Week 1 Problem Set

Answer the following questions and solve the following problems in the space provided.
When you are done, save the file in the format flastname_Week_1_Problem_Set.docx,
where flastname is your first initial and you last name, and submit it to the appropriate
dropbox.
Chapter 1 (page 19)
1. What is the most important difference between a corporation and all other
organizational forms?
Ans: Corporation is a legal entity separate and distinct from its owners, it is solely responsible
for its own obligations. The owners of a corporation are not liable for any obligations the
corporation enters into. Similarly, the corporation is not liable for any personal obligations of its
owners. It can enter into contracts, acquire assets, incur obligations, and it enjoys protection
under the U.S. Constitution against the seizure of its property. Its earnings are accounted for at
the corporate level but are taxed only at the shareholder level. Shareholders generally cannot
withdraw money or property from the corporation without recognizing income. A corporation is
less hands-on than owning a business since ownership claim is figured through the purchase of
stock shares. Selling stocks transfers ownership and stock holders are not liable for the debts of
the business as in the case of a proprietorship or partnership. The drawback to a corporation is
that stockholders pay higher taxes.
2. What does the phrase limited liability mean in a corporate context?
Ans: Limited liability is the situation when the firm's liability is limited to their investment.
Firms with limited liability include limited partnerships, limited liability companies, and
corporations. A limited liability company (LLC) is a limited partnership without a general
partner. That is, all the owners have limited liability, but unlike limited partners, they can also
run the business.
3. Which organizational forms give their owners limited liability?
Ans: Firms with limited liability include limited partnerships, limited liability companies, and
corporations. A limited partnership is a partnership with two kinds of owners, general partners
and limited partners. General partners have the same rights and privileges as partners in a
general. They are personally liable for the firms debt obligations. Limited partners, however,
have limited liability and their liability is limited to their investment. Their private property
cannot be seized to pay off the firms outstanding debts. A limited partner has no management
authority and cannot legally be involved in the managerial decision making for the business.
Private equity funds and venture capital funds are two examples of industries dominated by
limited partnerships. A limited liability company (LLC) is a limited partnership without a general
partner. That is, all the owners have limited liability, but unlike limited partners, they can also
run the business.
4. What are the main advantages and disadvantages of organizing a firm as a corporation?

Ans:
The distinguishing feature of a corporation is that it is a legally defined, a legal entity separate
from its owners. As such, it can enter into contracts, acquire assets, incur obligations, and it
enjoys protection under the U.S. Constitution against the seizure of its property. Because a
corporation is a legal entity separate and distinct from its owners, it is solely responsible for its
own obligations. Consequently, the owners of a corporation are not liable for any obligations the
corporation enters into. The corporation is not liable for any personal obligations of its owners. A
unique feature of a corporation is that there is no limitation on who can own its stock. That is, an
owner of a corporation need not have any special expertise or qualification. This feature allows
free trade in the shares of the corporation and provides one of the most important advantages of
organizing a firm as a corporation rather than as sole proprietorship, partnership, or LLC.
Corporations can raise substantial amounts of capital because they can sell ownership shares to
anonymous outside investors. Because a corporation is a separate legal entity, a corporations
profits are subject to taxation separate from its owners tax obligations. In effect, shareholders of
a corporation pay taxes twice. First, the corporation pays tax on its profits, and then when the
remaining profits are distributed to the shareholders, the shareholders pay their own personal
income tax on this income. This system is sometimes referred to as double taxation.
5. Explain the difference between an S corporation and a C corporation.
Ans: Corporations fall into two categories: C corporations and S corporations. A C corporation is
subject to double taxation. Its earnings are taxed first at the corporate level when earned, then
again at the shareholder level when distributed as dividends. An S corporation, by contrast, is
subject to single-level taxation, much like a partnership. Its earnings are accounted for at the
corporate level but are taxed only at the shareholder level.

