SolutionsmManua
l SolutionsmManual
Solutions Manual
m
Corporate Finance
m
Ross, Westerfield, and Jaffe 10
m m m m
th
edition
m
,SolutionsmManua
l
CHAPTER 1 m
INTRODUCTION TO CORPORATE FINA m m m
NCE
AnswersmtomConcept mQuestions
1. Inmthemcorporatemformmofmownership, mthemshareholdersmaremthemownersmofmthemfirm. mThemshareholdersm
melectmthemdirectorsmof mthemcorporation, mwhominmturnmappointmthemfirm’smmanagement. mThismseparation
mof mownershipmfrommcontrolminmthemcorporatemformmof morganizationmismwhatmcausesmagencymmproblems
mmtomexist. mManagementmmaymactminmitsmownmor msomeonemelse’smbestminterests, mrather mthanmthosemof mth
emshareholders. mIfmsuchmeventsmoccur, mtheymmaymcontradictmthemgoalmofmmaximizingmthemsharempricemof
mthemequitymof mthemfirm.
2. Suchmorganizationsmfrequentlympursuemsocialmormpoliticalmmissions, msommanymdifferentmgoalsmaremconc
eivable. mOnemgoalmthatmismoftenmcitedmismrevenuemminimization;mi.e., mprovidemwhatevermgoodsmandmser
vicesmaremofferedmatmthemlowestmpossiblemcostmtomsociety. mAmbettermapproachmmightmbemtomobserve mthat
mevenmamnot-for-
profitmbusinessmhasmequity. mThus, monemanswermismthatmthemappropriatemgoalmmis mmtommmaximizemthe mvalu
emofmthemequity.
3. Presumably, mthemcurrentmstockmvaluemreflectsmthemrisk, mtiming, mandmmagnitudemofmallmfuturemcashmflow
s, mbothmshort-termmandmlong-term. mIfmthismismcorrect, mthenmthemstatementmism false.
4. Anmargumentmcanmbemmademeithermway. mAtmthemonemextreme, mwemcouldmarguemthatminmammarketmecono
my, mallmofmthesemthingsmarempriced. mTheremismthusmanmoptimalmlevelmof, mformexample, methicalmand/ormill
egalmbehavior, mandmthemframeworkmofmstockmvaluationmexplicitlymincludesmthese. mAtmthemothermextreme
, mwemcouldmarguemthatmthesemaremnon-
economicmphenomenamandmarembestmhandledmthroughmthemmpoliticalmprocess. mAmclassicm(andmhighlymrel
evant)mthoughtmquestionmthatmillustratesmthismdebatemgoesmsomethingmlikemthis:m“Amfirmmhasm estimatedm
thatmthemcostmofmimprovingmthemsafetymofmonemofmitsmproductsmism$30mmillion. mHowever, mthemfirmmbelie
vesmthatmimprovingmthemsafetymofmthemproductmwillmonlymsavem$20mmmillionminmproductmliabilitymclaims.
mWhatmshouldmthemfirmm do?”
5. Themgoalmwillmbemthemsame, mbutmthembestmcoursemofmactionmtowardmthatmgoalmmaymbemdifferentmbecause
mof mdifferingmsocial, mpolitical, mandmeconomicm institutions.
6. Themgoalmofmmanagementmshouldmbemtommaximizemthemsharempricemformthemcurrentmshareholders. mIfmma
nagementmbelievesmthatmitmcanmimprovemthemprofitabilitymofmthemfirmmsomthatmthemsharempricemwillmmexc
eedm$35, mthenmtheymshouldmfightmthemoffermfrommthemoutsidemcompany. mIfmmanagementmbelievesmthatmt
hismbiddermormothermunidentifiedmbiddersmwillmactuallympaymmoremthanm$35mpermsharemtomacquiremthemc
ompany, mthenmtheymshouldmstillmfightmthemoffer. mHowever, mifmthemcurrentmmanagementmcannotmincrease
mthemvaluemof mthemfirmmbeyondmthembidmprice, mandmnomother mhigher mbidsmcomemin, mthenmmanagementmis
mnotmactingm inm them interestsm of m them shareholdersm bym fightingm them offer. m Sincem currentm managersm o
ftenm lose
, theirmjobsmwhenmthemcorporationmismacquired, mpoorlymmonitoredmmanagersmhavemanmincentivemtomfigh
tmcorporatemtakeoversminmsituationsmsuchmasmthis.
