Qdoc - Tips Principles of Managerial Finance 14th Edition Gitm

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Chapter 2
The Financial Market Environment
Instructor’s Resources
Ove
rvi
ew
Money and capital markets and their major components are introduced in this chapter. Firms need to raise capital
in order to survive. Financial institutions give firms access to the money they need to grow. However, greed can drive
financial managers and institutions to commit actions that get them into trouble and even force bankruptcy. These
bankruptcies result in limited
limited capital flows to firms, and both they and the whole
whole economy can suffer. Therefore,
financial institutions and markets should be well regulated. The final section covers a discussion of the impact of
taxation on the firm’s financial activities.
Sugges tedA ns w ertoOpener-

in-
Review
Qu
Ques tion
Consider a buyer who purchased a home that month for $150,000, using $30,000 of her own funds as a
down payment and borrowing the remaining $120,000 from a bank via a 30-year mortgage. Two years later,
prices in Phoenix rose by 30 percent, and the house was worth $195,000. Assuming that after making two
years of payments on the 30-year mortgage, the outstanding mortgage balance was still $118,000. How
much equity does the buyer have in her home? What rate of return has she earned on her initial $30,000
investment?
Buyer’s equity in her home =

home = $195,000 –
$195,000 – $118,000
$118,000 = $77,000
Rate of return = ($77,000 –

($77,000 – $30,000)
$30,000) ÷ $30,000 = $156.67%
A ns w ers toReview Ques tions

1. The key participants in financial transactions
transactions are individuals, businesses, and governments
governments. These parties
participate both as suppliers and demanders of funds. Individuals are the net suppliers, which means that they
save more dollars than they borrow, while both businesses and governments are net demanders because they
borrow more than they save. One could say that individuals provide the excess funds required by businesses
and governments.
Financial institutions include commercial banks and investment banks. The former assists both individuals and
companies with their banking needs, while the latter concentrates efforts
e fforts in the area of assisting corporations
corporations
with raising funds. Until the late 1990s, the Glass-Steagall Act created a separation between the two. A shadow
banking
banking system,
system, where
where non-deposi
non-deposit-tak
t-taking
ing enterprise
enterprisess lend
lend money
money to firms
firms needing
needing cash, has grown
grown to be as
large as the traditional banking system.
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anual
14 Gitman/Zutter • Principles of Managerial Finance, Fourteenth Edition
2. Financial markets provide a forum in which suppliers of funds and demanders of loans and investments can
transact business directly.
market is
Primary market is the name used to denote the fact that a security is being issued by the demander of funds to
the supplier of funds. An example would be Microsoft Corporation selling new shares of common stock to the
public.
Secondary market refers
refers to the trading
tr ading of securities among investors subsequent to the primary market
issuance. In secondary market trading, no new funds
f unds are being raised by the demander of funds. The security
is trading ownership among investors. An example would be individual “A” buying common stock of
Microsoft through a broker from individual “B.”
Financial institutions and financial markets are not independent of each other. It is quite common to find
financial institutions actively
actively participating in both the money market and the capital market as both suppliers
and demanders of funds. Financial institutions often channel their investments and obtain needed financing
through the financial markets. This relationship exists because these institutions must use the structure of the
financial marketplace to find a supplier of funds.
3. The money market is is created by a financial relationship between the suppliers and demanders of short-term
debt securities maturing in one year or less, such as U.S. Treasury bills, commercial paper, and negotiable
certificates of deposit. The Eurocurrency market is
Eurocurrency market is the international equivalent of the U.S. money market and
is used for short-term bank time deposits denominated in dollars or other major currencies.
4. The capital market is

is a financial relationship created by a number of institutions and arrangements that allows
the suppliers and demanders of long-term funds (with maturities greater than one year) to make transactions.
tra nsactions.
The key securities traded in the capital markets are bonds plus common and preferred stock.
5. The broker market consists

