, Solution manual for Fundamentals of
Corporate Finance, 4th Edition Robert Parrino
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,Fundamentals of Corporate Finance, 4th edition Solutions Manual
Chapter 1
The Financial Manager and the Firm
Before You Go On Questions and Answers
Section 1.1
1. What are the three most basic types of financial decisions managers must make?
The three most basic decisions each business must make are the capital budgeting decision,
the financing decision, and the working capital management decision. These decisions
determine which productive assets to buy, how to pay for or finance these purchases, and
how to manage the day-to-day financial matters so the company can pay its bills.
2. Explain why you would make an investment if the value of the expected cash flows
exceeds the cost of the project.
You would accept an investment project whose cash flows exceed the cost of the project
because such projects will increase the value of the firm, making the owners wealthier. Most
people start a business to increase their wealth. Remember that the cost of capital (time value
of money) will affect the decision about whether to invest.
3. Why are capital budgeting decisions among the most important decisions in the life of a
firm?
The capital budgeting decisions are considered the most important in the life of the firm
because these decisions determine which productive assets the firm purchases and these
assets generate most of the firm’s cash flows. Furthermore, capital budgeting decisions are
long-term decisions and if you make a mistake in selecting a productive asset, you are stuck
with the decision for a long time.
Section 1.2
Copyright © 2018 John Wiley & Sons, Inc. SM 1-1
,Fundamentals of Corporate Finance, 4th edition Solutions Manual
1. Why are many businesses operated as sole proprietorships or partnerships?
Many businesses elect to operate as sole proprietorships or partnerships because of the small
operating scale and capital base of their firms. Both of these forms of business organization
are fairly easy to start and impose few regulations on the owners.
2. What are some advantages and disadvantages of operating as a public corporation?
The main advantages of operating as a public corporation are the access to the public
securities markets, which makes it easier to raise large amounts of capital, and the ease of
ownership transfer. All the shareholders have to do is to call their broker to buy or sell shares
of stock. And because a public corporation usually has many shares outstanding, large blocks
of securities can be purchased or sold without an appreciable impact on the price of the stock.
The major disadvantage of corporations is the tax situation. Not only must the corporation
pay taxes on its income, but the owners of the corporation get taxed again when dividends
are paid to them. This is referred to as double taxation. In addition to taxes, public
corporations are subject to stringent reporting requirements, and the incentives may convince
managers to focus on shorter-term profitability than longer-term wealth creation.
3. Explain why professional partnerships such as physicians’ groups organize as limited
liability partnerships.
Professional partnerships such as physicians’ groups desire to organize as limited liability
partnerships (LLPs) to take advantage of the tax arrangements of partnerships combined with
the advantages of the limited liability of a corporation. By operating as an LLP, the
partnership is able to avoid a potential financial disaster resulting from the misconduct of one
partner.
Section 1.3
1. What are the major responsibilities of the CFO?
The major responsibilities of a CFO are recommendation and financial analysis of financial
decisions. Although all top managers in a firm participate in these decisions, the final report
and analysis is ultimately the responsibility of the CFO.
Copyright © 2018 John Wiley & Sons, Inc. SM 1-2
,Fundamentals of Corporate Finance, 4th edition Solutions Manual
2. Identify three financial officers who typically report to the CFO and describe their
duties.
The financial officers discussed in the chapter who report to the CFO are the controller, the
treasurer, and the internal auditor. The controller is the firm’s chief accounting officer, and
thus prepares the financial statements and taxes. This position also requires close cooperation
with the external auditors. The treasurer’s responsibility is the collection and disbursement of
cash, investing excess cash, raising new capital, handling foreign exchange, and overseeing
the company’s pension fund management. (S)he also assists the CFO in handling important
Wall Street relationships. Finally, the internal auditor is responsible for conducting risk
assessment and for performing audits of high-risk areas.
