Principles of Managerial Finance, 15th Edition Solution Manual

Preview (16 of 420 Pages)

100%

Principles of Managerial Finance, 15th Edition Solution Manual - Page 1 preview image

Loading page ...

PrrinciSiplesFFiftChadUniverScotIndiResofors of MFinanfteenth Ed J. Zrsity of Ptt B.iana UniourcrMannceEditionZuttePittsburgSmaiversityce MnagererghartManurialal

Principles of Managerial Finance, 15th Edition Solution Manual - Page 2 preview image

Loading page ...

Principles of Managerial Finance, 15th Edition Solution Manual - Page 3 preview image

Loading page ...

ContentsPART 1 Introduction to Managerial Finance11 The Role of Managerial Finance22 The Financial Market Environment19PART 2 Financial Tools293 Financial Statements and Ratio Analysis314 Long- and Short-Term Financial Planning555 Time Value of Money79PART 3 Valuation of Securities1096 Interest Rates and Bond Valuation1117 Stock Valuation133PART 4 Risk and the Required Rate of Return1498 Risk and Return1519 The Cost of Capital185PART 5 Long-Term Investment Decisions20710 Capital Budgeting Techniques20911 Capital Budgeting Cash Flows23112 Risk Refinements in Capital Budgeting259PART 6 Long-Term Financial Decisions28313 Leverage and Capital Structure28514 Payout Policy315PART 7 Short-Term Financial Decisions33315 Working Capital and Current Assets Management33516 Current Liabilities Management353PART 8 Special Topics in Managerial Finance37117 Hybrid and Derivative Securities37318 Mergers, LBOs, Divestitures, and Business Failure39319 International Managerial Finance411

Principles of Managerial Finance, 15th Edition Solution Manual - Page 4 preview image

Loading page ...

Part 1Introduction to Managerial FinanceChapters in This PartChapter 1The Role of Managerial FinanceChapter 2The Financial Market EnvironmentIntegrative Case 1: Merit Enterprise Corp.

Principles of Managerial Finance, 15th Edition Solution Manual - Page 5 preview image

Loading page ...

Chapter 1The Role of Managerial Finance2Chapter 1The Role of Managerial FinanceInstructor’s ResourcesChapter OverviewThis chapter introduces the field of finance through building-block terms and concepts. The discussion starts bydefining “firm” and stressing its principal goal—maximizing shareholder wealth. The importance of focusing onshareholders rather than stakeholders broadly and stock price rather than current profits is explained. Themanagerial-finance function is then described and differentiated from economics and accounting, with specialattention to the role ethics play in a financial manager’s efforts to maximize the firm’s stock price. Next, thethree basic legal forms of business organization (sole proprietorship, partnership, and corporation) arediscussed and the strengths and weaknesses of each form noted. The chapter concludes with an exploration ofthe agency problem—the conflict arising when the managers and owners of the firm are not the samepeople—and the private- and public-sector tools available to focus managerial attention on shareholderwealth.This chapter and the ones to follow stress the important role finance vocabulary, concepts, and tools will playin the professional and personal lives of students—even those choosing other majors, such as accounting,economics information systems, management, marketing, or operations. Whenever possible, personal-financeapplications are provided to motivate and illustrate topics. This pedagogical approach should inspire studentsto master chapter content quickly and easily.NOTE: After this text went to press, Congress passed the Tax Cuts and Job Act of 2017, which dramaticallychanged both corporate and personal tax rates. The first printing of this text did not reflect these tax changes,but subsequent print runs do. For tax-related problems, we provide solutions under both the old and the newtax law. Of particular relevance to this chapter, the corporate tax rate is now a flat 21%. Individuals still face aprogressive rate schedule, so there is still value in explaining the progressive nature of the old corporatestructure as well as the difference between marginal and average tax rates (which are essentially the sameunder a flat-rate structure). The change in the corporate tax code—in particular the introduction of a lower,flatter rate—can serve as a useful discussion point throughout this text. For example, instructors may wish todiscuss the impact of a lower tax rate on the NPV of investments or a firm’s optimal capital structure.Suggested Answer toOpener-in-ReviewStudents learned the stock price of Brookdale Senior Living tumbled 36% in 2016 to $12.35 per share,prompting Land and Buildings (a prominent stockholder) to urge the firm sell its real-estate holdings,distribute the anticipated net sales proceeds ($21 cash) to shareholders, and then focus on managing its seniorliving facilities. Students were asked whether the proposal would make Brookdale’s shareholders better off ifthe expected cash proceeds were realized, but stock price dipped to $5 per share.

