Foundations Of Financial Management, Tenth Canadian Edition Solution Manual

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Chapter1Foundations of Fin. Mgt.10CeBlock, Hirt,Danielsen,Short, Perretta1-1Discussion Questions1-1.Capital budgetingwas the first area of studyin which the financial manager waspresented with analytical techniques for allocating resources among the various assets ofthe firm.1-2.The student should beprepared to pay a higher price for the promised $2 from the RoyalBank. The risk is lower.1-3.The goal of shareholder wealth maximization implies that the firm will attempt to achievethe highest possible valuation in the marketplace. It is the one overriding objective of thefirm and should influence every decision. The problem with a profit maximization goal isthat it fails to take account of risk, the timing of the benefits is not considered, and profitmeasurement is a very inexact process.1-4.Agency theory examines the relationship between the owners of the firm and themanagers of the firm. In privately owned firms, management and the owners are usuallythe same people. Management operates the firm to satisfy its own goals, needs, financialrequirements and the like. As a company moves from private to public ownership,management now represents all owners. This places management in the agency positionof making decisions in the best interest of all shareholders.1-5.Because institutional investors such as pension funds(Ontario Teachers’, CPP)andmutual funds own a large percentage of major companies, they are having more to sayabout the way publicly owned companies are managed. As a group, they have the abilityto vote large blocks of shares for the election of a board of directors, which is suppose torun the company in an efficient, competitive manner. The threat of being able to replacepoor performing boards of directors makes institutional investors quite influential. Sincethese institutions, like pension funds and mutual funds, represent individual workers andinvestors, they have a responsibility to see that the firm is managed in an efficient andethical way.1-6.Insider trading occurs when someone has information that is not available to the publicand then uses the information to profit from trading in a company’s common stock. Theprovincial securities commissions are responsible for protecting against insider trading.1-7.Regulations set the “rules of the game” in which the firm operates.Shareholder wealthmaximization can and should still be sought within the rules,for economicefficiency tobe achieved. Society judges deregulationbenefitsagainst the costs of regulation.1-8.Managementoperateswithina competitive marketand they shouldbe paid theiropportunity cost. If managers do not act to maximize shareholder wealth, share priceswill become depressed. To the extent manager’s compensation is tied to share priceperformance, shareholders can fire managers, and there exists a market for corporatecontrol, management will be compensated based on their economic contribution.

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Chapter1Foundations of Fin. Mgt.10CeBlock, Hirt,Danielsen,Short, Perretta1-21-9.Daily functions-cash management, inventory control, receipt and disbursement of funds.Occasional-shareissue, bond issue, capital budgeting and dividend decisions.1-10.Thereisunlimitedliabilityforthesoleproprietorshipandpartnershipformsofownership. Under the limited partnership, only the general partner(s) has unlimitedliability, with limited partners obligated only to the extent of their initial contribution.Finally,allshareholdersinacorporationhavelimitedliability,althoughowner/shareholders of small businesses often have to give banks their personalguarantees.1-11.The corporate form is best suited to large organizations because of the easy divisibility ofownership through issuance of shares. Also, the corporation has continued existenceindependent of any shareholder.1-12.Money markets refer to those markets dealing with short-term securities that have a lifeof one year or less. Capitalmarkets refer to securities with a life of more than one year.1-13.A primary market refers to the use of the financial markets to raise new funds. After thesecurities are sold to the public (institutions and individuals), they trade in the secondarymarket between investors. It is in the secondary market that prices are continuallychanging as investors buy and sell securities based on the expectations of corporateprospects.A liquid secondary market promotes a successful primary market.1-14.Government debt loads require financing. This puts largedemands ($1trillion inaccumulated federal and provincial debt in 2011) on the capital markets,putting upwardpressure on interest rates and a corporation’s ability to invest in capital projects. Whengovernments financetheir deficits abroadthey placeCanada’s economic levers outside ofour control and debt servicing payments can impact the foreign exchange markets.Asgovernment debt loads have been reducedin recent yearsthere has been less pressure oninterest rates, corporations have borrowed more, butthere have been less ‘risk free’government securities available (causing liquidity problemsparticularly in the moneymarkets).1-15.Stakeholdersinclude:shareholders,creditors,employees,unions,environmentalists,consumer groups, Canada Revenue Agency, government regulatory bodies, customers,managers and others.Internet Resources and Questions1.www.nobelprize.org2.www.fin.gc.ca3.www.bankofcanada.ca4.http://onex.com/Principles_and_Values.aspxhttp://www.rbc.com/aboutus/visionandvalues.html5.http://www.bce.ca/responsibility/corporateresponsibility

