, SOLUTION MANUAL FOR
CFIN 8th Edition Besley
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Chapter 1: An Overview of Managerial Finance
Solution and Answer Guide
BESLEY AND BRIGHAM, CFIN, 8E, 2027, 9798214056692;
CHAPTER 1: AN OVERVIEW OF MANAGERIAL FINANCE
TABLE OF CONTENTS
Ethical Dilemma...........................................................................................................................1
Chances Are What They Don’t Know Won’t Hurt Them!...........................................................1
Chapter 1 Solutions .................................................................................................................... 3
Integrative Problem Solutions ................................................................................................. 10
ETHICAL DILEMMA
CHANCES ARE WHAT THEY DON’T KNOW WON’T HURT THEM!
Ethical dilemma:
It appears that the ethical dilemma is whether Futuristic Electronic Technologies (FET) should continue to
distribute its new micro system even though laboratory tests have shown the system might be flawed. To
make matters worse, as an executive with FET, your salary is based on the performance of the
company’s common stock, and it is expected the stock will not do well unless the new micro system is
successful. You need the new micro system to be successful to ensure the overall compensation you
earn from FET is sufficient to make the mortgage payments on the expensive house you just purchased.
What should you do?
Discussion questions:
Is there an ethical problem (dilemma)? If so, what is it?
You will get some interesting answers to these questions. In reality, the new micro system might not
be flawed. The information provided in the text indicates that the lab tests on the new micro system
are not conclusive—it is implied that additional tests are needed to reach more concrete conclusions.
If an ethical dilemma exists, it might be that FET is willing to introduce a new product without full
knowledge of its flaws; but this is not unusual in very competitive markets.
Should FET discontinue the distribution of its new micro system until further laboratory tests can be
completed?
Certainly, additional testing will give the company a better idea of whether a flaw actually exists, and,
if there is a flaw, to what degree it is harmful to customers. But, if distribution of the new micro system
is temporarily discontinued, FET’s competitors might be able to introduce their new systems and
significantly cut into FET’s share of the market. At the same time, if FET is not fully aware of any
flaws in its system, continuing to distribute a product of inferior quality might be extremely harmful to
the company’s reputation.
There is no clear answer to this question because the extent of the problem is unknown—the flaw
could be nonexistent, it could exist and be very insignificant, or it could exist and cause very
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Chapter 1: An Overview of Managerial Finance
significant difficulties for those customers purchasing the new micro system.
What action do you think FET should take?
There are a variety of responses to this question. Some students will suggest that FET ignore the flaw,
because it doesn’t seem to occur very often. Remind these students that the new micro system will be
used by such financial institutions as banks and savings and loan associations, by large corporations, and
by governments to store large amounts of financial data. If such data are lost, even once in 10 million
retrievals, the consequences could be devastating. Some students will suggest that FET should do “the
right thing,” and discontinue distribution until further testing is complete so it can be determined to what
extent a flaw does exist, and the necessary corrections can be made. A few students will suggest a third
alternative—continue to distribute the new micro system but inform those who buy it there is a possibility
that a flaw exists. In addition, inform the customers that the new micro system currently is undergoing
further tests, and the results will be publicly announced as soon as they are available. And, if it is
determined a flaw actually exists, corrections will be made at no cost to the customer, and with as little
interruption as possible.
References:
It is well documented in the business press that Intel Corporation was embroiled in controversy over a flaw in
the Pentium computer chip it introduced in 1994. The cost of replacing the flawed chips that were installed in
computers resulted in a fourth-quarter profit in 1994 that was
37 percent lower than the previous year. In addition, a number of lawsuits were filed accusing Intel of fraud,
false advertising, and various violations of state laws protecting consumers.
On the other hand, in part because of the controversy created by the Intel situation, in 1995,
Advanced Micro Devices, Inc. delayed the distribution of its new computer chip, which was intended to
compete directly with Intel’s Pentium chip, because it was felt technical corrections and additional testing
were needed.
You can find additional information concerning these two situations in articles that appear in The Wall
Street Journal at the end of 1994 and throughout 1995. The following articles might be assigned for
background material:
“Chip Shot: Computer Giants’ War over Flaw in Pentium Jolts the PC Industry,” The Wall Street Journal,
December 3, 1994, p. A1+.
“AMD Will Delay Delivery of New Chips Aimed at Competing with Intel Pentium,” The Wall Street Journal,
April 11, 1995, p. B5.
AnnickJesdanun, “Experts Spot Security Flaw in Windows Vista Software,” The Tampa Tribune,
December 27, 2006, Business 1+.
Other more recent examples can be found in the following articles:
Cade Metz and Nicole Perloth, “Researchers Discover Two Major Flaws in the World’s Computers,” The
New York Times, January 3, 2018. (http://www.nytimes.com) Available online at
https://www.nytimes.com/2018/01/03/business/computer-flaws.html.
Selena Larson, “Major Chip Flaws Affect Billions of Devices,” January 4, 2018, CNN Business.
(http://cnn.com/business) Available online at https://money.cnn.com/2018/01/03/
technology/computer-chip-flaw-security/index.html.
Roger Atiken, “Solving Blockchain’s Current Flaws & Enabling Future Mainstream Adoption.” Forbes,
February 28, 2019. (http://www.forbes.com) Available online at
https://www.forbes.com/sites/rogeraitken/2019/02/28/solving-blockchains-current-flaws-enabling-
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Chapter 1: An Overview of Managerial Finance
future-mainstream-adoption/#59bbeafa274b.
