Solutions Manual
Essentials of Corporate Finance
2025 Evergreen Release
Authors:
Stephen A. Ross
Randolph W. Westerfield
Bradford D. Jordan
ISBN: 9781265920159
Use for: Assignments | Exam Preparation | Concept Mastery
, TABLE OF CONTENTS
Chapter 1: Introduction to Financial Management
Chapter 2: Financial Statements, Taxes, and Cash Flow
Chapter 3: Working with Financial Statements
Chapter 4: Introduction to Valuation: The Time Value of Money
Chapter 5: Discounted Cash Flow Valuation
Chapter 6: Interest Rates and Bond Valuation
Chapter 7: Equity Markets and Stock Valuation
Chapter 8: Net Present Value and Other Investment Criteria
Chapter 9: Making Capital Investment Decisions
Chapter 10: Some Lessons from Capital Market History
Chapter 11: Risk and Return
Chapter 12: Cost of Capital
Chapter 13: Leverage and Capital Structure
Chapter 14: Dividends and Dividend Policy
Chapter 15: Raising Capital
Chapter 16: Short-Term Financial Planning
Chapter 17: Working Capital Management
Chapter 18: International Aspects of Financial Management
CHAPTER 1: INTRODUCTION TO CORPORATE FINANCE
Answers to Concepts Review and Critical Thinking Questions
1. Capital budgeting (deciding on whether to expand a manufacturing plant), capital structure
(deciding whether to issue new equity and use the proceeds to retire outstanding debt), and
working capital management (modifying the firm’s credit collection policy with its
customers).
2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, difficulty
in raising capital funds. Some advantages: simpler, less regulation, the owners are also the
managers, sometimes personal tax rates are better than corporate tax rates.
3. The primary disadvantage of the corporate form is the double taxation to shareholders of
distributed earnings and dividends. Some advantages include: limited liability, ease of
transferability, ability to raise capital, and unlimited life.
4. The treasurer’s office and the controller’s office are the two primary organizational groups
that report directly to the chief financial officer. The controller’s office handles cost and
financial accounting, tax management, and management information systems. The treasurer’s
, office is responsible for cash and credit management, capital budgeting, and financial
planning. Therefore, the study of corporate finance is concentrated within the functions of the
treasurer’s office.
5. To maximize the current market value (share price) of the equity of the firm (whether it’s
publicly traded or not).
6. 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 the share price of the equity of the firm.
7. A primary market transaction.
8. In auction markets like the NYSE, brokers and agents meet at a physical location (the
exchange) to buy and sell their assets. Dealer markets like NASDAQ represent dealers
operating in dispersed locales who buy and sell assets themselves, usually communicating
with other dealers electronically or literally over the counter.
9. Since such organizations frequently pursue social or political missions, many different goals
are conceivable. One goal that is often cited is revenue minimization; i.e., providing their
goods and services to society at the lowest possible cost. Another approach might be to
observe that even a not-for-profit business has equity. Thus, an appropriate goal would be to
maximize the value of the equity.
10. An argument can be made either way. At one extreme, we could argue that in a market
economy, all of these things are priced. This implies an optimal level of ethical and/or illegal
behavior and the framework of stock valuation explicitly includes these. At the other extreme,
we could argue that these are non-economic phenomena and are best handled through the
political process. The following is a classic (and highly relevant) thought question that
illustrates this debate: “A firm has estimated that the cost of improving the safety of one of its
products is $30 million. However, the firm believes that improving the safety of the product
will only save $20 million in product liability claims. What should the firm do?”
11. The goal will be the same, but the best course of action toward that goal may require
adjustments due to different social, political, and economic climates.
