Exam (elaborations) TEST BANK FOR Fundamentals of Corporate Finance 8th Edition By Stephen Ross (Solution manual)
Solutions Manual
Fundamentals of
... [Show More] Corporate Finance 8th edition
Ross, Westerfield, and Jordan
Updated 03-05-2007
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, hard to raise
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, unlimited life, and so forth.
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 firms 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 publiclytraded
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.
B-2 SOLUTIONS
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; i.e., 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 non-economic 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 other countries, primarily due to the 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 1 B-3
16. How much is too much? Who is worth more, Larry Ellison or Tiger Woods? 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 simply due to rising stock prices in general, not managerial
performance. Perhaps in the future, executive compensation will be designed to reward only
differential performance, i.e., stock price increases in excess of general market increases.
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 tradeoff
between relevance (market values) and objectivity (book values).
4. Depreciation is a non-cash 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 startup,
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.
CHAPTER 2 B-5
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 earning 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 $4,000 CL $3,400
NFA 22,500 LTD 6,800
OE ??
TA $26,500 TL & OE $26,500
We know that total liabilities and owner’s equity (TL & OE) must equal total assets of $26,500.
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 = $26,500 – 6,800 – 3,400 = $16,300
NWC = CA – CL = $4,000 – 3,400 = $600
B-6 SOLUTIONS
2. The income statement for the company is:
Income Statement
Sales $634,000
Costs 305,000
Depreciation 46,000
EBIT $283,000
Interest 29,000
EBT $254,000
Taxes(35%) 88,900
Net income $165,100
3. One equation for net income is:
Net income = Dividends + Addition to retained earnings
Rearranging, we get:
Addition to retained earnings = Net income – Dividends = $165,100 – 86,000 = $79,100
4. EPS = Net income / Shares = $165,100 / 30,000 = $5.50 per share
DPS = Dividends / Shares = $86,000 / 30,000 = $2.87 per share
5. To find the book value of current assets, we use: NWC = CA – CL. Rearranging to solve for
current assets, we get:
CA = NWC + CL = $410,000 + 1,300,000 = $1,710,000
The market value of current assets and fixed assets is given, so:
Book value CA = $1,710,000 Market value CA = $1,800,000
Book value NFA = $2,600,000 Market value NFA = $3,700,000
Book value assets = $4,310,000 Market value assets = $5,500,000
6. Taxes = 0.15($50K) + 0.25($25K) + 0.34($25K) + 0.39($325 – 100K) = $110,000
7. The average tax rate is the total tax paid divided by net income, so:
Average tax rate = $110,000 / $325,000 = 33.85%
The marginal tax rate is the tax rate on the next $1 of earnings, so the marginal tax rate = 39%.
CHAPTER 2 B-7
8. To calculate OCF, we first need the income statement:
Income Statement
Sales $14,200
Costs 5,600
Depreciation 1,200
EBIT $7,400
Interest 680
Taxable income $6,720
Taxes (35%) 2,352
Net income $4,368
OCF = EBIT + Depreciation – Taxes = $7,400 + 1,200 – 2,352 = $6,248
9. Net capital spending = NFAend – NFAbeg + Depreciation = $5.2M – 4.6M + 875K = $1.475M
10. Change in NWC = NWCend – NWCbeg
Change in NWC = (CAend – CLend) – (CAbeg – CLbeg)
Change in NWC = ($1,650 – 920) – ($1,400 – 870)
Change in NWC = $730 – 530 = $200
11. Cash flow to creditors = Interest paid – Net new borrowing = $340K – (LTDend – LTDbeg)
Cash flow to creditors = $280K – ($3.3M – 3.1M) = $280K – 200K = $80K
12. Cash flow to stockholders = Dividends paid – Net new equity
Cash flow to stockholders = $600K – [(Commonend + APISend) – (Commonbeg + APISbeg)]
Cash flow to stockholders = $600K – [($860K + 6.9M) – ($885K + 7.7M)]
Cash flow to stockholders = $600K – [$7.76M – 8.585M] = –$225K
Note, APIS is the additional paid-in surplus.
