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 on a standard
income statement not represent the actual cash inflows and outflows that occurred during a
period?
3. Accounting Statement of Cash Flows Looking at the accounting statement of cash flows,
what does the bottom line number mean? How useful is this number for analyzing a company?
4. Cash Flows How do financial cash flows and the accounting statement of cash flows differ?
Which is more useful for analyzing a company?
5. Book Values versus Market Values Under standard accounting rules, it is possible for a
company’s liabilities to exceed its assets. When this occurs, the owners’ equity is negative. 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 to be
negative for a particular period?
7. Operating Cash Flow Why is it not necessarily bad for the operating cash flow to be
negative for a particular period?
8. Net Working Capital and Capital Spending Could a company’s change in net working
capital be negative in a given year? (Hint: Yes.) Explain how this might come about. What
about net capital spending?
9. Cash Flow to Stockholders and Creditors Could a company’s cash flow to stockholders be
negative in a given year? (Hint: Yes.) Explain how this might come about. 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 the reported 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?

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?

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
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?

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?

5. Cash Flow to Creditors The 2014 balance sheet of Jordan’s Golf Shop, Inc., showed long-
term 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?

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?
7. Cash Flows Ritter Corporation’s accountants prepared the following financial statements
for year-end 2015:
a. Explain the change in cash during 2015.
b. Determine the change in net working capital in 2015.
c. Determine the cash flow generated by the firm’s assets during 2015.
Concept Questions and Exercises CORPORATE FINANCE 11e by Ross, Westerfield, Jaffe

INCOME STATEMENT 2015 BALANCE SHEET

Revenue $790 December 31
Expenses 575 2015 2014
Depreciation 90 Assets
Net income $125 Cash 80 60
Dividends $95 Other current assets 185 170
Net fixed assets 405 385
Total assets $670 $615
Liabilities and Equity
Accounts Payable 140 125
Long-term debt 160 150
Stockholders' equity 370 340
Total liabilities and $670 $615
equity
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?

b. What was Senbet’s operating cash flow?

9. Calculating Total Cash Flows Schwert Corp. shows the following information on its 2015
income statement: sales 5 $215,000; costs 5 $117,000; other expenses 5 $6,700; depreciation
expense 5 $18,400; interest expense 5 $10,000; taxes 5 $25,370; dividends 5 $9,500. In
addition, you’re told that the firm issued $8,100 in new equity during 2015 and redeemed
$7,200 in outstanding long-term debt.

a. What is the 2015 operating cash flow?

b. What is the 2015 cash flow to creditors?

c. What is the 2015 cash flow to stockholders?

d. If net fixed assets increased by $28,400 during the year, what was the addition to net
working 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.