Question: ABC Company had addition to retained earnings for the current fiscal year just ended of $395,0

Question:

ABC Company had addition to retained earnings for the current fiscal year just ended of $395,000. The firm paid out $195,000 in cash dividend, and it has ending total equity of $5.3 million. The company currently has 170,000 shares of common stock outstanding. Please answer the following questions:

1. What are earnings per share (E/PS)?

2. Dividends per share?

3. Book value of share?

4. If the stock currently sells for $64 per share, what is the market-to-book ratio?

5. The price to earnings ratio (P/E)?

6. The company had sales of $5.15 million, what is the price to sales ratio (P/S)?

7. Finally, explain the implication of P/E ratio for different types of investors.

Note:

1. Need to write the assignment in APA 7th edition format.

2. Provide your explanations and definitions in detail and be precise.

3. Comment on your findings.

4. Provide references for content when necessary.

5. Provide your work in detail and explain in your own words.

6. Support your statements with peer-reviewed in-text citation(s) and reference(s).

7. Need to include the information from the textbook as the reference.

8. Need to include at least 2 peer-reviewed articles as the reference.

9. Need to provide examples whenever applicable.

10. Please find the related power point and textbook in the attachment.

11. Please find the Course Learning Outcome list of this course in the attachment

Textbook Information:

Ross, S. A., Westerfield, R. W., & Jordan, R. D. (2018). Fundamentals of corporate finance (12th ed.). McGraw-Hill

ISBN: 9781259918957

Introduction to Corporate Finance

Chapter 1

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1.1

Define the basic types of financial management decisions and the role of the financial manager

Explain the goal of financial management

Articulate the financial implications of the different forms of business organization

Explain the conflicts of interest that can arise between managers and owners

Key Concepts and Skills

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Corporate Finance and the Financial Manager

Forms of Business Organization

The Goal of Financial Management

The Agency Problem and Control of the Corporation

Financial Markets and the Corporation

Chapter Outline

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1.3

Some important questions that are answered using finance:

What long-term investments should the firm take on?

Where will we get the long-term financing to pay for the investment?

How will we manage the everyday financial activities of the firm?

Corporate Finance

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1.4

Section 1.1 (A)

Emphasize that “business finance” is just another name for “corporate finance” mentioned under the four basic types. Students often get confused by the terminology, especially when different terms are used to refer to the same thing.

Financial managers try to answer some or all of these questions.

The top financial manager within a firm is usually the Chief Financial Officer (CFO).

Other financial managers include:

Treasurer – oversees cash management, credit management, capital expenditures, and financial planning

Controller – oversees taxes, cost accounting, financial accounting and data processing

Financial Manager

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1.5

Section 1.1 (B)

Capital budgeting

What long-term investments or projects should the business take on?

Capital structure

How should we pay for our assets?

Should we use debt or equity?

Working capital management

How do we manage the day-to-day finances of the firm?

Financial Management Decisions

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1.6

Provide some examples of capital budgeting decisions: what product or service will the firm sell, should we replace old equipment with newer, more advanced equipment, etc.

Be sure to define debt and equity.

Provide some examples of working capital management: who should we sell to on credit, how much inventory should we carry, when should we pay our suppliers, etc.

Three major forms in the United States (See: Nolo)

Sole Proprietorship

Partnership

General

Limited

Corporation

Limited Liability Company

Forms of Business Organization

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1.7

Section 1.2

www.nolo.com provides a discussion about which form of business may be appropriate for an entrepreneur.

Advantages

Easiest to start

Least regulated

Single owner keeps all the profits

Taxed once as personal income

Disadvantages

Limited to life of owner

Equity capital limited to owner’s personal wealth

Unlimited liability

Difficult to sell ownership interest

Sole Proprietorship

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1.8

Section 1.2 (A)

With the new Tax Cuts and Jobs Act, up to 20 percent of business income may be exempt from taxation.

Advantages

Two or more owners

More capital available

Relatively easy to start

Income taxed once as personal income

Disadvantages

Unlimited liability

General partnership

Limited partnership

Partnership dissolves when one partner dies or wishes to sell

Difficult to transfer ownership

Partnership

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1.9

Section 1.2 (B)

Note that unlimited liability applies to all partners in a general partnership but only to the general partners in a limited partnership.

Written agreements are essential due to the unlimited liability.

Limited partners cannot be involved in the business or else they may be deemed as general partners.