consists of national and regional securities exchanges. These organizations provide a
location, such as the New York Stock Exchange, to bring together the buyers and sellers of debt and equity.
They create a continuous market for securities, allocate scarce capital, determine and publicize security prices,
and aid in new financing.
In contrast, dealer markets are electronic markets for the buyers and sellers of securities not listed on the
major exchanges. In a dealer market, physical trading locations are replaced by security dealers who offer to
buy or sell securities
securities at stated bid/ask prices.
prices. Dealers buy securities from clients
clients and sell them to other
dealers, who in turn sell them to their clients. A majority of shares traded in the dealer market are
ar e listed on
Nasdaq, the National Association
Association of Securities
Securities Dealers Automated Quotation
Quotation System.
6. In addition to the U.S. capital markets, corporations can raise debt and equity funds in capital markets located
in other countries. The Eurobond market is
is the oldest and largest international debt market. Corporate a nd
government bonds issued in this market are denominated in dollars or other major currencies and sold to
investors outside the country in whose currency the bonds are denominated. Foreign bond markets also
provide corporations with
with the opportunity
opportunity to tap other capital sources.
sources. Corporations or governments
governments issue
bonds denominated in the local currency and sold only only in that home market. The international equity market
allows corporations to sell blocks of stock to investors in several countries, providing a diversified investor
base and additional opportunities
opportunities to raise larger
larger amounts of capital.

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Chapter 2 The Financial Market Environment 15
7. An efficient market will allocate funds to their most productive uses due to competition among wealth-
maximizing investors. Prices are assumed to be a function of information about the firm and economy. Only
new, unexpected information will cause investors to buy or sell securities. Investors determine the price of
assets through their participation in the financial markets. Changes in supply and demand continually impact
prices in an efficient market.
An alternate view of market pricing is put forth by advocates of behavioral finance. This explanation of market
prices combines finance and
and psychology. Though
Though prices may deviate from true value for psychological
psychological and
other reasons, few investors have been able to earn a risk-adjusted, positive rate of return.
8. Securitization is the process of pooling mortgages and then selling claims against that pool in the secondary
market. Investors buying these securities extend a loan to the homeowner.
9. Mortgage-backed securities represent claims on the cash flows generated by a pool of mortgages. As the
Mortgage-backed securities
homeowners pay off their mortgages, the money serves as income to the investors. The primary risk
r isk
associated with mortgage-backed securities is that homeowners may not repay their loans.
10. When a homeowner borrows

borrows money to buy a home,
home, he borrows a fixed amount
amount of money.
money. As housing prices
prices
rise, the gap between what he owes and what the house is worth widens. Lenders will allow borrowers who
have difficulty making mortgage payments tap this built-up equity. Therefore, mortgage default rates are
relatively low.
11. As home prices decline,

decline, the value of
of homes may be less than the amount
amount owed to the bank. Hence manymany
borrowers will simply
simply walk away from their homes and let let lenders repossess them.
them. There will be an added
supply of housing. If multiple homes in the area
a rea are facing foreclosure, the value of remaining homes will
drop. At the same time, borrowers having trouble making mortgage payments will not be able to tap into any
built-up equity. These
These homes will also be repossessed,
repossessed, and the number of homes for for sale in an area will rise.
Excess home availability will make the remaining homes less valuable, increasing the number of homeowners
with houses worth less than the amount owed to the bank.
12. A crisis in the

the financial sector
sector generally has a spillover effect on
on the other sectors
sectors of the economy.
economy. This can
be better understood by understanding the 20082008 financial crisis. As mortgage-backed
mortgage-backed security delinquency
delinquency
rates rose, the value of still solvent mortgage-backed securities fell. This fall led to the questions about the
solvency of investors, including financial institutions. Financial institutions cut back on the amount of
lending, requiring higher standards for those borrowing money. Unable to obtain money easily in the money
market, firms began to hoard cash and cut back expenditures. This decline hurt suppliers and curtailed
employment at companies. Throughout the economy, revenues fell as financial institutions
institutions cut back on
lending.
13. Due to their enormous

enormous impact, governments
governments typically regulate financial institutions
institutions more than most economic
economic
sectors. Banking sector troubles and other factors contributed to the worst economic contraction in U.S.
history during the Great Depression. Consequently, it is not surprising that an above-average amount of
legislation was enacted in the 1930s.
14. The Securities Act of 1933 was designed

designed to regulate
regulate activity in the primary market,
market, ensuring that sellers
sellers of
new securities provided extensive disclosure. The Securities Exchange Act of 1934 regulates the trading of
securities in secondary markets. The latter legislation also created the Securities Exchange Commission to
enforce federal securities laws.

