2.1. Which of the following statements is FALSE?

A. Liquidity measures the speed and ease with which assets can be converted to cash
without significant loss of value, and fortress balance sheets are especially liquid.
B. Even though depreciation is not a cash expense, it affects taxes, and corporations prefer
to depreciate assets using accelerated over straight line methods for tax purposes.
C. The marginal tax rate is the tax rate payable on the next dollar earned and is always
higher than the average tax rate.
D. Operating Cash Flow is generated from utilizing existing assets after deducting interest
expense
FALSE: Interest expense is not deducted for Operating Cash Flow

2.21. Which of the following statements is FALSE?

A. While the book value of equity can be negative, the market value of equity cannot be
negative.
B. Market values are the prices at which assets, liabilities, and equities can be bought or sold
for now.
C. EBIT is the bottom line.
FALSE: Bottom line refers to a company's net earnings, net income or earnings per share
D. Average Tax Rates are less useful for making financial decisions than Marginal Tax
Rates.

2.MC8. Firms that compile financial statements according to GAAP:

A. record income and expenses at the time they affect the firms cash flows
B. have no discretion of recording either revenue or expense items
C. must record all expenses when incurred
D. can still manipulate their earnings to some degree

2.F13. Which of the following statements is FALSE?

A. While the book value of equity can be negative, the market value of equity cannot be
negative.
B. On the income statement, financial analysts often focus on a companys EBIT, and items
above this line depend on the companys long-term financing choices among debt and
equity.
C. The average tax rate is always less than or equal to, and often considerably less than, the
marginal tax rate.
D. Managers should use the marginal tax rate when making decisions regarding new
investments and financing choices.

2.F12. Which of the following statements is FALSE?

A. The market value of any asset is what an item is actually worth if sold and must always
be a positive value.
B. Even though depreciation is not a cash expense, it affects taxes, and corporations prefer
to depreciate assets using accelerated over straight line methods for tax purposes.
C. The marginal tax rate is the tax rate payable on the next dollar earned and, due to
deductions and credits, the marginal tax rate is always higher than the average tax rate.
 D. Priority measures the speed and ease with which assets can be converted to cash without
significant loss of value.

2.S13.Hwk6&7. Which of the following statements is FALSE?

A. The average tax rate is the total tax expense divided by the total taxable income.
B. The marginal tax rate is the tax rate that applies to the next dollar of taxable income that a
firm earns.
C. The average tax rate is always less than or equal to, and often considerably less than, the
marginal tax rate.
D. Managers should use the average tax rate when making decisions regarding new
investments and financing choices.

2.Hwk5. Which of the following statements is CORRECT?

A. Shareholders equity is the residual value of a firm
B. Net working capital must be a positive value
C. An increase in cash reduces the liquidity of a firm
D. Equipment is generally considered a highly liquid asset

2.F15.8. Operating cash flow is defined as:

A. a firm's net profit over a specified period of time.
B. the cash that a firm generates from its normal business activities using its existing assets.
C. the change in the net working capital over a stated period of time.

D. the cash that is generated and added to retained earnings.

Q2.A. (16 points) (a) Calculate the operating cash flow for 2010. Briefly discuss or interpret it.

OCF = EBIT + Depreciation Taxes = 120 + 120 35 = 205

The firms existing assets generated $205m in cash during 2010.

(b) Calculate the net capital expenditures for 2010. Briefly discuss or interpret it.

CapEx = NFA + Depreciation = 1,300 1,200 + 120 = 220

The firm invested $220m in additional fixed assets during 2010, which is far more than enough
to replenish depreciating capital and even a little larger than the operating cash flow from
existing assets.

(c) Calculate the investment in working capital for 2010. Briefly discuss or interpret it.

NWC = CA CL = (410-400) (210-160) = 40

The firm saved or recovered $40m in net working capital during 2010, driven by increasing its
accounts payable, possibly by delaying payments to suppliers.

(d) Calculate the Free Cash Flow From Assets for 2010. Briefly discuss or interpret it.

FCF = (EBIT + Depreciation Taxes) CapEx NWA = 205 220 40 = +25

The firms cash flow generated from existing assets exceeds its investments in additional assets
by $25m. Thats the amount available to be paid to investors.
Q2.P8. (8 points) Hammett, Inc., has sales of $19,570, costs of goods sold of $9,460,
depreciation expense of $2,130, and interest expense of $1,620. If the tax rate is 35%, what is its
net income? What is its operating cash flow? Does that represent cash flowing into or flowing
out of the company?

First calculate EBIT = Sales COGS SGA Depreciation = $19,570 9,460 2,130 = $7,980
Taxable Income subtracts interest expense: $7,980 1,620 = $6,360
Taxes at 35% of Taxable Income are 35% * 6,360 = $2,226
Net Income = Taxable Income Taxes = $6,360 2, 226 = $4,134
OCF = EBIT + Depreciation Taxes = $7,980 + 2,130 2,226 = $7,884
This positive Operating Cash Flow represents cash flowing into the company from current
operations.

Q2.P9. (5 points) Rotweiler Obedience Schools December 31, 2009 balance sheet showed net
fixed assets of $1,725,000 and the December 31, 2010 balance sheet showed net fixed asset of
$2,040,000. The companys 2010 income statement showed a depreciation expense of $321,000.
What was Rotweilers net capital spending for 2010? Does that represent cash flowing into or
flowing out of the company?

Net capital spending is the increase in fixed assets, plus depreciation.

CapEx = NFA + Depreciation = $2,040,000 1,725,000 + 321,000 = $636,000
This positive capital expenditure represents cash flowing out of the company to invest for future
operations.

