Fundamentals of

Chapter 3 Corporate Finance

Fourth Edition

Accounting and
Finance

Slides by
Matthew Will

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Topics Covered
The Balance Sheet
The Income Statement
The Statement of Cash Flows
Accounting Practice & Malpractice
Taxes

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The Balance Sheet

Definition
Financial statements that show
the value of the firm’s assets and
liabilities at a particular point in
time (from an accounting
perspective).

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The Balance Sheet


The Main Balance Sheet Items

Current Liabilities
Current Assets
Payables
Cash & Securities
Short-term Debt
Receivables
Inventories
+
+
=
Long-term Liabilities
Fixed Assets
Tangible Assets +
Intangible Assets
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 firm’s 100 million
shares at $75 per share and the debt at $4 billion.
Q: What is the market value of your assets?

A: Since (Assets=Liabilities + Equity), your assets

must have a market value of $11.5 billion.

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Market Value vs. Book Value

Example (continued)
Book Value Balance Sheet
Assets = $10 bil Debt = $4 bil
Equity = $6 bil

Market Value Balance Sheet

Assets = $11.5 bil Debt = $4 bil
Equity = $7.5
bil
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The Income Statement

Definition
Financial statement that shows
the revenues, expenses, and net
income 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 firm’s cash receipts and cash
payments 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 373
Changes 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 financial
decisions

Marginal Tax Rate is the tax that the

individual pays on each extra dollar of
income.

Average Tax Rate is the total tax bill divided

by total income.

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

Firm A Firm B
EBIT 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 debt
and equity holders of the firm, which would generate
more cash flow to you? (assume Net Income = Cash
Flow)
Firm A Firm B
EBIT 100 100
Interest
Pretax Income 60
Taxes (35%)
40

21
100
0

35
?
Net Income 39 65

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Taxes
FOOD FOR THOUGHT - If you were both the debt
and 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 25
75,001-100,000 34
100,001-18,333,333 34-39
over 18,333,333 35

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Personal Tax Rates (2002)

Single Taxable Married Taxable

Income ($) Income ($) 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
Click to access web sites
Internet connection required

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

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