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15. The ordinary income of a corporation is income earned through

throug h the sale of a firm’s goods or services. Taxes
on corporate ordinary income have two components: a fixed a mount on the base figure for its income bracket
level, plus a progressive percentage, ranging from 15% to 39%, applied to the excess over the base bracket
figure. A capital gain occurs when a capital asset is sold for more than its initial purchase price. Capital gains
are added to ordinary income and taxed at the regular corporate rates. The average tax rate is calculated by
dividing taxes paid by taxable income. For firms with taxable income of $10 million or less, it ranges from
15% to 34%. For firms with taxable income in excess of $10 million, it ranges between 34% and 35%. The
marginal tax rate is the rate at which additional income is taxed.
16. Dividends received from another corporation, in which the shareholding firm’s position is less than one -fifth
of outstanding shares, is subject to a 70% exclusion for tax purposes. The tax rate is only 30% of what it
would be on fully taxable income.
17. The tax deductibility

deductibility of corporate
corporate expenses reduces
reduces their actual after-tax cost. Corporate interest is a tax-
tax-
deductible expense, while dividends are not.
Sugges tedA ns w ertoFocus on Pra

ctice
Bo
Box:Berk
s hireH atha
way:C an
Buff
etBe
BeRepla ced?
The share price of BRKA has never been
b een split. Why might the company refuse to split its shares to make
them more affordable to average investors?
The primary reason that Berkshire Hathaway does not split the price of its common stock is because Warren
Buffett’s philosophy
philosop hy is that a stock split is financially meaningless and only serves as a way to lower the stock
price so that more investors
investors are able to purchase the stock.
stock. Mr. Buffett has stated his belief that
that true investors are
long-term investors who hold a stock through thick and thin. With fewer shareholders, there are fewer fe wer people that
the company management must answer to, and investors who can afford the steep price of the Berkshire Hathaway
stock are likely to be serious individual investors or institutional
institutional investors such as mutual funds.
Sugges tedA ns w ertoFocus on Ethics Box:TheEthics ofI

ns ider
Trading
If efficiency is the goal of financial markets, is allowing or disallowing insider trading more unethical?
Price efficiency does not necessarily imply that insider trading is either et hical or unethical. The efficient-market
hypothesis suggests that stock prices reflect all publicly available information. Those in favor of allowing insider
trading argue that it will allow private information to become public faster, allowing prices to adjust more rapidly
to this information.
Does allowing insider trading create an ethical dilemma for insiders?
It certainly could. Consider Fama’s point discussed in the case. If insider trading is allowed, insiders might have
the incentive to hold back information in order to profit from the information before releasing it to the public. If
this were the case, stock prices could impound information more slowly when insider trading is permitted.

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A ns w ers toW arm-

UpEx
ercis es
E2-1. Suppliers and demanders of funds
Answer: Individuals as a whole spend less than they earn. The excess is invested, making it available for
businesses. If individuals
individuals consume more, fewer dollars will be available for investment.
investment. This would
reduce the amount of money available for
f or new projects and drive up the required return (i.e., required
return of investors buy bonds). Over time, employment, salaries, and gross domestic product would
decline.
E2-2 Raising funds

Answer: Financial institutions, such as investment banks, provide expertise in the acquisition of funds.
Investment banking institutions
institutions are able to use the expertise developed through the acquisition of funds
for many firms to reduce the effort and cost of acquiring funds for any single business. The investment
banking institution
institution will allow the
the Gaga Enterprises CFO to raise more
more money at a lower cost per dollar
raised.
E2-3 Money market vs. capital market

