INSTRUCTOR’S SOLUTIONS MANUAL
CORPORATE FINANCE
9TH CANADIAN EDITION
CHAPTER NO. 01: INTRODUCTION TO CORPORATE FINANCE
QUESTIONS AND PROBLEMS:
1.1 In the absence of agency problems, managers act in the best interest of shareholders and make
decisions to maximize shareholders’ wealth. They create value from the capital budgeting,
financing, and liquidity activities. For example, managers create value by buying assets that
generate more cash than they cost.
1.2 In the corporate form of ownership, the shareholders are the owners of the firm. The
shareholders elect the directors of the corporation, who in turn appoint the firm’s management.
This separation of ownership from control in the corporate form of organization is what causes
agency problems to exist. Management may act in its own or someone else’s best interests, rather
than those of the shareholders. If such events occur, they may contradict the goal of maximizing
shareholders’ wealth.
1.3 We would expect agency problems to be less severe in countries with a small percentage of individual
ownership. Fewer individual owners should reduce the number of diverse opinions concerning
corporate goals. The high percentage of institutional ownership might lead to a higher degree of
agreement between owners and managers on decisions concerning risky projects. In addition,
institutions may be better able to implement effective monitoring mechanisms on managers than can
individual owners, based on the institutions’ deeper resources and experiences with their own
management. The increase in institutional ownership of stock in the United States and the growing
activism of these large shareholder groups may lead to a reduction in agency problems for U.S.
corporations and a more efficient market for corporate control.
1.4 Canadian financial institutions include chartered banks and other depository institutions––trust
companies and credit unions as well as nondepository institutions––investment dealers, insurance
companies, pension funds and mutual funds.
Financial markets can be classified as either money markets or capital markets. Short–term debt
securities are bought and sold in money markets. Capital markets are the markets for long–term
debt and shares of stock, for example the TSX.
,1.5 Canadian Financial Markets, like all markets, are experiencing rapid globalization. The toolkit of
available financial management techniques has expanded in response to a need to control volatility
risk and to track complex dealing in many countries. Computer technology improvements make
new financial engineering applications practical and create opportunities to combine different types
of financial institutions. Financial institutions pressure authorities to deregulate in a process called
the regulatory dialectic. Increased uncertainty during the COVID-19 pandemic and other disruptive
events led Canadian companies to delay their investments and to hold more cash for precautionary
motives. Unfortunately, several companies, particularly retailers, sought court protection from their
creditors.
These trends have made financial management in Canada much more complex and technical. In the
face of increased global competition and disruptive shocks, the payoff for good financial
management is great with finance becoming important in corporate strategic planning.
Appendix 1A: Taxes
Questions and Problems:
1.A1 The average tax rate is total taxes paid divided by total taxable income whereas the marginal tax
rate is the extra tax payable on the next dollar earned.
1.A2 Personal investment income in the form of interest is taxed at the same rates as employment
income. Dividend income is initially taxed at the same rate as employment income but the dividend
tax credit reduces the effective tax rate on dividends for investors. Taxes on capital gains apply at
50 percent of the applicable marginal rate. However, before the 1994 Federal Budget, each
individual was entitled to receive a lifetime capital gains exemption of $100,000
net of any capital losses. From a corporate point of view, interest earned is fully taxable while
dividends on common shares of other Canadian corporations are received tax–free. As with
individuals, capital gains are taxed at 50 percent of the marginal rate.
1.A3 If the firm has an operating loss, it may be carried back to reduce net income in the three prior years
and carried forward for up to twenty years. In the case of capital losses, if capital losses exceed
capital gains, the net capital loss may be carried back to reduce taxable capital gains in three prior
years and carried forward indefinitely. An investment tax credit allows a qualified firm to subtract a
set percentage of an investment directly from taxes payable.
1.A4 a. Ontario
Corporation X: Taxes = .122 x $100,000 = $12,200
Corporation Y: Taxes = .265 x $1,000,000 = $265,000
, b. The firms have different marginal tax rates. Firm X pays (0.122 x $10,000) = $1,220 more
and Firm Y, pays an additional (0.265 x $10,000) = $2,650.