6. Chapter 2
The following is provided for use in answering the next set of questions. You may also find table
2.5 on page 53 of your text and all questions on pages 5657.
TABLE 2.5 20092013 Financial Statement Data and Stock Price Data for Mydeco Corp.
Mydeco Corp. 20092013
Income Statement
Revenue

(All data as of fiscal year end; in $ million)

2009
2010
2011
2012
2013
404.3
363.8
424.6
510.7
604.1

Cost of Goods Sold

(188.3)

(173.8)

(206.2)

(246.8)

(293.4)

Gross Profit
Sales and Marketing

216.0

190.0

218.4

263.9

310.7

(66.7)

(66.4)

(82.8)

(102.1)

(120.8)

(60.6)

(59.1)

(59.4)

(66.4)

(78.5)

(27.3)

(27.0)

(34.3)

(38.4)

(38.6)

61.4

37.5

41.9

57.0

72.8

(33.7)

(32.9)

(32.2)

(37.4)

(39.4)

27.7

4.6

9.7

19.6

33.4

(9.7)

(1.6)

(3.4)

(6.9)

(11.7)

18.0

3.0

6.3

12.7

21.7

55.0

55.0

55.0

55.0

55.0

$0.33

$0.05

$0.11

$0.23

$0.39

2009

2010

2011

2012

2013

48.8

68.9

86.3

77.5

85.0

88.6

69.8

69.8

76.9

86.1

33.7

30.9

28.4

31.7

35.3

171.1

169.6

184.5

186.1

206.4

Administration
Depreciation and Amortization
EBIT
Interest Income (Expense)
Pretax Income
Income Tax
Net Income
Shares outstanding (millions)
Earnings per share

Balance Sheet
Assets
Cash
Accounts Receivable
Inventory
Total Current Assets
Net Property, Plant, and Equip.

Mydeco Corp. 20092013

Goodwill and Intangibles

(All data as of fiscal year end; in $ million)

245.3
169.6
309
345.6
347.0
361.7

243.3

361.7

361.7

361.7

778.1

774.6

855.2

893.4

915.1

18.7

17.9

22.0

26.8

31.7

6.7

6.4

7.0

8.1

9.7

Total Current Liabilities

Long-term Debt

25.4

24.3

29.0

34.9

41.4

500.0

500.0

575.0

600.0

600.0

Total Liabilities
Stockholders Equity

525.4

524.3

604.0

634.9

641.4

252.7

250.3

251.2

258.5

273.7

Total Liabilities and Stockholders Equity 778.1

774.6

855.2

893.4

915.1

Total Assets
Liabilities and Stockholders Equity
Accounts Payable
Accrued Compensation

Statement of Cash Flows

Net Income

2009
18.0

2010
3.0

2011
6.3

2012
12.7

2013
21.7

Depreciation and Amortization

27.3

27.0

34.3

38.4

38.6

Chg. in Accounts Receivable

3.9

18.8

(0.0)

(7.1)

(9.2)

Chg. in Inventory

(2.9)

2.8

2.5

(3.3)

(3.6)

Chg. in Payables and Accrued Comp.

2.2

(1.1)

4.7

5.9

6.5

Cash from Operations

Capital Expenditures

48.5

50.5

47.8

46.6

54.0

(25.0)

(25.0)

(100.0)

(75.0)

(40.0)

Cash from Investing Activities

Dividends Paid

(25.0)

(25.0)

(100.0)

(75.0)

(40.0)

(5.4)

(5.4)

(5.4)

(5.4)

(6.5)

75.0

25.0

(5.4)

(5.4)

69.6

19.6

(6.5)

Sale (or purchase) of stock

Debt Issuance (Pay Down)
Cash from Financing Activities

Mydeco Corp. 20092013

(All data as of fiscal year end; in $ million)

Change in Cash

18.1

20.1

17.4

(8.8)

7.5

Mydeco Stock Price

$7.92

$3.30

$5.25

$8.71

$10.89

29. In fiscal year 2011, Starbucks Corporation (SBUX) had revenue of $11.70 billion, gross
profit of $6.75 billion, and net income of $1.25 billion. Peets Coffee and Tea (PEET) had
revenue of $372 million, gross profit of $72.7 million, and net income of $17.8 million.

a. Compare the gross margins for Starbucks and Peets.

b. Compare the net profit margins for Starbucks and Peets.

c. Which firm was more profitable in 2011?

Answer:
a) Starbucks Corporation SBUX:
Gross margin = Gross profit/Sales
=$6,750,000,000/$11,700,000,000
=57.69%
PEET: Gross margin = Gross profit/Sales
=$72,700,000/$372,000,000
=19.54%
b) SBUX: Net profit margin = Net income/Sales = $1,250,000,000/$11,700,000,000
=10.68%
PEET: Net profit margin = Net income/Sales
=$17,800,000/$372,000,000
=4.78%

c) In 2011, SBUX was more profitable compared to PEET because the net margin is higher for
SBUX when compared to PEET. In fact, SBUX has higher gross and net profit margin than
PEET.
31. See Table 2.5 showing financial statement data and stock price data for Mydeco Corp.

a. How did Mydecos accounts receivable days change over this period?

b. How did Mydecos inventory days change over this period?

c. Based on your analysis, has Mydeco improved its management of its working
capital during this time period?

a.

