Net Present Value and Net Income
1. What is the primary disadvantage of the corporate form of organization? Name at least two advantages of corporate organization.
The primary disadvantage of the corporate form is the double taxation to shareholders of distributed earnings and dividends. Some advantages include: limited liability, ease of transferability, ability to raise capital, and unlimited life.
2. Evaluate the following statement: Managers should not focus on the current stock value because doing so will lead to an overemphasis on short-term profits at the expense of long- term profits.
Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows, both short-term and long-term. If this is correct, then the statement is false.
3. Could a company’s cash flow to stockholders be negative in a given year? Explain how this might come about.
If a company raises more money from selling stock than it pays in dividends in a particular period its cash flow to stockholders will be negative. If a company borrows more than it pays in interest, its cash flow to creditors will be negative.
4. Jetson Spacecraft Corp. shows the following information on its 2009 income statement: sales $ 196,000; costs $ 104,000; other expenses $ 6,800; depreciation expense $ 9,100; interest expense $ 14,800; taxes $ 21,455; dividends $ 10,400. In addition, you’re told that the firm issued $ 5,700 in new equity during 2009 and redeemed $ 7,300 in outstanding long- term debt.
a. What is the 2009 operating cash flow?
b. What is the 2009 cash flow to creditors?
c. What is the 2009 cash flow to stockholders?
To find the OCF, we first calculate net income.
Income Statement Sales $196,000 Costs 104,000 Other expenses 6,800 Depreciation 9,100 EBIT $76,100 Interest 14,800 Taxable income $61,300 Taxes 21,455 Net income $39,845 Dividends