7. Wemwouldmexpectmagencymproblemsmtombemlessmsevereminmothermcountries, mprimarilymduemtomthemrelativ
elymsmallmpercentagemofmindividualmownership. mFewermindividualmownersmshouldmreducemthemnumberm
ofmdiversemopinionsmconcerningmcorporatemgoals. mThemhighmpercentagemofminstitutionalmownershipmmig
htmmleadmtomamhighermdegreemofmagreementmbetweenmownersmandmmanagersmonmdecisionsm concerningmri
skymprojects. mInmaddition, minstitutionsmmaymbembettermablemtomimplementmeffectivemmonitoringmmechan
ismsmmmonmmanagersmthanmcanmindividualmowners, mbasedmonmtheminstitutions’ mdeepermresources mandmex
periencesmwithmtheirmownmmanagement.
8. ThemincreaseminminstitutionalmownershipmofmstockminmthemUnitedmmStatesmandmthe mgrowingmactivismmofm
mthesemlargemshareholder mgroupsmmaymleadmtomamreductionminmagencymproblemsmfor mU.S. mcorporationsm
andmmmammoremefficientmmarketmformcorporatemcontrol. mHowever, mthismmaymnotmalwaysmbemthemcase. mIfmt
hemmanagersmofmthemmutualmfundmormpensionmplanmaremnotmconcernedmwithmtheminterestsmofmtheminvesto
rs, mthemagencymproblemmcouldmpotentiallymremainmthemsame, mormevenmincreasemsincemtheremismthe mpossi
bilitymofmagencymproblemsmbetweenmthemfundmandmitsm investors.
9. Howmmuchmismtoommuch?mWhomismworthmmore, mLarrymEllsionmormTigermWoods?mThemsimplestmanswer
mismthatmtheremismammarketmfor mexecutivesmjustmasmtheremismfor mallmtypesmof mlabor. mExecutivemcompensat
ionmismmthempricemthatmclearsmthemmarket. mThemsamemismtruemformathletesmand mperformers. mHavingmsaidmt
hat, monemaspectmofmexecutivemcompensationmdeservesmcomment. mAmprimarymreasonmexecutivemcompen
sationmhasmgrownmsomdramaticallymismthatmcompaniesmhavemincreasinglymmovedmmtomm stock-
basedmmcompensation. mSuchmmovementmismobviouslymconsistentmwithmthemattemptmtombettermalignm stock
holdermandmmanagementminterests. mInmrecentmyears, mstockmpricesmhavemsoared, msommanagementmhas mcle
anedmup. mItmismsometimesmarguedmthatmmuchmofmthismrewardmismsimplymduemtomrisingmstockmprices minmg
eneral, mnotmmanagerialmperformance. mPerhapsminmthemfuture, mexecutivemcompensationmwillmbemdesigne
dmtomrewardmonlymdifferentialmperformance, mi.e., mstockmpricemincreasesminmexcessmofmgeneralmmarketm in
creases.
10. Maximizingmthemcurrentmsharempricemismthemsamemasmmaximizingmthemfuturemsharempricem atmanymfuturem
period. mThemvaluemofmamsharemofmstockmdependsmonmallmofmthemfuturemcashmmflowsmofmcompany. mAnothe
rmmwaymtomlookmatmthismismthat, mbarringmlargemcashmpaymentsmtomshareholders, mthemexpectedmmprice mofmm
themmstockmmustmbemhigherminmthemfuturemthanmitmismtoday. mWhomwouldmbuymamstockmform$100mtodaymw
henmthemsharempriceminmonemyearmismexpectedmtombem $80?
, SolutionsmManua
l
CHAPTER 2 m
FINANCIAL STATEMENTS AND CASH Fm m m m
LOW
AnswersmtomConceptsmReviewmandmCriticalmThinkingmQuestions
1. True. mEverymassetmcanmbemconvertedmtomcashmatmsomemprice. mHowever, mwhenmwe maremreferringmtomamliq
uidmasset, mthemaddedmassumptionmthatmthemassetmcanmbemquicklymconvertedmtomcash matmormnearmmarketm
valuemismimportant.
2. Themrecognitionmandmmatchingmprinciplesminmfinancialmaccountingmcallmformrevenues, mandmthemcostsm as
sociatedmwithmproducingmthosemrevenues, mtombem“booked”mwhenmthemrevenuemprocessmismessentiallymco
mplete, mnotmnecessarilymwhenmthemcashmismcollectedmormbillsmarempaid. mNotemthatmthismwaymismnotmneces
sarilymcorrect;mit’smthemwaymaccountantsmhavemchosenmtomdom it.
3. Thembottommlinemnumbermshowsmthemchangeminmthemcashmbalancemonmthembalancem sheet. mAsm such, mitmis
mnotmmmamusefulmnumber mfor manalyzingmamcompany.