Accounts
Receivable Period

b. Inventory days

c.

Working Capital

2013

2012

2011

2010

2009

(Average Accounts
Receivable*365)/Sales

52.02

54.96

60.00

70.03

79.98

Sales

604.10

510.70

424.60

363.80

404.3

Average Accounts
Receivable

86.10

76.90

69.80

69.80

88.6

(Average
Inventory*365/Sales)

43.91

46.88

50.27

64.89

65.32

Cost of Goods Sold

293.4

246.8

206.2

173.8

188.3

Average Inventory

35.3

31.7

28.4

30.9

33.7

(Current assets - Current

Liability)

165

151.2

155.5

145.3

145.7

Current Assets

206.4

186.1

184.5

169.6

171.1

Current Liability

41.4

34.9

29

24.3

25.4

Answer:
a) The accounts receivable period has decreased year from 2009 to 2013 and so it means that it is
taking the company fewer days to collect its accounts receivable. This is a positive sign for the
company.
b) There is a decrease in inventory days from 2009 to 2013 which means company is efficiently
converting its inventory into sales and cash.
c) The working capital of the company has increased over the last five years which is a positive
sign. Company is better able to meet its current obligations.
32. See Table 2.5 showing financial statement data and stock price data for Mydeco Corp.

a. Compare Mydecos accounts payable days in 2009 and 2013.

b. Did this change in accounts payable days improve or worsen Mydecos cash

position in 2013?
Answer:
a. 2009 Account Payable Days = 18.7 /( 188.3/365) = 36.2
2013 Account Payable Days = 31.7/(293.4/365) = 39.4
b. Accounts payable days increased from 2009 to 2013 which shows that the cash position
of Mydeco has improved over the same period.
33. See Table 2.5 showing financial statement data and stock price data for Mydeco Corp.

a. By how much did Mydeco increase its debt from 2009 to 2013?

b. What was Mydecos EBITDA/Interest coverage ratio in 2009 and 2013? Did its
coverage ratio ever fall below 2?

c. Overall, did Mydecos ability to meet its interest payments improve or decline
over this period?

Answer:
a. Mydeco increase its debt from $ 500 M in 2009 to $ 600 M in 2013. The increase is by $
100 M.

b. 2009 EBITDA/interest Coverage ratio =

= (61.4 + 27.3) / 33.7 = 2.64

2013 EBITDA/interest Coverage ratio =

(72.8 + 38.6) / 39.4 = 2.83

Mydecos EBITDA/interest Coverage ratio fell below 2 in the year 2010 when it was 1.96.

c.

Overall, Mydecos ability to meet its interest payments improved over this period. There
was a dip in the year 2010.

42. For fiscal year 2011, Starbucks Corporation (SBUX) had total revenues of $11.70
billion, net income of $1.25 billion, total assets of $7.36 billion, and total shareholders
equity of $4.38 billion.

a. Calculate the Starbucks ROE directly, and using the DuPont Identity.

b. Comparing with the data for Peets in Problem 41, use the DuPont Identity to
understand the difference between the two firms ROEs.

Answer:
a) Return on Equity Starbucks:
= (Net Income /Sales)*(Sales/ Assets)*(Assets/Equity)
= (1.25/11.7)*(11.7/7.36)*(7.36/4.38)
= 28.54%
b) Return on Equity of PEET:
= (Net Income /Sales)*(Sales / Assets)*(Assets/Equity)
=4.78%*1.73*1.21
= 10.01%
The difference in ROE is due to the profit margin of Starbucks Corporation being higher than
PEETs net profit margin. SBUX profit margin is 10.68% while PEETs is only 4.78%. Also,
Starbucks has a higher Assets/Equity ratio than PEETs.
References:
Berk, J., & DeMarzo, P. (2014). Corporate Finance. Boston, MA: Pearson.

Chapter 1: The Corporation

Chapter 2: Introduction to Financial Statement Analysis