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Chapter 3Fundamentals of

Corporate Finance

Fourth Edition

Accounting andFinance

Slides by

Matthew Will

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Topics Covered

The Balance Sheet

The Income Statement

The Statement of Cash FlowsAccounting Practice & Malpractice

Taxes

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The Balance Sheet

Definition

Financial statements that show

the value of the firms assets andliabilities at a particular point in

time (from an accounting

perspective).

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The Balance Sheet

The Main Balance Sheet Items

Current Assets

Cash & Securities

ReceivablesInventories

+

Fixed Assets

Tangible Assets

Intangible Assets

Current Liabilities

Payables

Short-term Debt

+

Long-term Liabilities

+

Shareholders Equity

=

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Market Value vs. Book Value

Book Values are determined by GAAP

Market Values are determined by current

values

Equity and Asset Market Values are usually

higher than their Book Values

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Market Value vs. Book Value

Example

According to GAAP, your firm has equity worth $6

billion, debt worth $4 billion, assets worth $10

billion. The market values your firms 100 millionshares at $75 per share and the debt at $4 billion.

Q: What is the market value of your assets?

A: Since (Assets=L iabi l i ties + Equi ty), your assets

must have a market value of $11.5 bil l ion.

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The Income Statement

Definition

Financial statement that shows

the revenues, expenses, and netincome of a firm over a period of

time (from an accounting

perspective).

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The Income Statement

Earnings Before Income & Taxes (EBIT)

EBIT = - total Revenues

- costs

- deprecation

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The Income Statement

Pepsico Income Statement (year end 2001)

Net Sales 26,935

COGS 10,754

Other Expenses 392

Selling, G&A expenses 10,526

Depreciation expense 1,082

EBIT 4,181

Net interest expense 152

Taxable Income 4,029

Income Taxes 1,367

Net Income 2,662

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Profits vs. Cash Flows

Differences

Profits subtract depreciation (a non-cash expense)

Profits ignore cash expenditures on new capital

(the expense is capitalized)

Profits record income and expenses at the time of

sales, not when the cash exchanges actually occur

Profits do not consider changes in working capital

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The Statement of Cash Flows

Definition

Financial statement that shows

the firms cash receipts and cashpayments over a period of time.

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The Statement of Cash Flows

Pepsico Statement of Cash Flows (excerpt - year end 2001)

Net Income 2,662

Non-cash expenses

Depreciation 1,082

Other 373Changes in working capital

A/R=7 A/P=(236) Inv=(75) other=388 1,539

Cash Flow from operations 4,201

Cash Flow from investments (2,637)Cash provided by financing (1,919)

Net Change in Cash Position (355)

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Accounting Practice

Stock options

Allowance for bad debts

Revenue recognition

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Taxes

Taxes have a major impact on financialdecisions

Marginal Tax Rate is the tax that theindividual pays on each extra dollar ofincome.

Average Tax Rate is the total tax bill dividedby total income.

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Taxes

Example - Taxes and Cash Flows can be changed bythe use of debt. Firm A pays part of its profits asdebt interest. Firm B does not.

Firm A Firm BEBIT 100 100

Interest 40 0

Pretax Income 60 100

Taxes (35%) 21 35

Net Income 39 65

Example - Taxes and Cash Flows can be changed bythe use of debt. Firm A pays part of its profits asdebt interest. Firm B does not.

Firm AEBIT 100

Interest 40

Pretax Income 60

Taxes (35%) 21

Net Income 39

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Taxes

FOOD FOR THOUGHT - If you were both the debtand equity holders of the firm, which would generatemore cash flow to you? (assume Net Income = Cash

Flow)

Firm A Firm BEBIT 100 100

Interest 40 0

Pretax Income 60 100

Taxes (35%) 21 35

Net Income 39 65

?

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Taxes

FOOD FOR THOUGHT - If you were both the debtand equity holders of the firm, which would generate

more cash flow to you? (assume Net Income = Cash

Flow)

Firm A Firm B

Net Income 39 65

+ Interest 40 0

Net Cash Flow 79 65

?

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Corporate Tax Rates (2002)

Taxable Income ($) Tax Rate (%)

0-50,000 15

50,001-75,000 2575,001-100,000 34

100,001-18,333,333 34-39

over 18,333,333 35

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Personal Tax Rates (2002)

Single Taxable

Income ($)

Married Taxable

Income ($) Tax Rate (%)

0-6,000 0-12,000 10

6,000-27,950 12,000-46,700 15

27,950-67,700 46,700-112,850 27

67,700-141,250 112,850-171,950 30

141,250-307,050 171,950-307,050 35

over 307,050 over 307,050 38.6

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Web Resources

www.ibm.com/investor/financialguide

www.reportgallery.com

www.sec.gov/edgar.shtml

http://moneycentral.msn.com/tax/workshop/welcome.asp

www.aicpa.org/index.htm

www.businessweek.com/2001/01_04/b3716160.htm

www.irs.gov

Click to access web sitesInternet connection required

http://www.ibm.com/investor/financialguidehttp://www.reportgallery.com/http://www.sec.gov/edgar.shtmlhttp://moneycentral.msn.com/tax/workshop/welcome.asphttp://www.aicpa.org/index.htmhttp://www.businessweek.com/2001/01_04/b3716160.htmhttp://www.irs.gov/http://www.irs.gov/http://www.businessweek.com/2001/01_04/b3716160.htmhttp://www.aicpa.org/index.htmhttp://moneycentral.msn.com/tax/workshop/welcome.asphttp://www.sec.gov/edgar.shtmlhttp://www.reportgallery.com/http://www.ibm.com/investor/financialguide