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Chapter 9 for course website

# Chapter 9 for course website - Introduction To Financial...

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Introduction To Financial Accounting HKUST Chapter 9 Reporting and Interpreting Liabilities Slide 1 Chapter Nine ACCT 101 Fall 2010 Allen Huang Introduction To Financial Accounting HKUST Learning Objectives for Ch 9 Define, measure, and report current liabilities. Report long-term liabilities. Report contingent liabilities and capital lease. Report notes payable and explain the time value of money. Apply the concepts of the future and present values. Slide 2 Chapter Nine Apply present value concepts to liabilities.

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Introduction To Financial Accounting HKUST Understanding the Business The acquisition of assets is financed from two sources: Slide 3 Chapter Nine Debt - funds from creditors Equity - funds from stockholders Introduction To Financial Accounting HKUST Understanding the Business Debt vs Equity Cost? Benefit? Slide 4 Chapter Nine
Introduction To Financial Accounting HKUST Tax Shield of Interest Expense Income Statement Company A Company B Revenue 10,000 10,000 Expense 4,000 4,000 Net Income Before Interest and Tax 6,000 6,000 Interest 40,000*10%=4,000 0 Net Income Before Tax 2,000 6,000 Tax 2,000*30%=600 6,000*30%=1,800 Slide 5 Chapter Nine Net Income After Tax 1,400 4,200 Total Cash Flow Available for Shareholder and Bondholder 5,400 (1,400 + 4,000) 4,200 (4,200 + 0) \$40,000 * 10% (interest rate) * 30% (tax rate) = \$1,200 Introduction To Financial Accounting HKUST Using Debt to Enhance ROE Company A’s return on capital is 10%. Assume A has \$1,000,000 equity and no income tax, the net income is \$1,000,000 * 10% = 100,000. A’s ROE (Return on Equity) = Net Income / Equity = 10% Let’s say A can borrow at a 5% interest rate. If A borrows \$2,000,000. What’s A’s net income? (\$1,000,000 + \$2,000,000) * 10% \$2,000,000 * 5% = \$200,000 Slide 6 Chapter Nine A’s ROE (return on equity) = \$200,000 / \$1,000,000 = 20% As long as A’s borrowing cost is lower than its return on capital. A can enhance its ROE by borrowing.

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