Fundamentals Of Financial Management 13t PDF

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Fundamentals Of Financial Management 13th Edition Brigham Solutions Manual Full Download: https://testbanklive.com/download/fundamentals-of-financial-management-13th-edition-brigham-solutions-man

Chapter 3 Financial Statements, Cash Flow, and Taxes Learning Objectives

After reading this chapter, students should be able to:

 List each of the key financial statements and identify the kinds of information they provide to corporate managers and investors.

 Estimate a firm’s free cash flow and explain why free cash flow has such an important effect on firm value.

 Discuss the major features of the federal income tax system.

Learning Objectives

Chapter 3: Financial Statements, Cash Flow, and Taxes

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Lecture Suggestions

The goal of financial management is to take actions that will maximize the value of a firm’s stock. These actions will show up, eventually, in the financial statements, so a general understanding of financial statements is critically important. Note that Chapter 3 provides a bridge between accounting, which students have just covered, and financial management. Unfortunately, many non-accounting students did not learn as much as they should have in their accounting courses, so we find it necessary to spend more time on financial statements than we would like. Also, at Florida and many other schools, students vary greatly in their knowledge of accounting, with accounting majors being well-grounded because they have had more intense introductory courses and, more importantly, because they are taking advanced financial accounting concurrently with finance. This gives the accountants a major, and somewhat unfair, advantage over the others in dealing with Chapters 3 and 4 on exams. We know of no good solution to this problem, but what we do is pitch the coverage of this material to the non-accountants. If we pitch the lectures (and exams) to the accountants, they simply blow away and demoralize our nonaccountants, and we do not want that. Perhaps Florida has more of a difference between accounting and non-accounting students, but at least for us there really is a major difference. What we cover, and the way we cover it, can be seen by scanning the slides and Integrated Case solution for Chapter 3, which appears at the end of this chapter’s solutions. For other suggestions about the lecture, please see the “Lecture Suggestions” in Chapter 2, where we describe how we conduct our classes.

DAYS ON CHAPTER: 2 OF 56 DAYS (50-minute periods)

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Lecture Suggestions

Chapter 3: Financial Statements, Cash Flow, and Taxes

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Answers to End-of-Chapter Questions

3-1

The four financial statements contained in most annual reports are the balance sheet, income statement, statement of stockholders’ equity, and statement of cash flows.

3-2

Bankers and investors use financial statements to make intelligent decisions about what firms to extend credit or in which to invest, managers need financial statements to operate their businesses efficiently, and taxing authorities need them to assess taxes in a reasonable way.

3-3

No, because the $20 million of retained earnings would probably not be held as cash. The retained earnings figure represents the reinvestment of earnings by the firm over its life. Consequently, the $20 million would be an investment in all of the firm’s assets.

3-4

The balance sheet shows the firm’s financial position on a specific date, for example, December 31, 2012. It shows each account balance at that particular point in time. For example, the cash account shown on the balance sheet would represent the cash the firm has on hand and in the bank on December 31, 2012. The income statement, on the other hand, reports on the firm’s operations over a period of time, for example, over the last 12 months. It reports revenues and expenses that the firm has incurred over that particular time period. For example, the sales figures reported on the income statement for the period ending December 31, 2012, would represent the firm’s sales over the period from January 1, 2012, through December 31, 2012, not just sales for December 31, 2012.

3-5

Investors need to be cautious when they review financial statements. While companies are required to follow GAAP, managers still have quite a lot of discretion in deciding how and when to report certain transactions. Consequently, two firms in exactly the same operating situation may report financial statements that convey different impressions about their financial strength. Some variations may stem from legitimate differences of opinion about the correct way to record transactions. In other cases, managers may choose to report numbers in a way that helps them present either higher earnings or more stable earnings over time. As long as they follow GAAP, such actions are not illegal, but these differences make it harder for investors to compare companies and gauge their true performances. Unfortunately, there have also been cases where managers overstepped the bounds and reported fraudulent statements. Indeed, a number of high-profile executives have faced criminal charges because of their misleading accounting practices.

3-6

a. No, the average American household’s financial position has declined over 2004–2009. Over this period of time, mortgage and installment loan balances increased, total assets decreased due to the decline in cash in bank accounts and the values of retirement savings and personal homes, and income has declined slightly. b. As this text is being written (May 2011) unemployment is still high and the number of foreclosures and bank-owned properties have flooded the supply of homes so home prices are still on the decline. Consequently, one would expect the average household’s financial position not to have improved from the 2009 numbers. In fact, one might even estimate a further decline. However, there are markets like the Midwest with stronger economies (agriculture and energy) where the situation has improved, so some experts are anticipating a more rosy picture in 2012. Only time will tell…

3-7

Free cash flow is the amount of cash that could be withdrawn from the firm without harming its ability to operate and to produce future cash flows. It is calculated as after-tax operating income

Chapter 3: Financial Statements, Cash Flow, and Taxes

Answers and Solutions

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

plus depreciation less capital expenditures and the change in net operating working capital. It is more important than net income because it shows the exact amount available to all investors (stockholders and debtholders). The value of a company’s operations depends on expected future free cash flows. Therefore, managers make their companies more valuable by increasing their free cash flow. Net income, on the other hand, reflects accounting profit but not cash flow. Therefore, investors ought to focus on cash flow rather than accounting profit. 3-8

Yes. Negative free cash flow is not necessarily bad. Most rapidly growing companies have negative free cash flows because the fixed assets and working capital needed to support rapid growth generally exceed cash flows from existing operations. This is not bad, provided the new investments will eventually be profitable and they contribute to free cash flow.

