CHAPTERY1
IntroductionYtoYCorporateYFinance
TheYvaluesYshownYinYtheYsolutionsYmayYbeYroundedYforYdisplayYpurposes.YHowever,YtheYanswersYwereYd
erivedYusingYaYspreadsheetYwithoutYanyYintermediateYrounding.
AnswersYtoYProblemYSets
1. a. real
b. executiveYairplanes
c. brandYnames
d. financial
e. bonds
*f. investmentYorYcapitalYexpenditure
*g. capitalYbudgetingYorYinvestment
h. financing
*NoteYthatYfYandYgYareYinterchangeableYinYtheYquestion.
EstYtime:Y01-05
2. AYtrademark,YaYfactory,YundevelopedYland,YandYyourYworkYforceY(c,Yd,Ye,YandYg)YareYallYrealYasset
s.YRealYassetsYareYidentifiableYasYitemsYwithYintrinsicYvalue.YTheYothersYinYtheYlistYareYfinancialYas
sets,YthatYis,YtheseYassetsYderiveYvalueYbecauseYofYaYcontractualYclaim.
EstYtime:Y01-05
3. a.
FinancialYassets,YsuchYasYstocksYorYbankYloans,YareYclaimsYheldYbyYinvestors.YCo
rporationsYsellYfinancialYassetsYtoYraiseYtheYcashYtoYinvestYinYrealYassetsYsuchYasYplantY
andYequipment.YSomeYrealYassetsYareYintangible.
b. CapitalYexpenditureYmeansYinvestmentYinYrealYassets.YFinancingYmeansYraisingYtheYca
shYforYthisYinvestment.
c. TheYsharesYofYpublicYcorporationsYareYtradedYonYstockYexchangesYandYcanYbeYpurchas
edYbyYaYwideYrangeYofYinvestors.YTheYsharesYofYcloselyYheldYcorporationsYareYnotYpublicl
yYtradedYandYareYheldYbyYaYsmallYgroupYofYprivateYinvestors.
d. UnlimitedYliability:YInvestorsYareYresponsibleYforYallYtheYfirm‘sYdebts.YAYsoleYproprietorYh
asYunlimitedYliability.YInvestorsYinYcorporationsYhaveYlimitedYliability.YTheyYcanYloseYtheirY
investment,YbutYnoYmore.
EstYtime:Y01-05
©YMcGrawYHillYLLC.YAllYrightsYreserved.YNoYreproductionYorYdistributionYwithoutYtheYpriorYwrittenYconsentYofYMcGrawYH
illYLLC.
,4. ItemsYcYandYdYapplyYtoYcorporations.YBecauseYcorporationsYhaveYperpetualYlife,YownershipYcanYb
eYtransferredYwithoutYaffectingYoperations,YandYmanagersYcanYbeYfiredYwithYnoYeffectYonYownershi
p.YOtherYformsYofYbusinessYmayYhaveYunlimitedYliabilityYandYlimitedYlife.
EstYtime:Y01-05
5. SeparationYofYownershipYfacilitatesYtheYkeyYattributesYofYaYcorporation,YincludingYlimitedYliabilityYf
orYinvestors,YtransferabilityYofYownership,YaYseparateYlegalYpersonalityYofYtheYcorporation,YandYdel
egatedYcentralizedYmanagement.YTheseYfourYattributesYprovideYsubstantialYbenefitYforYinvestors,Y
includingYtheYabilityYtoYdiversifyYtheirYinvestmentYamongYmanyYuncorrelatedYreturns—
aYveryYvaluableYtoolYexploredYinYlaterYchapters.YAlso,YtheseYattributesYallowYinvestorsYtoYquicklyY
exit,Yenter,YorYshortYsellYanYinvestment,YtherebyYgeneratingYanYactiveYliquidYmarketYforYcorporation
s.
However,YtheseYpositiveYaspectsYalsoYintroduceYsubstantialYnegativeYexternalitiesYasYwell.YTheY
separationYofYownershipYfromYmanagementYtypicallyYleadsYtoYagencyYproblems,YwhereYmanage
rsYpreferYtoYconsumeYprivateYperksYorYmakeYotherYdecisionsYforYtheirYprivateYbenefit—
ratherYthanYmaximizeYshareholderYwealth.YShareholdersYtendYtoYexerciseYlessYoversightYofYeach
YindividualYinvestmentYasYtheirYdiversificationYincreases.YFinally,YtheYcorporation‘sYseparateYlegal
YpersonalityYmakesYitYdifficultYtoYenforceYaccountabilityYifYtheyYexternalizeYcostsYontoYsociety.
