ESSENTIALS OF CORPORATE FINANCE –TUTORIAL ONE

Tutorial One: Introduction to Corporate Finance

Chapter 1: Questions 1, 2, 3, 6, 14 pages 17-18

Chapter 1
1.The Financial Management Decision Process [LO1]. 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.
Solution

The three types of financial management decisions are:

Capital Budgeting: This is the question of what long-term assets or investments the firm should
acquire. For example, Metro is looking to open a branch in Long An may contribute $100,000
per year to the company for the next ten years; its required rate of return is 15%. Determining
what assets/ investments to take on depends partly on the firm’s nature of business. More
importantly, the financial manager should identify and invest in assets/ investments that
generate cash flows exceeding investment costs.

Capital Structure: This is the process in which financial manager decides what sources of funds
to finance these long-term assets and investments. For example, a firm may consider between
its owners’ capital and bank loan to pay for a new branch investment which costs $10 million.
They can borrow from Sacombank at the rate of 12%. The financial manager may ask what
source of fund is the least expensive for the firm. If the firm uses both debt and equity, what is
the optimal mix?

Working Capital Management: This type of decision deals with the question how to manage the
day-to-day finances of the company. For example, how much cash should be kept on hands if
the expected turnover per day is $10,000? How much inventory is the appropriate level?
Should we sell on credit? If so, what terms and which customers should we extend them to?

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2. Sole Proprietorships and Partnerships [LO3]. What are the four primary disadvantages to
the sale proprietorship and partnership forms of business organization? What benefits are
there to these types of business organization as opposed to the corporate form?
Solution

Four primary disadvantages of sole proprietorship and partnership:

- Limited life of business: The life of sole proprietorship and partnership is limited to the
life span of its owner.
- Unlimited liability: The owner has unlimited liability which means that creditors can look
beyond business assets to the proprietor’s personal assets for debt payment in the
event of bankruptcy.
- Equity capital limited to owner’s personal wealth: Sole proprietorship and partnership
have its equity capital limited to owner’s personal wealth. This characteristic prevents
sole proprietorship and partnership from exploiting new opportunity which requires
large amount of capital.
- Difficult to transfer ownership: The transfer of ownership in sole proprietorship and
partnership requires the sale of the whole business or the establishment of a new
partnership.

Benefits of these types of business organization as opposed to the corporate form:

- Easy to start: For sole proprietorship, you do not have to do anything more than getting
a business license and find a place to set up your office. The partnership form of
business organization requires the partners to prepare a partnership agreement which
can be a formal, written document or an informal, oral agreement.
- Taxed once as personal income: All the business income is treated as personal income
and taxed once only. This is an obvious advantage of sole proprietorship and
partnership over corporate form whose income is taxed twice, first at the corporate rate
and then again at personal rate.

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3. Corporations [LO3]. What is the primary disadvantage of the corporate form of organization?
Name at least two of the advantages of corporate organization.

Solution

The primary disadvantage of corporate forms of organization is the double taxation. Corporate
income is taxed at the corporate rate first. And then when the money is paid out to
shareholders in form of dividends, it is taxed again at the personal rate.

Advantages of the corporate organization are:

▪ Unlimited life: This is because ownership is transferred easily from investor A to investor B.
Hence, the life of corporation is not limited to the life of its owners.
▪ Separation of ownership and management: “The managers are not the owners” means that
corporation can hire and elect the most talented people to run the company. Owners do
not interfere with the day-to-day operation of the corporation while still being able to
control their investments. The owners can do so by either electing new board of directors or
selling and buying their shares in the corporation in the secondary market.
▪ Transfer of ownership is easy: Just mentioned above, there is a secondary market for selling
and buying shares of already floated corporations.
▪ Easier to raise capital: Corporation can easily raise capital by issuing new shares and
attracting new investors. This characteristic allows corporation to expand its size and exploit
new investment opportunities.

6. Goal of Financial Management [LO2]. What goal should always motivate the actions of the
firm's financial manager?
Solution

The goal “maximize the market value of the existing owner’s equity” should always motivate
the actions of a firm’s financial manager because it is applicable not only with corporation form
of organization but also with proprietorship and partnership forms. Also, the term “market
value” is used instead of “book value” or “accounting value” to reflect the fact that accounting
numbers have little to do with what is good or bad for the firm and what investors really care is
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the market value of the firm. Finally, our goal does not imply that financial manager should take
illegal and unethical actions to increase the value of the firm. What we mean is that the
financial manager should best serve the firm’s owners by identifying investments that add value
to the firm because they are desired and valued in marketplace.

