1、SolutionsManualCorporateFinanceRoss,Westerfield,andJaffe9theditionCHAPTER1INTRODUCTIONTOCORPORATEFINANCEAnswerstoConceptQuestionsInthecorporateformofownership,theshareholdersaretheownersofthefirm.Theshareholderselectthedirectorsofthecorporation,whointurnappointthefirmsmanagement.Thisseparationofowne

2、rshipfromcontrolinthecorporateformoforganizationiswhatcausesagencyproblemstoexist.ManagementmayactthoseofthethoseoftheofmaximizingSuchorganizationsfrequentlypursuesocialorpoliticalmissions,somanydifferentgoalsareconceivable.Onegoalthatisoftencitedisrevenueminimization;i.e.,providewhatevergoodsandser

3、vicesareofferedatthelowestpossiblecosttosociety.Abetterapproachmightbetoobservethatevenanot-for-profitbusinesshasequity.Thus,oneansweristhattheappropriategoalistomaximizethevalueoftheequity.Presumably,thecurrentstockvaluereflectstherisk,timing,andmagnitudeofallfuturecashflows,bothshort-termandlong-t

4、erm.Ifthisiscorrect,thenthestatementisfalse.Anargumentcanbemadeeitherway.Attheoneextreme,wecouldarguethatinamarketeconomy,allofthesethingsarepriced.Thereisthusanoptimallevelof,forexample,ethicaland/orillegalbehavior,andtheframeworkofstockvaluationexplicitlyincludesthese.Attheotherextreme,wecouldargu

5、ethatthesearenon-economicphenomenaandarebesthandledthroughthepoliticalprocess.Aclassic(andhighlyrelevant)thoughtquestionthatillustratesthisdebategoessomethinglikethis:“Afirmhasestimatedthatthecostofimprovingthesafetyofoneofitsproductsis$30million.However,thefirmbelievesthatimprovingthesafetyofthepro

6、ductwillonlysave$20millioninproductliabilityclaims.Whatshouldthefirmdo?”Thegoalwillbethesame,butthebestcourseofactiontowardthatgoalmaybedifferentbecauseofdifferingsocial,political,andeconomicinstitutions.Thegoalofmanagementshouldbetomaximizethesharepriceforthecurrentshareholders.Ifmanagementbelieves

7、thatitcanimprovetheprofitabilityofthefirmsothatthesharepricewillexceed$35,thentheyshouldfighttheofferfromtheoutsidecompany.Ifmanagementbelievesthatthisbidderorotherunidentifiedbidderswillactuallypaymorethan$35persharetoacquirethecompany,thentheyshouldstillfighttheoffer.However,ifthecurrentmanagement

8、cannotincreasethevalueofthefirmbeyondthebidprice,andnootherhigherbidscomein,thenmanagementisnotactingintheinterestsoftheshareholdersbyfightingtheoffer.Sincecurrentmanagersoftenlosetheirjobswhenthecorporationisacquired,poorlymonitoredmanagershaveanincentivetofightcorporatetakeoversinsituationssuchast

9、his.Wewouldexpectagencyproblemstobelesssevereinothercountries,primarilyduetotherelativelysmallpercentageofindividualownership.Fewerindividualownersshouldreducethenumberofdiverseopinionsconcerningcorporategoals.Thehighpercentageofinstitutionalownershipmightleadtoahigherdegreeofagreementbetweenownersa

10、ndmanagersondecisionsconcerningriskyprojects.Inaddition,institutionsmaybebetterabletoimplementeffectivemonitoringmechanismsonmanagersthancanindividualowners,basedontheinstitutionsdeeperresourcesandexperienceswiththeirownmanagement.TheincreaseininstitutionalownershipofstockintheUnitedStatesandthegrow

11、ingactivismoftheselargeshareholdergroupsmayleadtoareductioninagencyproblemsforU.S.corporationsandamoreefficientmarketforcorporatecontrol.However,thismaynotalwaysbethecase.Ifthemanagersofthemutualfundorpensionplanarenotconcernedwiththeinterestsoftheinvestors,theagencyproblemcouldpotentiallyremainthes