CHAPTER 1 SOLUTIONS
1-1 What is finance? What types of decisions do people in finance make? (LO 1-1)
Answer:
Finance deals with decisions about money. Finance decisions deal with how money is raised
and used by businesses, governments, and individuals. In business, decisions about cash
inflows include for what price products should be sold, how funds should be raised when firms
have good investment opportunities, and so forth. Decisions about cash outflows include what
expenses must be incurred, which investments should be purchased, and so forth.
1-2 Why should individuals who pursue careers in business have a basic understanding of finance
even if their jobs are in areas other than finance, such as marketing
or information systems? (LO 1-1)
Answer:
Simply stated, everyone should have a basic understanding of finance because everyone
faces financial decisions daily, whether those decisions are as simple as determining how
much money to carry in one’s pocket or they require more sophisticated thought processes,
such as the purchase of a house or planning for retirement. Persons who make business
decisions must understand finance because their decisions generally include an element of
finance in the sense that the results of their decisions generally require some type of funding to
be operationalized.
1-3 What does it mean to maximize the value of a corporation? (LO 1-3)
Answer:
The value of a firm can be measured by the market value of its stock. Thus, the firm maximizes
value/wealth by maximizing the value of its stock.
1-4 In general terms, how is value measured? What three factors determine value? How does
each factor affect value? (LO 1-3)
Answer:
Value is measured as the present value of the cash flows that an investment is expected to
generate during its life. The three factors that determine value are
(1) the amount of the future cash flows, (2) the timing of the future cash flows, and (3)
investors’ required rate of return. If the amount of the cash flows increases, the cash flows are
received sooner, investors’ required rate of return decreases, or any combination of these
events occur, the value of an investment will increase, and vice versa.
1-5 What is the difference between stock price maximization and profit maximization? Under what
conditions might profit maximization not lead to stock price maximization? (LO 1-3)
Answer:
A firm’s value is determined by the cash flows it is expected to generate long into the future, as well
as the risk associated with those expected cash flows. On the other hand, profit maximization is a
short-sighted goal because it doesn’t consider the impact on future earnings or the firm’s risk
position. Thus, profit maximization would not necessarily lead to stock price maximization. A firm
could maximize its current profit but go bankrupt in the near future by implementing “corner-cutting”
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Chapter 1: An Overview of Managerial Finance
measures that increase profits. Such measures might include not replacing equipment when it is
worn out, decreasing the quality of the product that is manufactured and sold, reducing the number
of employees, and so forth. Although cutting costs in this manner might maximize the firm’s net
income in the short term, it could lead to bankruptcy in the long run if the equipment required to
sustain operations ceases to work or customers take their business to competitors because the
quality of the products has declined.
1-6 What are some actions stockholders can take to ensure that management’s interests and the
interests of stockholders align? What are some other factors that might influence
management’s actions? (LO 1-3)
Answer:
Such factors as a compensation system that is based on management performance (e.g.,
bonuses tied to profits, stock option plans) as well as the possibility of being removed from
office (e.g., voted out of office, an unfriendly tender offer by another firm) serve to keep
management’s focus on stockholders’ interests. If a firm is taken over, or acquired, by another
firm, generally top management is let go. To help ensure that they are not in this position,
management should take steps to ensure the firm is operated as efficiently as possible.
Efficient firms generally are priced correctly in the financial markets, thus are not takeover
targets.
1-7 If you were the owner of a proprietorship, would you make decisions to maximize the value of
your business or your personal satisfaction? (LO 1-2 & LO 1-3)
Answer:
The answer to this question depends on which action satisfies you more as the sole owner of
the business. But chances are you would be inclined to maximize your personal satisfaction,
which does not preclude you from maximizing the value of the business. No agency problem
exists in a proprietorship because there is only one owner, and they are the person who makes
the day-to-day business decisions.
1-8 Suppose you are the president of a large corporation. How do you think the stockholders will
react if you decide to substantially increase the proportion of the company’s assets that is
financed with debt. (LO 1-3)
Answer:
Provided the rate of return on assets exceeds the interest rate on debt, greater use of debt will
raise the expected rate of return on stockholders’ equity. Also, the interest on debt is tax
deductible, which provides a further advantage. However,
(1) greater use of debt will have a negative impact on the stockholders if the company’s return
on assets falls below the cost of debt, and (2) increased use of debt increases the chances of
going bankrupt. The effects of the use of debt, called “financial leverage,” are discussed in
detail in Chapter 16.
1-9 What is corporate governance? How does corporate governance affect the returns generated
for stockholders? (LO 1-4)
Answer:
Corporate governance refers to the “set of rules” that a firm follows when conducting business. In
general, corporate governance relates to how a firm is operated. Corporate governance affects the
manner in which a firm approaches its decision-making tasks, treats its employees and customers,
constructs its financial statements, and so forth. Because its governance policy affects how a
company does business, corporate governance is a major factor that determines whether a firm
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accessible website, in whole or in part.
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Chapter 1: An Overview of Managerial Finance
“acts” ethically. If a firm does not have a good corporate governance policy—that is, a good set of
rules to follow—then there is a chance that management might behave unethically—either
intentionally or unintentionally—at some point. Firms that have good corporate governance policies
generally have higher values than firms that don’t.