Principles of Managerial Finance, 15th Edition Solution Manual - Page 6 preview image

Loading page ...

Chapter 1The Role of Managerial Finance3Before restructuring, an investor with one Brookdale share had $12.35 in total wealth. Afterward, that sameinvestor had a share worth $5 and $21 in cash—total wealth of $26. The hypothetical shareholder reaped again of $13.65 per share or 110.5%. Before the asset sale, with 185.45 million shares outstanding and a shareprice of $12.35, total shareholder wealth was $2.29 billion. After the sale, with same shares outstanding andwealth per share now $26, shareholder wealth rose to $4.82 billion– a net gain of $2.53billion.Here is a discussion question for the class to motivate future exploration of CEO compensation: SupposeBrookdale’s CEO came up with the asset-sale idea rather than a prominent shareholder, and Brookdale’sboard rewarded him with a $1 million dollar bonus—a figure alone that would easily vault the CEO into thetop 1% of U.S. income earners. Is the CEO’s compensation excessive?Answers to Review Questions1-1.The goal of a firm, and therefore of all financial managers, is maximizing shareholder wealth. Theproper metric for this goal is the price of the firm’s stock. Other things equal, an increasing price pershare of common stock relative to the stock market as a whole indicates achievement of this goal.1-2Actions that maximize the firm’s current profit may not produce the highest stock price because (1)some firm activities that result in slightly lower profit today generate much larger profits in the futureperiods (i.e., focusing on current profit overlooks the time value of money); (2) activities that generatehigher accounting profits today may not result in higher cash flows to stockholders; and (3) activitiesthat lead to high profits today may involve higher risk, which could result in significant future losses.1-3Risk is the chance actual outcomes may differ from expected outcomes. Financial managers mustconsider risk and return because the two factors tend to have an opposite effect on share price. That is,other things equal, an increase in the risk of cash flows to shareholders will depress firm stock pricewhile higher average cash flows to shareholders will increase stock price.1-4Maximizing shareholder wealth does not mean overlooking or minimizing the welfare of other firmstakeholders. Firms with satisfied employees, customers, and suppliers tend to produce higher (or lessrisky) cash flows for their shareholders compared with companies that neglect non-owner stakeholders.That said, customers prefer lower prices for firm output, firm employees prefer higher wages, and firmsuppliers prefer higher prices for the input goods and services they provide. So actions that produce thehighest price of the firm’s stock cannot simultaneously maximize customer, employee, and suppliersatisfaction.1-5Broadly speaking, the decisions made by financial managers fall under three headings: (i) investment,(ii) capital budgeting, and (iii) working capital. Investment decisions involve the firm’s long-termprojects while financing decisions concern the funding of those projects. Working-capital decisions, incontrast are related to the firm’s management of short-term financial resources.1-6Financial managers must recognize the tradeoff between risk and return because shareholders preferhigher cash flows but dislike large swings in cash flows. And, as a general rule, actions that boost thefirm’s average cash flows also result in greater cash-flow greater volatility. Viewed another way, firmactions to reduce the chance cash flows will be low or negative also tend to reduce average cash flowsover time. Understanding this tradeoff is important because shareholders are risk averse. That is, theywill only accept larger swings in a firm’s cash flows only if compensated over time with higher averagecash flows.

Principles of Managerial Finance, 15th Edition Solution Manual - Page 7 preview image

Loading page ...

