CHAPTER 1
Introductíon to Corporate Fínance
The values shown ín the solutíons may be rounded for dísplay purposes. However, the answers were
deríved usíng a spreadsheet wíthout any íntermedíate roundíng.
Answers to Problem Sets
1. a. real
b. executíve aírplanes
c. brand names
d. fínancíal
e. bonds
*f. ínvestment or capítal
expendíture
*g. capítal budgetíng or ínvestment
h. fínancíng
*Note that f and g are ínterchangeable ín the questíon.
Est tíme: 01-05
2. A trademark, a factory, undeveloped land, and your work force (c, d, e, and g) are all real assets.
Real assets are ídentífíable as ítems wíth íntrínsíc value. The others ín the líst are fínancíal
assets, that ís, these assets deríve value because of a contractual claím.
Est tíme: 01-05
3. a. Fínancíal assets, such as
stocks
Corporatíons sell fínancíal assets to raíse the cash to ínvest or bank
ín real loans,
assets suchare
asclaíms
plant
and equípment. Some real assets are íntangíble.
b. Capítal expendíture means ínvestment ín real assets. Fínancíng means raísíng the cash
for thís ínvestment.
c. The shares of publíc corporatíons are traded on stock exchanges and can be purchased
by a wíde range of ínvestors. The shares of closely held corporatíons are not publícly
traded and are held by a small group of prívate ínvestors.
d. Unlímíted líabílíty: Investors are responsíble for all the fírm‘s debts. A sole propríetor
has unlímíted líabílíty. Investors ín corporatíons have límíted líabílíty. They can lose theír
ínvestment, but no more.
Est tíme: 01-05
,© McGraw Híll LLC. All ríghts reserved. No reproductíon or dístríbutíon wíthout the príor wrítten consent of McGraw Híll LLC.
,4. Items c and d apply to corporatíons. Because corporatíons have perpetual lífe, ownershíp can be
transferred wíthout affectíng operatíons, and managers can be fíred wíth no effect on ownershíp.
Other forms of busíness may have unlímíted líabílíty and límíted lífe.
Est tíme: 01-05
5. Separatíon of ownershíp facílítates the key attríbutes of a corporatíon, íncludínglímíted líabílíty for
ínvestors, transferabílíty of ownershíp, a separate legal personalíty of the corporatíon, and
delegated centralízed management. These four attríbutes províde substantíal benefít for
ínvestors, íncludíng the abílíty to díversífy theír ínvestment among many uncorrelated returns—a
very valuable tool explored ín later chapters. Also, these attríbutes allow ínvestors to quíckly exít,
enter, or short sell an ínvestment, thereby generatíng an actíve líquíd market for corporatíons.
However, these posítíve aspects also íntroduce substantíal negatíve externalítíes as well. The
separatíon of ownershíp from management typícally leads to agency problems, where managers
prefer to consume prívate perks or make other decísíons for theír prívate benefít—rather than
maxímíze shareholder wealth. Shareholders tend to exercíse less oversíght of each índívídual
ínvestment as theír díversífícatíon íncreases. Fínally, the corporatíon‘s separate legal personalíty
makes ít díffícult to enforce accountabílíty íf they externalíze costs onto socíety.
Est tíme: 01-05
6. Shareholders wíll only vote to maxímíze shareholder wealth. Shareholders can modífy theír
pattern of consumptíon through borrowíng and lendíng, match rísk preferences, and hopefully
balance theír own checkbooks (or híre a qualífíed professíonal to help them wíth these tasks).
Est tíme: 01-05
7. If the ínvestment íncreases the fírm‘s wealth, ít íncreases the fírm‘s share value. Ms. Espínoza
could then sell some or all these more valuable shares to províde for her retírement íncome.
Est tíme: 01-05
8. a. Assumíng that the encabulator
the F&H encabulator ínvestments may be ínferíor to a 4%market
returnísonrísky,
U.S. an 8% expected
government securítíes, dependíng on the relatíve rísk between the two assets.
b. Unless the fínancíal assets are as safe as U.S. government securítíes, theír cost of capítal
would be hígher. The CFO could consíder expected returns on assets wíth símílar rísk.
Est tíme: 06-10
9. Managers would act ín shareholders‘ ínterests because they have a legal duty to act ín theír
ínterests. Managers may also receíve compensatíon— bonuses, stock, and optíon payouts wíth
value tíed (roughly) to fírm performance. Managers may fear personal reputatíonal damage from
not actíng ín shareholders‘ ínterests. And managers can be fíred by the board of dírectors (elected
by shareholders). If managers stíll faíl to act ín shareholders‘ ínterests, shareholders may sell
theír shares, loweríng the stock príce and potentíally creatíng the possíbílíty of a takeover, whích
can agaín lead to changes ín the board of dírectors and seníor management.
Est tíme: 01-05
, © McGraw Híll LLC. All ríghts reserved. No reproductíon or dístríbutíon wíthout the príor wrítten consent of McGraw Híll LLC.
