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Homework of Corporate Finance

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Homework of Corporate Finance
The 3rd Week
What is the primary disadvantage of the corporate form of organization? Name at least two advantages of corporate organization.

Answer: The primary disadvantage of the corporate form is the double taxation to shareholders of distributed earnings and dividends. Advantages include: limited liability; ability to raise capital; and unlimited life 【Agency Problem】

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?

Answer: In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect the directors of the corporation, who in turn appoint the firm’s management. This separation of ownership from control in the corporate form of organization is what causes agency problems to exist. Management may act in its own or someone else’s best interests, rather than those of the shareholders. If such events occur, they may contradict the goal of maximizing the share price of the equity of the firm. 【Liquidity】

What does liquidity measure? Explain the trade-off a firm faces between high liquidity and low liquidity levels.

【Calculating Cash Flows】
Dahlia Industries had the following operating results for 2009: sales = 22,800; cost of goods sold = 16,050; depreciation expense = 4,050; interest expense = 1,830; dividends paid = 1,300. At the beginning of the year, net fixed assets were 13,650, current assets were 4,800, and current liabilities were 2,700. At the end of the year, net fixed assets were 16,800, current assets were 5,930, and current liabilities were 3,150. The tax rate for 2009
was 34 percent. a. What is net income for 2009?

b. What is the operating cash flow for 2009?
c. What is the cash flow from assets for 2009? Is this possible? Explain. d. If no new debt was issued during the year, what is the cash flow to creditors? What is the cash flow to stockholders? Explain and interpret the positive and negative signs of your answers in (a) through (d). Answer:

Operating cash flow(b)
6454.2, which means that the firm’s cash inflows from its business operations are sufficient to cover its everyday cash outflows.

Net capital spending

Change in NWC
Cash flow from assets(c)
-1425.8, it is possible because the firm raised more money by borrowing and selling stock than it paid out to creditors and stockholders during the year.

Interest paid

Net new borrowing
Cash flow to creditors(d)
1830, which means that the creditors got interest payments
Dividends paid

Net new equity raised
Cash flow to stockholders(d)
1300, which means that the stockholders got dividend payments

Deadline of handing in homework is 5pm, 25th Sep. (Wednesday)

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