Concept Questions and Exercises
CORPORATE FINANCE 11e by Ross, Westerfield, Jaffe
CHAPTER 2
ACCOUNTING STATEMENTS AND CASH
FLOW
Concept Questions
1. Liquidity True or false: All assets are liquid at some price. Explain.
2. Accounting and Cash Flows Why might the revenue and cost figures shown ona standard
income statement not represent the actual cash inflows and outflows thatoccurred during a
period?
3. Accounting Statement of Cash Flows Looking at the accounting statement of cashflows,
what does the bottom line number mean? How useful is this number for analyzinga company?
4. Cash Flows How do financial cash flows and the accounting statement of cash flowsdiffer?
Which is more useful for analyzing a company?
5. Book Values versus Market Values Under standard accounting rules, it is possiblefor a
company’s liabilities to exceed its assets. When this occurs, the owners’ equity isnegative. Can
this happen with market values? Why or why not?
6. Cash Flow from Assets Why is it not necessarily bad for the cash flow from assets tobe
negative for a particular period?
7. Operating Cash Flow Why is it not necessarily bad for the operating cash flow to
benegative for a particular period?
8. Net Working Capital and Capital Spending Could a company’s change in networking
capital be negative in a given year? (Hint: Yes.) Explain how this might comeabout. What about
net capital spending?
9. Cash Flow to Stockholders and Creditors Could a company’s cash flow tostockholders be
negative in a given year? (Hint: Yes.) Explain how this might comeabout. What about cash flow
to creditors?
10. Firm Values Referring back to the Ford example at the beginning of the chapter,note that
we suggested that Ford’s stockholders probably didn’t suffer as a result of thereported loss.
What do you think was the basis for our conclusion?
Concept Questions and Exercises
CORPORATE FINANCE 11e by Ross, Westerfield, Jaffe
Exercises
1. Building a Balance Sheet Sankey, Inc., has current assets of $4,900, net fixed assets of
$25,000, current liabilities of $4,100, and long-term debt of $10,300. What is the value of the
shareholders’ equity account for this firm? How much is net working capital?
Assets
Liabilities & Shareholder’s Equity
Current assets
4,900
Current liabilities
4,100
Net fixed assets
25,000
Long term debt
10,300
Shareholder’s equity
?
Total
29,900
Total
29,900
Shareholder’s equity = 29,900 – 10,300 – 4,100 = $155,000
Net working capital = Current assets – Current liabilities = 4,900 – 4,100 = $800
2. Building an Income Statement Shelton, Inc., has sales of $435,000, costs of $216,000,
depreciation expense of $40,000, interest expense of $21,000, and a tax rate of 35 percent.
What is the net income for the firm? Suppose the company paid out $30,000 in cash dividends.
What is the addition to retained earnings?
Income statement
Sales
435,000
Costs
216,000
Depreciation
40,000
EBIT
197,000
Interest expenses
21,000
EBT
176,000
Tax
61,600
Net income
114,400
Addition to retained earnings = Net income – Dividends = 114,400 – 30,000 = 84,400
3. Market Values and Book Values Klingon Cruisers, Inc., purchased new cloaking
machinery three years ago for $9.5 million. The machinery can be sold to the Romulans today
Concept Questions and Exercises
CORPORATE FINANCE 11e by Ross, Westerfield, Jaffe
for $6.5 million. Klingon’s current balance sheet shows net fixed assets of $5.2 million, current
liabilities of $2.4 million, and net working capital of $800,000. If all the current assets were
liquidated today, the company would receive $2.6 million cash. What is the book value of
Klingon’s assets today? What is the market value?
Current assets = NWC + Current liabilities = 800,000 + 2,400,000 = 3,200,000
Book value
Market value
Current assets
3,200,000
Current assets
2,600,000
Net fixed assets
5,200,000
Net fixed assets
6,500,000
Book value assets
8,400,000
Market value assets
9,100,000
4. Calculating Taxes The Stefani Co. had $198,000 in taxable income. Using the rates from
Table 2.3 in the chapter, calculate the company’s income taxes. What is the average tax rate?
What is the marginal tax rate?
Taxes = 15% x 50,000 + 25% x (75,000 – 50,000) + 34% x (100,00 – 75,000) + 39% x
(198,000 – 100,000) = 60,470
Average tax rate =
𝑇𝑜𝑡𝑎𝑙 𝑡𝑎𝑥 𝑝𝑎𝑖𝑑
𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
=
60,470
198,000
= 30.5%
Marginal tax rate is the tax rate on the next $1 earnings => Marginal tax rate = 39%
5. Cash Flow to Creditors The 2014 balance sheet of Jordan’s Golf Shop, Inc., showed longterm debt of $1.625 million, and the 2015 balance sheet showed long-term debt of $1.73
million. The 2015 income statement showed an interest expense of $185,000. What was the
firm’s cash flow to creditors during 2015?
Concept Questions and Exercises
CORPORATE FINANCE 11e by Ross, Westerfield, Jaffe
Cash flow to creditors = Interest paid – (𝐿𝑜𝑛𝑔 𝑡𝑒𝑚 𝑑𝑒𝑏𝑡𝑒𝑛𝑑 − 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑏𝑒𝑔 )
= 185,000 – (1,730,000 – 1,625,000) = 80,000
6. Cash Flow to Stockholders The 2014 balance sheet of Jordan’s Golf Shop, Inc., showed
$510,000 in the common stock account and $3.6 million in the additional paid-in surplus
account. The 2015 balance sheet showed $545,000 and $3.85 million in the same two
accounts, respectively. If the company paid out $275,000 in cash dividends during 2015, what
was the cash flow to stockholders for the year?