1.A5
DIVIDENDS
Dividend $10,000.00
Gross up (38%) 3,800.00
Grossed–up dividends 13,800.00
Federal Tax (33%) 4,554.00
Less Federal Dividend Tax Credit (.150198 x $13,800) 2,072.73
Federal Tax Payable 2,481.27
Provincial Tax (.1316 x $13,800) 1,816.08
Less Provincial Tax credit (.1 × $13,800) 1,380.00
Provincial Tax Payable 436.08
Tax Payable 2,917.35
INTEREST
Interest $10,000.00
Federal Tax (33%) 3,300.00
Provincial Tax (13.16%) 1,316.00
Tax Payable $4,616.00
CAPITAL GAINS
Capital Gain $10,000.00
Federal Tax (.33 x $10,000 x 1/2) 1,650.00
Provincial Tax (.1316 x $10,000 x 1/2) 658.00
Tax Payable $2,308.00
After tax cash flow from Dividends = $10,000.00 – $2,917.35 = $7,082.65
After tax cash flow from Interest = $10,000.00 – $4,616.00 = $5,384.00
After tax cash flow from Capital Gains = $10,000.00 – $2,308 = $7,692.00
Total (after tax) Cash Flow = $20,158.65
, CHAPTER NO. 02: ACCOUNTING STATEMENTS AND CASH FLOW
Chapter Outline [PowerPoint slide 2-1]
2.1 Statement of Financial Position
2.2 Statement of Comprehensive Income
2.3 Net Working Capital
2.4 Financial Cash Flow
2.5 Summary and Conclusions
Appendix 2A: Financial Statement Analysis
Appendix 2B: Statement of Cash Flows
This chapter contains material that most students have already seen in a required financial accounting course.
Consequently, many professors do not have a separate lecture on Chapter 2. To the extent that this is a finance
course, go over topics that may not have been emphasized in the required accounting course, including financial
cash flows and financial statement analysis. A handout listing the financial ratios discussed in Appendix 2A is
provided at the end of the lecture notes. It is more convenient to have the ratios in a handout during class
discussions.
The Financial Statements [PowerPoint slides 2-3 to 2-29]
Review the balance sheet and income statement of the Canadian Composite Company from the text. During class
you may wish to discuss the firm's performance by going over the Financial Cash Flows in Table 2.3 [PowerPoint
slides 2-22 to 2-28] and financial ratios from the appendix of the text [PowerPoint slides 2-31 to 2-53] (see the
HANDOUT at the end of the Chapter 2 Lecture Notes).
Lecture Tip: Students sometimes find it difficult to see the relationship between the decisions made by financial
managers and the values that subsequently appear on the firm’s balance sheet. One way to help them see the “big
picture” is to emphasize that all finance decisions are either investment decisions or financing decisions. Investment
decisions involve the purchase and sale of any assets (not just financial assets). Investment decisions show up on the
left-hand side of the balance sheet. Financing decisions involve the choice of whether to borrow money to buy the
assets or to issue new ownership shares. Financing decisions show up on the right-hand side of the balance sheet.
Financial Cash Flows [PowerPoint slides 2-21 to 2-29]
The primary objective of this chapter is to encourage students to focus on cash flow rather than accounting profit.
The Financial Cash Flows in Table 2.3 [PowerPoint slides 2-22 to 2-28] illustrate cash flow accounting. The basic
balance sheet equality is:
CF(ASSETS) = CF(BONDS) + CF(STOCK)
That is: “what goes in must come out.”
