Question 1

At year-end 2018, Marvel Company total assets were $4.5 million, and its accounts payable were $850,000. Sales, which in 2018 were $5.5 million, are expected to increase by 25% in 2019. Total assets and accounts payable are proportional to sales, and that relationship will be maintained. Marvel typically uses no current liabilities other than accounts payable. Common stock amounted to $ 2.25 million in 2018, and retained earnings were $150,000. Marvel has arranged to sell $25,000 of new common stock in 2019 to meet some of its financing needs. The remainder of its financing needs will be met by issuing new long-term debt at the end of 2019. (Because the debt is added at the end of the year, there will be no additional interest expense due to the new debt.) Its net profit margin on sales is 2.5%, and 55% of earnings will be paid out as dividends.

a. What were Marvel’s total long-term debt and total liabilities in 2018?

b. How much new long-term debt financing will be needed in 2019? (Hint: AFN – New stock = New long-term debt.)

Question 2

Suppose you decide (as did Steve Jobs and Mark Zuckerberg) to start a company.

Your product is a software platform that integrates a wide range of media devices, including laptop computers, desktop computers, digital video recorders, and cell phones. Your initial market is the student body at your university. Once you have established your company and set up procedures for operating it, you plan to expand to other colleges in the area and eventually to go nationwide. At some point, hopefully sooner rather than later, you plan to go public with an IPO and then to buy a yacht and take off for the South Pacific to indulge in your passion for underwater photography. With these issues in mind, you need to answer for yourself, and potential investors, the following questions.

What is an agency relationship? When you first begin operations, assuming you are the only employee and only your money is invested in the business, would any agency conflicts exist? Explain your answer.

If you expanded and hired additional people to help you, might that give rise to agency problems? Explain your answer

Suppose you need additional capital to expand, and you sell some stock to outside investors. If you maintain enough stock to control the company, what type of agency conflict might occur? 

Suppose your company raises funds from outside lenders. What type of agency costs might occur? How might lenders mitigate the agency costs?

1. Suppose your company is very successful, and you cash out most of your stock and turn the company over to an elected board of directors. Neither you nor any other stockholders own a controlling interest (this is the situation at most public companies). List six potential managerial behaviors that can harm a firm’s value.
2. What is corporate governance? List five corporate governance provisions that are internal to a firm and under its control. What characteristics of the board of directors usually lead to effective corporate governance?
3. List three provisions in the corporate charter that affect takeovers.
4. Briefly describe the use of stock options in a compensation plan. What are some potential problems with stock options as a form of compensation?
5. What is block ownership? How does it affect corporate governance?
6. Briefly explain how regulatory agencies and legal systems affect corporate governance.

 

Question 1

At year-end 2018, Marvel Company total assets were $4.5 million, and its accounts payable were $850,000. Sales, which in 2018 were $5.5 million, are expected to increase by 25% in 2019. Total assets and accounts payable are proportional to sales, and that relationship will be maintained. Marvel typically uses no current liabilities other than accounts payable. Common stock amounted to $ 2.25 million in 2018, and retained earnings were $150,000. Marvel has arranged to sell $25,000 of new common stock in 2019 to meet some of its financing needs. The remainder of its financing needs will be met by issuing new long-term debt at the end of 2019. (Because the debt is added at the end of the year, there will be no additional interest expense due to the new debt.) Its net profit margin on sales is 2.5%, and 55% of earnings will be paid out as dividends

Marvel Company

Marvel's total long-term debt in 2018 = $1,250,000

a2. Marvel's total liabilities = $2,100,000 ($850,000 +$1,250,000)

New long-term debt financing needed in 2019 = $810,156 Explanation:

a) Data and Calculations:

Year-end 2018:

Total assets = $4.5 million Accounts payable $850,000 Sales = $5.5 million

Common Stock = $2.25 million Retained Earnings = $150,000

Long-term debt = Total assets Minus (Accounts payable + Equity)

= $4,500,000 - ($850,000 + 2,250,000 + 150,000)

= $1,250,000

Year 2019:

Sales = $6,875,000 ($5.5 million * 1.25)

Net profit margin on sales = $171,875 (2.5% * $6,875,000) Dividends = 55% of earnings = $94,531 (55% * $171,875) Retained earnings for the year = $77,344

Retained earnings for 2018:                150,000 Retained earnings, 2019:      $227,344

Common Stock = $2,275,000 ($2,250,000 + $25,000) Total equity = $2,502,344 ($2,250,000 + 227,344)

Total assets = $5,625,000 ($4.5 million * 1.25) Accounts payable = $1,062,500 ($850,000 * 1.25)

Long-term debt = Total Assets - (Total equity + Accounts Payable)

= $5,625,000 - ($2,502,344 + 1,062,500)

= $2,060,156

Increase in long-term debt = $810,156 ($2,060,156 - $1,250,000)

 

Question 2

Suppose you decide (like Steve Jobs and Mark Zuckerberg did) to start a company. Your product is a software platform that integrates a wide range of media devices, including laptop computers, desktop computers, digital video recorders, and cell phones. Your initial market is the student body at your university. Once you have established your company and set up procedures for operating it, you plan to expand to other colleges in the area, and eventually to go nationwide. At some point, hopefully sooner rather than later, you plan to go public with an IPO, then to buy a yacht and take off for the South Pacific to indulge in your passion for underwater photography. With these issues in mind, you need to answer for yourself, and potential investors, the following questions.

