Solutions Manual for Corporate
m m m m
Finance by Ross, Westerfield, an
m m m m
d Jaffe 10th Edition
m m m
Solutions Manual m
Corporate Finance
m
Ross, Westerfield, and Jaffe1
m m m m
0th edition m
,Solutionsm Manual
CHAPTER 1 m
INTRODUCTION TO CORPORATEFINAN m m m
CE
AnswersmtomConceptm Questions
1. Inm them corporatem formm ofm ownership,m them shareholdersm arem them ownersm ofm them firm.m Them sharehol
dersmelectmthemdirectorsmofmthemcorporation,mwhominmturnmappointmthemfirm’smmanagement.mThismseparat
ionmofmownershipmfrommcontrolminmthemcorporatem formmofmorganizationm ismwhatmcausesmagencym probl
emsmtomexist.mManagementmmaymactminmitsmownmormsomeonemelse’smbestminterests,mrathermthanmthosemof
mthemshareholders.mIfmsuchmeventsmoccur,mtheymmaymcontradictmthemgoalmofmmaximizingmthemsharemprice
mofmthemequitymofmthemfirm.
2. Suchmorganizationsmfrequentlympursuemsocialmormpoliticalmmissions,msommanymdifferentmgoalsmaremconc
eivable.mOnemgoalmthatmismoftenmcitedmismrevenuemminimization;mi.e.,mprovidemwhatevermgoodsmandmserv
icesmaremofferedmatmthemlowestmpossiblemcostmtomsociety.mAmbettermapproachmmightmbemtomobservemthatme
venmamnot-for-
profitmbusinessmhasmequity.mThus,monemanswermismthatmthem appropriatem goalm ism tommaximizemthemvalu
emofmthemequity.
3. Presumably,mthemcurrentmstockmvaluemreflectsmthemrisk,mtiming,mandmmagnitudemofmallmfuturemcashmflow
s,mbothmshort-termmandmlong-term.m Ifmthismismcorrect,mthenmthemstatementmismfalse.
4. Anm argumentm canm bem madem eitherm way.m Atm them onem extreme,m wem couldm arguem thatm inm am marketm econ
omy,mallmofmthesemthingsmarempriced.mTheremismthusmanmoptimalmlevelmof,mformexample,methicalmand/ormill
egalmbehavior,mandmthemframeworkmofmstockmvaluationmexplicitlymincludesmthese.mAtmthemothermextreme
,mwemcouldmarguemthatmthesemaremnon-
economicmphenomenamandmarembestmhandledmthroughm them politicalmprocess.m Am classicm (andm highlym r
elevant)m thoughtm questionm thatm illustratesm thism debatem goesm somethingmlikemthis:m“Amfirmmhasmestimat
edmthatmthemcostmofmimprovingmthemsafetymofmonemofmitsmproductsmism$30mmillion.mHowever,mthemfirmmb
elievesmthatmimprovingmthemsafetymofmthem productmwillmonlym savem $20mmillionminmproductmliabilitymcl
aims.mWhatmshouldmthemfirmmdo?”
5. Themgoalmwillmbemthemsame,mbutmthembestmcoursemofmactionmtowardmthatmgoalmmaymbemdifferentmbecause
mofmdifferingmsocial,m political,m andm economicminstitutions.
6. Themgoalmofmmanagementmshouldmbemtommaximizemthemsharempricemformthemcurrentmshareholders.mIfmma
nagementmbelievesmthatmitmcanmimprovemthemprofitabilitymofmthemfirmmsomthatmthem sharem pricemwillmexc
eedm$35,mthenmtheymshouldmfightmthemoffermfrommthemoutsidemcompany.mIfm managementmbelievesmthatmt
hismbiddermormothermunidentifiedmbiddersmwillmactuallympaymmoremthanm$35mpermsharemtomacquiremthemco
mpany,m thenm theym shouldm stillm fightm them offer.m However,m ifm them currentm managementm cannotm increa
semthemvaluemofmthemfirmmbeyondmthembidmprice,mandmnomothermhighermbidsmcomemin,mthenmmanagementm
ismnotmactingm inm them interestsm ofm them shareholdersm bym fightingm them offer.m Sincem currentm managersm
oftenm lose
, theirm jobsm whenm them corporationm ism acquired,m poorlym monitoredm managersm havem anm incentivem tom f
ightmcorporatemtakeoversminmsituationsmsuchmasmthis.
