,Solution manual for Fundamentals of Financial
Management Concise, 11th Edition Eugene F.
Brigham
Notes
1- The file is chapter after chapter.
2- We have shown you 10 pages.
3- The file contains all Appendix and Excel
sheet if it exists.
4- We have all what you need, we make
update at every time. There are many
new editions waiting you.
5- If you think you purchased the wrong file
You can contact us at every time, we can
replace it with true one.
Our email:
, Chapter 1
Learning Objectives
An Overview of Financial Management
After reading this chapter, students should be able to do the following:
Explain the role of finance and the different types of jobs in finance.
Identify the advantages and disadvantages of different forms of business organization.
Explain the links between stock price, intrinsic value, and executive compensation.
Identify the potential conflicts that arise within the firm between stockholders and managers and
between stockholders and bondholders, and discuss the techniques that firms can use to mitigate these
potential conflicts.
Discuss the importance of business ethics and the consequences of unethical behavior.
Chapter 1: An Overview of Financial Management Learning Objectives 1
© 2022 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, Lecture Suggestions
Chapter 1 covers some important concepts and discussing them in class can be interesting. However,
students can read the chapter on their own, so it can be assigned but not covered in class.
We spend the first day going over the syllabus and discussing grading and other mechanics relating
to the course. To the extent that time permits, we talk about the topics that will be covered in the course and
the structure of the book. We also briefly discuss the fact that it is assumed that managers try to maximize
stock prices, but that they may have other goals, hence that it is useful to tie executive compensation to
stockholder-oriented performance measures. If time permits, we think it’s worthwhile to spend at least a full
day on the chapter. If not, we ask students to read it on their own, and to keep them honest, we ask one or
two questions about the material on the first exam.
One point we emphasize in the first class is that students should print a copy of the PowerPoint
slides for each chapter covered and purchase a financial calculator immediately and bring both to class
regularly. We also put copies of the various versions of our “Brief Calculator Manual,” which in about 12
pages explains how to use the most popular calculators, in the copy center. Students will need to learn how
to use their calculators before time value of money concepts are covered in Chapter 5. It is important for
students to grasp these concepts early as many of the remaining chapters build on the TVM concepts.
We are often asked what calculator students should buy. If they already have a financial calculator
that can find IRRs, we tell them that it will do, but if they do not have one, we recommend either the
HP-10BII+ or 17BII+. Please see the “Lecture Suggestions” for Chapter 5 for more on calculators.
2 Lecture Suggestions Chapter 1: An Overview of Financial Management
© 2022 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, Answers to End-of-Chapter Questions
1-1 A firm’s intrinsic value is an estimate of a stock’s “true” value based on accurate risk and return
data. It can be estimated but not measured precisely. A stock’s current price is its market price—
the value based on perceived but possibly incorrect information as seen by the marginal investor.
From these definitions, you can see that a stock’s “true” long-run value is more closely related to its
intrinsic value rather than its current price.
1-2 Equilibrium is the situation where the actual market price equals the intrinsic value, so investors are
indifferent between buying and selling a stock. If a stock is in equilibrium then there is no
fundamental imbalance, hence no pressure for a change in the stock’s price. At any given time,
most stocks are reasonably close to their intrinsic values and thus are at or close to equilibrium.
However, at times stock prices and equilibrium values are different, so stocks can be temporarily
undervalued or overvalued. Investor optimism and pessimism, along with imperfect knowledge
about the true intrinsic value, leads to deviations between the actual prices and intrinsic values.
1-3 If the three intrinsic value estimates for Stock X were different, you would have the most confidence
in Company X’s CFO’s estimate. Intrinsic values are strictly estimates, and different analysts with
different data and different views of the future will form different estimates of the intrinsic value for
any given stock. However, a firm’s managers have the best information about the company’s future
prospects, so managers’ estimates of intrinsic value are generally better than the estimates of
outside investors.