Answer: Money markets are short-term markets, so firms using these would be in need of funds for less than a
year. Perhaps the business needs to increase inventory for a season, such as RV dealerships building
inventory prior to the spring/summer sales period. Immediately after a large sale, a business
business may need
to finance the presence of accounts receivable on their balance sheet. Capital markets, by contrast,
typically are used for fixed assets, which a company will use over several years.
E2-4 Mortgage-backed securities

Answer: Questions you would ask include
a. Real estate location
location (after all, the three
three most important
important determinants
determinants of real estate price are
“location, location, location”)
b. Percentage of properties in the region that are “under water” (homeowners owe more than they
borrowed) or in foreclosure
c. Type of real estate (commercial
(commercial properties offer less liquidity if the market turns sour,because
sour,because
empty homes can be rented for revenue)
d. Precedence in bankruptcy
bankruptcy (would
(would other lenders
lenders have a senior claim
claim to properties
properties in bankruptcy?)
bankruptcy?)
e. Quality of real estate
estate (is it in
in good condition,
condition, or would there need to be repairs
repairs prior to sale?)
sale?)
f. Creditworthiness of borrowers (how likely is it that that borrowers will lose their job and be unable
unable to
make payments on a timely basis?)
g. What percentage
percentage of borrowers are behind on their mortgage
mortgage payments?
h. Will borrowers soonsoon be experiencing
experiencing an interest rate
rate increase because they took out
out a mortgage
with a low initial rate that was adjustable after a period of time?
E2-5 Biggest benefit of government regulation

Answer: While the type and level of government regulation will always be debatable, the idea that we need and,
in fact, benefit from some level of government regulation of financial institutions and markets is quite
reasonable. The biggest benefit of government regulation is the resulting trust and confidence in the
financial institutions and markets derived by society. This trust and confidence is necessary to ensure
society’s participation
society’s participation in the financial market environment that nearly individual in one way or another
hopes to benefit from.

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E2-6. Dividends received exclusion

Answer: While 100% of corporate interest income is taxed at
a t ordinary tax rates, only 30% of corporate dividend
income is treated as taxable income. This would be the equivalent of recognizing only 1.5% [5% (1 –
0.7)] of the 5% annual dividend for tax purposes. Based solely on the tax treatment of corporate
dividend income vs. interest income, Pruro, Inc., would have greater after-tax income if it chooses the
Reston stock paying 5% dividends over the promissory note paying 5% interest.
Solutions
ns toProblems
P2-1. Corporate taxes
LG 6; Basic
a. Firm’s tax liability on $92,500 (from Table 2.1):
Total taxes due  $13,750  [0.34  ($92,500 –
($92,500 – $75,000)]
$75,000)]
 $13,750  (0.34  $17,500)
 $13,750  $5,950
 $19,700
b. After-tax earnings: $92,500 –
$92,500 – $19,700
$19,700  $72,800
c. Average tax rate: $19,700 ÷ $92,500  21.3%
d. Marginal tax rate: 34%
P2-2. Average corporate tax rates

LG 6; Basic
a. Tax calculations using Table 2.1:
$10,000: Tax liability: $10,000  0.15  $1,500

After-tax earnings: $10,000 –
$10,000 – $1,500
$1,500  $8,500
Average tax rate: $1,500 ÷ $10,000  15%
$80,000: Tax liability: $13,750  [0.34  (80,000 –

(80,000 – $75,000)]
$75,000)]
$13,750  (0.34  $5,000)
$13,750  $1,700
$15,450  Total tax
After-tax earnings: $80,000
$80,000 –
– $15,450
$15,450  $64,550
Average tax rate: $15,450 ÷ $80,000  19.3%
$300,000: Tax liability: $22,250 + [0.39  ($300,000 –

($300,000 – $100,000)]
$100,000)]
$22,250  (0.39  $200,000)
$22,250  $78,000
After-tax earnings: $300,000
$300,000 –
– $100,250
$100,250  $199,750
Average tax rate: $100,250 ÷ $300,000  33.4%

