978-1133019145 Chapter 10 Solution Manual

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CHAPTER 10

The Corporate Financial Structure

THEME

Chapter 10 serves as an introduction to the

corporation’s financial structure. The purpose

of this chapter is to familiarize students with

the basic definitions and concepts dealing with

the financial structure of the corporation, es-

pecially equity and debt financing and divi-

dends.

CHAPTER GOAL

The goal of this chapter is for students to

become familiar with the following terms

and topics concerning corporate financial

matters:

• Various forms of capitalization available to

corporations

• Equity financing to raise capital for the cor-

poration

• Debt financing to raise capital for the corpo-

ration

• Consideration for stock, stock issuance, and

stock redemption

• Types of dividends and the requirements for

paying dividends

• Stock splits

• Secured transactions and the Uniform Com-

mercial Code

• The role of the corporate paralegal when

working with corporate financial matters

• Resources available to corporate paralegals

who may be assisting with corporate finan-

cial matters

SUGGESTED APPROACH

To allow students to relate the information in

this chapter to real life, this chapter may be

discussed with the aid of financial statements

and other financial information found in the

annual reports of publicly held corporations.

LECTURE NOTES

Corporate Capitalization

1. Three main concerns must be addressed re-

garding a corporation’s financial structure.

These concerns are the following:

(1) Its ability to raise and maintain the

level of capital necessary to operate

the business

(2) The distribution of earnings and prof-

its to its shareholders

(3) The division of its assets upon disso-

lution

2. A corporation’s capital generally includes

all of the corporation’s assets.

3. The amount of capital a corporation

needs will be determined by the board of

directors and corporate management.

Equity Financing

4. Equity financing involves the issuance

of shares of stock of the corporation in

exchange for cash or other consideration

that will become corporate capital.

5. Equity securities must be authorized in

the corporation’s articles of incorporation

and are typically designated as common

stock or preferred stock.

6. Corporate shares, or stock, are the basic

units into which corporate ownership is

divided. The corporation’s articles of in-

corporation must set forth the number

and type of shares the corporation is au-

thorized to issue.

7. Shares of stock that are authorized in the

articles are referred to as authorized

shares. Once consideration has been re-

ceived for shares of stock and those

shares have been delivered to the share-

holders, they are considered to be issued

and outstanding shares.

72 PART I Guide for Instructors and Answers to Chapter Review Questions

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8. The articles of incorporation must au-

thorize the following:

• One or more classes or series of

shares that together have unlimited

voting rights

• One or more classes or series of

shares (which may be the same class

or classes as those with voting rights)

that together are entitled to receive

the net assets of the corporation upon

dissolution

Common Stock

9. If shares are not designated otherwise, they

are considered shares of common stock.

10. Unless otherwise provided in the articles

of incorporation, owners of common

stock are entitled to the right to partici-

pate in the control of the corporation, a

pro rata share of the corporation’s profits,

and a pro rata share of the corporation’s

assets on dissolution.

11. Preferred Stock: Preferred stock enjoys

certain limited rights and privileges—

usually dividend and liquidation priori-

ties—over other outstanding stock.

12. The terms of the preferred stock are set

forth in the corporation’s articles of in-

corporation and on the face of the pre-

ferred stock certificate.

13. Preferred stock may be issued with re-

demption rights or conversion rights.

14. A corporation’s board of directors may

issue preferred stock to attract investors

who are interested in a more secure in-

vestment with a steady income.

Par Value

15. Par value is the nominal value assigned

to shares of stock, which is imprinted on

the face of the stock certificate as a dollar

value. The trend in modern corporate law

is to eliminate the par value requirement.

Consideration for Shares of Stock

16. Generally, any consideration deemed ad-

equate by the board of directors is ac-

ceptable for the payment of the initial

shares of stock.

Issuance of Stock

17. The initial shares of a corporation’s stock

are typically issued at the organizational

meeting with the execution of stock sub-

scription agreements and the issuance of

stock certificates.

18. Stock certificates include the name of the

corporation, the state under which the

corporation is organized, the name of the

person to whom the stock is issued, and

the number and class of shares and the

designation of the series, if any, repre-

sented by the certificate.

