An Overview of Financial Management and the Financial Environment: Forms of Business Organization
The basic concepts of financial management are the same for all businesses, regardless of how they are organized. However, a firm’s legal structure affects its operations. The main forms of business organizations are: (1) proprietorships, (2) partnerships, (3) corporations, and (4) limited liability companies (LLCs) and limited liability partnerships (LLPs). In terms of numbers, most businesses are . However, based on the dollar value of sales, most business is done by . Businesses are frequently started as and then converted to when their growth results in disadvantages outweighing advantages.
A proprietorship has three important advantages: (1) It is easily and inexpensively formed, (2) it is subject to government regulations, and (3) it is subject to lower income taxes than are . However, a proprietorship also has three important limitations: (1) A proprietor has personal liability for the business’ debts. (2) The life of the business is limited to the life of the individual who created it. (3) A proprietorship has difficulty obtaining large sums of capital so proprietorships are used primarily for small businesses.
A partnership has two important advantages: (1) It is easily and inexpensively formed and (2) its income is allocated on a pro rata basis to partners and taxed on a(n) basis so the partnership avoids higher income taxes. A partnership has four important disadvantages: (1) personal liability, (2) life, (3) difficulty of transferring ownership, and (4) difficulty of raising large amounts of capital.
A corporation has the following advantages: (1) life, (2) ownership that is easily transferred through the exchange of stock, (3) liability, and (4) can raise large amounts of capital to operate large businesses. Its disadvantages are: (1) Corporate earnings may be subject to taxation and (2) setting up a corporation and filing required state and federal reports, which is more complex and time-consuming. Large corporations are known as C corporations. However, as an aid to small businesses Congress created S corporations.
Limited liability companies (LLCs) and limited liability partnerships (LLPs) have limited liability protection like but are taxed like . Investors in an LLC or LLP have votes in proportion to their ownership interest. LLCs and LLPs have been gaining in popularity, but large companies still find it advantageous to be corporations because of advantages in raising capital for growth.
2, Statement of Retained Earnings
In its most recent financial statements, Del-Castillo Inc. reported $35 million of net income and $820 million of retained earnings. The previous retained earnings were $800 million. How much in dividends did the firm pay to shareholders during the year? Enter your answer in dollars. For example, an answer of $1.2 million should be entered as 1,200,000. Round your answer to the nearest dollar.
$
3,
Corporate Tax Liability
The Talley Corporation had taxable operating income of $345,000 (i.e., earnings from operating revenues minus all operating costs). Talley also had (1) interest charges of $70,000, (2) dividends received of $20,000, and (3) dividends paid of $35,000. Its federal tax rate was 21% (ignore any possible state corporate taxes). Recall that 50% of dividends received are tax exempt.
What is the firm’s taxable income? Round your answer to the nearest dollar.
$
What is the tax expense? Round your answers to the nearest dollar.
$
What is the after-tax income? Round your answers to the nearest dollar.
$
4,
Corporate Tax Liability
The Wendt Corporation reported $40 million of taxable income. Its federal tax rate was 21% (ignore any possible state corporate taxes).
What is the company’s federal income tax bill for the year? Enter your answer in dollars. For example, an answer of $1.2 million should be entered as 1,200,000. Round your answer to the nearest dollar.
$
Assume the firm receives an additional $2 million of interest income from some bonds it owns. What is the additional tax on this interest income? Enter your answer in dollars. For example, an answer of $1.2 million should be entered as 1,200,000. Round your answer to the nearest dollar.
$
Now assume that Wendt does not receive the interest income but does receive an additional $2 million as dividends on some stock it owns. Recall that 50% of dividends received are tax exempt. What is the additional tax on this dividend income? Enter your answer in dollars. For example, an answer of $1.2 million should be entered as 1,200,000. Round your answer to the nearest dollar.
$
5,
Free Cash Flows
Rhodes Corporation’s financial statements are shown below.
Rhodes Corporation: Income Statements for Year Ending December 31
(Millions of Dollars)
2020 2019
Sales $ 13,000 $ 11,000
Operating costs excluding depreciation 11,590 9,748
Depreciation and amortization 350 320
Earnings before interest and taxes $ 1,060 $ 932
Less interest 220 200
Pre-tax income $ 840 $ 732
Taxes (25%) 210 183
Net income available to common stockholders $ 630 $ 549
Common dividends $ 204 $ 200
Rhodes Corporation: Balance Sheets as of December 31 (Millions of Dollars)
2020 2019
Assets
Cash $ 650 $ 600
Short-term investments 220 200
Accounts receivable 2,750 2,500
Inventories 1,450 1,400
Total current assets $ 5,070 $ 4,700
Net plant and equipment 3,750 3,500
Total assets $ 8,820 $ 8,200
Liabilities and Equity
Accounts payable $ 1,300 $ 1,200
Accruals 650 600
Notes payable 184 100
Total current liabilities $ 2,134 $ 1,900
Long-term debt 1,300 1,200
Total liabilities $ 3,434 3,100
Common stock 3,960 4,100
Retained earnings 1,426 1,000
Total common equity $ 5,386 $ 5,100
Total liabilities and equity $ 8,820 $ 8,200
Suppose the federal-plus-state tax corporate tax is 25%. Answer the following questions.
What is the net operating profit after taxes (NOPAT) for 2020? Enter your answer in millions. For example, an answer of $1 million should be entered as 1, not 1,000,000. Round your answer to the nearest whole number.
$ million
What are the amounts of net operating working capital for both years? Enter your answers in millions. For example, an answer of $1 million should be entered as 1, not 1,000,000. Round your answers to the nearest whole number.
2020: $ million
2019: $ million
What are the amounts of total net operating capital for both years? Enter your answers in millions. For example, an answer of $1 million should be entered as 1, not 1,000,000. Round your answers to the nearest whole number.
2020: $ million
2019: $ million
What is the free cash flow for 2020? Enter your answer in millions. For example, an answer of $1 million should be entered as 1, not 1,000,000. Cash outflow, if any, should be indicated by a minus sign. Round your answer to the nearest whole number.
$ million
What is the ROIC for 2020? Round your answer to two decimal places.
%
How much of the FCF did Rhodes use for each of the following purposes: after-tax interest, net debt repayments, dividends, net stock repurchases, and net purchases of short-term investments? (Hint: Remember that a net use can be negative.) Enter your answers in millions. For example, an answer of $1 million should be entered as 1, not 1,000,000. Round your answers to the nearest whole number.
After-tax interest payment $ million
Reduction (increase) in debt $ million
Payment of dividends $ million
Repurchase (Issue) stock $ million
Purchase (Sale) of short-term investments $ million