4. Themmajormdifferencemismthemtreatmentmofminterestmexpense. mThemaccountingmstatementmofmcashmflowsmt
reatsminterestmasmanmoperatingmcashmflow, mwhilemthemfinancialmcashmflowsmtreatminterestm asm amfinancingm
mcashmflow. mThemlogicmof mthemaccountingmstatementmof mcashmflowsmismthatm sinceminterestmappearsmonmth
emincomemstatement, mwhichmshowsmthemoperationsmformthemperiod, mitmismanmoperatingmcashmflow. mInmrea
lity, minterestmismamfinancingmexpense, mwhichmresultsmfrommthemcompany’smchoicemofmdebtmandmequity. m
Wemwillmhavemmoremtomsaymaboutmthisminmamlatermchapter. mWhenmcomparingmthemtwomcash mflowmstatem
ents, mthemfinancialmstatementmofmcashmflowsmismammoremappropriatemmeasuremofmthemcompany’smperfor
mancembecausemofmitsmtreatmentmofminterest.
5. Marketmvaluesmcanmnevermbemnegative. mImaginemamsharemofmstockmsellingmform–
$20. mmThismwouldmmmeanmmthatmifmyoumplacedmanmordermform100mshares, myoumwouldmgetmthemstockmalon
gmwithmamcheckmform$2,000. mmHowmmanymsharesmdomyoumwantmtombuy?mMoremgenerally, mbecause mofmco
rporatemandmindividualmbankruptcymlaws, mnetmworthmformampersonmormamcorporationmcannotmbemnegative
, mimplyingmthatmliabilitiesmcannotmexceedmassetsminmmarketmvalue.
6. Formamsuccessfulmcompanymthatmismrapidlymexpanding, mformexample, mcapitalmoutlaysmwillmbemmlarge, mpo
ssiblymleadingmtomnegativemcashmflowmfrommassets. mInmgeneral, mwhatmmattersmismwhethermthemmoneymism
spentmwisely, mnotmwhethermcashmflowmfrommassetsmismpositivemorm negative.
7. It’smprobablymnotmamgoodmsignmformanmestablishedmcompanymtomhavemnegativemcashmflowmfrommoperatio
ns, mbutmitmwouldmbemfairlymordinarymformamstart-up, msomitm depends.
l SolutionsmManual
Solutions Manual
m
Corporate Finance
m
Ross, Westerfield, and Jaffe 10
m m m m
th
edition
m
,SolutionsmManua
l
CHAPTER 1 m
INTRODUCTION TO CORPORATE FINA m m m
NCE
AnswersmtomConcept mQuestions
1. Inmthemcorporatemformmofmownership, mthemshareholdersmaremthemownersmofmthemfirm. mThemshareholdersm
melectmthemdirectorsmof mthemcorporation, mwhominmturnmappointmthemfirm’smmanagement. mThismseparation
mof mownershipmfrommcontrolminmthemcorporatemformmof morganizationmismwhatmcausesmagencymmproblems
mmtomexist. mManagementmmaymactminmitsmownmor msomeonemelse’smbestminterests, mrather mthanmthosemof mth
emshareholders. mIfmsuchmeventsmoccur, mtheymmaymcontradictmthemgoalmofmmaximizingmthemsharempricemof
mthemequitymof mthemfirm.
2. Suchmorganizationsmfrequentlympursuemsocialmormpoliticalmmissions, msommanymdifferentmgoalsmaremconc
eivable. mOnemgoalmthatmismoftenmcitedmismrevenuemminimization;mi.e., mprovidemwhatevermgoodsmandmser
vicesmaremofferedmatmthemlowestmpossiblemcostmtomsociety. mAmbettermapproachmmightmbemtomobserve mthat
mevenmamnot-for-
profitmbusinessmhasmequity. mThus, monemanswermismthatmthemappropriatemgoalmmis mmtommmaximizemthe mvalu
emofmthemequity.
3. Presumably, mthemcurrentmstockmvaluemreflectsmthemrisk, mtiming, mandmmagnitudemofmallmfuturemcashmflow
s, mbothmshort-termmandmlong-term. mIfmthismismcorrect, mthenmthemstatementmism false.