14. Agency Problems [LO4]. 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?

Solution

The current price share is $25. When the buyer offers $35 per share to acquire all the
outstanding stock, the shareholders of the company would obtain a $10 premium per share if
the firm accepted this offer. However, when the company’s management begins to fight against
this hostile bid, the shareholders lose the opportunity to get $10 premium per share. From the
shareholders’ point of view, the management is not acting on the shareholders’ best interest.
Instead, the management is protecting their jobs at the cost of the shareholders. If you were
the shareholders of the target company, would you be happy with your management?
Obviously, the answer is no.

Chapter 2: Questions 6, 7, 8, 9, 10, 11, 12, 14, 15, 17, 21 pages 43-45

Question 2, 5, 8 page 42 (Concept review and critical thinking)

6. Calculating Taxes [LO3]. The Anberlin Co. had $255,000 in taxable income. Using the rates
from Table 2.3 in the chapter, calculate the company's income taxes.

Solution

Taxable income = $255,000

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0.15 x 50,000 + 0.25 x (75,000 – 50,000) + 0.34 x (100,000 – 75,000) + 0.39 x (255,000 –
100,000) = $82,700

Taxable Income Tax Rate

$ 0- 50,000 15%
50,001 - 75,000 25
75,001- 100,000 34
100,001 - 335,000 39
335,001 - 10,000,000 34
10,000,001 - 15,000,000 35
15,000,001-18,333,333 38
18,333,334+ 35

7. Tax Rates. In Problem 6, what is the average tax rate? What is the marginal tax rate?
Solution

Average tax rate = tax bill/Taxable income = 82,700/255,000 = 32%

Marginal tax rate is the rate taken from the table, it is 39%.

8. Calculating OCF [LO4].Chevelle, Inc., has sales of $39,500, costs of $18,400, depreciation
expense of $1,900 and interest expense of $1,400. If the tax rate is 35 percent, what is the
operating cash flow, or OCF?

Solution

Sales $ 39,500
Costs $ 18,400
Depreciation $ 1,900
EBIT $ 19,200
Interest expense $ 1,400
Taxable income $ 17,800

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Taxes (35%) $ 6,230

Net income $ 11,570

Operating cash flow = EBIT + Depreciation – Taxes =19,200 + 1,900 – 6,230 = $14,870

9. Calculating Net Capital Spending [LO4]. Earhart Driving School's 2010, balance sheet showed
net fixed assets of $2.8 million and 2011 balance sheet showed net fixed assets of $3.6 million.
The company's 2011 income statement showed a depreciation expense of $345,000. What was
net capital spending for 2011?
Solution

Net Capital Spending = Ending net fixed assets – Beginning net fixed assets + Depreciation

= 3.6 – 2.8 + 0.345 = $1.145 million

10. Calculating Additions to NWC [LO4]. The 2010 balance sheet of Greystone, Inc., showed
current assets of $3,120 and current liabilities of $1670. The 2011 balance sheet showed
current assets of $3,460 and current liabilities of $1,980. What was the company's 2011 change
in net working capital, or NWC?
Solution

NWC 2010 = CA – CL = 3120 - 1670 = $1450

NWC 2011 = CA – CL = 3460 – 1980 = $1480

Change in NWC = Ending NWC – Beginning NWC = 1480 – 1450 = $30

11. Cash Flow to Creditors [LO4]. The 2010 balance sheet of Maria’s Tennis Shop, Inc., showed
long-term debt of $2.3 million, and the 2011 balance sheet showed long-term debt of $2.55
million. The 20011 income statement showed an interest expense of $190,000. What was the
firm's cash flow to creditors during 20011?
Solution

Net new borrowing = 2.55 – 2.3 = $0.25 million or $250,000

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Cash flow to creditors = Interest Paid – Net new borrowing = $190,000 – $250,000 = -$60,000

12. Cash Flow to Stockholders [LO4]. The 2010 balance sheet of Maria’s Tennis Shop, Inc.,
showed $680,000 in the common stock account and $4.3 million in the additional paid-in
surplus account. The 2011 balance sheet showed $715,000 and $4.7 million in the same two
accounts, respectively. If the company paid out $540,000 in cash dividends during 20011, what
was the cash flow to stockholders for the year?
Solution

