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

The most important difference between a corporation and all other organizational
form is that it is a legal entity separate and distinct from its owners. Therefore its
owners, employees, customers, etc. are not liable for any obligations of the
corporations, and vice versa, the corporation is not liable for any personal
obligations of its owners.

1-2. What does the phrase limited liability mean in a corporate context?

Limited liability mean that the owners liability is limited to their amount of
investment in the firm. Stockholders are not responsible for any debts or obligations
that the company enters into.

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

The Corporations and Limited Liability Companies (LLC) are the organizations that
give owners limited liability. Limited partners also provide limited liability, but only
to the limited partners and not for the general partners.

1-4. What are the main advantages and disadvantages of organizing a firm as a

The advantages of organizing a firm as a limited corporation are (1) Limited liability
(2.) Liquidity (3) Infinite Life and (4) Easier to acquire capital. The advantages are
(1) Double taxation and (2) Separation of ownership and control.

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

The difference between an S corporation and C corporation are in its ownership,
shareholder rights, and taxation. C corporations allow unlimited amounts of
shareholders while S corporations is limited to 75 shareholders and cannot have
foreign stockholders. C corporations can also have different types of stockholders,
ones whose votes count for more or less than other members. While S corporations
have just a single type of stockholder. C corporations has double taxation it pays
corporate income taxes and the shareholders pay income taxes as well, while S
corporations do not pay corporate taxes, but pass the income to shareholders to
whom it is taxable.


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?

Corporate earnings $2.00
Less: Corporate tax ($2 x 40%) .80
Dividend paid $1.20
Less: Personal tax ($1.20 x 30%) .36
Personal earnings after taxes $0.84

1-7. Repeat Problem 6 assuming the corporation is an S corporation.

Dividends $2.00
Less: Personal tax ($2 x 30%) .60
Personal earnings after taxes $1.40

Note: S corporation does not pay corporate income tax

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 GEs:
a. market capitalization?
b. market-to-book ratio?
c. enterprise value?

a.) 2009 Market Capitalization $113.4 billion
(10.5 billion shares x $10.80/share)
2012 Market Capitalization
(10.6 billion shares x $17/share) $180.20 billion

The Change over the period is $113.4 - $180.20 = $66.8 billion


b.) 2009 Market-to-Book 113.4 / 105 = 1.08
2012 Market-to-Book 180.2 / 116 = 1.55

The change over the period is 1.55 1.08 = 0.47

c.) 2009 Enterprise Value $113.4 48 + 524 = $589.4 billion
2012 Enterprise Value $180.2 84 + 410 = $506.2 billion

The change over the period is $506.2 - $589.4 = -$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 Globals EBIT in 2013?
b. What is Globals income in 2013?
c. If Globals P/E ratio and number of shares outstanding remains unchanged,
what is Globals share price in 2013?
a. 2012 Revenue 1.15 x 186.7 = $214.71 million
Globals EBIT for 2013 is 214.71 x 4.5% = $9.66 million

b. Net Income = EBIT Interest Expenses Taxes
EBIT 9.66
Interest Expense (7.70)
Pretax income 1.96
Taxes (1.96 x 26%) (.51)
Globals Net Income $1.45

c. 2013 Share price = 2012 P/E ratio x (Net income / shares outstanding)
2013 EPS = 25.20 x (1.45/3.6) = $10.17


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
firms 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 - $4 million receivables + $2
million inventory