13. Cash flow from assets = Cash flow to creditors + Cash flow to stockholders
= $80K – 225K = –$145K
Cash flow from assets = –$145K = OCF – Change in NWC – Net capital spending
= –$145K = OCF – (–$165K) – 760K
Operating cash flow = –$145K – 165K + 760K = $450K
B-8 SOLUTIONS
Intermediate
14. To find the OCF, we first calculate net income.
Income Statement
Sales $162,000
Costs 93,000
Depreciation 8,400
Other expenses 5,100
EBIT $55,500
Interest 16,500
Taxable income $39,000
Taxes (34%) 14,820
Net income $24,180
Dividends $9,400
Additions to RE $14,780
a. OCF = EBIT + Depreciation – Taxes = $55,500 + 8,400 – 14,820 = $49,080
b. CFC = Interest – Net new LTD = $16,500 – (–6,400) = $22,900
Note that the net new long-term debt is negative because the company repaid part of its longterm
debt.
c. CFS = Dividends – Net new equity = $9,400 – 7,350 = $2,050
d. We know that CFA = CFC + CFS, so:
CFA = $22,900 + 2,050 = $24,950
CFA is also equal to OCF – Net capital spending – Change in NWC. We already know OCF.
Net capital spending is equal to:
Net capital spending = Increase in NFA + Depreciation = $12,000 + 8,400 = $20,400
Now we can use:
CFA = OCF – Net capital spending – Change in NWC
$24,950 = $49,080 – 20,400 – Change in NWC
Solving for the change in NWC gives $3,730, meaning the company increased its NWC by
$3,730.
15. The solution to this question works the income statement backwards. Starting at the bottom:
Net income = Dividends + Addition to ret. earnings = $1,200 + 4,300 = $5,500
CHAPTER 2 B-9
Now, looking at the income statement:
EBT – EBT × Tax rate = Net income
Recognize that EBT × tax rate is simply the calculation for taxes. Solving this for EBT yields:
EBT = NI / (1– tax rate) = $5,500 / (1 – 0.35) = $8,462
Now you can calculate:
EBIT = EBT + Interest = $8,462 + 2,300 = $10,762
The last step is to use:
EBIT = Sales – Costs – Depreciation
EBIT = $34,000 – 16,000 – Depreciation = $10,762
Solving for depreciation, we find that depreciation = $7,238
16. The balance sheet for the company looks like this:
Balance Sheet
Cash $210,000 Accounts payable $430,000
Accounts receivable 149,000 Notes payable 180,000
Inventory 265,000 Current liabilities $610,000
Current assets $624,000 Long-term debt 1,430,000
Total liabilities $2,040,000
Tangible net fixed assets 2,900,000
Intangible net fixed assets 720,000 Common stock ??
Accumulated ret. earnings 1,865,000
Total assets $4,244,000 Total liab. & owners’ equity $4,244,000
Total liabilities and owners’ equity is:
TL & OE = CL + LTD + Common stock + Retained earnings
Solving for this equation for equity gives us:
Common stock = $4,244,000 – 1,865,000 – 2,040,000 = $339,000
17. The market value of shareholders’ equity cannot be zero. A negative market value in this case
would imply that the company would pay you to own the stock. The market value of
shareholders’ equity can be stated as: Shareholders’ equity = Max [(TA – TL), 0]. So, if TA is
$6,700, equity is equal to $600, and if TA is $5,900, equity is equal to $0. We should note here
that the book value of shareholders’ equity can be negative.
B-10 SOLUTIONS
18. a. Taxes Growth = 0.15($50K) + 0.25($25K) + 0.34($7K) = $16,130
Taxes Income = 0.15($50K) + 0.25($25K) + 0.34($25K) + 0.39($235K) + 0.34($7.865M)
= $2,788,000
b. Each firm has a marginal tax rate of 34% on the next $10,000 of taxable income, despite their
different average tax rates, so both firms will pay an additional $3,400 in taxes.
19. Income Statement
Sales $840,000
COGS 625,000
A&S expenses 120,000
Depreciation 130,000
EBIT –$35,000
Interest 85,000
Taxable income –$120,000
Taxes (35%) 0
a. Net income –$120,000
b. OCF = EBIT + Depreciation – Taxes = –$35,000 + 130,000 – 0 = $95,000
c. Net income was negative because of the tax deductibility of depreciation and interest
expense. However, the actual cash flow from operations was positive because depreciation is
a non-cash expense and interest is a financing expense, not an operating expense.
20. A firm can still pay out dividends if net income is negative; it just has to be sure there is sufficient
cash flow to make the dividend payments.
Change in NWC = Net capital spending = Net new equity = 0. (Given)
Cash flow from assets = OCF – Change in NWC – Net capital spending
Cash flow from assets = $95K – 0 – 0 = $95K
Cash flow to stockholders = Dividends – Net new equity = $30K – 0 = $30K
Cash flow to creditors = Cash flow from assets – Cash flow to stockholders = $95K – 30K = $65K
Cash flow to creditors = Interest – Net new LTD
Net new LTD = Interest – Cash flow to creditors = $85K – 65K = $20K
21. a.
