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Financial statements 5th Edition Stephen Barrad - Solutions

Explain what is meant by a financing risk premium in the equity cost of capital. When will a financing risk premium be negative?
A firm with positive financial assets will typically have a required return for equity that is greater than the return for its operations. Is this correct?
What is wrong with tying management bonuses the earnings per share? What measure would you propose as a management performance metric?
The management of a firm that ties employee bonuses to return on common equity repurchases some of the firm’s outstanding shares. What is the effect of this transaction on shareholders’ wealth?
An increase in financial leverage increases return on common equity (if the operating spread is positive), and thus increases residual earnings. The value of equity is based on forecasted residual earnings, yet it is claimed that the value of equity is not affected by a change in financial
Levered price-to-book ratios are always higher than unlevered price-to-book ratios. Is this correct?
During the 1990s and 2000s, many firms repurchased stock and borrowed to do so. What is the typical effect of stock repurchases on earnings-per-share growth and return on common equity? Predict how a rim that excessively engaged in these practices would have fared in the down turn in 2008.
If an investor wants to buy a stock with high earnings growth but with how risk, she must pay a high multiple of earnings for it. Correct?
Does an increase in financial leverage increase or decrease the (leverage) P/E ratio?
Established firms, like General Electric, have low beta risk, low earnings volatility, but consistently high earnings growth rates. These firms should have particularly high P/E ratios. Correct?
Here are summary financial statements for a firm (in millions of dollars):The required return for equity is 12 percent, the required return for operations is 11 percent, and the required return for debt is 10 percent. The firm pays no taxes.Calculate residual earnings, residual operating income,
Here are summary numbers from a firm's financial statements (in millions):The required return for operations is 10.1 percent. Calculate residual operating income, return on net operating assets (RNOA), and the growth rate for net operating assets for each year2007-2009.
Here are summary numbers from a firm's financial statements (in millions):The required return for operations is 10.1 percent. Calculate abnormal operating income growth for each year2007-2009.
Here are financial statements for a firm (in millions of dollars):The firm has a required return of 10 percent for operations. Calculate residual operating income for 2009 and 2008 using beginning-of-year balance sheet numbers. Then calculate abnormal operating income growth for2009.
From the following data, calculate the cost of capital for operations (WACC). Use the capital asset pricing model to estimate the cost of equity capital.U.S. Government long-term bond rate ....... 4.3%Market risk premium .............. 5.0%Equity beta .................. 1.3Per-share market
A firm with a required return of 10 percent for operations has book value of net debt of $ 2,450 million with a borrowing cost of 8 percent and tax rate of 37 percent. The firm’s equity is worth $8,280 million, what is the required return for its equity?
The following forecasts were made for a firm with net operating assets of $1.135 million and net financial obligations of $720 million at the end of 2005 (in millions of dollars):The required return for operations is 10.1 percent. Forecast residual operating income for these years and, from these
Using the forecasts in Exercise E 13.7, forecast abnormal operating income growth and, from these forecasts, value the operations and the equity. The required return for operations is 10.1 percent.
