Finance Chapter 2

If the depreciation is straight-line and the asset is written down to zero over that period, then:

$5,000/5 = $1,000 will be deducted each year as an expense.

The 2014 balance sheet of Steelo, Inc., showed current assets of $4,500 and current liabilities of $2,920. The 2015 balance sheet showed current assets of $3,000 and current liabilities of $1,530. What was the company's 2015 change in net working capital, or NWC? (Do not round intermediate calculations. Negative amount should be indicated by a minus sign.)

(110)

An example of long-term debt:

A loan that the firm will pay off in five years is one such

What does stockholders' equity represent?

A residual claim against the book value of the firm's assets. (The book value of the firm's assets less the book value of its liabilities.)

Long-term liabilities represents obligations of the firm lasting over________

A year

An example of a current liability where the money the firm owes to its supplier is:

Accounts payable

Residual value is the amount leftover after paying________.

Accounts payable Bondholders Other debt holders Preferred stockholders

Change in NWC is the same as:

Addition to NWC

Billy's Exterminators, Inc., has sales of $743,000, costs of $294,000, depreciation expense of $46,000, interest expense of $33,000, a tax rate of 35 percent, and paid out $68,000 in cash dividends. What is the addition to retained earnings? (Do not round intermediate calculations.) Addition to retained earnings $

Addition to retained earnings $ 172500

Billy's Exterminators, Inc., has sales of $604,000, costs of $308,000, depreciation expense of $60,000, interest expense of $40,000, a tax rate of 35 percent, and paid out $75,000 in cash dividends. What is the addition to retained earnings? (Do not round intermediate calculations.) Addition to retained earnings $

Addition to retained earnings $ 52400

Of course, there is no such thing as "free" cash (we wish!). Instead the name refers to cash that the firm is free to:

distribute to creditors and stockholders because it is not needed for working capital or fixed asset investments. We will stick with "cash flow from assets" as our label for this important concept because

Fixed assets can be:

either tangible, such as a truck or a computer, or intangible, such as a trademark or patent.

Equity holders are:

entitled to only the residual value, the portion left after creditors are paid.

depreciation is the accountant's estimate of the cost of __________ used up in the production process.

equipment

The use of debt in a firm's capital structure is called:

financial leverage.

Net capital spending is money spent on:

fixed assets less money received from the sale of fixed assets.

If our time horizon is relatively short, however, some costs are effectively:

fixed—they must be paid no matter what (property taxes, for example). Other costs, such as wages to laborers and payments to suppliers, are still variable. As a result, even in the short run, the firm can vary its output level by varying expenditures in these areas.

Cash flow from assets sometimes goes by a different name:

free cash flow.

The more debt a firm has (as a percentage of assets), the:

greater is its degree of financial leverage

debt acts like a lever in the sense that using it can:

greatly magnify both gains and losses.

Under Generally Accepted Accounting Principles (GAAP), audited financial statements in the United States mostly show assets at: historical cost. In other words, assets are "carried on the books" at what the firm paid for them, no matter how long ago they were purchased or how much they are worth today.

historical cost. In other words, assets are "carried on the books" at what the firm paid for them, no matter how long ago they were purchased or how much they are worth today.

Fixed assets are, for the most part, relatively:

illiquid.

Inventory is probably the:

least liquid of the current assets, at least for many businesses.

Current liabilities, like current assets, have a life of:

less than one year (meaning they must be paid within the year) and are listed before long-term liabilities.

A current asset has a life of:

less than one year. This means that the asset will convert to cash within 12 months

We will tend to use the terms bond and bondholders generically to refer to:

long-term debt and long-term creditors, respectively.

Henceforth, whenever we speak of the value of an asset or the value of the firm, we will normally mean its:

market value. So, for example, when we say the goal of the financial manager is to increase the value of the stock, we mean the market value of the stock.

The depreciation deduction is another application of the:

matching principle in accounting.

Non-cash items directly affect________ but doesn't directly affect_______.

net income; cash flow

The cash flows to creditors and stockholders represent the:

net payments to creditors and owners during the year. Their calculation is similar to that of cash flow from assets. Cash flow to creditors is interest paid less net new borrowing; cash flow to stockholders is dividends paid less net new equity raised.