Income Statement
Sales $15,200
Cost of good sold 11,400
Depreciation 2,700
EBIT $ 1,100
Interest 520
Taxable income $ 580
Taxes (34%) 197
Net income $ 383
b. OCF = EBIT + Depreciation – Taxes
= $1,100 + 2,700 – 197 = $3,603
CHAPTER 2 B-11
c. Change in NWC = NWCend – NWCbeg
= (CAend – CLend) – (CAbeg – CLbeg)
= ($3,850 – 2,100) – ($3,200 – 1,800)
= $1,750 – 1,400 = $350
Net capital spending = NFAend – NFAbeg + Depreciation
= $9,700 – 9,100 + 2,700 = $3,300
CFA = OCF – Change in NWC – Net capital spending
= $3,603 – 350 – 3,300 = –$47
The cash flow from assets can be positive or negative, since it represents whether the firm
raised funds or distributed funds on a net basis. In this problem, even though net income and
OCF are positive, the firm invested heavily in both fixed assets and net working capital; it
had to raise a net $47 in funds from its stockholders and creditors to make these investments.
d. Cash flow to creditors = Interest – Net new LTD = $520 – 0 = $520
Cash flow to stockholders = Cash flow from assets – Cash flow to creditors
= –$47 – 520 = –$567
We can also calculate the cash flow to stockholders as:
Cash flow to stockholders = Dividends – Net new equity
Solving for net new equity, we get:
Net new equity = $600 – (–567) = $1,167
The firm had positive earnings in an accounting sense (NI > 0) and had positive cash flow
from operations. The firm invested $350 in new net working capital and $3,300 in new fixed
assets. The firm had to raise $47 from its stakeholders to support this new investment. It
accomplished this by raising $1,167 in the form of new equity. After paying out $600 of this
in the form of dividends to shareholders and $520 in the form of interest to creditors, $47 was
left to meet the firm’s cash flow needs for investment.
22. a. Total assets 2006 = $725 + 2,990 = $3,715
Total liabilities 2006 = $290 + 1,580 = $1,870
Owners’ equity 2006 = $3,715 – 1,870 = $1,845
Total assets 2007 = $785 + 3,600 = $4,385
Total liabilities 2007 = $325 + 1,680 = $2,005
Owners’ equity 2007 = $4,385 – 2,005 = $2,380
b. NWC 2006 = CA06 – CL06 = $725 – 290 = $435
NWC 2007 = CA07 – CL07 = $785 – 325 = $460
Change in NWC = NWC07 – NWC06 = $460 – 435 = $25
B-12 SOLUTIONS
c. We can calculate net capital spending as:
Net capital spending = Net fixed assets 2007 – Net fixed assets 2006 + Depreciation
Net capital spending = $3,600 – 2,990 + 820 = $1,430
So, the company had a net capital spending cash flow of $1,430. We also know that net
capital spending is:
Net capital spending = Fixed assets bought – Fixed assets sold
$1,430 = $1,500 – Fixed assets sold
Fixed assets sold = $1,500 – 1,430 = $70
To calculate the cash flow from assets, we must first calculate the operating cash flow. The
operating cash flow is calculated as follows (you can also prepare a traditional income
statement):
EBIT = Sales – Costs – Depreciation = $9,200 – 4,290 – 820 = $4,090
EBT = EBIT – Interest = $4,090 – 234 = $3,856
Taxes = EBT × .35 = $3,856 × .35 = $1,350
OCF = EBIT + Depreciation – Taxes = $4,090 + 820 – 1,350 = $3,560
Cash flow from assets = OCF – Change in NWC – Net capital spending.
= $3,560 – 25 – 1,430 = $2,105
d. Net new borrowing = LTD07 – LTD06 = $1,680 – 1,580 = $100
Cash flow to creditors = Interest – Net new LTD = $234 – 100 = $134
Net new borrowing = $100 = Debt issued – Debt retired
Debt retired = $300 – 100 = $200
Challenge
23. Net capital spending = NFAend – NFAbeg + Depreciation
= (NFAend – NFAbeg) + (Depreciation + ADbeg) – ADbeg
= (NFAend – NFAbeg)+ ADend – ADbeg
= (NFAend + ADend) – (NFAbeg + ADbeg) = FAend – FAbeg
24. a. The tax bubble causes average tax rates to catch up to marginal tax rates, thus eliminating the
tax advantage of low marginal rates for high income corporations.
b. Taxes = 0.15($50K) + 0.25($25K) + 0.34($25K) + 0.39($235K) = $113.9K
Average tax rate = $113.9K / $335K = 34%
The marginal tax rate on the next dollar of income is 34 percent.
