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BKM_Sol_Ch_1 - Chapter 01 Investments Background and Issues...

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Chapter 01 - Investments: Background and Issues Chapter 1 Investments: Background and Issues 1. a. Cash is a financial asset because it is the liability of the federal government. b. No. The cash does not directly add to the productive capacity of the economy. c. Yes. d. Society as a whole is worse off, since taxpayers, as a group will make up for the liability. 2. a. The bank loan is a financial liability for Lanni. Lanni's IOU is the bank's financial asset. The cash Lanni receives is a financial asset. The new financial asset created is Lanni's promissory note held by the bank. b. The cash paid by Lanni is the transfer of a financial asset to the software developer. In return, Lanni gets a real asset, the completed software. No financial assets are created or destroyed. Cash is simply transferred from one firm to another. c. Lanni sells the software, which is a real asset, to Microsoft. In exchange Lanni receives a financial asset, 1,500 shares of Microsoft stock. If Microsoft issues new shares in order to pay Lanni, this would constitute the creation of new financial asset. d. In selling 1,500 shares of stock for $120,000, Lanni is exchanging one financial asset for another. In paying off the IOU with $50,000 Lanni is exchanging financial assets. The loan is "destroyed" in the transaction, since it is retired when paid. 1-1
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Chapter 01 - Investments: Background and Issues 3. a. Cash $70,000 Bank loan $50,000 Computers 30,000 Shareholders’ equity 50,000 Total $100,000 Total $100,000 Ratio of real to total assets = $30,000/$100,000 = 0.30 Assets Liabilities & Shareholders’ equity b. Software product* $70,000 Bank loan $50,000 Computers 30,000 Shareholders’ equity 50,000 Total $100,000 Total $100,000 *Valued at cost Ratio of real to total assets = $100,000/$100,000 = 1.0 Assets Liabilities & Shareholders’ equity c. Microsoft shares $120,000 Bank loan $50,000 Computers 30,000 Shareholders’ equity 100,000 Total $150,000 Total $150,000 Ratio of real to total assets = $30,000/$150,000 = 0.2 Conclusion: when the firm starts up and raises working capital, it will be characterized by a low ratio of real to total assets. When it is in full production, it will have a high ratio of real assets. When the project "shuts down" and the firm sells it Assets Liabilities & Shareholders’ equity 1-2
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Chapter 01 - Investments: Background and Issues 4. Ultimately, real assets determine the material well being of an economy. Individuals can benefit when financial engineering creates new products which allow them to manage portfolios of financial assets more efficiently.
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