12. The goal of management should be to maximize the share price for the current shareholders.
If management believes that it can improve the profitability of the firm so that the share price
will exceed $35, then they should fight the offer from the outside company. If management
, believes that this bidder or other unidentified bidders will actually pay more than $35 per
share to acquire the company, then they should still fight the offer. However, if the current
management cannot increase the value of the firm beyond the bid price, and no other higher
bids come in, then management is not acting in the interests of the shareholders by fighting
the offer. Since current managers often lose their jobs when the corporation is acquired, poorly
monitored managers have an incentive to fight corporate takeovers in situations such as this.
13. We would expect agency problems to be less severe in other countries, primarily due to the
relatively 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 able to
implement more effective monitoring mechanisms than can individual owners, given
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.
14. How much is too much? Who is worth more, Michael Rapino or LeBron James? The simplest
answer is that there is a market for executives just as there is for all types of labor. Executive
compensation is the price that clears the market. The same is true for athletes and performers.
Having said that, one aspect of executive compensation deserves comment. A primary reason
executive compensation has grown so dramatically is that companies have increasingly
moved to stock-based compensation. Such movement is obviously consistent with the attempt
to better align stockholder and management interests. In recent years, stock prices have
soared, so management has cleaned up. It is sometimes argued that much of this reward is due
to rising stock prices in general, not managerial performance. Perhaps in the future, executive
compensation will be designed to reward only differential performance, i.e., stock price
increases in excess of general market increases.
15. The biggest reason that a company would “go dark” is because of the increased audit costs
associated with Sarbanes-Oxley compliance. A company should always do a cost-benefit
analysis, and it may be the case that the costs of complying with Sarbox outweigh the benefits.
Of course, the company could always be trying to hide financial issues of the company! This
is also one of the costs of going dark: Investors surely believe that some companies are going
dark to avoid the increased scrutiny from Sarbox. This taints other companies that go dark
just to avoid compliance costs. This is similar to the lemon problem with used automobiles:
Buyers tend to underpay because they know a certain percentage of used cars are lemons. So,
investors will tend to pay less for the company stock than they otherwise would. It is important
to note that even if the company delists, its stock is still likely traded, but on the over-the-
counter market pink sheets rather than on an organized exchange. This adds another cost since
Essentials of Corporate Finance
2025 Evergreen Release
Authors:
Stephen A. Ross
Randolph W. Westerfield
Bradford D. Jordan
ISBN: 9781265920159
Use for: Assignments | Exam Preparation | Concept Mastery
, TABLE OF CONTENTS
Chapter 1: Introduction to Financial Management
Chapter 2: Financial Statements, Taxes, and Cash Flow
Chapter 3: Working with Financial Statements
Chapter 4: Introduction to Valuation: The Time Value of Money
Chapter 5: Discounted Cash Flow Valuation
Chapter 6: Interest Rates and Bond Valuation
Chapter 7: Equity Markets and Stock Valuation
Chapter 8: Net Present Value and Other Investment Criteria
Chapter 9: Making Capital Investment Decisions
Chapter 10: Some Lessons from Capital Market History
Chapter 11: Risk and Return
Chapter 12: Cost of Capital
Chapter 13: Leverage and Capital Structure
Chapter 14: Dividends and Dividend Policy
Chapter 15: Raising Capital
Chapter 16: Short-Term Financial Planning
Chapter 17: Working Capital Management
Chapter 18: International Aspects of Financial Management
CHAPTER 1: INTRODUCTION TO CORPORATE FINANCE
Answers to Concepts Review and Critical Thinking Questions
1. Capital budgeting (deciding on whether to expand a manufacturing plant), capital structure
(deciding whether to issue new equity and use the proceeds to retire outstanding debt), and
working capital management (modifying the firm’s credit collection policy with its
customers).
2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, difficulty
in raising capital funds. Some advantages: simpler, less regulation, the owners are also the
managers, sometimes personal tax rates are better than corporate tax rates.
3. The primary disadvantage of the corporate form is the double taxation to shareholders of
distributed earnings and dividends. Some advantages include: limited liability, ease of
transferability, ability to raise capital, and unlimited life.