Like sole proprietorships, with the new Tax Cuts and Jobs Act, up to 20 percent of business income may be exempt from taxation.

Advantages

Limited liability

Unlimited life

Separation of ownership and management

Transfer of ownership is easy

Easier to raise capital

Disadvantages

Double taxation (income taxed at the corporate rate and then dividends taxed at the personal rate)

Corporation

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1.10

Section 1.2 (C)

Discuss how separation of ownership and management can be both an advantage and a disadvantage:

Advantages

You can benefit from ownership in several different businesses (diversification)

You can take advantage of the expertise of others (comparative advantage)

Easier to transfer ownership

Disadvantage

Agency problems if management goals and owner goals are not aligned

A pertinent discussion is the implementation of Sarbanes-Oxley and the effect it has had. Although increased information flow is good for shareholders, it has come at a cost. In fact, some firms have chosen to “go dark,” while others have avoided going public altogether.

What should be the goal of a corporation?

Maximize profit?

Minimize costs?

Maximize market share?

Maximize the current value of the company’s stock?

Does this mean we should do anything and everything to maximize owner wealth?

Goal of Financial Management

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1.11

Section 1.3

Try to have the students discuss each of the goals above and the inherent problems of the first three goals:

Maximize profit – Are we talking about long-run or short-run profits? Do we mean accounting profits or some measure of cash flow?

Minimize costs – We can minimize costs today by not purchasing new equipment or delaying maintenance, but this may not be in the best interest of the firm or its owners.

Maximize market share – This was a strategy of many of the “dot.com” companies. They issued stock and then used it primarily for advertising to increase the number of “hits” to their web sites. Even though many of the companies had a huge market share, they still did not have positive earnings and their owners were not happy.

Maximize the current value of the company’s stock

There is no short run vs. long run here. The stock price should incorporate expectations about the future of the company and consider the trade-off between short-run profits and long-run profits.

The purpose of a for-profit business should be to make money for its owners. Maximizing the current stock price increases the wealth of the owners of the firm.

This is analogous to maximizing owners’ equity for firms that do not have publicly traded stock.

Non-profits can also follow the same principle, but their “owners” are the constituencies that they were created to help.

Also be sure to note that this goal is not specific to corporations, but is generally applied to any form of business, including not-for-profits.

Agency relationship

Principal hires an agent to represent his/her interests

Stockholders (principals) hire managers (agents) to run the company

Agency problem

Conflict of interest between principal and agent

The Agency Problem

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1.12

Section 1.4

A common example of an agency relationship is a real estate broker – in particular if you break it down between a buyer’s agent and a seller’s agent. A classic conflict of interest is when the agent is paid on commission, so they may be less willing to let the buyer know that a lower price might be accepted or they may elect to only show the buyer homes that are listed at the high end of the buyer’s price range.

Direct agency costs – the purchase of something by management that can’t be justified from a risk-return standpoint, and monitoring costs.

Indirect agency costs – management’s tendency to forgo risky or expensive projects that could be justified from a risk-return standpoint.

Managerial compensation

Incentives can be used to align management and stockholder interests.

The incentives need to be structured carefully to make sure that they achieve their goal.

Corporate control

The threat of a takeover may result in better management.

Other stakeholders

Managing Managers

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1.13

Section 1.4

Incentives – discuss how incentives must be carefully structured. For example, tying bonuses to profits might encourage management to pursue short-run profits and forego projects that require a large initial outlay. Stock options may work, but there may be an optimal level of insider ownership. Beyond that level, management may be in too much control and may not act in the best interest of all stockholders. The type of stock can also influence the effectiveness of the incentive. A relatively recent issue with the backdating of options also seems to run counter to the purpose of aligning incentives.

Corporate control – ask the students why the threat of a takeover might make managers work toward the goals of stockholders.

Other groups also have a financial stake in the firm. They can provide a valuable monitoring tool, but they can also try to force the firm to do things that are not in the owners’ best interests.

The Internet provides a wealth of information about individual companies.

One excellent site is Yahoo! Finance.

Go to the site, choose a company and see what information you can find!

Work the Web Example

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Section 1.5

1.14

Firm Cash Flows

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Section 1.5 (A)

Discuss the cash flows to and from the firm. The main point is that cash comes into the firm from the sale of debt and equity. The money is used to purchase assets. Those assets generate cash that is used to pay stakeholders, reinvest in additional assets, repay debtholders, and pay dividends to stockholders.