Q2.P10. (5 points) The December 31, 2009 balance sheet of Annas Tennis Shop, Inc., showed
current assets of $1,015 and current liabilities of $870. The December 31, 2010 balance sheet
showed current assets of $1,230 and current liabilities of $905. What was the companys 2010
change in net working capital? Does that represent cash flowing into or flowing out of the
company?

Net Working Capital is current assets less current liabilities

NWC = CA CL = $1,015 870 = $145 at the end of 2009
NWC = CA CL = $1,230 905 = $325 at the end of 2010

The change in net working capital is the end of period net working capital minus the beginning
of period net working capital:
NWC = $325 145 = $180 in 2010
This positive change in net working capital represents cash flowing out of the company to invest
in current operating assets.
Ch2.KP8. (8 points) Last year, Drumor, Inc. earned $20.4m. This year it has sales of $81.3m,
costs of goods sold of $60.7m, depreciation expense of $18.5m, and interest expense of $4.1m. If
the tax rate is 35%, what is its net income? What is its operating cash flow? Does that represent
cash flowing into or flowing out of the company?

First calculate EBIT = Sales COGS SGA Depreciation = $81.3 60.7 18.5 = $2.1m
Taxable Income subtracts interest expense: $2.1 4.1 = $2.0m
Taxes at 35% of Taxable Income are 35% * 2.0 = $0.7m, which is a refund and fully
recoverable immediately because Drumor earned a substantial profit last year.
Net Income = Taxable Income Taxes = $2.0 $0.7 = $1.3m
OCF = EBIT + Depreciation Taxes = 2.1 + 18.5 0.7 = +$21.3m
This positive Operating Cash Flow represents cash flowing into the company from current
operations. Even though net income is negative, depreciation is non-cash and taxes in this case
provided a refund.

Ch2.KP9. (5 points) Drumors current balance sheet showed net fixed assets of $160.4m and its
balance sheet last year showed net fixed asset of $174.3m. The companys income statement this
year showed a depreciation expense of $18.5m . What was Drumors net capital spending for the
current year? Does that represent cash flowing into or flowing out of the company?

Net capital spending is the increase in fixed assets, plus depreciation.

CapEx = NFA + Depreciation = ($160.4m $174.3) + $18.5m = +$4.6m
Net fixed assets fell but by a smaller amount than caused by noncash depreciation. This positive
capital expenditure represents cash flowing out of the company to invest for future operations.
Ch2.Q52a. (15 points) (a) How much did the firm receive from operating cash flows in 2013?

OCF = EBIT + Depreciation Taxes = 26 + 47 7 = 66

The firms existing assets generated $66m in cash during 2013. Revenues exceeded cash costs by
$73m, and $7m were paid in cash taxes.

b) Combined, how much did the firm spend in 2013 on new investments in both net working
capital and in net capital expenditures?

CapEx = NFA + Depreciation = (442 470) + 47 = +19

The firm invested $19m in additional fixed assets during 2013. While positive, that amount was
insufficient to replenish depreciation, and its net fixed assets, net of depreciation, actually
declined.
NWA = CA CL = (194 186) (319 284) = 27
The firm recovered $27m in net working capital during 2013, as its current liabilities climbed
substantially more than its current assets did. Delaying payments to its suppliers actually reduces
the cash that a firm requires for operations.
Combined, the firms investment in capital expenditures and net working capital are +19 27 =
$8m, and since that amount is negative, the firm essentially divested in operations overall.

c) Calculate the firms Free Cash Flows from assets. Briefly discuss or interpret it. AND briefly
discuss how it was either paid for or used (hint in this case: if its Free Cash Flows were negative,
what balance(s) increased, or if its FCFs were positive, what decreased?)

The firms operating cash flow from existing assets generated $66m, and combined with its $8m
recovered investment in assets for future operations, its Free Cash Flows, available to be paid to
investors, amounted to $74m.
FCF = OCF (CapEx + NWA) = 66 (8) = +74
Of that amount, $6m was paid in interest on debt and $2m was paid in dividends to equity
holders. The remainder $66m reduced the debt balance and/or the common & paid-in equity: The
debt balance actually decreased by $54m and the equity balance decreased by $12m. Not only
did this firm pay interest to debt holders and dividends to equity holders, this firm paid down its
debt balance a lot and even (depending on accounting conventions) bought back some shares.

Ch2.Hwk4b. (12 points) Roscoe's purchased new machinery three years ago for $1.8 million.
The machinery can be sold to Stewart's today for $1.2 million. Roscoe's current balance sheet
shows net fixed assets of $840,000, current liabilities of $348,000, and net working capital of
$144,000. If all the current assets were liquidated today, the company would receive $476,000
cash. What is the book value of the firm's assets today? What is the market value? If these values
are not the same, briefly discuss why they differ.

The purchase price of the machinery has been depreciated to $840,000 on the current balance
sheet
Since NWC = CA CL, CA = NWC + CL = $144,000 + $348,000 = $492,000
Book value = $840,000 + $492,000 = $1,332,000
Market value = $1,200,000 + $476,000 = $1,676,000
The market value of assets is their current liquidation or sale value, which must always be
positive.
Market values can be higher or lower than book values, which generally reflect their historical
costs.

2.T76. (6 points) Caldweiler & Co. owes a total of $21,684 in taxes for this year. The taxable
income is $72,000. If the firm earns $100 more in income, it will owe an additional $36 in taxes.
a) What will its average tax rate be on income of $72,100?

Average tax rate = ($21,684 + $36) / $72,100 = 30.12%

b) What is its marginal tax rate? Briefly compare these tax rates.
Marginal tax rate = $36 / $100 = 36%
The marginal tax rate is the tax on the next increment of income and is larger than the average
tax rate.