Capital spending refers to the:

net spending on fixed assets (purchases of fixed assets less sales of fixed assets).

the difference between a firm's current assets and its current liabilities is called:

net working capital

Intangible assets, such as a trademark, have:

no physical existence but can be very valuable. Like tangible fixed assets, they won't ordinarily convert to cash and are generally considered illiquid.

Expenses associated with the firm's financing of its assets are:

not included because they are not operating expenses.

Accounts receivable, for example, represent amounts:

not yet collected from customers on sales already made.

The balance sheet is a snapshot of the firm. It is a convenient means:

of organizing and summarizing what a firm owns (its assets), what a firm owes (its liabilities), and the difference between the two (the firm's equity) at a given point in time.

A fixed asset is:

one that has a relatively long life.

With a flat-rate tax, there is:

only one tax rate, so the rate is the same for all income levels. The 21 percent corporate tax created by the Tax Cuts and Jobs Act of 2017 is such a tax.

Cash flow from assets involves three components:

operating cash flow, capital spending, and change in net working capital.

The distinction between fixed and variable costs is important, at times, to the financial manager, but the way costs are reported on the income statement is not a good guide to which costs are which. The reason is that, in practice, accountants tend to classify costs as either:

product costs or period costs.

A highly liquid asset is therefore one that can be:

quickly sold without significant loss of value.

Your marginal tax rate is the:

rate of the extra tax you would pay if you earned one more dollar.

Product costs include such things as:

raw materials, direct labor expense, and manufacturing overhead. These are reported on the income statement as costs of goods sold, but they include both fixed and variable costs.

The general rule (the recognition or realization principle) is to:

recognize revenue when the earnings process is virtually complete and the value of an exchange of goods or services is known or can be reliably determined this principle usually means that revenue is recognized at the time of sale, which need not be the same as the time of collection.

An income statement prepared using GAAP will show:

revenue when it accrues. This is not necessarily when the cash comes in.

The basic idea here is to first determine:

revenues and then match those revenues with the costs associated with producing them.

So, financial leverage increases the potential:

reward to shareholders, but it also increases the potential for financial distress and business failure.

the balance sheet identity, or equation, always holds because:

shareholders' equity is defined as the difference between assets and liabilities.

A supplier might look at the:

size of accounts payable to see how promptly the firm pays its bills.

Liquidity refers to the: example?

speed and ease with which an asset can be converted to cash. Gold is a relatively liquid asset; a custom manufacturing facility is not.

Managers within the firm can track things like:

the amount of cash and the amount of inventory the firm keeps on hand.

the marginal tax rate is always the same as:

the average tax rate.

The accountant seeks to match the expense of purchasing the asset with:

the benefits produced from owning it.

A potential creditor would examine:

the liquidity and degree of financial leverage.

Because financial decisions usually involve new cash flows or changes in existing ones, this rate will tell us:

the marginal effect of a decision on our tax bill.

For financial managers, then, the accounting value of the stock is not an especially important concern; it is:

the market value that matters.

Expenses shown on the income statement are based on:

the matching principle.

change in net working capital is measured as:

the net change in current assets relative to current liabilities for the period being

the difference between the total value of the assets (current and fixed) and the total value of the liabilities (current and long-term) is:

the shareholders' equity, also called common equity or owners' equity

There is a standard financial accounting statement called :

the statement of cash flows

the value of the firm's assets is equal to:

the sum of its liabilities and shareholders' equity

The size of a company's tax bill is determined by:

the tax code, an often amended set of rules.

The use of a financial leverage can be:

to greatly modify gains and losses increase the potential reward for investors

Most importantly assets provide__________ to the firm.

value

In the long run, all business costs are:

variable. Given sufficient time, assets can be sold, debts can be paid, and so on.

Operating cash flow is an important number because it tells us:

whether a firm's cash inflows from its business operations are sufficient to cover its everyday cash outflows. For this reason, a negative operating cash flow is often a sign of trouble.

Your average tax rate is:

your tax bill divided by your taxable income— in other words, the percentage of your income that goes to pay taxes.