12、ame,orevenincreasesincethereisthepossibilityofagencyproblemsbetweenthefundanditsinvestors.Howmuchistoomuch?Whoisworthmore,RayIraniorTigerWoods?Thesimplestansweristhatthereisamarketforexecutivesjustasthereisforalltypesoflabor.Executivecompensationisthepricethatclearsthemarket.Thesameistrueforathletes

13、andperformers.Havingsaidthat,oneaspectofexecutivecompensationdeservescomment.Aprimaryreasonexecutivecompensationhasgrownsodramaticallyisthatcompanieshaveincreasinglymovedtostock-basedcompensation.Suchmovementisobviouslyconsistentwiththeattempttobetteralignstockholderandmanagementinterests.Inrecentye

14、ars,stockpriceshavesoared,somanagementhascleanedup.Itissometimesarguedthatmuchofthisrewardissimplyduetorisingstockpricesingeneral,notmanagerialperformance.Perhapsinthefuture,executivecompensationwillbedesignedtorewardonlydifferentialperformance,i.e.,stockpriceincreasesinexcessofgeneralmarketincrease

15、s.Maximizingthecurrentsharepriceisthesameasmaximizingthefuturesharepriceatanyfutureperiod.Thevalueofashareofstockdependsonallofthefuturecashflowsofcompany.Anotherwaytolookatthisisthat,barringlargecashpaymentstoshareholders,theexpectedpriceofthestockmustbehigherinthefuturethanitistoday.Whowouldbuyast

16、ockfor$100todaywhenthesharepriceinoneyearisexpectedtobe$80?CHAPTER2FINANCIALSTATEMENTSANDCASHFLOWAnswerstoConceptsReviewandCriticalThinkingQuestionsTrue.Everyassetcanbeconvertedtocashatsomeprice.However,whenwearereferringtoaliquidasset,theaddedassumptionthattheassetcanbequicklyconvertedtocashatornea

17、rmarketvalueisimportant.Therecognitionandmatchingprinciplesinfinancialaccountingcallforrevenues,andthecostsassociatedwithproducingthoserevenues,tobe“booked”whentherevenueprocessisessentiallycomplete,notnecessarilywhenthecashiscollectedorbillsarepaid.Notethatthiswayisnotnecessarilycorrect;itsthewayac

18、countantshavechosentodoit.Thebottomlinenumbershowsthechangeinthecashbalanceonthebalancesheet.Assuch,itisnotausefulnumberforanalyzingacompany.Themajordifferenceisthetreatmentofinterestexpense.Theaccountingstatementofcashflowstreatsinterestasanoperatingcashflow,whilethefinancialcashflowstreatinteresta

19、safinancingcashflow.Thelogicoftheaccountingstatementofcashflowsisthatsinceinterestappearsontheincomestatement,whichshowstheoperationsfortheperiod,itisanoperatingcashflow.Inreality,interestisafinancingexpense,whichresultsfromthecompanyschoiceofdebtandequity.Wewillhavemoretosayaboutthisinalaterchapter

20、.Whencomparingthetwocashflowstatements,thefinancialstatementofcashflowsisamoreappropriatemeasureofthecompanysperformancebecauseofitstreatmentofinterest.Marketvaluescanneverbenegative.Imagineashareofstocksellingfor-$20.Thiswouldmeanthatifyouplacedanorderfor100shares,youwouldgetthestockalongwithacheck

21、for$2,000.Howmanysharesdoyouwanttobuy?Moregenerally,becauseofcorporateandindividualbankruptcylaws,networthforapersonoracorporationcannotbenegative,implyingthatliabilitiescannotexceedassetsinmarketvalue.Forasuccessfulcompanythatisrapidlyexpanding,forexample,capitaloutlayswillbelarge,possiblyleadingto

