Solutions Manual for Corporate
n n n n
Finance by Ross, Westerfield, an
n n n nn
d Jaffe 10th Edition
n n n
Solutions Manual n
Corporate Finance
n
Ross, Westerfield, and Jaffe
n n n n
10th edition n
,Solutionsn Manual
CHAPTER 1 n
INTRODUCTION TO CORPORATE FINAN n n n
CE
Answersn tonConceptn Questions
1. Inn then corporaten formnofn ownership,n then shareholdersnaren then ownersn ofn then firm.n Thenshareholdersne
lectnthendirectorsnofnthencorporation,nwhoninnturnnappointnthenfirm’snmanagement.nThisnseparationnofnow
nershipn fromncontroln inn then corporaten formnofn organizationn isn whatn causesn agencyn problemsn tonexist
.nManagementnmaynactninnitsnownnornsomeonenelse’snbestninterests,nrathernthannthosenofnthenshareholders.
nIfnsuchneventsnoccur,ntheynmayncontradictnthengoalnofnmaximizingnthensharenpricenofnthenequitynofnthenfir
m.
2. Suchnorganizationsnfrequentlynpursuensocialnornpoliticalnmissions,nsonmanyndifferentngoalsnarenconceivab
le.nOnengoalnthatnisnoftenncitednisnrevenuenminimization;ni.e.,nprovidenwhateverngoodsnandnservicesnarenof
ferednatnthenlowestnpossiblencostntonsociety.nAnbetternapproachnmightnbentonobserventhatnevenn an not-for-
profitn businessn hasn equity.n Thus,n onen answern isn thatn then appropriaten goaln isn tonmaximizenthenvaluen
ofnthenequity.
3. Presumably,nthencurrentnstocknvaluenreflectsnthenrisk,ntiming,nandnmagnitudenofnallnfuturencashnflows,nbot
hnshort-termnandnlong-term.nIfnthisnisncorrect,nthennthenstatementnisnfalse.
4. Annargumentncannbenmadeneithernway.nAtnthenonenextreme,nwencouldnarguenthatninnanmarketneconomy,n al
lnofnthesenthingsnarenpriced.nTherenisnthusnannoptimalnlevelnof,nfornexample,nethicalnand/ornillegalnbehavio
r,nandnthenframeworknofnstocknvaluationnexplicitlynincludesnthese.nAtnthenothernextreme,nwencouldnarguent
hatnthesenarennon-
economicnphenomenanandnarenbestnhandlednthroughn then politicalnprocess.nAnclassicn(andnhighlyn relevan
t)nthoughtnquestionnthatnillustratesnthisndebatengoesnsomethingn likenthis:n“Anfirmnhasnestimatednthatnthenc
ostnofnimprovingnthensafetynofnonenofnitsnproductsnisn$30nmillion.nHowever,nthenfirmnbelievesnthatnimprov
ingn thensafetynofnthenproductnwillnonlyn saven$20n millionninnproductnliabilitynclaims.nWhatnshouldnthenfir
mndo?”
5. Thengoalnwillnbenthensame,nbutnthenbestncoursenofnactionntowardnthatngoalnmaynbendifferentnbecausenofndif
feringnsocial,npolitical,nandneconomicninstitutions.
6. Thengoalnofnmanagementnshouldnbentonmaximizenthensharenpricenfornthencurrentnshareholders.nIfnmanage
mentnbelievesnthatnitncannimproventhenprofitabilitynofnthenfirmnsonthatnthen sharen pricenwilln exceedn$35,nt
henntheynshouldnfightnthenoffernfromnthenoutsidencompany.nIfnmanagementnbelievesnthatnthisnbiddernornot
hernunidentifiednbiddersnwillnactuallynpaynmorenthann$35npernsharentonacquirenthencompany,nthenntheynsh
ouldnstillnfightn thenoffer.nHowever,nifnthencurrentnmanagementncannotnincreasen thenvaluenofnthenfirmnbey
ondnthenbidnprice,nandnnonothernhighernbidsncomenin,nthennmanagementnisnnotnactingn inn then interestsn ofn t
hen shareholdersn byn fightingn then offer.n Sincen currentn managersn oftenn lose
, theirn jobsn whenn then corporationn isn acquired,n poorlyn monitoredn managersn haven ann incentiven ton fightncorporat
entakeoversninnsituationsnsuchnasnthis.