4. Anmargumentmcanmbemmademeithermway. mAtmthemonemextreme, mwemcouldmarguemthatminmammarketmecono
my, mallmofmthesemthingsmarempriced. mTheremismthusmanmoptimalmlevelmof, mformexample, methicalmand/ormill
egalmbehavior, mandmthemframeworkmofmstockmvaluationmexplicitlymincludesmthese. mAtmthemothermextreme
, mwemcouldmarguemthatmthesemaremnon-
economicmphenomenamandmarembestmhandledmthroughmthemmpoliticalmprocess. mAmclassicm(andmhighlymrel
evant)mthoughtmquestionmthatmillustratesmthismdebatemgoesmsomethingmlikemthis:m“Amfirmmhasm estimatedm
thatmthemcostmofmimprovingmthemsafetymofmonemofmitsmproductsmism$30mmillion. mHowever, mthemfirmmbelie
vesmthatmimprovingmthemsafetymofmthemproductmwillmonlymsavem$20mmmillionminmproductmliabilitymclaims.
mWhatmshouldmthemfirmm do?”
5. Themgoalmwillmbemthemsame, mbutmthembestmcoursemofmactionmtowardmthatmgoalmmaymbemdifferentmbecause
mof mdifferingmsocial, mpolitical, mandmeconomicm institutions.
6. Themgoalmofmmanagementmshouldmbemtommaximizemthemsharempricemformthemcurrentmshareholders. mIfmma
nagementmbelievesmthatmitmcanmimprovemthemprofitabilitymofmthemfirmmsomthatmthemsharempricemwillmmexc
eedm$35, mthenmtheymshouldmfightmthemoffermfrommthemoutsidemcompany. mIfmmanagementmbelievesmthatmt
hismbiddermormothermunidentifiedmbiddersmwillmactuallympaymmoremthanm$35mpermsharemtomacquiremthemc
ompany, mthenmtheymshouldmstillmfightmthemoffer. mHowever, mifmthemcurrentmmanagementmcannotmincrease
mthemvaluemof mthemfirmmbeyondmthembidmprice, mandmnomother mhigher mbidsmcomemin, mthenmmanagementmis
mnotmactingm inm them interestsm of m them shareholdersm bym fightingm them offer. m Sincem currentm managersm o
ftenm lose
, theirmjobsmwhenmthemcorporationmismacquired, mpoorlymmonitoredmmanagersmhavemanmincentivemtomfigh
tmcorporatemtakeoversminmsituationsmsuchmasmthis.
7. Wemwouldmexpectmagencymproblemsmtombemlessmsevereminmothermcountries, mprimarilymduemtomthemrelativ
elymsmallmpercentagemofmindividualmownership. mFewermindividualmownersmshouldmreducemthemnumberm
ofmdiversemopinionsmconcerningmcorporatemgoals. mThemhighmpercentagemofminstitutionalmownershipmmig
htmmleadmtomamhighermdegreemofmagreementmbetweenmownersmandmmanagersmonmdecisionsm concerningmri
skymprojects. mInmaddition, minstitutionsmmaymbembettermablemtomimplementmeffectivemmonitoringmmechan
ismsmmmonmmanagersmthanmcanmindividualmowners, mbasedmonmtheminstitutions’ mdeepermresources mandmex
periencesmwithmtheirmownmmanagement.
8. ThemincreaseminminstitutionalmownershipmofmstockminmthemUnitedmmStatesmandmthe mgrowingmactivismmofm
mthesemlargemshareholder mgroupsmmaymleadmtomamreductionminmagencymproblemsmfor mU.S. mcorporationsm
andmmmammoremefficientmmarketmformcorporatemcontrol. mHowever, mthismmaymnotmalwaysmbemthemcase. mIfmt
hemmanagersmofmthemmutualmfundmormpensionmplanmaremnotmconcernedmwithmtheminterestsmofmtheminvesto
rs, mthemagencymproblemmcouldmpotentiallymremainmthemsame, mormevenmincreasemsincemtheremismthe mpossi
bilitymofmagencymproblemsmbetweenmthemfundmandmitsm investors.
9. Howmmuchmismtoommuch?mWhomismworthmmore, mLarrymEllsionmormTigermWoods?mThemsimplestmanswer
mismthatmtheremismammarketmfor mexecutivesmjustmasmtheremismfor mallmtypesmof mlabor. mExecutivemcompensat
ionmismmthempricemthatmclearsmthemmarket. mThemsamemismtruemformathletesmand mperformers. mHavingmsaidmt
hat, monemaspectmofmexecutivemcompensationmdeservesmcomment. mAmprimarymreasonmexecutivemcompen
sationmhasmgrownmsomdramaticallymismthatmcompaniesmhavemincreasinglymmovedmmtomm stock-
basedmmcompensation. mSuchmmovementmismobviouslymconsistentmwithmthemattemptmtombettermalignm stock
holdermandmmanagementminterests. mInmrecentmyears, mstockmpricesmhavemsoared, msommanagementmhas mcle
anedmup. mItmismsometimesmarguedmthatmmuchmofmthismrewardmismsimplymduemtomrisingmstockmprices minmg
eneral, mnotmmanagerialmperformance. mPerhapsminmthemfuture, mexecutivemcompensationmwillmbemdesigne
dmtomrewardmonlymdifferentialmperformance, mi.e., mstockmpricemincreasesminmexcessmofmgeneralmmarketm in
creases.