This is the balance sheet identity, or equation:

Assets = Liabilities + Shareholders' equity

Net Working Capital plus liabilities equals ____________

Current asset

Billy's Exterminators, Inc., has sales of $655,000, costs of $304,000, depreciation expense of $56,000, interest expense of $38,000, a tax rate of 35 percent, and paid out $88,000 in cash dividends. The firm has 100,000 shares of common stock outstanding. What are the earnings per share? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Earnings per share $ What are the dividends per share? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Dividends per share $

Earnings per share $ 1.67 Dividends per share $ .88

Billy's Exterminators, Inc., has sales of $743,000, costs of $294,000, depreciation expense of $46,000, interest expense of $33,000, a tax rate of 35 percent, and paid out $88,200 in cash dividends. The firm has 98,000 shares of common stock outstanding. What are the earnings per share? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Earnings per share $ 2.45 2.45 Correct What are the dividends per share? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Dividends per share $ .9 .9 Correct

Earnings per share $ 2.45 Dividends per share $ .9

Liquidity actually has two dimensions:

Ease of conversion versus loss of value.

What questions can be answered after reviewing a balance sheet statement?

How much debt is used to finance the firm? What is the total amount of assets the firm owns?

Bowyer Driving School's 2014 balance sheet showed net fixed assets of $5.4 million, and the 2015 balance sheet showed net fixed assets of $6 million. The company's 2015 income statement showed a depreciation expense of $425,000. What was net capital spending for 2015? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.) Net capital spending

Net capital spending $ 1,025,000

Billy's Exterminators, Inc., has sales of $646,000, costs of $286,000, depreciation expense of $38,000, interest expense of $29,000, and a tax rate of 35 percent. What is the net income for this firm? (Do not round intermediate calculations.) Net income $

Net income $ 190450

Billy's Exterminators, Inc., has sales of $737,000, costs of $282,000, depreciation expense of $34,000, interest expense of $27,000, and a tax rate of 35 percent. What is the net income for this firm? (Do not round intermediate calculations.) Net income $

Net income $ 256100

The 2014 balance sheet of Steelo, Inc., showed current assets of $2,930 and current liabilities of $1,390. The 2015 balance sheet showed current assets of $2,945 and current liabilities of $1,635. What was the company's 2015 change in net working capital, or NWC? (Do not round intermediate calculations. Negative amount should be indicated by a minus sign.) Net working capital $

Net working capital $ (230)

Cash flow from assets = Cash flow to creditors + Cash flow to stockholders What is this equation called?

This is the cash flow identity. It says that the cash flow from the firm's assets is equal to the cash flow paid to suppliers of capital to the firm.

the difference between the number of dollars that came in and the number of dollars that went out is called:

cash flow For example, if you were the owner of a business, you might be very interested in how much cash you actually took out of your business in a given year.

Operating cash flow refers to the:

cash flow that results from the firm's day-to-day activities of producing and selling.

Net working capital is positive when: What does this mean?

current assets exceed current liabilities. Based on the definitions of current assets and current liabilities, this means the cash that will become available over the next 12 months exceeds the cash that must be paid over the same period. For this reason, net working capital is usually positive in a healthy firm.

Assets are classified as either:

current or fixed assets.

The firm's liabilities are the first thing listed on the right side of the balance sheet. These are classified as either:

current or long-term.

Assets are normally listed on the balance sheet in order of:

decreasing liquidity, meaning that the most liquid assets are listed first.

Suppose a firm purchases an asset for $5,000 and pays in cash. Obviously, the firm has a $5,000 cash outflow at the time of purchase. However, instead of deducting the $5,000 as an expense, an accountant might:

depreciate the asset over a five-year period.

Corporate tax rate 2017 Federal Taxable Income Tax Rate $0− 50,000 15% 50,001− 75,000 25 75,001− 100,000 34 100,001− 335,000 39 335,001−10,000,000 34 10,000,001−15,000,000 35 15,000,001−18,333,333 38 18,333,334+ 35

Beginning in 2018, the corporate tax rate is 21 percent, and that rate applies regardless of the level of taxable income.