22、negativecashflowfromassets.Ingeneral,whatmattersiswhetherthemoneyisspentwisely,notwhethercashflowfromassetsispositiveornegative.Itsprobablynotagoodsignforanestablishedcompanytohavenegativecashflowfromoperations,butitwouldbefairlyordinaryforastart-up,soitdepends.Forexample,ifacompanyweretobecomemoree

23、fficientininventorymanagement,theamountofinventoryneededwoulddecline.Thesamemightbetrueifthecompanybecomesbetteratcollectingitsreceivables.Ingeneral,anythingthatleadstoadeclineinendingNWCrelativetobeginningwouldhavethiseffect.Negativenetcapitalspendingwouldmeanmorelong-livedassetswereliquidatedthanp

24、urchased.Ifacompanyraisesmoremoneyfromsellingstockthanitpaysindividendsinaparticularperiod,itscashflowtostockholderswillbenegative.Ifacompanyborrowsmorethanitpaysininterestandprincipal,itscashflowtocreditorswillbenegative.Theadjustmentsdiscussedwerepurelyaccountingchanges;theyhadnocashflowormarketva

25、lueconsequencesunlessthenewaccountinginformationcausedstockholderstorevaluethederivatives.SolutionstoQuestionsandProblemsNOTE:Allend-of-chapterproblemsweresolvedusingaspreadsheet.Manyproblemsrequiremultiplesteps.Duetospaceandreadabilityconstraints,whentheseintermediatestepsareincludedinthissolutions

26、manual,roundingmayappeartohaveoccurred.However,thefinalanswerforeachproblemisfoundwithoutroundingduringanystepintheproblem.BasicTofindownersequity,wemustconstructabalancesheetasfollows:BalanceSheetCA$5,300CL$3,900NFA26,000LTD14,200OE?TA$31,300TL&OE$31,300Weknowthattotalliabilitiesandownersequity(TL&

27、OE)mustequaltotalassetsof$31,300.WealsoknowthatTL&OEisequaltocurrentliabilitiespluslong-termdebtplusownersequity,soownersequityis:OE=$31,300-14,200-3,900=$13,200NWC=CA-CL=$5,300-3,900=$1,400Theincomestatementforthecompanyis:IncomeStatementSales$493,000Costs210,000Depreciation35,000EBIT$248,000Intere

28、st19,000EBT$229,000Taxes80,150Netincome$148,850Oneequationfornetincomeis:Netincome=Dividends+AdditiontoretainedearningsRearranging,weget:Additiontoretainedearnings=Netincome-DividendsAdditiontoretainedearnings=$148,850-50,000Additiontoretainedearnings=$98,850Tofindthebookvalueofcurrentassets,weuse:N

29、WC=CA-CL.Rearrangingtosolveforcurrentassets,weget:CA=NWC+CL=$800,000+2,100,000=$2,900,000Themarketvalueofcurrentassetsandnetfixedassetsisgiven,so:BookvalueCA=$2,900,000MarketvalueCA=$2,800,000BookvalueNFA=$5,000,000MarketvalueNFA=$6,300,000Bookvalueassets=$7,900,000Marketvalueassets=$9,100,000Taxes=

30、0.15($50K)+0.25($25K)+0.34($25K)+0.39($246K-100K)Taxes=$79,190Theaveragetaxrateisthetotaltaxpaiddividedbynetincome,so:Averagetaxrate=$79,190/$246,000Averagetaxrate=32.19%Themarginaltaxrateisthetaxrateonthenext$1ofearnings,sothemarginaltaxrate=39%.TocalculateOCF,wefirstneedtheincomestatement:IncomeSt

31、atement$14,9005,800$14,9005,8001,300$7,800780$7,0202,808$4,212CostsDepreciationEBITInterestTaxableincomeTaxesNetincomeOCF=EBIT+Depreciation-TaxesOCF=$7,800+1,300-2,808OCF=$6,292Netcapitalspending=NFA-NFAendbeg+Depreciation1,650,000+284,000Netcapitalspending=$1,730,000-+Depreciation1,650,000+284,000T