1-10 Why do U.S. corporations go international? (LO 1-5)
Answer:
Firms “go international” for many reasons, including to seek new markets, to get access to raw
materials, and to avoid political hurdles, to name a few. Considering differential labor costs
abroad, transportation, tax advantages, and so forth, U.S. corporations can increase long-run
profits by “going international.” There are also nonprofit behavioral and strategic
considerations, such as maximizing market share and enhancing the prestige of corporate
officers.
1-11 What are some factors that make financial decision making more complicated for firms that
operate in foreign countries than for purely domestic firms? (LO 1-5)
Answer:
The general techniques and concepts applied by purely domestic firms are also valid for
multinational firms. But, factors, such as differences in currency, language, culture,
governmental relations, political risk, legal structure, and economy make financial decision
making more complicated for firms that operate in foreign countries include. These factors
increase the risks multinational firms face when making financial decisions.
1-12 Describe the four general areas included in the study of finance. Why is it important for a
person who works in the financial markets to understand the responsibilities of a person who
works in managerial finance, and vice versa? (LO 1-1)
Answer:
The general areas of study in finance include (1) financial markets and institutions, which
includes the study of the roles of banks, credit unions, and other financial organizations in the
financial markets; (2) investments, which focuses on how investments are valued and selected
to be included in portfolios; (3) financial services, which refers to the area of study that deals
with the management of money, primarily for individuals; and (4) managerial finance, which
deals with how firms make decisions about their cash flows, both inflows and outflows.
Simply stated, finance deals with how firms generate and use funds. To do a good job,
people must understand how all four of the areas of finance are related. For example, publicly
traded firms raise money in the financial markets, which means financial managers must
understand the financial markets. Likewise, persons who work in the financial markets must
understand the needs of publicly traded firms and of investors to ensure they are offering
appropriate financial products.
1-13 Describe the major differences among the three primary forms of business organization
(proprietorship, partnership, and corporation). (LO 1-2)
Answer:
Proprietorship, partnership, and corporation are the three principal forms of business
organization. The advantages of the first two include the ease and low cost of formation. The
advantages of the corporation include limited liability, indefinite life, ease of ownership transfer,
and access to capital markets.
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Chapter 1: An Overview of Managerial Finance
The disadvantages of proprietorships and partnerships are (1) difficulty in obtaining large sums
of capital; (2) unlimited personal liability for business debts; (3) limited life; and (4) difficulty of
transferring ownership. The disadvantages of a corporation are (1) double taxation of earnings
and (2) setting up a corporation and filing required state and federal reports often are complex
and time-consuming.
1-14 Why do you think hybrid forms of business, such as limited liability partnerships (LLP) and limited
liability companies (LLC), have evolved over time? (LO 1-2)
Answer:
Hybrid forms of business have been created over the years as the result of the needs of
businesspeople and investors. The hybrid forms of business generally include the advantages of
partnerships and corporations in one business. As business operations change in the future, so too
will the structure of business organizations.
1-15 What does it mean to be ethical in business dealings? Should unethical business behavior be
encouraged by business owners (stockholders) if such behavior increases the value of the
stock they own? (LO 1-3 and LO 1-4)
Answer:
Ethics refers to the attitude and behavior that a firm applies when dealing with stakeholders. A
firm must consider all its stakeholders—that is, investors, customers, employees, local
community, environment, and so forth—when conducting business; otherwise, it will not stay in
business for very long. For example, if a firm makes huge profits at the expense of its
customers, then the customers will quit purchasing from the firm when they discover how they
have been treated—the customers will either begin purchasing from competitors or find
substitute products to purchase. As a result, although their satisfaction does not have to be
maximized, the firm must find a way to keep all stakeholders happy. Likewise, if a firm focuses
only on its common stockholders, other stakeholders will take appropriate actions, which could
mean the death of the company. A firm that increases the value of its stock in the short run,
risks going out of business because such a short-run decision is short-sighted and can be
extremely harmful to the long-run success of the firm.
1-16 Can a firm sustain its operations by maximizing stockholders’ wealth at the expense of other
stakeholders? (LO 1-3)
Answer:
A firm must consider all its stakeholders—that is, investors, customers, employees, local
community, environment, and so forth—when conducting business; otherwise, it will not stay in
business for very long. For example, if a firm makes huge profits at the expense of its
customers, then the customers will quit purchasing from the firm when they discover how they
have been treated—the customers will either begin purchasing from competitors or find
substitute products to purchase. As a result, although their satisfaction does not have to be
maximized, the firm must find a way to keep all stakeholders happy. Likewise, if a firm focuses
only on its common stockholders, other stakeholders will take appropriate actions, which could
mean the death of the company.
1-17 Compared to the ownership structure of U.S. firms, which are “open” companies, what are
some advantages of the ownership structure of foreign firms, many of which are “closed”
companies? Can you think of any disadvantages? (LO 1-5)
Answer:
The corporate structure of foreign firms generally is characterized by greater concentration in
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Chapter 1: An Overview of Managerial Finance
ownership, which often means more involvement in ownership and operations by large lenders,
such as banks and other financial institutions, and by large groups or families. In many
instances, this means that banks, other financial institutions, and ownership groups can meet
most or all of the financing needs of a firm. In the United States, on the other hand, banks and
financial institutions are restricted in the amounts of corporate debt and stock they can own.
