Chapter 7
Financing Activities
7-31
in whole or in part.
e. Common practice in the fast-food, specialty apparel, and coffee shop sectors is
costs.
Case 7.2: Oracle Corporation: Share-Based Compensation Effects/Statement of
Shareholders’ Equity
Compensation plans had a substantial effect on Oracle’s shareholders’ equity
change during 2008 (in millions):
Common Stock Awarded under Stock Award Plans ……………. $1,229
40.90%.
uity ratio represents an increase in long-term solvency risk. From a profitability
equity financing even further.
(Chapters 12–14 discuss the valuation effects of changes in leverage. Although
ROE is levered upward, increased financial risk increases both the cost of equi-
ty and debt financing.)
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Financing Activities
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in whole or in part.
b. The decrease in retained earnings occurred because Oracle (a) paid more to
If less than 100% of earnings are paid to the shareholders in dividends, the
their pro rata share of retained earnings. Therefore, when Oracle repurchased the
retained earnings.
c. Common stock awarded under stock award plans: Cash inflow represents exer-
cise price paid by employees upon exercise of options; this amount is reported
as a financing activity in the cash flow statement.
Assumption of stock awards in conjunction with acquisitions: Presumably,
cash flow statement.
Tax benefits from stock plans: Cash savings on income taxes due to the tax de-
and some in the financing sections.)
d. All increases in net assets from transactions with non-owners increase share-
holders’ equity indirectly via net income’s effect on retained earnings or direct-
ly via increases in other comprehensive income.
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Financing Activities
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in whole or in part.
An increase in accounts receivable from earning revenue increases net income.
An increase in accounts receivable from currency translation is one of the hand-
ful of increases in net assets that are not reflected in income but are reflected in
comprehensive income. Oracle reports $300 million in foreign currency transla-
income.
e. Opponents of the other comprehensive income approach dislike the exclusion of
gains and losses from net income. Doing so, they argue, hurts the ability of net
income to measure firm performance. Oracle operates a foreign subsidiary that
risk is not adequately measured.
Proponents of the comprehensive income approach question whether items such
as foreign currency translation gains are indicative of the ability to generate
current cash flow. The foreign subsidiary is not being liquidated (that is, turned
f. Oracle will not report a loss from allowing its employees to purchase shares at
95% of market value. Plans in which broad employee participation is allowed,
the discount is reasonable (for example, no greater than 5%), and other restric-
tions apply are considered noncompensatory. Therefore, the purchase of shares
Chapter 7
Financing Activities
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in whole or in part.
Case 7.3: Long-Term Solvency Risk: Southwest and Lufthansa Airlines
a. Summary Discussion
operating leases.
LTD to OCF to Interest
Liabilities Shareholders’ Total Coverage
to Assets Equity Liabilities (Cash Basis)
As Reported:
Adjusted for Operating
Leases:
plains the large rise in long-term debt relative to shareholders’ equity and the
negative operating cash flow for SWA (cash used to pay down short-term oper-
ating liabilities). Normally, SWA has a very healthy OCF to total liabilities ratio
(recall from the chapter text that 0.20 is considered healthy for most firms) and
ating cash flow in 2008 is transitory.
Lufthansa’s long-term solvency risk is very stable, although the operating cash-
flow-based ratios deteriorated a bit in 2008. Assuming that 2007 is a more accu-
rate portrayal of SWA’s risk, Lufthansa is riskier, with higher debt ratios, a
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Financing Activities
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in whole or in part.
Supporting computations for the ratios appear next.
LTD to OCF to Interest
Liabilities Shareholders’ Total Coverage
to Assets Equity Liabilities (Cash Basis)
As Reported:
SWA: 2008 $–1,521/
Lufthansa: 2008 2,473/
Adjusted for
Operating Leases:
SWA: 2008 ($14,308 – ($–1,521 +
SWA: 2007 ($16,772 – ($2,845 +
6,941 + ($2,050 + 382.40)/
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Financing Activities
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in whole or in part.
Lufthansa: 2008 (6,898 + (2,473 +
Lufthansa: 2007 (7,149 + (2,862 +
Supporting Computations for SWA:
Estimate of SWA’s Interest Rate:
(Note: This interest rate determines the factors in the following table using the
dicated in the note.)
Southwest Operating Lease Capitalization: 2008
Operating
Lease Present Value Present
Year Commitments Factor at 4.5% Value
$728/5 years = $145.6 million.
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Financing Activities
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in whole or in part.
Southwest Operating Lease Capitalization: 2007
Operating
Lease Present Value Present
Year Commitments Factor at 4.5% Value
*Present value of an annuity of $175.2 million for five periods at 4.5%; then
Restatement of Operating Cash Flow (2008):
Rent Expense in 2008 (per Note 8), which would be added back to
These cash flow effects are rough estimates, particularly interest expense because
it is based on the ending balance of the liability. An alternative (and more correct)
of new leases signed would have to be estimated, which, of course, would be done
with some error as well. Accordingly, this rough approximation of interest ex-
pense was used.
2007:
Approximation of interest expense for 2007 ($1,914.40 × 0.045),
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Financing Activities
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in whole or in part.
Supporting Computations for Lufthansa:
Estimate of Lufthansa’s Interest Rate:
Lufthansa Operating Lease Capitalization: 2008
Operating
Lease Present Value Present
Year Commitments Factor at 6.9% Value
2009 492 0.9354 460.22
is discounted back five periods at 6.9%.
Lufthansa Operating Lease Capitalization: 2007
Operating
Lease Present Value Present
Year Commitments Factor at 6.9% Value
2008 512 0.9354 478.92
is discounted back five periods at 6.9%.
Chapter 7
Financing Activities
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in whole or in part.
Restatement of Operating Cash Flow (2008):
Approximation of interest expense for 2008 ($2,439.66 ×
2007:
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Financing Activities
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in whole or in part.
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