Tutorial Sheet # 1 Suggested Solution

1. The goal of management should be to maximize the share price for the current shareholders. If management believes that it can improve the profitability of the firm so that the share price will exceed $35, then they should fight the offer from the outside company. If management believes that this bidder or other unidentified bidders will actually pay more than $35 per share to acquire the company, then they should still fight the offer. However, if the current management cannot increase the value of the firm beyond the bid price, and no other higher bids come in, then management is not acting in the interests of the shareholders by fighting the offer. Since current managers often lose their jobs when the corporation is acquired, poorly monitored managers have an incentive to fight corporate takeovers in situations such as this. A primary market transaction. Securities traded on the money market include: Government Treasury Bills, Commercial Paper, Bankers Acceptances, Bank Certificates of Deposits. The maturity term of the securities traded differentiates the money market from the capital market. Depreciation is a non-cash deduction that reflects adjustments made in asset book values in accordance with the matching principle in financial accounting. Interest expense is a cash outlay, but its a financing cost, not an operating cost. a) Taxes Growth = 0.15($50K) + 0.25($25K) + 0.34($7K) = $16,130 Taxes Income = 0.15($50K) + 0.25($25K) + 0.34($25K) + 0.39($235K) + 0.34($7.865M) = $2,788,000 b) Each firm has a marginal tax rate of 34% on the next $10,000 of taxable income, despite their different average tax rates, so both firms will pay an additional $3,400 in taxes. 1998 tax = $0, since the firm had a loss. The $95,000 loss will be used to offset future income. 1999 tax = $0; $70,000,000 income offset by $70,000 of 1998 loss. 2000 taxable income is reduced by remaining $25,000,000 of 1998 loss, so 2000 taxable income = $55,000 - $25,000 = $30,000, and 2000 tax = (0.15) ($30,000) = $4,500. 2001 tax =( $50,000 x 0.15 ) = $7,500 + (25,000 x .25)=6,250 + (5,000 x .34)=1,700 = $15,450 2002 tax = $0; $110,000 of loss can be carried back to offset income from 2000 and 2001, reducing taxes in those years to $0. The firm will get a refund of $4,500 + $15,450 = $19, 950 for taxes paid in those years. The remaining $40,000 loss can be carried forward. 6. Income 365,000 Less: Interest deduction (50,000) Plus: Dividends received 4,500 Taxable Income = 319,500 For a corporation, 70% of dividends received are excluded from taxes; therefore, taxable dividends are calculated as $15,000 (1 0.70) = $4,500. Tax =$22,250 + (319,500 - $100,000) (0.39) = $22,250 + 85,605 = $107,855 After-tax income: Taxable Income Taxes $319,500 -107,855

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Plus Non-taxable dividends received

10,500

Net Income 222,145 Non-taxable dividends are calculated as $15,000 x 0.70 = $10,500. The companys marginal tax rate is 39%. The companys average tax rate is $107,855/$319,500 = 33.76%