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1231231321313 Essay

5106 words - 21 pages

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Chapter 7
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Accounting for Financial Management
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ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS

7-1 The balance sheet shows the assets, along with the sources of funds used to acquire the assets, at a point in time, say 12/31/12. The income statement shows the sales and profits that were produced during an interval of time, say the year 2012. An individual would have assets, and a net worth, and a balance sheet would detail these holdings. The individual would also have income and expenses, and his or her income statement would detail these ...view middle of the document...

c. The stock market collapse had serious economic consequences. First, companies had a hard time raising new equity capital, and that restricted growth. Second, individuals who saw their portfolios decline were worried and thus spent less, and that put a further drag on the economy. In general, a strong economy needs good capital markets, and that can occur only if investors can obtain good information about the companies whose securities they are buying.

7-3 In essence, the statement of cash flows strips out non-cash charges that are shown on the income statement and ends up showing the surplus or deficit of cash generated during the year. For example, depreciation and amortization charges reduce net income, but they are non-cash charges, so they are added back when constructing the statement of cash flows. Since cash is what’s available to companies to spend or pay out to investors, the cash flow statement is quite important, especially after Enron.

7-4 Net income is the reported after-tax accounting profits, and EPS is net income divided by the number of shares outstanding. (If options are outstanding, the number of shares used to find EPS may be adjusted to reflect EPS after options have been exercised.) EBITDA is operating income before interest, taxes, depreciation, and amortization. This number is especially important to banks and other creditors because it is an approximation to the cash flow being generated from operations that is available to make payments on debt. NOPAT is net operating profit after taxes. It is found as EBIT(1-T), and it shows how much after-tax operating profit the firm would generate if it had no debt. Free cash flow is the cash flow available to investors after the firm has paid its taxes and made all investments in fixed assets and working capital necessary to sustain operations going forward. FCF = (NOPAT + Depreciation) – Gross investment in operating assets = NOPAT – Net investment in operating assets. MVA is the market value of the stock minus the book value, and it shows how much value management has added since the firm’s inception. EVA is economic value added, and it is found as EVA = EBIT(1-T) – (operating capital)(WACC). EVA shows how much management has added to the firm’s value through operations during a specific year. MVA is sometimes used to measure management’s performance and as a basis for long-run compensation to the top managers. EVA can be measured on a divisional basis, and it is used as a basis for annual incentive compensation plans.

7-5 Regular accounting statements reported the combined results generated from operating and non-operating assets (such as marketable security holdings), and cash and non-cash items are mixed. Management is interested in separating out operating results, and in cash flows as well as accounting income. So, the accounting statements are modified to produce information that is more useful to managers.

7-6 Free cash flow shows the...

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