7. Wemwouldmexpectmagencymproblemsmtombemlessmsevereminmothermcountries,mprimarilymduemtomthemrelativ
elymsmallmpercentagemofmindividualmownership.mFewermindividualmownersmshouldmreducemthemnumbermo
fmdiversem opinionsm concerningm corporatem goals.m Them highm percentagem ofm institutionalm ownershipm
mightmleadmtomamhighermdegreemofmagreementmbetweenmownersmandmmanagersmonmdecisionsmconcerningm
riskymprojects.m Inm addition,m institutionsm maym bem betterm ablem tom implementm effectivem monitoringm me
chanismsmonmmanagersmthanmcanmindividualmowners,mbasedmonmtheminstitutions’mdeepermresourcesmandme
xperiencesmwithmtheirmownmmanagement.
8. Them increasem inm institutionalm ownershipm ofm stockm inm them Unitedm Statesm andm them growingm activis
mm ofmthesem largem shareholderm groupsm maym leadm tom am reductionm inm agencym problemsm form U.S.m corpor
ationsm andmammoremefficientmmarketmformcorporatemcontrol.mHowever,mthismmaymnotmalwaysmbemthemcase
.mIfmthemmanagersmofmthemmutualmfundmormpensionmplanmaremnotmconcernedmwithmtheminterestsmofmthemin
vestors,mthemagencymproblemmcouldmpotentiallymremainmthemsame,mormevenmincreasemsincemtheremismthem
possibilitymofmagencymproblemsmbetweenmthemfundmandmitsminvestors.
9. Howmmuchmismtoommuch?mWhomismworthmmore,mLarrymEllsionmormTigermWoods?mThemsimplestmanswerm
ismthatmtheremismammarketmformexecutivesmjustm asmtheremism formallmtypesmofmlabor.mExecutivemcompensat
ionmismthempricemthatmclearsmthemmarket.mThemsamemismtruemformathletesmandmperformers.mHavingmsaidmth
at,monemaspectmofmexecutivemcompensationmdeservesmcomment.mAmprimarymreasonmexecutivemcompensa
tionmhasmgrownmsomdramaticallymismthatmcompaniesmhavemincreasinglym movedm tom stock-
basedm compensation.mSuchmmovementmismobviouslymconsistentmwithmthemattemptmtombettermalignmstock
holdermandmmanagementminterests.mInmrecentmyears,mstockmpricesmhavemsoared,msommanagementmhasmcle
anedmup.mItmismsometimesmarguedmthatmmuchmofmthismrewardmismsimplymduemtomrisingmstockmpricesminmge
neral,mnotmmanagerialmperformance.mPerhapsminmthemfuture,mexecutivemcompensationmwillmbemdesignedm
tomrewardm onlymdifferentialmperformance,mi.e.,mstockm pricemincreasesminmexcessmofmgeneralmmarketmincr
eases.
10. Maximizingmthemcurrentmsharempricemismthemsamemasmmaximizingmthemfuturemsharempricematmanymfuturem
period.m Them valuem ofm am sharem ofm stockm dependsm onm allm ofm them futurem cashm flowsm ofm company.m An
othermwaymtomlookmatmthismismthat,mbarringmlargemcashmpaymentsmtomshareholders,m them expectedm pricem
ofm themstockmmustmbemhigherminmthemfuturemthanmitmismtoday.mWhomwouldmbuymamstockmform$100mtodaym
whenmthemsharempriceminmonemyearmismexpectedmtombem$80?
, Solutionsm Manua
l
CHAPTER 2 m
FINANCIAL STATEMENTS AND CASHFL m m m m
OW
AnswersmtomConceptsmReviewm andmCriticalm Thinkingm Questions
1. True.mEverymassetmcanmbemconvertedmtomcashmatmsomemprice.mHowever,mwhenmwemaremreferringmtomamliq
uidmasset,mthemaddedmassumptionmthatmthemassetmcanmbemquicklymconvertedmtomcashmatmormnearmmarketmv
aluemismimportant.
2. Themrecognitionmandmmatchingmprinciplesminmfinancialmaccountingmcallmformrevenues,mandmthemcostsmas
sociatedmwithmproducingmthosemrevenues,mtombem“booked”mwhenmthemrevenuemprocessmismessentiallymco
mplete,mnotmnecessarilymwhenmthemcashmismcollectedmormbillsmarempaid.mNotemthatmthismwaymismnotmneces
sarilymcorrect;mit’smthemwaymaccountantsmhavemchosenmtomdomit.
3. Them bottomm linem numberm showsm them changem inm them cashm balancem onm them balancem sheet.mAsm such,m itm
ism notmamusefulmnumbermformanalyzingmamcompany.
