Chapter 9 - Solution Manual

Statement of cash flows the inflow from operating

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Statement of Cash Flows: The inflow from Operating Activities will be affected by the tax savings on the interest and depreciation taken on the tax return. The supplemental schedule disclosing financing and investing activities not affecting cash will include the purchase of the machine with the note. According to the efficient market theory, the only impact that postponing the purchase would have on stock price would result from cash flow impacts. These are described in part b. Finance theory on capital structure would suggest that the lower debt to equity ratio that would result from the postponement would imply less risk, because the debt to equity ratio is thought to be correlated with the firm's beta. If the debt to equity ratio is significantly affected, the market could perceive the increased risk in a negative manner. b. The cash flow impacts of postponing the purchase of the equipment comprise the time value of the tax effects of the interest and depreciation tax shields which total $77,143 ($20,000 + $57,143). Although the purchase would only be delayed three months, the first year depreciation is taken one year earlier and one fourth of the first year's interest is taken earlier. On the downside, the interest payments and the payment of principal are both shifted three months earlier. However, this shift is unlikely to have a material impact.
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170 c. Purchasing before year-end would be more favorable to stockholders. The market assesses the value of the firm in terms of the present value of future cash flows. The depreciation and interest tax shields that would occur during the current year would accelerate the tax benefits of these deductions for one year. The timing of the interest and loan principal payment would occur three months earlier. But, the tax timing difference would produce a more significant effect. Case 9-3 a. The conventional concept of depreciation accounting usually is defined as a system of accounting that aims to distribute the cost or other basic value of tangible capital assets, less salvage (if any), over the estimated useful life of the unit (which may be a group of assets) in a systematic and rational manner. It is a process of allocation, not of valuation. Depreciation for the year is the portion of the total charge under such a system that is allocated to the year. b.i. This is a static concept of depreciation in which the initial cost or other value is not changed during the life of the asset; thus total depreciation charges over the life of the asset are equal to the initial cost or value of the asset less any salvage value. This concept is based upon the cost, realization and matching concept of conventional financial accounting. Cost represents the amount that is recorded as the value of the asset to the entity at the date of acquisition. In subsequent periods cost less accumulated depreciation is considered to represent the minimum value to the entity of the services to be received from the plant asset during the remainder of its life. The realization concept requires that during the life of an asset
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