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MGTA05 Midterm: MGTA05, Fall 2015 Midterm, SAQ with Answers (1)

Management (MGT)
Course Code
H Laurence
Study Guide

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MGTA05, Fall 2015 Midterm Examination
Short Answer Questions, with Answers
Question 1 (25 overall marks)
Frank incorporated a private corporation, FCo Ltd., through which to carry on his new business
of paving driveways. He invested his savings of $15,000 in FCo, using the money to purchase
150 common shares of FCo. He then arranged for FCo to lease a paving machine for the year, at
a cost of $8,000. FCo also arranged for a revolving credit of up to $20,000 to cover day-to-day
expenses. Interest of 5% per annum was charged monthly on the outstanding balance of the
revolving credit. Over the course of the year, the interest expense on the revolving credit account
came to $1,000. FCo also purchased various shovels and other tools for a total of $800.
To pave the driveways, Frank hired a helper at a rate of $150 for each day worked. During his
first year of operations, Frank did well. He managed to get 80 different jobs for FCo. For each
job, FCo used $150 of asphalt paving material. Frank managed to get the paving done on each
job in one day, using his helper to complete each job. FCo charged each client $700 to pave a
a) Give a detailed account of FCo’s expenses during the year. (4 marks)
1a) Expenses (4 marks)
Machine lease $8,000 One mark for listing the lease, tools and interest
Tool cost $800
Interest on revolving credit $1,000 One mark for listing the asphalt and getting the
Asphalt (80 x 150) $12,000 calculation right, and one mark for listing the
Helper (80 x 150) $12,000 helper and getting the calculation right
Total expenses $33,800 One mark for adding correctly
b) What was FCo’s operating profit for the first years operations? (2 marks)
1b) Profit (2 marks)
Revenue (80 x 700) $56,000 One mark for getting the revenue correct
Expenses $33,800
Profit $22,200 One mark for getting the profit correct
c) What was the return on Frank’s equity investment in FCo, before taxes, during its first
year of operations? (3 marks)

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1c) Return on shareholder equity (3 marks)
Return on shareholders equity = $22,200 x 100 = 148%
(One mark for getting the formula right, one for getting the figures in the right places, even
if the profit has been wrongly calculated, and one for getting the right percentage from the
calculation. So if the calculation in 1b is incorrect, but is correctly carried through in 1c,
the student can get full marks in 1c)
d) At the end of the year, Frank paid himself a dividend on his shares of $15,000. How did
this affect the profit during the first year? (2 marks)
1d) Dividend payment (2 marks)
Dividends are paid AFTER profits are calculated. They represent an allocation of profits
to the owners/shareholders. Thus the payment of a dividend does not affect the profit.
(The payment of a dividend does reduce the amount of retained earnings.)
At the end of the year, FCo has the opportunity to purchase the paving machine. Since it has
been used, the cost to FCo would be only $15,000. The bank is prepared to lend FCo the money
on a 5-year term loan bearing interest at 5% per annum. Frank’s brother Jimmy is prepared to
loan FCo the money on a demand loan bearing no interest, but with the understanding that FCo
would pay Sam a “gift” of $600 in each year that FCo makes a profit. Frank’s uncle, Sam, is
prepared to purchase common shares of FCo at the same price Frank paid.
e) Which form of financing would cost FCo the least? Show all your calculations.
(3 marks)
1e) Cost of financing (3 marks)
Bank interest $15,000 x. 0.05 = $750/year, plus any fees
Jimmy interest $600/year of any profits
Sam no cost to issue shares of a private corporation
f) Other than the cost of financing, what other concerns would Frank have in deciding
which financing option to take? Give a detailed consideration of the options and their
benefits and drawbacks to FCo. (8 marks)
1f) Considerations on Financing (8 marks)
Both the bank and Jimmy are lending money, a form of debt financing. Sam is making an
equity investment. So the issue here is the contrast between debt and equity financing, and
the advantages and drawbacks of each.
Students should prepare a table with the advantages and disadvantages of equity and debt
financing. To get full marks, however, students must apply the general criteria to the
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