Corporate Finance, Global Second Edition Solution Manual

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SOLUTIONS MANUALForJonathan BerkPeter DeMarzoStanford UniversityStanford UniversityAccuracy EditorSukarnen Suwanto

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iiiContentsChapter 1The Corporation1Chapter 2Introduction to Financial Statement Analysis4Chapter 3Financial Decision Makingand the Law of One Price20Chapter 4The Time Value of Money30Chapter 5Interest Rates56Chapter 6Valuing Bonds75Chapter 7Investment Decision Rules92Chapter 8Fundamentals of Capital Budgeting112Chapter 9Valuing Stocks130Chapter 10Capital Markets and the Pricing of Risk142Chapter 11Optimal Portfolio Choice and the Capital Asset Pricing Model157Chapter 12Estimating the Cost of Capital177Chapter 13Investor Behavior and Capital Market Efficiency186Chapter 14Capital Structure in a Perfect Market196Chapter 15Debt and Taxes206Chapter 16Financial Distress, Managerial Incentives, and Information215Chapter 17Payout Policy231Chapter 18Capital Budgeting and Valuation with Leverage242Chapter 19Valuation and Financial Modeling: A Case Study262Chapter 20Financial Options271Chapter 21Option Valuation283Chapter 22Real Options295Chapter 23Raising Equity Capital321Chapter 24Debt Financing329Chapter 25Leasing333Chapter 26Working Capital Management341Chapter 27Short-Term Financial Planning348Chapter 28Mergers and Acquisitions354Chapter 29Corporate Governance359Chapter 30Risk Management362Chapter 31International Corporate Finance374

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1Chapter 1The Corporation1-1.What is the most important difference between a corporation andallother organizationalforms?A corporation is a legal entity separate from its owners.1-2.What does the phraselimited liabilitymean in a corporate context?Owners’liability is limited to the amount they invested in the firm.Stockholders are not responsiblefor any encumbrances of the firm; in particular, they cannot be required to pay back any debts incurredby the firm.1-3.Which organizational forms give their owners limited liability?Corporations and limited liability companiesgive owners limited liability. Limited partnershipsprovide limited liability for the limited partners, but not for the general partners.1-4.What are the main advantages and disadvantages of organizing a firm as a corporation?Advantages: Limited liability, liquidity, infinite lifeDisadvantages: Double taxation, separation of ownership and control1-5.Explain the difference between an S corporation and a C corporation.C corporations mustpay corporate income taxes; S corporations do not pay corporate taxes,but mustpass through the income to shareholders to whom it is taxable.S corporations are also limited to 75shareholders and cannot have corporate or foreign stockholders.1-6.You are a shareholder in a C corporation. The corporation earns $2 per share before taxes. Onceit has paid taxes it will distribute the rest of its earnings to you as a dividend. The corporate taxrate is 40% and the personal tax rate on (both dividend and non-dividend) income is 30%. Howmuch is left for you after all taxes are paid?First,the corporation pays the taxes. After taxes,$2(10.4)$1.20´-=is left to pay dividends. Oncethe dividend is paid, personal tax must be paid, which leaves$1.20(10.3)$0.84´-=.So,after all thetaxes are paid, you are left with 84¢.1-7.Repeat Problem 6 assuming the corporation is an S corporation.An S corporation does not pay corporate income tax.So it distributes $2 to its stockholders. Thesestockholdersmustthenpaypersonalincometaxonthe.Sotheyareleftwith$2(10.3)$1.40´-=.

