CramX Logo
RegisterLog in
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Document preview page 1

Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 1

Document preview content for Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition

Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition

Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition helps you stay ahead with clear explanations and well-organized study materials.

Benjamin Clark
Contributor
4.6
0
12 months ago
Preview (16 of 549 Pages)
100%
Log in to unlock
Page 1 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 1 preview imageEnd of Chapter SolutionsCorporate Finance: Principles and Applications5theditionRoss, Westerfield, Jaffe, and Jordan07-03-2016Prepared byBrad JordanUniversity of KentuckyJoe SmoliraBelmontUniversity
Page 2 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 2 preview image
Page 3 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 3 preview imageCHAPTER 1INTRODUCTION TO CORPORATEFINANCEAnswers to Concept Questions1.The three basic forms are sole proprietorships, partnerships, andcorporations. Some disadvantages ofsole proprietorships and partnerships are: unlimited liability, limited life, difficulty in transferringownership, and hard to raise capital funds. Some advantages are: simpler, less regulation, the ownersare also themanagers, and sometimes personal tax rates are better than corporate tax rates. The primarydisadvantage of the corporate form is the double taxation to shareholders on distributed earnings anddividends. Some advantages include: limited liability, ease oftransferability, ability to raise capital,and unlimited life. When a business is started, most take the form of a sole proprietorship or partnershipbecause of the relative simplicity of starting these forms of businesses.2.To maximize the current market value (share price) of the equity of the firm (whether it’s publiclytraded or not).3.In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders electthe directors of the corporation, who in turn appoint the firm’s management. This separation ofownership 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 thefirm.4.Such organizations frequently pursue social or political missions, so many different goals areconceivable. One goal that is often cited is revenueminimization; i.e., provide whatever goods andservices are offered at the lowest possible cost to society. A better approach might be to observe thateven a not-for-profit business has equity. Thus, one answer is that the appropriate goal is to maximizethe value of the equity.5.Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows,both short-termandlong-term. If this is correct, then the statement is false.6.An argument can be made either way. Atthe 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, unethical and/or illegalbehavior, and the framework of stock valuation explicitly includes these. At the other extreme, wecould 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 inproduct liability claims. What should the firm do?”7.The goal will be the same, but the best course of action toward that goal may be different because ofdiffering social, political, and economic institutions.
Page 4 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 4 preview imageCHAPTER 1 B-28.The goal of management should be to maximize the share price for the current shareholders. Ifmanagement 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 outsidecompany. If management believes that this bidderor other unidentified bidders will actually pay more than $35 per share to acquire the company, thenthey should still fight the offer. However, if the current management cannot increase the value of thefirm beyond the bid price, and no other higher bids come in, then management is not acting in theinterests of the shareholders by fighting the offer. Since current managers often lose their jobs whenthe corporation is acquired, poorly monitored managers have an incentive to fight corporate takeoversin situations such as this.9.We would expect agency problems to be less severe in other countries, primarily due to the relativelysmall percentage of individual ownership. Fewer individual owners should reduce the number ofdiverse opinions concerning corporate goals. The high percentage of institutional ownership mightlead to a higher degree of agreement between owners and managers on decisions concerning riskyprojects. In addition, institutions may be better able to implement effective monitoring mechanismson managers than canindividual owners, based on the institutions’ deeper resources and experienceswith their own management. The increase in institutional ownership of stock in the United States andthe growing activism of these large shareholder groups may lead to a reduction in agency problemsfor U.S. corporations and a more efficient market for corporate control.10.How much is too much? Who is worth more,Larry