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Chapter1Foundations of Fin. Mgt.10CeBlock, Hirt,Danielsen,Short, Perretta1-3Problems1-1.Incubus Corporationa.Common stock(contributed capital)$40,000Retained earnings(deficit)(7,000)$33,000b.Common stock$40,000Retained earnings2,000$42,000c.Common stock$60,000Retained earnings8,000$68,0001-2.PuppetCorporationa.Commonstock$20,000Retained earnings2,000$22,000b.Common stock$20,000Retained earnings8,000$28,000c.Common stock$30,000Retained earnings10,500$40,5001-3.Two to Ten Dollar Corporation would be expected to have the highervaluation becausethe $10 per share dividend (although achieved later) is expected to be sustained for amuch longer periodof time. Buildingearnings for longer termsustainability is morevaluable than quick returns that peter out.

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Chapter1Foundations of Fin. Mgt.10CeBlock, Hirt,Danielsen,Short, Perretta1-41-4.Share value is a combination of expected earnings (or cash flow) and the risk inherent inthose cash flows. Although the financial institution reports lower earnings it is becauseof restructuring charges that lower reported earnings. Cash flows are notlikely to beeffected. Future earnings should be more reliable and therefore less risky than those ofthe new health services company. Therefore the market is likely to suggest a highervalue for the financial institution.1-5.Board of Directors Decisiona.A combination of high profit margins and strong consumer acceptance should bepositive for share value. However a new product introduces a high degree of risk thatwill mitigate higher share values.b.More detailed financial information for investors should increase their confidence in theactivities of the firm and lower the risk of their investment. This will be offset by thelikely increase costs of providing this information. In an environment of questionableethics by management this should be slightly positive to share value.c.Pollution control devices will increase firm costs. The local residents will view the firmmore positively which should have some positive cash flow effects as they may be morewilling to purchase the firm’s products and will decrease possible litigations orharassment. Overall it is likely to be a neutral or slightly negative effect on share value.d.Aligning management compensation motivators with shareholder goals should bepositive for share values with implemented. The effect however may be small.There is no correct answer. It depends on the tradeoff between risk, returns and costs.

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Chapter 2Foundations of Fin. Mgt. 10CeBlock, Hirt, Danielsen, Short, Perretta2-1Discussion Questions2-1.The price-earnings ratio will be influenced by the earnings and sales growth of the firm,the risk or volatility in performance, the debt-equity structure of the firm, the dividendpayment policy, the quality of management,and a number of other factors.The ratiotends to be future-oriented, andwill be higherthe more positive theoutlook2-2.Book value per share is arrived at by taking the cost of the assets and subtracting outliabilities and preferred stock and dividing by the numberof common shares outstanding.It is based on thehistorical costs of the assets.Market value per share is based on currentassessed value of the firm in the marketplace and may bear little relationship to originalcost. Besides the disparity between book and market value caused by the historical costapproach, other contributing factors are the growth prospects for the firm, the quality ofmanagement, and the industry outlook.To the extent these are quite negative,or positive,market value may differ widely from book value.2-3.The only way amortization generates cash flows for the company is by serving as a taxshield against reported income. Allowable amortization for tax purposes is known ascapital cost allowance (CCA). In most instances this will be different than accountingamortization.This non-cash deduction may provide cash flow equal to the tax rate timesthe amortization charged.This much in taxes will be saved, while no cash paymentsoccur.2-4.Accumulated amortization is the sum of all past and present amortization charges, whileamortization expenseis the current year's charge.They are related in that the sum of allprior amortization expense should be equal to accumulated amortization (subject to somedifferential related to asset write-offs).2-5.The balancesheet, for private companiesusing ASPE,is based on historical costs.Whenpricesarerisingrapidly,historicalcostdatamaylosemuchoftheirmeaning-particularly for plant,equipment and inventory.However, the balance sheetof publiccompanies usingIFRS is based on market values and opposite order whereby non-currentassetsare listed ahead of current assets. The same applies to the liabilities section thatlists non-current liabilities first.2-6.The income statement and balance sheet are based on the accrual method of accounting,which attempts to match revenues and expenses in the period in which they occur.However, accrual accounting does not attempt to properly assess the cash flow positionof the firm.The statement of changes in financial position fulfills this need.The valueson these statements will differ for public companies using IFRScompared to privatefirms.2-7.The sections of the statementof cash flowsand sources of informationare:Cash flows from operating activities(Income statement)Cash flows from investing activities(non-current assets section of balance sheet)Cash flows from financing activities(non-current liabilities and equity section)