1-4 If a stock’s market price and intrinsic value are equal, then the stock is in equilibrium and there is no
pressure (buying/selling) to change the stock’s price. So, theoretically, it is better that the two be
equal; however, intrinsic value is a long-run concept. Management’s goal should be to maximize
the firm’s intrinsic value, not its current price. So, maximizing the intrinsic value will maximize the
average price over the long run but not necessarily the current price at each point in time. So,
stockholders in general would probably expect the firm’s market price to be under the intrinsic
value—realizing that if management is doing its job that current price at any point in time would not
necessarily be maximized. However, the CEO would prefer that the market price be high—since it
is the current price that he will receive when exercising his stock options. In addition, he will be
retiring after exercising those options, so there will be no repercussions to him (with respect to his
job) if the market price drops—unless he did something illegal during his tenure as CEO.
1-5 The board of directors should set CEO compensation dependent on how well the firm performs.
The compensation package should be sufficient to attract and retain the CEO but not go beyond
what is needed. Compensation should be structured so that the CEO is rewarded based on the
stock’s performance over the long run, not the stock’s price on an option exercise date. This means
that options (or direct stock awards) should be phased in over several years so the CEO will have
an incentive to keep the stock price high over time. If the intrinsic value could be measured in an
objective and verifiable manner, then performance pay could be based on changes in intrinsic
value. However, it is easier to measure the growth rate in reported profits than the intrinsic value,
although reported profits can be manipulated through aggressive accounting procedures and
intrinsic value cannot be manipulated. Since intrinsic value is not observable, compensation must
be based on the stock’s market price—but the price used should be an average over time rather
than on a specific date.
1-6 The different forms of business organization are proprietorships, partnerships, corporations, and
limited liability corporations and partnerships. The advantages of the first two include the ease and
low cost of formation. The advantages of corporations include limited liability, indefinite life, ease of
ownership transfer, and access to capital markets. Limited liability companies and partnerships
have limited liability like corporations.
The disadvantages of a proprietorship are (1) difficulty in obtaining large sums of capital; (2)
unlimited personal liability for business debts; and (3) limited life. The disadvantages of a
Chapter 1: An Overview of Financial Management Answers and Solutions 3
© 2022 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, partnership are (1) unlimited liability, (2) limited life, (3) difficulty of transferring ownership, and (4)
difficulty of raising large amounts of capital. The disadvantages of a corporation are (1) double
taxation of earnings and (2) setting up a corporation and filing required state and federal reports,
which are complex and time-consuming. Among the disadvantages of limited liability corporations
and partnerships are difficulty in raising capital and the complexity of setting them up.
1-7 Stockholder wealth maximization is a long-run goal. Companies, and consequently the
stockholders, prosper by management making decisions that will produce long-term earnings
increases. Actions that are continually shortsighted often “catch up” with a firm and, as a result, it
may find itself unable to compete effectively against its competitors. There has been much criticism
in recent years that U.S. firms are too short-run profit-oriented. A prime example is the U.S. auto
industry, which has been accused of continuing to build large “gas guzzler” automobiles because
they had higher profit margins rather than retooling for smaller, more fuel-efficient models.
1-8 Useful motivational tools that will aid in aligning stockholders’ and management’s interests include:
(1) reasonable compensation packages, (2) direct intervention by shareholders, including firing
managers who don’t perform well, and (3) the threat of takeover.
The compensation package should be sufficient to attract and retain able managers but not go
beyond what is needed. Also, compensation packages should be structured so that managers are
rewarded based on the stock’s performance over the long run, not the stock’s price on an option
exercise date. This means that options (or direct stock awards) should be phased in over several
years so managers will have an incentive to keep the stock price high over time. Since intrinsic
value is not observable, compensation must be based on the stock’s market price—but the price
used should be an average over time rather than on a specific date.
Stockholders can intervene directly with managers. Today, the majority of stock is owned by
institutional investors and these institutional money managers have the clout to exercise
considerable influence over firms’ operations. First, they can talk with managers and make
suggestions about how the business should be run. In effect, these institutional investors act as
lobbyists for the body of stockholders. Second, any shareholder who has owned $2,000 of a
company’s stock for one year can sponsor a proposal that must be voted on at the annual
stockholders’ meeting, even if management opposes the proposal. Although shareholder-
sponsored proposals are non-binding, the results of such votes are clearly heard by top
management. Shareholder activism has increasingly played an important part ensuring that
managers act in shareholders’ interests. Indeed, in 2014, activists established a record level of
influence when they were granted a board seat in 73% of the proxy fights that occurred that year.
