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  Solutions to Problems

P1-1. LG 1: Liability comparisons
Basic
a. Ms. Harper has unlimited liability.
b. Ms. Harper has unlimited liability.
c. Ms. Harper has limited liability, which guarantees that she cannot lose more than she
invested.

P1-2. LG 2, 4: Marginal cost-benefit analysis and the goal of the firm
Intermediate
a. Benefits from new robotics $560,000
Benefits from existing robotics 400,000
Marginal benefits $160,000

b. Initial cash investment $220,000
Receipt from sale of old robotics 70,000
Marginal cost $150,000

c. Marginal benefits $160,000
Marginal cost 150,000
Net benefits $ 10,000

d. Ken should recommend that the company replace the old robotics with the new robotics.
The net benefit to shareholders is positive which should make the shareholders better off.
e. Ken should consider more than just net benefits. He should incorporate the important points
of timing, cash flow, and risk, three important factors to determining the true impact on
shareholders’ wealth.

P1-3. LG 2: Annual income versus cash flow for a period

as a result. If the price offered by the competitor is too low. The manager may negotiate a deal with the merging competitor that is extremely beneficial to the executive and then sell the firm for less than its fair market value. Twelfth Edition Basic a. If she has such needs.200 + $222 = $4. Sales $760. If Jane is facing a shortage.She may for instance. . other firms will up the price closer to its fair market value. d. c.000 Net profit $460. Installation of a time clock that must be punched by the receptionist every time she leaves work and returns would result in either: (1) her returning on time or (2) reducing the cost to the firm by reducing her pay for the lost work. The company must pay someone to take her place during her absence. Money budgeted to cover the inflated costs of this project proposal is not available to fund other projects that may help to increase shareholder wealth.357 = $593 c. she should invest in a diversified portfolio.2  Gitman • Principles of Managerial Finance.e.357 b. she could cut back on some of her discretionary items.000 Net cash flow $390. Total cash inflow: $450 + $4. travel less). If Jane has a surplus in August. A good way to reduce the loss of shareholder wealth would be to open the firm up for purchase bids from other firms once the manager makes it known that the firm is willing to merge. including clothing. P1-5.000 + $500 + $800 + $355 + $280 + $1. b. costs.000 Cost of goods sold 300. The accounting net income includes amounts that will not be collected and. LG 4: Identifying agency problems. If her August net cash flow is not needed to pay anticipated bills.000 Cost of goods sold 300.950 Total cash outflow: $1.. Cash receipts $690. The cash flow statement is more useful to the financial manager.000 b. observe the existence of large automobile insurance bills or tendency to spend more during the Christmas holiday season.000 c. The costs to the firm are in the form of opportunity costs. P1-4. Net cash flow: $4. and gas (i. she should compare these cash flows to those of other months and verify that August’s cash flows are typical. In this case the employee is being compensated for unproductive time. where she is unlikely to face a decline in investment.950 – $4. Jane will want to save the $593 in a money market security. dining out. and resolutions Intermediate a.500 = $4. Make the management reward system based on how close the manager’s estimates come to the actual cost rather than having them come in below cost. do not contribute to the wealth of the owners. LG 1: Personal finance: Cash flow statement a.

250 = Total tax After-tax earnings: $300.000 = 19.3% d.750 + $1.500 After-tax earnings: $10.550 Average tax rate: $15.000 – $1. Tax calculations using Table 1.000: Tax liability: $13.950 = $19. LG 6: Average corporate tax rates Basic a.500 Average tax rate: $1.3% $300.000) $13. After-tax earnings: $92.500 ÷ $10.700 $15.000 – $75.4: $10.000) $22.34 × (80.750 + [0.250 = $199.500) = $13.000 × 0. One approach to reducing the problem would be to give the manager performance shares if they meet certain stated goals.000 – $100.750 + (0.250 + [0.750 + [0.34 × ($92.34 × $5.750 + (0.450 ÷ $80. Firm’s tax liability on $92.39 × ($300.4% .700 ÷ $92.500 – $19.000: Tax liability: $10.750 Average tax rate: $100.000)] $13.250 + $78.500 = $8.000)] $22. P1-6.700 = $72.34 × $17. This manager is getting rid of the highest cost employees to increase profits.500 = 21. Average tax rate: $19. Marginal tax rate: 34% P1-7. Implementing a stock incentive plan tying management compensation to share price would also encourage the manager to retain quality employees.000 – $15.4): Total taxes due = $13.800 c. Also. the better employees generally need to be highly compensated for their skills. LG 6: Corporate taxes Basic a.500 – $75.750 + $5.700 b. These workers have not been on the job as long to increase their work efficiency.500 (from Table 1. Generally part time or temporary workers are not as productive as full-time employees.15 = $1.39 × $200.000 – $100.000: Tax liability: $22.000 = 33.000 = 15% $80.000)] = $13.250 ÷ $300.450 = $64.250 + (0. Chapter 1 The Role and Environment of Managerial Finance  3 d.000 $100.450 = Total tax After-tax earnings: $80.

