Capital budgeting mini case solution

Richardses’ Tree Farm Grows Up Case Study

Review the "Richardses' Tree Farm Grows Up - Mini Case" located in Chapter 1 of Financial Management: Core Concepts.

Develop a 1,050-word analysis of the case study.

Include the following:

· Analyze whether the major financial management decisions of the Richards family involve capital budgeting, capital structure, and working capital management.

· Explain whether the Richards family should form a regular corporation or choose one of the hybrid forms.

· Explain how incorporating will affect the Richards family's ability to transfer ownership to their children.

· Justify Jake's concerns with hiring professional management.

· Analyze whether incorporating will affect the Richards family's ability to give up a small amount of profit in exchange for protecting the environment.

· Evaluate how Jake might obtain more equity funding and perhaps create considerable wealth for the Richards family in the process.

Include at least two sources to justify your assignment.

Format your assignment consistent with APA guidelines.

See if you can use this information on this mini case for this assignment. Please do not copy word for word use your own words, because I have to put the paper through a checker to see if I copied anything from other sites.

Solutions to Mini-Case Questions

Richards’ Tree Farm Grows Up

This case requires students to review the major financial decisions faced by any business, and the

advantages and disadvantages of various forms of business organization with emphasis on

incorporation. It introduces the agency problem and ethical decisions, using examples that will

be familiar to most students.

1. Major financial management decisions involve capital budgeting, capital structure, and

working capital management. Give an example of each that relates to Richards’ Tree

Farm.

Capital Budgeting: Whether they know it or not, when the Richards decide to purchase any

asset with a significant cost and a useful life of more than a year, they are making a capital

budgeting decision. Examples include the purchase of digging and packaging equipment,

tractors, trucks, and buildings. Capital Structure: The Richards had to decide whether to finance these purchases with their

savings, by reinvesting profits, or with loans and leases. All of these financing decisions

involved the overall capital structure decision of how much debt and how much of their

personal equity they were willing to use.

Working Capital: The Richards always have inventories of trees at various stages of maturity

and available for sale. They sell to commercial clients on credit and purchase supplies used in

their operations on credit. They need cash to pay their suppliers and employees. In other

words, the Richards need to decide on a day-to-day basis the proper levels of working capital

accounts such as cash, inventory, accounts receivable, and accounts payable.

2. Should the Richards form a regular corporation or choose one of the hybrid forms?

Whichever form they use, they intend to distribute ownership equally among Jake, his

wife, and their two children so that each party will own 25% of the shares. Consider the

tax consequences of their decision.

The major advantage to incorporating is the separation of personal income and assets from

business income and assets. Either a regular corporation or one of the alternative forms (LLC

or Subchapter S) will accomplish this goal. The distribution of shares more or less assures

that Jake Richards and his wife will maintain a controlling interest in the business, but they

might have kept a small majority just to be sure. The Richards want to share some of their

wealth with their children now, and probably hope that they will remain involved in the

business, but there is no guarantee of that. As their children marry, their spouses may also

become part owners of significant shares of the business. Disharmony anywhere in the

immediate family has the potential to create a difficult situation potentially requiring the sale

of the business or some its assets. The distribution of shares could make the business more

difficult to sell because potential buyers will have to deal with several parties who may each

have a different agenda.

In theory, basic incorporation subjects the Richards to double taxation, because income

could be taxed once at the corporate level, and again when it is distributed as dividends. By

taking appropriate salaries from the business, however, they might be able to have lower

marginal rates on both personal and business income. If they use dividends as a means of

sharing wealth with their children, double taxation could be an issue.

Smaller businesses often choose hybrid forms of organization, such as a Subchapter S

Corporation or a Limited Liability Company. These are so-called “pass through”

organizations that are taxed like partnerships. These organizations avoid the “double

taxation” problem, but could require principals to pay taxes on money that has not been

withdrawn from the business.

How does incorporating affect the family’s overall risk exposure?

In theory, at least, any problems with the business will leave the Richards liable only for the

value of their investment. The worst that could happen would be a forced liquidation of the

business, which would be unfortunate, but would leave any personal wealth intact. However,

in smaller businesses like this one, loans often require personal guarantees from the principal

owners.

4. How does incorporating affect the ability of the business to expand?

Although incorporating a relatively small business would not automatically give it easy access

to the capital markets, the Richards might be able to obtain additional equity by selling shares

to outside investors. Additional equity would make it easier to borrow larger amounts.

Because of limited liability protection, the Richards also may be more willing to take on

additional debt.

5. Jake is concerned that if the business gets much bigger or if he should just decide to slow

down and enjoy life a little more, he will need to hire professional management and

possibly lose control over key business decisions. Are his concerns justified?

