The major difference between the profit maximization goal and the goal of shareholderwealth maximization is that the latter goal deals with all the complexities of theoperating environment, while the profit maximization goal does not. The major factorsassumed away by the profit maximization goal are uncertainty and the timing of thereturns.

(a) A sole proprietorship is a business owned by a single individual who maintainscomplete title to the assets, but who is also personally liable for all indebtednessincurred.(b) A partnership is an association of two or more individuals coming together asco-owners for the purpose of operating a business for profit. The partnership isequivalent to the sole proprietorship, except that the partnership has multipleowners.(c). A corporation is a legal entity functioning separate and apart from its owners.It can individually sue and be sued, purchase, sell, or own property, and besubject to criminal punishment for crimes.

(a) The sole proprietor maintains title to the firm's assets, has unlimited liability, isentitled to the profits from the business, but must also absorb any lossesrealized. This form of business is easily initiated. Termination of the businesscomes by the owner discontinuing the business or upon his death.

Sharpe Mfg. Company Balance Sheet

31-Dec-03 ASSETS Cash 96000 Accounts receivable 120000 Inventory 110000 Total current assets 326000 Machinery and equipment 700000 Accumulated depreciation -236000 Net fixed assets 464000 Total assets 790000 LIABILITIES & EQUITY Liabilities Current Liabilities Notes payable 100000 Accounts payable 90000 Total current liabilities 190000 Long-term debt 160000 Total liabilities 350000 Equity Common stock 320000 Retained earnings Prior year 100000 Current year 20,000 Total equity 440000 Total liabilities and equity 790000 Sharpe Mfg. Company

Income Statement For the Year Ended December 31, 2003 Sales 800000 Cost of goods sold 500000 Gross profits 300000 Operating expense 280000 Net income 20000

Delaney, Inc. - Corporate Income Tax Sales $4,000,000 Cost of goods sold and cash operating expenses 2,400,000 Depreciation expense 100,000 Operating profit $1,500,000

1,350,000 459000

Interest expense 150,000 Taxable Income $1,350,000 Tax Liability: $50,000 x 0.15 = $7,500 25,000 x 0.25 = 6,250 25,000 x 0.34 = 8,500 235,000 x 0.39 = 91,650 1,015,000 x 0.34 = 345,100

T.P. Jarmon had a successful year, generating an after-tax cash flow of $82,900. Toincrease cash flow further, noninterest-bearing debt increased by $8,000. Part of this

T.P. Jarmon Free cash flows from an asset perspective: Step 1: Compute after-tax cash flows from operations Earnings before taxes $ 70,000 Plus interest expense 10,000 EBIT 80,000 Depreciation 30,000 EBITDA $ 110,000 Tax expense $ 27,100 Less change in tax payable - Cash taxes 27,100 After-tax cash flows from operations $ 82,900 Step 2: Change in net operating working capital Change in current assets: Change in cash $ (1,000) Change in accounts receivable (9,000) Change in inventory 33,000 Change in prepaid rent (100) Change in marketable securities 200 Change in current assets $ 23,100 Change in noninterest-bearing current debt: Change in accounts payable $ 9,000 Change in accrued expenses (1,000) Change in noninterest-bearing current debt: $ 8,000 Change in net operating working capital $ (15,100) Step 3: Change in long-term assets Purchase of fixed assets $ 14,000 (Change in net fixed assets + depr. expense) Change in other assets - Net cash used for investments $ (14,000) Asset free cash flows $ 53,800 Free cash flows from a financing perspective: Interest paid to investors $(10,000) Less change in interest payable - Interest received by investors $ (10,000) Decrease in long-term debt (10,000) Decrease in notes payable (2,000) Common stock dividends (31,800) Financing free cash flows $ (53,800)

cash was consumed when current assets were increased by $23,100 (of whichinventory increased by $33,000). Fixed assets of $14,000 were also purchased. Thesubstantial part of the cash flow, however, was distributed back to the investors. Debtwas decreased, both long-term and short-term, by $12,000. Interest of $10,000 wasalso paid on this debt. Finally, investors were paid $31,800 in dividends.

