Chapter 2

# Chapter 2 - Chapter 2 Financial Statements Taxes and Cash...

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Chapter 2 Financial Statements, Taxes, and Cash Flow We started the discussion in the previous chapter with a look at a firm’s balance sheet. In this chapter, we begin by examining the balance sheet in more detail. We will then discuss a firm’s income statement and how this differs from taxable income and the amount of taxes a firm needs to pay. We will conclude with a discussion of the calculation of a firm’s cash flow. The Balance Sheet In finance, we typically examine a balance sheet that reflects market values. Let’s call this the market value balance sheet. The accounting balance sheet (also called the book value balance sheet) is prepared based on generally accepted accounting principals (GAAP). The following will be used to explain market value and accounting balance sheets. The Lubbock Solar Power Car Company is a newly formed corporation that will buy solar power cars for resale to the public. To start operations, the company will purchase 2000 solar power cars from the manufacturer at \$40k each = \$80m (\$70m paid now, \$10m to be paid in 3 months) and invest \$15m in office furnishings, phones, computers, etc. It will also need \$5m in cash to pay for operating expenses as they come due. So, on day 0, the firm needs \$70m + \$15m + \$5m = \$90m. The \$90m will be financed with \$10m from the founders (Mr. and Mrs. Smith), \$20m from the sale of 2m shares of stock to new stockholders, and \$60m borrowed from the bank (terms: 5% interest rate, 20-year loan, interest only payments until the final year, principal due in full in 20 years). 1

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Accounting Balance Sheet January 1, 2008 Current Assets Current Liabilities Cash Accounts Payable Inventory Long-Term Liabilities Bank Loan Long Term (Fixed) Assets Office Furnishings Equity Common Stock Total Assets Total Liabilities and Equity Questions related to the beginning accounting balance sheet: 1) What is the cost of the assets? How much do you owe the manufacturer and the bank? How much did investors pay for the common stock? 2) What is the firm’s working capital balance? 3) The accounting balance sheet should always balance: BV of Assets = BV of Liabilities + BV of Equity 4) Long term assets: tangible versus intangible assets 2
Liquidity Assets are roughly ordered on the balance sheet by liquidity 1) Liquidity refers to the ability to convert an asset to cash 2) Highly liquid assets can be converted to cash quickly with little decrease in price

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Chapter 2 - Chapter 2 Financial Statements Taxes and Cash...

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