3. Why does the internal auditor report to both the CFO and the board of directors?
The internal auditor reports to the CFO on a day-to-day basis but is ultimately accountable
for reporting any accounting irregularities to the board of directors. The dual reporting
system serves as a check to ensure that there are no discrepancies in the company’s financial
statements.
Section 1.4
1. Why is profit maximization an unsatisfactory goal for managing a firm?
Profit maximization is not a satisfactory goal when managing a firm because it is rather
difficult to define profits since accountants can apply and interpret the same accounting
principles differently. Also, profit maximization does not define the size, the uncertainty, and
the timing of cash flows; it ignores the time value of money concept.
2. Explain why maximizing the current market price of a firm’s stock is an appropriate
goal for the firm’s management.
Maximizing the current market price of a firm’s stock is an appropriate goal for the firm’s
management because it is an unambiguous objective and it is easy to measure. One can
simply look at the value of the company’s stock on any given day to determine whether it
went up or down.
Copyright © 2018 John Wiley & Sons, Inc. SM 1-3
,Fundamentals of Corporate Finance, 4th edition Solutions Manual
3. What is the fundamental determinant of an asset’s value?
The fundamental determinant of an asset’s value is the future cash flow the asset is expected
to generate. Other factors that may help determine the price of an asset are internal decisions,
such as the company’s expansion strategy, as well as external stimulants, such as the state of
the economy.
Section 1.5
1. What are agency conflicts?
An agency conflict occurs when the goals of the principals are not aligned with the goals of
the agents. Management is often more concerned with pursuing its own self-interest, and so
the maximization of shareholder value is pushed to the side.
2. What are corporate raiders?
Corporate raiders can make the economy more efficient by keeping the top managers on their
toes. Top managers know that if the company’s performance declines and its stock slips, it
makes itself vulnerable to takeovers by corporate raiders who are just waiting to temporarily
acquire a company, turn it around, and sell it for profit. Therefore, the role of the corporate
raiders in the economy is twofold: first, the fear of takeovers pushes managers to do a better
job, and second, if the managers are not performing up to expectations, the company can be
rescued and restructured into a contributor again. However, the threat of a corporate raider
could result in an incentive conflict for managers, inducing them to focus on short-term
profitability over long-term value creation.
3. List the three main objectives of the Sarbanes-Oxley Act.
The three main goals of the Sarbanes-Oxley Act are to reduce agency costs in corporations,
to restore ethical conduct in the business sector, and to improve the integrity of accounting
reporting systems within firms.
Section 1.6
1. What is a conflict of interest in a business setting?
Copyright © 2018 John Wiley & Sons, Inc. SM 1-4
,Fundamentals of Corporate Finance, 4th edition Solutions Manual
Conflict of interest in the business setting refers to a conflict between a person’s personal or
institutional gain and the obligation to serve the interest of another party. For example, the
chapter discussed the problem that arises when the real estate agent helping you buy a house
is also the listing agent.
2. How would you define an ethical business culture?
An ethical business culture means that people have a set of principles, or moral values, that
helps them identify moral issues and then make ethical judgments without being told what to
do.
Self-Study Problems and Solutions
1.1 Give an example of a capital budgeting decision and a financing decision.
Solution: Capital budgeting involves deciding which productive assets the firm invests in,
such as buying a new plant or investing in the renovation of an existing facility.
Financing decisions determine how a firm will raise capital. Examples of
financing decisions include the decision to borrow from a bank or issue debt in
the public capital markets.
LO: 1
Level: Basic
1.2 What is the appropriate decision criterion for financial managers to use when
selecting a capital project?
Solution: Financial managers should select a capital project only if the value of the project’s
expected future cash flows exceeds the cost of the project. In other words,
managers should only make investments that will increase firm value, and thus
increase the stockholders’ wealth.
