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Chapter 1
Corporate Finance and the Financial Manager
Note: All problems in this chapter are available in MyLabFinance. An asterisk (*) indicates
problems with a higher level of difficulty.
1. A corporation is a legal entity separate from its owners. This means ownership shares in
the corporation can be freely traded. None of the other organizational forms share this
characteristic.
2. Owners’ liability is limited to the amount they invested in the firm. Stockholders are not
responsible for any encumbrances of the firm; in particular, they cannot be required to
pay back any debts incurred by the firm.
3. Corporations and limited liability companies. Limited partnerships provide limited
liability for the limited partners, but not for the general partners.
4. Advantages: Limited liability, liquidity, infinite life
Disadvantages: Double taxation, separation of ownership and control
5. Real estate corporations must pay corporate income taxes but REITs do not pay corporate
tax; instead, they must pass through substantially all of the income to the trust unit
holders to whom the income is taxable.
6. Excel Solution
Plan: First find the value remaining after corporate taxes. Then determine the remainder
after personal taxes.
Execute: First the corporation pays the taxes. After taxes, $2 × (1 – 0.34) = $1.32 per
share is left to pay dividends. Once the dividend is paid, personal tax on this must be paid
leaving $1.32 × (1 – 0.18) = $1.0824 per share.
Evaluate: After all the taxes are paid, you are left with $1.0824 per share.
7. Excel Solution
Plan: First find the value remaining after corporate taxes. Then determine the remainder
after personal taxes.
1
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, 2 Chapter 1: Corporate Finance and the Financial Manager
Execute: As a REIT, there is no corporate tax so the full $2 per share can be paid out to
you as a unit holder. You must then pay personal income tax on the distribution. So you
are left with $2 × (1 – 0.4) = $1.20 per share.
Evaluate: After all the taxes are paid, you are left with $1.20 per share.
8. The investment decision is the most important decision that a financial manager makes,
as the manager must decide how to put the owners’ money to its best use.
9. The goal of maximizing shareholder wealth is agreed upon by all shareholders because
all shareholders are better off when this goal is achieved.
10. Shareholders can do the following:
a. Ensure that employees are paid with company stock and/or stock options.
b. Ensure that underperforming managers are fired.
c. Write contracts that ensure that the interests of the managers and shareholders are
closely aligned.
d. Mount hostile takeovers.
11. When your parents pay for the meal, you benefit from the food but do not take on the cost
of the food. This is similar to the agency problem in corporations, when managers can
benefit from taking actions in their own personal interests using money that belongs to
shareholders.
12. The agent (renter) will not take the same care of the apartment as the principal (owner),
because the renter does not share in the costs of fixing damage to the apartment. To
mitigate this problem, having the renter pay a deposit would motivate the renter to keep
damages to a minimum. The deposit forces the renter to share in the costs of fixing any
problems that are caused by the renter.
13. There is an ethical dilemma when the CEO of a firm has opposite incentives to those of
the shareholders. In this case, you (as the CEO) have an incentive to potentially overpay
for another company (which would be damaging to your shareholders) because your pay
and prestige will improve.
*14. Plan: For each of parts (a) to (d) you must determine if your personal change in monetary
wealth more than offsets the value to you of losing your leisure time (valued at $51,000).
If it does, then you would decide to proceed with the new project.
Execute:
a. If you owned 100% of the company and the project were accepted, your personal
shares of stock would increase in value by 100% of $1 million = $1 million. This
Full download contact
Chapter 1
Corporate Finance and the Financial Manager
Note: All problems in this chapter are available in MyLabFinance. An asterisk (*) indicates
problems with a higher level of difficulty.
1. A corporation is a legal entity separate from its owners. This means ownership shares in
the corporation can be freely traded. None of the other organizational forms share this
characteristic.
2. Owners’ liability is limited to the amount they invested in the firm. Stockholders are not
responsible for any encumbrances of the firm; in particular, they cannot be required to
pay back any debts incurred by the firm.
3. Corporations and limited liability companies. Limited partnerships provide limited
liability for the limited partners, but not for the general partners.
4. Advantages: Limited liability, liquidity, infinite life
Disadvantages: Double taxation, separation of ownership and control
5. Real estate corporations must pay corporate income taxes but REITs do not pay corporate
tax; instead, they must pass through substantially all of the income to the trust unit
holders to whom the income is taxable.
6. Excel Solution
Plan: First find the value remaining after corporate taxes. Then determine the remainder
after personal taxes.
Execute: First the corporation pays the taxes. After taxes, $2 × (1 – 0.34) = $1.32 per
share is left to pay dividends. Once the dividend is paid, personal tax on this must be paid
leaving $1.32 × (1 – 0.18) = $1.0824 per share.
Evaluate: After all the taxes are paid, you are left with $1.0824 per share.
7. Excel Solution
Plan: First find the value remaining after corporate taxes. Then determine the remainder
after personal taxes.
1
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, 2 Chapter 1: Corporate Finance and the Financial Manager
Execute: As a REIT, there is no corporate tax so the full $2 per share can be paid out to
you as a unit holder. You must then pay personal income tax on the distribution. So you
are left with $2 × (1 – 0.4) = $1.20 per share.
Evaluate: After all the taxes are paid, you are left with $1.20 per share.
8. The investment decision is the most important decision that a financial manager makes,
as the manager must decide how to put the owners’ money to its best use.
9. The goal of maximizing shareholder wealth is agreed upon by all shareholders because
all shareholders are better off when this goal is achieved.
10. Shareholders can do the following:
a. Ensure that employees are paid with company stock and/or stock options.
b. Ensure that underperforming managers are fired.
c. Write contracts that ensure that the interests of the managers and shareholders are
closely aligned.
d. Mount hostile takeovers.
11. When your parents pay for the meal, you benefit from the food but do not take on the cost
of the food. This is similar to the agency problem in corporations, when managers can
benefit from taking actions in their own personal interests using money that belongs to
shareholders.
12. The agent (renter) will not take the same care of the apartment as the principal (owner),
because the renter does not share in the costs of fixing damage to the apartment. To
mitigate this problem, having the renter pay a deposit would motivate the renter to keep
damages to a minimum. The deposit forces the renter to share in the costs of fixing any
problems that are caused by the renter.
13. There is an ethical dilemma when the CEO of a firm has opposite incentives to those of
the shareholders. In this case, you (as the CEO) have an incentive to potentially overpay
for another company (which would be damaging to your shareholders) because your pay
and prestige will improve.
*14. Plan: For each of parts (a) to (d) you must determine if your personal change in monetary
wealth more than offsets the value to you of losing your leisure time (valued at $51,000).
If it does, then you would decide to proceed with the new project.
Execute:
a. If you owned 100% of the company and the project were accepted, your personal
shares of stock would increase in value by 100% of $1 million = $1 million. This
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