Corporate Finance Capital Structure Solution

Tutorial assignment for topic1 Solutions 1. Capital structure decisions include consideration of the: (I.) amount of long-term debt to assume. (II.) cost of acquiring funds. (III.) current assets and liabilities. (IV.) net working capital. A. I and II only b. II and III only c. III and IV only d. I, II, and IV only e. I, III, and IV only 2. Which one of the following is a capital budgeting decision? a. determining how much debt should be borrowed from a particular lender B. deciding whether or not to open a new store c. deciding when to repay a long-term debt d. determining how much inventory to keep on hand e. determining how much money should be kept in the checking account 3. Working capital management includes decisions concerning which of the following? (I.) accounts payable (II.) long-term debt (III.) accounts receivable (IV.) inventory a. I and II only b. I and III only c. II and IV only d. I, II, and III only E. I, III, and IV only 4. Which of the following are advantages of the corporate form of business ownership? (I.) limited liability for firm debt (II.) double taxation (III.) ability to raise capital (IV.) unlimited firm life a. I and II only b. III and IV only c. I, II, and III only d. II, III, and IV only E. I, III, and IV only 5. Which one of the following actions by a financial manager creates an agency problem? a. refusing to borrow money when doing so will create losses for the firm b. refusing to lower selling prices if doing so will reduce the net profits C. agreeing to expand the company at the expense of stockholders' value d. agreeing to pay bonuses based on the market value of the company stock e. increasing current costs in order to increase the market value of the stockholders' equity 6. _____ refers to the cash flow that results from the firm's ongoing, normal business activities. A. Cash flow from operating activities b. Capital spending c. Net working capital d. Cash flow from assets e. Cash flow to creditors 7. _____ refers to the firm's dividend payments less any net new equity raised. a. Operating cash flow b. Capital spending c. Net working capital d. Cash flow from creditors E. Cash flow to stockholders 8. Which of the following are included in current assets? (I) equipment (II) inventory (III) accounts payable (IV) cash A. II and IV only b. I and III only c. I, II, and IV only d. III and IV only e. II, III, and IV only 9. Which of the following are included in current liabilities? (I) note payable to a supplier in eighteen months (II) debt payable to a mortgage company in nine months (III) accounts payable to suppliers (IV) loan payable to the bank in fourteen months a. I and III only B. II and III only c. III and IV only d. II, III, and IV only e. I, II, and III only 10. Which one of the following statements concerning liquidity is correct? a. If you sold an asset today, it is a liquid asset. b. If you can sell an asset next year at a price equal to its actual value, the asset is highly liquid. c. Trademarks and patents are highly liquid. d. The less liquidity a firm has, the lower the probability the firm will encounter financial difficulties. E. Balance sheet accounts are listed in order of decreasing liquidity. 11. Which of the following accounts are included in shareholders' equity? (I) interest paid (II) retained earnings (III) share premium (IV) long-term debt a. I and II only b. II and IV only c. I and IV only D. II and III only e. I and III only 12. Book value: a. is equivalent to market value for firms with fixed assets. B. is based on historical cost. c. generally tends to exceed market value when fixed assets are included. d. is more of a financial than an accounting valuation. e. is adjusted to market value whenever the market value exceeds the stated book value. 