10. Maximizingmthemcurrentmsharempricemismthemsamemasmmaximizingmthemfuturemsharempricem atmanymfuturem
period. mThemvaluemofmamsharemofmstockmdependsmonmallmofmthemfuturemcashmmflowsmofmcompany. mAnothe
rmmwaymtomlookmatmthismismthat, mbarringmlargemcashmpaymentsmtomshareholders, mthemexpectedmmprice mofmm
themmstockmmustmbemhigherminmthemfuturemthanmitmismtoday. mWhomwouldmbuymamstockmform$100mtodaymw
henmthemsharempriceminmonemyearmismexpectedmtombem $80?
, SolutionsmManua
l
CHAPTER 2 m
FINANCIAL STATEMENTS AND CASH Fm m m m
LOW
AnswersmtomConceptsmReviewmandmCriticalmThinkingmQuestions
1. True. mEverymassetmcanmbemconvertedmtomcashmatmsomemprice. mHowever, mwhenmwe maremreferringmtomamliq
uidmasset, mthemaddedmassumptionmthatmthemassetmcanmbemquicklymconvertedmtomcash matmormnearmmarketm
valuemismimportant.
2. Themrecognitionmandmmatchingmprinciplesminmfinancialmaccountingmcallmformrevenues, mandmthemcostsm as
sociatedmwithmproducingmthosemrevenues, mtombem“booked”mwhenmthemrevenuemprocessmismessentiallymco
mplete, mnotmnecessarilymwhenmthemcashmismcollectedmormbillsmarempaid. mNotemthatmthismwaymismnotmneces
sarilymcorrect;mit’smthemwaymaccountantsmhavemchosenmtomdom it.
3. Thembottommlinemnumbermshowsmthemchangeminmthemcashmbalancemonmthembalancem sheet. mAsm such, mitmis
mnotmmmamusefulmnumber mfor manalyzingmamcompany.
4. Themmajormdifferencemismthemtreatmentmofminterestmexpense. mThemaccountingmstatementmofmcashmflowsmt
reatsminterestmasmanmoperatingmcashmflow, mwhilemthemfinancialmcashmflowsmtreatminterestm asm amfinancingm
mcashmflow. mThemlogicmof mthemaccountingmstatementmof mcashmflowsmismthatm sinceminterestmappearsmonmth
emincomemstatement, mwhichmshowsmthemoperationsmformthemperiod, mitmismanmoperatingmcashmflow. mInmrea
lity, minterestmismamfinancingmexpense, mwhichmresultsmfrommthemcompany’smchoicemofmdebtmandmequity. m
Wemwillmhavemmoremtomsaymaboutmthisminmamlatermchapter. mWhenmcomparingmthemtwomcash mflowmstatem
ents, mthemfinancialmstatementmofmcashmflowsmismammoremappropriatemmeasuremofmthemcompany’smperfor
mancembecausemofmitsmtreatmentmofminterest.
5. Marketmvaluesmcanmnevermbemnegative. mImaginemamsharemofmstockmsellingmform–
$20. mmThismwouldmmmeanmmthatmifmyoumplacedmanmordermform100mshares, myoumwouldmgetmthemstockmalon
gmwithmamcheckmform$2,000. mmHowmmanymsharesmdomyoumwantmtombuy?mMoremgenerally, mbecause mofmco
rporatemandmindividualmbankruptcymlaws, mnetmworthmformampersonmormamcorporationmcannotmbemnegative
, mimplyingmthatmliabilitiesmcannotmexceedmassetsminmmarketmvalue.
6. Formamsuccessfulmcompanymthatmismrapidlymexpanding, mformexample, mcapitalmoutlaysmwillmbemmlarge, mpo
ssiblymleadingmtomnegativemcashmflowmfrommassets. mInmgeneral, mwhatmmattersmismwhethermthemmoneymism
spentmwisely, mnotmwhethermcashmflowmfrommassetsmismpositivemorm negative.
7. It’smprobablymnotmamgoodmsignmformanmestablishedmcompanymtomhavemnegativemcashmflowmfrommoperatio
ns, mbutmitmwouldmbemfairlymordinarymformamstart-up, msomitm depends.