Ellisonor Tiger Woods? The simplest answer isthat there is a market for executives just as there is for all types of labor. Executive compensation isthe price that clears the market. The same is true for athletes and performers. Having said that, oneaspect ofexecutive compensation deserves comment. A primary reason that executive compensationhas grown so dramatically is that companies have increasingly moved to stock-based compensation.Such movementis obviously consistent with the attempt to better align stockholder and managementinterests. When stock prices soar, management cleans up. It is sometimes argued that much of thisreward is 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 priceincreases in excess of general market increases.
Page 5 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 5 preview imageCHAPTER 2FINANCIAL STATEMENTS AND CASHFLOWAnswers to Concept Questions1.Liquidity measures how quickly and easily an asset can be converted to cash without significant lossin value. It’s desirable for firms to have highliquidity so that they have a large factor of safety inmeeting short-term creditor demands. However, since liquidity also has an opportunity cost associatedwith it-namely that higher returns can generally be found by investing the cash into productiveassets-low liquidity levels are also desirable to the firm. It’s up to the firm’s financial management staff tofind a reasonable compromise between these opposing needs2.The recognition and matching principles in financial accounting call for revenues, and the costsassociated with producing those revenues, to be “booked” when the revenue process is essentiallycomplete, not necessarily when the cash is collected or billsare paid. Note that this way is notnecessarily correct; it’s the way accountants have chosen to do it.3.The bottom-line number shows the change in the cash balance on the balance sheet. As such, it is nota useful number for analyzing a company.4.The major difference is the treatment of interest expense. The accounting statement of cash flowstreats interest as an operating cash flow, while the financial statement of cash flows treats interest asa financing cash flow. The logic of the accounting statement of cash flows is that since interest appearson the income statement, which shows the operations for the period, it is an operating cash flow. Inreality, interest is a financing expense, which results from the company’s choice of debt/equity.Wewill have more to say about this in a later chapter. When comparing the two cash flow statements, thefinancial statement of cash flows is a more appropriate measure of the company’s operatingperformance because of its treatment of interest.5.Market values can never be negative. Imagine a share of stock selling for–$20. This would mean thatif you placed an order for 100 shares, you would get the stock along with a check for $2,000. Howmany shares do you want to buy? More generally, becauseof corporate and individual bankruptcylaws, net worth for a person or a corporation cannot be negative, implying that liabilities cannot exceedassets in market value.6.For a successful company that is rapidly expanding, for example, capital outlays will be large, possiblyleading to negative cash flow from assets. In general, what matters is whether the money is spentproductively, 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 start-up, so it depends.
Page 6 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 6 preview imageCHAPTER 2 B-28.For example, if acompany were to become more efficient in inventory management, the amount ofinventory needed would decline. The same might be true if it becomes better at collecting itsreceivables. In general, anything that leads to a decline in ending NWC relative to beginning wouldhave this effect. Negative net capital spending would mean more long-lived assets were liquidatedthan purchased.9.If a company raises more money from selling stock than it pays in dividends in a particular period, itscash flow to stockholders will be negative. If a company borrows more than it pays in interest andprincipal, its cash flow to creditors will be negative.10.The adjustments discussed were purely accounting changes; they had no cash flow or market valueconsequences.Solutions to Questions and ProblemsNOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiplesteps. Due to space and readability constraints, when these intermediate steps are included in this solutionsmanual,rounding may appear to have occurred. However, the final answer for each problem is foundwithout rounding during any step in the problem.Basic1.To find owners’equity, we must construct a balance sheet as follows:Balance SheetCA$6,800CL$5,400NFA29,400LTD13,100OE??TA$36,200TL & OE$36,200We know that total liabilities and owners’ equity (TL & OE) must equal total assets of $36,200. Wealso know that TL & OE is equal to current liabilities plus long-term debt plus owners’ equity, soowners’ equity is:Owners’ equity= $36,200–13,100–5,400 = $17,700NWC = CA–CL = $6,800–5,400 = $1,4002.The income statement for the company is:Income StatementSales$528,600Costs264,400Depreciation41,700EBIT$222,500Interest20,700EBT$201,800Taxes (35%)70,630Net income$131,170