4Zutter/Smart •Principles of Managerial Finance,Fifteenth Edition1-7Finance is often considered applied economics. One reason is firms operate within the larger economy.More importantly, the bedrock concept in economics—marginal benefit-marginal cost analysis—is alsocentral to managerial finance. Marginal benefit-marginal cost analysis is the notion a firm (or any othereconomic actor) should take only those actions for which the extra benefits exceed the extra costs.Nearly, all financial decisions ultimately turn on an assessment of their marginal benefits and marginalcosts.1-8Accountants and financial managers perform separate but equally important functions for the firm.Accountants primarily collect and present financial data according to generally accepted financialprinciples while financial managers make investment, capital-budgeting, and working-capital decisionswith financial data. In part because of their different functions, accountants and financial managers logfirm revenues and expenses using different conventions. Accountants operate on an accrual basis,recognizing revenues as firm output is sold (whether or not payment is actually received) and firmexpenses as incurred. Financial managers, in contrast, focus on actual inflows and outflows of cash,recognizing revenues when physically received and expenses when actually paid.1-9Like any economic actor, managers respond to incentives. Managers have a fiduciary duty to maximizeshareholder wealth, but as humans, they also have personal goals—such as maximizing their ownincome, wealth, reputation, and quality of life. If the personal benefits of delivering for shareholders (orthe costs of slighting them) are small, a financial manager might opt to further his own interest at theexpense of shareholders. For example, CEOs of large firms—those with more sales, assets, employees,etc.—tend to receive more compensation than CEOs of smaller firms. If a CEO has to choose betweentwo operating strategies—one that produces modest growth for his firm but a large jump in currentstock price and another that generates rapid growth but a more modest rise in share price—and thefirm’s board is not closely monitoring the CEO, she might pursue the high-growth strategy to boost herfuture compensation. A partial solution to such a problem is a compensation closely linking CEOcompensation to firm stock price.1-10Sole proprietorships are the most common form of business organization, while corporations tend to bethe largest. Large firms tend to organize as corporations to insulate owners from losses (limit liability)and facilitate acquisition of financial capital to fund growth.1-11Stockholders are the owners of a corporation. Their ownership (equity) takes the form of commonstock or, less frequently, preferred stock. Stockholders elect the board of directors, which has ultimateresponsibility for guiding corporate affairs and setting general policy. The board usually comprises keycorporate personnel and outside directors. The corporation’s president or chief executive officer (CEO)reports to the board. He or she oversees day-to-day operations subject to the general policies establishedby the board. The corporation’s owners (shareholders) do not have a direct relationship withmanagement; they provide input by electing board members and voting on major charter issues.Shareholders receive compensation in two forms: (i) dividends paid on their stock (from corporateearnings) and (ii) capital gains from increases in the price of their shares (which reflect marketexpectations about future dividends).1-12Generally speaking, income from sole proprietorships and partnerships is taxed only once at theindividual level; the owner or owners pay personal income tax on their share of firm’s profits. Incontrast, corporate income is taxed first at the firm level (via the corporate income tax paid on firmprofits) and then again at the personal level (via personal income tax paid on dividends or capital gainsenjoyed by shareholders).

Principles of Managerial Finance, 15th Edition Solution Manual - Page 8 preview image

Loading page ...

