 = $ 44,000 – 27,500 – Deprec iati on Depr eci at i on = $ 3,200

CHAPT CHAPTER ER22- 14 14

16. 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 $12,400,equityis equalto$1,100,andifTAis $9,600, equit y i s equal t o $0. We shoul d not e her ethatwhilethe marketvalueofequitycannot be negat i ve, t he book val ue of shar ehol der s’ equi t y can be negat i ve.

17. a. T axes Growt h = .15( $50,000) + .25( $25,000) + .34( $82,500 – 75,000) = $1 6,30 0 T axes Income = .15( $50,000) + .25( $25,000) + .34( $25,000) + .39( $235,000) + .34( $8, 250,000 – 335,000) = $2, 805,000 b. 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 pi t e t hei r di ff er ent aver age tax rat es, so bot h f ir ms wil l pay an a ddi ti onal $3,400 i n taxes.

18. Inco me St at ement Sal es COGS A&S expen ses Depr eci at i on EB IT Int er T income es axable t T axes ( 35% ) a.

Net i ncome

$590,000 455,000 85,000 125,000 –$75,000 65,000 –$140 ,000 0 –$140 ,000 b. OCF = EB IT + Depr eci at i on – Taxes OCF = –$75,000 + 1 25,000 – 0 OCF = $ 50,000 c. Net i ncome was negat i ve bec ause of t he t ax deductibi li t y of depr eci at ion and int erest expense .

However , t he act ual cash fl ow fr om oper at i ons was posit i ve beca use depr eci at ion 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.

19. 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 ca sh 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 = $50,000 – 0 – 0 = $50,000 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 = $34,000 – 0 = $34,000 Cas h fl ow t o credit or s = Cash fl ow fr om a ss ets – Cash f l ow t o st ockhol der s

CHAPT CHAPTER ER22- 15 15 Cas h fl ow t o credit or s = $50,000 – 34,000 Cas h fl ow t o credit or s = $16,000

CHAPT CHAPTER ER22- 16 16

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 = $65 ,000 – 16 ,000 Net new LT D = $49 ,000 20. a. T he i ncome s t at ement i s: Inco me St at ement Sal es Cost of good s sol d Depr eci at i on EB IT Int er es t T axable income T axes Net i ncome

$ 20,300 14,5 002,9 00 $ 2,900 6 $ 2,90 210884 $1,326

b. O

CF = EBIT + Depr eci at ion – Taxe s OCF = $ 2,900 + 2, 900 – 884 OCF = $4, 916

c.

Change i n NWC = NWCe nd – NWCbe g = ( CAe nd – CLe nd ) – ( CAbe g – CLbe g) = ( $ 5,345 – 2,785) – ( $4,630 – 2,520) = $2,560 – 2,110 = $ 450 Net capit al spe ndi ng = NFAe nd – NFAbe g + Depr ec i at i on = $1 7,120 – 15,470 + 2,900 = $4, 550 CFA = OCF – Change i n NWC – Net capit al spending = $4, 916 – 4 50 – 4,550 = –$84 T he cash fl ow f r om as set s ca n be posit i ve or negative, si nce it repres ent s whet her t he f irm raisedfundsordistributedfundsona net basi s. In t his pr obl em, even t hough net i ncomeand OCFarepositive,thefirminvest ed hea vi l y i n bot h fi xed as set s and net wor ki ngcapital;ithad toraiseanet$84infunds fr om i t s st ockhol der s and credit or s t o make t hese i nvestment s.

d. Cas h fl ow t o credit or s = Int er est – Net new LT D = $6 90 – 0 = $6 90

CHAPT CHAPTER ER22- 17 17

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 = –$84 – 690 = –$774 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 = $ 774 – ( –660) = $1, 434 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$450in new net wor ki ng ca pi t al and $4, 550 i n new f i xedassets. Thefirmhadtoraise$84fromits st akehol der s t o suppor t t hi s new i nves t ment .Itaccomplished thisbyraising$1,434int he f or m of new equit y. Af ter payi ng out $6 6 0 of thisintheformof dividendstoshareholder s and $6 9 0 i n the f or m of i nt er est t o cr edi t or s,$84waslefttomeetthe firm’scashflow nee ds f or inves t ment .

21. a.