7. Wenwouldnexpectnagencynproblemsntonbenlessnsevereninnotherncountries,nprimarilynduentonthenrelativelyns
mallnpercentagenofnindividualnownership.nFewernindividualnownersnshouldnreducenthennumbernofndiverse
nopinionsnconcerningncorporatengoals.nThenhighnpercentagenofninstitutionalnownershipnmightn leadntonanhi
gherndegreenofnagreementnbetweennownersnandnmanagersnonndecisionsnconcerningnriskynprojects.n Inn add
ition,n institutionsn mayn ben bettern ablen ton implementn effectiven monitoringn mechanismsnonnmanagersntha
nncannindividualnowners,nbasednonntheninstitutions’ndeepernresourcesnandnexperiencesnwithntheirnownnma
nagement.
8. Then increasen inn institutionaln ownershipn ofn stockn inn then Unitedn Statesn andn then growingn activismn ofn
thesen largen shareholdern groupsn mayn leadn ton an reductionn inn agencynproblemsn forn U.S.n corporationsn andn
anmorenefficientnmarketnforncorporatencontrol.nHowever,nthisnmaynnotnalwaysnbenthencase.nIfnthenmanager
snofnthenmutualnfundnornpensionnplannarennotnconcernednwithntheninterestsnofntheninvestors,nthenagencynpr
oblemncouldnpotentiallynremainnthensame,nornevennincreasensincentherenisnthenpossibilitynofnagencynprobl
emsnbetweennthenfundnandnitsninvestors.
9. Hownmuchnisntoonmuch?nWhonisnworthnmore,nLarrynEllsionnornTigernWoods?nThensimplestnanswernisntha
tntherenisnanmarketnfornexecutivesnjustn asntherenisn fornallntypesnofnlabor.nExecutivencompensationnisnthenpr
icenthatnclearsnthenmarket.nThensamenisntruenfornathletesnandnperformers.nHavingnsaidnthat,nonenaspectnofne
xecutivencompensationndeservesncomment.nAnprimarynreasonnexecutivencompensationnhasngrownn son dr
amaticallyn isn thatn companiesn haven increasinglyn movedn ton stock-
basedn compensation.nSuchnmovementnisnobviouslynconsistentnwithnthenattemptntonbetternalignnstockhold
ernandnmanagementninterests.nInnrecentnyears,nstocknpricesnhavensoared,nsonmanagementnhasncleanednup.n
Itnisnsometimesnarguednthatnmuchnofnthisnrewardnisnsimplynduentonrisingnstocknpricesninngeneral,nnotnmana
gerialnperformance.nPerhapsninnthenfuture,nexecutivencompensationnwillnbendesignedntonrewardn onlyndiff
erentialnperformance,ni.e.,nstocknpricenincreasesninnexcessnofngeneralnmarketnincreases.
10. Maximizingnthencurrentnsharenpricenisnthensamenasnmaximizingnthenfuturensharenpricenatnanynfuturenperio
d.n Then valuen ofn an sharen ofn stockn dependsn onn alln ofn then futuren cashn flowsn ofn company.n Anothernwayn
ton lookn atn thisn isn that,n barringn largen cashn paymentsn ton shareholders,n then expectedn pricen ofn thenstock
nmustnbenhigherninnthenfuturenthannitnisntoday.nWhonwouldnbuynanstocknforn$100ntodaynwhennthensharenpri
ceninnonenyearnisnexpectedntonben$80?
, Solutionsn Manual
CHAPTER 2 n
FINANCIAL STATEMENTS AND CASH FL n n n n
OW
AnswersntonConceptsnReviewn andnCriticalnThinkingn Questions
1. True.nEverynassetncannbenconvertedntoncashnatnsomenprice.nHowever,nwhennwenarenreferringntonanliquidnas
set,nthenaddednassumptionnthatnthenassetncannbenquicklynconvertedntoncashnatnornnearnmarketnvaluenisnimp
ortant.
2. Thenrecognitionnandnmatchingnprinciplesninnfinancialnaccountingncallnfornrevenues,nandnthencostsnassocia
tednwithnproducingnthosenrevenues,ntonben“booked”nwhennthenrevenuenprocessnisnessentiallyncomplete,nn
otnnecessarilynwhennthencashnisncollectednornbillsnarenpaid.nNotenthatnthisnwaynisnnotnnecessarilyncorrect;ni
t’snthenwaynaccountantsnhavenchosenntondonit.
3. Then bottomnlinen numbern showsn then changen inn then cashn balancen onn then balancen sheet.nAsn such,n itn isn notn
anusefulnnumbernfornanalyzingnancompany.
