Solutions Manual n
Fundamentals of Corporate Finance 8th editionRos
n n n n n n
s, Westerfield, and Jordan
n n n
Updated 03-05-2007
n
,
,CHAPTER 1 n
INTRODUCTION TO CORPORATE n n n
FINANCE
AnswersntonConceptsnReviewnandnCriticalnThinkingnQuestions
1. Capitalnbudgetingn(decidingnwhetherntonexpandnanmanufacturingnplant),ncapitalnstructuren(decidingnwh
etherntonissuennewnequitynandnusenthenproceedsntonretirenoutstandingndebt),nandnworkingncapitalnmanage
mentn(modifyingnthenfirm’sncreditncollectionnpolicynwithnitsncustomers).
2. Disadvantages:nunlimitednliability,nlimitednlife,ndifficultyninntransferringnownership,nhardntonraisencapit
alnfunds.nSomenadvantages:nsimpler,nlessnregulation,nthenownersnarenalsonthenmanagers,nsometimesnper
sonalntaxnratesnarenbetternthanncorporatentaxnrates.
3. Thenprimaryndisadvantagenofnthencorporatenformnisnthendoublentaxationntonshareholdersnofndistributedne
arningsnandndividends.nSomenadvantagesninclude:nlimitednliability,neasenofntransferability,nabilityntonrai
sencapital,nunlimitednlife,nandnsonforth.
4. InnresponsentonSarbanes-
Oxley,nsmallnfirmsnhavenelectedntongondarknbecausenofnthencostsnofncompliance.nThencostsntoncomplynw
ithnSarboxncannbenseveralnmillionndollars,nwhichncannbenanlargenpercentagen ofn an smalln firmsn profits.n A
n majorn costn ofn goingn darkn isn lessn accessn ton capital.n Sincen thenfirmnisnnonlongernpubliclyntraded,nitncann
nonlongernraisenmoneyninnthenpublicnmarket.nAlthoughnthencompanynwillnstillnhavenaccessntonbanknloans
nandnthenprivatenequitynmarket,nthencostsnassociatednwithnraisingnfundsninnthesenmarketsnarenusuallynhig
hernthannthencostsnofnraisingnfundsninnthenpublicnmarket.
5. Then treasurer’sn officen andn then controller’sn officen aren then twon primaryn organizationaln groupsn thatnr
eportndirectlyntonthenchiefnfinancialnofficer.nThencontroller’snofficenhandlesncostnandnfinancialnaccountin
g,ntaxnmanagement,nandnmanagementninformationnsystems,nwhilenthentreasurer’snofficenisnresponsiblen
forn cashn andn creditn management,n capitaln budgeting,n andn financialn planning.n Therefore,nthenstudynofn
corporatenfinancenisnconcentratednwithinnthentreasuryngroup’snfunctions.
6. Tonmaximizenthencurrentnmarketnvaluen(sharenprice)nofnthenequitynofnthenfirmn(whethernit’snpublicly-
ntradednornnot).
7. Innthencorporatenformnofnownership,nthenshareholdersnarenthenownersnofnthenfirm.nThenshareholdersnelec
tnthendirectorsnofnthencorporation,nwhoninnturnnappointnthenfirm’snmanagement.nThisnseparationnofnowne
rshipnfromncontrolninnthencorporatenformnofnorganizationnisnwhatncausesnagencynproblemsntonexist.nMan
agementnmaynactninnitsnownnornsomeonenelse’snbestninterests,nrathernthannthosenofnthenshareholders.nIfns
uchneventsnoccur,ntheynmayncontradictnthengoalnofnmaximizingnthensharenpricenofnthenequitynofnthenfirm.
8. Anprimarynmarketntransaction.
, B-2n SOLUTIONS
9. InnauctionnmarketsnlikenthenNYSE,nbrokersnandnagentsnmeetnatnanphysicalnlocationn(thenexchange)ntonm
atchnbuyersnandnsellersnofnassets.nDealernmarketsnlikenNASDAQnconsistnofndealersnoperatingnatndispers
ednlocalesnwhonbuynandnsellnassetsnthemselves,ncommunicatingnwithnotherndealersneithernelectronically
nornliterallyn over-the-counter.
