Foundations of Financial Management

14th Edition Block Solutions Manual

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Foundations of Financial Management 14th Edition Block Solutions Manual

Chapter 02: Review of Accounting

Chapter 2
Review of Accounting

Discussion Questions
2-1. Discuss some financial variables that affect the price-earnings ratio.

The price-earnings ratio will be influenced by the earnings and sales growth of
the firm, the risk or volatility in performance, the debt-equity structure of the
firm, the dividend payment policy, the quality of management, and a number of
other factors. The ratio tends to be future-oriented, and the more positive the
outlook, the higher it will be.

2-2. What is the difference between book value per share of common stock and
market value per share? Why does this disparity occur?

Book value per share is arrived at by taking the cost of the assets and
subtracting out liabilities and preferred stock and dividing by the number of
common shares outstanding. It is based on the historical cost of the assets.
Market value per share is based on current assessed value of the firm in the
marketplace and may bear little relationship to original cost. Besides the
disparity between book and market value caused by the historical cost approach,
other contributing factors are the growth prospects for the firm, the quality of
management, and the industry outlook. To the extent these are quite negative or
positive; market value may differ widely from book value.

2-3. Explain how depreciation generates actual cash flows for the company.

The only way depreciation generates cash flows for the company is by serving
as a tax shield against reported income. This non-cash deduction may provide
cash flow equal to the tax rate times the depreciation charged. This much in
taxes will be saved, while no cash payments occur.

2-4. What is the difference between accumulated depreciation and depreciation

expense? How are they related?

Accumulated depreciation is the sum of all past and present depreciation

charges, while depreciation expense is the current year’s charge. They are
related in that the sum of all prior depreciation expense should be equal to
accumulated depreciation (subject to some differential related to asset
write-offs).

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Chapter 02: Review of Accounting

2-5. How is the income statement related to the balance sheet?

The earnings (less dividends) reported in the income statement is transferred to

the ownership section of the balance sheet as retained earnings. Thus, what we
earn in the income statement becomes part of the ownership interest in the
balance sheet.

2-6. Comment on why inflation may restrict the usefulness of the balance sheet as
normally presented.

The balance sheet is based on historical costs. When prices are rising rapidly,
historical cost data may lose much of their meaning–particularly for plant and
equipment and inventory.

2-7. Explain why the statement of cash flows provides useful information that goes
beyond income statement and balance sheet data.

The income statement and balance sheet are based on the accrual method of
accounting, which attempts to match revenues and expenses in the period in
which they occur. However, accrual accounting does not attempt to properly
assess the cash flow position of the firm. The statement of cash flows fulfills
this need.

2-8. What are the three primary sections of the statement of cash flows? In what
section would the payment of a cash dividend be shown?

The sections of the statement of cash flows are:

Cash flows from operating activities

Cash flows from investing activities
Cash flows from financing activities

The payment of cash dividends falls into the financing activities category.

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Chapter 02: Review of Accounting

2-9. What is free cash flow? Why is it important to leveraged buyouts?

Free cash flow is equal to cash flow from operating activities:

Minus: Capital expenditures required to maintain the productive capacity

of the firm.

Minus: Dividends (required to maintain the payout on common stock and

to cover any preferred stock obligation).

The analyst or banker normally looks at free cash flow to determine whether
there are sufficient excess funds to pay back the loan associated with the
leveraged buy-out.

2-10. Why is interest expense said to cost the firm substantially less than the actual
expense, while dividends cost it 100 percent of the outlay?

Interest expense is a tax deductible item to the corporation, while dividend

payments are not. The net cost to the corporation of interest expense is the
amount paid multiplied by the difference of one minus the applicable tax rate.

For example, $100 of interest expense costs the company $65 after taxes when
the corporate tax rate is 35 percent; for example, $100 × (1 – .35) = $65.

Chapter 2

Problems
1. Income Statement (LO1) Frantic Fast Foods had earnings after taxes of $390,000 in the
year 2009 with 300,000 shares outstanding. On January 1, 2010, the firm issued 25,000
new shares. Because of the proceeds from these new shares and other operating
improvements, earnings after taxes increased by 20 percent.
a. Compute earnings per share for the year 2009.
b. Compute earnings per share for the year 2010.

2-1. Solution:

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 XXXVI. Carved Oak Furniture at Sizergh.
This fine Mansion from which we have already given some illustrations,
possesses much furniture of the description here given. The form or long
seat is peculiar in style and is one of a number, formerly in the Chapel. It
has the date 1562 and the letters W. S., the initials of the Strickland of that
time, carved upon it.
 XXXVII. Door of a Cupboard, and Carved Seat ends in the
Chapel of Brougham Hall.
This Chapel has become, for its size, perhaps the most gorgeously
decorated in England, under the direction of Mr. W. Brougham. Many rich
carvings have been collected and the whole illuminated. The cupboard or
press is beside the altar and holds the sacramental vessels. It is carved
wood, and the iron hinges and the lock have been lately gilt.