= =

== = =

Current Ratio $1,800 $3,500 = 1.94X Debt Ratio = $8,000 $3,900 = .49 or 49% Times Interest Earned = $367 $1,500 = 4.09X Average Collection Period = 365 $7,500 $1,500 ¸ = 73 days Inventory Turnover $1,000 $3,000 = 3.0X Fixed Asset Turnover $4,500 $7,500 = 1.67X

Total Asset Turnover = Net Sales /Total Assets = $8,000 $7,500 = .94X

= .60 or 60%= .20 or 20% =.17 or 17%

2003 % of Sales 2004 Sales 12,000,000 15,000,000 Net Income 1,200,000 2,000,000 Current Assets 3,000,000 25% 3,750,000 Net fixed assets 6,000,000 50% 7,500,000 Total Assets 9,000,000 11,250,000 Liabilities and Owner's Equity Accounts payable 3,000,000 25% 3,750,000 Long-term debt 2,000,000 NA 2,000,000 Total Liabilities 5,000,000 5,750,000 Common stock 1,000,000 NA 1,000,000 Paid-in capital 1,800,000 NA 1,800,000 Retained earnings 1,200,000 3,200,000 Common equity 4,000,000 6,000,000 Total Liabilities and Equity 9,000,000 11,750,000

DFN = (500,000)

(a) $10,000 = IRR) 1(1 $2,000 + + IRR) 2(1 $5,000 + + IRR) 3(1 $8,000 + Try 18%: $10,000 = $2,000(0.847) + $5,000 (0.718) + $8,000 (0.609)

= $1,694 + $3,590 + $4,872 = $10,156

Try 19% $10,000 = $2,000 (0.840) + $5,000 (0.706) + $8,000 (0.593)

= $1,680 + $3,530 + $4,744 = $9,954

Thus, IRR = approximately 19% (b) $10,000 = IRR) 1(1 $8,000 + IRR) 2(1 $5,000 + IRR) 3(1 $2,000

Try 30% $10,000 = $8,000 (0.769) + $5,000 (0.592) + $2,000 (0.455)

= $6,152 + $2,960 + $910 = $10,022

Try 31%: $10,000 = $8,000 (0.763) + $5,000 (0.583) + $2,000 (0.445)

= $6,104 + $2,915 + $890 = $9,909

Thus, IRR = approximately 30%

(c) $10,000 = 5 1t å = IRR) (1 $2,000 + t IRR )6(1 $5,000 + Try 11% $10,000 = = $2,000 (3.696) + $5,000 (0.535) $7,392 + $2,675

= $10,067 Try 12% $10,000 = = $2,000 (3.605) + $5,000 (0.507) $7,210 + $2,535

= $9,745 Thus, IRR = approximately 11%

(a) Project A: Payback Period = 2 years + $100/$200 = 2.5 years Project A: Discounted Payback Period Calculations:

Cumulative Undiscounted Discounted Discounted Year Cash Flows PVIF10%,n Cash Flows Cash Flows

0 -$1,000 1.000 -$1,000 -$1,000 1 600 .909 545 -455 2 300 .826 248 -207 3 200 .751 150 -57 4 100 .683 68 11 5 500 .621 311 322

Discounted Payback Period = 3.0 + 57/68 = 3.84 years. Project B: Payback Period = 2 years + $2,000/$3,000 = 2.67 years Project B: Discounted Payback Period Calculations:

Cumulative Undiscounted Discounted Discounted

Year Cash Flows PVIF10%,n Cash Flows Cash Flows 0 -$10,000 1.000 -$10,000 -$10,000 1 5,000 .909 4,545 -5,455 2 3,000 .826 2,478 -2,977 3 3,000 .751 2,253 -724 4 3,000 .683 2,049 1,325 5 3,000 .621 1,863 3,188

Discounted Payback Period = 3.0 + 724/2,049 = 3.35 years. Project C: Payback Period = 3 years + $1,000/$2,000 = 3.5 years Project C: Discounted Payback Period Calculations:

Cumulative Undiscounted Discounted Discounted

Year Cash Flows PVIF10%,n Cash Flows Cash Flows 0 -$5,000 1.000 -$5,000 -$5,000 1 1,000 .909 909 -4,091 2 1,000 .826 826 -3,265

3 2,000 .751 1,502 -1,763 4 2,000 .683 1,366 -397 5 2,000 .621 1,242 845

Discounted Payback Period = 4.0 + 397/1,242 = 4.32 years. Project Traditional Payback Discounted Payback A Accept Reject B Accept Reject C Reject Reject

(a) Tax payments associated with the sale for $35,000 Recapture of depreciation = ($35,000-$15,000) (0.34) = $6,800

(b) Tax payments associated with sale for $25,000 Recapture of depreciation = ($25,000-$15,000) (0.34) = $3,400

(c) No taxes, because the machine would have been sold for its book value. (d) Tax savings from sale below book value: Tax savings = ($15,000-$12,000) (0.34) = $1,020

(a) 0.98 0.02 x 20 / 360 1 = 0.36734 or 36.73% (b) 0.97 0.03 x 15 / 360 1 = 0.74226 or 74.23% (c) 0.97 0.03 x 30 / 360 1 = 0.37113 or 37.11% (d) 0.98 0.02 x 45 / 360 1 = 0.16327 or 16.33%

(a) Interest = .14 x $100,000 = $14,000

Ther efore, the effective rate of interest on the lo APR = 14,000 $100 ,000 $14,000 - x = .1628 or 16.28%

Deal er Financing Alternative APR = $100 ,000 $16 ,300 x 360 / 360 1 = .163 or 16.3%

Analysis. The costs of the two sources of financing are identical for practical purposes. The final choice can now be made based upon other nonquantitative factors. For example, the firm may find that using dealer financing is less time consuming and allows the firm to leave its credit line within the bank unchanged. Since bank credit can be used for a much wider array of financing needs than dealer financing, R. Morin would find that using dealer financing leaves the firm with greater flexibility in raising funds for its future needs.

(b) If the compensating balance becomes binding, then the effective rate on the bank loan alternative will be Interest = .14 x $100,000 = $14,000 Compensating Balance = .15 x $100,000 = $15,000 APR = 15,000 14,000 $100 ,000 $14,000 -- x = .197 or 19.7% Thus, where the 15 percent compensating balance requirement is binding on R. Morin, the cost of the bank loan rises to 19.7 percent. In this case, dealer financing is clearly less costly. Note that equipment dealers will frequently price their merchandise so as to compensate them for offering "below market" rates of interest for financing. This may well be the case here such that R. Morin should use the dealer financing unless it can negotiate a price concession equal to the value of "bargain financing."

an is calculated as follows: 360 / 360 1

(b) If the compensating balance becomes binding, then the effective rate on the bank loan alternative will be

Step 1: Estimate the Change in Profit. = ($1,000,000 x .20) - ($1,000,000 x .08) = $200,000 - $80,000 = $120,000 Step 2: Estimate the cost of additional investment in accounts receivable and inventory.

Estimate the additional investment in accounts receivable: = ($6,000,000 / 360) x 90 - ($5,000,000 / 360) x 60

= $1,500,000 - $833,333 = $666,667

Additional accounts receivable and inventory times the required rate of return: = ($666,667 + $50,000) .15 = $107,500 Step 3: Estimate the change in the cost of the cash discount

= $0 (no change) Step 4: Compare incremental revenues with incremental costs. = Step 1 - (Step 2 + Step 3) = $120,000 - $107,500 = $12,500 The policy can be adopted.

accounts

(a) Q* = C 2SO = 2(500 ,000 )90 .40 = 15,000 Units

(b) (c) (d)

15,000 500 ,000 = 33 1/3 orders per year Inventory order point = delivery time stock + safety stock = 50 1 x 500,000 + 15,000 = 10,000 + 15,000 = 25,000 units Average inventory = 2 EOQ + safety time stock = 2 15,000 + 15,000 = 7,500 + 15,000 = 22,500 units