 

What is an agency relationship? When you first begin operations, assuming you are the only employee and only your money is invested in the business, would any agency conflicts exist? Explain your answer.

 

The agent-principal connection is referred to as the agency relationship. The principal is the individual(s) who engage the agent's services. When I am the only employee and my money is invested in operations, there are NO agency conflicts since no other parties are engaged. A dispute between agent and principle is characterized as an agency conflict. There is currently no agent in the situation described above. I am the only party in this transaction.

 

If you expanded, and hired additional people to help you, might that give rise to agency problems?

Hiring new staff may set the path for future agency issues. In this scenario, the workers act as agents, while I act as the Principal. This results in the formation of an agency relationship. If there is a disagreement between the employee and I, it may result in agency conflicts.

Suppose you need additional capital to expand and you sell some stock to outside investors. If you maintain enough stock to control the company, what type of agency conflict might occur?

Several types of agency conflicts may arise under this situation, including those between shareholders and managers, investors and creditors, and shareholders, creditors, and management staff.

 

Suppose your company raises funds from outside lenders. What type of agency costs might occur? How might lenders mitigate the agency costs?

When obtaining money from external lenders, agency expenses associated with increased dividend payments to existing shareholders may possibly increase. The reason for this is that shareholders may object to the division of ownership of a company. This agency cost may be offset by compensating managers well and providing dividends to shareholders.

Suppose your company is very successful and you cash out most of your stock and turn the company over to an elected board of directors. Neither you nor any other stockholders own a controlling interest (this is the situation at most public companies). List six potential managerial behaviors that can harm a firm’s value.

The six management behaviors that may detract from a firm's value include the following:

 

1. Managers may lack the time and effort necessary to optimize the firm's worth. For instance, managers may spend more time on non-productive tasks for the business.
2. Managers' use of company resources (non-pecuniary advantages) for their personal profit rather than the interest of shareholders.
3. Managers avoiding tough and value-enhancing choices in order to avoid affecting their friends.
4. Managers may exaggerate their confidence and take on additional risks.
5. When a business has a positive free cash flow, management may decide to hoard it in the form of a marketable security.
6. Managers are prohibited from disclosing material information to shareholders.

 

The managers at KFS have heard that corporate governance can affect shareholder value. What is corporate governance? List five corporate governance provisions that are internal to a firm and are under its control.

Corporate governance refers to the procedures, methods, and relationships that regulate and steer companies. Corporate governance often reflects the interests of shareholders and establishes a path for achieving owners' goals. The five corporate governance principles are as follows:

1. Board of directors oversight and discipline
2. Provisions of the charter and by-laws that have an effect on the probability of a hostile takeover
3. Compensation scheme
4. Structure of capital and internal control systems
5. External environmental variables that are outside the control of a business 

What characteristics of the board of directors usually lead to effective corporate governance?

• The board of directors must be varied in composition and composed of people with distinct business skills.
• The board should not be too large in size.
• The CEO of the business should not be the chairman of the board of directors.
• Board members should be compensated fairly.

 

List three provisions in the corporate charter that affect takeovers.

• Targeted share repurchase: This is when a business offers to buy back a raider's shares at a higher price.
• The business acquires the shares from the raider, not the stockholders. This provision allows shareholders of a targeted company to purchase a certain number of shares at a discounted price.
• Restricted voting rights: When a shareholder holds more than the specified number of shares, his or her voting rights are immediately terminated.

 

Briefly describe the use of stock options in a compensation plan. What are some potential problems with stock options as a form of compensation?

Employers may utilize stock options as a form of remuneration for their workers. For instance, a business may offer shares to its workers at an exercise price as part of a compensation plan, referred to as an employee stock option plan (ESOP). A possible issue that may arise is the amount of pay paid to each employee. Another potential problem arises when ownership is diluted.

 

What is block ownership? How does it affect corporate governance?

When someone owns huge blocks of stock in a business, this is referred to as block ownership. Block ownership has a direct impact on company governance in two ways:

Investment firms want block ownership in order to exert influence over management. Controlling management implies that investors have the ability to exercise influence on corporate governance.

Activist investors with significant stakes in companies contribute significantly to good corporate governance. They look for businesses that have great potential but are in the red owing to poor performance. They appoint a new management team to take over the failing company. The new management team will be equipped with powerful management methods, enabling them to reorganize corporate governance rules.

 

Briefly explain how regulatory agencies and legal systems affect corporate governance.

A country with robust investor protection would have better corporate governance. In such a scenario, investors' interests will take precedence.

The regulatory bodies and legal system of a country determine the laws under which a business must operate. This will have a direct effect on the corporate governance rules.