Chapter 1The Role of Managerial Finance51-13Agency problems arise when managers place personal goals ahead of their duty to shareholders tomaximize stock price. The attendant costs are called agency costs. Agency costs can be implicit orexplicit; either way they reduce shareholder wealth. An example of an “implicit” agency cost is thedividends or capital gains shareholders miss out on because the firm’s management team pursued apersonal interest (like maximizing sales to boost future compensation) rather than maximizingshareholder wealth. Of course, if shareholders sense stock price is not what it should be, they will startmonitoring management more closely (as in the chapter opener with Brookdale Senior Living). Theexpenses associated with greater monitoring are an example of an “explicit” agency cost. Agencyproblems in a firm can be reduced with a properly constructed and followed corporate-governancestructure. Such a structure will feature checks and balances that reduce management’s interest in andability to deviate from shareholder-wealth maximization. Like all corporate decisions, reducing agencycosts is subject to marginal benefit–marginal cost analysis. In other words, the firm should invest inpolicies to align the incentives of management and shareholders as long as the marginal benefits exceedthe marginal costs.1-14Firms most commonly try to mitigate agency problems by linking pay to metrics connected withshareholder wealth. Incentive plans tie compensation to share price. For example, the CEO mightreceive options offering the right to purchase stock at a set price (say current price) any time in the nextfew years. If the CEO takes actions that subsequently boost share price, she can profit personally byexercising the option—purchasing stock at the set price—and reselling at the higher market price. Thehigher the firm’s stock price, the more money the CEO can make, so options create a powerfulincentive to focus laser-like on shareholder wealth. There is a downside, however. Sometimes generalmarket trends swamp all the good done by management, so even though the CEO obsessed overshareholder wealth, her options proved worthless because a bear market hammered the firm’s stockprice. This problem has made performance plans more popular. These plans link compensation withperformance measures related to stock price that management can more closely control—such asearnings per share (EPS) and EPS growth. When targets for the performance metrics are attained,managers receive rewards likeperformance shares and/or cash bonuses.1-15If the board of directors fails to keep management focused on shareholder wealth, market forces canapply the necessary pressure. Two such forces are activism by institutional investors (such as Land andBuildings in the chapter opener) and the threat of hostile takeovers. Institutions typically hold largequantities of shares in many corporations. Because of their large stakes, these investors activelymonitor management and vote their shares for the benefit of all shareholders. Large institutionalinvestors reduce agency problems by using their voting clout to elect new directors that will make thechanges in policies and personnel necessary to get underperforming stock to its highest possible price.The threat of hostile takeover can also keep management focused on shareholders. Say a firm has astock price of $15, but that price could be $20 with bold action management is reluctant to take. Thelure of a $5 capital gain per share could tempt an outside individual, group of investors or firm notsupported by existing management to purchase controlling interest and force the necessary changes.Incumbent management knows “necessary changes” means unemployment, so the threat of takeovercould be enough to align their interests with those of the owners.

Principles of Managerial Finance, 15th Edition Solution Manual - Page 9 preview image

Loading page ...

6Zutter/Smart •Principles of Managerial Finance,Fifteenth EditionSuggested Answer toFocus on EthicsBox:Do Corporate Executives Have a Social Responsibility?How would Friedman view a sole proprietor’s use of firm resources to pursue social goals?In a sole proprietorship, the owner and manager are one in the same. So a manager using firm resources tosupport social goals would be doing exactly what the owner wanted. Put another way, Friedman would notsee a conflict. He did not oppose pursuit of social goals by a firm or individual; he opposed doing so withsomeone else’s money.Suggested Answer toFocus on PracticeBox:Must Search Engines Screen Out Fake News?Is the goal of maximizing shareholder wealth necessarily ethical or unethical?The “end” of maximizing shareholder wealth is neither ethical nor unethical; it is neutral. But the meansemployed to pursue the end can be ethical or unethical. For example, taking actions to raise share price inclear violation of U.S. law is unethical—that is to say, wrong even if the violations are not uncovered.What responsibility, if any, does Google have to help users assess the veracity of online content?Management’s overriding concern should be shareholder wealth. Knowingly posting content a reasonableperson could see is fake harms shareholders by damaging the Google brand, so some due diligence iswarranted. How much Google should invest in validating online content depends on the marginal benefits andcosts. Specifically, Google should verify as long as the marginal benefit to shareholders exceeds the marginalcost—that is, only as long as the net effect on stock price is positive.Answers to Warm-Up ExercisesE1-1.Advantages and disadvantages of partnership versus incorporation(LG 5)Answer:Each form of business organization has advantages and disadvantages. One advantage of a simplepartnership is that each partner’s income is taxed only once as personal income (i.e., subject to thepersonal income tax). Corporate income, in contrast, is taxed twice—corporate profits will besubject to the corporate income tax, and the dividends and capital gains from each partner’s stockwill be taxed as personal income.Taxation is a key factor in choosing the form of business organization, but two other factors arealso important. In a partnership, each partner has unlimited liability and may have to cover debtsof other partners, while corporate owners have limited liability that guarantees they cannot losemore than they have invested in the corporation. The third major consideration is ease of transferof the business. Partnerships are harder to transfer and technically dissolved when a partner dies,while a corporation has an infinite life (absent bankruptcy, merger, or acquisition) with ownershipreadily transferable through sale of existing shares.

Principles of Managerial Finance, 15th Edition Solution Manual - Page 10 preview image

Loading page ...