Box 13.5 in this chapter demonstrated how stock repurchases and leverage changes can increase earnings- per-share growth. Answer the following questions regarding the effect of the stock repurchase.a. Why does the stock repurchase have no effect on the per-share value of the equity?b. Why does
A firm has the following summary balance sheet and income statement (in millions):Net operating assets .... $469Net financial obligations .. 236Common equity ..... $233Operating income ...... $ 70Net financial expense .... 14Earnings ......... $56The firm held the same amount of net financial
The following pro forma was prepared for a firm at the end of 2009 (in millions of dollars):The firm has a required return for its operations of 9 percent and a 5 percent after-tax cost of debt. Pro forma financial statements after 2012 are forecasted to be similar to those in 2012.a. Forecast the
The Quality of Carrying Values for Equity Investments: SunTrust Bank (Easy). In 1993, SunTrust Bank of Atlanta reported investment securities on its balance sheet of $10,644 million, an increase over the $8,715 million reported for 1992. Footnotes revealed that most of the securities were
Pennzoil (now PennzEnergy Corporation), the oil company, has a substantial holding of Chevron Corporation, another oil company. But the holding (of 7.1 million shares at the end of 1998) is less than 20 percent of Chevron. The Chevron shares are classified as available for sale, so are carried at
IBM's 1,385.2 million outstanding shares traded at $102 each when its 2007 financial statements were published. Those statements reported common shareholders' equity of $28,470 million and net financial obligations of $19,619 million. Footnotes reveal that the firm's net borrowing cost (after tax)
Reformulated balance sheets and income statements for General Mill's 2008 fiscal year are in Exhibits 9.5 and 9.11 in Chapter 9. The firm's 337.5 million outstanding shares traded at $60 each at the time the 2008 statements were published. From these financial statements, calculate the following
Dell, Inc., reported after-tax operating income of $2,618 million for fiscal year 2008, along with operating assets at the beginning of the year of $13,230 million and operating liabilities of $ 20,439 million.Using a cost of capital for operations of 12 percent, calculate Dell's residual
At the end of its 2004 fiscal year, the 263.1 million outstanding shares of Nike, Inc., traded at $75 each. The following summary numbers are from the 2004 financial report (in millions of dollars}.a. Calculate the levered and unlevered (enterprise) price-to-book ratios at which Nike traded at the
The following summary numbers (in millions of dollars) were calculated from Nike's 2005 balance sheet:Net operating assets ............. 4,632Net financial assets .............. 1.012Common equity (261.1 million shares outstanding) 5,644Analysts were forecasting $5.08 in earnings per share for
In June 2007, the Web travel firm Expedia, Inc., announced that it would buy back as much as 42 percent of its shares, with the repurchase financed by new borrowings.a. What is the likely effect on earnings per share and earnings per share growth?b. What is the effect on the risk that the
Chubb Corporation is a property and casualty insurance holding company providing insurance through its subsidiaries in the United States, Canada, Europe, and parts of Latin America and Asia. Its subsidiaries include Federal, Vigilant, Pacific Indemnity, Great Northern, Chubb National, Chubb
Why is income in the equity portion of the balance sheet called "dirty-surplus" income?
Why can "value be lost" if an analyst works with reported net income rather than comprehensive income?
Are currency translation gains and losses real gains and losses to shareholders? Aren't they just an accounting effect that is necessary to consolidate financial statements prepared in different currencies?
In accounting for the conversion of convertible bonds to common stock, most firms record the issue of shares at the amount of the book value of the bonds. The issue of the shares could be recorded at their market value, with the difference between the market value of the shares and the book value
The compensation vice president of General Mills was quoted in The Wall Street Journal on January 14, 1997, as saying that option programs are "very attractive for shareholders" because they cut fixed costs and boost profits. So, for General Mill's 1996 year, selling, general, and administrative
Before it found the practice to be too expensive, Microsoft (and a number of other firms) was in the habit of repurchasing some of the shares that it issued each year as employees exercised stock options. The rationale, according to commentators, was to avoid the dilution from shares issued to
Cisco Systems, the networking equipment firm, reported a tax benefit from the exercise of stock options of $537 million in its fiscal 2004shareholders' equity statement. Over the previous years, the tax benefits had cut more than 25 percent off the firm's tax bills. Commentators saw this tax
