1-1. What is the most important difference between a corporation and all other organizational forms? Owners of a corporation are not liable for obligations the corporation enters into because a corporation is defined as a legal entity separate from its owners.
1-2. What does the phrase limited liability mean in a corporate context? Limited liability means that owners/investors are solely liable for the amounts they invested in the company; and owners/investors are not responsible for any debts, delinquent funds, or collections incurred by the company.
1-3. Which organizational forms give their owners limited liability? Corporations give owners limited liability and limited partnerships give limited liability to the limited partners, not the general partners.
1-4. What are the main advantages and disadvantages of organizing a firm as a corporation? The main advantages of an organization are they offer limited liability to the owners, greater liquidity and life span due to an unlimited number of potential owners investing funds into the firm. The main disadvantages of an organization are their double taxation of profits/dividends and the separation between ownership and control of the firm.
1-5. Explain the difference between an S corporation and a C corporation. The difference between a C corporation and S corporation is a C corporation pays corporate income taxes on profits and then the profits are distributed to the owners, whom are responsible for paying income taxes on these earnings. S corporations do not pay corporate taxes on profits, but they pass the entire tax liability onto the owners. The owners of an S corporation are limited to no more than 100 U.S. citizens.
1-6. You are a shareholder in a C corporation. The corporation earns $2 per share before taxes. Once it has paid taxes it will distribute the rest of its earnings to you as a dividend. The corporate tax rate is 40% and the personal tax rate on (both dividend and non-dividend) income is 30%. How much is left for you after all taxes are paid? Dividend available after corporate taxes: $2 x (1-0.4) = $1.20 Dividend available after personal taxes: $1.20 x (1-0.3) = $0.84 After taxes are paid, a dividend of $0.84 per share is available for distribution.
1-7. Repeat Problem 6 assuming the corporation is an S corporation. Dividend available after corporate taxes: $2, S corporations are not subject to corporate taxes. Dividend available after personal taxes: $2 x (1-0.3) = $1.40 After taxes are paid, a dividend of $1.40 per share is available for distribution.
2.8 In early 2009, General Electric (GE) had a book value of equity of $105 billion, 10.5 billion shares outstanding, and a market price of $10.80 per share. GE also had cash of $48 billion, and total debt of $524 billion. Three years later, in early 2012, GE had a book value of equity of $116 billion, 10.6 billion shares outstanding with a market price of $17 per share, cash of $84 billion, and total debt of $410 billion. Over this period, what was the change in GE’s: a. market capitalization? Market Value of Equity = Shares outstanding × Market price per share 2009: 10.5 billion shares x $10.80 per share = $113.4 billion 2012: 10.6 billion shares x $17 per share = $180.2 billion
The change in market capitalization between 2009 and 2012 is: $180.2 billion – $113.4 billion = $66.8 billion. b. market-to-book ratio?
2009: $113.4 / $105 = 1.08 2012: $180.2/ $116 = 1.55
The change in market-to-book ratio between 2009 and 2012 is: 1.55 – 1.08 = 0.47 c. enterprise value? Enterprise Value = Market Value of Equity + Debt − Cash 2009: $113.4 + 524 – 48 = $589.4 billion
2012: $180.2 + 410 – 84 = $506.2 billion
The change in enterprise value between 2009 and 2012 is: $506.2 billion – $589.4 billion = -$83.2 billion 2-11. Suppose that in 2013, Global launches an aggressive marketing campaign that boosts sales by 15%. However, their operating margin falls from 5.57% to 4.50%. Suppose that they have no other income, interest expenses are unchanged, and taxes are the same percentage of pretax income as in 2012. a. What is Global’s EBIT in 2013?
2013 Revenues: $186.7 million x 1.15 = $214.705 million
EBIT = $214.705 million x 0.045 = $9.66 million
b. What is Global’s net income in 2013?
Net income = EBIT – Interest Expenses – Taxes
2013 Net income: ($9.66 million – $7.7 million) x (1-0.26) = $1.45 million c. If Global’s P/E ratio and number of shares outstanding remains unchanged, what is Global’s share price in 2013? 2013 P/E ratio: 2012 share price/earnings per share = $14/$0.556 = 25.17 2013 EPS: 2013 Net income/shares outstanding = $1.45 million/3.6 million shares = $0.403 2013 Share price = 25.17 x $0.403 = $10.14 per share
2-24. Suppose your firm receives a $5 million order on the last day of the year. You fill the order with $2 million worth of inventory. The customer picks up the entire order the same day and pays $1 million upfront in cash; you also issue a bill for the customer to pay the remaining balance of $4 million in 30 days. Suppose your firm’s tax rate is 0% (i.e., ignore taxes). Determine the consequences of this transaction for each of the following:
a. Revenues = Increase by $5 million
b. Earnings = Increase by $ 3 million
c. Receivables = Increase by 4 million
d. Inventory = Decrease by $2 million
e. Cash = Increase by $1 million ($3 million earnings + $2 million inventory – $4 million receivables)
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