SOLUTION MANUAL
CORPORATE FINANCE
, Solutions Manual
Corporate Finance 13th EditionRoss, Westerfield,
And Jordan
Prepared
ByBrad
Jordan
University Of Florida
Joe Smolira
Belmont University
,CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers To Concepts Review And Critical Thinking Questions
1. Capital Budgeting (Deciding Whether To Expand A Manufacturing Plant), Capital Structure
(Deciding Whether To Issue New Equity And Use The Proceeds To Retire Outstanding Debt), And
Working Capital Management (Modifying The Firm‗S Credit Collection Policy With Its Customers).
2. Disadvantages: Unlimited Liability, Limited Life, Difficulty In Transferring Ownership, Difficulty
In Raising Capital Funds. Some Advantages: Simpler, Less Regulation, The Owners Are Also The
Managers, Sometimes Personal Tax Rates Are Better Than Corporate Tax Rates.
3. The Primary Disadvantage Of The Corporate Form Is The Double Taxation To Shareholders Of
Distributed Earnings And Dividends. Some Advantages Include: Limited Liability, Ease Of
Transferability, Ability To Raise Capital, And Unlimited Life.
4. In Response To Sarbanes-Oxley, Small Firms Have Elected To Go Dark Because Of The Costs Of
Compliance. The Costs To Comply With Sarbox Can Be Several Million Dollars, Which Can Be A
Large Percentage Of A Small Firm‗S Profits. A Major Cost Of Going Dark Is Less Access To
Capital. Since The Firm Is No Longer Publicly Traded, It Can No Longer Raise Money In The
Public Market. Although The Company Will Still Have Access To Bank Loans And The Private
Equity Market, The Costs Associated With Raising Funds In These Markets Are Usually Higher
Than The Costs Of Raising Funds In The Public Market.
5. The Treasurer‗S Office And The Controller‗S Office Are The Two Primary Organizational Groups
That Report Directly To The Chief Financial Officer. The Controller‗S Office Handles Cost And
Financial Accounting, Tax Management, And Management Information Systems, While The
Treasurer‗S Office Is Responsible For Cash And Credit Management, Capital Budgeting, And
Financial Planning. Therefore, The Study Of Corporate Finance Is Concentrated Within The
Treasury Group‗S Functions.
6. To Maximize The Current Market Value (Share Price) Of The Equity Of The Firm (Whether It‗S
Publicly Traded Or Not).
7. In The Corporate Form Of Ownership, The Shareholders Are The Owners Of The Firm. The
Shareholders Elect The Directors Of The Corporation, Who In Turn Appoint The Firm‗S
Management. This Separation Of Ownership From Control In The Corporate Form Of Organization
Is What Causes Agency Problems To Exist. Management May Act In Its Own Or Someone Else‗S
Best Interests, Rather Than Those Of The Shareholders. If Such Events Occur, They May Contradict
The Goal Of Maximizing The Share Price Of The Equity Of The Firm.
8. A Primary Market Transaction.
,
,2 SOLUTIONS MANUAL
9. In Auction Markets Like The NYSE, Brokers And Agents Meet At A Physical Location (The
Exchange) To Match Buyers And Sellers Of Assets. Dealer Markets Like NASDAQ Consist Of
Dealers Operating At Dispersed Locales Who Buy And Sell Assets Themselves, Communicating
With Other Dealers Either Electronically Or Literally Over-The-Counter.
10. Such Organizations Frequently Pursue Social Or Political Missions, So Many Different Goals Are
Conceivable. One Goal That Is Often Cited Is Revenue Minimization; That Is, Provide Whatever
Goods And Services Are Offered At The Lowest Possible Cost To Society. A Better Approach
Might Be To Observe That Even A Not-For-Profit Business Has Equity. Thus, One Answer Is That
The Appropriate Goal Is To Maximize The Value Of The Equity.