In February 1999, Boots, the leading retail chemist in the United Kingdom, announced plans to reform its employee option compensation scheme. In the future, it said, the firm will purchase its own shares to provide shares to issue when options are exercised, and it will charge the difference
In September 1999, Microsoft agreed to buy Visio Corporation for stock valued at $1.26billion. Visio sells a popular line of technical drawing software. At the time, Microsoft had $14 billion of cash on its balance sheet. Why might Microsoft pay for the acquisition with its own stock rather than in
(a) A firm listed total shareholders’ equity on its balance sheet at $237 million. Preferred shareholders’ equity was $32 million, what is the common shareholders’ equity?(b) From the following information, calculate the net dividend to shareholders and comprehensive income (in
From the following information, calculate the return on common equity for the year 2009 (amount in millions of dollars). There were no share repurchases.Common stockholders’ equity, December 31, 2008 ..... 174.8Dividends paid to common stockholders ......... 8.3Share issue on December 31, 2009
From the following information prepare a reformulated statement of common shareholders’ equity for 2008. Amounts are in millions.Balance, December 31, 2007 ..... $1,206Net income .............. 241Foreign currency translation loss .... (11)Unrealized gain on debt security held ... 24Issue of
The following is a statement of common shareholders’ equity with some numbers missing (in millions of dollars).Balance, December 31, 2007 ............... ?Net income ....................... ? Common dividends ................ (132)Preferred dividends ................ (30)Issue of shares
In 2004, an employee was granted 305 options on the stock of a firm with an exercise price of $20 per option. In 2009, after the options had vested and when the stock was trading at $35 per share, she exercised the options. The firms’ income tax rate is 36 percent. What was the after-tax cost to
Reformulate the following statement of shareholders’ equity. The firm’s tax rate is 35%.Balance, end of fiscal year 2008 ........ 1,430Share issues from exercised employee stock options . 810Repurchase of 24 million shares ......... (720)Cash dividend ................ (180)Tax benefit from
Reformulate the following statement of shareholders' equity statement for J.C. Penney Company. Dividends paid consisted of $24 million in preferred dividends and $225 million in commondividend
The statement of shareholders' equity below for Starbucks Corporation, the retail coffee vendor, is for fiscal year 2007.(a) Reformulate the statement to distinguish comprehensive income from transactions with shareholders(b) Calculate the after-tax loss to shareholders from the exercise of stock
The following is adapted from the statement of shareholders’ equity for Intel Corporation for 2000 (in millions of dollars). Intel faces a 38 percent tax rate.Balance, December 25, 1999 .......... 32,535Net income ................. 10,535Unrealized loss on available-for-sale securities ...
In 1996, Microsoft issued 12.5 million convertible preferred shares carrying a dividend of 2.75 percent for $980 million. The shares were converted into common shares in December 1999, with each preferred share receiving 1.1273 common shares. At the time of conversion, Microsoft’s common shares
In September 2008, in the midst of the credit on Wall Street, Goldman Sachs invited Warren Buffett, the legendary fundamental investors, to contribute much-needed equity capital to firm. Buffett seemingly got a very good deal. For a $5 billion cash infusion, he received perpetual preferred equity
The following is a condensed version of the statement of shareholders’ equity for Dell, Inc., for fiscal year ending January 31, 2003 (in millions of dollars):Balance at February 1, 2002 ........ 4,694Net income ............... 2,122Unrealized gain on debt investments ...... 26Unrealized loss on
Using the statement of shareholders’ equity in Exhibit 8.1, carry out a ratio analysis that highlights the information about Nike in that statement.
Household International (acquired by HSBC in 2003 and now known as HSBC Finance Corporation) is one of the largest U.S. lenders to consumers with poor credit histories, carrying receivables for auto loans, Master card and Visa credit card debt, and a significant amount of private noncredit card
Microsoft has undoubtedly been the most successful software firm ever. Between 1994 and 2000, the firm's revenues increased from $2.8 billion to $23.0 billion, and its earnings from $ 708 million to $9.4 billion. Over the two year 1998 to 2000, its stock price increased from $36 per share to almost
Why are reformulated statements necessary to discover operating profitability?
Classify each of the following as a financial asset or an operating asset:a. Cash in a checking account used to pay bills.b. Accounts receivable.c. Finance receivables for an automobile firm.d. Cash in 90-day interest-bearing deposits (cash equivalents).e. Debt investments held to maturity.f.