4. The treasurer’s office and the controller’s office are the two primary organizational groups
that report directly to the chief financial officer. The controller’s office handles cost and
financial accounting, tax management, and management information systems. The treasurer’s
, office is responsible for cash and credit management, capital budgeting, and financial
planning. Therefore, the study of corporate finance is concentrated within the functions of the
treasurer’s office.
5. To maximize the current market value (share price) of the equity of the firm (whether it’s
publicly traded or not).
6. 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 the share price of the equity of the firm.
7. A primary market transaction.
8. In auction markets like the NYSE, brokers and agents meet at a physical location (the
exchange) to buy and sell their assets. Dealer markets like NASDAQ represent dealers
operating in dispersed locales who buy and sell assets themselves, usually communicating
with other dealers electronically or literally over the counter.
9. Since such organizations frequently pursue social or political missions, many different goals
are conceivable. One goal that is often cited is revenue minimization; i.e., providing their
goods and services to society at the lowest possible cost. Another approach might be to
observe that even a not-for-profit business has equity. Thus, an appropriate goal would be to
maximize the value of the equity.
10. An argument can be made either way. At one extreme, we could argue that in a market
economy, all of these things are priced. This implies an optimal level of ethical and/or illegal
behavior and the framework of stock valuation explicitly includes these. At the other extreme,
we could argue that these are non-economic phenomena and are best handled through the
political process. The following is a classic (and highly relevant) thought question that
illustrates this debate: “A firm has estimated that the cost of improving the safety of one of its
products is $30 million. However, the firm believes that improving the safety of the product
will only save $20 million in product liability claims. What should the firm do?”
11. The goal will be the same, but the best course of action toward that goal may require
adjustments due to different social, political, and economic climates.
12. The goal of management should be to maximize the share price for the current shareholders.
If management believes that it can improve the profitability of the firm so that the share price
will exceed $35, then they should fight the offer from the outside company. If management
, believes that this bidder or other unidentified bidders will actually pay more than $35 per
share to acquire the company, then they should still fight the offer. However, if the current
management cannot increase the value of the firm beyond the bid price, and no other higher
bids come in, then management is not acting in the interests of the shareholders by fighting
the offer. Since current managers often lose their jobs when the corporation is acquired, poorly
monitored managers have an incentive to fight corporate takeovers in situations such as this.
13. We would expect agency problems to be less severe in other countries, primarily due to the
relatively 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 able to
implement more effective monitoring mechanisms than can individual owners, given
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.
14. How much is too much? Who is worth more, Michael Rapino or LeBron James? The simplest
answer is that there is a market for executives just as there is for all types of labor. Executive
compensation is the price that clears the market. The same is true for athletes and performers.
Having said that, one aspect of executive compensation deserves comment. A primary reason
executive compensation has grown so dramatically is that companies have increasingly
moved to stock-based compensation. Such movement is obviously consistent with the attempt
to better align stockholder and management interests. In recent years, stock prices have
soared, so management has cleaned up. It is sometimes argued that much of this reward is due
to rising stock prices in general, not managerial performance. Perhaps in the future, executive
compensation will be designed to reward only differential performance, i.e., stock price
increases in excess of general market increases.
15. The biggest reason that a company would “go dark” is because of the increased audit costs
associated with Sarbanes-Oxley compliance. A company should always do a cost-benefit
analysis, and it may be the case that the costs of complying with Sarbox outweigh the benefits.
Of course, the company could always be trying to hide financial issues of the company! This
is also one of the costs of going dark: Investors surely believe that some companies are going
dark to avoid the increased scrutiny from Sarbox. This taints other companies that go dark
just to avoid compliance costs. This is similar to the lemon problem with used automobiles:
Buyers tend to underpay because they know a certain percentage of used cars are lemons. So,
investors will tend to pay less for the company stock than they otherwise would. It is important
to note that even if the company delists, its stock is still likely traded, but on the over-the-
counter market pink sheets rather than on an organized exchange. This adds another cost since