4. Thenmajorndifferencenisnthentreatmentnofninterestnexpense.nThenaccountingnstatementnofncashnflowsn treat
sninterestnasnannoperatingncashnflow,nwhilenthenfinancialncashnflowsntreatninterestnasnanfinancingn cashnflo
w.nThenlogicnofnthenaccountingnstatementnofncashnflowsnisnthatnsinceninterestnappearsnonnthenincomenstate
ment,nwhichnshowsnthenoperationsnfornthenperiod,nitnisnannoperatingncashnflow.nInnreality,ninterestnisnanfina
ncingnexpense,nwhichnresultsnfromnthencompany’snchoicenofndebtnandnequity.nWenwillnhavenmorentonsayna
boutnthisninnanlaternchapter.nWhenncomparingnthentwoncashnflownstatements,nthenfinancialnstatementnofnca
shnflowsnisnanmorenappropriatenmeasurenofnthencompany’sn performancen becausenofnitsntreatmentnofninter
est.
5. Marketn valuesn cann nevern ben negative.n Imaginen an sharen ofn stockn sellingn forn –
$20.n Thisn wouldn meannthatnifn younplacedn ann ordernforn100n shares,nyoun wouldn getnthen stockn alongn wit
hn ancheckn forn$2,000.nHownmanynsharesndonyounwantntonbuy?nMorengenerally,nbecausenofncorporatenand
n individualnbankruptcynlaws,nnetnworthnfornanpersonnornancorporationncannotnbennegative,nimplyingnthatnl
iabilitiesncannotnexceednassetsninnmarketnvalue.
6. Fornansuccessfulncompanynthatnisnrapidlynexpanding,nfornexample,ncapitalnoutlaysnwilln ben large,npossibl
ynleadingntonnegativencashnflownfromnassets.nInngeneral,nwhatnmattersnisnwhethernthenmoneynisnspentnwis
ely,nnotnwhetherncashnflownfromnassetsnisnpositivenornnegative.
7. It’snprobablynnotnangoodnsignnfornannestablishedncompanyntonhavennegativencashnflownfromnoperations,nbu
tnitnwouldnbenfairlynordinarynfornanstart-up,nsonitndepends.
n n n n
Finance by Ross, Westerfield, an
n n n nn
d Jaffe 10th Edition
n n n
Solutions Manual n
Corporate Finance
n
Ross, Westerfield, and Jaffe
n n n n
10th edition n
,Solutionsn Manual
CHAPTER 1 n
INTRODUCTION TO CORPORATE FINAN n n n
CE
Answersn tonConceptn Questions
1. Inn then corporaten formnofn ownership,n then shareholdersnaren then ownersn ofn then firm.n Thenshareholdersne
lectnthendirectorsnofnthencorporation,nwhoninnturnnappointnthenfirm’snmanagement.nThisnseparationnofnow
nershipn fromncontroln inn then corporaten formnofn organizationn isn whatn causesn agencyn problemsn tonexist
.nManagementnmaynactninnitsnownnornsomeonenelse’snbestninterests,nrathernthannthosenofnthenshareholders.
nIfnsuchneventsnoccur,ntheynmayncontradictnthengoalnofnmaximizingnthensharenpricenofnthenequitynofnthenfir
m.
2. Suchnorganizationsnfrequentlynpursuensocialnornpoliticalnmissions,nsonmanyndifferentngoalsnarenconceivab
le.nOnengoalnthatnisnoftenncitednisnrevenuenminimization;ni.e.,nprovidenwhateverngoodsnandnservicesnarenof
ferednatnthenlowestnpossiblencostntonsociety.nAnbetternapproachnmightnbentonobserventhatnevenn an not-for-
profitn businessn hasn equity.n Thus,n onen answern isn thatn then appropriaten goaln isn tonmaximizenthenvaluen
ofnthenequity.
3. Presumably,nthencurrentnstocknvaluenreflectsnthenrisk,ntiming,nandnmagnitudenofnallnfuturencashnflows,nbot
hnshort-termnandnlong-term.nIfnthisnisncorrect,nthennthenstatementnisnfalse.
