However, the firm’s net cash flow is also quite important, especially if one distrusts management and thinks the accounting statements might be misleading. 7-2a. WorldCom understated costs. This had the effect of increasing its reported profits and its net worth. Also, since assets were not reduced by the correct amounts, reported assets were too high. This caused the reported debt ratio (debt/assets) to be too low, making the company look stronger than it actually was. Enron essentially transferred and got off its books debt that it was responsible for, along with assets that were actually worth less than had been paid for them.
Enron “sold” the transferred assets to sham companies at inflated prices, thus allowing it to inflate its reported profits. Since both companies were able to report high profits and to look stronger than they actually were, their stock prices were much higher than they would have been had proper accounting been used. b. When the deceptions were revealed, both Enron’s and WorldCom’s stock prices collapsed. Investors then became worried that other companies might have been doing the same thing (they were), so the prices of other stocks, including companies that were playing entirely by the rules, also fell. c.
The stock market collapse had serious economic consequences. First, companies had a hard time raising new equity capital, and that restricted growth. Second, individuals who saw their portfolios decline were worried and thus spent less, and that put a further drag on the economy. In general, a strong economy needs good capital markets, and that can occur only if investors can obtain good information about the companies whose securities they are buying. 7-3In essence, the statement of cash flows strips out non-cash charges that are shown on the income statement and ends up showing the surplus or deficit of cash generated during the year.
The Research paper on Dividends Policy And Common Stock Prices
... of the company. In other words, prices are the result of discounting expected future cash flows (Criss, 1995). 2.2.2.2FACTORS THE AFFECT STOCK PRICES This is ... by the use of the assets involved. These returns could be in the form of share of profits (dividends) or interest to ... an ownership right in the assets of the corporation and a right to a proportionate share of profits after payment of corporate ...
For example, depreciation and amortization charges reduce net income, but they are non-cash charges, so they are added back when constructing the statement of cash flows. Since cash is what’s available to companies to spend or pay out to investors, the cash flow statement is quite important, especially after Enron. 7-4Net income is the reported after-tax accounting profits, and EPS is net income divided by the number of shares outstanding. (If options are outstanding, the number of shares used to find EPS may be adjusted to reflect EPS after options have been exercised. EBITDA is operating income before interest, taxes, depreciation, and amortization. This number is especially important to banks and other creditors because it is an approximation to the cash flow being generated from operations that is available to make payments on debt. NOPAT is net operating profit after taxes. It is found as EBIT(1-T), and it shows how much after-tax operating profit the firm would generate if it had no debt. Free cash flow is the cash flow available to investors after the firm has paid its taxes and made all investments in fixed assets and working capital necessary to sustain operations going forward.
FCF = (NOPAT + Depreciation) – Gross investment in operating assets = NOPAT – Net investment in operating assets. MVA is the market value of the stock minus the book value, and it shows how much value management has added since the firm’s inception. EVA is economic value added, and it is found as EVA = EBIT(1-T) – (operating capital)(WACC).
EVA shows how much management has added to the firm’s value through operations during a specific year. MVA is sometimes used to measure management’s performance and as a basis for long-run compensation to the top managers.
EVA can be measured on a divisional basis, and it is used as a basis for annual incentive compensation plans. 7-5Regular accounting statements reported the combined results generated from operating and non-operating assets (such as marketable security holdings), and cash and non-cash items are mixed. Management is interested in separating out operating results, and in cash flows as well as accounting income. So, the accounting statements are modified to produce information that is more useful to managers. 7-6Free cash flow shows the cash that is available to investors.
The Essay on Taxation Taxes The Income
The accelerating growth in global trade has occasioned the creation of new types of cooperative enterprises. For example, companies routinely form joint ventures or other partnership arrangements to engage in isolated projects or systematically to conduct business. Various forms of limited liability companies are also business and investment vehicles in the global arena. The application of ...
Some of the cash is generated by normal operations—selling items at prices greater than cost—but some may also be generated by reducing assets. Also, firms normally have to increase their assets if they are growing, and this required investment is deducted to find FCF. 7-7a. Interest is deductible to the corporate payer, but dividend payments are not deductible. This leads to a bias toward debt financing by businesses. Individual investors must pay taxes on either interest or dividends. So, there is a double taxation of dividend income (the company pays taxes, and then investors pay taxes on already-taxed income distributed as dividends).
President Bush, in early 2003, proposed a major change in the tax laws that would exempt dividends received from taxes. This proposal is supported by many, because it would eliminate the bias in favor of debt financing. (Most other nations already exempt dividends from taxation. ) However, it is opposed by many others who argue that it’s a “tax break for the wealthy” because they own most of the stocks and receive most of the dividends. b. Dividends are taxed (currently, before the proposed change) at regular tax rates, whereas capital gains are taxed at lower rates (a maximum of 20% for someone in the 38% tax bracket).
This leads to a bias on the part of corporations to retain earnings and use the cash to repurchase stock, thus lowering stockholders taxes. President Bush’s proposed tax change also includes a rather complicated provision that would exempt capital gains that arise from retained earnings from the capital gains tax, for without this provision taxes would give corporations incentive to pay out all of their earnings as dividends rather than retain some earnings to support growth. Elimination of the tax on dividends would, of course, encourage investors to shift funds from bonds to stocks. -8a. Lowering personal tax rates would leave investors with more disposable income, which could be spent to stimulate the economy. Also, recognize that small business income is generally taxed as personal income to the owners, so lowering personal tax rates would leave more cash to invest in the businesses, thus stimulating the economy. Lowering corporate tax rates would leave more income to invest or pay out, both of which would stimulate the economy. Also, a lower tax rate would make capital budgeting projects look better because after-tax cash flows would be increased.
The Essay on Interest Rate Increase Bank Rates
Objectives: Primary To successfully invest $200 m of funds into short term securities with the highest possible yield in order to maximise our return on profit. 10% of our funds are required to be invested in the overnight market and 50% should be available over the next 3 months. Secondary To speculate in the market according to interest rate movements over the next 6 months by buying and selling ...
However, the after-tax cost of debt would increase as a result of the lower T, but that would be a second-order effect. Reducing taxes, if not accompanied by a sharply growing economy and/or a reduction of government spending, would increase the federal deficit, and that could drive up inflation and thus interest rates. b. Depreciation schedules could be changed (toward shorter depreciable lives, or faster early-years write-offs) so as to increase cash flows. This would increase FCF and thus stimulate business investment and thus help the economy.
Again, this might increase the federal deficit and thus increase inflation and interest rates. c. As indicated above, our current tax system creates a bias toward debt financing. President Bush’s proposal to change the dividend tax situation would eliminate this bias and presumably lead to greater use of equity financing. Of course, the proposal would also put more money in the hands of investors, who would surely spend some of it and thus stimulate the economy. A stronger economy would probably lead to somewhat higher (but not necessarily excessive) interest rates.