XXXVIII. Knocker. Fibulae. Celt. Spur.

1. Great Knocker on the door of Durham Cathedral. 2. Bronze Fibula
about 3 in. diameter found in the Tyne. 3. Beautiful enamelled Fibula. The
original is a third larger than the engraving. It is of brass or bronze thickly
enamelled, and is an elegant adaptation of the form of a harp to the
purposes of a buckle. It was dug up at Risington, Northumberland, 1842. 4.
Ancient bronze Celt. This form of weapon has been frequently found, but
the present example is decorated with a formal ornament, which gives it a
greater value. 5. A Spur found in a morass; it resembles the earliest form in
the collection at Goodrich Court, described as Norman by Sir S. Meyrick.
 PLATE I
Nautilus Cup and Cover
SET IN GOLD
The Property of P. H. Howard Esqʳ. M. P. Corby Castle
Pubᵈ. by G. Bell Fleet Sᵗ. London
 PLATE II
Ivory Cup Set in Gold
The Property of P. H. Howard Esqʳ. M. P. Corby Castle
Pubᵈ. by G. Bell Fleet Sᵗ. London
 PLATE III
Antiquities in Jarrow Church
1ˢᵗ. Chair of the Venerable Bede. 2ⁿᵈ. Norman Stone Carving. 3ʳᵈ. Oak Reading Desk.
Pubᵈ. by G. Bell Fleet Stᵗ. London
 PLATE IV
Norman Book Cover
In the Library of Durham Cathedral.
The seperate stamps are the size of the Originals.
Pubᵈ. by G. Bell Fleet Sᵗ. London
 PLATE V
Relics of the Commonwealth
1ˢᵗ. Sword of Cromwell. 2ⁿᵈ. Sword of Genˡ. Lambert. 3ʳᵈ. Sword of Sir T. Fairfax. 4ᵗʰ. Cromwell’s
Watch. 5ᵗʰ. Matrix of seal for the Licensing of Preachers.
The property of F. H. Fawkes Esqʳ. Farnley Hall.
Pubᵈ. by G. Bell Fleet Sᵗ. London.
 PLATE VI
Carved Chimney Piece.
In the Merchants Hall. Guildhall. Newcastle.
Pubᵈ. by G. Bell Fleet Sᵗ. London.
 PLATE VII
Norman Wall-Painting
In the Galilee. Durham Cathedral.
Pubᵈ. by G. Bell Fleet Sᵗ. London.
 PLATE VIII
Norman Wall-Painting
In the Galilee. Durham Cathedral.
Pubᵈ. by G. Bell Fleet Sᵗ. London.
 PLATE IX
Carved Chairs
& Earthenware FLOWER JAR. for the Wall
Property of the Revᵈ. G. Abbes Cleadon
Pubᵈ. by G. Bell Fleet Sᵗ. London.
 PLATE X
Carved Furniture
Property of E. Charlton Esqʳ. M.D. Newcastle
Pubᵈ. by G. Bell Fleet Sᵗ. London
 Plate XI
Ancient Pulpit
Of Jarrow Church from portions in the Possession of G. Rippon Esq. North Shields.
Pubᵈ. by G. Bell Fleet Sᵗ. London
 PLATE XII
Small Figures.
Under Canopies on the Altar Tomb of John Lord Neville 1389. Durham Cathedral.
(HEADS ALL RESTORED)
Pubᵈ. by G. Bell Fleet Sᵗ. London.
 PLATE XIII
Pastoral Staff,
Of Ivory Illuminated, Property of P. H. Howard Esq.
2 Ornament on Base. 3 Ivory Pastoral Staff in the Museum, Newcastle.
Pubᵈ. by G. Bell Fleet Sᵗ. London.
 PLATE XIV
1 Frith Stool of the Ancient Sanctuary, Hexham Church. 2 Enrichments Arcade, ditto. 3 Ancient Key
of Sᵗ. Edmund’s Church, Gateshead. 4 Key found at Tynemouth Abbey. 5 Ancient Copper Vessel,
presented to Wreay Church, by Miss Losh of Woodside.
 Pubᵈ. by G. Bell Fleet Sᵗ. London.

PLATE XV
Antiquities in York Minster.
1 Horn of Ulphus. 2 Cordwainer’s Bowl. 3 Ancient Tiles.
Pubᵈ. by G. Bell Fleet Sᵗ. London.
 PLATE XVI
Crucifix.
Enamelled and Gilt on Copper, in the possession of W. H. Charlton Esq.
Pubᵈ. by G. Bell Fleet Sᵗ. London.
 PLATE XVII
Oak Chair.
In Corby Castle, the Seat of P. H. Howard Esq M. P.