to Solution Problem Set 1 - FINA 4200 Spring 2010
I.
Multiple Choices
1. d
6. d
11. a
2. d
7. d
12. a
3. b
8. d
13. a
16. b
21. d
26. c
31. d
36. d
17. c
22. b
27. e
32. b
37. a
18. d
23. a
28. d
33. c
38. b
4. b
9. c
14. c
19. a
24. c
29. b
34. a
39. d
5. c
10. b
15. d
20. b
25. b
30. e
35. b
II. Essay Questions
Chapter 1
Q1. a. Stockholder wealth maximization is the appropriate goal for management decisions. The
risk and timing associated with expected earnings per share and cash flows are considered in order
to maximize the price of the firms common stock.
d.
An agency relationship arises whenever one or more individuals, the principals, hire another
individual, the agent, to perform some service and then delegate decision-making authority to that
agent. Primary agency relationships exist between (1) stockholders and managers, and (2) between
debtholders and stockholders.
e.
Agency costs include all costs borne by shareholders to encourage managers to maximize a
firms stock price rather than act in their own self-interests. The three major categories of agency
costs are (1) expenditures to monitor managerial actions, such as audit costs; (2) expenditures to
structure the organization in a way that will limit undesirable managerial behavior, such as
appointing outside investors to the board of directors; and (3) opportunity costs which are incurred
when shareholder-imposed restrictions, such as requirements for stockholder votes on certain issues,
limit the ability of managers to take timely actions that would enhance shareholder wealth.
i.
A market is said to be transparent when reliable and accurate information is available to all
market participants.
k.
The Sarbanes-Oxley Act of 2002 established increased requirements for corporate
accountability, and increased penalties for corporate fraud. It was enacted in response to the
widespread accounting scandals of the early 2000s.
Q2.
The of goal a financial manager is to maximize shareholders value. However, agency
problem could cause a manager to take actions to maximize his/her own interests rather than
maximize shareholders value. The approaches to fix agency problem include compensation system
that is based on management performance (bonuses tied to profits, stock option plans) as well as the
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shareholder intervention (such as proxy fight), and possibility of being removed from office (voted
out of office, an unfriendly takeover by another firm).
Chapter 7
Q3. NI = $3,000,000; EBIT = $6,000,000; T = 40%; Interest = ?
Need to set up an income statement and work from the bottom up.
EBIT
Interest
EBT
Taxes (40%)
NI
$6,000,000
1,000,000
$5,000,000
2,000,000
$3,000,000
$3,000,000
EBT = (1 T)
=
$3,000,000
0.6
Interest = EBIT EBT = $6,000,000 $5,000,000 = $1,000,000.
Q5. NI = $3,100,000; DEP = $500,000; AMORT = 0; NCF = ?
NCF = NI + DEP and AMORT = $3,100,000 + $500,000 = $3,600,000.
Q11.
a.
Sales revenues
Costs except
depreciation
Depreciation
EBT
Taxes (40%)
Net income
Add back depreciation
Net cash flow
Income Statement
$12,000,000
9,000,000
1,500,000
$ 1,500,000
600,000
$ 900,000
1,500,000
$ 2,400,000
b. If depreciation doubled, taxable income would fall to zero and taxes would be zero.
Thus, net income would decrease to zero, but net cash flow would rise to $3,000,000.
Menendez would save $600,000 in taxes, thus increasing its cash flow:
CF = T(Depreciation) = 0.4($1,500,000) = $600,000.
c. If depreciation were halved, taxable income would rise to $2,250,000 and taxes to
$900,000. Therefore, net income would rise to $1,350,000, but net cash flow would fall
to $2,100,000.
d. You should prefer to have higher depreciation charges and higher cash flows. Net cash
flows are the funds that are available to the owners to withdraw from the firm and,
therefore, cash flows should be more important to them than net income.
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