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2Berk/DeMarzo,Corporate Finance,FourthEdition, Global Edition1-8.You have decided to form a new start-up company developing applications for the iPhone. Giveexamples of the three distinct types of financial decisions you will need to make.As the manager of an iPhone applications developer,you will make three types of financial decisions.i.You will make investment decisions such as determining which type of iPhone applicationprojects will offer your company a positive NPV andthatyour company,therefore,shoulddevelop.ii.You will make the decision on how to fund your iPhone application investments and what mix ofdebt and equity your company will have.iii.You will be responsible for the cash management of your company, ensuring that your companyhas the necessary funds to make investments, pay interest on loans, and pay your employees.1-9.When a pharmaceutical company develops a new drug, it often receives patent protection forthat medication, allowing it to charge a higher price. Explain how this public policy of providingpatent protection might help align the corporation’s interests with society’s interests.Without patent protection, the developer of the drug would be forced to lower prices to compete withgeneric manufacturers.Because this price competition would lower expected future profits, thedeveloper would be willing to spend much less in R&D to develop the drug initially, and druginnovation would be curtailed.Alternatively, by allowing the drug’s developer to earn higher profits that are commensurate with thevalue of the drug to society, drug developers will find it in their best interests to spend more on R&D,and drug innovation is enhanced.Thus,patent protection can align the corporation’s and society’sinterests and provide for more efficient spending on drug R&D.1-10.Corporate managers work for the owners of the corporation. Consequently, they should makedecisions that are in the interests of the owners, rather than their own. What strategies areavailable to shareholders to help ensure that managers are motivated to act this way?Shareholders cando the following.i.Ensure that employees are paid with company stock and/or stock options.ii.Ensure that underperforming managers are fired.iii.Write contracts that ensure that the interests of the managers and shareholders are closely aligned.iv.Mount hostile takeovers.1-11.Suppose you are considering renting an apartment. You, the renter, can be viewed as an agentwhile the company that owns the apartment can be viewed as the principal. What principal-agent conflicts do you anticipate? Suppose instead that you work for the apartment company.What features would you put into the lease agreement that would give the renter incentives totake good care of the apartment?The agent (renter) will not take the same care of the apartment as the principal (owner), because therenter does not share in the costs ofrepairingdamage to the apartment. To mitigate this problem,having the renter pay a depositshould motivate the renter to keep damages to a minimum. The depositforces the renter to share in the costs ofrepairingany problems thattheycause.1-12.You are the CEO of a company and you are considering entering into an agreement to have yourcompany buy another company. You think the price might be too high, but you will be the CEOof the combined, much larger,company. You know that when the company gets bigger, your payand prestige will increase. What is the nature of the agency conflict here and how is it related toethical considerations?There is an ethical dilemma when the CEO of a firm hastheopposite incentives to those of theshareholders. In this case, you (as the CEO) have an incentive to potentially overpay for anothercompany (which would be damaging to your shareholders) because your pay and prestige willimprove.1-13.Are hostile takeovers necessarily bad for firms or their investors? Explain.No.They are a way to discipline managers who are not working in the interests of shareholders.

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Chapter 1/The Corporation31-14.What is the difference between a public and private corporation?The shares of a public corporation are traded on an exchange (or“over the counter”in an electronictrading system) while the shares of a private corporation are not traded on a public exchange.1-15.Describe the important changes that have occurred in stock markets over the last decade.Markets have become more fragmented, stocks no longer predominantly trade on the markets on whichthey are listed, off exchange transactions in dark pools are now much more common,andofficialmarket makers have largely disappeared, replaced now by the limit order book.1-16.Explain why the bid-ask spread is a transaction cost.Investors always buy at the ask and sell at the bid.Since ask prices always exceed bid prices, investors“lose”this difference. It is one of the costs of transacting.Since the market makers take the other sideof the trade, they make this difference.1-17.Explain how the bid-ask spread is determined today.The bid-ask spread of a stock is determined by the outstanding limit orders. The limit sell order withthe lowest price is the ask price. The limit buy order with the highest price is the bid price.1-18.The following quote on Yahoo! Stock appeared onJuly 23, 2015, on Yahoo! Finance:If you wanted to buy Yahoo!, what price would you pay? How much would you receive if youwanted to sell Yahoo!?You would buy at $39.66 and sell for $39.65.1-19.Suppose the following orders are received by an exchange for Cisco stock:•Limit Order:Buy 200 shares at $25•Limit Order:Sell 200 shares at $26•Limit Order:Sell 100 shares at $25.50•Limit Order:Buy 100 shares at $25.25a)What are the best bid and ask prices for Cisco stock?Best bid = $25.25, Best ask = $25.50b)What is the current bid-ask spread for Cisco stock?Bid-Ask spread = $25.50–25.25 = $0.25c)Suppose a market order arrives to buy 200 shares of Cisco.What average price will thebuyer pay?Buy 100 shares at $25.50 and 100 shares at $26, for an average price of $25.75d)After the market order in (c)clears, what are the new best bid and ask prices, and what isthe new bid-ask spread for Cisco?Best bid = $25.75, Best ask = $26, Bid-Ask spread = $0.25

