Explain what current assets and fixed assets are and give as many examples as you can for each. What is the difference between tangible and intangible assets?

Explain what current assets and fixed assets are and give as many examples as you can for each. What is the difference between tangible and intangible assets?

Liabilities and owner’s equity are listed on the right-hand side respectively. Liabilities are also classified as current liabilities and long-term liabilities.

Here is your second question:

Explain what current liabilities differ from long-term liabilities and give as many examples as you can for each.

Owner’s equity (also known as shareholders’ equity, common equity) is the difference between total value of assets and total value of liabilities. That is, if you were to use your assets to pay off the debts, whatever is left over (the residual) would belong to shareholders. That is why they are known as residual claimants. Hence we have the identity;

Assets = Liabilities + Shareholders’ equity

Net working capital is simply equal to current assets minus current liabilities. When net working capital is positive, it means cash that will be available over the next 12 months exceeds what must be paid. It is important for a healthy firm to have positive net working capital.

Here is your third question:

A firm has current assets of $100, net fixed assets of $500, short-term debt of $70 and long-term debt of $200. What is shareholders’ equity. Construct a balance sheet

for this company. Is net working capital positive or negative? If so by how much? (Hint: You may utilize Example 2.1 on page 24 of the textbook).

Liquidity refers to how quickly you can convert an asset into cash. A highl liquid asset is one that can be converted into cash quickly without significant loss of value. Assets are listed on the balance sheet from most liquid to least liquid. The more liquid a firm is, the less likely it will experience financial distress. But liquid assets are less profitable to hold because of the time value of money.

Debtholders get paid first and equity holders are only entitle to residual value that is whatever is left after all creditors are paid. The use of debt in capital structure decisions (remember from first chapter) is called financial leverage. The more debt the firm has, the greater is its financial leverage. Debt serves as a lever but it can magnify losses as well as gains.

The true value of the firm is its market value. Market value is the amount of cash one would get if we sold the firm now. The values reported in the balance sheet however are book values and usually differe from what actually assets are worth.

Here is your fourth question:

What is GAAP and what is meant by reporting of assets based on historical cost? Why might the difference between market value and book value be very similar for current assets but differ greatly for fixed assets? In your opinion which one matters most for investors market value or book value?

The income statement measures the performance of a firm over a year or quarter. It is a flow concept (over a period of time) whereas the balance sheet was a stock concept (snapshot, at a given point in time).

The income statement equation is expressed as:

Revenues – Expenses = Income

At this point it would be good to memorize the items in the Income Statement (here EBIT stands for earnings before interest and taxes). Net Income is calculated in the following manner

Net Sales minus Cost of Goods Sold minus Depreciation = EBIT

EBIT minus Interest Paid = Taxable Income

Taxable Income minus Taxes = Net Income

Net Income = Dividends plus Addition to retained earnings

Here is your fifth question:

During the year, Company A had sales of $2,400,000. Cost of goods sold, and depreciation expense were $1,860,000 and $490,000 respectively. The company had net interest expense of $215,000 and a tax rate of 35%. What is Company A’s net income?

Dividends per share are calculated by dividing Dividends by the total number of shares outstanding. Earnings per share are calculated similarly, net income divided by total number of shares outstanding. According GAAP, income statements report revenue when they are accrued (revenue recognized at the time of sale and not necessarily when cash comes in).

Here is your sixth question:

Provide a definition for noncash items and give as many examples as you can as to what constitutes a noncash item.

Average tax rate is equal to total taxes paid, divided by total taxable income. Marginal tax rate, is the amount of tax payable on the next dollar earned. Here is an example (example 2.4) from the textbook, page 33, . Please familiarize yourselves with the corporate tax rates table (Table 2.3) on page 33 of the textbook first. Algernon, Inc., has a taxable income of $85,000. What is its tax bill? What would be its average and marginal tax rate?. From the Table 2.3 corporate tax rate table, the tax rate applied to the first $50,000 would be 15% ($50,000*.15 = $7,500), the rate applied to the next $25,000 would be 25% ($25,000*.25=6250), and the rate applied afterwards to the remaining $10,000 would be 34% ($10,000*.34=$3,400). Thus the company would have to pay $7,500+$6,250+$3,400=$17,150. The average tax rate would be $17,150/$85,000=20.18% and the marginal tax rate would be 34% since if the company had another dollar of taxable its taxes would rise by 34 cents.

Here is your seventh question:

Corporation B has $89,000 in taxable income. What is the tax bill for this firm? What is its avegare tax rate? What is its marginal tax rate?

Just like the balance sheet composition the cash flow from assets equals cash flow to creditors plus cash flow to stockholders.

Cash flow from assets involve three different constructs; Operating cash flow, capital spending, and change in net working capital. We will be using balance sheet example on page 25, Table 2.1 and income statement from Table 2.2 on page 28.