LO: 1
Level: Basic
Copyright © 2018 John Wiley & Sons, Inc. SM 1-5
,Fundamentals of Corporate Finance, 4th edition Solutions Manual
1.3 What are some of the things that managers do to manage a firm’s working capital?
Solution: Working capital management is the day-to-day management of a firm’s short-
term assets and liabilities. Working capital can be managed by maintaining the
optimal level of inventory, managing receivables and payables, deciding to whom
the firm should extend credit, and making appropriate investments with excess
cash.
LO: 1
Level: Basic
1.4 Which one of the following characteristics does not pertain to corporations?
a. Can enter into contracts
b. Can borrow money
c. Are the easiest type of business to form
d. Can be sued
e. Can own stock in other companies
Solution: The answer that does not pertain to corporations is: c. Are the easiest type of
business to form.
LO: 2
Level: Basic
1.5 What are typically the main components of an executive compensation package?
Solution: The three main components of a typical executive compensation package are:
base salary, bonus based on accounting performance, and compensation tied to
the firm’s stock price.
LO: 5
Level: Basic
Discussion Questions and Answers
Copyright © 2018 John Wiley & Sons, Inc. SM 1-6
,Fundamentals of Corporate Finance, 4th edition Solutions Manual
1.1 Describe the cash flows between a firm and its stakeholders.
Cash flows are generated by a firm’s productive assets that were purchased through either
issuing debt or raising equity. These assets generate revenues through the sale of goods
and services. A portion of this revenue is then used to pay wages and salaries to
employees, pay suppliers, pay taxes, and pay interest on the borrowed money. The
leftover money, residual cash, is then either reinvested back in the business or is paid out
to stockholders in the form of dividends.
LO: 1
Level: Basic
Bloomcode: Comprehension
AACSB: Analytic
IMA: Corporate Finance
AICPA: Industry/Sector Perspective
1.2 What are the three fundamental decisions the financial manager is concerned with, and
how do they affect the firm’s balance sheet?
The primary financial management decisions every company faces are capital budgeting
decisions, financing decisions, and working capital management decisions. Capital
budgeting addresses the question of which productive assets to buy; thus, it affects the
asset side of the balance sheet. Financing decisions focus on raising the money the firm
needs to buy productive assets. This is typically accomplished by selling long-term debt
and equity. Finally, working capital decisions involve how firms manage their current
assets and liabilities. The focus here is seeing that a firm has enough money to pay its
bills and that any spare money is invested to earn a return.
LO: 1
Level: Basic
Bloomcode: Comprehension
AACSB: Analytic
IMA: Decision Analysis
AICPA: Decision Modeling
Copyright © 2018 John Wiley & Sons, Inc. SM 1-7
, Fundamentals of Corporate Finance, 4th edition Solutions Manual
1.3 What is the difference between stockholders and stakeholders?
Stockholders, also referred to as shareholders, are the owners of the company. A
stakeholder, on the other hand, is anyone with a claim on the assets of the firm, including,
but not limited to, shareholders. Stakeholders include the firm’s employees, suppliers,
creditors, and the government.
LO: 1
Level: Basic
Bloomcode: Analysis
AACSB: Analytic
IMA: Corporate Finance
AICPA: Industry/Sector Perspective
1.4 Suppose that a group of accountants wants to start an accounting business. What
organizational form would they most likely choose, and why?
Most lawyers, accountants, and doctors form what are known as limited liability
partnerships. This formation combines the tax advantages of partnerships with the
limited liability of corporations.
LO: 2
Level: Basic
Bloomcode: Application
AACSB: Analysis
IMA: Business Economics
AICPA: Industry/Sector Perspective
1.5 Why would the owners of a business choose to form a corporation even though they will
face double taxation?
Because the benefits, such as limited liability and access to large amounts of capital at
relatively low cost in the public markets, outweigh the cost of double taxation (as well as
the higher costs associated with forming a corporation).