Classify each of the following as a financial liability, an operating liability, or neither:a. Accrued compensation.b. Deferred revenues.c. Preferred stock.d. Deferred tax liability.e. Lease obligations.f. Interest-bearing note payable.
From the point of view of the common shareholders, minority interest is a financial obligation. Correct?
What is meant by saying that debt provides a tax shield?
When can a firm lose the tax benefit of debt?
What does an operating profit margin reveal?
(a) The following numbers were extracted from a balance sheet (in million):Operating assets ... $547Financial assets .... 145Total liabilities ..... 322Of the total liabilities, $190 million were deemed to the financing liabilities. Prepare a reformulated balance sheet that distinguishes items
A firm reported $818 million of net income in its income statement after $140 million of net interest expenses and income taxes, using a statutory tax rate of 35 percent.
From the following income statement (in millions), calculate operating income after tax, using both the top-down and bottom-up methods. Use a tax rate of 37 percent.Revenue ......... $ 6,450Cost of goods sold ..... (3,870)Operating expenses .... (1,843)Interest expense ...... (135)Income taxes
Reformulate the following balance sheet and income statement for a manufacturing concern. Amounts are in millions. The firm bears a 36 percent statutory taxrate.
The following financial statement reported for a firm for fiscal year 2099 (in millions of dollars):The firm's tax rate is 35%. The firm reported $15 million in interest income and $98 million in interest expenses for 2009. Sales revenue was $3,726 million.(a) Reformulate the balance sheet for 2009
Fill in the missing number, indicated by capital letters, in the following reformulated income statement. Amounts are in millions of the dollars. The firm€™s marginal tax rate is 35 percent.What is the firm€™s effective tax rate on operatingincome?
In October 2008, the 142.562 outstanding shares of Realnetworks, Inc., traded at $3.96 each. The most recent quarterly balance sheet reported $454 million in net financial assets and $876 million in common shareholders’ equity?(a) What is the price to-book ratio for the firm’s equity?(b) What
Pepsi, Inc. reported the following income statement for 1999 (in millions) of dollars:Net sales ........... 20,367Operating expenses .... 117,484Restructuring charge ...... (65)Operating profit ....... 2,818Gain on asset sales ...... 1,083Interest expense ....... (363)Interest income .........
Below are comparative income statements and balance sheets for Stabucks Corporation, the retail coffee vendor, fiscal year ending September 30, 2007, along with a statement of shareholders’ equity. Read the statement along with the notes under them, then answer the following questions:(a) Prepare
Home Depot is the largest home improvement retailer in the United States and one of the largest retailers.Home Depot is income statements for 2003-2005 are below, along with an extract from its tax footnote. Reformulate the income statement for 2005 with the appropriate tax allocation between
Formed in 1837 by William Procter and James Gamble as a small family-operated soap and candle company, Procter & Gamble Co. is now a leading consumer products company with over $83 billion in revenues. Headquartered in Cincinnati, Ohio, the firm's products are sold in more than 180
Chubb Corporation is a property and casualty insurance holding company providing insurance through its subsidiaries in the United States, Canada, Europe, and parts of Latin America and Asia. Its subsidiaries include Federal, Vigilant, Pacific Indemnity, Great Northern, Chubb National, Chubb
Why might cash flow analysis be important for valuing firms?
For what purposes might forecasting cash flows be an analysis tool?
For a pure equity firm (with no net debt), how is free cash flow disposed of?
By investing in short-term securities to absorb excess cash, a firm reduces its cash flow after investing activities in its published cash flow statement. What is wrong with this picture?
Do you consider the direct method to be more informative than the indirect method of presenting cash flow from operations?
GAAP cash flow statements treat interest capitalized during construction as investment in plant, do you agree with this practice?
Why is free cash flow sometimes referred to as a liquidation concept?