T ot al asse ts 2014 T ot al li abi li ti es 2014 s’ equi t y 2014 Owner

= $ 964 + 4, 384 = $ 5,348 = $ 401 + 2, 380 = $2, 781 = $5, 348 – 2, 781 = $2,567

T ot al asse ts 2015 T ot al li abi li ti es 2015 == $4 + 2, 713 = =$ $3,158 $1,45 176 + 5,104 Owner s’ equi t y 2015 = 6,280 $ 6,280 – 3,158 = $ 3,122 = CA14 – CL14 = $964 – 401 = $5 63 = CA15 – CL15 = $1, 176 – 445 = $ 731 = NWC15 – NWC14 = $ 731 – 563 = $ 168 c. We can cal cul at e net ca pi t al spendi ng as:

b.

NWC 2014 NWC 2015 Change i n NWC

Net capit al spe ndi ng = Net f i xed asset s 2015 – Net fi xed as set s 2014 + Deprec iati on Net capit al spe ndi ng = $ 5,104 – 4,384 + 1,1 90 Net capit al spe ndi ng = $ 1,910 So, t he company had a net ca pit al spending ca sh f l ow of $ 1,910 . 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 $ 1,910 = $2, 350 – Fixed ass et s sold Fixe d as set s sold = $2, 350 – 1,910 Fixe d as set s sold = $ 440

CHAPT CHAPTER ER22- 18 18

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.The operatingcashflowiscalculatedas f ol l ows ( you ca n al so pr epar e a tr adi tional i ncome st at ement ): EB IT = Sal es – Costs – Depr eci at i on EB IT = $1 4,740 – 5,932 – 1,190 EB IT = $ 7,618 EBT = EBIT – Int er est EBT = $7,618 – 328 EBT = $7,290 T axes = EBT .40 T axes = $ 7,290 .40 T axes = $ 2,916 OCF = EB IT + Depr eci at i on – Taxes OCF = $ 7,618 + 1,1 90 – 2,916 OCF = $ 5,892 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 = $5,892 – 168 – 1,910 Cas h fl ow fr om as se ts = $3,814 d. Net new bor rowi ng = LT D1 5 – LT D1 4 Net new bor rowi ng = $2, 713 – 2, 380 Net new bor rowi ng = $ 333 Net new bor rowi ng = $ 333 = Debt i ssued – Debt r et ir ed Debt reti red = $455 – 333 Debt reti red = $122 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 = $328 – 333 Cas h fl ow t o credit or s = – $5

CHAPT CHAPTER ER22- 19 19

22.

Cas h Acc ounts rec ei vabl eIn vent or y

Bal ance s heet as of Dec. 31, 201 4 $4,931 Acc ount s pa yabl e 6,527 Not es payabl e

Net fi xed as sets

11,604 Cur r ent l i abil it ies $23,062 Long-t er m debt $41,346 Owner s' equi t y

T ot al asse ts

$64,408 T ot al li ab. & equit y

Cur r ent ass et s

Cas h Acc ounts rec ei vabl eIn vent or y Cur r ent ass et s Net fi xed as sets T ot al asse ts

Bal ance s heet as of Dec. 31, 201 5 $6,244 Acc ount s pa yabl e 7,352 Not es payabl e 11,926 $25,522 $42,332 $67,854

Cur r ent l i abil it ies Long-t er m debt Owner s' equi t y

T ot al li ab. & equit y 201 4 Income St atement 201 5 Income St atement Sal es $9,402.00 Sal es $10,091.00 COGS 3,235.00 COGS 3,672.00 Ot her expe nse s 767.00 Ot her expe nse s 641.00 Depr eci at i on 1,350.00 Depr eci at i on 1,351.00 EB IT $4,050.00 EB IT $4,427.00 Int er es t 630.00 Int er es t 724.00 EBT $3,420.00 EBT $3,703.00 T axes 1,162.80 T axes 1,259.02 Net i ncome $2,257.20 Net i ncome $2,443.98 Di vi dends Addi ti ons t o RE

$1,147.00 1,110.20

Di vi dends Addi ti ons t o RE

23. OCF = EB IT + Depr eci at i on – Taxes OCF = $4,427 + 1, 351 – 1,259.02 OCF = $4,518.98 Change i n NWC = NWC e nd – NWCbe g = ( CA – CL) e nd – ( CA – CL) be g Change i n NWC = ( $2 5,522 – 5,917) – ($23,062 – 6,132 ) Change i n NWC = $ 2,675 Net capit al spe ndi ng = NFA e nd – NF Abe g + Depr eci at ion Net capit al spe ndi ng = $ 42,332 – 41,346 + 1,351 Net capit al spe ndi ng = $ 2,337