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$500,000: Tax liability: $113,900  [0.34  ($500,000 –

($500,000 – $335,000)]
$335,000)]
$113,900  (0.34  $165,000)
$113,900  $56,100
After-tax earnings: $500,000 –
$500,000 – $170,000
$170,000  $330,000
Average tax rate: $170,000 ÷ $500,000  34%
$1,500,000: Tax liability: $113,900  [0.34  ($1,500,000 –

($1,500,000 – $335,000)]
$335,000)]
$113,900  (0.34  $1,165,000)
$113,900  $396,100
After-tax earnings: $1,500,000 –
$1,500,000 – $510,000
$510,000  $990,000
Average tax rate: $510,000  $1,500,000  34%
$10,000,000: Tax liability: $113,900 + [0.34  ($10,000,000 –

($10,000,000 – $335,000)]
$335,000)]
$113,900  (0.34  $9,665,000)
$113,900  $3,286,100
$3,400,000  Total tax
After-tax earnings:
earnings: $10,000,000 –
$10,000,000 – $3,400,000
$3,400,000  $6,600,000
Average tax rate: $3,400,000 ÷ $10,000,000  34%
$20,000,000: Tax liability: $6,416,667  [0.35  ($20,000,000 –

($20,000,000 – $18,333,333)]
$18,333,333)]
$6,416,667  (0.35  $1,666,667)
$6,416,667  583,333
$7,000,000  Total tax
After-tax earnings:
earnings: $20,000,000 –
$20,000,000 – $7,000,000
$7,000,000  $13,000,000
Average tax rate: $7,000,000 ÷ $20,000,000  35%
b.
As income increases, the rate reaches 35%.

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P2-3. Marginal corporate tax rates

LG 6; Basic
a.
Tax Calculation
Pre-Tax Amount Total Marginal
Income Base Tax % Over Base Tax Rate
$ 15,000 $0 (0.15 15,000) $ 2,250 15.0%

60,000 7,500 (0.25 10,000) 10,000 25.0%
90,000 13,750 (0.34 15,000) 18,850 34.0%
200,000 22,250 (0.39 100,000) 61,250 39.0%
400,000 113,900 (0.34 65,000) 136,000 34.0%
1,000,000 113,900 (0.34 665,000) 340,000 34.0%
20,000,000 6,416,667 (0.35 1,666,667) 7,00,0000 35.0%
b.
As income increases to $335,000, the marginal tax rate approaches and peaks at 39%. For income in
excess of $335,000, the marginal tax rate declines to 34%, and after $10 million, the marginal rate
increases slightly to 35%.

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P2-4. Interest vs. dividend income

LG 6; Intermediate
a. Tax on operating earnings: $490,000  0.40 tax rate  $196,000
b. and c.
(b) (c)
Interest Income Dividend Income
Before-tax amount $20,000 $20,000
Less: Applicable exclusion 0 14,000 (0.70  $20,000)
Taxable amount 20,000 6,000
Tax (40%) 8,000 2,400
After-tax amount 12,000 17,600
d. The after-tax amount of dividends received, $17,600,

$17,600, exceeds the after-tax amount of interest,
$12,000, due to the 70% corporate dividend exclusion. This increases the attractiveness of stock
investments by one corporation in another relative to bond investments.
e. Total tax liability:
Taxes on operating earnings (from a.) $196,000
 Taxes on interest income (from b.) 8,000
 Taxes on dividend income (from c.) 2,400
Total tax liability $206,400
P2-5. Interest vs. dividend expense
LG 6; Intermediate
a. EBIT $50,000
Less: Interest expense 12,000
Earnings before taxes $38,000
Less: Taxes (35%) 13,300
Earnings after taxes * $24,700
*
This is also earnings available to common stockholders.
. EBIT $50,000
Less: Taxes (35%) 17,500
Earnings after taxes $32,500
Less: Preferred dividends 12,000
Earnings available for
common stockholders $20,500

