CHAPTER 1

INTRODUCTION TO CORPORATE FINANCE

CONCEPT QUESTIONS
1. Agency Problems Who owns a corporation? Describe the process whereby the owners
control the firm’s management. What is the main reason that an agency relationship exists in the
corporate form of organization? In this context, what kinds of problems can arise?
2. Not-for-Profit Firm Goals Suppose you were the financial manager of a not-for-profit
business (a not-for-profit hospital, perhaps). What kinds of goals do you think would be
appropriate?
3. Goal of the Firm Evaluate the following statement: Managers should not focus on the current
stock value because doing so will lead to an overemphasis on short-term profits at the expense
of long-term profits.
4. Ethics and Firm Goals Can the goal of maximizing the value of the stock conflict with other
goals, such as avoiding unethical or illegal behavior? In particular, do you think subjects like
customer and employee safety, the environment, and the general good of society fit in this
framework, or are they essentially ignored? Think of some specific scenarios to illustrate your
answer.
5. International Firm Goal Would the goal of maximizing the value of the stock differ for
financial management in a foreign country? Why or why not?
6. Agency Problems Suppose you own stock in a company. The current price per share is $25.
Another company has just announced that it wants to buy your company and will pay $35 per
share to acquire all the outstanding stock. Your company’s management immediately begins
fighting off this hostile bid. Is management acting in the shareholders’ best interests? Why or
why not?
7. Agency Problems and Corporate Ownership Corporate ownership varies around the world.
Historically, individuals have owned the majority of shares in public corporations in the United
States. In Germany and Japan, however, banks, other large financial institutions, and other
companies own most of the stock in public corporations. Do you think agency problems are
likely to be more or less severe in Germany and Japan than in the United States?
8. Agency Problems and Corporate Ownership In recent years, large financial institutions
such as mutual funds and pension funds have become the dominant owners of stock in the
United States, and these institutions are becoming more active in corporate affairs. What are the
implications of this trend for agency problems and corporate control?
9. Executive Compensation Critics have charged that compensation to top managers in the
United States is simply too high and should be cut back. For example, focusing on large
corporations, Larry Ellison of Oracle has been one of the best-compensated CEOs in the United
States, earning about $76.9 million in 2013. Are such amounts excessive? In answering, it might
be helpful to recognize that superstar athletes such as Cristiano Ronaldo, top earners in the
entertainment field such as James Cameron and Oprah Winfrey, and many others at the top of
their respective fields earn at least as much, if not a great deal more.
10. Goal of Financial Management Why is the goal of financial management to maximize the
current value of the company’s stock? In other words, why isn’t the goal to maximize the future
value?
11. Cash Flows How do financial cash flows and the accounting statement of cash flows differ?
Which is more useful for analyzing a company?
12. Cash Flow from Assets Why is it not necessarily bad for the cash flow from assets to be
negative for a particular period?
13. Operating Cash Flow Why is it not necessarily bad for the operating cash flow to be
negative for a particular period?
14. Net Working Capital and Capital Spending Could a company’s change in networking
capital be negative in a given year? (Hint: Yes.) Explain how this might come about. What
about net capital spending?
15. Cash Flow to Stockholders and Creditors Could a company’s cash flow to stockholders be
negative in a given year? (Hint: Yes.) Explain how this might come about. What about cash
flow to creditors?

EXERCISES
1. Building an Income Statement Shelton, Inc., has sales of $435,000, costs of $216,000,
depreciation expense of $40,000, interest expense of $21,000, and a tax rate of 35 percent. What
is the net income for the firm? Suppose the company paid out $30,000 in cash dividends. What
is the addition to retained earnings?
2. Cash Flow to Creditors The 2014 balance sheet of Jordan’s Golf Shop, Inc., showed long-
term debt of $1.625 million, and the 2015 balance sheet showed long-term debt of $1.73 million.
The 2015 income statement showed an interest expense of $185,000. What was the firm’s cash
flow to creditors during 2015?
3. Cash Flow to Stockholders The 2014 balance sheet of Jordan’s Golf Shop, Inc., showed
$510,000 in the common stock account and $3.6 million in the additional paid-in surplus
account. The 2015 balance sheet showed $545,000 and $3.85 million in the same two accounts,
respectively. If the company paid out $275,000 in cash dividends during 2015, what was the
cash flow to stockholders for the year?
4. Cash Flows Ritter Corporation’s accountants prepared the following financial statements for
year-end 2015:
a. Explain the change in cash during 2015.
b. Determine the change in net working capital in 2015.
c. Determine the cash flow generated by the firm’s assets during 2015.
INCOME STATEMENT 2015 BALANCE SHEET
Revenue $790 December 31
Expenses 575 2015 2014
Depreciation 90 Assets
Net income $125 Cash 80 60
Dividends $95 Other current assets 185 170
Net fixed assets 405 385
Total assets $670 $615
Liabilities and Equity
Accounts Payable 140 125
Long-term debt 160 150
Stockholders' equity 370 340
Total liabilities and equity $670 $615
5. Building an Income Statement During the year, the Senbet Discount Tire Company had
gross sales of $925,000. The firm’s cost of goods sold and selling expenses were $490,000 and
$220,000, respectively. Senbet also had notes payable of $740,000. These notes carried an
interest rate of 4 percent. Depreciation was $120,000. Senbet’s tax rate was 35 percent.
a. What was Senbet’s net income?
b. What was Senbet’s operating cash flow?
6. Calculating Total Cash Flows Schwert Corp. shows the following information on its 2015
income statement: sales = $215,000; costs = $117,000; other expenses = $6,700; depreciation
expense = $18,400; interest expense = $10,000; taxes = $25,370; dividends = $9,500. In
addition, you’re told that the firm =sued $8,100 in new equity during 2015 and redeemed $7,200
in outstanding long-term debt.
a. What is the 2015 operating cash flow?
b. What is the 2015 cash flow to creditors?
c. What is the 2015 cash flow to stockholders?
d. If net fixed assets increased by $28,400 during the year, what was the addition to networking
capital (NWC)?
7. Using Income Statements Given the following information for O’Hara Marine Co., calculate
the depreciation expense: sales = $44,000; costs = $27,500; addition to retained earnings =
$5,200; dividends paid = $1,670; interest expense = $1,850; tax rate = 40 percent.
8. Net Income and OCF: During 2015, Rainbow Umbrella Corp. had sales of $590,000. Cost
of goods sold, administrative and selling expenses, and depreciation expenses were
$455,000, $85,000, and $125,000, respectively. In addition, the company had an interest
expense of $65,000 and a tax rate of 35 percent. (Ignore any tax loss carryback or carryforward
provisions.)
a. What is the company’s net income for 2015?
b. What is its operating cash flow?
c. Explain your results in (a) and (b).
9. Accounting Values versus Cash Flows: In Problem 8, suppose Rainbow Umbrella Corp.
paid out $34,000 in cash dividends. Is this possible? If spending on net fixed assets and net
working capital was zero, and if no new stock was issued during the year, what was the change
in the firm’s long-term debt account?
10. Calculating Cash Flows: Consider the following abbreviated financial statements for
Weston Enterprises:

a. What is owners’ equity for 2014 and 2015?