Cash flow to stockholders = Dividends paid – (Stock sold – Repurchased)
= Dividends paid – [(𝐶𝑜𝑚𝑚𝑜𝑛𝑒𝑛𝑑 + 𝐴𝑃𝐼𝑆𝑒𝑛𝑑 ) − (𝐶𝑜𝑚𝑚𝑜𝑛𝑏𝑒𝑔 + 𝐴𝑃𝐼𝑆𝑏𝑒𝑑 )]
= 275,000 – [(545,000 + 3,850,000) – (510,000 + 3,600,000)] = -10,000
7. Cash Flows Ritter Corporation’s accountants prepared the following financial statements
for year-end 2015:
INCOME STATEMENT 2015
Revenue
$790
Expenses
575
Depreciation
90
Net income
$125
Dividends
$95
BALANCE SHEET
December 31
2015
Assets
Cash
Other current assets
Net fixed assets
Total assets
Liabilities and Equity
Accounts Payable
Long-term debt
Stockholders' equity
Total liabilities and
equity
a. Explain the change in cash during 2015.
Statement of cash flow
Operations
Net income
125
Depreciation
90
Change in other current assets
(-) 15
Account payable
(-) 15
Total cash flow operations
215
Investing activities
2014
80
185
405
$670
60
170
385
$615
140
160
370
$670
125
150
340
$615
Concept Questions and Exercises
CORPORATE FINANCE 11e by Ross, Westerfield, Jaffe
Acquisition of fixed assets
110
Total cash flow from investing activities
(-) 110
Financing activities
Proceeds of long-term debt
10
Dividends
(-) 95
Total cash flow from financing activities
(-) 85
Change in cash (on balance sheet)
20
b. Determine the change in net working capital in 2015.
Change in NWC = 𝑁𝑊𝐶𝑒𝑛𝑑 − 𝑁𝑊𝐶𝑏𝑒𝑔 = (𝐶𝐴𝑒𝑛𝑑 − 𝐶𝐿𝑒𝑛𝑑 ) − (𝐶𝐴𝑏𝑒𝑔 − 𝐶𝐿𝑏𝑒𝑔 )
= [(80 + 185) – 140] – [(60 + 170) – 125] = 20
c. Determine the cash flow generated by the firm’s assets during 2015.
8. Building an Income Statement During the year, the Senbet Discount Tire Company had
gross sales of $925,000. The firm’s cost of goods sold and selling expenses were $490,000 and
$220,000, respectively. Senbet also had notes payable of $740,000. These notes carried an
interest rate of 4 percent. Depreciation was $120,000. Senbet’s tax rate was 35 percent.
a. What was Senbet’s net income?
Income statement
Sales
925,000
Cost of good sold
490,000
Selling expenses
220,000
Depreciation
120,000
EBIT
95,000
Interest
29,600
EBT
65,400
Taxes
22,890
Net income
45,510
b. What was Senbet’s operating cash flow?
Concept Questions and Exercises
CORPORATE FINANCE 11e by Ross, Westerfield, Jaffe
Operating cash flow = EBIT + Depreciation – Taxes
= 95,000 + 120,000 – 22,890 = 237,890
9. Calculating Total Cash Flows Schwert Corp. shows the following information on its 2015
income statement: sales = $215,000; costs = $117,000; other expenses = $6,700; depreciation
expense = $18,400; interest expense = $10,000; taxes = $25,370; dividends = $9,500. In
addition, you’re told that the firm =sued $8,100 in new equity during 2015 and redeemed
$7,200 in outstanding long-term debt.
Income statement
Sales
215,000
Costs
117,000
Other expenses
6,700
Depreciation expense
18,400
EBIT
72,900
Interest expense
10,000
EBT
62,900
Taxes
25,370
Net income
37,530
Dividends
9,500
Additions to retained earning
28,030
a. What = the 2015 operating cash flow?
Operating cash flow = EBIT + Depreciation – Taxes
= 72,900 + 18,400 – 25,370 = 65,930
b. What = the 2015 cash flow to creditors?
Cash flow to creditors = Interest – Net new long-term debt = 10,000 – (-7,200) = 17,200
c. What = the 2015 cash flow to stockholders?
Concept Questions and Exercises
CORPORATE FINANCE 11e by Ross, Westerfield, Jaffe
Cash flow to stockholders = Dividends – Net new equity = 9,500 – 8,100 = 1,400
d. If net fixed assets increased by $28,400 during the year, what was the addition to
networking capital (NWC)?
10. Using Income Statements Given the following information for O’Hara Marine Co.,
calculate the depreciation expense: sales = $44,000; costs = $27,500; addition to retained
earnings = $5,200; dividends paid = $1,670; interest expense = $1,850; tax rate = 40 percent.
Net income = Dividends + Addition to retained earnings = 1,670 + 5,200 = 6,870
Net income = EBT – (EBT x 40%) => EBT = 11,450
EBIT = EBT + Interest = 13,300
Depreciation = Sales – Costs – EBIT = 3,200