5283answers8.feb273 - End of Chapter 8 Questions, Problems...

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Unformatted text preview: End of Chapter 8 Questions, Problems and Solutions CORPORATE FINANCE Professor Megginson February 27, 2003 Questions [See problems in book] *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** *** Answers to End of Chapter 8 Questions 8.1. Accounting numbers may not accurately reflect when revenues are received or when payments are made. Net present value focuses on when money is actually received or paid and then discounts these cash flows at an appropriate rate to find whether a project adds value to a company. This emphasis recognizes that whatever accounting earnings a company has, it must generate sufficient cash to pay its bills or it will not stay in business very long. 8.2. Interest expense should be ignored and should not be treated as a cash outflow. The discount rate already captures the costs associated with financing a project, and deducting these costs from the projects cash flows would be double counting. 8.3. Depreciation positively impacts cash flow. Depreciation reduces taxable income. The lower the taxable income, the lower the taxes paid, which are a real cash outflow. Cash flow from operations is net income with depreciation added back in. Higher depreciation means higher cash flow. From a net present value perspective, the faster depreciation is taken the better. More depreciation in the early years of a project means higher cash flows and higher net present value for a project. Many companies use accelerated deprecation for cash flow/net present value purposes and straight line depreciation for reporting purposes. This ensures that the depreciation method used does not impact reported earnings per share; however, it does allow the company to take maximum tax advantage of depreciation and reduce its tax bill. 8.4. An increase in accounts payable is a cash inflow in the sense that the firm is asking its creditors to finance more of its purchases. The creditor is providing non-interest bearing financing for the firms working capital needs. The company is able to purchase more current assets since it has less of a need to pay its creditors. 8.5. Terminal value can be calculated using the growing perpetuity model, which states that terminal value = CF t+1 /(r g). Terminal value can also be calculated by multiplying the final years cash flow by a market multiple such as price-to-cash-flow ratio. One could also use an investments book value or its expected liquidation value to estimate terminal value. 8.6. If an investment is sold for more than its book value, then the firm has a capital gain on the difference between market price and book value and must pay capital gains taxes on that difference....
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5283answers8.feb273 - End of Chapter 8 Questions, Problems...

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