10. Suchnorganizationsnfrequentlynpursuensocialnornpoliticalnmissions,nsonmanyndifferentngoalsnarenconceiv
able.nOnengoalnthatnisnoftenncitednisnrevenuenminimization;ni.e.,nprovidenwhateverngoodsnandnservicesna
renofferednatnthenlowestnpossiblencostntonsociety.nAnbetternapproachnmightnbentonobserventhatnevennannot
-for-
profitnbusinessnhasnequity.nThus,nonenanswernisnthatnthenappropriatengoalnisn tonmaximizenthenvaluenofnt
henequity.
11. Presumably,nthencurrentnstocknvaluenreflectsnthenrisk,ntiming,nandnmagnitudenofnallnfuturencashnflows,nb
othnshort-termnandnlong-term.nIfnthisnisncorrect,nthennthenstatementnisnfalse.
12. Annargumentncannbenmadeneithernway.nAtnthenonenextreme,nwencouldnarguenthatninnanmarketneconomy,na
llnofnthesenthingsnarenpriced.nTherenisnthusnannoptimalnlevelnof,nfornexample,nethicalnand/ornillegalnbehav
ior,nandnthenframeworknofnstocknvaluationnexplicitlynincludesnthese.nAtnthenothernextreme,nwencouldnarg
uenthatnthesenarennon-
economicnphenomenanandnarenbestnhandlednthroughnthenpoliticalnprocess.nAnclassicn(andnhighlynreleva
nt)nthoughtnquestionnthatnillustratesnthisndebatengoesnsomethingnlikenthis:n“Anfirmnhasnestimatednthatnth
encostnofnimprovingnthensafetynofnonenofnitsnproductsnisn$30nmillion.nHowever,nthenfirmnbelievesnthatnim
provingnthensafetynofnthenproductnwillnonlynsaven$20nmillionninnproductnliabilitynclaims.nWhatnshouldnt
henfirmndo?”
13. Thengoalnwillnbenthensame,nbutnthenbestncoursenofnactionntowardnthatngoalnmaynbendifferentnbecausenofnd
ifferingnsocial,npolitical,nandneconomicninstitutions.
14. Thengoalnofnmanagementnshouldnbentonmaximizenthensharenpricenfornthencurrentnshareholders.nIfnmanag
ementnbelievesnthatnitncannimproventhenprofitabilitynofnthenfirmnsonthatnthensharenpricenwillnexceedn$35,n
thenntheynshouldnfightnthenoffernfromnthenoutsidencompany.nIfnmanagementnbelievesnthatnthisnbiddernorn
othernunidentifiednbiddersnwillnactuallynpaynmorenthann$35npernsharentonacquirenthencompany,nthennthe
ynshouldnstillnfightnthenoffer.nHowever,nifnthencurrentnmanagementncannotnincreasenthenvaluenofnthenfir
mnbeyondnthenbidnprice,nandnnonothernhighernbidsncomenin,nthennmanagementnisnnotnactingninnthenintere
stsnofnthenshareholdersnbynfightingnthenoffer.nSincencurrentnmanagersnoftennlosentheirnjobsnwhennthencor
porationnisnacquired,npoorlynmonitorednmanagersnhavenannincentiventonfightncorporatentakeoversninnsitu
ationsnsuchnasnthis.
15. Wenwouldnexpectnagencynproblemsntonbenlessnsevereninnotherncountries,nprimarilynduentonthenrelativelyns
mallnpercentagenofnindividualnownership.nFewernindividualnownersnshouldnreducenthennumbernofndiver
senopinionsnconcerningncorporatengoals.nThenhighnpercentagenofninstitutionalnownershipnmightnleadnton
anhigherndegreenofnagreementnbetweennownersnandnmanagersnonndecisionsnconcerningnriskynprojects.nI
nnaddition,ninstitutionsnmaynbenbetternablentonimplementneffectivenmonitoringnmechanismsnonnmanager
snthanncannindividualnowners,nbasednonntheninstitutions’ndeepernresourcesnandnexperiencesnwithntheirno
wnnmanagement.nThenincreaseninninstitutionalnownershipnofnstockninnthenUnitednStatesnandnthengrowing
nactivismnofnthesenlargenshareholderngroupsnmaynleadntonanreductionninnagencynproblemsnfornU.S.ncorpo
rationsnandnanmorenefficientnmarketnforncorporatencontrol.
