Chapter 7 Accounting for Financial Management Answers to Beginning-of-Chapter Questions

5144 Words Oct 26th, 2012 21 Pages
Chapter 7
Accounting for Financial Management
ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS

7-1 The balance sheet shows the assets, along with the sources of funds used to acquire the assets, at a point in time, say 12/31/07. The income statement shows the sales and profits that were produced during an interval of time, say the year 2007. An individual would have assets, and a net worth, and a balance sheet would detail these holdings. The individual would also have income and expenses, and his or her income statement would detail these flows. For a business, the most important number—the “bottom line”—is generally thought to be the net income. However, the firm’s net cash flow is also quite important, especially if one
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EVA shows how much management has added to the firm’s value through operations during a specific year. MVA is sometimes used to measure management’s performance and as a basis for long-run compensation to the top managers. EVA can be measured on a divisional basis, and it is used as a basis for annual incentive compensation plans.

7-5 Regular accounting statements reported the combined results generated from operating and non-operating assets (such as marketable security holdings), and cash and non-cash items are mixed. Management is interested in separating out operating results, and in cash flows as well as accounting income. So, the accounting statements are modified to produce information that is more useful to managers.

7-6 Free cash flow shows the cash that is available to investors. Some of the cash is generated by normal operations—selling items at prices greater than cost—but some may also be generated by reducing assets. Also, firms normally have to increase their assets if they are growing, and this required investment is deducted to find FCF.

7-7 a. Interest is deductible to the corporate payer, but dividend payments are not deductible. This leads to a bias toward debt financing by businesses. Individual investors must pay taxes on either interest or dividends. So, there is a double taxation of dividend income (the company pays taxes, and then investors pay taxes

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