Copyright © 2018 John Wiley & Sons, Inc. SM 1-8
Corporate Finance, 4th Edition Robert Parrino
Hello all ,
We have all what you need with best price
Our email :
Our website :
testbanks-store.com
,Fundamentals of Corporate Finance, 4th edition Solutions Manual
Chapter 1
The Financial Manager and the Firm
Before You Go On Questions and Answers
Section 1.1
1. What are the three most basic types of financial decisions managers must make?
The three most basic decisions each business must make are the capital budgeting decision,
the financing decision, and the working capital management decision. These decisions
determine which productive assets to buy, how to pay for or finance these purchases, and
how to manage the day-to-day financial matters so the company can pay its bills.
2. Explain why you would make an investment if the value of the expected cash flows
exceeds the cost of the project.
You would accept an investment project whose cash flows exceed the cost of the project
because such projects will increase the value of the firm, making the owners wealthier. Most
people start a business to increase their wealth. Remember that the cost of capital (time value
of money) will affect the decision about whether to invest.
3. Why are capital budgeting decisions among the most important decisions in the life of a
firm?
The capital budgeting decisions are considered the most important in the life of the firm
because these decisions determine which productive assets the firm purchases and these
assets generate most of the firm’s cash flows. Furthermore, capital budgeting decisions are
long-term decisions and if you make a mistake in selecting a productive asset, you are stuck
with the decision for a long time.
Section 1.2
Copyright © 2018 John Wiley & Sons, Inc. SM 1-1
,Fundamentals of Corporate Finance, 4th edition Solutions Manual
1. Why are many businesses operated as sole proprietorships or partnerships?
Many businesses elect to operate as sole proprietorships or partnerships because of the small
operating scale and capital base of their firms. Both of these forms of business organization
are fairly easy to start and impose few regulations on the owners.
2. What are some advantages and disadvantages of operating as a public corporation?
The main advantages of operating as a public corporation are the access to the public
securities markets, which makes it easier to raise large amounts of capital, and the ease of
ownership transfer. All the shareholders have to do is to call their broker to buy or sell shares
of stock. And because a public corporation usually has many shares outstanding, large blocks
of securities can be purchased or sold without an appreciable impact on the price of the stock.
The major disadvantage of corporations is the tax situation. Not only must the corporation
pay taxes on its income, but the owners of the corporation get taxed again when dividends
are paid to them. This is referred to as double taxation. In addition to taxes, public
corporations are subject to stringent reporting requirements, and the incentives may convince
managers to focus on shorter-term profitability than longer-term wealth creation.
3. Explain why professional partnerships such as physicians’ groups organize as limited
liability partnerships.
Professional partnerships such as physicians’ groups desire to organize as limited liability
partnerships (LLPs) to take advantage of the tax arrangements of partnerships combined with
the advantages of the limited liability of a corporation. By operating as an LLP, the
partnership is able to avoid a potential financial disaster resulting from the misconduct of one
partner.
Section 1.3
1. What are the major responsibilities of the CFO?
The major responsibilities of a CFO are recommendation and financial analysis of financial
decisions. Although all top managers in a firm participate in these decisions, the final report
and analysis is ultimately the responsibility of the CFO.
Copyright © 2018 John Wiley & Sons, Inc. SM 1-2
,Fundamentals of Corporate Finance, 4th edition Solutions Manual
2. Identify three financial officers who typically report to the CFO and describe their
duties.
The financial officers discussed in the chapter who report to the CFO are the controller, the
treasurer, and the internal auditor. The controller is the firm’s chief accounting officer, and
thus prepares the financial statements and taxes. This position also requires close cooperation
with the external auditors. The treasurer’s responsibility is the collection and disbursement of
cash, investing excess cash, raising new capital, handling foreign exchange, and overseeing
the company’s pension fund management. (S)he also assists the CFO in handling important
Wall Street relationships. Finally, the internal auditor is responsible for conducting risk
assessment and for performing audits of high-risk areas.