GE is one of a small group of companies that has voluntarily made it easier for shareholders to
secure a board seat. The firm’s new plan allows shareholder groups holding at least 3% of the
company’s stock to directly nominate candidates for its board.
If a firm’s stock is undervalued, then corporate raiders will see it to be a bargain and will attempt
to capture the firm in a hostile takeover. If the raid is successful, the target’s executives will almost
certainly be fired. This situation gives managers a strong incentive to take actions to maximize their
stock’s price.
1-9 a. Corporate philanthropy is always a sticky issue, but it can be justified in terms of helping to
create a more attractive community that will make it easier to hire a productive work force. This
corporate philanthropy could be received by stockholders negatively, especially those
stockholders not living in its headquarters city. Stockholders are interested in actions that
maximize share price, and if competing firms are not making similar contributions, the “cost” of
this philanthropy must be borne by someone—the stockholders. Thus, stock price could
decrease.
b. Companies must make investments in the current period to generate future cash flows.
Stockholders should be aware of this, and assuming a correct analysis has been performed,
they should react positively to the decision. The international plant is in this category. Capital
4 Answers and Solutions Chapter 1: An Overview of Financial Management
© 2022 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, budgeting is covered in depth in Part 4 of the text. Assuming that the correct capital budgeting
analysis has been made, the stock price should increase in the future.
c. U.S. Treasury bonds are considered safe investments, while common stocks are far riskier. If
the company were to switch the emergency funds from Treasury bonds to stocks, stockholders
should see this as increasing the firm’s risk because stock returns are not guaranteed—
sometimes they increase and sometimes they decline. The firm might need the funds when the
prices of their investments were low and not have the needed emergency funds.
Consequently, the firm’s stock price would probably fall.
1-10 a. No, TIAA-CREF is not an ordinary shareholder. Because it is one of the largest institutional
shareholders in the United States and it controls more than 900 billion in pension funds, its
voice carries a lot of weight. This “shareholder” in effect consists of many individual
shareholders whose pensions are invested with this group.
b. For TIAA-CREF to be effective in wielding its weight, it must act as a coordinated unit. To do
this, the fund’s managers should solicit from the individual shareholders their “votes” on the
fund’s practices, and from those “votes” act on the majority’s wishes. In so doing, the individual
teachers whose pensions are invested in the fund have, in effect, determined the fund’s voting
practices.
1-11 Earnings per share in the current year will decline due to the cost of the investment made in the
current year and no significant performance impact in the short run. However, the company’s stock
price should increase due to the significant cost savings expected in the future.
1-12 The board of directors should set CEO compensation dependent on how well the firm performs.
The compensation package should be sufficient to attract and retain the CEO but not go beyond
what is needed. Compensation should be structured so that the CEO is rewarded based on the
stock’s performance over the long run, not the stock’s price on an option exercise date. This means
that options (or direct stock awards) should be phased in over several years so the CEO will have
an incentive to keep the stock price high over time. If the intrinsic value could be measured in an
objective and verifiable manner, then performance pay could be based on changes in intrinsic
value. Since intrinsic value is not observable, compensation must be based on the stock’s market
price—but the price used should be an average over time rather than on a specific date. The board
should probably set the CEO’s compensation as a mix between a fixed salary and stock options.
The actions of the vice president of Company X would be different than if he were CEO of some
other company.
1-13 Setting the compensation policy for three division managers would be different than setting the
compensation policy for a CEO because performance of each of these managers could be more
easily observed. For a CEO, an award based on stock price performance makes sense, while
basing the compensation for division managers on stock price performance doesn’t make sense.
Each of the managers could still be given stock awards; however, rather than the award being
based on stock price it could be determined from some observable measure like increased gas
output, oil output, etc.