3-9

This statement means that the higher one’s income, the larger the percentage paid in taxes.

3-10

Double taxation refers to the fact that corporate income is subject to an income tax, and then stockholders are subject to a further personal tax on dividends received. In fact, because of double taxation Congress was motivated to reduce the tax rate on dividends to the same rate (15%) as long-term capital gains (at least through 2012). However, the tax rate is scheduled to rise on January 1, 2013. Income could even be subject to triple taxation. Triple taxation occurs when (1) the original corporation is first taxed, (2) the second corporation is then taxed on the dividends it received, and (3) the individuals who receive the final dividends are taxed again. Therefore, corporations that receive dividend income can exclude some of the dividends from its taxable income. This provision in the Tax Code minimizes the amount of triple taxation that would otherwise occur.

3-11

Because interest paid is tax deductible but dividend payments are not, the after-tax cost of debt is lower than the after-tax cost of equity. This encourages the use of debt rather than equity. This point is discussed in detail in Chapters 10 and 14.

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Answers and Solutions

Chapter 3: Financial Statements, Cash Flow, and Taxes

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Solutions to End-of-Chapter Problems

3-1

From the data given in the problem, we know the following: Current assets Net plant and equipment

$ 500,000b 2,000,000

Total assets

$2,500,000

Accounts payable and accruals Notes payable Current liabilities Long-term debt Total common equity Total liabilities and equity

$ 100,000d 150,000 $ 250,000c 750,000 1,500,000 $2,500,000a

Note: Superscripts correspond to parts below. a. We are given that the firm’s total assets equal $2,500,000. Since both sides of the balance sheet must equal, total liabilities and equity must equal total assets = $2,500,000. b.

Total assets $2,500,000 Current assets Current assets

= Current assets + Net plant and equipment = Current assets + $2,000,000 = $2,500,000 – $2,000,000 = $500,000.

c.

Total liabilities and equity $2,500,000 $2,500,000 Current liabilities Current liabilities

d.

Current liabilities $250,000 Accounts payable and accruals Accounts payable and accruals

= Current liabilities + Long-term debt + Total common equity = Current liabilities + $750,000 + $1,500,000 = Current liabilities + $2,250,000 = $2,500,000 – $2,250,000 = $250,000. = Accounts payable and accruals + Notes payable = Accounts payable and accruals + $150,000 = $250,000 – $150,000 = $100,000.

e. Net working capital = Current assets – Current liabilities Net working capital = $500,000 – $250,000 Net working capital = $250,000. f.

Net operating working capital = Current assets – (Current liabilities – Notes payable) Net operating working capital = $500,000 – ($250,000 – $150,000) Net operating working capital = $400,000.

g. NOWC – NWC = $400,000 – $250,000 NOWC – NWC = $150,000. The difference between the two is equal to the notes payable balance.

Chapter 3: Financial Statements, Cash Flow, and Taxes

Answers and Solutions

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© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

3-2

NI = $3,000,000; EBIT = $6,000,000; T = 40%; Interest = ? Need to set up an income statement and work from the bottom up. EBIT Interest EBT Taxes (40%) NI

$6,000,000 1,000,000 $5,000,000 2,000,000 $3,000,000

EBT =

$3,000,000 $3,000,000  (1  T) 0.6

Interest = EBIT – EBT = $6,000,000 – $5,000,000 = $1,000,000.

3-3

EBITDA Depreciation EBIT Interest EBT Taxes (40%) NI

$7,500,000 2,500,000 $5,000,000 2,000,000 $3,000,000 1,200,000 $1,800,000

(Given) Deprec. = EBITDA – EBIT = $7,500,000 – $5,000,000 EBIT = EBT + Int = $3,000,000 + $2,000,000 (Given) $1,800,000 $1,800,000  (1  T ) 0.6 Taxes = EBT × Tax rate (Given)

3-4

NI = $50,000,000; R/EY/E = $810,000,000; R/EB/Y = $780,000,000; Dividends = ? R/E B/Y + NI – Div = R/EY/E $780,000,000 + $50,000,000 – Div = $810,000,000 $830,000,000 – Div = $810,000,000 $20,000,000 = Div.

3-5

MVA = (P0  Number of common shares)  BV of equity $130,000,000 = $60X  $500,000,000 $630,000,000 = $60X X = 10,500,000 common shares.

3-6

Book value of equity = $35,000,000. Price per share (P0 ) = $30.00. Common shares outstanding = 2,000,000 shares. Market value of equity = P0 × Common shares outstanding = $30 × 2,000,000 = $60,000,000. MVA = Market value of equity – Book value of equity = $60,000,000 – $35,000,000 = $25,000,000.