3. Why does the internal auditor report to both the CFO and the board of directors?
The internal auditor reports to the CFO on a day-to-day basis but is ultimately accountable
for reporting any accounting irregularities to the board of directors. The dual reporting
system serves as a check to ensure that there are no discrepancies in the company’s financial
statements.
Section 1.4
1. Why is profit maximization an unsatisfactory goal for managing a firm?
Profit maximization is not a satisfactory goal when managing a firm because it is rather
difficult to define profits since accountants can apply and interpret the same accounting
principles differently. Also, profit maximization does not define the size, the uncertainty, and
the timing of cash flows; it ignores the time value of money concept.
2. Explain why maximizing the current market price of a firm’s stock is an appropriate
goal for the firm’s management.
Maximizing the current market price of a firm’s stock is an appropriate goal for the firm’s
management because it is an unambiguous objective and it is easy to measure. One can
simply look at the value of the company’s stock on any given day to determine whether it
went up or down.
Copyright © 2018 John Wiley & Sons, Inc. SM 1-3
,Fundamentals of Corporate Finance, 4th edition Solutions Manual
3. What is the fundamental determinant of an asset’s value?
The fundamental determinant of an asset’s value is the future cash flow the asset is expected
to generate. Other factors that may help determine the price of an asset are internal decisions,
such as the company’s expansion strategy, as well as external stimulants, such as the state of
the economy.
Section 1.5
1. What are agency conflicts?
An agency conflict occurs when the goals of the principals are not aligned with the goals of
the agents. Management is often more concerned with pursuing its own self-interest, and so
the maximization of shareholder value is pushed to the side.
2. What are corporate raiders?
Corporate raiders can make the economy more efficient by keeping the top managers on their
toes. Top managers know that if the company’s performance declines and its stock slips, it
makes itself vulnerable to takeovers by corporate raiders who are just waiting to temporarily
acquire a company, turn it around, and sell it for profit. Therefore, the role of the corporate
raiders in the economy is twofold: first, the fear of takeovers pushes managers to do a better
job, and second, if the managers are not performing up to expectations, the company can be
rescued and restructured into a contributor again. However, the threat of a corporate raider
could result in an incentive conflict for managers, inducing them to focus on short-term
profitability over long-term value creation.
3. List the three main objectives of the Sarbanes-Oxley Act.
The three main goals of the Sarbanes-Oxley Act are to reduce agency costs in corporations,
to restore ethical conduct in the business sector, and to improve the integrity of accounting
reporting systems within firms.
Section 1.6
1. What is a conflict of interest in a business setting?
Copyright © 2018 John Wiley & Sons, Inc. SM 1-4
,Fundamentals of Corporate Finance, 4th edition Solutions Manual
Conflict of interest in the business setting refers to a conflict between a person’s personal or
institutional gain and the obligation to serve the interest of another party. For example, the
chapter discussed the problem that arises when the real estate agent helping you buy a house
is also the listing agent.
2. How would you define an ethical business culture?
An ethical business culture means that people have a set of principles, or moral values, that
helps them identify moral issues and then make ethical judgments without being told what to
do.
Self-Study Problems and Solutions
1.1 Give an example of a capital budgeting decision and a financing decision.
Solution: Capital budgeting involves deciding which productive assets the firm invests in,
such as buying a new plant or investing in the renovation of an existing facility.
Financing decisions determine how a firm will raise capital. Examples of
financing decisions include the decision to borrow from a bank or issue debt in
the public capital markets.
LO: 1
Level: Basic
1.2 What is the appropriate decision criterion for financial managers to use when
selecting a capital project?
Solution: Financial managers should select a capital project only if the value of the project’s
expected future cash flows exceeds the cost of the project. In other words,
managers should only make investments that will increase firm value, and thus
increase the stockholders’ wealth.