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P2-6. Capital gains taxes

LG 6; Basic
a. Capital gain:
Asset X  $2,250 –
$2,250 – $2,000
$2,000  $250
Asset Y  $35,000 –
$35,000 – $30,000
$30,000  $5,000
b. Tax on sale of asset:
Asset X  $250  0.40  $100
Asset Y  $5,000  0.40  $2,000
P2-7. Capital gains taxes

LG 6; Basic
a. and b.
Capital Gain Tax

Sale Price Purchase Price (1) – (2)
(2) (3) 0.40
Asset (1) (2) (3) (4)
$3,400 $3,000 $400 $160
B 12,000 12,000 0 0
C 80,000 62,000 18,000 7,200
45,000 41,000 4,000 1,600
E 18,000 16,500 1,500 600
P2-8. Ethics problem

LG 5; Intermediate
The primary ethical issue is whether the insider is basing his buy or sale of company shares on internal
information. If he is basing his decisions on information not a vailable to the general public, he would be
making decisions in an unethical manner. The insider may, for instance, be aware
a ware of the likelihood of a
favorable acquisition and unethically buy company shares on that knowledge. On the other hand, insider
sales based upon soon-to-be-released information about the loss of an important contract to a competitor
would also be unethical.
Case
Case studies are available on www.myfinancelab.com.
ThePros andCo
Cons
ns ofBei
ngPubl
icl
yLis ted
a. Being a publicly
publicly listed company
company provides access to the money the company needs to grow. Shareholders also
provide cash without
without having an ability to take the company to bankruptcy
bankruptcy court if a payment is notnot made.
Going public gives the owner a chance to get a return for his or her hard effort.
eff ort. By going public, the owner
owner
can diversify his or her portfolio. In fact, without going public, it is difficult to determine the value of the firm.

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b. There are many disadvantages

disadvantages to going public. One, there
there is no guarantee that shareholders
shareholders will want to
invest in one’s firm. If they avoid
avo id its shares, it will be priced below expected value. There also may be low
low
trading volume. Another disadvantage is that going public leaves the owner opens to the potential that an
individual or firm might purchase all the publicly available shares, or at least enough to control the board of
directors, and remove the founder from the management team.
c. Not enough information

information is provided
provided to determine
determine whether Robo-Tech meets
meets the listing
listing requirements to be on
the NYSE Euro next. That would be the goal because it is the largest and has the largest number of potential
investors.
d. Capital market efficiency

efficiency is important for many
many reasons. IfIf the market is efficient, prices are an unbiased
unbiased estimate
estimat e
of firm value. The better the estimate of fair value the more confidence investors have in the market place.
Having an increased number of potential investors helphelpss Robo-Tech sell shares now and a nd in the future, as it
continues to need funds to finance expansions.
(Students may expand on these answers.)
Spr
eads heetExerci
se
The answer to Chapter 2’s Hemingway Corporation spreadsheet problem is located on the Instructor’s Resource
Center at www.pearsonhighered.com/irc under the Instructor’s Manual .
G roupExer
cise
There is no group exercise for Chapter 2.
I
ntegr
a ti
veCa
Cas e1
:Mer
itEnter
pris eC orp.
a. There are limited
limited benefits and risks with Option
Option 1. With
With the loan,
loan, Merit will obtain the money needed and
will have to make periodic reports regarding its financial condition to the lenders. Option 1 results in an
interest expense and fixed date for the repayment of principal. As a sole proprietorship, however, Merit would
have less access to capital markets when it apparently needs a large cash infusion
i nfusion to enable a large production
expansion.
b. Option 2 has a much greater potential to impact Merit. If the firm’s recent financial performance has resulted
in this being an ideal time to go public, simply borrowing the needed funds would hold back the wealth that
could be amassed by Merit’s owners. As shareholders, the new owners would not be able to force Merit into
bankruptcy. In fact, the new owners
owners may not be paid a dividend
dividend at all for several years. Furthermore,
Furthermore, being
public allows employees
employees to benefit if their firm succeeds.
succeeds.
Other benefits include the fact that in corporations, owners have limited liability. This would allow the
current owners to only have their remaining investment at risk of complete loss. Stock sales may allow Merit
to become larger. The corporate form of business also extends Merit’s life bey ond the lifetime of the current
owner(s).
On the other hand, going public opens Merit up to a variety of issues. There is a cost of the initial public issue
and the subsequent reporting to the public. This reporting will give competitors more insight into the
company. Also, a majority of shares might be obtained by a single individual or business, effectively
acquiring Merit.