Page 7 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 7 preview imageCHAPTER 2 B-3One equation for net income is:Net income = Dividends + Addition to retained earningsRearranging, we get:Addition to retained earnings = Net income–DividendsAddition to retained earnings = $131,170–27,000Addition to retained earnings = $104,1703.To find the book value of current assets, we use the NWC equation, that is:NWC = CA–CLRearranging to solve for current assets, we get:CA = NWC + CLCA = $320,000 + 1,075,000CA = $1,395,000So, the book value balance sheet will be:Book Value Balance SheetCurrent assets$1,395,000Fixed assets3,900,000Total assets$5,295,000The market value of current assets is given, so the market value balance sheet is:Market Value Balance SheetNWC$410,000Fixed assets5,300,000Total assets$5,710,0004.Taxes = .15($50,000) + .25($25,000) + .34($25,000) + .39($328,500–100,000)Taxes = $111,365The average tax rate is the total tax paid divided by taxable income, so:Average tax rate = $111,365/ $328,500Average tax rate = .3390, or 33.90%The marginal tax rate is the tax rate on the next $1 of earnings, so the marginal tax rate is 39 percent.
Page 8 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 8 preview imageCHAPTER 2 B-45.To calculate OCF, we first need the income statement:Income StatementSales$30,700Costs11,100Depreciation expense2,100EBIT$17,500Interest expense1,140EBT$16,360Taxes (40%)6,544Net income$ 9,816Using the equation for OCF, we get:OCF = EBIT + Depreciation–TaxesOCF = $17,500 +2,100–6,544OCF = $13,0566.The net capital spending is the increase in fixed assets, plus depreciation, so:Net capital spending = NFAend–NFAbeg+ DepreciationNet capital spending = $4,450,000–3,750,000 + 395,000Net capital spending = $1,095,0007.The long-term debt account will increase by $9.5million, the amount of the new long-term debt issue.Since the company sold 4 million new shares of stock with a $1 par value, the common stock accountwill increase by $4 million. The capital surplus account will increase by $22million, the value of thenew stock sold above its par value. Since the company had a net income of $15.3million, and paid$3.1million in dividends, the addition to retained earnings was $12.2million, which will increase theaccumulated retained earnings account. So, the new long-term debt and stockholders’ equity portionof the balance sheet will be:Long-term debt$46,500,000Total long-term debt$46,500,000Shareholders’ equityPreferred stock$ 2,100,000Common stock ($1 par value)12,900,000Capital surplus63,000,000Accumulated retained earnings87,500,000Total equity$ 165,500,000
Page 9 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 9 preview imageCHAPTER 2 B-58.The cash flow to creditors is the interest paid minus the change in long-term debt, so:Cash flow to creditors = Interest paid–Net new borrowingCash flow to creditors = $187,000–(LTDend–LTDbeg)Cash flow to creditors = $187,000–($2,530,000–2,400,000)Cash flow to creditors = $57,0009.The cash flow to stockholders is the dividends paid minus any new equity purchased by shareholders,so:Cash flow to stockholders = Dividends paid–Net new equityCash flow to stockholders = $270,000–[(Commonend+ APISend)–(Commonbeg+ APISbeg)]Cash flow to stockholders = $270,000–[($595,000 + 6,180,000)–($540,000 + 5,600,000)]Cash flow to stockholders =–$365,000Note: APIS is the additional paid-in surplus.10.We know that the cash flow from assets must be equal to the cash flow to creditors plus the cash flowto stockholders, so:Cash flow from assets = Cash flow to creditors + Cash flow to stockholdersCash flow from assets = $57,000–365,000Cash flow from assets =–$308,000Now, we can use the relationship between the cash flow from assets and the operating cashflow,change in net working capital, and capital spending to find the operating cash flow. Doing so, we find:Cash flow from assets=–$308,000 = OCF–Change in NWC–Net capital spending–$308,000= OCF–(–$65,000)–640,000Operating cash flow= $267,000
Page 10 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 10 preview imageCHAPTER 2 B-6Intermediate11.a.The accounting statement of cash flows explains the change in cash during the year. Theaccounting statement of cash flows will be:Statement of cash flowsOperationsNet income$148Depreciation77Changes in other current assets–12Change in accounts payable6Total cash flow from operations$219Investing activitiesAcquisition of fixed assets–$211Total cash flow from investingactivities–$211Financing activitiesProceeds of long-term debt$44Dividends–40Total cash flow from financing activities$4Change in cash (on balance sheet)$12b.The change in net working capital is theending net working capital minus the beginning networking capital, so:Change in NWC= NWCend–NWCbeg= (CAend–CLend)–(CAbeg–CLbeg)= [($93+ 265)–301]–[($81+ 253)–295)= $57–39= $18c.To find the cash flowgenerated by the firm’s assets, we need the operating cash flow, and thecapital spending. Since there are no interest payments, EBIT is the same as EBT. Calculatingeach of these, we find:Operating cash flowEBT$246Depreciation77–Taxes98Operating cash flow$225