EstYtime:Y01-05
6. ShareholdersYwillYonlyYvoteYtoYmaximizeYshareholderYwealth.YShareholdersYcanYmodifyYtheirY
patternYofYconsumptionYthroughYborrowingYandYlending,YmatchYriskYpreferences,YandYhopeful
lyYbalanceYtheirYownYcheckbooksY(orYhireYaYqualifiedYprofessionalYtoYhelpYthemYwithYtheseYtas
ks).
EstYtime:Y01-05
7. IfYtheYinvestmentYincreasesYtheYfirm‘sYwealth,YitYincreasesYtheYfirm‘sYshareYvalue.Y Ms.YEspinoz
aYcouldYthenYsellYsomeYorYallYtheseYmoreYvaluableYsharesYtoYprovideYforYherYretirementYincome
.
EstYtime:Y01-05
8. a.
AssumingYthatYtheYencabulatorYmarketYisYrisky,YanY8%YexpectedYre
turnYonYtheYF&HYencabulatorYinvestmentsYmayYbeYinferiorYtoYaY4%Yreturn
YonYU.S.
governmentYsecurities,YdependingYonYtheYrelativeYriskYbetweenYtheYtwoYassets.
b.
UnlessYtheYfinancialYassetsYareYasYsafeYasYU.S.YgovernmentYsecurities,YtheirYcostYo
fYcapitalYwouldYbeYhigher.YTheYCFOYcouldYconsiderYexpectedYreturnsYonYassetsYwithYsimil
arYrisk.
EstYtime:Y06-10
9. ManagersYwouldYactYinYshareholders‘YinterestsYbecauseYtheyYhaveYaYlegalYdutyYtoYactYinYtheirYinte
rests.YManagersYmayYalsoYreceiveYcompensation—
Ybonuses,Ystock,YandYoptionYpayoutsYwithYvalueYtiedY(roughly)YtoYfirm Yperformance.YManagersYma
yYfearYpersonalYreputationalYdamageYfromYnotYactingYinYshareholders‘Yinterests.YAndYmanagersYc
©YMcGrawYHillYLLC.YAllYrightsYreserved.YNoYreproductionYorYdistributionYwithoutYtheYpriorYwrittenYconsentYofYMcGrawYH
illYLLC.
, anYbeYfiredYbyYtheYboardYofYdirectorsY(electedYbyYshareholders).Y IfYmanagersYstillYfailYtoYactYinYsha
reholders‘Yinterests,YshareholdersYmayYsellYtheirYshares,YloweringYtheYstockYpriceYandYpotentiallyY
creatingYtheYpossibilityYofYaYtakeover,YwhichYcanYagainYleadYtoYchangesYinYtheYboardYofYdirectorsY
andYseniorYmanagement.
EstYtime:Y01-05
©YMcGrawYHillYLLC.YAllYrightsYreserved.YNoYreproductionYorYdistributionYwithoutYtheYpriorYwrittenYconsentYofYMcGrawYH
illYLLC.
, 10. ManagersYthatYareYinsulatedYfromYtakeoversYmayYbeYmoreYproneYtoYagencyYproblemsYandYtheref
oreYmoreYlikelyYtoYactYinYtheirYownYinterestsYratherYthanYinYshareholders‘.Y IfYaYfirmYinstitutedYaYne
wYtakeoverYdefense,YweYmightYexpectYtoYseeYtheYvalueYofYitsYsharesYdeclineYasYagencyYproblem
sYincreaseYandYlessYshareholderYvalueYmaximizationYoccurs.YTheYcounterargumentYisYthatYdefens
iveYmeasuresYallowYmanagersYtoYnegotiateYforYaYhigherYpurchaseYpriceYinYtheYfaceYofYaYtakeover
Ybid—toYtheYbenefitYofYshareholderYvalue.
EstYtime:