13. When you are making a financial decision, the most relevant tax rate is the _____ rate. a. average b. fixed C. marginal d. total e. variable 14. The cash flow to creditors includes the cash: a. received by the firm when payments are paid to suppliers. b. outflow of the firm when new debt is acquired. C. outflow when interest is paid on outstanding debt. d. inflow when accounts payable decreases. e. received when long-term debt is paid off. 15. Net capital spending is equal to: a. net additions to net working capital. B. the net change in fixed assets. c. net income plus depreciation. d. total cash flow to stockholders less interest and dividends paid. e. the change in total assets. 16. Free cash flow is: a. without cost to the firm. b. net income plus taxes. c. an increase in net working capital. D. cash that the firm is free to distribute to creditors and stockholders. e. None of the above. 17. A firm has £300 in inventory, £600 in fixed assets, £200 in accounts receivables, £100 in accounts payable, and £50 in cash. What is the amount of the current assets? a. £500 B. £550 c. £600 d. £1,150 e. £1,200 Current assets = £300 + £200 + £50 = £550 18. The total assets are £900, the fixed assets are £600, long-term debt is £500, and short-term debt is £200. What is the amount of net working capital? a. £0 B. £100 c. £200 d. £300 e. £400 Net working capital = £900 - £600 - £200 = £100 19. At the beginning of the year, a firm has current assets of £380 and current liabilities of £210. At the end of the year, the current assets are £410 and the current liabilities are £250. What is the change in net working capital? a. -£30 B. -£10 c. £0 d. £10 e. £30 Change in net working capital = (£410 - £250) - (£380 - £210) = -£10 20. Calculate net income based on the following information. Sales are £250, cost of goods sold is £160, depreciation expense is £35, interest paid is £20, and the tax rate is 34%. a. £11.90 B. £23.10 c. £35.00 d. £36.30 e. £46.20 Net Income = ((Sales-COGS)-Depreciation-Interest)×(1-Tax rate) = ((£250-£160)-£35-£20)×(1-0.34) = £23.10 Greenbacks, Ltd. 2015 Income Statement (£ in millions) Net sales Less: Cost of goods sold Less: Depreciation Earnings before interest and taxes Less: Interest paid Taxable Income Less: Taxes Net income £9,610 6,310 1,370 1,930 630 £1,300 455 £ 845 Greenbacks, Ltd. 2014 and 2015 Balance Sheets (£ in millions) 2014 2015 Cash £310 £405 Accounts rec. 2,640 3,055 Inventory 3,275 3,850 Total C.A. £ 6,225 £ 7,310 Net fixed assets 10,960 10,670 Total assets £17,185 £17,980 Accounts payable Notes payable Total C.L. Long-term debt Common stock Retained earnings Total liab.& equity 2014 2015 £ 2,720 £ 2,570 100 0 £ 2,820 £ 2,570 7,875 8,100 5,000 5,250 1,490 2,060 £17,185 £17,980 21. Change in working capital = (£7,310 - £2,570) – (£6,225 - £2,820) = £1,335 The non-cash expense is depreciation in the amount of £1,370. Net capital spending = £10,670 – (£10,960 - £1,370) = £1,080 Net Capital Spending may also be called Fixed Capital Investment or Capital Expenditure Net new borrowing = £8,100 - £7,875 = £225 Cash flow to creditors = £630 - (£8,100 - £7,875) = £405 Operating cash flow=EBIT+Non-cash Expenses (Depreciation & Amortization) -Taxes = £1930+£1370-£455=£2845 Free Cash Flow of the Firm (FCFF) = Operating Cash Flow – Change in Working Capital – Net Capital Spending = £2845-£1335-£1080 = £430 Notes: In Corporate Finance, we calculate operating cash flow and cash flow of the firm as above, which could be quite different from how cash flow from operating activities is calculated for cash flow statements in Financial Accounting. Below are different approaches to calculate cash flow from operating activities(CFO) in Financial Accounting: CFO = Net Income + Interest Expense + Non-cash Expenses - Change in non-cash working capital =£845+£630+ £1,370-£1240 = £1,605 CFO = EBIT–Taxes +Non-cash expenses -Changes in non-cash working capital =£1,930 + £1,370-£1240 - £455 = £1,605 Below are different approaches to calculate Free Cash flow of the firm (FCFF) in Financial Accounting: FCFF = Net Income + Interest Expense (1-Tax Rate) + Non-cash Expenses - Change in non-cash working capital -Net capital spending =£845+£409.5+£1,370-£1,240-£1,080=£304.5 FCFF= [EBIT×(1 – Tax rate)] + Non-cash expenses – Change in non-cash working capital – Net capital spending = £1930×(1-35%)+£1,370-£1,240-£1,080=£304.5 FCFF=CFO- (Interest Expense × Tax rate) -Net capital spending =£1,605-£630×35%£1,080=£304.5