500. the rate reaches 35%.000: Tax liability: $113.667 + [0.000 Average tax rate: $510.34 × ($10.000: Tax liability: $6.000 – $7.400.000.000.000 – $335.000: Tax liability: $113.665. .34 × $165.000.000 = $6.000 ÷ $20.000 = 34% $10.000 = $990.333.34 × ($1.600.000 Average tax rate: $170.000.34 × $1.000.34 × $9.000) $113.500.000 ÷ $1.100 $3.000 – $335.900 + (0.900 + $56.000.667 + 583.000 = $330.000: Tax liability: $113.000 Average tax rate: $3.45 = Total tax After-tax earnings: $20.000 ÷ $500.000.667 + (0.45 $7.000 – $18.000 = 34% $20.000) $113.000 = Total tax After-tax earnings: $1.416.000) $113.100 $170.400.165.900 + [0.000)] $113.333)] $6.416.000.286.000.000)] $113.900 + $3.100 $510.000.500.000.000 = 35% b.000 Average tax rate: $7.333.900 + [0.000 – $335.000 – $3.500.35 × $1.416.35 × ($20.900 + [0.900 + $396.900 + (0.000.000.666.000 – $170.900 + (0.000.45 = $13.000)] $113.34 × ($500.000 ÷ $10.000 = Total tax After-tax earnings: $10.400.667) $6.000 – $510.4  Gitman • Principles of Managerial Finance.000 = Total tax After-tax earnings: $500. As income increases. Twelfth Edition $500.000 = 34% $1.

LG 6: Marginal corporate tax rates Basic a. . Chapter 1 The Role and Environment of Managerial Finance  5 P1-8.

000 $ 0 + (0.15 × 15.250 15.0% 200.000 34.000) = $ 2.39 × 100.000 13.0% 400.0% 90.850 34.000) = 136. Twelfth Edition Tax Calculation Pretax Amount Marginal Income Base Tax + % × over Base = Tax Rate $ 15.900 + (0.250 + (0.34 × 665.0% 60.34 × 15.25 × 10.000) = 61.0% 1.900 + (0.000 113.250 39.6  Gitman • Principles of Managerial Finance.000 7.000) = 10.000) = 18.500 + (0.000.000) = 340.000 34.750 + (0.34 × 65.000 113.0% .000 25.000 22.

667 + (0.35 × 1.666) = 700. Chapter 1 The Role and Environment of Managerial Finance  7 20.666.416.000 6.000.000 35.0% .

000. the marginal tax rate declines to 34%.000.8  Gitman • Principles of Managerial Finance. the marginal tax rate approaches and peaks at 39%. Tax on operating earnings: $490. P1-9. As income increases to $335.000 b. and c .40 tax rate = $196.000 × 0. LG 6: Interest versus dividend income Intermediate a. and after $10 million the marginal rate increases slightly to 35%. Twelfth Edition b. For income in excess of $335.

Chapter 1 The Role and Environment of Managerial Finance  9 (b) (c) Interest Income Dividend Income Before-tax amount $20.000) Taxable amount 20.70 × $20.000 Tax (40%) 8.000 6.000 (0.400 .000 $20.000 Less: Applicable exclusion 0 14.000 2.

600 . Twelfth Edition After-tax amount 12.000 17.10  Gitman • Principles of Managerial Finance.

$12. due to the 70% corporate dividend exclusion.600. This increases the attractiveness of stock investments by one corporation in another relative to bond investments.000. Total tax liability: . $17. Chapter 1 The Role and Environment of Managerial Finance  11 d. e. The after-tax amount of dividends received. exceeds the after-tax amount of interest.

000  + Taxes on interest income (from (b)) 8.000  + Taxes on dividend income (from 2. Twelfth Edition Taxes on operating earnings (from (a)) $196.400 (c)) .12  Gitman • Principles of Managerial Finance.

400 . Chapter 1 The Role and Environment of Managerial Finance  13 Total tax liability $206.

LG 6: Interest versus dividend expense Intermediate . Twelfth Edition P1-10.14  Gitman • Principles of Managerial Finance.

000 .000 Less: Interest expense 10. Chapter 1 The Role and Environment of Managerial Finance  15 a.000 Less: Taxes (40%) 12. EBIT $40.000 Earnings before taxes $30.

000 .16  Gitman • Principles of Managerial Finance. Twelfth Edition Earnings after taxes* $18.

000 1.000 Less: Preferred dividends 10. Examples of ethical considerations that might enter into decisions include not exaggerating product quality or durability. while others are ethical and pass through the filter. LG 4: Ethics problem Intermediate Maximizing shareholder wealth.40 Asset (1) (2) (3) (4) A $3. involves carefully evaluating each decisions impact on cash flow amount.000 P1-12. or the stock price.000 12. and risk.000 × 0.40 = $2.000 = $250 Asset Y = $35.000 41.000 Earnings available for  common stockholders $14.000 – $30.000 0 0 C 80.000 62. Think of all decisions being sifted through an “ethical filter”—some decisions are unethical and do not make it through the filter.000 = $5. Chapter 1 The Role and Environment of Managerial Finance  17 *This is also earnings available to common stockholders.000 $400 $60 B 12. Tax on sale of asset: Asset X = $250 × 0. The phrase “subject to ethical constraints” implies that there are ethical facets of business decisions that may or may not be a significant part of a decision’s cash flow projections. No doubt you have thought of other examples as well.200 D 45. LG 6: Capital gains taxes Basic a. and not exaggerating future cash flow projections in order to get a lower interest rate on a bank loan or bond issue.250 – $2.000 Earnings after taxes $24.000 7. However. LG 6: Capital gains taxes Basic (a) and (b) Capital Gain Tax Sale Price Purchase Price (1) – (2) (3) × 0. . b.40 = $100 Asset Y = $5.000 P1-11. correcting environmental problems even though regulators or the general public would never know about them.000 Less: Taxes (40%) 16.600 E 18.500 1. Each of these examples may decrease the size or delay the timing of cash inflows. EBIT $40.500 600 P1-13. Capital gain: Asset X = $2.000 4. timing.000 b.000 16.000 18.400 $3. or increase the riskiness of future cash flows—thereby reducing the stock price relative to what it could have been had one acted unethically. that statement includes nothing that directly incorporates the ethical aspect of decisions.