Thus, most large U.S. firms have very dispersed ownership structures because they must raise
needed funds from a large number of sources—it generally is not possible to get the large
amount of funds needed from a single source or even from very few sources. “One-stop”
financing outlets do not currently exist in the United States. It is argued that greater
concentration in ownership breeds fewer agency-related problems, so managers can better
focus on maximizing the wealth of the firm, which are also their self-fulfilling goals. In addition,
because creditors generally have a significant ownership position in the firm, it is in their best
interests to make sure the firm is successful. Therefore, when financial difficulties arise, such
creditors are perhaps more likely to “bail out” the company than creditors in the United States.
On the other hand, many argue that the foreign ownership structures create a corporate
environment in which managers can easily become entrenched. If true, it could be very difficult
to get rid of inefficient management. In addition, creditors might be too eager to try and save
failing firms, and hence turn “good money” into “bad money” instead of walking away and not
compounding their existing losses.
It is difficult to say which form of business organization is better—the “open” company with disperse
ownership that we have in the United States and Canada, or the more “closed” company with more
concentrated ownership that we find in Japan, Germany, and many other countries. Government
regulations, the sophistication of both the financial markets and the product markets, and the
culture of the country greatly impact which type of business organization works better.
1-18 Should stockholder wealth maximization be thought of as a long-term goal or a short-term
goal? Why? (LO 1-3)
Answer:
Stockholder wealth maximization is a long-run goal. Companies, and consequently the
stockholders, prosper when management makes decisions that will produce long-term
increases in earnings. Actions that are continually short-sighted often “catch up” with a firm
and, as a result, it may find itself unable to compete effectively with its competitors. There has
been much criticism in recent years that U.S. firms are too short-sighted, focusing on profits
rather than value. A prime example was the U.S. auto industry in the 1970s and early 1980s,
which was accused of continuing to build large “gas guzzler” automobiles because they had
higher profit margins rather than retooling for smaller, more fuel-efficient models.
1-19 Discuss the possibility of agency problems in a business that is a (a) proprietorship, (b)
partnership with five partners, and (c) corporation with 1 million stockholders. (LO 1-3)
Answer:
(a) Agency problems should not exist in a proprietorship, because there is only one owner,
who generally is the sole decision maker. The owner operates the business in a fashion that
will improve their own welfare. Thus, the owner can do whatever makes them happy, even if
such actions are harmful to the business.
(b) As more owners are included in a business, the likelihood of agency problems increases
because the potential for conflicts about how to promote the best interests of all owners
increases. As a result, the possibility of agency problems in a partnership is greater than
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accessible website, in whole or in part.
, Solution and Answer Guide: Besley and Brigham, CFIN, 8e, 2027, 9798214056692;
Chapter 1: An Overview of Managerial Finance
in a proprietorship. And, businesses with greater numbers of partners have greater
chances of experiencing agency problems.
(c) As mentioned in part (b), the greater the number of owners in a business, the greater the
possibility of agency problems. Consequently, we would expect the potential for agency
problems to be much greater in a corporation with 100,000 stockholders than in a
partnership with 100 partners. Similarly, we would expect the possibility of agency
problems to be even greater in a corporation that is publicly traded with millions of
stockholders.
1-20 Discuss the validity of the following statement: “When a firm’s stock price falls, it is evidence
that the firm’s managers are not acting in the best interests of the shareholders.” (LO 1-3)
Answer:
The statement is not valid in every instance. Clearly, there are cases in which a firm’s stock
price has declined as the result of managerial decisions that were not in the best interests of
shareholders. However, the stock prices of firms are also based on external factors, including
economic conditions. In a poor economy, the stock prices of most companies decline even
when management is making decisions that are considered in the best interests of their
shareholders.
1-21 Why do most firms form as proprietorships or partnerships when they first start doing business
and then change to the corporate form of business when they grow larger? (LO 1-2)
Answer:
Generally small businesses start as proprietorships and partnerships because these forms of
business are easy to set up. But, as a company becomes more successful and grows larger, it
probably should change from a proprietorship or a partnership to a corporation. A major reason
for changing to a corporation is to protect personal wealth—the owners of a corporation are not
personally liable for the debts of the business, whereas the owners of proprietorships and
partnerships are personally fully liable for all business debts. When a company becomes very
large, most owners believe that the limited liability offered by the corporate form of business is
extremely important. In addition, a corporation has additional sources available to raise funds,
because this type of business can issue debt and stock.
1-22 Describe how you think the landscape of financial management will change in the future as the
technologies used in fintech and artificial intelligence advance/improve. (LO 1-6)
Answer:
Technologies used in business, especially in finance, are changing rapidly. Fintech and AI
have revolutionized (1) the manner in which data are collected and analyzed (2) payment and
collection systems, (3) how finances are managed, (4) how companies interact with customers,
regulators, and other stakeholders, and (5) the decision-making processes firms implement.
Algorithms based on these technologies are able to collect and analyze data much faster than
previously, perform certain customer-related tasks, and evaluate complicated relationships
among a great number of factors to recommend decisions based on more accurate predictions
and to manage and mitigate the firm’s risk. Many tasks completed by humans now are
completed by fintech and AI.
In the future, fintech and AI will continue to restructure the way we perform business and make
business decisions. Future technologies will be developed to “act” more like humans—they will
be more intelligent, be able to learn from their past experiences, and perhaps even have some
rudimentary cognitive abilities.
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accessible website, in whole or in part.
CFIN 8th Edition Besley
Important Notes
The file includes the complete test bank, organized chapter by chapter.
A sample of selected pages has been provided for preview.
All available appendices and Excel files (if included in the original resources) are
provided.
We continuously update our files to ensure you receive the latest and most accurate
editions.
