bkmsol_ch01 - CHAPTER 1: INVESTMENTS: BACKGROUND AND ISSUES...

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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 (that is, Lanni’s IOU to the bank). b. Lanni transfers financial assets (cash) to the software developers. In return, Lanni gets a real asset, the completed software. No financial assets are created or destroyed; cash is simply transferred from one party to another. c. Lanni gives the real asset (the software) to Microsoft in exchange for a financial asset, 1,500 shares of stock in Microsoft. If Microsoft issues new shares in order to pay Lanni, then this would represent the creation of new financial assets. d. Lanni exchanges one financial asset (1,500 shares of stock) for another ($120,000). Lanni gives a financial asset ($50,000 cash) to the bank and gets back another financial asset (its IOU). The loan is "destroyed" in the transaction, since it is retired when paid off and no longer exists. 3. a. Assets Liabilities & Shareholders’ equity 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 b. Assets Liabilities & Shareholders’ equity Software product* $ 70,000 Bank loan $ 50,000 Computers 30,000 Shareholders’ equity 50,000 Total $100,000 Total $100,000 1-1
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*Valued at cost Ratio of real to total assets = $100,000/$100,000 = 1.0 c. Assets Liabilities & Shareholders’ equity 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 = 0.20 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 off for cash, financial assets once again replace real assets. 4.
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bkmsol_ch01 - CHAPTER 1: INVESTMENTS: BACKGROUND AND ISSUES...

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