Chapter 1The Role of Managerial Finance7If a third party were asked to decide which legal form of business A&J Tax Preparation shouldtake, it would be useful to have the following information:•Relevant specifics of current personaland corporate income tax codes (such asmarginal rates, deductions, etc.)•Expected future changes in tax law•Expected longevity of firm•Age of current owners•Current succession plan•Risk tolerance of owners•Capital needs of firm•Growth prospects of firm•Reasons for each partner’sview on preferred form ofownershipE1-2Timing of cash flows(LG 4)Answer:Based on the information provided, the choice is not obvious. Even though the second project isexpected to provide a larger overall increase in earnings, the goal of the firm is maximizingshareholder value (not earningsper se), so the timing and risk of cash flows must be considered todetermine which project is superior. For example, even if the second project’s cash flows are higher,they tend to arrive later, so it is not clear whether the second project is preferable to the first.E1-3.Cash flow vs. profits(LG 4)Answer:It is not unusual for profitable firms to suffer a cash crunch. This typically happens when expensesmust be paid before revenue can be collected. In such cases, the firm must arrange financing toplug the gap between cash inflows and outflows. If cash crunches are regular, management shouldconsider going ahead with the party, particularly if it is important for employee morale (i.e.,cancelling might significantly reduce productivity)—provided adequate short-term funding isavailable. If the crunch is new, larger problems could lie ahead, and funding a party before thecash-flow outlook became clear might expose the firm to financial risk.E1-4.Sunk costs(LG 5)Answer:Marginal benefit-marginal cost analysis ignores sunk costs, so the $2.5 million dollars spent overthe past 15 years is irrelevant to the current decision. At this point, what matters is whether expectedrevenues from additional investment exceed expected costs, after adjusting for the risk and timing ofcash flows. If so, and funding is available, the investment is sound (irrespective of the specificcapital expenditure required). The key to the decision may well lie in the satellite-divisionmanager’s candid assessment that the project has little chance of viability. That assessmentsuggests additional expenditure is likely to throw good money after bad.E1-5.Agency costs(LG 6)Answer:Agency costs arise when one party (principal) designates another party (agent) to act on her behalfand the second party (agent) has latitude to pursue her own interest at the expense of the principal.In a corporation, shareholders are principals and managers agents. If shareholders fail to monitoradequately, managers could focus on personal goals rather than shareholder value. The resultingnegative impact on stock price is an example of an agency cost. Another example is the cost ofstock options, which focus manager attention on share price but also raise managerialcompensation.In the Donut Shop, Inc. example, the principal is store management, and the agents are employees.As normal humans, employees might prefer talking with other each or taking long breaks tofocusing laser-like on customers. Banning tips led to poorer service, which could ultimately drivecustomers elsewhere and cost store managers their jobs. Tipping, like options, aligns the interests

Principles of Managerial Finance, 15th Edition Solution Manual - Page 11 preview image

Loading page ...

8Zutter/Smart •Principles of Managerial Finance,Fifteenth Editionof principals and agents. The prospect of a tip kept employees (agents) focused on customersatisfaction, just as store management (principals) wished.One potential solution for Donut Shop, Inc., is a profit-sharing plan that includes employees whosebehavior reduced customer satisfaction. For the new benefit to be effective, Donut Shop must sell theplan as a replacement for tipping and structure it to provide generous bonuses when profits rise(because profit sharing lacks the immediacy of tips for good service). Perhaps a simpler solution isrecognizing the ban on tipping led to customer-service problems in the first place and reversing thepolicy.E1-6.Corporate tax liability(LG 5)Answer:Note to instructors: After the first print run of this text, Congress made major changes to corporatetaxes. A revised printing incorporated the newest tax changes, but some students may be using aversion of the text with a graduated corporate tax code rather than the current 21% flat tax. Theanswer to this question under current law is that taxes are 21% of income, which is $500,000 plusthe $25,000 capital gain. 21% × $525,000 = $110,250. For students using the first print run withthe old tax rates, the answer is as follows. Ross purchased the asset for $125,000 and sold it for$150,000, thereby netting a $25,000 capital gain. This gain is taxed as ordinary corporate income, sototal taxable income is $525,000. From Table 1.2, the tax liability equals (0.15) ($50,000) + (0.25)($75,000 – $50,000) + (0.34) ($100,000 – $75,000) + (0.39) ($335,000 – $100,000) + (0.34)($525,000 – $335,000) = $178,500.Solutions to ProblemsP1-1.Liability comparisons(LG 5; Basic)a.Ms. Harper has unlimited personal liability, so she is liable for the firm’s $60,000 in unpaid debts.b. Initially, Ms. Harper is liable for $30,000 (50% of total unpaid debts). But if her partner cannotcover half the debt, Ms. Harper is liable for the full amount.c.Ms. Harper has limited liability; she cannot lose more than her $25,000 investment.P1-2.Accrual income vs. cash flow for a period(LG 4; Basic)a.Sales$760,000Cost of goods sold300,000Net profit$460,000b. Cash receipts$690,000Cost of goods sold300,000Net cash flow$390,000c.A financial manager will find the cash-flow statement more useful. Accounting net incomeincludes uncollected revenues that do not contribute to owner wealth. Cash flows, not accountingprofits, matter to shareholders.

