Chapter 2 questions

Chapter 2 questions - 4. Depreciation and interest expense...

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1. Liquidity measures how quickly and easily an asset can be converted to cash without significant loss in value. It’s desirable for firms to have high liquidity so that they have a large factor of safety in meeting short-term creditor demands. However, since liquidity also has an opportunity cost associated with it-namely that higher returns can generally be found by investing the cash into productive assets-low liquidity levels are also desirable to the firm 2. The recognition and matching principles in financial accounting call for revenues, and the costs associated with producing those revenues, to be “booked” when the revenue process is essentially complete, not necessarily when the cash is collected or bills are paid. 3. Standard accounting focuses on historical costs rather than market value because historical costs can be objectively and precisely measured whereas market values can be difficult to estimate, and different analysts would come up with different numbers.
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Unformatted text preview: 4. Depreciation and interest expense are two items in net income that arent in operating cash flow. Depreciation is a non-cash expense (reflects adjustments in value), and interest expense is a financing cost, not an operating cost. 5. Market values can never be negative because of bankruptcy laws. Nobody is going to pay a firm -$20 for a share of stock. Net worth can never be negative. So, liabilities can never be greater than assets in market value. 6. There can be a negative cash flow from assets if a company is expanding and investing. This would mean that it is spending cash to buy assets. 7. If a companys operating cash flow is continuously negative, that would mean that the company is losing money. This would probably happen for a company that has recently started up. 8. A companys change in networking capital could be negative for a given year if it needed less inventory, or if it becomes better at collecting its receivables....
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