Net new equity = (Ending common stock & APIC) – (Beginning common stock & APIC)

= (715,000 + 4,700,000) – (680,000 + 4,300,000)

= $435,000

Cash flow to stockholders =Dividends paid–Net new equity raised =540,000–435,000 =$105,000

14. Calculating Total Cash Flows [LO4]. Jetson Spaces craft shows the following information on
its 2011 income statement: sales = $235,000; costs = $141,000; other expenses = $7,900;
depreciation expense = $17,300; interest expense = $12,900; taxes = $19,565; dividends =
$12,300. In addition, you're told that the firm issued $6,100 in new equity during 2011, and
redeemed $4,500 in outstanding long-term debt.
a. What is the 2011 operating cash flow?
b. What is the 2011 cash flow to creditors?
c. What is the 2011 cash flow to stockholders?
d. If net fixed assets increased by $25,000 during the year, what was the addition to NWC?
Solution
Sales $235,000
Costs $141,000
Other expenses $7,900
Depreciation $17,300
EBIT $68,800

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Interest paid $12,900

Taxable income $55,900
Taxes $19,565
Net income $36,335
Dividends $12,300
Addition to retained earnings $24,035
Newly issued equity (+) $6,100
Redeemed long-term debt(-) ($4,500)
a) OCF = EBIT + Depreciation – Taxes = $66,535
b) Cash flow to creditors is the interest paid minus net new borrowing. Since the firm
redeemed $4,500 in outstanding long-term debt during 2011, the net new borrowing is
negative by this amount.

Cash flow to creditors = Interest Paid – Net new borrowing = 12,900 – (– 4,500) = $17,400

c) Cash flow to stockholders is the dividends paid minus net new equity. The net new equity is
$6,100.

Cash flow to stockholders = Dividends paid – Net new equity raised = $12,300 – 6,100 = $6,200

d) Cash flow from assets (CFFA) = cash flow to creditors + cash flow to stockholders
= $17,400 + 6,200 = $23,600

Net Capital Spending = Increase in fixed assets + Depreciation = 25,000 + 17,300 = $42,300

Also, CFFA = OCF – Net Capital Spending – Change in NWC

23,600 = 66,535 – 42,300 – Change in NWC

Change in NWC = 66,535 – 42,300 –23,600 = $635

The addition to NWC is $635.

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15. Using Income Statements [LO1]. Given the following information for Calvani Pizza Co.,
calculate the depreciation expense: sales = $52,000; costs = $27,300; addition to retained
earnings = $5,300; dividends paid = $1,800; interest expense = $4,900; tax rate = 35 percent.
Solution
From the income statement, we know that:

Depreciation = Sales – Cost – EBIT. So, we need to find EBIT as sales and costs were given from
the question.

Net income = Dividends paid + Addition to retained earnings = 1800 + 5300 = $7100

Taxable income = Net income + Taxes

Taxable income = 7100 + 0.35 Taxable income→Taxable income = $10,923

EBIT = Taxable income + Interest paid = 10,923 + 4,900 = $15,823

Depreciation = Sales – Costs – EBIT = 52,000 – 27,300 – 15,823 = $8,877

17. Residual Claims [LO1].Dime, Inc., is obligated to pay its creditors $5,800 during the year.
a. What is the value of the shareholders' equity if assets equal $7,100?
b. What if assets equal $5,200?
Solution
Liabilities = $5,800

a) If market value of assets = $7,100

Shareholders’ equity = Max [(Total assets – total liabilities); $0] = Max [($7,100 – $5,800); $0] =
Max [$1,300; $0] = $1,300

b) If value of assets = $5,200

Shareholders’ equity = Max [(Total assets – total liabilities), 0] = Max [($5,200 – $5,800); $0] =
Max [-$600; $0] = $0 ($0> -$600 → we choose $0)

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21. Calculating Cash Flows [LO2].ZigIndutries had the following operating results for 2011: sales
= $27,360; cost of goods sold = $19,260; depreciation expense = $4,860; interest expense =
$2,190; dividends paid = $1,560. At the beginning of the year, net fixed assets were $16,380,
current assets were $5,760, and current liabilities were $3,240. At the end of the year, net fixed
assets were $20,160, current assets were $7,116, and current liabilities were $3,780. The tax
rate for 2011 was 35 percent.
a. What is net income for 20011?
b. What is the operating cash flow for 2011?
c. What is the cash flow from assets for 2011? Is this possible? Explain.
d. If no new debt was issued during the year, what is the cash flow to creditors? What is the
cash flow to stockholders? Explain and interpret the positive and negative signs of your answers
in (a) through (d).
Solution
Income statement