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4Chapter 2Introduction to Financial StatementAnalysis2-1.What four financial statements can be found in a firm’s 10-K filing? What checks are there onthe accuracy of these statements?In a firm’s 10-K filing, four financialstatements can be found: the balance sheet, income statement,statement of cash flows, and statement of stockholders’ equity.Financial statements in form 10-K arerequired to be audited by a neutral third party, who checks and ensures that the financial statements areprepared according to GAAP and that the information contained is reliable.2-2.Who reads financial statements? List at least three different categories of people. For eachcategory, provide an example of the type of information they might be interested in and discusswhy.Users of financial statements include present and potential investors, financial analysts, and otherinterested outside parties (such as lenders, suppliers and other trade creditors, and customers).Financial managers within the firm also use the financial statements when making financial decisions.Investors. Investors are concerned with the risk inherent in,and return provided by,their investments.Bondholders use the firm’s financial statements to assess the ability of the company to make its debtpayments.Stockholders use the statements to assess the firm’s profitability and ability to make futuredividend payments.Financialanalysts.Financialanalystsgatherfinancialinformation,analyzeit,andmakerecommendations. They read financial statements to determine a firm’s value and project futureearnings, so that they can provide guidance to businesses and individuals to help them with theirinvestment decisions.Managers. Managers use financial statementsto look at trends in their own business, and to comparetheir own results with that of competitors.2-3.Find the most recent financial statements for Starbucks’ corporation (SBUX) using the followingsources:a.From the company’s Websitewww.starbucks.com (Hint:Search for “investor relations.”)b.From the SEC Web site www.sec.gov.(Hint:Search for company filings in the EDGARdatabase.)c.From the Yahoo! Finance Web site http://finance.yahoo.com.d.From at least one other source. (Hint:Enter “SBUX 10K” at www.google.com.)Each method will help find the same SEC filings. Yahoo! Finance also provides some analysis such ascharts and key statistics.

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Chapter 2/Introduction to Financial Statement Analysis52-4.Consider the following potential events that might havetaken place atGlobal Conglomerate onDecember 30, 2015. For each one, indicate which line items in Global’s balance sheet would beaffected and by how much. Also indicate the change to Global’s book value of equity. (In allcases, ignore any tax consequences for simplicity.)a.Global used $20 million of its available cash to repay $20 million of its long-term debt.b.A warehouse fire destroyed $5 million worth of uninsured inventory.c.Global used $5 million in cash and $5 million in new long-term debt to purchase a $10million building.d.A large customer owing $3 million for products it already received declared bankruptcy,leaving no possibility that Global would ever receive payment.e.Global’s engineers discover a new manufacturing process that will cut the cost of its flagshipproduct by over 50%.f.A key competitor announces a radical new pricing policy that will drastically undercutGlobal’s prices.a.Long-term liabilities would decrease by $20 million, and cash would decrease by the sameamount.The book value of equity would be unchanged.b.Inventory would decrease by $5 million, as would the book value of equity.c.Long-term assets would increase by $10 million, cash woulddecrease by $5 million, and long-term liabilities would increase by $5 million.There would be no change to the book value ofequity.d.Accounts receivable would decrease by $3 million, as would the book value of equity.e.This event would not affect the balance sheet.f.This event would not affect the balance sheet.2-5.What was the change in Global Conglomerate’s book value of equity from 2014to 2015according to Table 2.1? Does this imply that the market price of Global’s shares increased in2015? Explain.Global Conglomerate’s book value of equity increased by $1 million from2014to2015. An increasein book value does not necessarily indicate an increase in Global’s share price. The market value of astock does not depend on the historical cost of the firm’s assets, but on investors’ expectation of thefirm’s future performance. There are many events that may affect Global’s future profitability, andhence its share price, that do not show up on the balance sheet.2-6.Use EDGAR to find Qualcomm’s 10-K filing for 2015. From the balance sheet, answer thefollowing questions:a.How much did Qualcomm have in cash and short-term investments?b.What were Qualcomm’s total accounts receivable?c.What were Qualcomm’s total assets?d.What were Qualcomm’s total liabilities? How much of this was long-term debt?e.What was the book value of Qualcomm’s equity?a.$7,560million (cash) and $9,761million (short-term investments/marketable securities) for atotalof $17,321millionb.$1,964millionc.$50,796million