Redemption of Equity Shares

19. Redemption refers to the repurchase by a

corporation of its own shares of stock. Pre-

ferred stock is often issued with redemption

rights.

Dividends

20. Dividends, which may be paid only out of

the profits of the corporation, are payments

to the stockholders of a corporation as a re-

turn on their investment.

21. Directors are usually under no obligation

to declare a dividend in the corporation

and may decide that it is in the company’s

best interest to reinvest the surplus and

profits in the business. Once a dividend is

declared, it becomes an obligation of the

corporation to the shareholders entitled to

receive the dividend.

Stock Splits

22. Stock splits are used to lower the price of

a corporation’s stock. The effect of a split

is to split the value of each share of stock

into smaller denominations. Stock splits

CHAPTER 10 The Corporate Financial Structure 73

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increase the number of outstanding shares

of a corporation that represent its capital.

The actual amount of capital and surplus

remains unchanged.

Debt Financing

23. Debt financing refers to obtaining capital

through loans to the corporation, which

must be repaid with interest upon the

terms agreed to by contract between the

corporation and the lender. Debt is part of

the permanent capital structure of nearly

all established corporations.

24. The board of directors usually decides

include bank loans, commercial paper,

and bonds.

Secured Financing and the Uniform Com-

mercial Code (UCC)

25. Lenders will often require a security in-

26. When a lender assumes a security interest

in the borrower’s collateral, it is a secured

transaction. Secured transactions are sub-

ject to Article 9 of the UCC.

Equity Capital versus Debt Capital

27. The board of directors often works with

corporate management to determine the

optimal capital structure for the corpora-

tion—the best mix of both equity capital

and debt capital.

The Paralegal’s Role

28. Corporate paralegals may be involved in

researching questions concerning re-

quirements for debt and equity financing,

and for drafting several different types of

nancial structure.

29. Paralegals are often instrumental in clos-

ing large bank loans and debt financing

projects.

REVIEW QUESTIONS

1. The owners of A & S Marketing, Inc.

need financing to expand their business.

A & S has only three shareholders and

few assets. However, the company does

have a marketing plan for substantial,

sustained growth in revenue. What type

of financing may be most beneficial to

the owners of A & S Marketing, Inc.?

Debt financing may be best, but equity

Why?

The advantages to A & S Marketing,

Inc. for debt financing include a lower

cost of raising capital, tax deductibility

of interest, and no loss of control by

2. Assume that G&A Corporation, an estab-

lished manufacturing business, is owned

by six shareholders who all actively par-

ticipate in the business. G&A Corpora-

tion has an opportunity to enter into a

very lucrative new contract, but the cor-

poration needs $500,000 in capital to hire

extra personnel and design and build the

new equipment it will need to fulfill the

contract. Why might current shareholders

want to issue preferred stock to raise the

funds it will need?

If the six current shareholders all ac-

tively participate in the business, they

may wish to issue preferred stock

without voting rights. In doing so, the

74 PART I Guide for Instructors and Answers to Chapter Review Questions

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3. Assume the same circumstances as in

Question 2. Why might the current

shareholders want to use debt capital to

fund their expansion?

As with the issuance of preferred stock

with no voting rights, the six current

shareholders would not lose any con-

Corporation authorize “10,000 shares of

stock?

5. What two widely accepted requirements

must be granted to shareholders under the

MBCA?

At least one class of shareholders must

have full voting rights, and at least one

stock back to the corporation upon

8. What are conversion rights?

They are rights often granted to pre-

of preferred stock that allow the pre-

ferred shareholders to convert their

shares of preferred stock into common

stock at some specific point in time,

usually at the shareholders’ option.

9. What are some possible drawbacks to is-

suing stock with a par value?

• Par value stock may not be issued

• All consideration received for par

• State filing fees and taxes may be

10. What information is typically required to

be included on stock certificates?

• The name of the issuing corpora-

tion

• The state of domicile

11. The authorized stock of Rob’s Boat-

son for $800, what term is used to de-

scribe Mr. Peterson’s shares?

What are the possible consequences to

Mr. Peterson?

CHAPTER 10 The Corporate Financial Structure 75

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Mr. Peterson may be liable for the dif-