CF(ASSETS) are net cash flows to the firm's assets. It consists of net changes in net working capital, net changes in
fixed assets, and cash flows from operations. For the Canadian Composite Corporation:
Cash flow of the firm (in $ millions)
Operating cash flow
(Earnings before interest and taxes plus depreciation minus taxes) $238
Capital spending
(Acquisitions of fixed assets minus sales of fixed assets) ($173)
Additions to net working capital ($23)
Total $42
CORPORATE FINANCE
9TH CANADIAN EDITION
CHAPTER NO. 01: INTRODUCTION TO CORPORATE FINANCE
QUESTIONS AND PROBLEMS:
1.1 In the absence of agency problems, managers act in the best interest of shareholders and make
decisions to maximize shareholders’ wealth. They create value from the capital budgeting,
financing, and liquidity activities. For example, managers create value by buying assets that
generate more cash than they cost.
1.2 In the corporate form of ownership, the shareholders are the owners of the firm. The
shareholders elect the directors of the corporation, who in turn appoint the firm’s management.
This separation of ownership from control in the corporate form of organization is what causes
agency problems to exist. Management may act in its own or someone else’s best interests, rather
than those of the shareholders. If such events occur, they may contradict the goal of maximizing
shareholders’ wealth.
1.3 We would expect agency problems to be less severe in countries with a small percentage of individual
ownership. Fewer individual owners should reduce the number of diverse opinions concerning
corporate goals. The high percentage of institutional ownership might lead to a higher degree of
agreement between owners and managers on decisions concerning risky projects. In addition,
institutions may be better able to implement effective monitoring mechanisms on managers than can
individual owners, based on the institutions’ deeper resources and experiences with their own
management. The increase in institutional ownership of stock in the United States and the growing
activism of these large shareholder groups may lead to a reduction in agency problems for U.S.
corporations and a more efficient market for corporate control.
1.4 Canadian financial institutions include chartered banks and other depository institutions––trust
companies and credit unions as well as nondepository institutions––investment dealers, insurance
companies, pension funds and mutual funds.
Financial markets can be classified as either money markets or capital markets. Short–term debt
securities are bought and sold in money markets. Capital markets are the markets for long–term
debt and shares of stock, for example the TSX.
,1.5 Canadian Financial Markets, like all markets, are experiencing rapid globalization. The toolkit of
available financial management techniques has expanded in response to a need to control volatility
risk and to track complex dealing in many countries. Computer technology improvements make
new financial engineering applications practical and create opportunities to combine different types
of financial institutions. Financial institutions pressure authorities to deregulate in a process called
the regulatory dialectic. Increased uncertainty during the COVID-19 pandemic and other disruptive
events led Canadian companies to delay their investments and to hold more cash for precautionary
motives. Unfortunately, several companies, particularly retailers, sought court protection from their
creditors.
These trends have made financial management in Canada much more complex and technical. In the
face of increased global competition and disruptive shocks, the payoff for good financial
management is great with finance becoming important in corporate strategic planning.
Appendix 1A: Taxes
Questions and Problems:
1.A1 The average tax rate is total taxes paid divided by total taxable income whereas the marginal tax
rate is the extra tax payable on the next dollar earned.
1.A2 Personal investment income in the form of interest is taxed at the same rates as employment
income. Dividend income is initially taxed at the same rate as employment income but the dividend
tax credit reduces the effective tax rate on dividends for investors. Taxes on capital gains apply at
50 percent of the applicable marginal rate. However, before the 1994 Federal Budget, each
individual was entitled to receive a lifetime capital gains exemption of $100,000
net of any capital losses. From a corporate point of view, interest earned is fully taxable while
dividends on common shares of other Canadian corporations are received tax–free. As with
individuals, capital gains are taxed at 50 percent of the marginal rate.
1.A3 If the firm has an operating loss, it may be carried back to reduce net income in the three prior years
and carried forward for up to twenty years. In the case of capital losses, if capital losses exceed
capital gains, the net capital loss may be carried back to reduce taxable capital gains in three prior
years and carried forward indefinitely. An investment tax credit allows a qualified firm to subtract a
set percentage of an investment directly from taxes payable.
1.A4 a. Ontario
Corporation X: Taxes = .122 x $100,000 = $12,200
Corporation Y: Taxes = .265 x $1,000,000 = $265,000
, b. The firms have different marginal tax rates. Firm X pays (0.122 x $10,000) = $1,220 more
and Firm Y, pays an additional (0.265 x $10,000) = $2,650.