32、helong-termdebtaccountwillincreaseby$10million,theamountofthenewlong-termdebtissue.Sincethecompanysold10millionnewsharesofstockwitha$1parvalue,thecommonstockaccountwillincreaseby$10million.Thecapitalsurplusaccountwillincreaseby$33million,thevalueofthenewstocksoldaboveitsparvalue.Sincethecompanyhadan

33、etincomeof$9million,andpaid$2millionindividends,theadditiontoretainedearningswas$7million,whichwillincreasetheaccumulatedretainedearningsaccount.So,thenewlongtermdebtandstockholdersequityportionofthebalancesheetwillbe:$82,000,000$82,000,000$9,000,000$82,000,000$82,000,000$9,000,00030,000,000104,000,

34、00076,000,000$219,000,000$301,000,000Totallong-termdebtShareholdersequityPreferredstockCommonstock($1parvalue)AccumulatedretainedearningsCapitalsurplusTotalequityTotalLiabilities&EquityCashflowtocreditors=Interestpaid-NetnewborrowingCashflowtocreditors=$118,000-(LTD-LTD)endbegCashflowtocreditors=$11

35、8,000-($1,390,000-1,340,000)Cashflowtocreditors=$118,000-50,000Cashflowtocreditors=$68,000Cashflowtostockholders=Dividendspaid-NetnewequityCashflowtostockholders=$385,000-(Common+APIS)-(Common+APIS)endendbegbegCashflowtostockholders=$385,000-($450,000+3,050,000)-($430,000+2,600,000)Cashflowtostockho

36、lders=$385,000-($3,500,000-3,030,000)Cashflowtostockholders=-$85,000Note,APISistheadditionalpaid-insurplus.Cashflowfromassets=Cashflowtocreditors+Cashflowtostockholders=$68,000-85,000=-$17,000Cashflowfromassets=-$17,000=OCF一ChangeinNWC一Netcapitalspending-$17,000=OCF-(-$69,000)-Operatingcashflow=-$17

37、,000-69,000875,000+875,000Operatingcashflow875,000+875,000Intermediatea.Theaccountingstatementofcashflowsexplainsthechangeincashduringtheyear.Theaccountingstatementofcashflowswillbe:StatementofcashflowsOperationsTOC o 1-5 h zNetincome$105Depreciation90Changesinothercurrentassets(55)Accountspayable(1

38、0)Totalcashflowfromoperations$170InvestingactivitiesAcquisitionoffixedassets$(140)Totalcashflowfrominvestingactivities$(140)FinancingactivitiesTOC o 1-5 h zProceedsoflong-termdebt$30Dividends(45)Totalcashflowfromfinancingactivities($15)Changeincash(onbalancesheet)$15b.ChangeinNWC=NWCend(CAend($50NWC

39、begb.ChangeinNWC=NWCend(CAend($50NWCbeg-CL)end+155)-(CAbeg-85-CL)beg($35+140)95)=$120-80=$40c.Tofindthecashflowgeneratedbythefirmsassets,weneedtheoperatingcashflow,andthecapitalspending.So,calculatingeachofthese,wefind:OperatingcashflowTOC o 1-5 h zNetincome$105Depreciation90Operatingcashflow$195Not

40、ethatwecancalculateOCFinthismannersincetherearenotaxes.CapitalspendingEndingfixedassets$340Beginningfixedassets(290)Depreciation90Capitalspending$140Nowwecancalculatethecashflowgeneratedbythefirmsassets,whichis:Cashflowfromassets$195(140)$195(140)(40)CapitalspendingChangeinNWCCashflowfromassets$15as

41、setsWiththeinformationprovided,thecashflowsfromthefirmarethecapitalspendingandthechangeinnetworkingcapital,so:CashflowsfromthefirmCapitalspendingAdditionstoNWC$(15,000)(1,500)Cashflowsfromthefirm$(16,500)Andthecashflowstotheinvestorsofthefirmare:CashflowstoinvestorsofthefirmSaleoflong-termdebt(19,00