New editions are added regularly – stay connected for updates!
Purchase Guarantee
If you believe you have purchased the wrong file, don’t worry. Contact us anytime and we
will gladly replace it with the correct version.
Contact Email:
, Solution and Answer Guide: Besley and Brigham, CFIN, 8e, 2027, 9798214056692;
Chapter 1: An Overview of Managerial Finance
Solution and Answer Guide
BESLEY AND BRIGHAM, CFIN, 8E, 2027, 9798214056692;
CHAPTER 1: AN OVERVIEW OF MANAGERIAL FINANCE
TABLE OF CONTENTS
Ethical Dilemma...........................................................................................................................1
Chances Are What They Don’t Know Won’t Hurt Them!...........................................................1
Chapter 1 Solutions .................................................................................................................... 3
Integrative Problem Solutions ................................................................................................. 10
ETHICAL DILEMMA
CHANCES ARE WHAT THEY DON’T KNOW WON’T HURT THEM!
Ethical dilemma:
It appears that the ethical dilemma is whether Futuristic Electronic Technologies (FET) should continue to
distribute its new micro system even though laboratory tests have shown the system might be flawed. To
make matters worse, as an executive with FET, your salary is based on the performance of the
company’s common stock, and it is expected the stock will not do well unless the new micro system is
successful. You need the new micro system to be successful to ensure the overall compensation you
earn from FET is sufficient to make the mortgage payments on the expensive house you just purchased.
What should you do?
Discussion questions:
Is there an ethical problem (dilemma)? If so, what is it?
You will get some interesting answers to these questions. In reality, the new micro system might not
be flawed. The information provided in the text indicates that the lab tests on the new micro system
are not conclusive—it is implied that additional tests are needed to reach more concrete conclusions.
If an ethical dilemma exists, it might be that FET is willing to introduce a new product without full
knowledge of its flaws; but this is not unusual in very competitive markets.
Should FET discontinue the distribution of its new micro system until further laboratory tests can be
completed?
Certainly, additional testing will give the company a better idea of whether a flaw actually exists, and,
if there is a flaw, to what degree it is harmful to customers. But, if distribution of the new micro system
is temporarily discontinued, FET’s competitors might be able to introduce their new systems and
significantly cut into FET’s share of the market. At the same time, if FET is not fully aware of any
flaws in its system, continuing to distribute a product of inferior quality might be extremely harmful to
the company’s reputation.
There is no clear answer to this question because the extent of the problem is unknown—the flaw
could be nonexistent, it could exist and be very insignificant, or it could exist and cause very
© 2027 Cengage Learning, Inc. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly 1
accessible website, in whole or in part.
, Solution and Answer Guide: Besley and Brigham, CFIN, 8e, 2027, 9798214056692;
Chapter 1: An Overview of Managerial Finance
significant difficulties for those customers purchasing the new micro system.
What action do you think FET should take?
There are a variety of responses to this question. Some students will suggest that FET ignore the flaw,
because it doesn’t seem to occur very often. Remind these students that the new micro system will be
used by such financial institutions as banks and savings and loan associations, by large corporations, and
by governments to store large amounts of financial data. If such data are lost, even once in 10 million
retrievals, the consequences could be devastating. Some students will suggest that FET should do “the
right thing,” and discontinue distribution until further testing is complete so it can be determined to what
extent a flaw does exist, and the necessary corrections can be made. A few students will suggest a third
alternative—continue to distribute the new micro system but inform those who buy it there is a possibility
that a flaw exists. In addition, inform the customers that the new micro system currently is undergoing
further tests, and the results will be publicly announced as soon as they are available. And, if it is
determined a flaw actually exists, corrections will be made at no cost to the customer, and with as little
interruption as possible.
References:
It is well documented in the business press that Intel Corporation was embroiled in controversy over a flaw in
the Pentium computer chip it introduced in 1994. The cost of replacing the flawed chips that were installed in
computers resulted in a fourth-quarter profit in 1994 that was
37 percent lower than the previous year. In addition, a number of lawsuits were filed accusing Intel of fraud,
false advertising, and various violations of state laws protecting consumers.
On the other hand, in part because of the controversy created by the Intel situation, in 1995,
Advanced Micro Devices, Inc. delayed the distribution of its new computer chip, which was intended to
compete directly with Intel’s Pentium chip, because it was felt technical corrections and additional testing
were needed.
You can find additional information concerning these two situations in articles that appear in The Wall
Street Journal at the end of 1994 and throughout 1995. The following articles might be assigned for
background material:
“Chip Shot: Computer Giants’ War over Flaw in Pentium Jolts the PC Industry,” The Wall Street Journal,
December 3, 1994, p. A1+.
“AMD Will Delay Delivery of New Chips Aimed at Competing with Intel Pentium,” The Wall Street Journal,
April 11, 1995, p. B5.
AnnickJesdanun, “Experts Spot Security Flaw in Windows Vista Software,” The Tampa Tribune,
December 27, 2006, Business 1+.
Other more recent examples can be found in the following articles:
Cade Metz and Nicole Perloth, “Researchers Discover Two Major Flaws in the World’s Computers,” The
New York Times, January 3, 2018. (http://www.nytimes.com) Available online at
https://www.nytimes.com/2018/01/03/business/computer-flaws.html.
Selena Larson, “Major Chip Flaws Affect Billions of Devices,” January 4, 2018, CNN Business.