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6Berk/DeMarzo,Corporate Finance,FourthEdition, Global Editiond.$19,382million,$9,969 million.e.$31,414million.2-7.Find onlinethe annual 10-K report forCostco Wholesale Corporation(COST)forfiscal year2015 (filed in October 2015).Answer the following questions from their balance sheet:a.How much cash didCostcohave at the end of the fiscal year?b.What wereCostco’s total assets?c.What wereCostco’s total liabilities? How much debt didCostcohave?d.What was the book value ofCostco’s equity?a.At the end of the fiscal year,Costcohad cash andcash equivalents of $4,801million.b.Costco’stotal assets were $33,440million.c.Costco’stotal liabilities were $22,597million,and ithad$6,157million indebt.d.Thebook value ofCostco’s equity was $10,843million.2-8.In early 2012, General Electric (GE) had a book value of equity of $109 billion, 10.3 billionshares outstanding, and a market price of $9.66 per share. GE also had cash of $40 billion, andtotal debt of $530 billion. Three years later, in early 2015, GE had abook value of equity of$112billion, 10.9 billion shares outstanding with a market price of $16.59 per share, cash of$85billion, and total debt of $417 billion. Over this period, what was the change in GE’sa.market capitalization?b.market-to-book ratio?c.enterprise value?a.2012Market Capitalization:10.3 billion shares$9.66/share =$99.5billion.2015 MarketCapitalization: 10.9 billion shares$16.59/share = $180.8.The change over the period is $180.8–$99.5 =$81.3billion.b.2012Market-to-Book= 99.5/109 = 0.91.2015Market-to-Book= 180.8/112 = 1.61. Thechangeover the period is: 1.61–0.91 = 0.70.e.2012Enterprise Value = $109–40+ 530 = $599billion.2015 Enterprise Value = $112–85 +417= $444billion. The change over the period is:$599–$444 =–$155billion.2-9.In early-2015, Abercrombie & Fitch (ANF) had a book equity of $1390million, a price per shareof $25.52, and 69.35million shares outstanding. At the same time, The Gap(GPS) had a bookequity of $2983million, a share price of $41.19, and421million shares outstanding.a.What is the market-to-book ratio of each of these clothing retailers?b.What conclusions can you draw by comparing the two ratios?a.ANF’smarket-to-book ratio = (25.52 x 69.35)/1,390 = 1.27.GPS’smarket-to-book ratio = (41.19 x 421)/2,983 = 5.81.b.For the market, the outlook of Abercrombie and Fitchisless favorablethanthat ofThe Gap.Forevery dollar of equity invested in ANF,the market values that dollar today at $1.27versus $5.81for a dollar invested in the GPS. Equity investors are willing to pay relativelylesstoday for sharesof ANF than for GPS because they expectGPSto produce superior performance in the future.2-10.See Table 2.5 showing financial statement data and stock price data for Mydeco Corp.a.What is Mydeco’s market capitalization at the end of each year?b.What is Mydeco’s market-to-book ratio at the end of each year?c.What is Mydeco’s enterprise value at the end of each year?2012–2016Financial Statement Data and Stock Price Data for Mydeco Corp.