42、0)Saleofcommonstock(3,000)Dividendspaid19,500Cashflowstoinvestorsofthefirm$(2,500)a.Theinterestexpenseforthecompanyistheamountofdebttimestheinterestrateonthedebt.So,theincomestatementforthecompanyis:IncomeStatementSales$1,200,000Costofgoodssold450,000Sellingcosts225,000Depreciation110,000EBIT$415,00

43、0Interest81,000Taxableincome$334,000Taxes116,900Netincome$217,100b.Andtheoperatingcashflowis:OCF=EBIT+Depreciation-TaxesOCF=$415,000+110,000-116,900OCF=$408,100TofindtheOCF,wefirstcalculatenetincome.IncomeStatementSales$167,000Costs91,000Depreciation8,000Otherexpenses5,400EBIT$62,600Interest11,000Ta

44、xableincome$51,600Taxes18,060Netincome$33,540Dividends$9,500AdditionstoRE$24,040OCF=EBIT+Depreciation-TaxesOCF=$62,600+&000-18,060OCF=$52,540CFC=Interest-NetnewLTDCFC=$11,000-(-$7,100)CFC=$18,100Notethatthenetnewlong-termdebtisnegativebecausethecompanyrepaidpartofitslong-termdebt.c.CFS=Dividends-Net

45、newequityCFS=$9,500-7,250CFS=$2,250d.WeknowthatCFA=CFC+CFS,so:CFA=$18,100+2,250=$20,350CFAisalsoequaltoOCF-Netcapitalspending-ChangeinNWC.WealreadyknowOCF.Netcapitalspendingisequalto:Netcapitalspending=IncreaseinNFA+DepreciationNetcapitalspending=$22,400+8,000Netcapitalspending=$30,400Nowwecanuse:CF

46、A=OCF-Netcapitalspending-ChangeinNWC$20,350=$52,540-30,400-ChangeinNWC.SolvingforthechangeinNWCgives$1,790,meaningthecompanyincreaseditsNWCby$1,790.Thesolutiontothisquestionworkstheincomestatementbackwards.Startingatthebottom:Netincome=Dividends+Additiontoret.earningsNetincome=$1,530+5,300Netincome=

47、$6,830Now,lookingattheincomestatement:EBT-(EBTxTaxrate)=NetincomeRecognizethatEBTxtaxrateissimplythecalculationfortaxes.SolvingthisforEBTyields:EBT=NI/(1-Taxrate)EBT=$6,830/(1-0.65)EBT=$10,507.69Nowwecancalculate:EBIT=EBT+InterestEBIT=$10,507.69+1,900EBIT=$12,407.69Thelaststepistouse:EBIT=Sales-Cost

48、s-Depreciation$12,407.69=$43,000-27,500-DepreciationDepreciation=$3,092.31Solvingfordepreciation,wefindthatdepreciation=$3,092.31Thebalancesheetforthecompanylookslikethis:BalanceSheetCash$183,000AccountsreceivableCash$183,000Accountsreceivable138,000Inventory297,000Currentassets$618,000Tangiblenetfi

49、xedassets3,200,000Intangiblenetfixedassets695,000Totalassets$4,513,000Accountspayable$465,000Notespayable145,000Currentliabilities$610,000Long-termdebt1,550,000Totalliabilities$2,160,000Commonstock?Accumulatedret.earnings1,960,000Totalliab.&ownersequity$4,513,000Totalliabilitiesandownersequityis:TL&

50、OE=Totaldebt+Commonstock+AccumulatedretainedearningsSolvingforthisequationforequitygivesus:Commonstock=$4,513,000-1,960,000-2,160,000Commonstock=$393,000Themarketvalueofshareholdersequitycannotbenegative.Anegativemarketvalueinthiscasewouldimplythatthecompanywouldpayyoutoownthestock.Themarketvalueofs

51、hareholdersequitycanbestatedas:Shareholdersequity=Max(TA-TL),0.So,ifTAis$9,700,equityisequalto$800,andifTAis$6,800,equityisequalto$0.Weshouldnoteherethatwhilethemarketvalueofequitycannotbenegative,thebookvalueofshareholdersequitycanbenegative.a.TaxesGrowth=0.15($50K)+0.25($25K)+0.34($3K)=$14,770Taxe