4. Themmajormdifferencemismthemtreatmentmofminterestmexpense.mThemaccountingm statementmofmcashm flows
mtreatsminterestmasmanmoperatingmcashmflow,mwhilemthem financialmcashmflowsmtreatminterestmasmam financi
ngmcashmflow.mThemlogicmofmthemaccountingmstatementmofmcashmflowsmismthatmsinceminterestmappearsmon
mthemincomemstatement,mwhichmshowsmthemoperationsmformthemperiod,mitmismanmoperatingmcashmflow.mInm
reality,minterestmismamfinancingmexpense,mwhichmresultsmfrommthemcompany’smchoicemofmdebtmandmequity
.mWemwillmhavemmoremtomsaymaboutmthisminmamlatermchapter.mWhenmcomparingmthemtwomcashmflowmstate
ments,mthemfinancialmstatementmofmcashmflowsmismammoremappropriatemmeasuremofmthem company’sm perf
ormancembecausemofmitsmtreatmentmofminterest.
5. Marketm valuesm canm neverm bem negative.m Imaginem am sharem ofm stockm sellingm form –
$20.m Thism wouldm meanmthatm ifm youm placedm anm orderm form 100m shares,m youm wouldm getm them stockm alo
ngm withm am checkm form $2,000.mHowmmanymsharesmdomyoumwantmtombuy?mMoremgenerally,mbecausemofmc
orporatemandm individualmbankruptcymlaws,mnetmworthmformampersonmormamcorporationmcannotmbemnegati
ve,mimplyingmthatmliabilitiesmcannotmexceedmassetsminmmarketmvalue.
6. Formamsuccessfulmcompanymthatmismrapidlymexpanding,mformexample,mcapitalmoutlaysmwillm bem large,mpo
ssiblymleadingmtomnegativemcashmflowmfrommassets.mInmgeneral,mwhatmmattersmismwhethermthemmoneymism
spentmwisely,mnotmwhethermcashmflowmfrommassetsmismpositivemormnegative.
7. It’smprobablymnotmamgoodmsignmformanmestablishedmcompanymtomhavemnegativemcashmflowmfrommoperatio
ns,mbutmitmwouldmbemfairlymordinarymformamstart-up,msomitmdepends.
m m m m
Finance by Ross, Westerfield, an
m m m m
d Jaffe 10th Edition
m m m
Solutions Manual m
Corporate Finance
m
Ross, Westerfield, and Jaffe1
m m m m
0th edition m
,Solutionsm Manual
CHAPTER 1 m
INTRODUCTION TO CORPORATEFINAN m m m
CE
AnswersmtomConceptm Questions
1. Inm them corporatem formm ofm ownership,m them shareholdersm arem them ownersm ofm them firm.m Them sharehol
dersmelectmthemdirectorsmofmthemcorporation,mwhominmturnmappointmthemfirm’smmanagement.mThismseparat
ionmofmownershipmfrommcontrolminmthemcorporatem formmofmorganizationm ismwhatmcausesmagencym probl
emsmtomexist.mManagementmmaymactminmitsmownmormsomeonemelse’smbestminterests,mrathermthanmthosemof
mthemshareholders.mIfmsuchmeventsmoccur,mtheymmaymcontradictmthemgoalmofmmaximizingmthemsharemprice
mofmthemequitymofmthemfirm.
2. Suchmorganizationsmfrequentlympursuemsocialmormpoliticalmmissions,msommanymdifferentmgoalsmaremconc
eivable.mOnemgoalmthatmismoftenmcitedmismrevenuemminimization;mi.e.,mprovidemwhatevermgoodsmandmserv
icesmaremofferedmatmthemlowestmpossiblemcostmtomsociety.mAmbettermapproachmmightmbemtomobservemthatme
venmamnot-for-
profitmbusinessmhasmequity.mThus,monemanswermismthatmthem appropriatem goalm ism tommaximizemthemvalu
emofmthemequity.
3. Presumably,mthemcurrentmstockmvaluemreflectsmthemrisk,mtiming,mandmmagnitudemofmallmfuturemcashmflow
s,mbothmshort-termmandmlong-term.m Ifmthismismcorrect,mthenmthemstatementmismfalse.
