BUS 438 Chapter Problems

1-1. What is the most important difference between a corporation and all other organizational forms?

A corporation is a legal entity separate from its owners.

2-14. See Table 2.5 showing financial statement data and stock price data for Mydeco Corp. Suppose Mydeco repurchases 2 million shares each year from 2010 to 2013. What would its earnings per share be in 2013?

A repurchase does not impact earnings directly, so any change to EPS will come from a reduction in shares outstanding. 2013 shares outstanding = 55 - 4 × 2 = 47 million, EPS .

2-4. Consider the following potential events that might have taken place at Global Conglomerate on December 30, 2012. For each one, indicate which line items in Global's balance sheet would be affected and by how much. Also indicate the change to Global's book value of equity. (In all cases, ignore any tax consequences for simplicity.)

a. Global used $20 million of its available cash to repay $20 million of its long-term debt. b. A warehouse fire destroyed $5 million worth of uninsured inventory. c. Global used $5 million in cash and $5 million in new long-term debt to purchase a $10 million building. d. A large customer owing $3 million for products it already received declared bankruptcy, leaving no possibility that Global would ever receive payment. e. Global's engineers discover a new manufacturing process that will cut the cost of its flagship product by over 50%. f. A key competitor announces a radical new pricing policy that will drastically undercut Global's prices. a. Long-term liabilities would decrease by $20 million, and cash would decrease by the same amount. The book value of equity would be unchanged. b. Inventory would decrease by $5 million, as would the book value of equity. c. Long-term assets would increase by $10 million, cash would decrease by $5 million, and long-term liabilities would increase by $5 million. There would be no change to the book value of equity. d. Accounts receivable would decrease by $3 million, as would the book value of equity. e. This event would not affect the balance sheet. f. This event would not affect the balance sheet.

2-34. See Table 2.5 showing financial statement data and stock price data for Mydeco Corp.

a. How did Mydeco's book debt-equity ratio change from 2009 to 2013? b. How did Mydeco's market debt-equity ratio change from 2009 to 2013? c. Compute Mydeco's debt-to-enterprise value ratio to assess how the fraction of its business that is debt financed has changed over the period. a. 2009 book debt-equity ratio . 2013 book debt-equity ratio . b. 2009 market debt-equity ratio . 2013 market debt-equity ratio . c. 2009 debt-enterprise value ratio . 2013 debt-enterprise value ratio .

2-7. Find online the annual 10-K report for Peet's Coffee and Tea (PEET) for fiscal year 2011 (filed in January, 2012). Answer the following questions from their balance sheet:

a. How much cash did Peet's have at the end of the fiscal year? b. What were Peet's total assets? c. What were Peet's total liabilities? How much debt did Peet's have? d. What was the book value of Peet's equity? a. At the end of the fiscal year, Peet's had cash and cash equivalents of $30.755 million. b. Peet's total assets were $215.27 million. c. Peet's total liabilities were $37.32 million, and it had no debt. d. The book value of Peet's equity was $177.96 million.

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 b. Earnings c. Receivables d. Inventory e. Cash 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 $3 million (earnings) - $4 million (receivables) + $2 million (inventory) = $1 million (cash).

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? b. What is Global's income in 2013? c. If Global's P/E ratio and number of shares outstanding remains unchanged, what is Global's share price in 2013? a. Revenues in 2012 = 1.15 × 186.7 = $214.705 million. EBIT = 4.50% × 214.705 = $9.66 million (there is no other income). b. Net Income = EBIT - Interest Expenses - Taxes = (9.66 - 7.7) × (1 - 26%) = $1.45 million. c. . Note: Differences from spreadsheet solutions due to rounding.