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Chapter 2Foundations of Fin. Mgt. 10CeBlock, Hirt, Danielsen, Short, Perretta2-2The payment of cash dividends falls into the financing activities category.2-8.We can examine the various sources that were utilized by the firm as indicated on thestatement. Possible sources for the financing of an increase in assets might be profits,increases in liabilities, or decreases in other asset accounts.2-9.Free cash flow is equal to:Cashflow from operating activitiesMinus:Capital expenditures required to maintain the productive capacity of thefirm.Minus:Dividends (required to maintain the payout on common stock and to coverany preferred stockobligation).The analyst or banker normally looks at free cash flow to determine whether there aresufficient excess funds to pay back the loan associated with the leveraged buy-out(acompany with limited cash acquiring stocks of another company toacquirecontrol).2-10.Interest expense is a tax deductible item to the corporation, while dividend payments arenot.The net cost to the corporation of interest expense is the amount paid multiplied bythe difference of (one minus the applicable tax rate). The firm must bear the full burdenof thecash outflowof dividend paymentsbecause they are not an expense, but rather adistribution out of retained earnings.Internet Resources and Questions1.www.cica.ca,www.cpa.ca2.www.cma-canada.org3.www.cga-canada.org4.www.ifrs.org.5.www.kpmg.ca/taxi6.www.pwc.com/ca/tax7.www.cra-arc.gc.ca

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Chapter 2Foundations of Fin. Mgt. 10CeBlock, Hirt, Danielsen, Short, Perretta2-3Problems(The following solutions use the2014tax ratesor rates givenin the text. The2013rates are also shown but subject to change).2-1.Bradley Bus Inc.a.Last YearEarnings after taxes$600,000Sharesoutstanding300,000Earnings per share($600,000/300,000 shares)$2.00b.Current YearEarnings after taxes ($600,000 × 125%)$750,000Shares outstanding (300,000 + 40,000)340,000Earnings per share($750,000/340,000 shares)$2.212-2.DoverRiver Companya.Operating profit (EBIT).........................$200,000Interest expense.................................10,000Earnings before taxes (EBT)..................190,000Taxes..................................................61,250Earnings after taxes (EAT)......................128,750Preferred dividends ...........................18,750Available to common shareholders........$110,000Commondividends............................$ 30,000Increase in retained earnings..................$ 80,000EPS=Earnings available to common shareholders/Number of shares of common stock outstanding= $110,000/20,000 shares=$5.50 per shareDividends per Share= $30,000/20,000 shares=$1.50 per shareb.Payout Ratio=Dividend per share/Earnings per share=1.50/5.50 per share=27.27%c.Increase in retained earnings=$80,000d.Price/earnings ratio= $26.40/ $5.50=4.8×

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Chapter 2Foundations of Fin. Mgt. 10CeBlock, Hirt, Danielsen, Short, Perretta2-42-3.Far EastFast Foodsa.2014Earnings aftertaxes$230,000Shares outstanding200,000Earnings per share$1.15b.2015Earnings aftertaxes($230,000 × 125%)$287,500Shares outstanding230,000Earnings per share$1.252-4.Sheridan Travela.EPS =$600,000=$2.00 per share300,000b.New Net Income: $600,000 x 125% = $750,000Shares: 300,000 + 40,000 = 340,000 sharesNew EPS =$750,000=$2.21 per share340,000

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Chapter 2Foundations of Fin. Mgt. 10CeBlock, Hirt, Danielsen, Short, Perretta2-52-5.Moore Enterprise/ Kipling CorporationMooreKiplingGross profit.........................$880,000$880,000Selling and adm. expense...120,000760,000120,000760,000Amortization.......................360,00060,000Operating profit..................400,000700,000Taxes (40%)........................160,000280,000Earnings after-taxes..............240,000420,000Plus:AmortizationExpense...360,00060,000Cash Flow...........................$600,000$480,000Moore had $300,000 more in amortization, which provided $120,000(0.40 × $300,000) more in cash flow. Moore paid0.40×300,000(difference in operating income) = $120,000 less taxes.

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Chapter 2Foundations of Fin. Mgt. 10CeBlock, Hirt, Danielsen, Short, Perretta2-62-6.Yes,Aztec Book Company made a profit of $13,920 for theyear ended December 31,2015.AztecBook CompanyIncome StatementForthe Year ended December 31,2015Sales (1,400 books at $84each)....................................$117,600Cost of goods sold (1,400 books at $63each)..............88,200GrossProfit...............................................................29,400Selling expense..............................................................2,000Amortization expense....................................................5,000Operating profit.........................................................22,400Interest expense..............................................................5,000Earnings before taxes................................................17,400Taxes @20%.................................................................3,480Earnings aftertaxes....................................................$13,920