Prepare a 2011 balance sheet for Cornell Corp. based on the following information: cash = $127,000; patents and copyrights = $630,000; accounts payable = $210,000; accounts receivable = $105,000; tangible net fixed assets = $1,620,000; inventory = $293,000; notes payable = $160,000; accumulated retained earnings = $1,278,000; long-term debt = $845,000. (Be sure to list the accounts in order of their liquidity.) CORNELL COP. Balance Sheet Assets $ Current assets $ Total assets $ Liabilities $ Current liabilities $ Total liabilities $ Total liabilities & owners equity $

CORNELL COP. Balance Sheet Assets Cash $ 127,000 Accounts receivable 105,000 Inventory Correct 293,000 Current assets $ 525,000 Tangible net fixed assets 1,620,000 Intangible net fixed assets 630,000 Total assets $ 2,775,000 Liabilities Accounts payable Correct $ 210,000 Notes payable 160,000 Current liabilities $ 370,000 Long-term debt Correct 845,000 Total liabilities $ 1,215,000 Common stock 282,000 Accumulated retained earnings 1,278,000 Total liabilities & owners equity $2,775,000

Use the following information for Taco Swell, Inc., (assume the tax rate is 34 percent): 2010 2011 Sales $ 11,573 $ 12,936 Depreciation 1,661 1,736 Cost of goods sold 3,979 4,707 Other expenses 946 824 Interest 776 926 Cash 6,067 6,466 Accounts receivable 8,034 9,427 Short-term notes payable 1,171 1,147 Long-term debt 20,320 24,636 Net fixed assets 50,888 54,273 Accounts payable 4,384 4,644 Inventory 14,283 15,288 Dividends 1,411 1,618 For 2011, calculate the cash flow from assets, cash flow to creditors, and cash flow to stockholders. (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.) Cash flow from assets $ Cash flow to creditors $ Cash flow to stockholders $

Cash flow from assets $ (1889.62) Cash flow to creditors $ (3390) Cash flow to stockholders $ 1500.38

When looking at an income statement, the financial manager needs to keep three things in mind:

GAAP, cash versus noncash items, and time and costs.

True or False Operating cash flow includes capital spending and working capital requirements.

False

Blance Sheet

Financial Statement showing a firm's accounting value on a particular date

Costs that do not change in the short-run arise because of __________.

Fixed commitments

Why is positive NWC important?

It means the firm should have sufficient cash to meet its current obligation.

Ridiculousness, Inc., has sales of $47,000, costs of $25,700, depreciation expense of $1,700, and interest expense of $1,700. If the tax rate is 35 percent, what is the operating cash flow, or OCF? (Do not round intermediate calculations.) Operating cash flow $

Operating cash flow $ 15035

Ridiculousness, Inc., has sales of $45,500, costs of $20,200, depreciation expense of $2,000, and interest expense of $1,200. If the tax rate is 35 percent, what is the operating cash flow, or OCF? (Do not round intermediate calculations.) Operating cash flow $

Operating cash flow $ 17565

KCCO, Inc., has current assets of $4,000, net fixed assets of $23,100, current liabilities of $2,500, and long-term debt of $12,400. What is the value of the shareholders' equity account for this firm? (Do not round intermediate calculations.) Shareholders' equity $ How much is net working capital? (Do not round intermediate calculations.) Net working capital $

Shareholders' equity $ 12200 Net working capital $ 1500

KCCO, Inc., has current assets of $4,500, net fixed assets of $23,500, current liabilities of $2,750, and long-term debt of $12,900. What is the value of the shareholders' equity account for this firm? (Do not round intermediate calculations.) Shareholders' equity $ How much is net working capital? (Do not round intermediate calculations.) Net working capital $

Shareholders' equity $ 12350 Net working capital $ 1750

Liquidity refers to the ease of changing _________.

assets to cash.

So, if we manufacture a product and then sell it on credit, the revenue is realized___________. The production and other costs associated with the sale of that product will be recognized________. Once again, the actual cash outflows may have occurred at_____________.

at the time of sale. at the time. some different time.

What can be one of the largest cash outflows a firm experience?

Taxes For example: the fiscal year 2016, JPMorgan Chase's earnings before taxes were about $34.54 billion. Its tax bill, including all taxes paid worldwide, was a whopping $9.8 billion, or about 28 percent of its pretax earnings. Also for fiscal year 2016, Walmart had a taxable income of $20.50 billion, and the company paid $6.2 billion in taxes—an average tax rate of 30 percent.

