Copyright 2016 McGraw-Hill Ryerson Limited

1-1 Copyright © 2016 McGraw-Hill Ryerson Limited Brealey 6CE Solutions to Chapter 1

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executive airplanes brand names financial stocks investment capital budgeting financing

• A firm might cut its labour force dramatically which could reduce immediate expenses

and increase profits in the short term. Over the long term, however, the firm might not be able to serve its customers properly or it might alienate its remaining workers; if so, future profits will decrease, and the stock price will decrease in anticipation of these problems.

Similarly, a firm can boost profits over the short term by using less costly materials even if this reduces the quality of the product. Once customers catch on, sales will decrease and profits will fall in the future. The stock price will fall.

The moral of these examples is that, because stock prices reflect present and future profitability, the firm should not necessarily sacrifice future prospects for short-term gains.

• The key advantage of separating ownership and management in a large corporation

is that it gives the corporation permanence. The corporation continues to exist if managers are replaced or if stockholders sell their ownership interests to other investors. The corporation’s permanence is an essential characteristic in allowing corporations to obtain the large amounts of financing required by many business entities.

Both public and private corporations are distinct legal entities, separate from its owners (ie., its shareholders). The key difference between public and private corporations is the rules governing the sale of their common shares. The common shares of a public corporation are listed for trading on a stock exchange and investors can freely buy and sell the corporation’s shares at the current stock price.The common shares of a private corporations are not listed for trading on a stock exchange. Shareholders of private corporations must negotiate directly with (Fundamentals of Corporate Finance, 6th Canadian Edition 6e Brealey Richard ,Myers Stewart, Marcus Alan, Maynes Elizabeth, Mitra Devashis) (Solution Manual, For Complete File, Download link at the end of this File) 1 / 4

1-2 Copyright © 2016 McGraw-Hill Ryerson Limited potential buyers and are subject to resale restrictions.

You can learn to identify the risks associated with investing in private companies

by going to Ontario Securities Commission's website at:

http://www.osc.gov.on.ca/en/Investors_cbyi_index.htm

• A sole proprietorship is easy to set up with a minimum of legal work. The business

itself is not taxed. For tax purposes, the income of the proprietorship is treated as the income of the proprietor. The main disadvantages of a proprietorship are the proprietor’s unlimited liability for the debts of the firm, and difficulty in raising large amounts of financing as the business grows.

A partnership has the same tax advantage as the proprietorship. The partnership per se does not pay taxes. The partnership files a tax return, but all of the partnership income is allocated to the partners and treated as personal income. Also, it is fairly easy to set up a partnership. Because there can be many partners, a partnership can raise capital more easily than a proprietorship. However, like sole proprietors, partners have unlimited liability for the debts of the firm. In fact, each partner has unlimited liability for all the business’s debts, not just his or her share.

Corporate organization has the advantage of limited liability. Its owners, the shareholders, are not personally responsible for the debts of the corporation. It also allows for separation of ownership and management, since shares in the firm can be traded without changing management. A public corporation has the added advantage of easier access to equity financing because its shares are traded in public stock markets. The major disadvantage of corporate organization is the double taxation of income. Corporations pay taxes on their income, and that income is taxed again when it is passed through to shareholders in the form of dividends. Another disadvantage of corporate organization is the extra time and cost required in order to manage a corporation’s legal affairs. These costs arise because the corporation must be chartered and is considered a distinct legal entity. Such administrative costs are significant only for small corporations, however. Furthermore, public corporations must provide investors with detailed financial information in their annual reports and inform investors about significant events. Disclosure takes time and resources and may also be costly in the sense that competitor firms learn what is going on too.

LLP’s may be considered to be hybrid organizations to the extent that while individual partners have unlimited liability, they are not liable for the actions of their partners.

• Double taxation means that a corporation’s income is taxed first at the corporate tax

rate, and then, when the income is distributed to shareholders as dividends, the income is taxed again at the shareholder’s personal tax rate.

• a, c, d.

• On the website, www.td.com, the various businesses are listed in a table in the

middle of the page. Click a business, such as TD Canada Trust, and the main 2 / 4

1-3 Copyright © 2016 McGraw-Hill Ryerson Limited business activities appear in a box under the table. To work as an investment banker, you would work for TD Securities, listed under the heading “Wholesale Banking”. Clicking on “TD Securities” and then on “Learn more” takes you to a webpage, www.tdsecurities.com/tds/content/AU_AboutUs1?language=en_CA that

says:

With more than 3,500 people in 15 12 offices around the world, TD Securities provides a wide range of capital market products and services to corporate, government and institutional clients who choose us for our knowledge, innovation

and experience in the following key areas of finance:

• Investment and Corporate Banking • Capital Markets • Interest Rate, Currency and Derivative Products • Commodities Our services include the underwriting and distribution of new debt and equity issues, providing advice on strategic acquisitions and divestitures, and executing daily trading and investment needs.With our history of delivering results, we’ve developed considerable strengths, including recognized trading expertise and street- level market intelligence that we use to consistently create value for our clients.

To trade securities, join TD Asset Management,

http://www.tdassetmanagement.com/Content/Homepage/p_Homepage.asp, “a

highly diversified North American investment management firm with leading market positions in active, quantitative and passive portfolio management. The firm serves a large and diversified client base including pension funds, corporations, institutions, endowments, foundations and high net worth individuals. We also offer private money management services and manage retail mutual funds.” To work as retail investment advisor, join TD Waterhouse Private Client services,

http://www.tdwaterhouse.ca/pcs/pia/index.jsp

• Investment decision
• Financial asset
• Public corporation
• Corporation
• Treasurer
• The cost resulting from conflicts of interest between managers and shareholders

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1-4 Copyright © 2016 McGraw-Hill Ryerson Limited Introduction to corporate finance

• Financing decisions involve sources of capital used in the running of a firm.

Investment decisions, typically called capital budgeting, involve the uses of capital raised in the financing process.

• Investment decision
• Financing decision
• Investment decision
• Investment decision
• Investment decision

f. Financing decision: On the surface, this may appear similar to a dividend

decision, but in reality retiring debt is a change in capital structure and more closely aligned with a financing decision.

• a. Private corporation
• Partnership
• Public corporation
• Public corporation

• C. Ownership can be transferred without affecting operations and D. Managers

can be fired with no effect on ownership.

• The individual stockholders of a corporation (i.e., the owners) are legally distinct

from the corporation itself, which is a separate legal entity. Consequently, the stockholders are not personally liable for the debts of the corporation; the stockholders’ liability for the debts of the corporation is limited to the investment each stockholder has made in the shares of the corporation.

• A corporation might cut its labor force dramatically, which could reduce

immediate expenses and increase profits in the short term. Over the long term, however, the firm might not be able to serve its customers properly, or it might alienate its remaining workers; if so, future profits will decrease, and the stock price, and the market value of the firm, will decrease in anticipation of these problems. Similarly, a corporation can boost profits over the short term by using less costly materials even if this reduces the quality of the product. Once

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