2-10. See Table 2.5 showing financial statement data and stock price data for Mydeco Corp.

a. What is Mydeco's market capitalization at the end of each year? b. What is Mydeco's market-to-book ratio at the end of each year? c. What is Mydeco's enterprise value at the end of each year? 2009-2013 Financial Statement Data and Stock Price Data for Mydeco Corp. a. Image b. Image c. Image

2-12. Find online the annual 10-K report for Peet's Coffee and Tea (PEET) for fiscal year 2011 (filed in January, 2012). Answer the following questions from their income statement:

a. What were Peet's revenues for fiscal year 2011? By what percentage did revenues grow from the prior year? b. What was Peet's operating income for the fiscal year? c. What was Peet's average tax rate for the year? d. What were Peet's diluted earnings per share in fiscal year 2011? What number of shares is this EPS based on? a. Revenues = $371.919 million. Revenue growth . b. Operating Income = $27.607 million. c. Average tax rate . d. The diluted earnings per share in 2011 was $1.33. The number of shares used in this calculation of diluted EPS was 13.37 million.

1-5. Explain the difference between an S corporation and a C corporation.

C corporations must pay corporate income taxes; S corporations do not pay corporate taxes, but must pass through the income to shareholders to whom it is taxable. S corporations are also limited to 75 shareholders and cannot have corporate or foreign stockholders.

1-3. Which organizational forms give their owners limited liability?

Corporations and limited liability companies give owners limited liability. Limited partnerships provide limited liability for the limited partners, but not for the general partners.

2-1. What four financial statements can be found in a firm's 10-K filing? What checks are there on the accuracy of these statements?

In a firm's 10-K filing, four financial statements can be found: the balance sheet, income statement, statement of cash flows, and statement of stockholders' equity. Financial statements in form 10-K are required to be audited by a neutral third party, who checks and ensures that the financial statements are prepared according to GAAP and that the information contained is reliable.

1-10. Corporate managers work for the owners of the corporation. Consequently, they should make decisions that are in the interests of the owners, rather than their own. What strategies are available to shareholders to help ensure that managers are motivated to act this way?

Shareholders can do the following. i. Ensure that employees are paid with company stock and/or stock options. ii. Ensure that underperforming managers are fired. iii. Write contracts that ensure that the interests of the managers and shareholders are closely aligned. iv. Mount hostile takeovers.

2-13. See Table 2.5 showing financial statement data and stock price data for Mydeco Corp.

a. By what percentage did Mydeco's revenues grow each year from 2010 to 2013? b. By what percentage did net income grow each year? c. Why might the growth rates of revenues and net income differ? a. b. c. Net Income growth rate differs from revenue growth rate because cost of goods sold and other expenses can move at different rates than revenues. For example, revenues declined in 2010 by 10%, however, cost of goods sold only declined by 7%.

2-29. In fiscal year 2011, Starbucks Corporation (SBUX) had revenue of $11.70 billion, gross profit of $6.75 billion, and net income of $1.25 billion. Peet's Coffee and Tea (PEET) had revenue of $372 million, gross profit of $72.7 million, and net income of $17.8 million.

a. Compare the gross margins for Starbucks and Peet's. b. Compare the net profit margins for Starbucks and Peet's. c. Which firm was more profitable in 2011? a. Starbucks' gross margin = ; Peet's gross margin = . b. Starbucks' net margin = ; Peet's net margin = . c. Starbucks was more profitable in 2011.

2-38. In mid-2012, United Airlines (UAL) had a market capitalization of $6.8 billion, debt of $12.4 billion, and cash of $7.3 billion. United also had annual revenues of $37.4 billion. Southwest Airlines (LUV) had a market capitalization of $6.6 billion, debt of $3.3 billion, cash of $3.3 billion, and annual revenues of $17.0 billion.

a. Compare the market capitalization-to-revenue ratio (also called the price-to-sales ratio) for United Airlines and Southwest Airlines. b. Compare the enterprise value-to-revenue ratio for United Airlines and Southwest Airlines. c. Which of these comparisons is more meaningful? Explain. a. Market capitalization-to-revenue ratio: for United Airlines. for Southwest Airlines. b. Enterprise value-to-revenue ratio: for United Airlines. for Southwest Airlines. c. The market capitalization to revenue ratio cannot be meaningfully compared when the firms have different amounts of leverage, as market capitalization measures only the value of the firm's equity. The enterprise value to revenue ratio is therefore more useful when firm's leverage is quite different, as it is here.