Operating cash flow is the cash flow resulting from daily activities of producing and selling. Expenses that have to do with financing of its assets are not included in operating cash flow since they are not operating expenses.

Operating cash flow therefore equals EBIT plus depreciation minus taxes.

Assume EBIT is $694, depreciation is $65 and taxes are $212. Operating cash flow would be $694+$65-$212=$547.

Capital spending is the net spending on fixed assets such as purchase or sale of fixed assets.

Net capital spending therefore equals ending fixed assets minus beginning fixed assets plus depreciation.

Assume for example that if ending fixed assets are $1,709 and beginning fixed assets and depreciation are $1,644 and $65 respectively. Net capital spending would be ($1,709-$1,644+$65) = $130.

Change in net working capital is net increase or decrease in current assets over current liabilities.

Assume for example that at the end of 2010 current assets and current liabilities were $1,403 and $389. Then net working capital in 2010 would be the difference between the two, $1,403 – $389 = $1,014. Similarly in 2009 net working capital would be current assets minus current liabilities in that year. Let’s assume them to be $1,112, and $428 the difference would be $684. The change in net working capital then is net working capital in 2010 minus net working capital in 2009 that is $1,014-$684=$330.

Now we are ready to calculate cash flow from assets. If you remember this from our earlier discussion, we calculated this by the following method.

Operating cash flow – net capital spending – change in NWC. Thus, Cash flow from assets would be $547-$130-$330=$87.

Lastly, cash flow to creditors is interest paid less net new borrowing whereas cash flow to stockholders is dividends paid less net new equity raised.

For example, if interest paid to creditors is $70 and if long-term debt in 2010 and 2009 was $454 and $408, then cash flow to creditors would be $70 – ($454-$408) = $24

Assume dividends are equal to $103 and common stock in 2010 and 2009 were $640 and $600 respectively. Then, cash flow to stockholders wuold be $103 – ($640-$600) = $63.

When we add these two items, cash flow to creditors ($24) and cash flow to stockholders ($63) it should equal cash flow from assets ($87) and indeed they are.

We will just suffice for the timing being with the definition of free cash flow which is the cash the firm is free to distribute to creditors and stockholders because it is not needed for working capital or fixed asset investments.

Here is your eight question that brings together all that we covered:

This is from page 41 of the textbook, self-test problem 2.1. Based on the following information for Rasputin Corporation, prepare the following assuming a 34% tax rate:

1.) An income statement for 2010

2.) Balance sheet for 2009

3.) Balance sheet for 2010.

4.) Cash flow from assets for 2010

5.) Cash flow to creditors for 2010

6.) Cash flow to stockholders for 2010

 

 

 

answer:

Explain what current assets and fixed assets are and give as many examples as you can for each. What is the difference between tangible and intangible assets?

Current assets are cash, cash equivalents and other assets that can be converted into cash within operating cycle of the company, which is usually one year.

Fixed assets are assets that are long-term assets meant to be held for a period longer than one operating cycle of the company (1 year).

Examples of Current assets: Cash, Checking accounts, Inventory, Accounts Receivables, Short Term Deposits

Examples of Fixed Assets: Land, Building, Plant & Machinery, Computers, Equipment

Tangible Assets are fixed assets that have a physical form. Intangible Assets are fixed assets are conceptual and do not have any physical form.

2.

Explain what current liabilities differ from long-term liabilities and give as many examples as you can for each.

Current Liabilities are liabilities that are due for payment in cash or settlement by other than cash within a period of one operating cycle (usually one year). Long-term liabilities are liabilities that are due for payment or settlement by other than cash after one operating cycle (usually one year).

3.

A firm has current assets of $100, net fixed assets of $500, short-term debt of $70 and long-term debt of $200. What is shareholders’ equity. Construct a balance sheet

for this company. Is net working capital positive or negative? If so by how much? (Hint: You may utilize Example 2.1 on page 24 of the textbook).

Assets Amount Liability Amount
Current Asset $100 Short Term Debt $70
Net Fixed Asset $500 Long Term Debt $200
Equity
Shareholder’s Equity $330
Total Assets $600 Total Equity & Liability $600

The Net working capital is calculated by Current Assets – Current Liability = $100 – $70 = $30. It is positive by $30.

4.

What is GAAP and what is meant by reporting of assets based on historical cost? Why might the difference between market value and book value be very similar for current assets but differ greatly for fixed assets? In your opinion which one matters most for investors market value or book value?

).

GAAP stands for generally accepted accounting standard, is a set of standards and principles for financial reporting. Reporting on historical cost means recording assets at the cost at which they were initially purchased/initially recognized. Current assets are assets that are cycled within one year, there for the book value and market value might not very much. But in case of fixed assets which is held for more than year, the value in books and market value may differ significantly over a period of time. While investing, what matters most is the actually value of the firm/company as opposed to whatever value at which the firm/company is recording it in its books. Therefore, market value matters most.

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