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Of course, the typical disadvantages of the corporate form of ownership would apply. Merit would pay
corporate tax. There also tends to be greater governmental regulation of corporations.
c. Sara Lehn should make her decision

decision on the basis
basis of which option
option will maximize
maximize the wealth of the current
owners. Merit’s fine financial performance will reportedly command a high price and make it possible to
offer incentives to employees. The risks would be spread out between the current owners and new owners.
Therefore, Sara should propose that Merit goes public at the upcoming meeting of the board of directors.

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Qdoc - Tips Principles of Managerial Finance 14th Edition Gitm

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Full file at https://testbankuni

Sugges tedA ns w ertoOpener-

Buyer’s equity in her home =

Rate of return = ($77,000 –

A ns w ers toReview Ques tions

© 2015 Pearson Education, Inc.

Full file at https://testbankuniv.eu/Principles

14 Gitman/Zutter • Principles of Managerial Finance, Fourteenth Edition

4. The capital market is

5. The broker market consists

© 2015 Pearson Education, Inc.

Full file at https://testbankuniv.eu/Principles

Chapter 2 The Financial Market Environment 15

10. When a homeowner borrows

11. As home prices decline,

12. A crisis in the

13. Due to their enormous

14. The Securities Act of 1933 was designed

© 2015 Pearson Education, Inc.

Full file at https://testbankuniv.eu/Principles

16 Gitman/Zutter • Principles of Managerial Finance, Fourteenth Edition

15. The ordinary income of a corporation is income earned through

17. The tax deductibility

Sugges tedA ns w ertoFocus on Pra

Sugges tedA ns w ertoFocus on Ethics Box:TheEthics ofI

Does allowing insider trading create an ethical dilemma for insiders?

© 2015 Pearson Education, Inc.

Full file at https://testbankuniv.eu/Principles

Chapter 2 The Financial Market Environment 17

A ns w ers toW arm-

E2-2 Raising funds

E2-3 Money market vs. capital market

E2-4 Mortgage-backed securities

E2-5 Biggest benefit of government regulation

© 2015 Pearson Education, Inc.

Full file at https://testbankuniv.eu/Principles

18 Gitman/Zutter • Principles of Managerial Finance, Fourteenth Edition

E2-6. Dividends received exclusion

P2-2. Average corporate tax rates

$10,000: Tax liability: $10,000  0.15  $1,500

$80,000: Tax liability: $13,750  [0.34  (80,000 –

$300,000: Tax liability: $22,250 + [0.39  ($300,000 –

© 2015 Pearson Education, Inc.

Full file at https://testbankuniv.eu/Principles

Chapter 2 The Financial Market Environment 19

$500,000: Tax liability: $113,900  [0.34  ($500,000 –

$1,500,000: Tax liability: $113,900  [0.34  ($1,500,000 –

$10,000,000: Tax liability: $113,900 + [0.34  ($10,000,000 –

$20,000,000: Tax liability: $6,416,667  [0.35  ($20,000,000 –

As income increases, the rate reaches 35%.

© 2015 Pearson Education, Inc.

Full file at https://testbankuniv.eu/Principles

20 Gitman/Zutter • Principles of Managerial Finance, Fourteenth Edition

P2-3. Marginal corporate tax rates

$ 15,000 $0 (0.15 15,000) $ 2,250 15.0%

© 2015 Pearson Education, Inc.

Full file at https://testbankuniv.eu/Principles

Chapter 2 The Financial Market Environment 21

P2-4. Interest vs. dividend income