(http://cnn.com/business) Available online at https://money.cnn.com/2018/01/03/
technology/computer-chip-flaw-security/index.html.
Roger Atiken, “Solving Blockchain’s Current Flaws & Enabling Future Mainstream Adoption.” Forbes,
February 28, 2019. (http://www.forbes.com) Available online at
https://www.forbes.com/sites/rogeraitken/2019/02/28/solving-blockchains-current-flaws-enabling-
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Chapter 1: An Overview of Managerial Finance
future-mainstream-adoption/#59bbeafa274b.
CHAPTER 1 SOLUTIONS
1-1 What is finance? What types of decisions do people in finance make? (LO 1-1)
Answer:
Finance deals with decisions about money. Finance decisions deal with how money is raised
and used by businesses, governments, and individuals. In business, decisions about cash
inflows include for what price products should be sold, how funds should be raised when firms
have good investment opportunities, and so forth. Decisions about cash outflows include what
expenses must be incurred, which investments should be purchased, and so forth.
1-2 Why should individuals who pursue careers in business have a basic understanding of finance
even if their jobs are in areas other than finance, such as marketing
or information systems? (LO 1-1)
Answer:
Simply stated, everyone should have a basic understanding of finance because everyone
faces financial decisions daily, whether those decisions are as simple as determining how
much money to carry in one’s pocket or they require more sophisticated thought processes,
such as the purchase of a house or planning for retirement. Persons who make business
decisions must understand finance because their decisions generally include an element of
finance in the sense that the results of their decisions generally require some type of funding to
be operationalized.
1-3 What does it mean to maximize the value of a corporation? (LO 1-3)
Answer:
The value of a firm can be measured by the market value of its stock. Thus, the firm maximizes
value/wealth by maximizing the value of its stock.
1-4 In general terms, how is value measured? What three factors determine value? How does
each factor affect value? (LO 1-3)
Answer:
Value is measured as the present value of the cash flows that an investment is expected to
generate during its life. The three factors that determine value are
(1) the amount of the future cash flows, (2) the timing of the future cash flows, and (3)
investors’ required rate of return. If the amount of the cash flows increases, the cash flows are
received sooner, investors’ required rate of return decreases, or any combination of these
events occur, the value of an investment will increase, and vice versa.
1-5 What is the difference between stock price maximization and profit maximization? Under what
conditions might profit maximization not lead to stock price maximization? (LO 1-3)
Answer:
A firm’s value is determined by the cash flows it is expected to generate long into the future, as well
as the risk associated with those expected cash flows. On the other hand, profit maximization is a
short-sighted goal because it doesn’t consider the impact on future earnings or the firm’s risk
position. Thus, profit maximization would not necessarily lead to stock price maximization. A firm
could maximize its current profit but go bankrupt in the near future by implementing “corner-cutting”
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Chapter 1: An Overview of Managerial Finance
measures that increase profits. Such measures might include not replacing equipment when it is
worn out, decreasing the quality of the product that is manufactured and sold, reducing the number
of employees, and so forth. Although cutting costs in this manner might maximize the firm’s net
income in the short term, it could lead to bankruptcy in the long run if the equipment required to
sustain operations ceases to work or customers take their business to competitors because the
quality of the products has declined.
1-6 What are some actions stockholders can take to ensure that management’s interests and the
interests of stockholders align? What are some other factors that might influence
management’s actions? (LO 1-3)
Answer:
Such factors as a compensation system that is based on management performance (e.g.,
bonuses tied to profits, stock option plans) as well as the possibility of being removed from
office (e.g., voted out of office, an unfriendly tender offer by another firm) serve to keep
management’s focus on stockholders’ interests. If a firm is taken over, or acquired, by another
firm, generally top management is let go. To help ensure that they are not in this position,
management should take steps to ensure the firm is operated as efficiently as possible.
Efficient firms generally are priced correctly in the financial markets, thus are not takeover
targets.
1-7 If you were the owner of a proprietorship, would you make decisions to maximize the value of
your business or your personal satisfaction? (LO 1-2 & LO 1-3)
Answer:
The answer to this question depends on which action satisfies you more as the sole owner of
the business. But chances are you would be inclined to maximize your personal satisfaction,
which does not preclude you from maximizing the value of the business. No agency problem
exists in a proprietorship because there is only one owner, and they are the person who makes
the day-to-day business decisions.
1-8 Suppose you are the president of a large corporation. How do you think the stockholders will
react if you decide to substantially increase the proportion of the company’s assets that is
financed with debt. (LO 1-3)
Answer:
Provided the rate of return on assets exceeds the interest rate on debt, greater use of debt will
raise the expected rate of return on stockholders’ equity. Also, the interest on debt is tax
deductible, which provides a further advantage. However,
(1) greater use of debt will have a negative impact on the stockholders if the company’s return
on assets falls below the cost of debt, and (2) increased use of debt increases the chances of
going bankrupt. The effects of the use of debt, called “financial leverage,” are discussed in
detail in Chapter 16.
1-9 What is corporate governance? How does corporate governance affect the returns generated
for stockholders? (LO 1-4)
Answer:
Corporate governance refers to the “set of rules” that a firm follows when conducting business. In
general, corporate governance relates to how a firm is operated. Corporate governance affects the
manner in which a firm approaches its decision-making tasks, treats its employees and customers,
constructs its financial statements, and so forth. Because its governance policy affects how a
company does business, corporate governance is a major factor that determines whether a firm
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Chapter 1: An Overview of Managerial Finance
“acts” ethically. If a firm does not have a good corporate governance policy—that is, a good set of
rules to follow—then there is a chance that management might behave unethically—either
intentionally or unintentionally—at some point. Firms that have good corporate governance policies
generally have higher values than firms that don’t.