4. Annargumentncannbenmadeneithernway.nAtnthenonenextreme,nwencouldnarguenthatninnanmarketneconomy,n al
lnofnthesenthingsnarenpriced.nTherenisnthusnannoptimalnlevelnof,nfornexample,nethicalnand/ornillegalnbehavio
r,nandnthenframeworknofnstocknvaluationnexplicitlynincludesnthese.nAtnthenothernextreme,nwencouldnarguent
hatnthesenarennon-
economicnphenomenanandnarenbestnhandlednthroughn then politicalnprocess.nAnclassicn(andnhighlyn relevan
t)nthoughtnquestionnthatnillustratesnthisndebatengoesnsomethingn likenthis:n“Anfirmnhasnestimatednthatnthenc
ostnofnimprovingnthensafetynofnonenofnitsnproductsnisn$30nmillion.nHowever,nthenfirmnbelievesnthatnimprov
ingn thensafetynofnthenproductnwillnonlyn saven$20n millionninnproductnliabilitynclaims.nWhatnshouldnthenfir
mndo?”
5. Thengoalnwillnbenthensame,nbutnthenbestncoursenofnactionntowardnthatngoalnmaynbendifferentnbecausenofndif
feringnsocial,npolitical,nandneconomicninstitutions.
6. Thengoalnofnmanagementnshouldnbentonmaximizenthensharenpricenfornthencurrentnshareholders.nIfnmanage
mentnbelievesnthatnitncannimproventhenprofitabilitynofnthenfirmnsonthatnthen sharen pricenwilln exceedn$35,nt
henntheynshouldnfightnthenoffernfromnthenoutsidencompany.nIfnmanagementnbelievesnthatnthisnbiddernornot
hernunidentifiednbiddersnwillnactuallynpaynmorenthann$35npernsharentonacquirenthencompany,nthenntheynsh
ouldnstillnfightn thenoffer.nHowever,nifnthencurrentnmanagementncannotnincreasen thenvaluenofnthenfirmnbey
ondnthenbidnprice,nandnnonothernhighernbidsncomenin,nthennmanagementnisnnotnactingn inn then interestsn ofn t
hen shareholdersn byn fightingn then offer.n Sincen currentn managersn oftenn lose
, theirn jobsn whenn then corporationn isn acquired,n poorlyn monitoredn managersn haven ann incentiven ton fightncorporat
entakeoversninnsituationsnsuchnasnthis.
7. Wenwouldnexpectnagencynproblemsntonbenlessnsevereninnotherncountries,nprimarilynduentonthenrelativelyns
mallnpercentagenofnindividualnownership.nFewernindividualnownersnshouldnreducenthennumbernofndiverse
nopinionsnconcerningncorporatengoals.nThenhighnpercentagenofninstitutionalnownershipnmightn leadntonanhi
gherndegreenofnagreementnbetweennownersnandnmanagersnonndecisionsnconcerningnriskynprojects.n Inn add
ition,n institutionsn mayn ben bettern ablen ton implementn effectiven monitoringn mechanismsnonnmanagersntha
nncannindividualnowners,nbasednonntheninstitutions’ndeepernresourcesnandnexperiencesnwithntheirnownnma
nagement.
8. Then increasen inn institutionaln ownershipn ofn stockn inn then Unitedn Statesn andn then growingn activismn ofn
thesen largen shareholdern groupsn mayn leadn ton an reductionn inn agencynproblemsn forn U.S.n corporationsn andn
anmorenefficientnmarketnforncorporatencontrol.nHowever,nthisnmaynnotnalwaysnbenthencase.nIfnthenmanager
snofnthenmutualnfundnornpensionnplannarennotnconcernednwithntheninterestsnofntheninvestors,nthenagencynpr
oblemncouldnpotentiallynremainnthensame,nornevennincreasensincentherenisnthenpossibilitynofnagencynprobl
emsnbetweennthenfundnandnitsninvestors.
9. Hownmuchnisntoonmuch?nWhonisnworthnmore,nLarrynEllsionnornTigernWoods?nThensimplestnanswernisntha
tntherenisnanmarketnfornexecutivesnjustn asntherenisn fornallntypesnofnlabor.nExecutivencompensationnisnthenpr
icenthatnclearsnthenmarket.nThensamenisntruenfornathletesnandnperformers.nHavingnsaidnthat,nonenaspectnofne
xecutivencompensationndeservesncomment.nAnprimarynreasonnexecutivencompensationnhasngrownn son dr
amaticallyn isn thatn companiesn haven increasinglyn movedn ton stock-
basedn compensation.nSuchnmovementnisnobviouslynconsistentnwithnthenattemptntonbetternalignnstockhold
ernandnmanagementninterests.nInnrecentnyears,nstocknpricesnhavensoared,nsonmanagementnhasncleanednup.n
Itnisnsometimesnarguednthatnmuchnofnthisnrewardnisnsimplynduentonrisingnstocknpricesninngeneral,nnotnmana
gerialnperformance.nPerhapsninnthenfuture,nexecutivencompensationnwillnbendesignedntonrewardn onlyndiff
erentialnperformance,ni.e.,nstocknpricenincreasesninnexcessnofngeneralnmarketnincreases.