The values shown on the balance sheet for the firm's assets are:

book values and generally are not what the assets are actually worth.

Current assets are relatively liquid and include:

cash and assets we expect to convert to cash over the next 12 months.

___________ costs change as the output of the firm changes.

Variable

The difference between average and marginal tax rates can best be illustrated with an example. Suppose our corporation had a taxable income of $200,000 in 2017. What was the tax bill? .15($50,000) = $ 7,500 .25($75,000 − 50,000) = 6,250 .34($100,000 − 75,000) = 8,500 .39($200,000 − 100,000) = 39,000 $61,250 Our total tax was $61,250. In our example, what is the average tax rate? What is the marginal tax rate?

We had a taxable income of $200,000 and a tax bill of $61,250, so the average tax rate is $61,250/$200,000 = 30.625 percent. If we made one more dollar, the tax on that dollar would be 39 cents, so our marginal rate is 39 percent.

What does the cash flow identity reflect?

What it reflects is the fact that a firm generates cash through its various activities, and that cash is either used to pay creditors or paid out to the owners of the firm.

Period costs are incurred during:

a particular time period and might be reported as selling, general, and administrative expenses. Once again, some of these period costs may be fixed and others may be variable. The company president's salary, for example, is a period cost and is probably fixed, at least in the short run.

FA consist of tangible things such as:

buildings and equipment that don't convert to cash at all in normal business activity (they are, of course, used in the business to generate cash).

An illiquid asset is one that:

cannot be quickly converted to cash without a substantial price reduction.

Volbeat Corp. shows the following information on its 2015 income statement: sales = $275,000; costs = $188,000; other expenses = $7,900; depreciation expense = $15,200; interest expense = $13,600; taxes = $17,605; dividends = $10,500. In addition, you're told that the firm issued $5,100 in new equity during 2015 and redeemed $3,600 in outstanding long-term debt. a. What is the 2015 operating cash flow? (Do not round intermediate calculations.) Operating cash flow $ b. What is the 2015 cash flow to creditors? (Do not round intermediate calculations.) Cash flow to creditors $ c. What is the 2015 cash flow to stockholders? (Do not round intermediate calculations.) Cash flow to stockholders $ d. If net fixed assets increased by $22,000 during the year, what was the addition to NWC? (Do not round intermediate calculations.) Addition to NWC $

a. Operating cash flow $ 61495 b. Cash flow to creditors $ 17200 c. Cash flow to stockholders $ 5400 d. Addition to NWC $ 1695

Volbeat Corp. shows the following information on its 2015 income statement: sales = $398,000; costs = $298,000; other expenses = $7,900; depreciation expense = $15,400; interest expense = $14,200; taxes = $21,875; dividends = $11,500. In addition, you're told that the firm issued $5,700 in new equity during 2015 and redeemed $4,200 in outstanding long-term debt. a. What is the 2015 operating cash flow? (Do not round intermediate calculations.) Operating cash flow $ b. What is the 2015 cash flow to creditors? (Do not round intermediate calculations.) Cash flow to creditors $ c. What is the 2015 cash flow to stockholders? (Do not round intermediate calculations.) Cash flow to stockholders $ d. If net fixed assets increased by $30,000 during the year, what was the addition to NWC? (Do not round intermediate calculations.) Addition to NWC $

a. Operating cash flow $ 70225 b. Cash flow to creditors $ 18400 c. Cash flow to stockholders $ 5800 d. Addition to NWC $ 625

The important thing to recognize is that this $1,000 deduction isn't cash—it's an:

accounting number. The actual cash outflow occurred when the asset was purchased.

The percentage tax rates (corporate tax rate) are:

all marginal rates. Put another way, the tax rates applied to the part of income in the indicated range only, not all income.

A primary reason that accounting income differs from cash flow is that:

an income statement contains non-cash items. The most important of these is depreciation.

Normally the marginal tax rate is relevant for financial decision making. The reason is that:

any new cash flows will be taxed at that marginal rate.

A debt that is not due in the coming year is classified:

as a long-term liability.