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MGFB10H3 (6)
Lecture

# CDQ_C.2-3.docx

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School
University of Toronto Scarborough
Department
Finance
Course
MGFB10H3
Professor
Derek Chau
Semester
Summer

Description
1 Chapter 2 16. Janice borrowed \$100,000 from friends and family to start her company (a sole proprietorship). Recently, business has been poor, and Janice has decided to cease operations and liquidate the firm. She expects to obtain \$108,000 from selling the assets of the company. How much money will the debt-holders receive, and how much will be left for Janice? Would these figures be different if the company had been a corporation? Topic: Limited Liability (Types of Business Organizations) Level of difficulty: Difficult Solution: When operating as a sole proprietorship, all of the assets of the company belong to the owner; the company’s debts are also the owner’s debts. Janice will have to pay her friends and family (the debt-holders) the full \$100,000 they are owed. This will leave her with \$8,000. Acorporation exists independently from its owners. The \$108,000 obtained from selling the assets will first be used to pay the debt-holders what they are owed.Any remaining funds will be paid to Janice. Because the value of the assets is greater than the money owed to the debt-holders, the payments are the same as they were with the sole proprietorship. 17. Suppose Janice (see problem 16) only obtains \$93,000 when she sells all the assets of the firm. How much money would the debt-holders receive if the business were a corporation? If it were a sole proprietorship? How much would Janice receive in each case? Topic: Limited Liability (Types of Business Organizations) Level of difficulty: Difficult Solution: The debt-holders will receive the entire \$93,000 obtained from selling the assets. The remaining \$7,000 that they were owed will not be paid because the company has no more funds. Furthermore, the limited liability of shareholders in a corporation means that the debt- holders have no legal right to expect Janice to pay them the rest of the money. Nonetheless, Janice receives nothing from the asset sale. If the business were a sole proprietorship, the debt-holders would receive the \$93,000 from the sale of assets. However, they would also have the right to force Janice to pay them the extra \$7,000 they were owed. Janice would not only receive no money from the sale of the assets, she would have to pay the extra \$7,000! 2 18. When you hired Dan to manage your business, you agreed to pay him a bonus of 10 percent of profits at the end of each year. The company now has a choice between two projects (it can only take on one of them). ProjectAwill generate profits of \$50,000 per year, and the detailed financial calculations show that it will increase the value of the firm by \$123,100. Project B will generate profits of \$40,000 per year, but will increase the firm’s value by \$125,500. Which project is Dan likely to choose, and why? Which project would you, the owner of the firm, prefer? Topic:Agency Issues Level of difficulty: Difficult Solution: Dan is likely to prefer ProjectAbecause it will result in a \$5,000 annual bonus for him, whereas Project B would provide only a \$4,000 annual bonus. On the other hand, you would be better off choosing Project B as it creates more value. Chapter 3 30. Jason’s business purchased several pieces of machinery some time ago for \$25,000.At the beginning of the current year this pool of assets had a UCC of \$15,000. During the year, Jason decided to sell all of the assets from this pool. For each of the three sale prices below, determine if the firm will report a capital gain, and the amount (if any) of CCArecapture and/or terminal loss. A. \$30,000 B. \$20,000 C. \$10,000 Topic: Corporate Taxes (Examples 3-2 and 3-3) Level of difficulty: Medium Solution: A. The sale price is greater than the original capital cost (purchase price), so there is a capital gain of \$30,000 –
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