1-10 Why do U.S. corporations go international? (LO 1-5)
Answer:
Firms “go international” for many reasons, including to seek new markets, to get access to raw
materials, and to avoid political hurdles, to name a few. Considering differential labor costs
abroad, transportation, tax advantages, and so forth, U.S. corporations can increase long-run
profits by “going international.” There are also nonprofit behavioral and strategic
considerations, such as maximizing market share and enhancing the prestige of corporate
officers.
1-11 What are some factors that make financial decision making more complicated for firms that
operate in foreign countries than for purely domestic firms? (LO 1-5)
Answer:
The general techniques and concepts applied by purely domestic firms are also valid for
multinational firms. But, factors, such as differences in currency, language, culture,
governmental relations, political risk, legal structure, and economy make financial decision
making more complicated for firms that operate in foreign countries include. These factors
increase the risks multinational firms face when making financial decisions.
1-12 Describe the four general areas included in the study of finance. Why is it important for a
person who works in the financial markets to understand the responsibilities of a person who
works in managerial finance, and vice versa? (LO 1-1)
Answer:
The general areas of study in finance include (1) financial markets and institutions, which
includes the study of the roles of banks, credit unions, and other financial organizations in the
financial markets; (2) investments, which focuses on how investments are valued and selected
to be included in portfolios; (3) financial services, which refers to the area of study that deals
with the management of money, primarily for individuals; and (4) managerial finance, which
deals with how firms make decisions about their cash flows, both inflows and outflows.
Simply stated, finance deals with how firms generate and use funds. To do a good job,
people must understand how all four of the areas of finance are related. For example, publicly
traded firms raise money in the financial markets, which means financial managers must
understand the financial markets. Likewise, persons who work in the financial markets must
understand the needs of publicly traded firms and of investors to ensure they are offering
appropriate financial products.
1-13 Describe the major differences among the three primary forms of business organization
(proprietorship, partnership, and corporation). (LO 1-2)
Answer:
Proprietorship, partnership, and corporation are the three principal forms of business
organization. The advantages of the first two include the ease and low cost of formation. The
advantages of the corporation include limited liability, indefinite life, ease of ownership transfer,
and access to capital markets.
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Chapter 1: An Overview of Managerial Finance
The disadvantages of proprietorships and partnerships are (1) difficulty in obtaining large sums
of capital; (2) unlimited personal liability for business debts; (3) limited life; and (4) difficulty of
transferring ownership. The disadvantages of a corporation are (1) double taxation of earnings
and (2) setting up a corporation and filing required state and federal reports often are complex
and time-consuming.
1-14 Why do you think hybrid forms of business, such as limited liability partnerships (LLP) and limited
liability companies (LLC), have evolved over time? (LO 1-2)
Answer:
Hybrid forms of business have been created over the years as the result of the needs of
businesspeople and investors. The hybrid forms of business generally include the advantages of
partnerships and corporations in one business. As business operations change in the future, so too
will the structure of business organizations.
1-15 What does it mean to be ethical in business dealings? Should unethical business behavior be
encouraged by business owners (stockholders) if such behavior increases the value of the
stock they own? (LO 1-3 and LO 1-4)
Answer:
Ethics refers to the attitude and behavior that a firm applies when dealing with stakeholders. A
firm must consider all its stakeholders—that is, investors, customers, employees, local
community, environment, and so forth—when conducting business; otherwise, it will not stay in
business for very long. For example, if a firm makes huge profits at the expense of its
customers, then the customers will quit purchasing from the firm when they discover how they
have been treated—the customers will either begin purchasing from competitors or find
substitute products to purchase. As a result, although their satisfaction does not have to be
maximized, the firm must find a way to keep all stakeholders happy. Likewise, if a firm focuses
only on its common stockholders, other stakeholders will take appropriate actions, which could
mean the death of the company. A firm that increases the value of its stock in the short run,
risks going out of business because such a short-run decision is short-sighted and can be
extremely harmful to the long-run success of the firm.
1-16 Can a firm sustain its operations by maximizing stockholders’ wealth at the expense of other
stakeholders? (LO 1-3)
Answer:
A firm must consider all its stakeholders—that is, investors, customers, employees, local
community, environment, and so forth—when conducting business; otherwise, it will not stay in
business for very long. For example, if a firm makes huge profits at the expense of its
customers, then the customers will quit purchasing from the firm when they discover how they
have been treated—the customers will either begin purchasing from competitors or find
substitute products to purchase. As a result, although their satisfaction does not have to be
maximized, the firm must find a way to keep all stakeholders happy. Likewise, if a firm focuses
only on its common stockholders, other stakeholders will take appropriate actions, which could
mean the death of the company.
1-17 Compared to the ownership structure of U.S. firms, which are “open” companies, what are
some advantages of the ownership structure of foreign firms, many of which are “closed”
companies? Can you think of any disadvantages? (LO 1-5)
Answer:
The corporate structure of foreign firms generally is characterized by greater concentration in
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Chapter 1: An Overview of Managerial Finance
ownership, which often means more involvement in ownership and operations by large lenders,
such as banks and other financial institutions, and by large groups or families. In many
instances, this means that banks, other financial institutions, and ownership groups can meet
most or all of the financing needs of a firm. In the United States, on the other hand, banks and
financial institutions are restricted in the amounts of corporate debt and stock they can own.