1-14 a. The expected payoff to debtholders is $77 million. The expected payoff to stockholders is (0.5 ×
$13 million + 0.5 × $53 million) = $33 million. If management selects Project L, then the firm will
have enough cash flow to fully pay debtholders the promised $77 million, regardless of the state
of the economy. The stockholders receive the cash flows that are available after the
debtholders have been paid.
b. The expected payoff to debtholders is (0.5 × $50 million + 0.5 × $77 million) = $63.5 million.
The expected payoff to stockholders is (0.5 × 0 + 0.5 × $93) = $46.5 million. If management
selects Project H and the economy is weak, then the company will not have enough cash to
Chapter 1: An Overview of Financial Management Answers and Solutions 5
© 2022 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, fully pay off its debts. In this case, the debtholders would receive all the available cash ($50
million) and there will be nothing left over for the stockholders. If the economy is strong, there
will be enough cash to fully pay off the debtholders and the stockholders will receive all the
remaining cash ($170 million – $77 million = $93 million).
c. The bondholders would clearly prefer that the company select Project L, since it would give
them a higher cash flow and less risk.
d. Even though Project L and Project H have the same overall expected payoff, Project H shifts
the distribution of the firm’s cash flow payoffs from debtholders to stockholders. So, in many
instances, despite the higher risk, stockholders may prefer Project H because it provides them
with a significantly higher expected payoff.
e. Bondholders attempt to protect themselves by including covenants in the bond agreements that
limit firms’ use of additional debt and constraining managers’ actions (such as taking on risky
projects to the detriment of bondholders) in other ways.
6 Answers and Solutions Chapter 1: An Overview of Financial Management
© 2022 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, Learning Objectives
Chapter 2
Financial Markets and Institutions
After reading this chapter, students should be able to do the following:
Identify the different types of financial markets and financial institutions, and explain how these markets
and institutions enhance capital allocation.
Explain how the stock market operates, and list the distinctions between the different types of stock
markets.
Explain how the stock market has performed in recent years.
Discuss the importance of market efficiency, and explain why some markets are more efficient than
others.
Develop a simple understanding of behavioral finance.
Chapter 2: Financial Markets and Institutions Learning Objectives 7
© 2022 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, Lecture Suggestions
Chapter 2 presents an overview of financial markets and institutions. Students have an interest in financial
markets and institutions. We base our lecture on the integrated case. The case goes systematically
through the key points in the chapter, and within a context that helps students see the real-world relevance
of the material in the chapter. We ask the students to read the chapter, and to “look over” the case before
class. However, our class consists of about 1,000 students, many of whom view the lecture online, so we
cannot count on them to prepare for class. For this reason, we designed our lectures to be useful to both
prepared and unprepared students.
Since we have easy access to computer projection equipment, we generally use the PowerPoint
slides as the core of our lectures. We make these slides available to our students, and we strongly suggest
to our students that they print a copy of the PowerPoint slides for the chapter and bring it to class. This will
provide them with a hard copy of our lecture, and they can take notes in the space provided. Students can
then concentrate on the lecture rather than on taking notes.
We do not stick strictly to the slide show—we go to the board frequently to present somewhat
different examples, to help answer questions, and the like. We like the spontaneity and change of pace trips
to the board provide, and, of course, use of the board provides needed flexibility. Also, if we feel that we
have covered a topic adequately at the board, we then click quickly through one or more slides.
The lecture notes we take to class consist of our own marked-up copy of the PowerPoint slides,
with notes on the comments we want to say about each slide. If we want to bring up some current event,
provide an additional example, or the like, we use post-it notes attached at the proper spot. The advantages
of this system are (1) that we have a carefully structured lecture that is easy for us to prepare (now that we
have it done) and for students to follow, and (2) that both we and the students always know exactly where
we are. The students also appreciate the fact that our lectures are closely coordinated with both the text
and our exams.
The slides contain the essence of the solution to each part of the integrated case, but we also
provide more in-depth solutions in this Instructor’s Manual. It is not essential, but you might find it useful to
read through the detailed solution. Also, we put a copy of the solution on reserve in the library for interested
students, but most find that they do not need it. Finally, we remind students again, at the start of the lecture
on Chapter 2, that they should bring a printout of the PowerPoint slides to class; otherwise, they will find it
difficult to take notes.
