Sole proprietorships, partnerships and corporations — MCQs

Northstar Packaging is evaluating an automated packaging line with a four-year operating life. The equipment will be installed in a warehouse owned by Northstar. The warehouse is currently unused, but an unrelated logistics company has offered to lease it for four years at the annual amount shown in Exhibit 1. The lease payments would be received at each year-end and taxed at Northstar's 25% corporate tax rate. Northstar paid for a feasibility study last year, and the study has no alternative use. The equipment and installation costs will be depreciated straight-line to a zero book value over four years. Revenue and cash operating costs are expected to occur evenly during each year but are modeled as year-end cash flows. Initial net working capital is invested at time 0 and fully recovered at the end of year 4. The forecast salvage amount in Exhibit 1 is already stated after tax. Northstar's capital-allocation committee requires analysts to include all incremental opportunity costs, exclude sunk costs, and discount the project at 10%. The treasurer is also reviewing working-capital policy. Northstar currently purchases inputs throughout the year and generally pays suppliers on day 40. The company has sufficient capacity under a revolving-credit facility to finance early supplier payments, but the treasurer is concerned that drawing on the facility will increase reported short-term borrowings. She instructs an analyst to compare the explicit bank rate with the implicit annualized cost of not taking the supplier discount. Northstar's current financing policy uses long-term debt for permanent working capital and short-term credit for seasonal requirements. A proposed conservative policy would use long-term debt for both permanent and seasonal working-capital requirements. The chief financial officer expects the conservative policy to create periods of surplus cash but believes it may protect the company against disruptions in short-term credit markets. No commitment fees, compensating balances, or transaction costs apply to the revolver, and all stated rates may be compared on a simple annualized basis.

Two founders form a general partnership without a limited-liability election. One partner signs an authorised supplier contract, and the partnership defaults. The supplier may most likely pursue:

An analyst assessing a publicly traded corporation should most likely conclude that:

A project has an asset beta of 0.90, target debt-to-equity of 0.50, and tax rate of 25%. With a 4.0% risk-free rate and 5.5% equity risk premium, the calculated project cost of equity is closest to:

A company is financed with 60% equity and 40% debt by market value. Its equity cost is 10%, pre-tax debt cost is 6%, and tax rate is 25%. The calculated value of WACC is closest to:

Solara Media is a publicly traded digital-content company founded by its current chief executive officer. Solara has two share classes. Public investors primarily own Class A shares, while the founder owns all Class B shares. Both classes have equal economic rights per share, but the Class B shares carry substantially more votes. The founder can elect a majority of directors despite holding less than one-quarter of the company's total economic interest. Several institutional shareholders have expressed concern that the board includes five current or former Solara executives among its eight directors. The founder also serves as board chair and controls the agenda for director nominations. Solara has met all debt obligations, and its loan agreements contain conventional restrictions on additional borrowing and distributions. Management proposes leasing a production studio for ten years from a private company wholly owned by the founder's sibling. Management states that the location is strategically important, but it has not obtained an independent assessment of the lease rate. The founder argues that the full board should approve the lease because the company's external auditor has confirmed that the founder's relationship to the lessor will be disclosed in the notes to the financial statements. Several outside shareholders request a review process that addresses both the pricing and the conflict of interest before the company signs the agreement. Solara also has excess cash and is considering the open-market share repurchase summarized in Exhibit 1. Assume the company can repurchase shares immediately at the current market price, the repurchased shares are retired, annual earnings otherwise remain unchanged, and the transaction has no signaling, tax, or transaction-cost effects. The founder has stated that no Class B shares will be sold. Management expects the repurchase to be supplied entirely by Class A shareholders. An analyst reviewing the proposal notes that the repurchase reduces interest income but also reduces the number of shares outstanding. The analyst also considers how the repurchase would affect the founder's voting power, given that each outstanding Class A share continues to have one vote and each outstanding Class B share continues to have ten votes.

Meridian Distribution operates a wholesale distribution platform that purchases consumer products from manufacturers and resells them to independent retailers. Its business model requires substantial investment in inventory and trade receivables. Following a decline in demand, Meridian's board asks management to improve liquidity, reduce leverage, and concentrate resources on the company's core distribution network. The treasurer proposes tighter inventory controls and automated customer credit monitoring. The expected changes in operating-cycle measures are presented in Exhibit 1. Management does not expect the proposal to affect supplier payment terms, sales volume, or gross margins. The board evaluates the proposal using the cash conversion cycle and expects that a shorter cycle will reduce the amount of external financing required for operations. Meridian's debt agreements do not prohibit exchanges of debt for equity. A group of creditors has offered to exchange USD 80 million of outstanding debt for newly issued common shares. The exchange would occur at fair market value and would not involve a cash payment. EBIT is expected to remain unchanged immediately after the transaction, but the interest expense associated with the exchanged debt would be eliminated. The board wants to understand the directional effects on financial leverage and interest coverage rather than any accounting gain or loss on extinguishment. Meridian also owns a non-core logistics software segment that licenses route-planning software under multiyear subscriptions. The segment has stable renewal rates and is expected to generate the cash flows shown in Exhibit 2. A strategic acquirer has made an all-cash offer for the segment. As an alternative, Meridian could complete a tax-free spin-off by distributing the segment's shares pro rata to Meridian shareholders. Transaction costs and taxes may be ignored for both alternatives. Management intends to use any cash received from a segment sale to repay debt. A spin-off would create an independently financed public company, but Meridian itself would receive no cash from the share distribution. The board evaluates the sale offer by comparing it with the segment's standalone value under a constant-growth model.