11. Presumably, The Current Stock Value Reflects The Risk, Timing, And Magnitude Of All Future
Cash Flows, Both Short-Term And Long-Term. If This Is Correct, Then The Statement Is False.
12. An Argument Can Be Made Either Way. At The One Extreme, We Could Argue That In A Market
Economy, All Of These Things Are Priced. There Is Thus An Optimal Level Of, For Example,
Ethical And/Or Illegal Behavior, And The Framework Of Stock Valuation Explicitly Includes These.
At The Other Extreme, We Could Argue That These Are Noneconomic Phenomena And Are Best
Handled Through The Political Process. A Classic (And Highly Relevant) Thought Question That
Illustrates This Debate Goes Something Like This: ―A Firm Has Estimated That The Cost Of
Improving The Safety Of One Of Its Products Is $30 Million. However, The Firm Believes That
Improving The Safety Of The Product Will Only Save $20 Million In Product Liability Claims.
What Should The Firm Do?‖
13. The Goal Will Be The Same, But The Best Course Of Action Toward That Goal May Be Different
Because Of Differing Social, Political, And Economic Institutions.
14. The Goal Of Management Should Be To Maximize The Share Price For The Current Shareholders.
If Management Believes That It Can Improve The Profitability Of The Firm So That The Share Price
Will Exceed $35, Then They Should Fight The Offer From The Outside Company. If Management
Believes That This Bidder Or Other Unidentified Bidders Will Actually Pay More Than $35 Per
Share To Acquire The Company, Then They Should Still Fight The Offer. However, If The Current
Management Cannot Increase The Value Of The Firm Beyond The Bid Price, And No Other Higher
Bids Come In, Then Management Is Not Acting In The Interests Of The Shareholders By Fighting
The Offer. Since Current Managers Often Lose Their Jobs When The Corporation Is Acquired,
Poorly Monitored Managers Have An Incentive To Fight Corporate Takeovers In Situations Such As
This.
15. We Would Expect Agency Problems To Be Less Severe In Countries With A Relatively Small
Percentage Of Individual Ownership. Fewer Individual Owners Should Reduce The Number Of
Diverse Opinions Concerning Corporate Goals. The High Percentage Of Institutional Ownership
Might Lead To A Higher Degree Of Agreement Between Owners And Managers On Decisions
Concerning Risky Projects. In Addition, Institutions May Be Better Able To Implement Effective
Monitoring Mechanisms On Managers Than Can Individual Owners, Based On The Institutions‗
Deeper Resources And Experiences With Their Own Management. The Increase In Institutional
Ownership Of Stock In The United States And The Growing Activism Of These Large Shareholder
Groups May Lead To A Reduction In Agency Problems For
U.S. Corporations And A More Efficient Market For Corporate Control.
, CHAPTER 2 - 3
16. How Much Is Too Much? Who Is Worth More, Mark Parker Or Lebron James? The Simplest
Answer Is That There Is A Market For Executives Just As There Is For All Types Of Labor.
Executive Compensation Is The Price That Clears The Market. The Same Is True For Athletes And
Performers. Having Said That, One Aspect Of Executive Compensation Deserves Comment. A
Primary Reason Executive Compensation Has Grown So Dramatically Is That Companies Have
Increasingly Moved To Stock-Based Compensation. Such Movement Is Obviously Consistent With
The Attempt To Better Align Stockholder And Management Interests. In Recent Years, Stock Prices
Have Soared, So Management Has Cleaned Up. It Is Sometimes Argued That Much Of This Reward
Is Due To Rising Stock Prices In General, Not Managerial Performance. Perhaps In The Future,
Executive Compensation Will Be Designed To Reward Only Differential Performance, That Is,
Stock Price Increases In Excess Of General Market Increases.
,4 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, ButIt‗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.
, CHAPTER 2 - 5
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 That 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. Thus, 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 Owners‗ Equity, We Must Construct A Balance Sheet As Follows:
Balance Sheet
CA $ 5,400 CL $ 4,100
NFA 28,100 LTD 10,600
OE ??