8 Lecture Suggestions Chapter 2: Financial Markets and Institutions
© 2022 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Management Concise, 11th Edition Eugene F.
Brigham
Notes
1- The file is chapter after chapter.
2- We have shown you 10 pages.
3- The file contains all Appendix and Excel
sheet if it exists.
4- We have all what you need, we make
update at every time. There are many
new editions waiting you.
5- If you think you purchased the wrong file
You can contact us at every time, we can
replace it with true one.
Our email:
, Chapter 1
Learning Objectives
An Overview of Financial Management
After reading this chapter, students should be able to do the following:
Explain the role of finance and the different types of jobs in finance.
Identify the advantages and disadvantages of different forms of business organization.
Explain the links between stock price, intrinsic value, and executive compensation.
Identify the potential conflicts that arise within the firm between stockholders and managers and
between stockholders and bondholders, and discuss the techniques that firms can use to mitigate these
potential conflicts.
Discuss the importance of business ethics and the consequences of unethical behavior.
Chapter 1: An Overview of Financial Management Learning Objectives 1
© 2022 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, Lecture Suggestions
Chapter 1 covers some important concepts and discussing them in class can be interesting. However,
students can read the chapter on their own, so it can be assigned but not covered in class.
We spend the first day going over the syllabus and discussing grading and other mechanics relating
to the course. To the extent that time permits, we talk about the topics that will be covered in the course and
the structure of the book. We also briefly discuss the fact that it is assumed that managers try to maximize
stock prices, but that they may have other goals, hence that it is useful to tie executive compensation to
stockholder-oriented performance measures. If time permits, we think it’s worthwhile to spend at least a full
day on the chapter. If not, we ask students to read it on their own, and to keep them honest, we ask one or
two questions about the material on the first exam.
One point we emphasize in the first class is that students should print a copy of the PowerPoint
slides for each chapter covered and purchase a financial calculator immediately and bring both to class
regularly. We also put copies of the various versions of our “Brief Calculator Manual,” which in about 12
pages explains how to use the most popular calculators, in the copy center. Students will need to learn how
to use their calculators before time value of money concepts are covered in Chapter 5. It is important for
students to grasp these concepts early as many of the remaining chapters build on the TVM concepts.
We are often asked what calculator students should buy. If they already have a financial calculator
that can find IRRs, we tell them that it will do, but if they do not have one, we recommend either the
HP-10BII+ or 17BII+. Please see the “Lecture Suggestions” for Chapter 5 for more on calculators.
2 Lecture Suggestions Chapter 1: An Overview of Financial Management
© 2022 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, Answers to End-of-Chapter Questions
1-1 A firm’s intrinsic value is an estimate of a stock’s “true” value based on accurate risk and return
data. It can be estimated but not measured precisely. A stock’s current price is its market price—
the value based on perceived but possibly incorrect information as seen by the marginal investor.
From these definitions, you can see that a stock’s “true” long-run value is more closely related to its
intrinsic value rather than its current price.
1-2 Equilibrium is the situation where the actual market price equals the intrinsic value, so investors are
indifferent between buying and selling a stock. If a stock is in equilibrium then there is no
fundamental imbalance, hence no pressure for a change in the stock’s price. At any given time,
most stocks are reasonably close to their intrinsic values and thus are at or close to equilibrium.
However, at times stock prices and equilibrium values are different, so stocks can be temporarily
undervalued or overvalued. Investor optimism and pessimism, along with imperfect knowledge
about the true intrinsic value, leads to deviations between the actual prices and intrinsic values.
1-3 If the three intrinsic value estimates for Stock X were different, you would have the most confidence
in Company X’s CFO’s estimate. Intrinsic values are strictly estimates, and different analysts with
different data and different views of the future will form different estimates of the intrinsic value for
any given stock. However, a firm’s managers have the best information about the company’s future
prospects, so managers’ estimates of intrinsic value are generally better than the estimates of
outside investors.