Principles of Managerial Finance, 15th Edition Solution Manual - Page 12 preview image

Loading page ...

Chapter 1The Role of Managerial Finance9P1-3.Personal finance: cash flows(LG 4; Intermediate)a.Total cash inflow: $450+$4,500=$4,950Total cash outflow: $1,000+$500+$800+$355+$280+$1,200+$222=$4,357b. Net cash flow: Total cash inflows—Total cash outflows = $4,950−$4,357=$593c.If Jane is facing a shortage, she could reduce spending on discretionary items such as clothing,dining out, and gas (i.e., travel less).d. Jane should examine anticipated cash flows in other months to verify August is typical. She may,for instance, discover expenditures not in her August budget—like large quarterly automobile-insurance expenses or large gift purchases in December. To prepare for such outlays, Jane shouldput the $593 in a bank deposit or money-market account where the funds are readily accessible,and capital losses unlikely. If the $593 will not needed for anticipated bills, Jane should explorelonger-term investment options, such as a diversified portfolio of stocks and bonds.P1-4.Marginal benefit-marginal cost analysisand goal of the firm(LG 2 and LG 4; Challenging)a.Marginal benefits of proposed robotics =Marginal benefits of new robotics−Marginal benefits of original robotics$560,000−$400,000=$160,000b. Marginal cost of proposed robotics =Marginal cost of new robotics – Sales price of current robotics$220,000−$70,000=$150,000c.Net benefits of new robotics=Marginal benefits of proposed robotics−Marginal cost of proposed robotics$160,000−$150,000 = $10,000d. Provided cash flows from new and existing robotics are equally risky and either (i) cash flowsfrom each option have the same timing or (ii) the discount (interest rate) is zero, Ken Allen shouldrecommend new robotics because the marginal benefits exceed marginal costs.e.Three other important factors are cash-flow risk, cash-flow timing, and interest rates. Newtechnology sometimes presents unique risks—new robotics, for example, could have unanticipatedbreakdowns that necessitate a recall—so Ken Allen should investigate the riskiness of each cashflow under the marginal-benefit and marginal-cost headings. He should also determine the exacttiming of cash inflows/outflows for both options as well as the opportunity cost of funds invested(i.e., the interest rate). Timing and the interest rate are important because the project spans fiveyears, and dollars received/spent today are worth more than dollars received/spent tomorrow.P1-5.Identifying agency problems, costs, and resolutions(LG 6; Intermediate)a.The agency cost is wages paid to an idle employee whose responsibilities must be covered bysomeone else. One solution is a time clock everyone must punch when arriving for work, take alunchbreak, and leave for the day. A punch clock would reduce agency costs by (1) prompting thereceptionist to return from lunch on time or (2) reduce wages paid for unproductive time.b. The agency costs are opportunity costs—money budgeted for inflated cost estimates that cannot beused to fund other projects to enhance shareholder wealth. One solution is rewarding managers foraccurate cost estimates rather keeping actual costs below their estimates.

Principles of Managerial Finance, 15th Edition Solution Manual - Page 13 preview image

Loading page ...