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Chapter 2/Introduction to Financial Statement Analysis7

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8Berk/DeMarzo,Corporate Finance,FourthEdition, Global Editiona.Year20122013201420152016Shares Outstanding (millions)56.856.856.856.856.8StockPrice$7.02$3.55$5.86$8.33$11.57Market capitalization (millions)$398.7$201.6$332.8$473.1$657.2b.Year20122013201420152016Market capitalization (millions)$398.7$201.6$332.8$473.1$657.2Stockholders' Equity(millions)$255.0$255.6$257.8$270.8$279.8Market-to-book1.560.791.291.752.35c.Year20122013201420152016Market capitalization (millions)$398.7$201.6$332.8$473.1$657.2Cash (millions)$49.4$68.0$91.7$80.4$83.6Long-term Debt (millions)$498.9$498.9$572.2$597.5$597.5Enterprise value (millions)$848.2$632.5$813.3$990.2$1,171.12-11.Suppose that in 2016, Global launches an aggressive marketing campaign that boosts sales by15%.However, their operating margin falls from 5.57% to 4.50%. Suppose that they have noother income, interest expenses are unchanged, and taxes are the same percentage of pretaxincome as in 2015.a.What is Global’s EBIT in 2016?b.What is Global’snetincome in 2016?c.If Global’s P/E ratio and number of shares outstanding remains unchanged, whatis Global’sshare price in 2016?a.Revenues in 2016= 1.15 × 186.7 = $214.705 million.EBIT = 4.50% × 214.705 = $9.66 million (there is no other income).b.Net Income = EBIT–Interest Expenses–Taxes = (9.66–7.7) × (1–26%) = $1.45 million.c.Share price = (P/E Ratio in 20015) x (EPS in 2016) = 25.2 x (1.45/3.6) = $10.15.Note: Differences from spreadsheet solutions due to rounding.2-12.Findonline the annual 10-K report for Costco Wholesale Corporation (COST) for fiscal year2015 (filed in October 2015).Answer the following questions from their income statement:a.What wereCostco'srevenues for fiscal year 2015? By what percentage did revenues growfrom the prior year?b.What wasCostco'soperating income for the fiscal year?c.What wasCostco'saverage tax rate for the year?d.What wereCostco'sdiluted earnings per share in fiscal year 2015? What number of sharesis this EPS based on?a.Revenues = $116,199million. Revenue growth= (116,199/112,640)–1 = 3.16%.b.Operating Income = $3,624million.c.Average tax rate=1,195/3,604 = 33.16%.d.The diluted earnings per share in 2015was $5.37. The number of shares used in this calculation ofdiluted EPS was442.72million.

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Chapter 2/Introduction to Financial Statement Analysis92-13.See Table 2.5 showing financial statement data and stock price data for Mydeco Corp.a.By what percentage did Mydeco’s revenues grow each year from 2013 to 2016?b.By what percentage did net income grow each year?c.Why might the growth rates of revenues and net income differ?a.Year20122013201420152016Revenue (millions)$401.9$361.6$429.6$513.6$602.6Revenue growth–10.0%18.8%19.6%17.3%b.Year20122013201420152016NetIncome (millions)$15.0$4.3$9.6$11.8$16.2Net income growth–71.3%123.3%22.9%37.3%c.Net Income growth rate differs from revenue growth rate because cost of goods sold and otherexpenses can move at different rates than revenues. Forexample, revenues declined in 2013 by10%, however, cost of goods sold only declined by 9%.2-14.See Table 2.5 showing financial statement data and stock price data for Mydeco Corp. SupposeMydeco repurchases 2.3 million shares each year from 2013 to 2016. What would its earningsper share be in years 2013–2016? (Assume Mydeco pays for the shares using its available cashand that Mydeco earns no interest on its cash balances.)A repurchase does not impact earnings directly, so any change to EPS will come from a reduction inshares outstanding.Year20122013201420152016Shares Outstanding (millions)56.854.552.249.947.6Net Income (millions)$15.0$4.3$9.6$11.8$16.2EPS$0.26$0.08$0.18$0.24$0.342-15.See Table 2.5 showing financial statement data and stock price data for Mydeco Corp. SupposeMydeco had purchased additional equipment for $12.3 million at the end of 2013, and thisequipment was depreciated by $4.1 million per year in 2014, 2015, and 2016. Given Mydeco’staxrate of 35%, what impact would this additional purchase have had on Mydeco’s net incomeinyears 2013–2016? (Assume the equipment is paid for out of cash and that Mydeco earns nointerest on its cash balances.)The equipment purchase does not impact net income directly, however the increased depreciationexpense and tax savings changes net income.Year20122013201420152016Net Income$15.0$4.3$9.6$11.8$16.2Additional Depreciation–$4.1–$4.1–$4.1Tax savings$1.4$1.4$1.4New Net Income (millions)$15.0$4.3$6.9$9.1$13.52-16.See Table 2.5 showing financial statement data and stock price data for Mydeco Corp. SupposeMydeco’scosts and expenses had been the same fraction of revenues in 2013–2016 as they werein 2012. What would Mydeco’s EPS have been each year in this case?If Mydeco’s costs and expenses had been the same fraction of revenues in 2013–2016 as they were in2012, then their net profit margins would have been equal.