1-4 If a stock’s market price and intrinsic value are equal, then the stock is in equilibrium and there is no
pressure (buying/selling) to change the stock’s price. So, theoretically, it is better that the two be
equal; however, intrinsic value is a long-run concept. Management’s goal should be to maximize
the firm’s intrinsic value, not its current price. So, maximizing the intrinsic value will maximize the
average price over the long run but not necessarily the current price at each point in time. So,
stockholders in general would probably expect the firm’s market price to be under the intrinsic
value—realizing that if management is doing its job that current price at any point in time would not
necessarily be maximized. However, the CEO would prefer that the market price be high—since it
is the current price that he will receive when exercising his stock options. In addition, he will be
retiring after exercising those options, so there will be no repercussions to him (with respect to his
job) if the market price drops—unless he did something illegal during his tenure as CEO.
1-5 The board of directors should set CEO compensation dependent on how well the firm performs.
The compensation package should be sufficient to attract and retain the CEO but not go beyond
what is needed. Compensation should be structured so that the CEO is rewarded based on the
stock’s performance over the long run, not the stock’s price on an option exercise date. This means
that options (or direct stock awards) should be phased in over several years so the CEO will have
an incentive to keep the stock price high over time. If the intrinsic value could be measured in an
objective and verifiable manner, then performance pay could be based on changes in intrinsic
value. However, it is easier to measure the growth rate in reported profits than the intrinsic value,
although reported profits can be manipulated through aggressive accounting procedures and
intrinsic value cannot be manipulated. Since intrinsic value is not observable, compensation must
be based on the stock’s market price—but the price used should be an average over time rather
than on a specific date.
1-6 The different forms of business organization are proprietorships, partnerships, corporations, and
limited liability corporations and partnerships. The advantages of the first two include the ease and
low cost of formation. The advantages of corporations include limited liability, indefinite life, ease of
ownership transfer, and access to capital markets. Limited liability companies and partnerships
have limited liability like corporations.
The disadvantages of a proprietorship are (1) difficulty in obtaining large sums of capital; (2)
unlimited personal liability for business debts; and (3) limited life. The disadvantages of a
Chapter 1: An Overview of Financial Management Answers and Solutions 3
© 2022 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, partnership are (1) unlimited liability, (2) limited life, (3) difficulty of transferring ownership, and (4)
difficulty of raising large amounts of capital. The disadvantages of a corporation are (1) double
taxation of earnings and (2) setting up a corporation and filing required state and federal reports,
which are complex and time-consuming. Among the disadvantages of limited liability corporations
and partnerships are difficulty in raising capital and the complexity of setting them up.
1-7 Stockholder wealth maximization is a long-run goal. Companies, and consequently the
stockholders, prosper by management making decisions that will produce long-term earnings
increases. Actions that are continually shortsighted often “catch up” with a firm and, as a result, it
may find itself unable to compete effectively against its competitors. There has been much criticism
in recent years that U.S. firms are too short-run profit-oriented. A prime example is the U.S. auto
industry, which has been accused of continuing to build large “gas guzzler” automobiles because
they had higher profit margins rather than retooling for smaller, more fuel-efficient models.
1-8 Useful motivational tools that will aid in aligning stockholders’ and management’s interests include:
(1) reasonable compensation packages, (2) direct intervention by shareholders, including firing
managers who don’t perform well, and (3) the threat of takeover.
The compensation package should be sufficient to attract and retain able managers but not go
beyond what is needed. Also, compensation packages should be structured so that managers are
rewarded based on the stock’s performance over the long run, not the stock’s price on an option
exercise date. This means that options (or direct stock awards) should be phased in over several
years so managers will have an incentive to keep the stock price high over time. Since intrinsic
value is not observable, compensation must be based on the stock’s market price—but the price
used should be an average over time rather than on a specific date.
Stockholders can intervene directly with managers. Today, the majority of stock is owned by
institutional investors and these institutional money managers have the clout to exercise
considerable influence over firms’ operations. First, they can talk with managers and make
suggestions about how the business should be run. In effect, these institutional investors act as
lobbyists for the body of stockholders. Second, any shareholder who has owned $2,000 of a
company’s stock for one year can sponsor a proposal that must be voted on at the annual
stockholders’ meeting, even if management opposes the proposal. Although shareholder-
sponsored proposals are non-binding, the results of such votes are clearly heard by top
management. Shareholder activism has increasingly played an important part ensuring that
managers act in shareholders’ interests. Indeed, in 2014, activists established a record level of
influence when they were granted a board seat in 73% of the proxy fights that occurred that year.