Sales $ 27,360
COGS $ 19,260
Depreciation $ 4,860
EBIT $ 3,240
Interest paid $ 2,190
Taxable income $ 1,050
Taxes (34%) 35% $ 357 367.5

Net income $ 693 682.5

a) Net income for 2011 = $693 682.5
b) OCF = EBIT + Depreciation – Taxes = 3240 + 4860 – 357 = $7,743
c) Net capital spending (NCS)=Ending net fixes assets–Beginning net fixed assets +Depreciation

= 20160 – 16380 + 4860 = $8,640

Change in NWC = Ending NWC – Beginning NWC = (7116 – 3780) –(5760 – 3240)= $816

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CFFA = OCF – NCS – Change in NWC = 7743 – 8640 –816= –$1,713

Cash flow from assets can be negative if the firm invests heavily on both fixed assets and
working capital.

d) Where there is no new debt is issued, the cash flow to creditors which is the interest
expense minus net new borrowing is equal to interest expense, $2,190.

CFFA = Cash flow to creditors + Cash flow to stockholders

–$1713 = $2,190 + Cash flow to stockholders

→ Cash flow to stockholders = –$1713 – $2190 = –$3,903

Cash flow to stockholders = Dividends – Net new equity

→ Net new equity = Dividends – Cash flow to stockholders = 1,560 – (–3903) = $5,463

The firm had positive accounting earnings (Net income > $0) and positive operating cash flow
($7,743). After investing $8,640 in new fixed assetsand $816 in net working capital, the firm had
raise $3,831 from its stakeholders to finance the new investment. It accomplished by raising
$5,463 in form of new equity. After paying out $1,560of this in the form of dividends to
shareholders and $2,190 in the form of interest to creditors, $1,713 was left to just meet the
firm's cash flow needs for investment.

Concept review and critical thinking questions

2. Accounting and Cash Flows [LO2] Why might the revenue and cost figures shown on a
standard income statement not be representative of the actual cash inflows and outflows that
occurred during a period?

Solution

The recognition and matching principles in financial accounting call for revenues, and the
costs associated with producing those revenues, to be “booked” when the revenue
process is essentially complete, not necessarily when the cash is collected or bills are

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paid. Note that this way is not necessarily correct; it’s the way accountants have chosen to
do it.

5. Book Values versus Market Values [LO1]Under standard accounting rules, it is possible for a
company’s liabilities to exceed its assets. When this occurs, the owners’ equity is negative. Can
this happen with market values? Why or why not?

Solution

Market values can never be negative. Imagine a share of stock selling for –$20. This would
mean that if you placed an order for 100 shares, you would get the stock along with a check for
$2,000. How many shares do you want to buy? More generally, because ofcorporate and
individual bankruptcy laws, net worth for a person or a corporation cannot be negative,
implying that liabilities cannot exceed assets in market value

8. Net working Capital and Capital Spending [LO4] Could a company’s change in NWC be
negative in a given year? Explain how this might come about. What about net capital spending?

Solution

For example, if a company were to become more efficient in inventory management, the
amount of inventory needed would decline. The same might be true if it becomes better
at collecting its receivables. In general, anything that leads to a decline in ending NWC relative
to beginning NWC would have this effect. Negative net capital spending would mean more
long-lived assets were liquidated than purchased.

Participation:

Discussion: Vietnamese regulations on different forms of business organization.

1) Which legal documents set the ground for different forms of business organization in
Vietnam? List out the most updated documents.
▪ Enterprise Law 2005
▪ Government Decree No 43/2010/ND-CP on Enterprise Registration

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▪ Circular No 14/2010/TT-BKH of the Ministry of Planning and Investment: Guidance

on procedures and dossiers for business registration
2) How many forms of business organization are legally recognized in Vietnam?
▪ private enterprises
▪ partnerships
▪ limited liability companies
▪ joint-stock companies
3) How different are they compared to those in developed countries (USA, Australia,
Canada…)?
http://dddn.com.vn/ban-doc/thanh-lap-doanh-nghiep-tai-hoa-ky-2734.htm

Deliverables:

Completion of assignments and discussion questions

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