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10Berk/DeMarzo,Corporate Finance,FourthEdition, Global Edition2012 net profit margin = 15/401.9 = 3.73%.Year20122013201420152016Revenue$401.9$361.6$429.6$513.6$602.6Net Profit Margin3.7%3.7%3.7%3.7%3.7%New Net Income$15.0$13.5$16.0$19.2$22.5Shares Outstanding56.856.856.856.856.8New EPS$0.26$0.24$0.28$0.34$0.402-17.Suppose a firm’s tax rate is 30%.a.What effect would a $10 million operating expense have on this years earnings? What effectwould it have on next year’s earnings?b.What effect would a $10 million capital expense have on this years earnings if the capitalexpenditure isdepreciated at a rate of $2 million per year for five years? What effect wouldit have on next year’s earnings?a.A $10 million operating expense would be immediately expensed, increasing operating expensesby $10 million. This would lead to a reduction in taxes of 30% × $10 million = $3 million. Thus,earnings would decline by 10–3 = $7 million. There would be no effect on next year’s earnings.b.Capital expenses do not affect earnings directly. However, the depreciation of $2 million wouldappear each year as an operating expense. With a reduction in taxes of 2 × 30% = $0.6 million,earnings would be lower by 2–0.6 = $1.4 million for each of the next 5 years.2-18.Quisco Systems has 6.17 billion shares outstanding and a share price of $18.96. Quisco isconsideringdevelopinganewnetworkingproductin-houseatacostof$509million.Alternatively,Quisco can acquire a firm that already has the technology for $893 million worth(at the currentprice) of Quisco stock. Suppose that absent the expense of the new technology,Quisco willhave EPS of $0.83.a.Suppose Quisco develops the product in-house. What impact would the development costhave on Quisco’s EPS? Assume all costs are incurred this year and are treated as an R&Dexpense, Quisco’s tax rate is 35%, and the number of shares outstanding is unchanged.b.Suppose Quisco does not develop the product in-house but instead acquires the technology.What effect would the acquisition have on Quisco’s EPS this year? (Note that acquisitionexpenses do not appear directly on the income statement. Assume the firm was acquired atthe start of the year and has no revenues or expenses of its own, so that the only effect onEPS is due to the change in the number of shares outstanding.)c.Which method of acquiring the technology has a smaller impact on earnings? Is this methodcheaper? Explain.a.If Quisco develops the product in-house, its earnings would fall by $509 × (1–35%) = $330.85million. With no change to the number of shares outstanding, its EPS would decrease by($330.9/6,170) = $0.054 to $0.776. (Assume the new product would not change this year’srevenues.)b.If Quisco acquires the technology for $893 million worth of its stock, it will issue $893/18.96 =47.10 million new shares. Since earnings without this transaction are $0.83 × 6.17 billion = $5.12billion, its EPS with the purchase is 5,121/(6,170 + 47.10) = $0.82.c.Acquiring the technology would have a smaller impact on earnings, but this method is notcheaper. Developing it in-house is less costly and provides an immediate tax benefit. The earningsimpact is not a good measure of the expense. In addition, note that because the acquisitionpermanently increases the number of shares outstanding, it will reduce Quisco’s earnings per sharein future years as well.