Why might an analysis not put much weight on a firm’s current free cash flow as an indication of future free cash flow?
Consider the following quote from the CFO of Lear Corp. “Sales of receivable and operating cash flows are entirely separate events. We see sales of receivables as a low-cost financing method; it shouldn’t generate operating cash flow.” Do you agree?
What factors produce growth in free cash flow?
State whether the following transactions affect cash flow from operations, free cash flow, financing flows, or none of them.(a) Payment of a receivable by a customer(b) Sale to a customers on credit(c) Expenditure on plant(d) Expenditure on research and development(e) Payment of interest (f)
A firm reported comprehensive income of $376 million for 2009, consisting of $500 million in operating income (after tax) less $124 million of net financial expenses (after tax). It also reported the following comparative balance sheet (in millions of dollars):Compute the cash flow using Method 1
Considered the following comparative balance sheets for the Liquidity Company:The company paid a dividend of $150,000 during 2008 and there were no equity contributions or stock repurchases.a. Calculate free cash flow generated during 2008.b. where did the increase in cash come from?c. how would
The following information is form the financial of a pure equity company (one with no net debt). In millions of dollars.Common shareholders' equity, December 31, 2008 .... 174.8Common dividends, paid December 2009 ......... 8.3Issue of common shares on December 31, 2009 ....... 34.4Common
The following is for a firm that has net debt on its balance sheet (in millions of dollars).Common shareholders' equity, December 31, 2007 ... 174.8Common dividends, paid December 2008 ........ 8.3Issue of common shares, December 2008 ....... 34.4Common shareholders' equity, December 31, 2008 ...
A firm reported free cash flow of $430 million and operating income of $390 million. (a) By how much did its net operating assets change during the period?(b) The firm invested $29 million cash in new operating assets during the period. What were its operating accruals?(c) The firm incurred net
An analyst prepared reformulated balance sheets for the year 2009 and 2008 follows (in millions of dollars):The firms reported $100 million in comprehensive income for 2009 and no net financial income or expense.(a) Calculate the free cash flow for 2009.(b) How was the free cash flow disposed
The following summarizes free cash flows generated by General Electric from 2000-2004 (in millions of dollars).a. Explain why such a profitable firm as General Electric can have negative free cash flow.b. In 2005, the firm announced that the years of building its set of businesses was "largely
Refer to the reformulated balance sheets and income statements for General Mills, Inc., in Exhibits 9.5 and 9.11 in Chapter 9. Calculate free cash flow for 2008 from these statements.
Below are summary numbers from reformulate balance sheets for 2007 and 2006 for Kimberly-Clark Corporation, the paper products company, along with numbers from the reformulated income statement for 2007 (in millions).a. The net payout to shareholders (dividends and share repurchases minus share
For many years, Microsoft has generated considerable free cash flow. Up to 2004, it paid no dividends and had no debt to pay off, so it invested the cash in interest-bearing securities. Its balance sheet at the end of its second (December) quarter for fiscal year ending June 2005 reported the
At various points in this book, Dell, Inc., the computer manufacturer, has been highlighted. The firm's 2008 financial statements are reproduced in Exhibit 2.1 in Chapter 2 and its reformulated balance sheets and income statements appear in Exhibits 9.4 and 9.10 in Chapter 9. Reported cash flows
Under what condition conditions would a firm’s return on common equity (ROCE) be equal to its return on net operating assets (RNOA)?
Under what condition would firm’s return on net operating assets (RNOA) be equal to its return on operating assets (ROOA)?
State whether the following measures drive return on common equity (ROCE) positively, negatively, or depending on the circumstances:(a) Gross margin.(b) Advertising expense ratio(c) Net Borrowing cost.(d) Operating liability leverage.(e) Operating liability leverage spread.(f) Financial
Explain why borrowing might lever up the return on common equity.
Explain why operating liabilities might lever up the return on net operating assets.

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