Corporations do create the possibility of separating ownership and management, but as long

as the Richards retain a clear majority of the shares, hired managers will serve at their

discretion. The Richards would have to decide how much money and effort they would be

willing to spend to detect and prevent agency problems.

6. Jake occasionally hires day workers, who may or may not be in the United States legally.

What are his legal and ethical obligations with respect to this decision?

Jake has a clear legal and ethical responsibility to verify the immigration status of all

employees, even temporary ones. Such a choice could lead to serious penalties that would

jeopardize the business. By doing so, Jake is also unwittingly exerting downward pressure on

the wages and employment benefits of legal agricultural workers.

7. The Richards are deeply concerned with environmental issues and know that the best

practices for pesticide and fertilizer usage increase production costs. Will incorporating

affect their ability to give up a small amount of profit in exchange for protecting the

environment?

Again, as long as the Richards maintain a controlling interest in the firm, they can establish

and enforce whatever policies they wish regarding the use of fertilizers and pesticides. If they

become minority shareholders or simply stop playing an active role in the management of

the business, profit pressures could make it difficult to follow best environmental practices.

At times, best practices such as avoiding unnecessary pesticide applications can actually

lower costs. Some customers may also be willing to pay a higher price for responsibly farmed

crops.

8. How does incorporating affect the Richards’ ability to transfer ownership of the tree

farm to their children?

Incorporating creates many convenient options for transferring ownership of the business.

The Richards can gradually sell or give their children increasing numbers of shares as they see

fit. If they hold shares at the time of their deaths, their will can arrange to distribute them

according to their wishes. Inherited shares are not subject to capital gains taxes at the time

they are received. Shares could also be sold to outside parties. If they choose the LLC form of

organization, which retains more features of partnerships, provisions for transferring

ownership will need to be carefully spelled out in the original agreement.

9. Suppose at some point in the future, this business has an opportunity to become much

larger. How might it obtain more equity funding and perhaps create considerable wealth

for the Richards family in the process?

A handful of similar businesses are publicly traded on NASDAQ (which will be discussed in

more detail in Chapter 7 on stocks), so it is possible to imagine that by acquiring other

properties and employing professional managers, the business could eventually become big

enough to warrant an initial public offering (which will be discussed in more detail in

Chapter 15 on raising capital). Such an event could raise large amounts of capital for the

business and allow the Richards to sell their shares at the market price. At present, however,

such an event seems rather unlikely. If the Richards have any such ambitions, they would be

better off organizing as a regular corporation rather than choosing one of the hybrid forms.

Richardses’ Tree Farm Grows Up Case Study

Review

the "Richardses' Tree Farm Grows Up

-

Mini Case" located in Chapter 1 of

Financial

Management: Core Concepts.

Develop

a 1,050

-

word analysis of the case study.

Include

the following:

·

Analyze whether the

major financial management decisions of the Richards family

involve capital budgeting, capital structure, and working capital management.

·

Explain whether the Richards family should form a regular corporation or choose one

of the hybrid forms.

·

Explain how i

ncorporating will affect the Richards family's ability to transfer

ownership to their children.

·

Justify Jake's concerns with hiring professional management.

·

Analyze whether incorporating will affect the Richards family's ability to give up a

small amount o

f profit in exchange for protecting the environment.

·

Evaluate how Jake might obtain more equity funding and perhaps create

considerable wealth for the Richards family in the process.

Include

at least two sources to justify your assignment.

Format

your assi

gnment consistent with APA guidelines.

See if you can use this information on this mini case for this

assignment. Please

do not copy

word for word use your own words,

because I have to put the paper

through

a checker to see if I copied

anything

from other sites.

Solutions to Mini

-

Case Questions

Richardses’ Tree Farm Grows Up Case Study

Review the "Richardses' Tree Farm Grows Up - Mini Case" located in Chapter 1 of Financial

Management: Core Concepts.

Develop a 1,050-word analysis of the case study.

Include the following:

 Analyze whether the major financial management decisions of the Richards family

involve capital budgeting, capital structure, and working capital management.

 Explain whether the Richards family should form a regular corporation or choose one

of the hybrid forms.

 Explain how incorporating will affect the Richards family's ability to transfer

ownership to their children.

 Justify Jake's concerns with hiring professional management.

 Analyze whether incorporating will affect the Richards family's ability to give up a

small amount of profit in exchange for protecting the environment.

 Evaluate how Jake might obtain more equity funding and perhaps create

considerable wealth for the Richards family in the process.

Include at least two sources to justify your assignment.

Format your assignment consistent with APA guidelines.

See if you can use this information on this mini case for this

assignment. Please do not copy word for word use your own words,

because I have to put the paper through a checker to see if I copied

anything from other sites.

Solutions to Mini-Case Questions