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Chapter 2/Introduction to Financial Statement Analysis112-19.Find online the annual 10-K report for Costco Wholesale Corporation (COST) for fiscal year2015 (filed in October 2015).Answer the following questions from their cash flow statement:a.How much cash didCostcogenerate from operating activities infiscal year 2015?b.What wasCostcodepreciationand amortization expense?c.How much cash was invested innew property and equipment(net of any sales)?d.How much didCostcoraise from the sale of shares of its stock (net of any purchases)?a.Net cash provided by operating activities was $4,285million infiscal year 2015.b.Depreciation and amortization expenses were $1,127million.c.Net cash used incapital expenditures forproperty and equipmentwas $2,393million.d.Costcoraised nothingfromthesale of shares of its stock, while it spent $481million on thepurchase of common stock.Costcoraised–$481million from the sale of its shares of stock (net ofany purchases).2-20.See Table 2.5 showing financial statement data and stock price data for Mydeco Corp.a.From 2012 to 2016, what was the total cash flow fromoperations that Mydeco generated?b.What fraction of the total in (a) was spent on capital expenditures?c.What fraction of the total in (a) was spent paying dividends to shareholders?d.What was Mydeco’s total retained earnings for this period?a.Total cash flow from operations = 45.2 + 47.6 + 53.1 + 44 + 48.8 = $238.7 million.b.Total fraction spent on capital expenditures = (26.6 + 23.8 + 97.5 + 75.4 + 40)/238.7 = 110.3%.c.Total fraction spent on dividends = (5.2 × 4 + 5.6)/238.7 = 11.06%.d.Retained earnings = Net Income–Dividends = (15 + 4.3 + 9.6 + 11.8 + 16.2)–(5.2 × 4 + 5.6) =$30.5 million.2-21.See Table 2.5 showing financial statement data and stock price data for Mydeco Corp.a.In what year was Mydeco’s net income the lowest?b.In what year did Mydeco need to reduce its cash reserves?c.Why did Mydeco need to reduce its cash reserves in ayear when net income was reasonablyhigh?a.In 2013 (net income was $4.3 million).b.2015 (cash was reduced from 91.7 to 80.4).c.Mydeco needed to reduce cash (it also issued debt) to pay for large capital expenditures in 2014and 2015. In addition, even though net income was reasonably high, cash from operations was atthelowest amountinthe five-year period duetoanincreaseinaccounts receivableandinventories.2-22.See Table 2.5 showing financial statement data and stock price data for Mydeco Corp. Use thedata from the balance sheetand cash flow statement in 2012to determine the following:a.How much cash did Mydecohave at the end of 2011?b.What were Mydeco’s accounts receivableand inventory at the end of 2011?c.What were Mydeco’s total liabilities at the end of 2011?d.Assuming goodwill and intangibles were equal in 2011 and 2012, what was Mydeco’s netproperty, plant,and equipment at the end of 2011?a.20011 Cash = 2012 Cash–2012 Change in Cash = 49.4–13.4 = $36 million.

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12Berk/DeMarzo,Corporate Finance,FourthEdition, Global Editionb.2011 Accounts Receivable = 87.6–3.9 = $83.7 million; 2011 inventory = 33.5–(-2.9) = $36.4millionc.2011 TotalLiabilities = 525.3–1.7 = $523.6 million.d.2011 net property, plant, and equipment = 2012 net property, plant, and equipment–2012 capitalexpenditures + 2012 depreciation = 244.3–26.6 + 27.5 = $245.2 million2-23.Can a firm with positive net income run out of cash? Explain.A firm can have positive net income but still run out of cash. For example, to expand its currentproduction, a profitable company may spend more on investment activities than it generates fromoperating activities and financing activities. Net cash flow for that period would be negative, althoughits net income is positive. It could also run out of cashifit spends a lot on financing activities, perhapsby paying off other maturing long-term debt, repurchasing shares, or paying dividends.2-24.Suppose your firm receives a $4.1million order on the last day of the year. You fill the orderwith $2.9million worth of inventory. The customer picks up the entire order the same day andpays $1.5million upfront in cash; you also issue a bill for the customer to pay the remainingbalance of $2.6million in 30 days. Suppose your firm’s tax rate is 0% (i.e., ignore taxes).Determine the consequences of this transaction for each of the following:a.Revenuesb.Earningsc.Receivablesd.Inventorye.Casha.Revenues: increase by $4.1 millionb.Earnings: increase by 4.1–2.9 = $1.2 millionc.Receivables: increase by $2.6 milliond.Inventory: decrease by $2.9 millione.Cash: increase by $1.2 million (earnings)–$2.6 million (receivables) + $2.9 million (inventory) =$1.5 million (cash).2-25.NokelaIndustriespurchasesa$38.5millioncyclo-converter.Thecyclo-converterwillbedepreciated by $7.7million per year over four years, starting this year. Suppose Nokela’s taxrate is 40%.a.What impact will the cost of the purchase have on earnings for each of the next fiveyears?b.What impact will the cost of the purchase have on the firm’s cash flow for the next fiveyears?a.To calculate the impact on earnings for the next fiveyears, we would have to deduct thedepreciation expense. After taxes, this would lead to a decline of 7.7 × (1–40%) = $4.62 millioneach year for the next five years.b.Cash flow for the next five years: less $35.42 million (–4.62 + 7.7–38.5) this year, and add $3.08million (–4.62 + 7.7) for the four following years.2-26.See Table 2.5 showing financial statement data and stock price data for Mydeco Corp.a.What were Mydeco’s retained earnings each year?b.Using the data from2012, what was Mydeco’s total stockholders’ equity in 2011?a.Retained earnings = Net Income–Dividends Paid