TA $33,500 TL & OE $33,500
, 6 SOLUTIONS MANUAL
We Know That Total Liabilities And Owners‗ Equity (TL & OE) Must Equal Total Assets Of
$33,500. We Also Know That TL & OE Is Equal To Current Liabilities Plus Long-Term
Debt Plus Owners‗Equity, So Owners‗ Equity Is:
Owners‗ Equity = $33,500 – 10,600 –
4,100Owners‗ Equity = $18,800
And Net Working Capital (NWC) Is:
NWC = CA – CL
NWC = $5,400 – 4,100
NWC = $1,300
2. The Income Statement For The Company Is:
Income Statement
Sales $742,000
Costs 316,000
Depreciation 39,000
EBIT $387,000
Interest 34,000
EBT $353,000
Taxes (21%) 74,130
Net Income $278,870
3. One Equation For Net Income Is:
Net Income = Dividends + Addition To Retained Earnings
Rearranging, We Get:
Addition To Retained Earnings = Net Income – Dividends = $278,870 – 125,000 = $153,870
4. EPS = Net Income/Shares = $278,870/75,000 = $3.72 Per
ShareDPS = Dividends/Shares =
$125,000/75,000 = $1.67 Per Share
5. Taxes = .10($9,875) + .12($40,125 – 9,875) + .22($85,525 – 40,125) + .24($163,300 – 85,525)
+ .32($189,000 – 163,300)
Taxes = $41,495.50
The Average Tax Rate Is The Total Tax Paid Divided By Taxable
Income, So:Average Tax Rate = $41,495.50/$189,000
Average Tax Rate = .2196, Or 21.96%
The Marginal Tax Rate Is The Tax Rate On The Next $1 Of Earnings, So The Marginal Tax Rate Is 32 Percent.
6. To Calculate OCF, We First Need The Income Statement:
CORPORATE FINANCE
, Solutions Manual
Corporate Finance 13th EditionRoss, Westerfield,
And Jordan
Prepared
ByBrad
Jordan
University Of Florida
Joe Smolira
Belmont University
,CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers To Concepts Review And Critical Thinking Questions
1. Capital Budgeting (Deciding Whether To Expand A Manufacturing Plant), Capital Structure
(Deciding Whether To Issue New Equity And Use The Proceeds To Retire Outstanding Debt), And
Working Capital Management (Modifying The Firm‗S Credit Collection Policy With Its Customers).
2. Disadvantages: Unlimited Liability, Limited Life, Difficulty In Transferring Ownership, Difficulty
In Raising Capital Funds. Some Advantages: Simpler, Less Regulation, The Owners Are Also The
Managers, Sometimes Personal Tax Rates Are Better Than Corporate Tax Rates.
3. The Primary Disadvantage Of The Corporate Form Is The Double Taxation To Shareholders Of
Distributed Earnings And Dividends. Some Advantages Include: Limited Liability, Ease Of
Transferability, Ability To Raise Capital, And Unlimited Life.
4. In Response To Sarbanes-Oxley, Small Firms Have Elected To Go Dark Because Of The Costs Of
Compliance. The Costs To Comply With Sarbox Can Be Several Million Dollars, Which Can Be A
Large Percentage Of A Small Firm‗S Profits. A Major Cost Of Going Dark Is Less Access To
Capital. Since The Firm Is No Longer Publicly Traded, It Can No Longer Raise Money In The
Public Market. Although The Company Will Still Have Access To Bank Loans And The Private
Equity Market, The Costs Associated With Raising Funds In These Markets Are Usually Higher
Than The Costs Of Raising Funds In The Public Market.