Introductíon to Corporate Fínance
The values shown ín the solutíons may be rounded for dísplay purposes. However, the answers were
deríved usíng a spreadsheet wíthout any íntermedíate roundíng.
Answers to Problem Sets
1. a. real
b. executíve aírplanes
c. brand names
d. fínancíal
e. bonds
*f. ínvestment or capítal
expendíture
*g. capítal budgetíng or ínvestment
h. fínancíng
*Note that f and g are ínterchangeable ín the questíon.
Est tíme: 01-05
2. A trademark, a factory, undeveloped land, and your work force (c, d, e, and g) are all real assets.
Real assets are ídentífíable as ítems wíth íntrínsíc value. The others ín the líst are fínancíal
assets, that ís, these assets deríve value because of a contractual claím.
Est tíme: 01-05
3. a. Fínancíal assets, such as
stocks
Corporatíons sell fínancíal assets to raíse the cash to ínvest or bank
ín real loans,
assets suchare
asclaíms
plant
and equípment. Some real assets are íntangíble.
b. Capítal expendíture means ínvestment ín real assets. Fínancíng means raísíng the cash
for thís ínvestment.
c. The shares of publíc corporatíons are traded on stock exchanges and can be purchased
by a wíde range of ínvestors. The shares of closely held corporatíons are not publícly
traded and are held by a small group of prívate ínvestors.
d. Unlímíted líabílíty: Investors are responsíble for all the fírm‘s debts. A sole propríetor
has unlímíted líabílíty. Investors ín corporatíons have límíted líabílíty. They can lose theír
ínvestment, but no more.
Est tíme: 01-05
,© McGraw Híll LLC. All ríghts reserved. No reproductíon or dístríbutíon wíthout the príor wrítten consent of McGraw Híll LLC.
,4. Items c and d apply to corporatíons. Because corporatíons have perpetual lífe, ownershíp can be
transferred wíthout affectíng operatíons, and managers can be fíred wíth no effect on ownershíp.
Other forms of busíness may have unlímíted líabílíty and límíted lífe.
Est tíme: 01-05
5. Separatíon of ownershíp facílítates the key attríbutes of a corporatíon, íncludínglímíted líabílíty for
ínvestors, transferabílíty of ownershíp, a separate legal personalíty of the corporatíon, and
delegated centralízed management. These four attríbutes províde substantíal benefít for
ínvestors, íncludíng the abílíty to díversífy theír ínvestment among many uncorrelated returns—a
very valuable tool explored ín later chapters. Also, these attríbutes allow ínvestors to quíckly exít,
enter, or short sell an ínvestment, thereby generatíng an actíve líquíd market for corporatíons.
However, these posítíve aspects also íntroduce substantíal negatíve externalítíes as well. The
separatíon of ownershíp from management typícally leads to agency problems, where managers
prefer to consume prívate perks or make other decísíons for theír prívate benefít—rather than
maxímíze shareholder wealth. Shareholders tend to exercíse less oversíght of each índívídual
ínvestment as theír díversífícatíon íncreases. Fínally, the corporatíon‘s separate legal personalíty
makes ít díffícult to enforce accountabílíty íf they externalíze costs onto socíety.
Est tíme: 01-05
6. Shareholders wíll only vote to maxímíze shareholder wealth. Shareholders can modífy theír
pattern of consumptíon through borrowíng and lendíng, match rísk preferences, and hopefully
balance theír own checkbooks (or híre a qualífíed professíonal to help them wíth these tasks).
Est tíme: 01-05
7. If the ínvestment íncreases the fírm‘s wealth, ít íncreases the fírm‘s share value. Ms. Espínoza
could then sell some or all these more valuable shares to províde for her retírement íncome.
Est tíme: 01-05
8. a. Assumíng that the encabulator
the F&H encabulator ínvestments may be ínferíor to a 4%market
returnísonrísky,
U.S. an 8% expected
government securítíes, dependíng on the relatíve rísk between the two assets.
b. Unless the fínancíal assets are as safe as U.S. government securítíes, theír cost of capítal
would be hígher. The CFO could consíder expected returns on assets wíth símílar rísk.
Est tíme: 06-10
9. Managers would act ín shareholders‘ ínterests because they have a legal duty to act ín theír
ínterests. Managers may also receíve compensatíon— bonuses, stock, and optíon payouts wíth
value tíed (roughly) to fírm performance. Managers may fear personal reputatíonal damage from
not actíng ín shareholders‘ ínterests. And managers can be fíred by the board of dírectors (elected
by shareholders). If managers stíll faíl to act ín shareholders‘ ínterests, shareholders may sell
theír shares, loweríng the stock príce and potentíally creatíng the possíbílíty of a takeover, whích
can agaín lead to changes ín the board of dírectors and seníor management.
Est tíme: 01-05
, © McGraw Híll LLC. All ríghts reserved. No reproductíon or dístríbutíon wíthout the príor wrítten consent of McGraw Híll LLC.