$5,179 953 $6,132 $16,152 42,124 $64,408

$5,022 895 $5,917 $19,260 42,677 $67,854

$1,261.00 1,182.98

CHAPT CHAPTER ER22- 20 20

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 = $4,518.98 – 2, 675 – 2,337 Cas h fl ow fr om as se ts = –$493.02 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 = $724 – ( $19,260 – 16,152) Cas h fl ow t o credit or s = –$2,384 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 = REbe g + Addi t i ons to RE Net new equit y = OEe nd – OEbe g + REbe g – ( REbe g + Addi t i ons t o RE) = OEe nd – OEbe g – Addi t i ons t o RE Net new equit y = $ 42,677 – 42,124 – 1,182.98 = –$ 629.98 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 = $1, 261– ( – $629.98) Cas h fl ow t o stockhol der s = $1, 890.98 As a check, ca sh f l ow f r om as set s i s –$ 493.02 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 = –$2,384+ 1,890.98 Cas h fl ow fr om as se ts = –$493.02 Chal lenge 24. We wil l begi n by ca l cul ati ng t he oper at ing ca sh fl ow. Fir st , we need the EBIT , whi c h ca n be ca l cul at ed as: EB IT = Net i ncome + Current t axes + Def er r ed t axes + Int er es t EB IT = $1 92 + 84 + 13 + 41 EB IT = $33 0 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 $330 Depr eci at i on 76 Cur r ent t axes –84 Oper at i ng cash fl ow $322

CHAPT CHAPTER ER22- 21 21

T he cas h fl ow fr om as set s i s f ound in t he i nvest i ng act i vi ti es por ti on of t he acc ount ing st at ement of ca sh f l ows, so: Cash fl ow from assets Acqui si ti on of fi xed asset s $198 Sal e of fi xed asse ts –21 Capit al spe ndi ng $177 T he net wor ki ng ca pi t al ca sh f l ows are al l f ound intheoperationscashflowsectionofthe ac count ing st at ement of cash fl ows. However , i nst ead of cal cul at ing t he net wor ki ng ca pit al cash flowsasthechangeinnetworkingcapit al, we must cal cul at e ea ch it em i ndi vi dual l y. Doing so, we f i nd: Net worki ng capi t al cash flow Cas h $29 Acc ounts rec ei vabl e 1 6 In vent or i es –17 Acc ounts pa yable –13 Acc r ued expens es 7 Ot her – 2 NWC cas h fl ow $20 Except f or t he i nt erest expens e, t he cas h f l ow to credi t or s is f ound i n t he f i nancing ac t i vi ti es of the ac count ing st at ement of ca sh f l ows. T he i nteres t expense fr om t he i ncome s t at ement is gi ven, s o: Cash fl ow t o cr edit ors Int er es t Ret ir ement of debt Debt ser vi ce Proc eeds f r om sa le of l ong-t er m debt T ot al

$41 150 $191 –115 $76

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 Proc eeds f r om new st ock i ssue T ot al

$ 81 11 $ 92 –43 $ 49

CHAPT CHAPTER ER22- 22 22

25. 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 26. a.

b.

T he t ax bubbl e ca uses average t ax rates t o cat ch up to mar gi nal t ax r at es , t hus el imi tnat axiadva ng t he nt age of l ow mar gi nal r ates f or hi gh i ncome c or porati ons.

Ass umi ng a t axa bl e i ncome of $335,000, t he t axes wil l be: T axes = . 15($50K ) + .25( $25K) + .34( $25K) + .39( $235K) = $113.9K Aver age t ax r at e = $113.9K / $335K = 34% T he mar gi nal tax r ate on t he ne xt doll ar of i ncome i s 34 perce nt .

For cor por at e t axable i ncome l evel s of $335K to $10M, average t ax rat es ar e equal t o mar gi nal t ax r ates .

T axes = . 34($10M) + .35( $5M) + .38($3.333M) = $6,416,667 Aver age t ax r at e = $6,416,667 / $18,333,334 = 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 por ate 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 X ( $100K )X X

= .34( $200K ) = $68K = .15( $50K ) + .25( $25K ) + .34($25K) + X ($100K = $68K –); 22.25K = $45.75K = $45.75K / $100K = .4575, or 45.75%

CHAPT CHAPTER ER22- 23 23

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