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1©2014PearsonEducation,Inc.Chapter1TheCorporation1-1.Whatisthemostimportantdifferencebetweenacorporationandallotherorganizationalforms?Acorporationisalegalentityseparatefromitsowners.1-2.Whatdoesthephraselimitedliabilitymeaninacorporatecontext?Owners’liabilityislimitedtotheamounttheyinvestedinthefirm.Stockholdersarenotresponsibleforanyencumbrancesofthefirm;inparticular,theycannotberequiredtopaybackanydebtsincurredbythefirm.1-3.Whichorganizationalformsgivetheirownerslimitedliability?Corporationsandlimitedliabilitycompaniesgiveownerslimitedliability.Limitedpartnershipsprovidelimitedliabilityforthelimitedpartners,butnotforthegeneralpartners.1-4.Whatarethemainadvantagesanddisadvantagesoforganizingafirmasacorporation?Advantages:Limitedliability,liquidity,infinitelifeDisadvantages:Doubletaxation,separationofownershipandcontrol1-5.ExplainthedifferencebetweenanScorporationandaCcorporation.Ccorporationsmustpaycorporateincometaxes;Scorporationsdonotpaycorporatetaxes,butmustpassthroughtheincometoshareholderstowhomitistaxable.Scorporationsarealsolimitedto75shareholdersandcannothavecorporateorforeignstockholders.1-6.YouareashareholderinaCcorporation.Thecorporationearns$2persharebeforetaxes.Onceithaspaidtaxesitwilldistributetherestofitsearningstoyouasadividend.Thecorporatetaxrateis40%andthepersonaltaxrateon(bothdividendandnon-dividend)incomeis30%.Howmuchisleftforyouafteralltaxesarepaid?First,thecorporationpaysthetaxes.Aftertaxes,$2(10.4)$1.20´-=islefttopaydividends.Oncethedividendispaid,personaltaxmustbepaid,whichleaves$1.20(10.3)$0.84´-=.So,afterallthetaxesarepaid,youareleftwith84¢.1-7.RepeatProblem6assumingthecorporationisanScorporation.AnScorporationdoesnotpaycorporateincometax.Soitdistributes$2toitsstockholders.Thesestockholdersmustthenpaypersonalincometaxonthedistribution.Sotheyareleftwith$2(10.3)$1.40´-=.2Berk/DeMarzo,CorporateFinance,ThirdEdition©2014PearsonEducation,Inc.1-8.Youhavedecidedtoformanewstart-upcompanydevelopingapplicationsfortheiPhone.Giveexamplesofthethreedistincttypesoffinancialdecisionsyouwillneedtomake.AsthemanagerofaniPhoneapplicationsdeveloper,youwillmakethreetypesoffinancialdecisions.i.YouwillmakeinvestmentdecisionssuchasdeterminingwhichtypeofiPhoneapplicationprojectswillofferyourcompanyapositiveNPVandthatyourcompany,therefore,shoulddevelop.ii.YouwillmakethedecisiononhowtofundyouriPhoneapplicationinvestmentsandwhatmixofdebtandequityyourcompanywillhave.iii.Youwillberesponsibleforthecashmanagementofyourcompany,ensuringthatyourcompanyhasthenecessaryfundstomakeinvestments,payinterestonloans,andpayyouremployees.1-9.Whenapharmaceuticalcompanydevelopsanewdrug,itoftenreceivespatentprotectionforthatmedication,allowingittochargeahigherprice.Explainhowthispublicpolicyofprovidingpatentprotectionmighthelpalignthecorporation’sinterestswithsociety’sinterests.Withoutpatentprotection,thedeveloperofthedrugwouldbeforcedtolowerpricestocompetewithgenericmanufacturers.Becausethispricecompetitionwouldlowerexpectedfutureprofits,thedeveloperwouldbewillingtospendmuchlessinR&Dtodevelopthedruginitially,anddruginnovationwouldbecurtailed.Alternatively,byallowingthedrug’sdevelopertoearnhigherprofitsthatarecommensuratewiththevalueofthedrugtosociety,drugdeveloperswillfinditintheirbestintereststospendmoreonR&D,anddruginnovationisenhanced.Thus,patentprotectioncanalignthecorporation’sandsociety’sinterestsandprovideformoreefficientspendingondrugR&D.1-10.Corporatemanagersworkfortheownersofthecorporation.Consequently,theyshouldmakedecisionsthatareintheinterestsoftheowners,ratherthantheirown.Whatstrategiesareavailabletoshareholderstohelpensurethatmanagersaremotivatedtoactthisway?Shareholderscandothefollowing.i.Ensurethatemployeesarepaidwithcompanystockand/orstockoptions.ii.Ensurethatunderperformingmanagersarefired.iii.Writecontractsthatensurethattheinterestsofthemanagersandshareholdersarecloselyaligned.iv.Mounthostiletakeovers.1-11.Supposeyouareconsideringrentinganapartment.You,therenter,canbeviewedasanagentwhilethecompanythatownstheapartmentcanbeviewedastheprincipal.Whatprincipal-agentconflictsdoyouanticipate?Supposeinsteadthatyouworkfortheapartmentcompany.Whatfeatureswouldyouputintotheleaseagreementthatwouldgivetherenterincentivestotakegoodcareoftheapartment?Theagent(renter)willnottakethesamecareoftheapartmentastheprincipal(owner),becausetherenterdoesnotshareinthecostsofrepairingdamagetotheapartment.Tomitigatethisproblem,havingtherenterpayadepositshouldmotivatetherentertokeepdamagestoaminimum.Thedepositforcestherentertoshareinthecostsofrepairinganyproblemsthattheycause.1-12.YouaretheCEOofacompanyandyouareconsideringenteringintoanagreementtohaveyourcompanybuyanothercompany.Youthinkthepricemightbetoohigh,butyouwillbetheCEOofthecombined,muchlarger,company.Youknowthatwhenthecompanygetsbigger,yourpayandprestigewillincrease.Whatisthenatureoftheagencyconflicthereandhowisitrelatedtoethicalconsiderations?ThereisanethicaldilemmawhentheCEOofafirmhastheoppositeincentivestothoseoftheshareholders.Inthiscase,you(astheCEO)haveanincentivetopotentia