Page 11 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 11 preview imageCHAPTER 2 B-7Next, we will calculate the capital spending, which is:Capital spendingEnding fixed assets$824–Beginning fixed assets690Depreciation77Capital spending$211Now we cancalculate the cash flow generated by the firm’s assets, which is:Cash flow from assetsOperating cash flow$225–Capital spending211–Change in NWC18Cash flow from assets–$4Notice that the accounting statement of cashflows shows a positive cash flow, but the financial cashflows show a negative cash flow. The financial cash flow is a better number for analyzing the firm’sperformance.12.To construct the cash flow identity, we will begin cash flow from assets. Cash flow from assets is:Cash flow from assets = OCF–Change in NWC–Net capital spendingSo, the operating cash flow is:OCF = EBIT + Depreciation–TaxesOCF = $153,769+66,513–45,671OCF = $174,611Next, we will calculate the change in networking capital which is:Change in NWC = NWCend–NWCbegChange in NWC = (CAend–CLend)–(CAbeg–CLbeg)Change in NWC = ($66,284–32,978)–($57,026–29,342)Change in NWC = $5,622Now, we can calculate the capital spending. The capital spending is:Net capital spending = NFAend–NFAbeg+ DepreciationNet capital spending = $498,312–415,289+ 66,513Net capital spending = $149,536Now, we have the cash flow from assets, which is:Cash flow from assets = OCF–Change in NWC–Netcapital spendingCash flow from assets = $174,611–5,622–149,536Cash flow from assets = $19,453
Page 12 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 12 preview imageCHAPTER 2 B-8The company generated $19,453from its assets. The cash flow from operations was $174,611, andthe company spent $5,622on net working capital and $149,536in fixed assets.The cash flow to creditors is:Cash flow to creditors = Interest paid–New long-term debtCash flow to creditors = Interest paid–(Long-term debtend–Long-term debtbeg)Cash flow to creditors = $23,280–($179,400–165,300)Cash flow to creditors = $9,180The cash flow to stockholders is a little trickier in this problem. First, we need to calculate the newequity sold. The equity balance increased during the year. The only way to increase the equity balanceis to addaddition to retained earnings or sell equity. To calculate the new equity sold, we can use thefollowing equation:New equity = Ending equity–Beginning equity–Addition to retained earningsNew equity = $352,218–277,673–69,618New equity = $4,927What happened was the equity account increased by $74,545. Of this increase, $69,618came fromaddition to retained earnings, so the remainder must have been the sale of new equity. Now we cancalculate the cash flow to stockholders as:Cash flow to stockholders = Dividends paid–Net new equityCash flow to stockholders = $15,200–4,927Cash flow to stockholders = $10,273The company paid $9,180to creditors and $10,273to its stockholders.Finally, the cash flow identity is:Cash flow from assets = Cash flow to creditors+ Cash flow to stockholders$19,453=$4,927+$10,273The cash flow identity balances, which is what we expect.13.With the information provided, the cash flows from the firm are the capital spending and the changein net working capital, so:Cash flows from the firmCapital spending–$19,200Additions to NWC–2,700Cash flows from the firm–$21,900
Page 13 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 13 preview imageCHAPTER 2 B-9And thecash flows to the investors of the firm are:Cash flows to investors of the firmSale of long-term debt–$16,500Sale of common stock–2,700Dividends paid7,100Cash flows to investors of the firm–$12,10014.a.Theinterest expense for the company is the amount of debt times the interest rate on the debt.So, the income statement for the company is:Income StatementSales$757,000Cost of goods sold249,800Selling expenses146,000Depreciation expense87,000EBIT$274,200Interest expense40,500EBT$233,700Taxes81,795Net income$151,905b.And the operating cash flow is:OCF = EBIT + Depreciation–TaxesOCF = $274,200 +87,000–81,795OCF = $279,40515.To find the OCF, we first calculate net income.Income StatementSales$225,000Costs103,200Other expenses6,100Depreciation expense15,300EBIT$100,400Interest expense11,200EBT$89,200Taxes31,227Net income$57,973Dividends$18,100Addition to retained earnings$39,873