10. Maximizingnthencurrentnsharenpricenisnthensamenasnmaximizingnthenfuturensharenpricenatnanynfuturenperio
d.n Then valuen ofn an sharen ofn stockn dependsn onn alln ofn then futuren cashn flowsn ofn company.n Anothernwayn
ton lookn atn thisn isn that,n barringn largen cashn paymentsn ton shareholders,n then expectedn pricen ofn thenstock
nmustnbenhigherninnthenfuturenthannitnisntoday.nWhonwouldnbuynanstocknforn$100ntodaynwhennthensharenpri
ceninnonenyearnisnexpectedntonben$80?
, Solutionsn Manual
CHAPTER 2 n
FINANCIAL STATEMENTS AND CASH FL n n n n
OW
AnswersntonConceptsnReviewn andnCriticalnThinkingn Questions
1. True.nEverynassetncannbenconvertedntoncashnatnsomenprice.nHowever,nwhennwenarenreferringntonanliquidnas
set,nthenaddednassumptionnthatnthenassetncannbenquicklynconvertedntoncashnatnornnearnmarketnvaluenisnimp
ortant.
2. Thenrecognitionnandnmatchingnprinciplesninnfinancialnaccountingncallnfornrevenues,nandnthencostsnassocia
tednwithnproducingnthosenrevenues,ntonben“booked”nwhennthenrevenuenprocessnisnessentiallyncomplete,nn
otnnecessarilynwhennthencashnisncollectednornbillsnarenpaid.nNotenthatnthisnwaynisnnotnnecessarilyncorrect;ni
t’snthenwaynaccountantsnhavenchosenntondonit.
3. Then bottomnlinen numbern showsn then changen inn then cashn balancen onn then balancen sheet.nAsn such,n itn isn notn
anusefulnnumbernfornanalyzingnancompany.
4. Thenmajorndifferencenisnthentreatmentnofninterestnexpense.nThenaccountingnstatementnofncashnflowsn treat
sninterestnasnannoperatingncashnflow,nwhilenthenfinancialncashnflowsntreatninterestnasnanfinancingn cashnflo
w.nThenlogicnofnthenaccountingnstatementnofncashnflowsnisnthatnsinceninterestnappearsnonnthenincomenstate
ment,nwhichnshowsnthenoperationsnfornthenperiod,nitnisnannoperatingncashnflow.nInnreality,ninterestnisnanfina
ncingnexpense,nwhichnresultsnfromnthencompany’snchoicenofndebtnandnequity.nWenwillnhavenmorentonsayna
boutnthisninnanlaternchapter.nWhenncomparingnthentwoncashnflownstatements,nthenfinancialnstatementnofnca
shnflowsnisnanmorenappropriatenmeasurenofnthencompany’sn performancen becausenofnitsntreatmentnofninter
est.
5. Marketn valuesn cann nevern ben negative.n Imaginen an sharen ofn stockn sellingn forn –
$20.n Thisn wouldn meannthatnifn younplacedn ann ordernforn100n shares,nyoun wouldn getnthen stockn alongn wit
hn ancheckn forn$2,000.nHownmanynsharesndonyounwantntonbuy?nMorengenerally,nbecausenofncorporatenand
n individualnbankruptcynlaws,nnetnworthnfornanpersonnornancorporationncannotnbennegative,nimplyingnthatnl
iabilitiesncannotnexceednassetsninnmarketnvalue.
6. Fornansuccessfulncompanynthatnisnrapidlynexpanding,nfornexample,ncapitalnoutlaysnwilln ben large,npossibl
ynleadingntonnegativencashnflownfromnassets.nInngeneral,nwhatnmattersnisnwhethernthenmoneynisnspentnwis
ely,nnotnwhetherncashnflownfromnassetsnisnpositivenornnegative.
7. It’snprobablynnotnangoodnsignnfornannestablishedncompanyntonhavennegativencashnflownfromnoperations,nbu
tnitnwouldnbenfairlynordinarynfornanstart-up,nsonitndepends.