1.A5
DIVIDENDS
Dividend $10,000.00
Gross up (38%) 3,800.00
Grossed–up dividends 13,800.00
Federal Tax (33%) 4,554.00
Less Federal Dividend Tax Credit (.150198 x $13,800) 2,072.73
Federal Tax Payable 2,481.27
Provincial Tax (.1316 x $13,800) 1,816.08
Less Provincial Tax credit (.1 × $13,800) 1,380.00
Provincial Tax Payable 436.08
Tax Payable 2,917.35
INTEREST
Interest $10,000.00
Federal Tax (33%) 3,300.00
Provincial Tax (13.16%) 1,316.00
Tax Payable $4,616.00
CAPITAL GAINS
Capital Gain $10,000.00
Federal Tax (.33 x $10,000 x 1/2) 1,650.00
Provincial Tax (.1316 x $10,000 x 1/2) 658.00
Tax Payable $2,308.00
After tax cash flow from Dividends = $10,000.00 – $2,917.35 = $7,082.65
After tax cash flow from Interest = $10,000.00 – $4,616.00 = $5,384.00
After tax cash flow from Capital Gains = $10,000.00 – $2,308 = $7,692.00
Total (after tax) Cash Flow = $20,158.65
, CHAPTER NO. 02: ACCOUNTING STATEMENTS AND CASH FLOW
Chapter Outline [PowerPoint slide 2-1]
2.1 Statement of Financial Position
2.2 Statement of Comprehensive Income
2.3 Net Working Capital
2.4 Financial Cash Flow
2.5 Summary and Conclusions
Appendix 2A: Financial Statement Analysis
Appendix 2B: Statement of Cash Flows
This chapter contains material that most students have already seen in a required financial accounting course.
Consequently, many professors do not have a separate lecture on Chapter 2. To the extent that this is a finance
course, go over topics that may not have been emphasized in the required accounting course, including financial
cash flows and financial statement analysis. A handout listing the financial ratios discussed in Appendix 2A is
provided at the end of the lecture notes. It is more convenient to have the ratios in a handout during class
discussions.
The Financial Statements [PowerPoint slides 2-3 to 2-29]
Review the balance sheet and income statement of the Canadian Composite Company from the text. During class
you may wish to discuss the firm's performance by going over the Financial Cash Flows in Table 2.3 [PowerPoint
slides 2-22 to 2-28] and financial ratios from the appendix of the text [PowerPoint slides 2-31 to 2-53] (see the
HANDOUT at the end of the Chapter 2 Lecture Notes).
Lecture Tip: Students sometimes find it difficult to see the relationship between the decisions made by financial
managers and the values that subsequently appear on the firm’s balance sheet. One way to help them see the “big
picture” is to emphasize that all finance decisions are either investment decisions or financing decisions. Investment
decisions involve the purchase and sale of any assets (not just financial assets). Investment decisions show up on the
left-hand side of the balance sheet. Financing decisions involve the choice of whether to borrow money to buy the
assets or to issue new ownership shares. Financing decisions show up on the right-hand side of the balance sheet.
Financial Cash Flows [PowerPoint slides 2-21 to 2-29]
The primary objective of this chapter is to encourage students to focus on cash flow rather than accounting profit.
The Financial Cash Flows in Table 2.3 [PowerPoint slides 2-22 to 2-28] illustrate cash flow accounting. The basic
balance sheet equality is:
CF(ASSETS) = CF(BONDS) + CF(STOCK)
That is: “what goes in must come out.”
CF(ASSETS) are net cash flows to the firm's assets. It consists of net changes in net working capital, net changes in
fixed assets, and cash flows from operations. For the Canadian Composite Corporation:
Cash flow of the firm (in $ millions)
Operating cash flow
(Earnings before interest and taxes plus depreciation minus taxes) $238
Capital spending
(Acquisitions of fixed assets minus sales of fixed assets) ($173)
Additions to net working capital ($23)
Total $42
