Case Solutions

Essentials of Corporate Finance Ross, Westerfield, and Jordan 7th edition

02/17/2010 Prepared by Joe Smolira Belmont University

CHAPTER 1 THE McGEE CAKE COMPANY

1. The advantages to a LLC are: 1) Reduction of personal liability. A sole proprietor has unlimited liability, which can include the potential loss of all personal assets. 2) Taxes. Forming an LLC may mean that more expenses can be considered business expenses and be deducted from the companys income. 3) Improved credibility. The business may have increased credibility in the business world compared to a sole proprietorship 4) Ability to attract investment. Corporations, even LLCs, can raise capital through the sale of equity. 5) Continuous life. Sole proprietorships have a limited life, while corporations have a potentially perpetual life. 6) Transfer of ownership. It is easier to transfer ownership in a corporation through the sale of stock. The biggest disadvantage is the potential cost, although the cost of forming a LLC can be relatively small. There are also other potential costs, including more expansive record-keeping. 2. 3. Forming a corporation has the same advantages as forming a LLC, but the costs are likely to be higher. As a small company, changing to a LLC is probably the most advantageous decision at the current time. If the company grows, and Doc and Lyn are willing to sell more equity ownership, the company can reorganize as a corporation at a later date. Additionally, forming a LLC is likely to be less expensive than forming a corporation.

CHAPTER 2 CASH FLOWS AND FINANCIAL STATEMENTS AT SUNSET BOARDS

Below are the financial statements that you are asked to prepare. 1. The income statement for each year will look like this: Income statement 2009 $277,855 141,641 27,854 39,983 $68,377 8,702 $59,675 11,935 $47,740 $23,870 23,870

Sales Cost of goods sold Selling & administrative Depreciation EBIT Interest EBT Taxes Net income Dividends Addition to retained earnings 2.

2010 $338,688 178,839 36,355 45,192 $78,302 9,962 $68,340 13,668 $54,672 $27,336 27,336

The balance sheet for each year will be: Balance sheet as of Dec. 31, 2009 $20,437 Accounts payable 14,482 Notes payable 30,475 Current liabilities $65,394 Long-term debt $176,400 Owners' equity $241,794 Total liab. & equity

Cash Accounts receivable Inventory Current assets Net fixed assets Total assets

$36,120 16,464 $52,584 $89,040 $100,170 $241,794

In the first year, equity is not given. Therefore, we must calculate equity as a plug variable. Since total liabilities & equity is equal to total assets, equity can be calculated as:

CASE 7 C-4

Equity = $241,794 89,040 52,854 Equity = $100,170

C-5 CASE SOLUTIONS

Cash Accounts receivable Inventory Current assets Net fixed assets Total assets

Balance sheet as of Dec. 31, 2010 $30,880 Accounts payable 18,785 Notes payable 41,821 Current liabilities $91,486 Long-term debt $214,184 Owners' equity $305,670 Total liab. & equity

$40,908 17,976 $58,884 $102,480 $144,306 $305,670

The owners equity for 2010 is the beginning of year owners equity, plus the addition to retained earnings, plus the new equity, so: Equity = $100,170 + 27,336 + 16,800 Equity = $144,306 3. Using the OCF equation: OCF = EBIT + Depreciation Taxes The OCF for each year is: OCF2009 = $68,377 + 39,983 11,935 OCF2009 = $96,425 OCF2010 = $78,302 + 45,192 13,668 OCF2010 = $109,826 4. To calculate the cash flow from assets, we need to find the capital spending and change in net working capital. The capital spending for the year was: Capital spending Ending net fixed assets Beginning net fixed assets + Depreciation Net capital spending

$214,184 176,400 45,192 $ 82,976

And the change in net working capital was: Change in net working capital Ending NWC Beginning NWC Change in NWC

$32,602 12,810 $19,792

CASE 7 C-6 So, the cash flow from assets was: Cash flow from assets Operating cash flow Net capital spending Change in NWC Cash flow from assets 5. The cash flow to creditors was: Cash flow to creditors Interest paid Net new borrowing Cash flow to creditors 6. The cash flow to stockholders was: Cash flow to stockholders Dividends paid Net new equity raised Cash flow to stockholders Answers to questions 1. The firm had positive earnings in an accounting sense (NI > 0) and had positive cash flow from operations. The firm invested $19,792 in new net working capital and $82,976 in new fixed assets. The firm gave $7,058 to its stakeholders. It raised $3,478 from bondholders, and paid $10,536 to stockholders. 2. The expansion plans may be a little risky. The company does have a positive cash flow, but a large portion of the operating cash flow is already going to capital spending. The company has had to raise capital from creditors and stockholders for its current operations. So, the expansion plans may be too aggressive at this time. On the other hand, companies do need capital to grow. Before investing or loaning the company money, you would want to know where the current capital spending is going, and why the company is spending so much in this area already.

$109,826 82,976 19,792 $ 7,058

$9,962 13,440 $3,478

$27,336 16,800 $10,536