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1、Chapter 2Discussion Questions2-1.Discuss some financial variables that affect the price-earnings ratio.The price-earnings ratio will be influenced by the earnings and sales growth of the firm, the risk or volatility in performance, the debt-equity structure of the firm, the dividend payment policy,
2、the quality of management, and a number of other factors. The ratio tends to be future-oriented, and the more positive the outlook, the higher it will be.2-2.What is the difference between book value per share of common stock and market value per share? Why does this disparity occur?Book value per s
3、hare is arrived at by taking the cost of the assets and subtracting out liabilities and preferred stock and dividing by the number of common shares outstanding. It is based on the historical cost of the assets. Market value per share is based on current assessed value of the firm in the marketplace
4、and may bear little relationship to original cost. Besides the disparity between book and market value caused by the historical cost approach, other contributing factors are the growth prospects for the firm, the quality of management, and the industry outlook. To the extent these are quite negative
5、 or positive, market value may differ widely from book value.2-3.Explain how depreciation generates actual cash flows for the company.The only way depreciation generates cash flows for the company is by serving as a tax shield against reported income. This non-cash deduction may provide cash flow eq
6、ual to the tax rate times the depreciation charged. This much in taxes will be saved, while no cash payments occur.2-4.What is the difference between accumulated depreciation and depreciation expense? How are they related?Accumulated depreciation is the sum of all past and present depreciation charg
7、es, while depreciation expense is the current years charge. They are related in that the sum of all prior depreciation expense should be equal to accumulated depreciation (subject to some differential related to asset write-offs).2-5.How is the income statement related to the balance sheet?The earni
8、ngs (less dividends) reported in the income statement is transferred to the ownership section of the balance sheet as retained earnings. Thus, what we earn in the income statement becomes part of the ownership interest in the balance sheet.2-6.Comment on why inflation may restrict the usefulness of
9、the balance sheet as normally presented.The balance sheet is based on historical costs. When prices are rising rapidly, historical cost data may lose much of their meaningparticularly for plant and equipment and inventory.2-7.Explain why the statement of cash flows provides useful information that g
10、oes beyond income statement and balance sheet data.The income statement and balance sheet are based on the accrual method of accounting, which attempts to match revenues and expenses in the period in which they occur. However, accrual accounting does not attempt to properly assess the cash flow posi
11、tion of the firm. The statement of cash flows fulfills this need.2-8.What are the three primary sections of the statement of cash flows? In what section would the payment of a cash dividend be shown?The sections of the statement of cash flows are:Cash flows from operating activitiesCash flows from i
12、nvesting activitiesCash flows from financing activitiesThe payment of cash dividends falls into the financing activities category.2-9.What is free cash flow? Why is it important to leveraged buyouts?Free cash flow is equal to cash flow from operating activities:Minus:Capital expenditures required to
13、 maintain the productive capacity of the firm.Minus:Dividends (required to maintain the payout on common stock and to cover any preferred stock obligation).The analyst or banker normally looks at free cash flow to determine whether there are insufficient excess funds to pay back the loan associated
14、with the leveraged buy-out.2-10.Why is interest expense said to cost the firm substantially less than the actual expense, while dividends cost it 100 percent of the outlay?Interest expense is a tax deductible item to the corporation, while dividend payments are not. The net cost to the corporation o
15、f interest expense is the amount paid multiplied by the difference of one minus the applicable tax rate.For example, $100 of interest expense costs the company $65 after taxes when the corporate tax rate is 35 percent. (e.g. $100 x (1 .35) = $65).Problems2-1.Rockwell Paper Company had earnings after
16、 taxes of $580,000 in the year 2003 with 400,000 shares outstanding. On January 1, 2004, the firm issued 35,000 new shares. Because of the proceeds from these new shares and other operating improvements, earnings after taxes increased by 25 percent.a.Compute earnings per share for the year 2003.b.Compute earnings per