CHAPTER 2 B-13
For corporate taxable income levels of $335K to $10M, average tax rates are equal to
marginal tax rates.
Taxes = 0.34($10M) + 0.35($5M) + 0.38($3.333M) = $6,416,667
Average tax rate = $6,416,667 / $18,333,334 = 35%
The marginal tax rate on the next dollar of income is 35 percent. For corporate taxable
income levels over $18,333,334, average tax rates are again equal to marginal tax rates.
c. Taxes = 0.34($200K) = $68K = 0.15($50K) + 0.25($25K) + 0.34($25K) + X($100K);
X($100K) = $68K – 22.25K = $45.75K
X = $45.75K / $100K
X = 45.75%
25.
Balance sheet as of Dec. 31, 2006
Cash $2,528 Accounts payable $2,656
Accounts receivable 3,347 Notes payable 488
Inventory 5,951 Current liabilities $3,144
Current assets $11,826
Long-term debt $8,467
Net fixed assets $21,203 Owners' equity 21,418
Total assets $33,029 Total liab. & equity $33,029
Balance sheet as of Dec. 31, 2007
Cash $2,694 Accounts payable $2,683
Accounts receivable 3,928 Notes payable 478
Inventory 6,370 Current liabilities $3,161
Current assets $12,992
Long-term debt $10,290
Net fixed assets $22,614 Owners' equity 22,155
Total assets $35,606 Total liab. & equity $35,606
2006 Income Statement 2007 Income Statement
Sales $4,822.00 Sales $5,390.00
COGS 1,658.00 COGS 1,961.00
Other expenses 394.00 Other expenses 343.00
Depreciation 692.00 Depreciation 723.00
EBIT $2,078.00 EBIT $2,363.00
Interest 323.00 Interest 386.00
EBT $1,755.00 EBT $1,977.00
Taxes (34%) 596.70 Taxes (34%) 672.18
Net income $1,158.30 Net income $1,304.82
Dividends $588.00 Dividends $674.00
Additions to RE 570.30 Additions to RE 630.82
B-14 SOLUTIONS
26. OCF = EBIT + Depreciation – Taxes = $2,363 + 723 – 672.18 = $2,413.82
Change in NWC = NWCend – NWCbeg = (CA – CL) end – (CA – CL) beg
= ($12,992 – 3,161) – ($11,826 – 3,144)
= $1,149
Net capital spending = NFAend – NFAbeg + Depreciation
= $22,614 – 21,203 + 723 = $2,134
Cash flow from assets = OCF – Change in NWC – Net capital spending
= $2,413.82 – 1,149 – 2,134 = –$869.18
Cash flow to creditors = Interest – Net new LTD
Net new LTD = LTDend – LTDbeg
Cash flow to creditors = $386 – ($10,290 – 8,467) = –$1,437
Net new equity = Common stockend – Common stockbeg
Common stock + Retained earnings = Total owners’ equity
Net new equity = (OE – RE) end – (OE – RE) beg
= OEend – OEbeg + REbeg – REend
REend = REbeg + Additions to RE04
∴ Net new equity = OEend – OEbeg + REbeg – (REbeg + Additions to RE0)
= OEend – OEbeg – Additions to RE
Net new equity = $22,155 – 21,418 – 630.82 = $106.18
CFS = Dividends – Net new equity
CFS = $674 – 106.18 = $567.82
As a check, cash flow from assets is –$869.18.
CFA = Cash flow from creditors + Cash flow to stockholders
CFA = –$1,437 + 567.82 = –$869.18
CHAPTER 3
WORKING WITH FINANCIAL
STATEMENTS
Answers to Concepts Review and Critical Thinking Questions
1. a. If inventory is purchased with cash, then there is no change in the current ratio. If inventory is
purchased on credit, then there is a decrease in the current ratio if it was initially greater than 1.0.
b. Reducing accounts payable with cash increases the current ratio if it was initially greater than 1.0.
c. Reducing short-term debt with cash increases the current ratio if it was initially greater than 1.0.
d. As long-term debt approaches maturity, the principal repayment and the remaining interest
expense become current liabilities. Thus, if debt is paid off with cash, the current ratio increases
if it was initially greater than 1.0. If the debt has not yet become a current liability, then paying it
off will reduce the current ratio since current liabilities are not affected.
e. Reduction of accounts receivables and an increase in cash leaves the current ratio unchanged.
f. Inventory sold at cost reduces inventory and raises cash, so the current ratio is unchanged.
g. Inventory sold for a profit raises [Show Less]