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Section 1.2 Does business finance include determining which long-term
assets a firm should purchase?
Section 1.3 Under what forms of organization does the owner have unlimited
liability?
Section 1.4 What is the intent of the Sarbanes-Oxley Act of 2002?
Section 1.5 Who are the stakeholders in a firm?
Section 1.6 What are the features of a dealer market?
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1.1
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1.2
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CRITICAL THINKING AND CONCEPTS REVIEW connect
FINANCE
The Financial Management Decision Process. What are the three types
of financial management decisions? For each type of decision, give an example of
a business transaction that would be relevant.
Sole Proprietorships and Partnerships. What are the four primary
disadvantages to the sole proprietorship and partnership forms of business
organization? What benefits are there to these types of business organization as
opposed to the corporate form?
1.3 Corporations. What is the primary disadvantage of the corporate form of
organization? Name at least two of the advantages of corporate organization.
1.4 Corporate Finance Organization. In a large corporation, what are the two
distinct groups that report to the chief financial officer? Which group is the focus
of corporate finance?
1.5 Goal of Financial Management. What goal should always motivate the
actions of the firm's financial manager?
1.6 Agency Problems. Who owns a corporation? Describe the process whereby
the owners control the firm's management. What is the main reason that an agency
relationship exists in the corporate form of organization? In this context, what
kinds of problems can arise?
Primary versus Secondary Markets. You've probably noticed coverage in
the financial press of an initial public offering (IPO) of a company's securities.
Social networking company Facebook is a relatively recent example. Is an IPO a
primary-market transaction or a secondary-market transaction?
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1.7
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1.8
not-
York Stock Excha
from dealer markets? What kind of mark
Not-for-Profit Firm Goals. Suppose you were the financial manager
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1.9
for-profit business (a not-for-profit hospital, perhaps). What kinds of goals do you
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think would be appropriate?
1.10 Ethics and Firm Goals. Can our goal of maximizing the value of the stock
conflict with other
goals
, such as avoiding unethical or illegal behavior? In particular
,
do you think subjects such as customer and employee safety, the environment, and
the general good of society fit in this framework, or are they essentially ignored? Try
to think of some specific scenarios to illustrate your answer.
1.11 International Firm Goal. Would our goal of maximizing the value of the
stock be different if we were thinking about financial management in a foreign
country? Why or why not?
1.12 Agency Problems. Suppose you own stock in a company. The current price
per share is $25. Another company has just announced that it wants to buy your
company and will pay $35 per share to acquire all the outstanding stock. Your
company's management immediately begins fighting off this hostile bid. Is
management acting in the shareholders' best interests? Why or why not?
1.13 Agency Problems and Corporate Ownership. Corporate ownership varies
around the world. Historically, individuals have owned the majority of shares
in public corporations in the United States. In Germany and Japan, however,
banks, other large financial institutions, and other companies own most of the
stock in public corporations. Do you think agency problems are likely to be
more or less severe in Germany and Japan than in the United States? Why? In
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recent years, large financial institutions such as mutual funds and pension funds
have been becoming the dominant owners of stock in the United States, and
these institutions are becoming more active in corporate affairs. What are the
implications of this trend for agency problems and corporate control?
1.14 Executive Compensation. Critics have charged that compensation to top
management in the United States is simply too high and should be cut back. For
example, focusing on large corporations, John Hammergren, CEO of McKesson,
earned about $131 million in 2011 and about $285 million over the 2007-2011
period. Are such amounts excessive? In answering, it might be helpful to recognize
that
superstar athletes such as LeBron James, top entertainers such as Oprah Winfrey,
and many others at the top of their respective fields earn at least as much, if not more.
1.15 Sarbanes-Oxley. In response to the Sarbanes-Oxley Act, many small firms
in the United States have opted to "go dark" and delist their stock. Why might a
company choose this route? What are the costs of "going dark"?
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HAT'S ON
E WEB?
1.1 Listing Requirements. This chapter discussed some of the listing requirements for
the NYSE and NASDAQ. Find the complete listing requirements for the New York Stock
Exchange at www.nyse.com and NASDAQ at www.nasdaq.com. Which has more stringent
listing requirements? Why don't they have the same listing requirements?
1.2 Business Formation. As you may (or may not) know, many companies incorporate
in Delaware for a variety of reasons. Visit BizFilings at www.bizfilings.com to find out
why. Which state has the highest fee for incorporation? For an LLC? While at the site, look
at the FAQ section regarding corporations and LLCs.
45
Financial Statements, Taxes, and Cash Flow
CHAPTER 2
some extra
$150 was
year. Cash
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QUESTIONS AND PROBLEMS connect Select problems are available in McGraw-Hill
JFINANCE section of the preface for more information.
1. Building a Balance Sheet. Kroeger, Inc., has current assets of $1,970, net fixed Basic
assets of $9,650, current liabilities of $1,520, and long-term debt of $4,370. What is (Questions 1-13)
the value of the shareholders' equity account for this firm? How much is net working
capital?
2. Building an Income Statement. Draiman, Inc., has sales of $795,000, costs of
$345,000, depreciation expense of $76,000, interest expense of $41,000, and a tax
rate of 35 percent. What is the net income for this firm?
3. Dividends and Retained Earnings. Suppose the firm in Problem 2 paid out
$56,000 in cash dividends. What is the addition to retained earnings?
4. Per-Share Earnings and Dividends. Suppose the firm in Problem 3 had 60,000
shares of common stock outstanding. What is the earnings per share, or EPS, figure?
What is the dividends per share figure?
5. Market Values and Book Values. Klingon Widgets, Inc., purchased new
cloaking machinery three years ago for $8 million. The machinery can be sold to the
Romulans today for $6.7 million. Klingon's current balance sheet shows net fixed
assets of $3.1 million, current liabilities of $790,000, and net working capital of
$145,000. If all the current assets were liquidated today, the company would receive
$865,000 cash. What is the book value of Klingon's total assets today? What is the
market value?
editors plus
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6. Calculating Taxes. The SGS Co. had $215,000 in taxable income. Using the
rates from Table 2.3 in the chapter, calculate the company's income taxes.
7. Tax Rates. In Problem 6, what is the average tax rate? What is the marginal tax
rate?
8. Calculating OCF. Hammett, Inc., has sales of $34,630, costs of $10,340,
depreciation expense of $2,520, and interest expense of $1,750. If the tax rate is
35 percent, what is the operating cash flow, or OCF?
9. Calculating Net Capital Spending. Rotweiler Obedience School's December 31,
2013, balance sheet showed net fixed assets of $1,635,000, and the December 31,
2014, balance sheet showed net fixed assets of $1,976,000. The company's 2014
income statement showed a depreciation expense of $305,000. What was Rotweiler's
net capital spending for 2014?
10. Calculating Additions to NWC. The December 31, 2013, balance sheet of
Maria's Tennis Shop, Inc., showed current assets of $1,045 and current liabilities of
$960. The December 31, 2014, balance sheet showed current assets of $1,310 and
current liabilities of $1,090. What was the company's 2014 change in net working
capital, or NWC?
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11. Cash Flow to Creditors. The December 31, 2013, balance sheet of Schism, Inc.,
showed long-term debt of $1,280,000, and the December 31, 2014, balance sheet
showed long-term debt of $1,410,000. The 2014 income statement showed an interest
expense of $93,400. What was the firm's cash flow to creditors during 2014?
12. Cash Flow to Stockholders. The December 31, 2013, balance sheet of Schism,
Inc., showed $120,000 in the common stock account and $2,120,000 in the additional
paid-in surplus account. The December 31, 2014, balance sheet showed $135,000
and $2,380,000 in the same two accounts, respectively. If the company paid out
$135,000 in cash dividends during 2014, what was the cash flow to stockholders for
cash flow
is might
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the year?
suffer
our
Understanding Financial Statements and Cash Flow
PART 2
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13. Calculating Cash Flows. Given the information for Schism, Inc., in Problems
11 and 12, suppose you also know that the firm's net capital spending for 2014 was
$640,000, and that the firm reduced its net working capital investment by $105,000.
What was the firm's 2014 operating cash flow, or OCF?
14. Calculating Cash Flows. Weiland Co. shows the following information on
its 2014 income statement: sales = $167,000; costs = $88,600; other expenses =
$4,900; depreciation expense = $11,600; interest expense = $8,700; taxes
$18,620;
dividends = $9,700. In addition, you're told that the firm issued $2,900 in new equity
during 2014, and redeemed $4,000 in outstanding long-term debt.
What is the 2014 operating cash flow?
b. What is the 2014 cash flow to creditors?
What is the 2014 cash flow to stockholders?
ermediate
Jestions 14-23)
a.
C.
d. If net fixed assets increased by $23,140 during the year, what was the addition to
NWC?
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15. Using Income Statements. Given the following information for Sookie's
$43,200;
Cookies Co., calculate the depreciation expense: sales = $55,000; costs =
addition to retained earnings = $2,600; dividends paid = $1,150; interest expense
$1,670; tax rate =
40 percent.
16. Preparing a Balance Sheet. Prepare a balance sheet for Alaskan Orange Corp.
as of December 31, 2014, based on the following information: cash = $197,000;
patents and copyrights = $863,000; accounts payable = $288,000; accounts
receivable = $265,000; tangible net fixed assets = $5,300,000; inventory
$563,000; notes payable = $194,000; accumulated retained earnings = $4,586,000;
long-term debt = $1,450,000.
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17. Residual Claims. Chevelle, Inc., is obligated to pay its creditors $7,800 during
the year.
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a. What is the value of the shareholders' equity if assets equal $9,300?
b. What if assets equal $6,900?
18. Marginal versus Average Tax Rates. (Refer to Table 2.3.) Corporation Growth
has $83,000 in taxable income, and Corporation Income has $8,300,000 in taxable
income.
a. What is the tax bill for each firm?
b. Suppose both firms have identified a new project that will increase taxable
income by $10,000. How much in additional taxes will each firm
this amount the same?
19. Net Income and OCF. Nuri
$2,600,000
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porate
person
partnership terminates when a general partner wishes to sell out or
as personal income to the partners, and the amount of equity that can be raised is limited
to the partners' combined wealth. Ownership by a general partner is not easily transferred
because a new partnership must be formed. A limited partner's interest can be sold without
dissolving the partnership, but finding a buyer may be difficult.
Because a partner in a general partnership can be held responsible for all partner-
ship debts, having a written agreement is very important. Failure to spell out the rights
and duties of the partners frequently leads to misunderstandings later on. Also, if you
are a limited partner, you must not become deeply involved in business decisions un-
less you are willing to assume the obligations of a general partner. The reason is that if
things go badly, you may be deemed to be a general partner even though you say you
are a limited partner.
Based on our discussion, the primary disadvantages of sole proprietorships and
nerships as forms of business organization are (1) unlimited liability for business debts
part-
on the part of the owners, (2) limited life of the business, and (3) difficulty of transfer-
ring ownership. These three disadvantages add up to a single, central problem: The abil-
ity of such businesses to grow can be seriously limited by an inability to raise cash for
investment.
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corporation
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Corporation
The corporation is the most important form (in terms of size) of business organization in
the United States. A corporation is a legal "person" separate and distinct from its owners,
and it has many of the rights, duties, and privileges of an actual person. Corporations can
borrow money and own property, can sue and be sued, and can enter into contracts. A cor-
poration can even be a general partner or a limited partner in a partnership, and a corpora-
tion can own stock in another corporation.
Not surprisingly, starting a corporation is somewhat more complicated than starting
the other forms of business organization. Forming a corporation involves preparing articles
of incorporation (or a charter) and a set of bylaws. The articles of incorporation must con-
tain a number of things, including the corporation's name, its intended life (which can be
forever), its business purpose, and the number of shares that can be issued. This informa-
tion must normally be supplied to the state in which the firm will be incorporated. For most
legal purposes, the corporation is a "resident" of that state.
The bylaws are rules describing how the corporation regulates its own existence. For
example, the bylaws describe how directors are elected. The bylaws may be amended or
extended from time to time by the stockholders.
In a large corporation, the stockholders and the managers are usually separate groups.
The stockholders elect the board of directors, who then select the managers. Management
is charged with running the corporation's affairs in the stockholders' interests. In principle,
stockholders control the corporation because they elect the directors.
As a result of the separation of ownership and management, the corporate form has
several advantages. Ownership (represented by shares of stock) can be readily transferred,
and the life of the corporation is therefore not limited. The corporation borrows money in
its own name. As a result, the stockholders in a corporation have limited liability for corpo-
rate debts. The most they can lose is what they have invested.
The relative ease of transferring ownership, the limited liability for business debts,
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and the unlimited life of the business are the reasons why the corporate form is superior
when it comes to raising cash. If a corporation needs new equity, it can sell new shares of
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