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Explain why depreciation is shown as an adjustment to cash i

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Property, plant and equipment generally represent a material portion of the total assets of most companies. Accounting for the acquisition and usage of such assets is, therefore, an important part of the financial report process.

Distinguish between revenue and capital expenditures and explain why this distinction is important.

Briefly define depreciation as used in accounting.

Identify the factors that are relevant in determining the annual depreciation and explain whether these factors are determined objectively or whether they are based on judgment.

Explain why depreciation is shown as an adjustment to cash in the operations section on the statement of cash flows.

Your answer is 284 words in everyday language suitable for a novice.

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Your answer is 284 words.

Revenue expenditure (expense) is one that is "used up" and not expected to benefit future periods. Capital expenditures are not used up in the current period and are expected to benefit future periods. This distinction is important because measurement of profit is dependent on the proper matching of what assets were used in the period. If the asset is not used up, it should not reduce that period's profits.

Depreciation in ...

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Your answer is 284 words in everyday language suitable for a novice.

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Financial targets and Capital Structure for Bixton

Chapter 17: Problem Sets
(pp. 500)
Problem B1 (Choosing financial targets) Bixton Company's new chief financial officer is evaluating Bixton's capital structure. She is concerned that the firm might be underleveraged, even though the firm has larger-than-average research and development and foreign tax credits when compared to other firms in its industry. Her staff prepared the industry comparison shown here.

a. Bixton's objective is to achieve a credit standing that falls, in the words of the chief financial officer, "comfortably within the 'A' range." What target range would you recommend for each of the three credit measures?

b. Before settling on these target ranges, what other factors should Bixton's chief financial officer consider?

c. Before deciding whether the target ranges are really appropriate for Bixton in its current financial situation, what key issues specific to Bixton must the chief financial officer resolve?


Aa 4.00-5.25x 60-80% 17-23%
A 3.00-4.30 45-65 22-32
Baa 1.95-3.40 35-55 30-41

Chapter 18: Problem Sets
Problem A10: (Dividend adjustment model) Regional Software has made a bundle selling spreadsheet software and has begun paying cash dividends. The firm's chief financial officer would like the firm to distribute 25% of its annual earnings (POR = 0.25) and adjust the dividend rate to changes in earnings per share at the rate ADJ = 0.75. Regional paid $1.00 per share in dividends last year. It will earn at least $8.00 per share this year and each year in the foreseeable future. Use the dividend adjustment model, Equation (18.1), to calculate projected dividends per share for this year and the next four.

Problem B2: (Dividend policy) A firm has 20 million common shares outstanding. It currently pays out $1.50 per share per year in cash dividends on its common stock. Historically, its payout ratio has ranged from 30% to 35%. Over the next five years it expects the earnings and discretionary cash flow shown below in millions.

a. Over the five-year period, what is the maximum overall payout ratio the firm could achieve without triggering a securities issue?

b. Recommend a reasonable dividend policy for paying out discretionary cash flow in years 1 through 5.

1 2 3 4 5 THEREAFTER
Earnings 100 125 150 120 140 150+ per year
Discretionary cash flow 50 70 60 20 15 50+ per year

Chapter 20: pg 603
Problem A2: (Comparing borrowing costs) Stephens Security has two financing alternatives: (1) A publicly placed $50 million bond issue. Issuance costs are $1 million, the bond has a 9% coupon paid semiannually, and the bond has a 20-year life. (2) A $50 million private placement with a large pension fund. Issuance costs are $500,000, the bond has a 9.25% annual coupon, and the bond has a 20-year life. Which alternative has the lower cost (annual percentage yield)?

Chapter 21: pg 632
Problem C2: (Leasing, taxes, and the time value of money) The lessor can claim the tax deductions associated with asset ownership and realize the leased asset's residual value. In return, the lessor must pay tax on the rental income.

a. Explain why a financial lease represents a secured loan in which the lender's entire debt service stream is taxable as ordinary income to the lessor/lender.

b. In view of this tax cost, what tax condition must hold in order for a financial lease transaction to generate positive net-present-value tax benefits for both the lessor and lessee?

c. Suppose the lease payments in Table 21-2 must be made in advance, not arrears. (Assume that the timing of the lease payment tax deductions/obligations changes accordingly but the timing of the depreciation tax deductions does not change). Show that the net advantage to leasing for NACCO must decrease as a result. Explain why this reduction occurs.

TABLE 21-2 Direct cash flow consequences to NACCO of lease financing an electric shovel (amounts in thousands).

YEAR 0 1 2 3 4 5 6 7 8 9 10

Benefits of Leasing
Initial outlay (avoided) 10,000
Costs of Leasing
Lease payments -1,745 -1,745 -1,745 -1,745 -1,745 -1,745 -1,745 -1,745 -1,745 -1,745
Lease payment tax credit 698 698 698 698 698 698 698 698 698 698
Depreciation tax credits forgon e -380 -380 -380 -380 -380 -380 -380 -380 -380 -380
Salvage value forgone 0 0 0 0 0 0 0 0 0 0 -500
10,000 -1,427 -1,427 -1,427 -1,427 -1,427 -1,427 -1,427 -1,427 -1,427 -1,927

Lease payments made annually in arrears.
Assumes the lessee's marginal income tax rate is 40%
Assumes straight-line depreciation to a $500,000 terminal book value for tax purposes.

d. Show that if NACCO is nontaxable, the net advantage to leasing is negative and greater in absolute value than the net advantage of the lease to the lessor.

e. Either find a lease rate that will give the financial lease a positive net advantage for both lessor and lessee, or show that no such lease rate exists.

f. Explain what your answer to part e implies about the tax costs and tax benefits of the financial lease when lease payments are made in advance.

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