CH29 - CHAPTER 29 Financial Analysis and Planning Answers...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: CHAPTER 29 Financial Analysis and Planning Answers to Practice Questions 1. Internet exercise; answers will vary. 2. Internet exercise; answers will vary. 3. Internet exercise; answers will vary. 4. a. The following are examples of items that may not be shown on the company’s books: intangible assets, off-balance sheet debt, pension assets and liabilities (if the pension plan has a surplus), derivatives positions. b. The value of intangible assets generally does not show up on the company’s balance sheet. This affects accounting rates of return because book assets are too low. It can also make debt ratios seem high, again because assets are undervalued. Research and development expenditures are generally recorded as expenses rather than assets, thereby understating income and understating assets. Patents and trademarks, which can be extremely valuable assets, are not recorded as assets unless they are acquired from another company. c. Inventory profits can increase. Depreciation is understated, as are asset values. Equity income is depressed because the inflation premium in interest payments is not offset by a reduction in the real value of debt. 5. Individual exercise; answers will vary. 6. The answer, as in all questions pertaining to financial ratios, is, “It depends on what you want to use the measure for.” For most purposes, a financial manager is concerned with the market value of the assets supporting the debt, but, since intangible assets may be worthless in the event of financial distress, the use of book values may be an acceptable proxy. You may need to look at the market value of debt, e.g., when calculating the weighted average cost of capital. However, if you are concerned with, say, probability of default, you are interested in what a 18 firm has promised to pay, not necessarily in what investors think that promise is worth. Looking at the face value of debt may be misleading when comparing firms with debt having different maturities. After all, a certain payment of $1,000 ten years from now is worth less than a certain payment of $1,000 next year. Therefore, if the information is available, it may be helpful to discount face value at the risk- free rate, i.e., calculate the present value of the exercise price on the option to default. (Merton refers to this measure as the quasi-debt ratio.) You should not exclude items just because they are off-balance-sheet, but you need to recognize that there may be other offsetting off-balance-sheet items, e.g., the pension fund. How you treat preferred stock depends upon what you are trying to measure. Preferred stock is largely a fixed charge that accentuates the risk of the common stock. On the other hand, as far as lenders are concerned, preferred stock is a junior claim on firm assets....
View Full Document

Page1 / 16

CH29 - CHAPTER 29 Financial Analysis and Planning Answers...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online