5. The Treasurer‗S Office And The Controller‗S Office Are The Two Primary Organizational Groups
That Report Directly To The Chief Financial Officer. The Controller‗S Office Handles Cost And
Financial Accounting, Tax Management, And Management Information Systems, While The
Treasurer‗S Office Is Responsible For Cash And Credit Management, Capital Budgeting, And
Financial Planning. Therefore, The Study Of Corporate Finance Is Concentrated Within The
Treasury Group‗S Functions.
6. To Maximize The Current Market Value (Share Price) Of The Equity Of The Firm (Whether It‗S
Publicly Traded Or Not).
7. In The Corporate Form Of Ownership, The Shareholders Are The Owners Of The Firm. The
Shareholders Elect The Directors Of The Corporation, Who In Turn Appoint The Firm‗S
Management. This Separation Of Ownership From Control In The Corporate Form Of Organization
Is What Causes Agency Problems To Exist. Management May Act In Its Own Or Someone Else‗S
Best Interests, Rather Than Those Of The Shareholders. If Such Events Occur, They May Contradict
The Goal Of Maximizing The Share Price Of The Equity Of The Firm.
8. A Primary Market Transaction.
,
,2 SOLUTIONS MANUAL
9. In Auction Markets Like The NYSE, Brokers And Agents Meet At A Physical Location (The
Exchange) To Match Buyers And Sellers Of Assets. Dealer Markets Like NASDAQ Consist Of
Dealers Operating At Dispersed Locales Who Buy And Sell Assets Themselves, Communicating
With Other Dealers Either Electronically Or Literally Over-The-Counter.
10. Such Organizations Frequently Pursue Social Or Political Missions, So Many Different Goals Are
Conceivable. One Goal That Is Often Cited Is Revenue Minimization; That Is, Provide Whatever
Goods And Services Are Offered At The Lowest Possible Cost To Society. A Better Approach
Might Be To Observe That Even A Not-For-Profit Business Has Equity. Thus, One Answer Is That
The Appropriate Goal Is To Maximize The Value Of The Equity.
11. Presumably, The Current Stock Value Reflects The Risk, Timing, And Magnitude Of All Future
Cash Flows, Both Short-Term And Long-Term. If This Is Correct, Then The Statement Is False.
12. An Argument Can Be Made Either Way. At The One Extreme, We Could Argue That In A Market
Economy, All Of These Things Are Priced. There Is Thus An Optimal Level Of, For Example,
Ethical And/Or Illegal Behavior, And The Framework Of Stock Valuation Explicitly Includes These.
At The Other Extreme, We Could Argue That These Are Noneconomic Phenomena And Are Best
Handled Through The Political Process. A Classic (And Highly Relevant) Thought Question That
Illustrates This Debate Goes Something Like This: ―A Firm Has Estimated That The Cost Of
Improving The Safety Of One Of Its Products Is $30 Million. However, The Firm Believes That
Improving The Safety Of The Product Will Only Save $20 Million In Product Liability Claims.
What Should The Firm Do?‖
13. The Goal Will Be The Same, But The Best Course Of Action Toward That Goal May Be Different
Because Of Differing Social, Political, And Economic Institutions.
14. The Goal Of Management Should Be To Maximize The Share Price For The Current Shareholders.
If Management Believes That It Can Improve The Profitability Of The Firm So That The Share Price
Will Exceed $35, Then They Should Fight The Offer From The Outside Company. If Management
Believes That This Bidder Or Other Unidentified Bidders Will Actually Pay More Than $35 Per
Share To Acquire The Company, Then They Should Still Fight The Offer. However, If The Current
Management Cannot Increase The Value Of The Firm Beyond The Bid Price, And No Other Higher
Bids Come In, Then Management Is Not Acting In The Interests Of The Shareholders By Fighting
The Offer. Since Current Managers Often Lose Their Jobs When The Corporation Is Acquired,
Poorly Monitored Managers Have An Incentive To Fight Corporate Takeovers In Situations Such As
This.