52、sIncome=0.15($50K)+0.25($25K)+0.34($25K)+0.39($235K)+0.34($7.465M)=$2,652,000Eachfirmhasamarginaltaxrateof34%onthenext$10,000oftaxableincome,despitetheirdifferentaveragetaxrates,sobothfirmswillpayanadditional$3,400intaxes.IncomeStatementSales$740,000COGS610,000A&Sexpenses100,000Depreciation140,000EB

53、IT($115,000)Interest70,000Taxableincome($185,000)Taxes(35%)0a.Netincome($185,000)a.OCF=EBIT+Depreciation-TaxesOCF=($115,000)+140,0000OCF=$25,000Netincomewasnegativebecauseofthetaxdeductibilityofdepreciationandinterestexpense.However,theactualcashflowfromoperationswaspositivebecausedepreciationisanon

54、-cashexpenseandinterestisafinancingexpense,notanoperatingexpense.Afirmcanstillpayoutdividendsifnetincomeisnegative;itjusthastobesurethereissufficientcashflowtomakethedividendpayments.ChangeinNWC=Netcapitalspending=Netnewequity=0.(Given)Cashflowfromassets=OCF-ChangeinNWC-NetcapitalspendingCashflowfro

55、massets=$25,000-0-0=$25,000Cashflowtostockholders=Dividends-NetnewequityCashflowtostockholders=$30,000-0=$30,000Cashflowtocreditors=Cashflowfromassets-CashflowtostockholdersCashflowtocreditors=$25,000-30,000Cashflowtocreditors=-$5,000Cashflowtocreditorsisalso:Cashflowtocreditors=Interest一NetnewLTDSo

56、:NetnewLTD=Interest-CashflowtocreditorsNetnewLTD=$70,000-(-5,000)NetnewLTD=$75,000a.Theincomestatementis:IncomeStatementSalesCostofgoodsoldDepreciationEBITInterestTaxableincomeTaxesNetincome$15,30010,9002,100$2,300520$1,780712$1,068b.OCF=EBIT+Depreciation-TaxesOCF=$2,300+2,100712OCF=$3,68822.22.a.To

57、talassets2009=$780+3,480=$4,260c.ChangeinNWC=NWCendc.ChangeinNWC=NWCend=(CAendNWCbeg-CL)end($3,950$2,000-(CA-CL)begbeg1,950)-($3,4001,500=$5001,900)Netcapitalspending=NFA一NFA+Depreciationendbeg=$12,90011,800+2,100=$3,200CFA=OCF-ChangeinNWC-Netcapitalspending=$3,688-500-3,200=-$12Thecashflowfromasset

58、scanbepositiveornegative,sinceitrepresentswhetherthefirmraisedfundsordistributedfundsonanetbasis.Inthisproblem,eventhoughnetincomeandOCFarepositive,thefirminvestedheavilyinbothfixedassetsandnetworkingcapital;ithadtoraiseanet$12infundsfromitsstockholdersandcreditorstomaketheseinvestments.Cashflowtocr

59、editors=Interest-NetnewLTD=$520-0=$520Cashflowtostockholders=Cashflowfromassets-Cashflowtocreditors=-$12-520=-$532Wecanalsocalculatethecashflowtostockholdersas:Cashflowtostockholders=Dividends-NetnewequitySolvingfornetnewequity,weget:Netnewequity=$500-(-532)=$1,032Thefirmhadpositiveearningsinanaccou

60、ntingsense(NI0)andhadpositivecashflowfromoperations.Thefirminvested$500innewnetworkingcapitaland$3,200innewfixedassets.Thefirmhadtoraise$12fromitsstakeholderstosupportthisnewinvestment.Itaccomplishedthisbyraising$1,032intheformofnewequity.Afterpayingout$500ofthisintheformofdividendstoshareholdersand