3-7

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Statements b and d will decrease the amount of cash on a company’s balance sheet. Statement a will increase cash through the sale of common stock. Selling stock provides cash through financing activities. On one hand, Statement c would decrease cash; however, it is also possible that Statement c would increase cash, if the firm receives a tax refund for taxes paid in a prior year.

Answers and Solutions

Chapter 3: Financial Statements, Cash Flow, and Taxes

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

3-8

3-9

Ending R/E $278,900,000 $278,900,000 Net income

Tax rate WACC Investor-supplied operating capital

35% 9% $15,000,000

Sales Operating costs (including depreciation) EBIT

$22,500,000 18,000,000 $ 4,500,000

EVA = = = =

3-10

= Beg. R/E  Net income  Dividends = $212,300,000  Net income  $22,500,000 = $189,800,000  Net income = $89,100,000.

(EBIT)(1 – T) − (Operating Capital)(WACC) $4,500,000(0.65) – ($15,000,000)(0.09) $2,925,000 − $1,350,000 $1,575,000.

a. From the statement of cash flows the change in cash must equal cash flow from operating activities plus long-term investing activities plus financing activities. First, we must identify the change in cash as follows: Cash at the end of the year – Cash at the beginning of the year Change in cash

–

$25,000 55,000 -$30,000

The sum of cash flows generated from operations, investment, and financing must equal a negative $30,000. Therefore, we can calculate the cash flow from operations as follows: CF from operations  CF from investing  CF from financing =  in cash CF from operations  $250,000  $170,000 = -$30,000 CF from operations = $50,000. b. Since we determined that the firm’s cash flow from operations totaled $50,000 in Part a of this problem, we can now calculate the firm’s net income as follows:

Increase in Increase in CF from accrued  A/R and = operations liabilitie s inventory NI + $10,000 + $25,000 – $100,000 = $50,000 NI – $65,000 = $50,000 NI = $115,000.

NI  Depreciati on 

Chapter 3: Financial Statements, Cash Flow, and Taxes

Answers and Solutions

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3-11 I.

3-12

Statement of Cash Flows Operating Activities Net income Depreciation NWC Net cash provided by operating activities

$5,000,000 450,000 0 $5,450,000

II. Long-Term Investing Activities Additions to property, plant, and equipment Net cash used in investing activities

($5,500,000) ($5,500,000)

III. Financing Activities Increase in long-term debt Payment of common dividends Net cash provided by financing activities

$1,000,000 (750,000) $ 250,000

IV. Summary Net increase in cash (Net sum of I., II., and III.) Cash at beginning of year Cash at end of year

$ 200,000 100,000 $ 300,000

a. NOWC2011 = Total CA – (Current liabilities – Notes payable) = $59,000 – ($20,150 – $5,150) = $44,000. NOWC 2012 = $72,125 – ($25,100 – $6,700) = $53,725. b. FCF2012 = [EBIT(1 – T) + Deprec.] – [Capital expenditures + NOWC] = [$39,000(1 – 0.4) + $5,000] – [$8,000 + $9,725] = $10,675. Note: To arrive at capital expenditures you add depreciation to the change in net FA, so Capital expenditures = $5,000 + $3,000 = $8,000. c.

Balances, 12/31/11 2012 Net income Cash dividends Addition (Subtraction) to retained earnings Balances, 12/31/12

Statement of Stockholders’ Equity, 2012 Common Stock Retained Shares Amount Earnings 5,000 $50,000 $20,850 22,350 (11,175)

5,000

$50,000

$32,025

Total Stockholders’ Equity $70,850

11,175 $82,025

d. From Bailey’s 2012 financial statements, you can determine EBIT = $39,000 and Tax rate = 40%. NOWC 2012 was calculated in Part a. Investor-supplied operating capital2012 = Net fixed assets2012 + NOWC2012 = $50,000 + $53,725 = $103,725.

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Answers and Solutions

Chapter 3: Financial Statements, Cash Flow, and Taxes

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

WACC = 10% (given in problem) EVA = EBIT(1 – T) – (Total investor-supplied capital)(WACC) = $39,000(0.6) – ($103,725)(0.10) = $23,400 – $10,372.50 = $13,027.50. 3-13

Working up the income statement you can calculate the new sales level would be $12,681,482. Sales Operating costs (excl. Deprec.) Depreciation EBIT Interest EBT Taxes (40%) Net income

3-14

a. Balances, 12/31/11 2012 Net income Cash dividends Addition to RE Balances, 12/31/12

$12,681,482 6,974,815 880,000 $ 4,826,667 660,000 $ 4,166,667 1,666,667 $ 2,500,000

S – 0.55S – Deprec. = EBIT $12,681,482  0.55 $800,000  1.10 $4,166,667 + $660,000 $600,000  1.10 $2,500,000/(1  0.4) $4,166,667  0.40

Common Stock Shares Amount 100,000,000 $260,000,000

Retained Earnings $1,374,000,000 372,000,000 (146,000,000)

100,000,000

$1,600,000,000

$260,000,000

Total Stockholders’ Equity $1,634,000,000

226,000,000 $1,860,000,000

The retaine...