Fundamentals of Corporate Finance 8th editionRos
n n n n n n
s, Westerfield, and Jordan
n n n
Updated 03-05-2007
n
,
,CHAPTER 1 n
INTRODUCTION TO CORPORATE n n n
FINANCE
AnswersntonConceptsnReviewnandnCriticalnThinkingnQuestions
1. Capitalnbudgetingn(decidingnwhetherntonexpandnanmanufacturingnplant),ncapitalnstructuren(decidingnwh
etherntonissuennewnequitynandnusenthenproceedsntonretirenoutstandingndebt),nandnworkingncapitalnmanage
mentn(modifyingnthenfirm’sncreditncollectionnpolicynwithnitsncustomers).
2. Disadvantages:nunlimitednliability,nlimitednlife,ndifficultyninntransferringnownership,nhardntonraisencapit
alnfunds.nSomenadvantages:nsimpler,nlessnregulation,nthenownersnarenalsonthenmanagers,nsometimesnper
sonalntaxnratesnarenbetternthanncorporatentaxnrates.
3. Thenprimaryndisadvantagenofnthencorporatenformnisnthendoublentaxationntonshareholdersnofndistributedne
arningsnandndividends.nSomenadvantagesninclude:nlimitednliability,neasenofntransferability,nabilityntonrai
sencapital,nunlimitednlife,nandnsonforth.
4. InnresponsentonSarbanes-
Oxley,nsmallnfirmsnhavenelectedntongondarknbecausenofnthencostsnofncompliance.nThencostsntoncomplynw
ithnSarboxncannbenseveralnmillionndollars,nwhichncannbenanlargenpercentagen ofn an smalln firmsn profits.n A
n majorn costn ofn goingn darkn isn lessn accessn ton capital.n Sincen thenfirmnisnnonlongernpubliclyntraded,nitncann
nonlongernraisenmoneyninnthenpublicnmarket.nAlthoughnthencompanynwillnstillnhavenaccessntonbanknloans
nandnthenprivatenequitynmarket,nthencostsnassociatednwithnraisingnfundsninnthesenmarketsnarenusuallynhig
hernthannthencostsnofnraisingnfundsninnthenpublicnmarket.
5. Then treasurer’sn officen andn then controller’sn officen aren then twon primaryn organizationaln groupsn thatnr
eportndirectlyntonthenchiefnfinancialnofficer.nThencontroller’snofficenhandlesncostnandnfinancialnaccountin
g,ntaxnmanagement,nandnmanagementninformationnsystems,nwhilenthentreasurer’snofficenisnresponsiblen
forn cashn andn creditn management,n capitaln budgeting,n andn financialn planning.n Therefore,nthenstudynofn
corporatenfinancenisnconcentratednwithinnthentreasuryngroup’snfunctions.
6. Tonmaximizenthencurrentnmarketnvaluen(sharenprice)nofnthenequitynofnthenfirmn(whethernit’snpublicly-
ntradednornnot).
7. Innthencorporatenformnofnownership,nthenshareholdersnarenthenownersnofnthenfirm.nThenshareholdersnelec
tnthendirectorsnofnthencorporation,nwhoninnturnnappointnthenfirm’snmanagement.nThisnseparationnofnowne
rshipnfromncontrolninnthencorporatenformnofnorganizationnisnwhatncausesnagencynproblemsntonexist.nMan
agementnmaynactninnitsnownnornsomeonenelse’snbestninterests,nrathernthannthosenofnthenshareholders.nIfns
uchneventsnoccur,ntheynmayncontradictnthengoalnofnmaximizingnthensharenpricenofnthenequitynofnthenfirm.
8. Anprimarynmarketntransaction.
, B-2n SOLUTIONS
9. InnauctionnmarketsnlikenthenNYSE,nbrokersnandnagentsnmeetnatnanphysicalnlocationn(thenexchange)ntonm
atchnbuyersnandnsellersnofnassets.nDealernmarketsnlikenNASDAQnconsistnofndealersnoperatingnatndispers
ednlocalesnwhonbuynandnsellnassetsnthemselves,ncommunicatingnwithnotherndealersneithernelectronically
nornliterallyn over-the-counter.