LO: 1
Level: Basic
Copyright © 2018 John Wiley & Sons, Inc. SM 1-5
,Fundamentals of Corporate Finance, 4th edition Solutions Manual
1.3 What are some of the things that managers do to manage a firm’s working capital?
Solution: Working capital management is the day-to-day management of a firm’s short-
term assets and liabilities. Working capital can be managed by maintaining the
optimal level of inventory, managing receivables and payables, deciding to whom
the firm should extend credit, and making appropriate investments with excess
cash.
LO: 1
Level: Basic
1.4 Which one of the following characteristics does not pertain to corporations?
a. Can enter into contracts
b. Can borrow money
c. Are the easiest type of business to form
d. Can be sued
e. Can own stock in other companies
Solution: The answer that does not pertain to corporations is: c. Are the easiest type of
business to form.
LO: 2
Level: Basic
1.5 What are typically the main components of an executive compensation package?
Solution: The three main components of a typical executive compensation package are:
base salary, bonus based on accounting performance, and compensation tied to
the firm’s stock price.
LO: 5
Level: Basic
Discussion Questions and Answers
Copyright © 2018 John Wiley & Sons, Inc. SM 1-6
,Fundamentals of Corporate Finance, 4th edition Solutions Manual
1.1 Describe the cash flows between a firm and its stakeholders.
Cash flows are generated by a firm’s productive assets that were purchased through either
issuing debt or raising equity. These assets generate revenues through the sale of goods
and services. A portion of this revenue is then used to pay wages and salaries to
employees, pay suppliers, pay taxes, and pay interest on the borrowed money. The
leftover money, residual cash, is then either reinvested back in the business or is paid out
to stockholders in the form of dividends.
LO: 1
Level: Basic
Bloomcode: Comprehension
AACSB: Analytic
IMA: Corporate Finance
AICPA: Industry/Sector Perspective
1.2 What are the three fundamental decisions the financial manager is concerned with, and
how do they affect the firm’s balance sheet?
The primary financial management decisions every company faces are capital budgeting
decisions, financing decisions, and working capital management decisions. Capital
budgeting addresses the question of which productive assets to buy; thus, it affects the
asset side of the balance sheet. Financing decisions focus on raising the money the firm
needs to buy productive assets. This is typically accomplished by selling long-term debt
and equity. Finally, working capital decisions involve how firms manage their current
assets and liabilities. The focus here is seeing that a firm has enough money to pay its
bills and that any spare money is invested to earn a return.
LO: 1
Level: Basic
Bloomcode: Comprehension
AACSB: Analytic
IMA: Decision Analysis
AICPA: Decision Modeling
Copyright © 2018 John Wiley & Sons, Inc. SM 1-7
, Fundamentals of Corporate Finance, 4th edition Solutions Manual
1.3 What is the difference between stockholders and stakeholders?
Stockholders, also referred to as shareholders, are the owners of the company. A
stakeholder, on the other hand, is anyone with a claim on the assets of the firm, including,
but not limited to, shareholders. Stakeholders include the firm’s employees, suppliers,
creditors, and the government.
LO: 1
Level: Basic
Bloomcode: Analysis
AACSB: Analytic
IMA: Corporate Finance
AICPA: Industry/Sector Perspective
1.4 Suppose that a group of accountants wants to start an accounting business. What
organizational form would they most likely choose, and why?
Most lawyers, accountants, and doctors form what are known as limited liability
partnerships. This formation combines the tax advantages of partnerships with the
limited liability of corporations.
LO: 2
Level: Basic
Bloomcode: Application
AACSB: Analysis
IMA: Business Economics
AICPA: Industry/Sector Perspective
1.5 Why would the owners of a business choose to form a corporation even though they will
face double taxation?
Because the benefits, such as limited liability and access to large amounts of capital at
relatively low cost in the public markets, outweigh the cost of double taxation (as well as
the higher costs associated with forming a corporation).
Copyright © 2018 John Wiley & Sons, Inc. SM 1-8