GE is one of a small group of companies that has voluntarily made it easier for shareholders to
secure a board seat. The firm’s new plan allows shareholder groups holding at least 3% of the
company’s stock to directly nominate candidates for its board.
If a firm’s stock is undervalued, then corporate raiders will see it to be a bargain and will attempt
to capture the firm in a hostile takeover. If the raid is successful, the target’s executives will almost
certainly be fired. This situation gives managers a strong incentive to take actions to maximize their
stock’s price.
1-9 a. Corporate philanthropy is always a sticky issue, but it can be justified in terms of helping to
create a more attractive community that will make it easier to hire a productive work force. This
corporate philanthropy could be received by stockholders negatively, especially those
stockholders not living in its headquarters city. Stockholders are interested in actions that
maximize share price, and if competing firms are not making similar contributions, the “cost” of
this philanthropy must be borne by someone—the stockholders. Thus, stock price could
decrease.
b. Companies must make investments in the current period to generate future cash flows.
Stockholders should be aware of this, and assuming a correct analysis has been performed,
they should react positively to the decision. The international plant is in this category. Capital
4 Answers and Solutions Chapter 1: An Overview of Financial Management
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, budgeting is covered in depth in Part 4 of the text. Assuming that the correct capital budgeting
analysis has been made, the stock price should increase in the future.
c. U.S. Treasury bonds are considered safe investments, while common stocks are far riskier. If
the company were to switch the emergency funds from Treasury bonds to stocks, stockholders
should see this as increasing the firm’s risk because stock returns are not guaranteed—
sometimes they increase and sometimes they decline. The firm might need the funds when the
prices of their investments were low and not have the needed emergency funds.
Consequently, the firm’s stock price would probably fall.
1-10 a. No, TIAA-CREF is not an ordinary shareholder. Because it is one of the largest institutional
shareholders in the United States and it controls more than 900 billion in pension funds, its
voice carries a lot of weight. This “shareholder” in effect consists of many individual
shareholders whose pensions are invested with this group.
b. For TIAA-CREF to be effective in wielding its weight, it must act as a coordinated unit. To do
this, the fund’s managers should solicit from the individual shareholders their “votes” on the
fund’s practices, and from those “votes” act on the majority’s wishes. In so doing, the individual
teachers whose pensions are invested in the fund have, in effect, determined the fund’s voting
practices.
1-11 Earnings per share in the current year will decline due to the cost of the investment made in the
current year and no significant performance impact in the short run. However, the company’s stock
price should increase due to the significant cost savings expected in the future.
1-12 The board of directors should set CEO compensation dependent on how well the firm performs.
The compensation package should be sufficient to attract and retain the CEO but not go beyond
what is needed. Compensation should be structured so that the CEO is rewarded based on the
stock’s performance over the long run, not the stock’s price on an option exercise date. This means
that options (or direct stock awards) should be phased in over several years so the CEO will have
an incentive to keep the stock price high over time. If the intrinsic value could be measured in an
objective and verifiable manner, then performance pay could be based on changes in intrinsic
value. Since intrinsic value is not observable, compensation must be based on the stock’s market
price—but the price used should be an average over time rather than on a specific date. The board
should probably set the CEO’s compensation as a mix between a fixed salary and stock options.
The actions of the vice president of Company X would be different than if he were CEO of some
other company.
1-13 Setting the compensation policy for three division managers would be different than setting the
compensation policy for a CEO because performance of each of these managers could be more
easily observed. For a CEO, an award based on stock price performance makes sense, while
basing the compensation for division managers on stock price performance doesn’t make sense.
Each of the managers could still be given stock awards; however, rather than the award being
based on stock price it could be determined from some observable measure like increased gas
output, oil output, etc.
