Fundamentals of Corporate Finance 10th edition (Ross, Westerfield, Jordan) solutions manual and test bank

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Fundamentals of Corporate Finance 10th edition (Ross, Westerfield, Jordan) solutions manual and test bank

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Fundamentals of Corporate Finance 10th edition (Ross, Westerfield, Jordan) solutions manual and test bank

Fundamentals of Corporate Finance 10th edition (Ross, Westerfield, Jordan) solutions manual and test bank 
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Solutions manual


CHAPTER 2
FINANCIAL STATEMENTS, TAXES, AND CASH FLOW

 

 

Answers to Concepts Review and Critical Thinking Questions


1.     Liquidity measures how quickly and easily an asset can be converted to cash without significant loss in value. It’s desirable for firms to have high liquidity so that they have a large factor of safety in meeting short-term creditor demands. However, since liquidity also has an opportunity cost associated with it—namely that higher returns can generally be found by investing the cash into productive assets—low liquidity levels are also desirable to the firm. It’s up to the firm’s financial management staff to find a reasonable compromise between these opposing needs.

2.     The recognition and matching principles in financial accounting call for revenues, and the costs associated with producing those revenues, to be “booked” when the revenue process is essentially complete, not necessarily when the cash is collected or bills are paid. Note that this way is not necessarily correct; it’s the way accountants have chosen to do it.

3.     Historical costs can be objectively and precisely measured whereas market values can be difficult to estimate, and different analysts would come up with different numbers. Thus, there is a trade-off between relevance (market values) and objectivity (book values).

4.     Depreciation is a noncash deduction that reflects adjustments made in asset book values in accordance with the matching principle in financial accounting. Interest expense is a cash outlay, but it’s a financing cost, not an operating cost.

5.     Market values can never be negative. Imagine a share of stock selling for –$20. This would mean that if you placed an order for 100 shares, you would get the stock along with a check for $2,000. How many shares do you want to buy? More generally, because of corporate and individual bankruptcy laws, net worth for a person or a corporation cannot be negative, implying that liabilities cannot exceed assets in market value.

6.     For a successful company that is rapidly expanding, for example, capital outlays will be large, possibly leading to negative cash flow from assets. In general, what matters is whether the money is spent wisely, not whether cash flow from assets is positive or negative.

7.     It’s probably not a good sign for an established company, but it would be fairly ordinary for a start-up, so it depends.

8.        For example, if a company were to become more efficient in inventory management, the amount of inventory needed would decline. The same might be true if it becomes better at collecting its receivables. In general, anything that leads to a decline in ending NWC relative to beginning would have this effect. Negative net capital spending would mean more long-lived assets were liquidated than purchased.

9.     If a company raises more money from selling stock than it pays in dividends in a particular period, its cash flow to stockholders will be negative. If a company borrows more than it pays in interest, its cash flow to creditors will be negative.

10.   The adjustments discussed were purely accounting changes; they had no cash flow or market value consequences unless the new accounting information caused stockholders to revalue the derivatives.
11.   Enterprise value is the theoretical takeover price. In the event of a takeover, an acquirer would have to take on the company's debt but would pocket its cash. Enterprise value differs significantly from simple market capitalization in several ways, and it may be a more accurate representation of a firm's value. In a takeover, the value of a firm's debt would need to be paid by the buyer when taking over a company. This enterprise value provides a much more accurate takeover valuation because it includes debt in its value calculation.

12.   In general, it appears that investors prefer companies that have a steady earnings stream. If true, this encourages companies to manage earnings. Under GAAP, there are numerous choices for the way a company reports its financial statements. Although not the reason for the choices under GAAP, one outcome is the ability of a company to manage earnings, which is not an ethical decision. Even though earnings and cash flow are often related, earnings management should have little effect on cash flow (except for tax implications). If the market is “fooled” and prefers steady earnings, shareholder wealth can be increased, at least temporarily. However, given the questionable ethics of this practice, the company (and shareholders) will lose value if the practice is discovered.

Solutions to Questions and Problems

NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and readability constraints, when these intermediate steps are included in this solutions manual, rounding may appear to have occurred. However, the final answer for each problem is found without rounding during any step in the problem.

            Basic

1.         To find owner’s equity, we must construct a balance sheet as follows:

                                          Balance Sheet
            CA        $   4,800                     CL              $  4,200          
            NFA         27,500                     LTD              10,500          
                                                            OE                     ??
            TA          $32,300                     TL & OE      $32,300

We know that total liabilities and owner’s equity (TL & OE) must equal total assets of $32,300. We also know that TL & OE is equal to current liabilities plus long-term debt plus owner’s equity, so owner’s equity is:

              OE = $32,300 – 10,500 – 4,200 = $17,600
             
              NWC = CA – CL = $4,800 – 4,200 = $600


2.         The income statement for the company is:
           
                                    Income Statement
                        Sales                           $734,000
                        Costs                           315,000
                        Depreciation                 48,000
                        EBIT                          $371,000
                        Interest                         35,000
                        EBT                            $336,000
                        Taxes (35%)                 117,600
                        Net income                 $218,400


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