Corporate Finance
Chapter 1&2 Tutorial
Concept Questions:
Chapter 1
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 kind of problems can arise?
6. Agency problems Suppose you own a 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 shareholder’s best interests?
Why or why not?
8. Agency problems and Corporate Ownership In recent years, large financial institu-
tions such as mutual funds and pension funds have become the dominant owners of stock in
the US, and these institutions are becoming more active in corporate affairs. What are the im-
plications of this trend for agency problems and corporate control?
Chapter 2
1. Liquidity True or false: All assets are liquid at some point. Explain.
5. Book Values versus Market Values Under standard accounting rules, it is possible
for a company’s liabilities to exceed its assets. When this occurs, the owners’ equity is nega-
tive. Can this happen with market values? Why or why not?
8. Net Working Capital and Capital Spending Could a company’s change in net work-
ing capital be negative in a given year> (Hint: Yes) Explain how this might come about. What
about net capital spending?
9. Cash Flow to Stockholders and Creditors Could a company’s cash flow to stock-
holders be negative in a given year? (Hint: Yes) Explain how this might come about. What
about cash flow to creditors?
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Study Problems:
Chapter 2
1. Building a Balance Sheet Sankey, Inc., has current assets of $4,900, net fixed assets of
$25,000, current liabilities of $4,100, and long-term debt of $10,300. What is the value of the
shareholders’ equity account for this firm? How much is net working capital?
2. 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%. 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?
7. Building a Balance Sheet The following table presents the long-term liabilities and stock-
holders’ equity of Information Control Corp. one year ago:
Long-term debt $55,000,000
Preferred stock $3,100,000
Common stock ($1 par value) $12,000,000
Accumulated retained earnings $119,000,000
Capital surplus $56,000,000
During the past year, the company issued 5 million shares of new stock at a total price of $63
million and issued $30 million in new long-term debt. The company generated $8 million in net
income and paid $1.8 million in dividends. Construct the current balance sheet reflecting the
changes that occurred at the company during the year.
13. Building an Income Statement During the year, the Senbet Discount Tire Company
had gross sales of $925,000. The firm’s COGS and selling expenses were $490,000 and
$220,000, respectively. Senbet also had notes payables 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?
16. Residual Claims Josipovich, Inc., is obligated to pay its creditors $11,300 very soon.
a. What is the market value of the shareholders’ equity if assets have a market value of
$12,400?
b. What if assets equal $9,600?
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