15. We Would Expect Agency Problems To Be Less Severe In Countries With A Relatively Small
Percentage Of Individual Ownership. Fewer Individual Owners Should Reduce The Number Of
Diverse Opinions Concerning Corporate Goals. The High Percentage Of Institutional Ownership
Might Lead To A Higher Degree Of Agreement Between Owners And Managers On Decisions
Concerning Risky Projects. In Addition, Institutions May Be Better Able To Implement Effective
Monitoring Mechanisms On Managers Than Can Individual Owners, Based On The Institutions‗
Deeper Resources And Experiences With Their Own Management. The Increase In Institutional
Ownership Of Stock In The United States And The Growing Activism Of These Large Shareholder
Groups May Lead To A Reduction In Agency Problems For
U.S. Corporations And A More Efficient Market For Corporate Control.
, CHAPTER 2 - 3
16. How Much Is Too Much? Who Is Worth More, Mark Parker Or Lebron James? The Simplest
Answer Is That There Is A Market For Executives Just As There Is For All Types Of Labor.
Executive Compensation Is The Price That Clears The Market. The Same Is True For Athletes And
Performers. Having Said That, One Aspect Of Executive Compensation Deserves Comment. A
Primary Reason Executive Compensation Has Grown So Dramatically Is That Companies Have
Increasingly Moved To Stock-Based Compensation. Such Movement Is Obviously Consistent With
The Attempt To Better Align Stockholder And Management Interests. In Recent Years, Stock Prices
Have Soared, So Management Has Cleaned Up. It Is Sometimes Argued That Much Of This Reward
Is Due To Rising Stock Prices In General, Not Managerial Performance. Perhaps In The Future,
Executive Compensation Will Be Designed To Reward Only Differential Performance, That Is,
Stock Price Increases In Excess Of General Market Increases.
,4 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, ButIt‗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.
, CHAPTER 2 - 5
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 That 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. Thus, 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 Owners‗ Equity, We Must Construct A Balance Sheet As Follows:
Balance Sheet
CA $ 5,400 CL $ 4,100
NFA 28,100 LTD 10,600
OE ??
TA $33,500 TL & OE $33,500
, 6 SOLUTIONS MANUAL
We Know That Total Liabilities And Owners‗ Equity (TL & OE) Must Equal Total Assets Of
$33,500. We Also Know That TL & OE Is Equal To Current Liabilities Plus Long-Term
Debt Plus Owners‗Equity, So Owners‗ Equity Is:
Owners‗ Equity = $33,500 – 10,600 –
4,100Owners‗ Equity = $18,800
And Net Working Capital (NWC) Is:
NWC = CA – CL
NWC = $5,400 – 4,100
NWC = $1,300
2. The Income Statement For The Company Is:
Income Statement
Sales $742,000
Costs 316,000
Depreciation 39,000
EBIT $387,000
Interest 34,000
EBT $353,000
Taxes (21%) 74,130
Net Income $278,870
3. One Equation For Net Income Is:
Net Income = Dividends + Addition To Retained Earnings
Rearranging, We Get:
Addition To Retained Earnings = Net Income – Dividends = $278,870 – 125,000 = $153,870
4. EPS = Net Income/Shares = $278,870/75,000 = $3.72 Per
ShareDPS = Dividends/Shares =
$125,000/75,000 = $1.67 Per Share
5. Taxes = .10($9,875) + .12($40,125 – 9,875) + .22($85,525 – 40,125) + .24($163,300 – 85,525)
+ .32($189,000 – 163,300)
Taxes = $41,495.50
The Average Tax Rate Is The Total Tax Paid Divided By Taxable
Income, So:Average Tax Rate = $41,495.50/$189,000
Average Tax Rate = .2196, Or 21.96%
The Marginal Tax Rate Is The Tax Rate On The Next $1 Of Earnings, So The Marginal Tax Rate Is 32 Percent.
6. To Calculate OCF, We First Need The Income Statement:
