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1.
Reston, Inc., has asked your corporation, Pruro, Inc., for financial assistance. As a long-time customer of Reston,
your firm has decided to give that assistance. The question you are debating is whether Pruro should take Reston
stock with a 4.3 %4.3%
annual dividend or a promissory note paying
4.3 %4.3%
annual interest.
Assuming payment is guaranteed and the dollar amounts for annual interest and dividend income are identical, which option
will result in greater after-tax income for the first year?
What option will result in greater after-tax income for the first year?
(Select the best answer below.)
A.
While
100 %100%
of corporate interest income is taxed at ordinary tax rates, only
30 %30%
of corporate dividend income is treated as taxable income.
B.
Based solely on the tax treatment of corporate dividend income versus interest income, Pruro, Inc. would have greater aftertax income if it chooses the Reston stock paying
4.3 %4.3%
dividends over the promissory note paying
4.3 %4.3%
interest.
C.
The current tax treatment of corporate dividend income would be the equivalent of recognizing only
1.29 %1.29%
left parenthesis 0.30 times 4.3 % right parenthesis(0.30×4.3%)
of the
4.3 %4.3%
annual dividend for tax purposes.
D.
All of the above.
2. Identifying agency problems, costs, and resolutions
Explain why each of the following situations is an agency
problem and what costs to the firm might result from it. Suggest how the problem might be dealt with short of firing the
individual(s) involved.
a.
The front desk receptionist routinely takes an extra 20 minutes of lunch time to run personal errands.
b.
Division managers are padding cost estimates so as to show short-term efficiency gains when the costs come in
lower than the estimates.
c.
The firm's chief executive officer has had secret talks with a competitor about the possibility of a merger in which she
would become the CEO of the combined firms.
d.
A branch manager lays off experienced full-time employees and staffs customer service positions with part-time or
temporary workers to lower employment costs and raise this year's branch profit. The manager's bonus is based on
profitability.
a.
The front desk receptionist routinely takes an extra 20 minutes of lunch time to run personal errands. Which of the
following statements correctly identifies the cost and possible solution for the agency problem in this case?
(Choose all
correct responses.)
A.
The front desk receptionist is being compensated for unproductive time.
B.
The company could install a time clock that would result in either (1) her returning on time or (2) reducing the cost to the
firm.
C.
The management could bring the situation to the attention of the receptionist. The extra emphasis on meeting her duties
may be all that is required.
D.
The company should do . Any attempt to solve the problem would likely create an unhappy employee and only make the
situation worse.
b.
Division managers are padding cost estimates so as to show short-term efficiency gains when the costs come in
lower than the estimates. Which of the following statements correctly identifies the cost and possible solution for the agency
problem in this case?
(Choose all correct responses.)
A.
One agency cost is that money budgeted to cover the project proposal is not available to fund other projects that may help to
increase shareholder wealth.
B.
There is no agency cost in this problem.
C.
One way to reduce the agency cost is to base the reward system on how close the employee's estimates come to the actual
cost rather than having them come in below cost.
D.
A reward system based on increasing shareholder wealth might motivate the division managers to make more accurate
estimates in order to be able to take on additional profitable projects.
c.
The firm's chief executive officer has had secret talks with a competitor about the possibility of a merger in which she
would become the CEO of the combined firms. Which of the following statements correctly identifies the cost and possible
solution for the agency problem in this case?
(Choose all correct responses.)
A.
One agency cost is that the CEO may negotiate a deal with the merging competitor that is extremely beneficial to herself at
the expense of selling the firm for less than its fair market value.
B.
A good way to reduce the loss of shareholder wealth would be to open the firm up for purchase bids from other firms once
the manager makes it known that the firm is willing to merge.
C.
An open bidding process may encourage other firms to offer a price closer to the fair market value of the firm.
D.
There is no agency cost. Secrecy must be maintained in order to get the best possible price for the firm.
d.
A branch manager lays off experienced full-time employees and staffs customer service positions with part-time or
temporary workers to lower employment costs and raise this year's branch profit. The manager's bonus is based on
profitability. Which of the following statements correctly identifies the cost and possible solution for the agency problem in
this case?
(Choose all correct responses.)
A.
Generally part-time or temporary workers are not as productive as full-time employees. These workers have not been on the
job as long to increase their work efficiency.
B.
This manager is getting rid of good employees to increase short-term profits.
C.
One approach to reducing the problem would be to give the manager performance share if certain stated goals are met.
D.
Implementing a stock incentive plan tying management compensation to share price would also encourage the manager to
retain quality employees.
3. Average corporate tax rates
Using the corporate tax rate schedule given here
LOADING...
,
perform the following:
a. Calculate the tax liability, after-tax earnings, and average tax rates for the following levels of corporate earnings before
taxes:
$ 9 comma 400$9,400;
$ 81 comma 700$81,700;
$ 305 comma 000$305,000;
$ 501 comma 000$501,000;
$ 1.4$1.4
million;
$ 9.7$9.7
million; and
$ 20.4$20.4
million.
b. Plot the average tax rates (measured on the y axis) against the pretax income levels (measured on the x axis). What
generalization can be made concerning the relationship between these variables?
a. Find the marginal tax rate for the following levels of corporate earnings before taxes:
$ 9 comma 400$9,400;
$ 81 comma 700$81,700;
$ 305 comma 000$305,000;
$ 501 comma 000$501,000;
$ 1 comma 400 comma 000$1,400,000;
$ 9.7$9.7
million; and
$ 20.4$20.4
million.
The tax liability for earnings before taxes of
$ 9 comma 400$9,400
is
$
.
(Round to the nearest dollar.)
The after-tax earnings on
$ 9 comma 400$9,400
are
$
.
(Round to the nearest dollar.)
The average tax rate for the
$ 9 comma 400$9,400
in pretax earnings is
%.
(Round to one decimal place.)
The tax liability for earnings before taxes of
$ 81 comma 700$81,700
is
$
.
(Round to the nearest dollar.)
The after-tax earnings on
$ 81 comma 700$81,700
are
$
.
(Round to the nearest dollar.)
The average tax rate for the
$ 81 comma 700$81,700
in pretax earnings is
%.
(Round to one decimal place.)
The tax liability for earnings before taxes of
$ 305 comma 000$305,000
is
$
.
(Round to the nearest dollar.)
The after-tax earnings on
$ 305 comma 000$305,000
are
$
.
(Round to the nearest dollar.)
The average tax rate for the
$ 305 comma 000$305,000
in pretax earnings is
%.
(Round to one decimal place.)
The tax liability for earnings before taxes of
$ 501 comma 000$501,000
is
$
.
(Round to the nearest dollar.)
The after-tax earnings on
$ 501 comma 000$501,000
are
$
.
(Round to the nearest dollar.)
The average tax rate for the
$ 501 comma 000$501,000
in pretax earnings is
%.
(Round to one decimal place.)
The tax liability for earnings before taxes of
$ 1.4$1.4
million is
$
.
(Round to the nearest dollar.)
The after-tax earnings on
$ 1.4$1.4
million are
$
.
(Round to the nearest dollar.)
The average tax rate for the
$ 1.4$1.4
million in pretax earnings is
%.
(Round to one decimal place.)
The tax liability for earnings before taxes of
$ 9.7$9.7
million is
$
.
(Round to the nearest dollar.)
The after-tax earnings on
$ 9.7$9.7
million are
$
.
(Round to the nearest dollar.)
The average tax rate for the
$ 9.7$9.7
million in pretax earnings is
%.
(Round to one decimal place.)
The tax liability for earnings before taxes of
$ 20.4$20.4
million is
$
.
(Round to the nearest dollar.)
The after-tax earnings on
$ 20.4$20.4
million are
$
.
(Round to the nearest dollar.)
The average tax rate for the
$ 20.4$20.4
million in pretax earnings is
%.
(Round to one decimal place.)
b. Plot the average tax rates (measured on the y axis) against the pretax income levels (measured on the x axis).
The correct shape of the curve is:
(Select the best answer below.)
x y graph
What generalization can be made concerning the relationship between these variables? (Select from the drop-down menu.)
This chart demonstrates the "progressive" nature of the U.S. tax code in that income tax rates increase dramatically as the
level of income rises. The top corporate average tax rate is
▼
25%
34%
39%
34%
4.
Accrual income versus cash flow for a period.
Thomas Book Sales, Inc., supplies textbooks to college
and university bookstores. The books are shipped with a proviso that they must be paid for within 30 days but can
be returned for a full refund credit within 90 days. In 2014, Thomas shipped and billed book titles totaling
$760 comma 000760,000.
Collections, net of return credits, during the year totaled
$690 comma 000690,000.
The company spent
$300 comma 000300,000
acquiring the books that it shipped.
a.
Using accrual accounting and the preceding values, show the firm's net profit for the past year.
b. Using cash accounting and the preceding values, show the firm's net cash flow for the past year.
c. Which of these statements is more useful to the financial manager? Why?
a.
Using accrual accounting and the preceding values, show the firm's net profit for the past year in the following table.
(Round to the nearest dollar.)
Accounting View
(accrual basis)
Thomas Book Sales, Inc.
Income Statement
for the Year Ended 12/31
Sales revenue
$
Less: Costs
Net profit
$
b. Using cash accounting and the preceding values, show the firm's net cash flow for the past year in the following table.
(Round to the nearest dollar.)
Financial View
(cash basis)
Thomas Book Sales, Inc.
Cash Flow Statement
for the Year Ended 12/31
Cash inflow
$
Less: Cash outflow
Net cash flow
$
c. Which is more useful to the financial manager?
A.
The income statement because it recognizes revenues at the time of sale (whether payment has been received or not) and
recognizes expenses when they are incurred.
B.
The income statement because it recognizes amounts that will not be collected and, as a result, will not contribute to the
wealth of the owners.
C.
The cash flow statement because it recognizes amounts that will not be collected and, as a result, will not contribute to the
wealth of the owners.
D.
The cash flow statement because it recognizes revenues at the time of sale (whether payment has been received or not)
and recognizes expenses when they are incurred.
5.
What does it mean to say that individuals as a group are net suppliers of funds for financial institutions? What do
you think the consequences might be in financial markets if individuals consumed more of their incomes and
thereby reduced the supply of funds available to financial institutions?
What does it mean to say that individuals as a group are net suppliers of funds for financial institutions?
(Select the best
answer below.)
A.
Individuals, as a whole, spend more than they make. The excess is provided for by financial institutions.
B.
Individuals, as a whole, spend less than they make. The amount that they spend is made available to businesses through
financial institutions.
C.
Individuals, as a whole, spend less than they make. The excess is invested, making it available for businesses and
goverments.
D.
Individuals, as a whole, spend more than they make. The excess is provided for by businesses.
What do you think the consequences might be in financial markets if individuals consumed more of their incomes and
thereby reduced the supply of funds available to financial institutions?
(Select the best answers from thedrop-down
menus.)
If individuals consume more,
fewer
fewer
more
dollars will be available for investment. This would
reduce
increase
reduce
the amount of money available for new projects and drive
up
up
down
the required return (i.e., required return of investors to buybonds). Over time, employment, salaries, and gross domestic
product would
decline
decline
rise
6. Liability comparisons
Merideth Harper has invested $25,000 in Southwest Development Company. The firm has
recently declared bankruptcy and has $60,000 in unpaid debts. Explain the nature of payments, if any, by Ms. Harper in
each of the following situations.
a.
Southwest Development Company is a sole proprietorship owned by Ms. Harper.
b.
Southwest Development Company is a 50-50 partnership of Ms. Harper and Christopher Black.
c.
Southwest Development Company is a
corporation.
a.
If Southwest Development Company is a sole proprietorship owned by Ms. Harper,:
(Select the best answer
below.)
A.
Ms. Harper has unlimited liability, which means creditors can only claim against the $25,000 she invested.
B.
Ms. Harper has unlimited liability, which means creditors can claim against her personal assets.
C.
Ms. Harper has limited liability, which is the amount of $60,000 in unpaid debts.
D.
Ms. Harper has limited liability, which guarantees that she cannot lose more than the $25,000 she invested.
b.
If Southwest Development Company is a 50-50 partnership of Ms. Harper and Christopher Black,:
(Select the best
answer below.)
A.
Ms. Harper has limited liability, which is $30,000, or half of the $60,000 in unpaid debts.
B.
Ms. Harper has limited liability, which guarantees that she cannot lose more than the $25,000 she invested.
C.
Ms. Harper has unlimited liability, which means creditors can only claim against the $25,000 she invested.
D.
Ms. Harper has unlimited liability, which means creditors can claim against her personal assets.
c. If Southwest Development Company is a corporation,:
(Select the best answer below.)
A.
Ms. Harper has unlimited liability, which means creditors can claim against her personal assets.
B.
Ms. Harper has limited liability, which guarantees that she cannot lose more than the $25,000 she invested.
C.
Ms. Harper has limited liability, which is the amount of $60,000 in unpaid debts.
D.
Ms. Harper has unlimited liability, which means creditors can only claim against the $25,000 she invested.
.