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Chapter 2/Introduction to Financial Statement Analysis13Year20122013201420152016Net Income$15.0$4.3$9.6$11.8$16.2Dividends Paid–$5.2–$5.2–$5.2–$5.2–$5.6Retained Earnings (millions)$9.8–$0.9$4.4$6.6$10.6b.2011 stockholders’ equity = 2012 stockholders’ equity–2012 retained earnings = 255–9.8 =$245.2 million.2-27.Find online the annual 10-K report for Costco Wholesale Corporation (COST) for fiscal year2015 (filed in October2015).Answer the following questions from the notes to their financialstatements:a.How many stores did Costco open outside of the U.S. in 2015?b.What property doesCostcolease? What are the minimum lease payments due in 2016?c.What wasCostco’sworldwide member renewal rate for 2015?What proportion ofCostcocardholders had Gold Star memberships in 2015?d.What fraction ofCostco’s 2015sales came fromgas stations, pharmacy, food court, andoptical? What fraction came fromapparel andsmall appliances?a.Costcoopened 11 stores outside of the U.S. in 2015.b.Costcoleasesland and/or buildings at warehouses and certain other office andfacilities.The minimum lease payments due in 2016are $211million.c.Costco had a worldwide member renewal rate of 88% for 2015.34,000/81,300 = 42% of Costcocardholders had Gold Star memberships in 2015.d.16%ofCostco’s 2015sales came fromgas stations, pharmacy, food court, and optical.11% ofCostco’s 2015sales came fromapparel and small appliances.2-28.See Table 2.5 showing financial statement data and stock price data for Mydeco Corp.a.What were Mydeco’s gross margins each year?b.Comparing Mydeco’s gross margin, EBIT margin, and net profit margin in 2012 and 2016,which margins improved?a.Year20122013201420152016Revenue$401.9$361.6$429.6$513.6$602.6Gross Profit$209.8$186.2$222.5$265.3$306.8Gross Margin52.2%51.5%51.8%51.7%50.9%b.None of the margins improved from 2012 to 2016Year20122013201420152016Revenue$401.9$361.6$429.6$513.6$602.6Gross Profit$209.8$186.2$222.5$265.3$306.8EBIT$55.5$38.4$46.7$55.2$65.8Net Income$15.0$4.3$9.6$11.8$16.2Gross Margin52.2%51.5%51.8%51.7%50.9%EBIT Margin13.8%10.6%10.9%10.7%10.9%Net Profit Margin3.7%1.2%2.2%2.3%2.7%2-29.Forfiscal yearend2015,Walmart Stores, Inc. (WMT)had revenue of $485.65billion, grossprofit of $120.57billion, and net income of $16.36billion.Costco Wholesale Corporation (COST)had revenue of $116.20billion, gross profit of $15.13billion,and net income of $2.38billion.a.Compare the gross margins forWalmartandCostco.

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