Solutions Manual
For
Corporate Finance
Ross, Westerfield, Jaffe and Jordan
13th edition
, CHAPTER 2 - 2
CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers to Concept Questions
1. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect
the directors of the corporation, who in turn appoint the firm’s management. This separation of
ownership from control in the corporate form of organization is what causes agency problems to exist.
Management may act in its own or someone else’s best interests, rather than those of the shareholders.
If such events occur, they may contradict the goal of maximizing the share price of the equity of the
firm.
2. Such organizations frequently pursue social or political missions, so many different goals are
conceivable. One goal that is often cited is revenue minimization; i.e., provide whatever goods and
services are offered at the lowest possible cost to society. A better approach might be to observe that
even a not-for-profit business has equity. Thus, one answer is that the appropriate goal is to maximize
the value of the equity.
3. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows,
both short-term and long-term. If this is correct, then the statement is false.
4. An argument can be made either way. At the one extreme, we could argue that in a market economy,
all of these things are priced. There is thus an optimal level of, for example, ethical and/or illegal
behavior, and the framework of stock valuation explicitly includes these. At the other extreme, we
could argue that these are non-economic phenomena and are best handled through the political process.
A classic (and highly relevant) thought question that illustrates this debate goes something like this:
“A firm has estimated that the cost of improving the safety of one of its products is $30 million.
However, the firm believes that improving the safety of the product will only save $20 million in
product liability claims. What should the firm do?”
5. The goal will be the same, but the best course of action toward that goal may be different because of
differing social, political, and economic institutions.
6. The goal of management should be to maximize the share price for the current shareholders. If
management believes that it can improve the profitability of the firm so that the share price will exceed
$35, then they should fight the offer from the outside company. If management believes that this
bidder, or other unidentified bidders, will actually pay more than $35 per share to acquire the company,
then they should still fight the offer. However, if the current management cannot increase the value of
the firm beyond the bid price, and no other higher bids come in, then management is not acting in the
interests of the shareholders by fighting the offer. Since current managers often lose their jobs when
the corporation is acquired, poorly monitored managers have an incentive to fight corporate takeovers
in situations such as this.
For
Corporate Finance
Ross, Westerfield, Jaffe and Jordan
13th edition
, CHAPTER 2 - 2
CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers to Concept Questions
1. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect
the directors of the corporation, who in turn appoint the firm’s management. This separation of
ownership from control in the corporate form of organization is what causes agency problems to exist.
Management may act in its own or someone else’s best interests, rather than those of the shareholders.
If such events occur, they may contradict the goal of maximizing the share price of the equity of the
firm.
2. Such organizations frequently pursue social or political missions, so many different goals are
conceivable. One goal that is often cited is revenue minimization; i.e., provide whatever goods and
services are offered at the lowest possible cost to society. A better approach might be to observe that
even a not-for-profit business has equity. Thus, one answer is that the appropriate goal is to maximize
the value of the equity.
3. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash flows,
both short-term and long-term. If this is correct, then the statement is false.
4. An argument can be made either way. At the one extreme, we could argue that in a market economy,
all of these things are priced. There is thus an optimal level of, for example, ethical and/or illegal
behavior, and the framework of stock valuation explicitly includes these. At the other extreme, we
could argue that these are non-economic phenomena and are best handled through the political process.
A classic (and highly relevant) thought question that illustrates this debate goes something like this:
“A firm has estimated that the cost of improving the safety of one of its products is $30 million.
However, the firm believes that improving the safety of the product will only save $20 million in
product liability claims. What should the firm do?”
5. The goal will be the same, but the best course of action toward that goal may be different because of
differing social, political, and economic institutions.
6. The goal of management should be to maximize the share price for the current shareholders. If
management believes that it can improve the profitability of the firm so that the share price will exceed
$35, then they should fight the offer from the outside company. If management believes that this
bidder, or other unidentified bidders, will actually pay more than $35 per share to acquire the company,
then they should still fight the offer. However, if the current management cannot increase the value of
the firm beyond the bid price, and no other higher bids come in, then management is not acting in the
interests of the shareholders by fighting the offer. Since current managers often lose their jobs when
the corporation is acquired, poorly monitored managers have an incentive to fight corporate takeovers
in situations such as this.
