Chapter 3 Practice Problems - Conceptual

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FI 311 – Fall 2022 – Chapter 3 Practice Problems Conceptual: 1. Define liquidity as it is used at the asset level and at the firm level. a. Asset level: How well an asset can be converted into cash and without losing significant value b. Firm level: How well a company is at meeting its short-term obligations 2. Explain the trade-off a firm faces between high liquidity and low liquidity levels. a. If a firm has high liquidity, it has more than adequate resources to cover short- term obligations, but it is not putting its resources out to maximize earnings b. Low liquidity means a company is putting resources to work, but could have issues with short-term obligations 3. Debt is often described as “leverage”. Why, and what are the implications of this? a. Leverage is just something that magnifies the power of something else; Amplifies the power of assets… potential gains and losses. The implication is increasing earning power, but making sure you can manage debt 4. Describe the difference between book value and market value as well as their implications in financial decision-making. a. Book value: Value of an asset that appears on books of company; Historical cost – any accumulated depreciation; Known quantity … may have no bearing on what that asset is truly worth today b. Market value: What someone else is willing to pay you right now… It’s true worth; Sometimes it’s very difficult to know what something is truly worth… more important though 5. In preparing a balance sheet, why do you think standard accounting practice focuses on historical cost rather than market value? a. Historical cost and book value is a known quantity… know quantities are preferred for accuracy reasons, estimates are not good enough 6. Suppose a company’s cash flow from assets is negative for a particular period. Is this necessarily a good sign or a bad sign? a. Not necessarily a good or bad sign; Like everything in finance, always look beyond numbers, they don’t tell the full story Calculating:

7. Company W has current assets of $4,900, net fixed assets of $27,300, current liabilities of $4,100, and long-term debt of $10,200. What is the company’s amount of Net Working Capital? 8. Fictitious company G’s revenue for the previous year was $796,000, total costs were $327,000, depreciation expense was $42,000, interest expense was $34,000, and the company has a tax rate of 21%. What was last year’s Net Income? 9. A company’s 2017 balance sheet showed current assets of $4,810 and current liabilities of $2,230. The 2018 balance sheet showed current assets of $5,360 and current liabilities of $2,970. What was the company’s 2018 change in NWC? 10. Company K’s 2017 balance sheet showed long-term debt of $1.87 million, and its 2018 balance sheet showed long-term debt of $2.21 million. The 2018 income statement showed an interest expense of $255,000. What was the firm’s Cash Flow to Creditors in 2018? 11. The company in Question 10’s 2017 balance sheet also showed $4.63 million in Common Stock (paid-in capital is included in this figure); the 2018 balance sheet common stock number was $5.005 million. If the company paid out $545,000 in cash dividends in 2018, what was the Cash Flow to Stockholders for the year? 12. Using the data from Questions 10 and 11 above, what is the amount of the firm’s Cash Flow From Assets? 13. Williamston Widgets, Inc. (WWI), purchased a new widget machine 3 years ago for $6 million (this is the company’s only fixed asset). Stockbridge Sprockets has offered to buy the machine from them today for $5.1 million. WWI has taken a total of $2.6 million in depreciation thus far on its widget machine. By how much does the market value of the firm’s fixed assets exceed the book value? Use the following for Q 14-16: Company M’s financial statements showed the following information: • Current Accounts: – 2019: current assets = 4,400; current liabilities = 1,500 – 2018: current assets = 3,500; current liabilities = 1,200 • Fixed Assets and Depreciation – 2019: net fixed assets = 3,400; 2018: net fixed assets = 3,100 – Depreciation Expense = 400 • Long-term Debt and Equity (Paid-in capital included in Common Stock) – 2019: LTD = 4,000; Common stock = 500 – 2018: LTD = 3,950; Common stock = 400 • Income Statement – EBIT = 2,000; Taxes = 300

Interest Expense = 350; Dividends = 500 14. What was the company’s Cash Flow to Creditors in 2019? 15. What was the company’s Cash Flow to Stockholders in 2019? 16. What was the company’s Cash Flow From Assets in 2019? Use the following data for questions 17 and 18: Company W has Current Assets of $5,900, Net Fixed Assets of $29,300, Current Liabilities of $4,100, and Long-Term Debt of $10,200. 17. How much does the company have in Shareholders’ Equity? 18. What is the firm’s Net Working Capital? Use the following information for questions 19 and 20: Caterpillar, Inc. purchased new machinery three years ago for $7 million. The machinery can be sold today for $4.9 million. The company’s current balance sheet shows net fixed assets of $3.7 million, current liabilities of $1.1 million, and net working capital of $380,000. If all the current assets of the company were liquidated today, the company would receive $1.6 million cash. 19. What is the book value of the firm’s assets? 20. What is the market value of the firm’s assets?

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