10Zutter/Smart •Principles of Managerial Finance,Fifteenth Editionc.The agency cost is lost shareholder wealth; the CEO might agree to sell the firm for less than fair-market value in return for a post-merger position with more income, wealth, power, or visibility.One safeguard is allowing bids from other potential partners once the CEO has publicly disclosedfirm interest in merging. Competitive bidding should reveal a merger price fair to shareholders.d. Part-time or temporary workers are less productive than full-time workers for two reasons: (i) newemployees must learn their jobs, and (ii) fully trained employees obtain insights about improvingefficiency from experience. In the short run, any decline in service caused by part-time ortemporary workers would probably not drive branch customers away. And the same revenue withlower costs (from cheaper workers) will, indeed, boost profits. Over the long run, however,consistently less-productive employees will hurt profitability by reducing revenue or raising costs.One solution is rewarding managers with stock for meeting performance targets over a longerhorizon (like average branch profit over the past three years).P1-6Corporate taxes(LG 5; Basic)a.Firm’s tax liability on $92,500 using Table 1.2:Total taxes due=$13,750+[0.34×($92,500 – $75,000)] = $13,750+$5,950=$19,700For students with the text updated with the latest tax information, the taxes due would be 21% ×$92,500 = $19,425.b.After-tax earnings: $92,500 – $19,700=$72,800. For students with the text updated with thelatest tax information, after tax earnings are $92,500 – $19,425 = $73,075.c.Average tax rate: $19,700 ÷ $92,500=21.3%. For students with the text updated with the latesttax information, the average tax rate is $19,425 ÷ $92,500=21.0%.d.Marginal tax rate: 34%. For students with the text updated with the latest tax information, themarginal tax rate is 21%. Notice that the marginal and average tax rates are the same under a flattax.P1-7Average corporate tax rates(LG 6; Basic)a.Tax calculations using Table 1.2:$10,000:Tax liability:$10,000×0.15=$1,500After-tax earnings:$10,000 – $1,500=$8,500Average tax rate:$1,500 ÷ $10,000=15%$80,000:Tax liability:$13,750+[0.34×(80,000 – $75,000)]= $13,750 + $1,700 = $15,450After-tax earnings:$80,000 – $15,450 = $64,550Average tax rate:$15,450 ÷ $80,000=19.3%$300,000:Tax liability:$22,250 + [0.39×($300,000 – $100,000)]= $22,250 + $78,000 = $100,250After-tax earnings:$300,000 – $100,250=$199,750Average tax rate:$100,250 ÷ $300,000 = 33.4%$500,000:Tax liability:$113,900+[0.34×($500,000 – $335,000)]= $113,900+$56,100 = $170,000After-tax earnings:$500,000 – $170,000 = $330,000Average tax rate:$170,000 ÷ $500,000 = 34%

Principles of Managerial Finance, 15th Edition Solution Manual - Page 14 preview image

Loading page ...