10. Suchnorganizationsnfrequentlynpursuensocialnornpoliticalnmissions,nsonmanyndifferentngoalsnarenconceiv
able.nOnengoalnthatnisnoftenncitednisnrevenuenminimization;ni.e.,nprovidenwhateverngoodsnandnservicesna
renofferednatnthenlowestnpossiblencostntonsociety.nAnbetternapproachnmightnbentonobserventhatnevennannot
-for-
profitnbusinessnhasnequity.nThus,nonenanswernisnthatnthenappropriatengoalnisn tonmaximizenthenvaluenofnt
henequity.
11. Presumably,nthencurrentnstocknvaluenreflectsnthenrisk,ntiming,nandnmagnitudenofnallnfuturencashnflows,nb
othnshort-termnandnlong-term.nIfnthisnisncorrect,nthennthenstatementnisnfalse.
12. Annargumentncannbenmadeneithernway.nAtnthenonenextreme,nwencouldnarguenthatninnanmarketneconomy,na
llnofnthesenthingsnarenpriced.nTherenisnthusnannoptimalnlevelnof,nfornexample,nethicalnand/ornillegalnbehav
ior,nandnthenframeworknofnstocknvaluationnexplicitlynincludesnthese.nAtnthenothernextreme,nwencouldnarg
uenthatnthesenarennon-
economicnphenomenanandnarenbestnhandlednthroughnthenpoliticalnprocess.nAnclassicn(andnhighlynreleva
nt)nthoughtnquestionnthatnillustratesnthisndebatengoesnsomethingnlikenthis:n“Anfirmnhasnestimatednthatnth
encostnofnimprovingnthensafetynofnonenofnitsnproductsnisn$30nmillion.nHowever,nthenfirmnbelievesnthatnim
provingnthensafetynofnthenproductnwillnonlynsaven$20nmillionninnproductnliabilitynclaims.nWhatnshouldnt
henfirmndo?”
13. Thengoalnwillnbenthensame,nbutnthenbestncoursenofnactionntowardnthatngoalnmaynbendifferentnbecausenofnd
ifferingnsocial,npolitical,nandneconomicninstitutions.
14. Thengoalnofnmanagementnshouldnbentonmaximizenthensharenpricenfornthencurrentnshareholders.nIfnmanag
ementnbelievesnthatnitncannimproventhenprofitabilitynofnthenfirmnsonthatnthensharenpricenwillnexceedn$35,n
thenntheynshouldnfightnthenoffernfromnthenoutsidencompany.nIfnmanagementnbelievesnthatnthisnbiddernorn
othernunidentifiednbiddersnwillnactuallynpaynmorenthann$35npernsharentonacquirenthencompany,nthennthe
ynshouldnstillnfightnthenoffer.nHowever,nifnthencurrentnmanagementncannotnincreasenthenvaluenofnthenfir
mnbeyondnthenbidnprice,nandnnonothernhighernbidsncomenin,nthennmanagementnisnnotnactingninnthenintere
stsnofnthenshareholdersnbynfightingnthenoffer.nSincencurrentnmanagersnoftennlosentheirnjobsnwhennthencor
porationnisnacquired,npoorlynmonitorednmanagersnhavenannincentiventonfightncorporatentakeoversninnsitu
ationsnsuchnasnthis.
15. Wenwouldnexpectnagencynproblemsntonbenlessnsevereninnotherncountries,nprimarilynduentonthenrelativelyns
mallnpercentagenofnindividualnownership.nFewernindividualnownersnshouldnreducenthennumbernofndiver
senopinionsnconcerningncorporatengoals.nThenhighnpercentagenofninstitutionalnownershipnmightnleadnton
anhigherndegreenofnagreementnbetweennownersnandnmanagersnonndecisionsnconcerningnriskynprojects.nI
nnaddition,ninstitutionsnmaynbenbetternablentonimplementneffectivenmonitoringnmechanismsnonnmanager
snthanncannindividualnowners,nbasednonntheninstitutions’ndeepernresourcesnandnexperiencesnwithntheirno
wnnmanagement.nThenincreaseninninstitutionalnownershipnofnstockninnthenUnitednStatesnandnthengrowing
nactivismnofnthesenlargenshareholderngroupsnmaynleadntonanreductionninnagencynproblemsnfornU.S.ncorpo
rationsnandnanmorenefficientnmarketnforncorporatencontrol.