1-14 a. The expected payoff to debtholders is $77 million. The expected payoff to stockholders is (0.5 ×
$13 million + 0.5 × $53 million) = $33 million. If management selects Project L, then the firm will
have enough cash flow to fully pay debtholders the promised $77 million, regardless of the state
of the economy. The stockholders receive the cash flows that are available after the
debtholders have been paid.
b. The expected payoff to debtholders is (0.5 × $50 million + 0.5 × $77 million) = $63.5 million.
The expected payoff to stockholders is (0.5 × 0 + 0.5 × $93) = $46.5 million. If management
selects Project H and the economy is weak, then the company will not have enough cash to
Chapter 1: An Overview of Financial Management Answers and Solutions 5
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, fully pay off its debts. In this case, the debtholders would receive all the available cash ($50
million) and there will be nothing left over for the stockholders. If the economy is strong, there
will be enough cash to fully pay off the debtholders and the stockholders will receive all the
remaining cash ($170 million – $77 million = $93 million).
c. The bondholders would clearly prefer that the company select Project L, since it would give
them a higher cash flow and less risk.
d. Even though Project L and Project H have the same overall expected payoff, Project H shifts
the distribution of the firm’s cash flow payoffs from debtholders to stockholders. So, in many
instances, despite the higher risk, stockholders may prefer Project H because it provides them
with a significantly higher expected payoff.
e. Bondholders attempt to protect themselves by including covenants in the bond agreements that
limit firms’ use of additional debt and constraining managers’ actions (such as taking on risky
projects to the detriment of bondholders) in other ways.
6 Answers and Solutions Chapter 1: An Overview of Financial Management
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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, Learning Objectives
Chapter 2
Financial Markets and Institutions
After reading this chapter, students should be able to do the following:
Identify the different types of financial markets and financial institutions, and explain how these markets
and institutions enhance capital allocation.
Explain how the stock market operates, and list the distinctions between the different types of stock
markets.
Explain how the stock market has performed in recent years.
Discuss the importance of market efficiency, and explain why some markets are more efficient than
others.
Develop a simple understanding of behavioral finance.
Chapter 2: Financial Markets and Institutions Learning Objectives 7
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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, Lecture Suggestions
Chapter 2 presents an overview of financial markets and institutions. Students have an interest in financial
markets and institutions. We base our lecture on the integrated case. The case goes systematically
through the key points in the chapter, and within a context that helps students see the real-world relevance
of the material in the chapter. We ask the students to read the chapter, and to “look over” the case before
class. However, our class consists of about 1,000 students, many of whom view the lecture online, so we
cannot count on them to prepare for class. For this reason, we designed our lectures to be useful to both
prepared and unprepared students.
Since we have easy access to computer projection equipment, we generally use the PowerPoint
slides as the core of our lectures. We make these slides available to our students, and we strongly suggest
to our students that they print a copy of the PowerPoint slides for the chapter and bring it to class. This will
provide them with a hard copy of our lecture, and they can take notes in the space provided. Students can
then concentrate on the lecture rather than on taking notes.
We do not stick strictly to the slide show—we go to the board frequently to present somewhat
different examples, to help answer questions, and the like. We like the spontaneity and change of pace trips
to the board provide, and, of course, use of the board provides needed flexibility. Also, if we feel that we
have covered a topic adequately at the board, we then click quickly through one or more slides.
The lecture notes we take to class consist of our own marked-up copy of the PowerPoint slides,
with notes on the comments we want to say about each slide. If we want to bring up some current event,
provide an additional example, or the like, we use post-it notes attached at the proper spot. The advantages
of this system are (1) that we have a carefully structured lecture that is easy for us to prepare (now that we
have it done) and for students to follow, and (2) that both we and the students always know exactly where
we are. The students also appreciate the fact that our lectures are closely coordinated with both the text
and our exams.
The slides contain the essence of the solution to each part of the integrated case, but we also
provide more in-depth solutions in this Instructor’s Manual. It is not essential, but you might find it useful to
read through the detailed solution. Also, we put a copy of the solution on reserve in the library for interested
students, but most find that they do not need it. Finally, we remind students again, at the start of the lecture
on Chapter 2, that they should bring a printout of the PowerPoint slides to class; otherwise, they will find it
difficult to take notes.
8 Lecture Suggestions Chapter 2: Financial Markets and Institutions
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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