4. Anm argumentm canm bem madem eitherm way.m Atm them onem extreme,m wem couldm arguem thatm inm am marketm econ
omy,mallmofmthesemthingsmarempriced.mTheremismthusmanmoptimalmlevelmof,mformexample,methicalmand/ormill
egalmbehavior,mandmthemframeworkmofmstockmvaluationmexplicitlymincludesmthese.mAtmthemothermextreme
,mwemcouldmarguemthatmthesemaremnon-
economicmphenomenamandmarembestmhandledmthroughm them politicalmprocess.m Am classicm (andm highlym r
elevant)m thoughtm questionm thatm illustratesm thism debatem goesm somethingmlikemthis:m“Amfirmmhasmestimat
edmthatmthemcostmofmimprovingmthemsafetymofmonemofmitsmproductsmism$30mmillion.mHowever,mthemfirmmb
elievesmthatmimprovingmthemsafetymofmthem productmwillmonlym savem $20mmillionminmproductmliabilitymcl
aims.mWhatmshouldmthemfirmmdo?”
5. Themgoalmwillmbemthemsame,mbutmthembestmcoursemofmactionmtowardmthatmgoalmmaymbemdifferentmbecause
mofmdifferingmsocial,m political,m andm economicminstitutions.
6. Themgoalmofmmanagementmshouldmbemtommaximizemthemsharempricemformthemcurrentmshareholders.mIfmma
nagementmbelievesmthatmitmcanmimprovemthemprofitabilitymofmthemfirmmsomthatmthem sharem pricemwillmexc
eedm$35,mthenmtheymshouldmfightmthemoffermfrommthemoutsidemcompany.mIfm managementmbelievesmthatmt
hismbiddermormothermunidentifiedmbiddersmwillmactuallympaymmoremthanm$35mpermsharemtomacquiremthemco
mpany,m thenm theym shouldm stillm fightm them offer.m However,m ifm them currentm managementm cannotm increa
semthemvaluemofmthemfirmmbeyondmthembidmprice,mandmnomothermhighermbidsmcomemin,mthenmmanagementm
ismnotmactingm inm them interestsm ofm them shareholdersm bym fightingm them offer.m Sincem currentm managersm
oftenm lose
, theirm jobsm whenm them corporationm ism acquired,m poorlym monitoredm managersm havem anm incentivem tom f
ightmcorporatemtakeoversminmsituationsmsuchmasmthis.
7. Wemwouldmexpectmagencymproblemsmtombemlessmsevereminmothermcountries,mprimarilymduemtomthemrelativ
elymsmallmpercentagemofmindividualmownership.mFewermindividualmownersmshouldmreducemthemnumbermo
fmdiversem opinionsm concerningm corporatem goals.m Them highm percentagem ofm institutionalm ownershipm
mightmleadmtomamhighermdegreemofmagreementmbetweenmownersmandmmanagersmonmdecisionsmconcerningm
riskymprojects.m Inm addition,m institutionsm maym bem betterm ablem tom implementm effectivem monitoringm me
chanismsmonmmanagersmthanmcanmindividualmowners,mbasedmonmtheminstitutions’mdeepermresourcesmandme
xperiencesmwithmtheirmownmmanagement.
8. Them increasem inm institutionalm ownershipm ofm stockm inm them Unitedm Statesm andm them growingm activis
mm ofmthesem largem shareholderm groupsm maym leadm tom am reductionm inm agencym problemsm form U.S.m corpor
ationsm andmammoremefficientmmarketmformcorporatemcontrol.mHowever,mthismmaymnotmalwaysmbemthemcase
.mIfmthemmanagersmofmthemmutualmfundmormpensionmplanmaremnotmconcernedmwithmtheminterestsmofmthemin
vestors,mthemagencymproblemmcouldmpotentiallymremainmthemsame,mormevenmincreasemsincemtheremismthem
possibilitymofmagencymproblemsmbetweenmthemfundmandmitsminvestors.
9. Howmmuchmismtoommuch?mWhomismworthmmore,mLarrymEllsionmormTigermWoods?mThemsimplestmanswerm
ismthatmtheremismammarketmformexecutivesmjustm asmtheremism formallmtypesmofmlabor.mExecutivemcompensat
ionmismthempricemthatmclearsmthemmarket.mThemsamemismtruemformathletesmandmperformers.mHavingmsaidmth
at,monemaspectmofmexecutivemcompensationmdeservesmcomment.mAmprimarymreasonmexecutivemcompensa
tionmhasmgrownmsomdramaticallymismthatmcompaniesmhavemincreasinglym movedm tom stock-
basedm compensation.mSuchmmovementmismobviouslymconsistentmwithmthemattemptmtombettermalignmstock
holdermandmmanagementminterests.mInmrecentmyears,mstockmpricesmhavemsoared,msommanagementmhasmcle
anedmup.mItmismsometimesmarguedmthatmmuchmofmthismrewardmismsimplymduemtomrisingmstockmpricesminmge
neral,mnotmmanagerialmperformance.mPerhapsminmthemfuture,mexecutivemcompensationmwillmbemdesignedm
tomrewardm onlymdifferentialmperformance,mi.e.,mstockm pricemincreasesminmexcessmofmgeneralmmarketmincr
eases.