Thus, most large U.S. firms have very dispersed ownership structures because they must raise
needed funds from a large number of sources—it generally is not possible to get the large
amount of funds needed from a single source or even from very few sources. “One-stop”
financing outlets do not currently exist in the United States. It is argued that greater
concentration in ownership breeds fewer agency-related problems, so managers can better
focus on maximizing the wealth of the firm, which are also their self-fulfilling goals. In addition,
because creditors generally have a significant ownership position in the firm, it is in their best
interests to make sure the firm is successful. Therefore, when financial difficulties arise, such
creditors are perhaps more likely to “bail out” the company than creditors in the United States.
On the other hand, many argue that the foreign ownership structures create a corporate
environment in which managers can easily become entrenched. If true, it could be very difficult
to get rid of inefficient management. In addition, creditors might be too eager to try and save
failing firms, and hence turn “good money” into “bad money” instead of walking away and not
compounding their existing losses.
It is difficult to say which form of business organization is better—the “open” company with disperse
ownership that we have in the United States and Canada, or the more “closed” company with more
concentrated ownership that we find in Japan, Germany, and many other countries. Government
regulations, the sophistication of both the financial markets and the product markets, and the
culture of the country greatly impact which type of business organization works better.
1-18 Should stockholder wealth maximization be thought of as a long-term goal or a short-term
goal? Why? (LO 1-3)
Answer:
Stockholder wealth maximization is a long-run goal. Companies, and consequently the
stockholders, prosper when management makes decisions that will produce long-term
increases in earnings. Actions that are continually short-sighted often “catch up” with a firm
and, as a result, it may find itself unable to compete effectively with its competitors. There has
been much criticism in recent years that U.S. firms are too short-sighted, focusing on profits
rather than value. A prime example was the U.S. auto industry in the 1970s and early 1980s,
which was accused of continuing to build large “gas guzzler” automobiles because they had
higher profit margins rather than retooling for smaller, more fuel-efficient models.
1-19 Discuss the possibility of agency problems in a business that is a (a) proprietorship, (b)
partnership with five partners, and (c) corporation with 1 million stockholders. (LO 1-3)
Answer:
(a) Agency problems should not exist in a proprietorship, because there is only one owner,
who generally is the sole decision maker. The owner operates the business in a fashion that
will improve their own welfare. Thus, the owner can do whatever makes them happy, even if
such actions are harmful to the business.
(b) As more owners are included in a business, the likelihood of agency problems increases
because the potential for conflicts about how to promote the best interests of all owners
increases. As a result, the possibility of agency problems in a partnership is greater than
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Chapter 1: An Overview of Managerial Finance
in a proprietorship. And, businesses with greater numbers of partners have greater
chances of experiencing agency problems.
(c) As mentioned in part (b), the greater the number of owners in a business, the greater the
possibility of agency problems. Consequently, we would expect the potential for agency
problems to be much greater in a corporation with 100,000 stockholders than in a
partnership with 100 partners. Similarly, we would expect the possibility of agency
problems to be even greater in a corporation that is publicly traded with millions of
stockholders.
1-20 Discuss the validity of the following statement: “When a firm’s stock price falls, it is evidence
that the firm’s managers are not acting in the best interests of the shareholders.” (LO 1-3)
Answer:
The statement is not valid in every instance. Clearly, there are cases in which a firm’s stock
price has declined as the result of managerial decisions that were not in the best interests of
shareholders. However, the stock prices of firms are also based on external factors, including
economic conditions. In a poor economy, the stock prices of most companies decline even
when management is making decisions that are considered in the best interests of their
shareholders.
1-21 Why do most firms form as proprietorships or partnerships when they first start doing business
and then change to the corporate form of business when they grow larger? (LO 1-2)
Answer:
Generally small businesses start as proprietorships and partnerships because these forms of
business are easy to set up. But, as a company becomes more successful and grows larger, it
probably should change from a proprietorship or a partnership to a corporation. A major reason
for changing to a corporation is to protect personal wealth—the owners of a corporation are not
personally liable for the debts of the business, whereas the owners of proprietorships and
partnerships are personally fully liable for all business debts. When a company becomes very
large, most owners believe that the limited liability offered by the corporate form of business is
extremely important. In addition, a corporation has additional sources available to raise funds,
because this type of business can issue debt and stock.
1-22 Describe how you think the landscape of financial management will change in the future as the
technologies used in fintech and artificial intelligence advance/improve. (LO 1-6)
Answer:
Technologies used in business, especially in finance, are changing rapidly. Fintech and AI
have revolutionized (1) the manner in which data are collected and analyzed (2) payment and
collection systems, (3) how finances are managed, (4) how companies interact with customers,
regulators, and other stakeholders, and (5) the decision-making processes firms implement.
Algorithms based on these technologies are able to collect and analyze data much faster than
previously, perform certain customer-related tasks, and evaluate complicated relationships
among a great number of factors to recommend decisions based on more accurate predictions
and to manage and mitigate the firm’s risk. Many tasks completed by humans now are
completed by fintech and AI.
In the future, fintech and AI will continue to restructure the way we perform business and make
business decisions. Future technologies will be developed to “act” more like humans—they will
be more intelligent, be able to learn from their past experiences, and perhaps even have some
rudimentary cognitive abilities.
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