1.15

Cash flows to and from the firm

Primary vs. secondary markets

Dealer vs. auction markets

Listed vs. over-the-counter securities

NYSE

NASDAQ

Financial Markets

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1.16

Section 1.5 (B)

Students are often confused by the fact that the NASDAQ is an OTC market. Explain that the NASDAQ market site is just a convenient place for reporters to show how stocks are moving, but that trading does not actually take place there.

You may wish to note the evolution of these particular markets, e.g., moving to publicly traded firms, emergence of electronic trading, and increased industry consolidation.

www: Click on the NYSE and NASDAQ hyperlinks to go to their respective web sites

What are the three types of financial management decisions and what questions are they designed to answer?

What are the three major forms of business organization?

What is the goal of financial management?

What are agency problems and why do they exist within a corporation?

What is the difference between a primary market and a secondary market?

Quick Quiz

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Is it ethical for tobacco companies to sell a product that is known to be addictive and a danger to the health of the user? Is it relevant that the product is legal?

Should boards of directors consider only price when faced with a buyout offer?

Is it ethical to concentrate only on shareholder wealth, or should stakeholders as a whole be considered?

Should firms be penalized for attempting to improve returns by stifling competition (e.g., Microsoft)?

Ethics Issues

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1.18

These Ethics Issues can be addressed throughout the chapter or as a dedicated discussion as given here.

The second issue relates to the buyout offer for Gillette that was rejected due to information regarding the launch of the highly successful “Sensor” razor.

End of chapter

Chapter 1

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Financial Statements, Taxes, and Cash Flow

Chapter 2

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2.1

Describe the difference between accounting value (or “book” value) and market value

Describe the difference between accounting income and cash flow

Describe the difference between average and marginal tax rates

Determine a firm’s cash flow from its financial statements

Key Concepts and Skills

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The Balance Sheet

The Income Statement

Taxes

Cash Flow

Chapter Outline

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The balance sheet is a snapshot of the firm’s assets and liabilities at a given point in time.

Assets are listed in order of decreasing liquidity.

Ease of conversion to cash

Without significant loss of value

Balance Sheet Identity

Assets = Liabilities + Stockholders’ Equity

Balance Sheet

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2.4

Section 2.1

Liquidity is a very important concept. Students tend to remember the “convert to cash quickly” component of liquidity, but often forget the part about “without loss of value.” Remind them that we can convert anything to cash quickly if we are willing to lower the price enough, but that doesn’t mean it is liquid.

Also, point out that a firm can be TOO liquid. Excess cash holdings lead to overall lower returns.

The Balance Sheet Figure 2.1

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2.5

Section 2.1

The left-hand side lists the assets of the firm. Current assets are listed first because they are the most liquid. Fixed assets can include both tangible and intangible assets, and they are listed at the bottom because they generally are not very liquid. These are a direct result of management’s investment decisions. (Please emphasize that “investment decisions” are not limited to investments in financial assets.)

Note that the balance sheet does not list some very valuable assets, such as the people who work for the firm. The liabilities and equity (or ownership) components of the firm are listed on the right-hand side. This indicates how the assets are paid for. Since the balance sheet has to balance, total equity = total assets – total liabilities. The portion of equity that can most easily fluctuate to create this balance is retained earnings. The right-hand side of the balance sheet is a direct result of management’s financing decisions.

Remember that shareholders’ equity consists of several components and that total equity includes all of these components, not just the “common stock” item. In particular, remind students that retained earnings belong to the shareholders.

Net Working Capital

= Current Assets – Current Liabilities

Positive when the cash that will be received over the next 12 months exceeds the cash that will be paid out

Usually positive in a healthy firm

Liquidity

Ability to convert to cash quickly without a significant loss in value

Liquid firms are less likely to experience financial distress.

But liquid assets typically earn a lower return.

Trade-off to find balance between liquid and illiquid assets

Net Working Capital and Liquidity

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2.6

Section 2.1 (C)

After a basic accounting class, students may believe a higher current ratio (or, similarly, more cash on hand) is always better. So, it is good to remind students that a cash balance is a use of funds and has an opportunity cost.

U.S. Corporation Balance Sheet Table 2.1

To I/S

Back to Example

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2.7

Section 2.1 (E)

The first example computing cash flows has a link to the information in this table. The arrow in the corner is used to return you to the example.

Here is an example of a simplified balance sheet. Many students make it through business school without ever seeing an actual balance sheet, particularly those who are not majoring in finance or accounting. I encourage you to bring in some annual reports and let the students see the differences between the simplified statements they see in textbooks and the real thing.