10. Maximizingmthemcurrentmsharempricemismthemsamemasmmaximizingmthemfuturemsharempricematmanymfuturem
period.m Them valuem ofm am sharem ofm stockm dependsm onm allm ofm them futurem cashm flowsm ofm company.m An
othermwaymtomlookmatmthismismthat,mbarringmlargemcashmpaymentsmtomshareholders,m them expectedm pricem
ofm themstockmmustmbemhigherminmthemfuturemthanmitmismtoday.mWhomwouldmbuymamstockmform$100mtodaym
whenmthemsharempriceminmonemyearmismexpectedmtombem$80?
, Solutionsm Manua
l
CHAPTER 2 m
FINANCIAL STATEMENTS AND CASHFL m m m m
OW
AnswersmtomConceptsmReviewm andmCriticalm Thinkingm Questions
1. True.mEverymassetmcanmbemconvertedmtomcashmatmsomemprice.mHowever,mwhenmwemaremreferringmtomamliq
uidmasset,mthemaddedmassumptionmthatmthemassetmcanmbemquicklymconvertedmtomcashmatmormnearmmarketmv
aluemismimportant.
2. Themrecognitionmandmmatchingmprinciplesminmfinancialmaccountingmcallmformrevenues,mandmthemcostsmas
sociatedmwithmproducingmthosemrevenues,mtombem“booked”mwhenmthemrevenuemprocessmismessentiallymco
mplete,mnotmnecessarilymwhenmthemcashmismcollectedmormbillsmarempaid.mNotemthatmthismwaymismnotmneces
sarilymcorrect;mit’smthemwaymaccountantsmhavemchosenmtomdomit.
3. Them bottomm linem numberm showsm them changem inm them cashm balancem onm them balancem sheet.mAsm such,m itm
ism notmamusefulmnumbermformanalyzingmamcompany.
4. Themmajormdifferencemismthemtreatmentmofminterestmexpense.mThemaccountingm statementmofmcashm flows
mtreatsminterestmasmanmoperatingmcashmflow,mwhilemthem financialmcashmflowsmtreatminterestmasmam financi
ngmcashmflow.mThemlogicmofmthemaccountingmstatementmofmcashmflowsmismthatmsinceminterestmappearsmon
mthemincomemstatement,mwhichmshowsmthemoperationsmformthemperiod,mitmismanmoperatingmcashmflow.mInm
reality,minterestmismamfinancingmexpense,mwhichmresultsmfrommthemcompany’smchoicemofmdebtmandmequity
.mWemwillmhavemmoremtomsaymaboutmthisminmamlatermchapter.mWhenmcomparingmthemtwomcashmflowmstate
ments,mthemfinancialmstatementmofmcashmflowsmismammoremappropriatemmeasuremofmthem company’sm perf
ormancembecausemofmitsmtreatmentmofminterest.
5. Marketm valuesm canm neverm bem negative.m Imaginem am sharem ofm stockm sellingm form –
$20.m Thism wouldm meanmthatm ifm youm placedm anm orderm form 100m shares,m youm wouldm getm them stockm alo
ngm withm am checkm form $2,000.mHowmmanymsharesmdomyoumwantmtombuy?mMoremgenerally,mbecausemofmc
orporatemandm individualmbankruptcymlaws,mnetmworthmformampersonmormamcorporationmcannotmbemnegati
ve,mimplyingmthatmliabilitiesmcannotmexceedmassetsminmmarketmvalue.
6. Formamsuccessfulmcompanymthatmismrapidlymexpanding,mformexample,mcapitalmoutlaysmwillm bem large,mpo
ssiblymleadingmtomnegativemcashmflowmfrommassets.mInmgeneral,mwhatmmattersmismwhethermthemmoneymism
spentmwisely,mnotmwhethermcashmflowmfrommassetsmismpositivemormnegative.
7. It’smprobablymnotmamgoodmsignmformanmestablishedmcompanymtomhavemnegativemcashmflowmfrommoperatio
ns,mbutmitmwouldmbemfairlymordinarymformamstart-up,msomitmdepends.