Page 14 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 14 preview imageCHAPTER 2 B-10a.The operating cash flow was:OCF = EBIT + Depreciation–TaxesOCF = $100,400 + 15,300–31,227OCF = $84,473b.The cash flow to creditors is theinterest paid minus any net new long-term debt, so:CFC = Interest–Net new LTDCFC = $11,200–(–$8,500)CFC = $19,700Note that the net new long-term debt is negative because the company repaid part of its long-term debt.c.The cashflow to stockholders is the dividends paid minus any net new equity, or:CFS = Dividends–Net new equityCFS = $18,100–6,000CFS = $12,100d.We know that CFA = CFC + CFS, so:CFA = $19,700 + 12,100CFA= $31,800CFA 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 + DepreciationNet capital spending = $33,000 + 15,300Net capital spending = $48,300Now wecan use:CFA = OCF–Net capital spending–Change in NWC$31,800 = $84,473–48,300–Change in NWCSolving for the change in NWCyields$4,373, meaning the company increased its NWC by$4,373.16.The solution to this question works the income statement backwards. Starting at the bottom:Net income = Dividends + Addition to retained earningsNet income = $5,200 +8,100Net income = $13,300Now, looking at the income statement:EBT–(EBT × Tax rate) = Net income
Page 15 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 15 preview imageCHAPTER 2 B-11Recognize that EBT ×Tax rate is the calculation for taxes. Solving this for EBT yields:EBT = NI / (1–Tax rate)EBT = $13,300 / (1–.35)EBT = $20,462Now we can calculate:EBIT = EBT + InterestEBIT = $20,462+2,050EBIT = $22,512The last step is to use:EBIT = Sales–Costs–Depreciation$22,512= $57,900–28,600–DepreciationDepreciation = $6,78817.The balance sheet for the company looks like this:Balance SheetCash$168,000Accounts payable$429,000Accounts receivable237,000Notes payable171,000Inventory385,000Current liabilities$600,000Current assets$790,000Long-term debt1,985,000Total liabilities$2,585,000Tangible net fixed assets3,410,000Intangible net fixed assets827,000Common stock??Accumulated ret. earnings2,084,000Total assets$5,027,000Total liab. & owners’ equity$5,027,000Total liabilities and owners’ equity is:TL & OE =CL + LTD + Common stockSolving this equation for equity gives us:Common stock = $5,027,000–2,084,000–2,585,000Common stock = $358,00018.The market value of shareholders’ equity cannot be negative. A negative market value in this casewould 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 $15,100, equity isequal to $3,500, and if TA is $9,900, equity is equal to $0. We should note here that the book value ofshareholders’ equity can be negative.19.a.Taxes Growth= .15($50,000) + .25($25,000) + .34($4,500) = $15,280Taxes Income= .15($50,000) + .25($25,000) + .34($25,000) + .39($235,000)+ .34($7,950,000–335,000)= $2,703,000
Page 16 of 16
Solution Manual For Corporate Finance: Core Principles and Applications, 5th Edition - Page 16 preview imageCHAPTER 2 B-12b.Each firm has a marginal tax rate of 34 percent on the next $10,000 of taxable income, despitetheir different average tax rates, so both firms will pay an additional $3,400 in taxes.20.a.The income statement for thecompany is:Income StatementSales$809,000Costs549,000Administrative and selling expenses136,000Depreciation expense85,000EBIT$39,000Interest expense67,000EBT–$28,000Taxes0Net income–$28,000b.OCF = EBIT + Depreciation–TaxesOCF = $39,000 + 85,000–0OCF = $124,000c.Net income was negative because of the tax deductibility of depreciation and interest expense.However, the actual cash flow from operations was positive becausedepreciation is a non-cashexpense and interest is a financing expense, not an operating expense.21.A firm can still pay out dividends if net income is negative; it just has to be sure there is sufficientcash 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 spendingCash flow from assets = $124,000–0–0 = $124,000Cash flow to stockholders = Dividends–Net new equityCash flow to stockholders = $75,000–0 = $75,000Cash flow to creditors = Cash flow from assets–Cash flow to stockholdersCash flow to creditors = $124,000–75,000Cash flow to creditors = $49,000Cash flow to creditors is also:Cash flow to creditors = Interest–Net new LTDSo:Net new LTD = Interest–Cash flow to creditorsNet new LTD = $67,000–49,000Net new LTD = $18,000
Preview Mode

This document has 549 pages. Sign in to access the full document!

Study Now!

X-Copilot AI
Unlimited Access
Secure Payment
Instant Access
24/7 Support
Document Chat

Document Details

Subject
Finance
Textbook
Corporate Finance: Core Principles ...

Related Documents

View all
Class Notes

Study Notes For Corporate Finance: Core Principles and Applications, 5th Edition

5.0
00
Document

Introduction Microfinance - the concept of microfi

Past Exams

Texas Life and Health Insurance Exam 150 Questions

Class Notes

Understanding Obligation and Deobligation in Resou

Solved Assignments

Budgeting for Life After High School

Solved Assignments

Ch 4 les 1

Class Notes

Understanding Credit Reports Analyzing John's Fina

Solved Assignments

Essentials of Risk Management

4.4
00
Solved Assignments

Stock Trak Investments Week 4

4.3
00
Solved Assignments

Analysis of ABC Company

4.3
00