This is a good place to talk about some of the specific types of items that show up on a balance sheet and remind the students what accounts receivable, accounts payable, notes payable, etc. are.

The embedded links are used to navigate through a later example.

The balance sheet provides the book value of the assets, liabilities, and equity.

Market value is the price at which the assets, liabilities, or equity can actually be bought or sold.

Market value and book value are often very different. Why?

Which is more important to the decision-making process?

Market Value vs. Book Value

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2.8

Section 2.1 (F)

Current assets and liabilities generally have book values and market values that are very close. This is not necessarily the case with the other assets, liabilities, and equity of the firm.

Assets are listed at historical costs less accumulated depreciation – this may bear little resemblance to what they could actually be sold for today. The balance sheet also does not include the value of many important assets, such as human capital. Consequently, the “Total Assets” line on the balance sheet is generally not a very good estimate of what the assets of the firm are actually worth.

Liabilities are listed at face value. When interest rates change or the risk of the firm changes, the value of those liabilities change in the market as well. This is especially true for longer-term liabilities.

Equity is the ownership interest in the firm. The market value of equity (stock price times number of shares) depends on the future growth prospects of the firm and on the market’s estimation of the current value of ALL of the assets of the firm.

The best estimate of the market value of the firm’s assets is market value of liabilities + market value of equity.

Market values are generally more important for the decision making process because they are more reflective of the cash flows that would occur today.

Example 2.2 Klingon Corporation

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2.9

Section 2.1 (F)

Shareholders are the ones that benefit from increases in the market value of a firm’s assets. They are also the ones that bear the losses of a decrease in market value. Consequently, managers need to consider the impact of their decisions on the market value of assets, not on their book value. Here is a good illustration:

Suppose that the MV of assets declined to $700 and the market value of long-term debt remained unchanged. What would happen to the market value of equity? It would decrease to 700 – 500 = 200.

The market-to-book ratio, which compares the market value of equity to the book value of equity, is often used by analysts as a measure of valuation for a stock. It is generally a bad sign if a company’s market-to-book ratio approaches 1.00 (meaning market value = book value) because of the GAAP employed in creating a balance sheet. It is definitely a bad sign if the ratio is less than 1.00.

GAAP does provide for some assets to be marked-to-market, primarily those assets for which current market values are readily available due to trading in liquid markets. However, it does not generally apply to long-term assets, where market values and book values are likely to differ the most.

The income statement is more like a video of the firm’s operations for a specified period of time.

You generally report revenues first and then deduct any expenses for the period.

Matching principle – GAAP says to show revenue when it accrues and match the expenses required to generate the revenue

Income Statement

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2.10

Section 2.2

Matching principle – this principle leads to non-cash deductions like depreciation. This is why net income is NOT a measure of the cash flow during the period.

Consider discussing that the top half of the income statement addresses investment decisions, whereas the bottom half deals with financing.

U.S. Corporation Income Statement – Table 2.2

To B/S

Back to Example

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2.11

Section 2.2

The first example computing cash flows has a link to the information in this table. The arrow in the corner is used to return you to the example.

Remember that these are simplified income statements for illustrative purposes.

Earnings before interest and taxes is often called operating income.

COGS would include both the fixed costs and the variable costs needed to generate the revenues.

Analysts often look at EBITDA (earnings before interest, taxes, depreciation, and amortization) as a measure of the operating cash flow of the firm. It is not true in the strictest sense because taxes are an operating cash flow as well, but it does provide a reasonable estimate for analysis purposes.

It is important to point out that depreciation expense is often figured two different ways, depending on the purpose of the financial statements. If we are computing the taxes that we will owe, we use the depreciation schedule provided by the IRS. In this instance, the “life” of the asset for depreciation purposes may be very different from the useful life of the asset. Statements that are prepared for investors often use straight-line depreciation because it will tend to have a lower depreciation charge than MACRS early in the asset’s life. This reduces the “expense,” and thus increases the firm’s reported EPS. This is a good illustration of why it is important to look at a firm’s cash flow and not just its EPS.

The embedded links are used to navigate through a later example.

Publicly traded companies must file regular reports with the Securities and Exchange Commission.

These reports are usually filed electronically and can be searched at the SEC public site called EDGAR.

Visit EDGAR to search for company filings.

Work the Web Example

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Section 2.2

2.12

The one thing we can rely on with taxes is that they are always changing.

In fact, the

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