Summary
Summary Concepts notes accounting
- Course
- Accounting 200
- Institution
- University Of Johannesburg (UJ)
This document provides a description of accounting terms for better understanding
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CHAPTER 1INTRODUCTION TO FINANCIAL
MANAGEMENT
Basic
1. Capital budgeting (deciding on whether to expand a manufacturing plant), capital structure (deciding
whether to issue new equity and use the proceeds to retire outstanding debt), and working capital
management (modifying the firm’s credit collection policy with its customers).
2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, hard to raise
capital funds. Some advantages: simpler, less regulation, the owners are also the managers,
sometimes personal tax rates are better than corporate tax rates.
3. The primary disadvantage of the corporate form is the double taxation to shareholders of distributed
earnings and dividends. Some advantages include: limited liability, ease of transferability, ability to
raise capital, unlimited life, and so forth.
4. The treasurer’s office and the controller’s office are the two primary organizational groups that
report directly to the chief financial officer. The controller’s office handles cost and financial
accounting, tax management, and management information systems, while the treasurer’s office is
responsible for cash and credit management, capital budgeting, and financial planning. Therefore,
the study of corporate finance is concentrated within the treasury group’s functions.
5. To maximize the current market value (share price) of the equity of the firm (whether it’s publicly-
traded or not).
6. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders
elect the directors of the corporation, who in turn appoint the firm’s management. This separation of
ownership 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 the firm.
Intermediate
7. Such organizations frequently pursue social or political missions, so many different goals are
conceivable. One goal that is often cited is revenue minimization; i.e., provide whatever goods and
services are offered at the lowest possible cost to society. A better approach might be to observe that
even a not-for-profit business has equity. Thus, one answer is that the appropriate goal is to
maximize the value of the equity.
8. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows,
both short-term and long-term. If this is correct, then the statement is false.
,B-2 Solutions
9. An argument can be made either way. At the 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, ethical and/or illegal
behavior, and the framework of stock valuation explicitly includes these. At the other extreme, we
could 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 in product liability claims. What should the firm do?”
10. The goal will be the same, but the best course of action toward that goal may be different because of
differing social, political, and economic institutions.
11. The goal of management should be to maximize the share price for the current shareholders. If
management 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 outside company. If management believes that
this bidder or other unidentified bidders will actually pay more than $35 per share to acquire the
company, then they should still fight the offer. However, if the current management cannot increase
the value of the firm beyond the bid price, and no other higher bids come in, then management is not
acting in the interests of the shareholders by fighting the offer. Since current managers often lose
their jobs when the corporation is acquired, poorly monitored managers have an incentive to fight
corporate takeovers in situations such as this.
15. How much is too much? Who is worth more, Jack Welch or Tiger Woods? The simplest answer is
that there is a market for executives just as there is for all types of labor. Executive compensation is
the price that clears the market. The same is true for athletes and performers. Having said that, one
aspect of executive compensation deserves comment. A primary reason executive compensation has
grown so dramatically is that companies have increasingly moved to stock-based compensation.
Such movement is obviously consistent with the attempt to better align stockholder and management
interests. In recent years, stock prices have soared, so management has cleaned up. It is sometimes
argued that much of this reward is simply 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 price increases in excess of general market increases.
,CHAPTER 2
FINANCIAL STATEMENTS, TAXES, AND
CASH FLOW
Basic
1. Balance Sheet
CA $2,500 CL $1,000 OE = $8,850 – 5,800 = $3,050
NFA 6,350 LTD 4,800 NWC = $2,500 – 1,000 = $1,500
TA $8,850 OE 3,050
TL + OE $8,850
2. Income Statement
Sales $350,000
Costs 175,000
Depreciation 25,000
EBIT $150,000
Interest 17,000
EBT $133,000
Taxes 45,220
Net income $87,780
3. Net income = Divs + Add. to ret. earnings; Add. to ret. earnings = $87,780 – 21,000 = $66,780
4. EPS = NI / shares = $87,,000 = $4.39 per share
DPS = Divs / shares = $21,,000 = $1.05 per share
5. NWC = CA – CL; CA = 500K + 750K = $1.25M
Book value CA = $1.25M Market value CA = $1.50M
Book value NFA = $0.75M Market value NFA = $1M
Book value assets = 1.25 + 0.75 = $2M Market value assets = 1.5 + 1 = $2.5M
6. Taxes = 0.15( $50K) + 0.25( $25K) + 0.34( $25K) + 0.39( $190K – $100K) = $57,350
7. Average tax rate = $57,,000 = 30.18%; Marginal tax rate = 39%
, B-4 Solutions
8. Income Statement
Sales $10,000 OCF = EBIT + D – T
Costs 6,350 = 1,550 + 2,100 – 423.50 = $3,226.50
Depreciation 2,100
EBIT $1,550
Interest 340
Taxable income $1,210
Taxes (35%) 423.50
Net income $786.50
9. Net capital spending = NFAend – NFAbeg + Depreciation = 4.9M – 3.6M + 780K = $2,080,000
10. Change in NWC = NWCend – NWCbeg = ( CAend – CLend) – ( CAbeg – CLbeg)
= ( 1,150 – 475) – ( 900 – 400) = 675 – 500 = $175
11. Cash flow to creditors = Interest paid – Net new borrowing = 360K – ( LTDend – LTDbeg)
= 360K – ( 3.4M – 3.0M) = 360K – 400K = – $40K
12. Cash flow to stockholders = Dividends paid – Net new equity = 250K – [ ( Commonend +
APISend) – ( Commonbeg + APISbeg) ]
= 300K – [ (825K + 7.7M) – (750K + 7.2M)]
= 300K – [8.525M – 7.95M] = –$275K
13. Cash flow from assets = Cash flow to creditors + Cash flow to stockholders
= –$40K – 275K = –$315K
Cash flow from assets = –$315K = OCF – Change in NWC – Net capital spending
= OCF – (–$135K) – ($600K) = –$315K;
Operating cash flow = –$315K – 135K + 600K = $150K
Intermediate
14. Income Statement
Sales $125,000 a. OCF = EBIT + D – T
Costs 76,000 = 32,000 + 5,000 – 9,860 = $27,140
Gross margin $49,000 b. CFC = Interest – Net new LTD
Other expenses 12,000 = 3,000 – ( –4,500) = $7,500
Depreciation 5,000 c. CFS = Dividends – Net new equity
EBIT $32,000 = 4,300 – 1,200 = $3,100
Interest 3,000 d. CFA = CFC + CFS = 7,500 + 3,100 = $10,600
Taxable income $29,000 10,600 = OCF – Net cap. sp. – Change in NWC;
Taxes (34%) 9,860 Net cap. sp. = Inc. in NFA + Depreciation
Net income $19,140 = 5,050 + 5,000 = $10,050
Dividends 4,300 Change in NWC = OCF – Net cap. sp. – CFA
Add. to ret. earnings $14,840 = 27,140 – 10,050 – 10,600
= $6,490
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