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Chapter 2Foundations of Fin. Mgt. 10CeBlock, Hirt, Danielsen, Short, Perretta2-72-7.CarrAuto WholesalersIncome StatementFor the Year ended December 31, 2015a.Sales……………………………………………..$900,000Cost of goods sold@ 65%...................................585,000Gross profit…………………………………..315,000Selling and administration expense@ 9%.........81,000Amortization expense…………………………...10,000Operatingprofit………………………………224,000Interest expense………………………………….8,000Earnings before taxes…………………………216,000Taxes@ 30%........................................................64,800Earnings aftertaxes……………………………$151,200b.Sales……………………………………………..$1,000,000Cost of goods sold@ 60%....................................600,000Gross profit…………………………………...400,000Sellingand administration expense @ 12%.........120,000Amortization expense…………………….……..10,000Operating profit………………………………270,000Interest expense………………………………….15,000Earnings before taxes…………………………255,000Taxes @ 30%……………………………………76,500Earnings aftertaxes……………………………$ 178,500Ms. Hood’s idea will increase profitability.

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Chapter 2Foundations of Fin. Mgt. 10CeBlock, Hirt, Danielsen, Short, Perretta2-82-8.IncomeStatementSalesCostof goods soldGross profitSelling and administrative expenseAmortization expenseOperating profitInterest expenseEarnings before taxesTaxesEarnings aftertaxesPreferred stock dividendsEarnings available tocommon shareholdersShares outstandingEarnings per share

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Chapter 2Foundations of Fin. Mgt. 10CeBlock, Hirt, Danielsen, Short, Perretta2-92-9.David’s Magic Storesa.Operating profit(EBIT).........................$210,000Interest expense.................................30,000Earnings beforetaxes (EBT)..................180,000Taxes..................................................59,300Earnings aftertaxes (EAT)......................120,700Preferred dividends...........................24,700Available to common shareholders........$96,000Common dividends............................36,000Increase in retained earnings..................$60,000EPS=Earnings available to common shareholdersNumber of shares ofcommon stock outstanding=$96,000/16,000shares=$6.00per shareDividends per Share=$36,000/16,000 shares=$2.25per shareb.Payout ratio = $2.25/ $6.00 = .375 =37.5%c.Increase in retained earnings=$60,000d.Price/earnings ratio= $90/ $6.00=15.02-10.Thermo Dynamicsa.Retained earnings, December 31,2015.............$450,000Less: Retained earnings, December 31,2014....400,000Change in retainedearnings...............................50,000Add: Common stockdividends..........................25,000Earnings available to common shareholders......$ 75,000b.Earnings per share= $75,000/20,000 shares=$3.75per sharec.Payout ratio = $25,000/ $75,000 = .333 =33.33%d.Price/earnings ratio=$30.00/$3.75=8.0×

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Chapter 2Foundations of Fin. Mgt. 10CeBlock, Hirt, Danielsen, Short, Perretta2-102-11.Brandon Fast Foods Inc.a.Operating Income–Taxes–Interest=Net income after taxes= $210,000–$59,300–$30,000 = $120,700Net income after taxes–Preferred dividends= Earnings availableto common shareholders=$120,700–$24,700 = $96,000EPS = $96,000/ 16,000 shares =$6EPSCommon Dividendsper Share = Div. paid /shares=$36,000/16,000 shares =$2.25 Dividend per Shareb.Increase in RE = Income–Dividends–PreferredDividend= $120,700–$36,000–$24,700 =$60,000.2-12.Balance Sheet ItemsCommon stock–noncurrentAccounts payable–currentPreferred stock–noncurrentPrepaid expenses–currentBonds payable–noncurrentInventory–currentInvestments–noncurrentMarketable securities–currentAccounts receivable–currentPlant and equipment–noncurrentAccrued wages payable–currentRetained earnings–noncurrent

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Chapter 2Foundations of Fin. Mgt. 10CeBlock, Hirt, Danielsen, Short, Perretta2-112-13.Balance SheetAssetsCurrent AssetsCash...................................................$ 10,000Marketable securities.........................20,000Accounts receivable...........................$48,000Less: Allowance for bad debts......6,00042,000Inventory............................................66,000Total Current Assets.................138,000Other Assets:Investments........................................20,000Capital Assets:Plant and equipment..........................680,000Less: Accumulated amortization..300,000Net plant and equipment...................380,000Total Assets...........................................$538,000Liabilities and Shareholders' EquityCurrent Liabilities:Accounts payable..............................$35,000Notes payable....................................33,000Total current Liabilities................68,000Long-Term Liabilities............................Bonds payable...................................136,000Total Liabilities.............................204,000Shareholders' Equity:Preferred stock,1,000 shares outstanding…....50,000Common stock,100,000 shares outstanding....188,000Retained earnings.............................................96,000TotalShareholders' Equity...........................334,000Total Liabilities and Shareholders' Equity……....$538,000

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