Chapter 1The Role of Managerial Finance11$1,500,000:Tax liability:$113,900+[0.34×($1,500,000 – $335,000)]= $113,900 + $396,100 =$510,000After-tax earnings:$1,500,000 – $510,000=$990,000Average tax rate:$510,000÷$1,500,000=34%$10,000,000:Tax liability:$113,900 + [0.34×($10,000,000 – $335,000)]= $113,900+$3,286,100 =$3,400,000After-tax earnings:$10,000,000 – $3,400,000 = $6,600,000Average tax rate:$3,400,000 ÷ $10,000,000=34%$20,000,000:Tax liability:$6,416,667 + [0.35×($20,000,000 – $18,333,333)]= $6,416,667+583,333 = $7,000,000After-tax earnings:$20,000,000 – $7,000,000=$13,000,000Average tax rate:$7,000,000 ÷ $20,000,000=35%Note that the answers above apply to the version of the text that did not have updated tax information. In therevised version with new tax information, the problem was modified to ask about partnership income rather thancorporate income. Partnership income is taxed at the new, 2018 individual income tax rates presented in a revisedTable 1.2 (which shows tax rates for a single taxpayer). For this revised question, the appropriate answers appearbelow. The answers assume that the person receiving this income flowing from a partnership has no other income.a.Tax calculations using Table 1.2:$10,000:Tax liability:$953+$475×0.12 = $1,010After-tax earnings:$10,000 – $1,010=$8,990Average tax rate:$1,010 ÷ $10,000=10.1%$80,000:Tax liability:$4,454+[0.22×(80,000 – $38,700)] = $13,540After-tax earnings:$80,000 – $13,540 = $66,460Average tax rate:$13,540÷ $80,000=16.9%$300,000:Tax liability:$45,690 + [0.35×($300,000 – $200,000)] = $80,690After-tax earnings:$300,000 – $80,690=$219,310Average tax rate:$80,690 ÷ $300,000 = 26.9%$500,000:Tax liability:$150,690 (just the base tax number from Table 1.2)After-tax earnings:$500,000 – $150,690 = $349,310Average tax rate:$150,690 ÷ $500,000 = 30.1%$1,000,000:Tax liability:$150,690+[0.37×($1,000,000 – $500,000)] = $335,690After-tax earnings:$1,000,000 – $335,690=$664,310Average tax rate:$335,690÷$1,000,000=33.6%$1,500,000:Tax liability:$150,690 + [0.37×($1,500,000 - $500,000)] = $520,690After-tax earnings:$1,500,000 – $520,690 = $979,310Average tax rate:$520,690 ÷ $1,500,000=34.7%$2,000,000:Tax liability:$150,690 + [0.37×($2,000,000 – $500,000)] = $705,690After-tax earnings:$2,000,000 – $705,690=$1,294,310Average tax rate:$705,690 ÷ $2,000,000=35.3%

Principles of Managerial Finance, 15th Edition Solution Manual - Page 15 preview image

Loading page ...

12Zutter/Smart •Principles of Managerial Finance,Fifteenth Editionb. The graph below pertains to the version of the text WITHOUT tax updates. As taxable corporateincome rises, the average tax rate approaches 35%.Under the new tax law, the partnership’s average tax rate gets closer and closer to 37% as incomegoes higher and higher.051015202530354005000001000000150000020000002500000Average Tax RateIncomeAverage Tax Rate and Income Levels

Principles of Managerial Finance, 15th Edition Solution Manual - Page 16 preview image

Loading page ...

Chapter 1The Role of Managerial Finance13P1-8Marginal corporate tax rates(LG 6; Basic)As was true in the previous problem, there are different solutions depending on whether a student hasa book with updated tax information or a book with the old tax information. Following is the solutionfor the original version of the problem.a.Pre-TaxIncomeBase Tax+%×AmountOver Base=TotalTaxMarginalRate$15,000$ 0+(0.15×15,000)=$ 2,25015.0%60,0007,500+(0.25×10,000)=10,00025.0%90,00013,750+(0.34×15,000)=18,85034.0%200,00022,250+(0.39×100,000)=61,25039.0%400,000113,900+(0.34×65,000)=136,00034.0%1,000,000113,900+(0.34×665,000)=340,00034.0%20,000,0006,416,667+(0.35×1,666,667)=7,00,000035.0%b.As income rises to $335,000, the marginal tax rate approaches a peak of 39%. For income above$335,000, the marginal rate first dips to 34%, and then edges up to 35% after $10 million..Here is a solution for the new version of the problem to reflect the updated tax code. Note that theproblem was revised to focus on proprietorship income rather than corporate income, and the incomelevels that students were asked to work with here are slightly different than in the original problem.a.The marginal tax rates at the specified income levels areIncomeMarginal rate$15,00012%$60,00022%$90,00024%$150,00024%$250,00035%$450,00035%

Preview Mode

This document has 420 pages. Sign in to access the full document!

Report

Study Now!

Document Details

Related Documents

Solution Manual For Principles of Managerial Finance, 8th Edition

Test Bank for Principles of Managerial Finance, Arab World Edition

Test Bank for Principles of Managerial Finance, 15th Edition

Test Bank for Principles of Managerial Finance, 8th Edition

Introduction Microfinance - the concept of microfi

Texas Life and Health Insurance Exam 150 Questions

Understanding Obligation and Deobligation in Resou

Budgeting for Life After High School

Ch 4 les 1

Understanding Credit Reports Analyzing John's Fina

Company

Explore

Study Tools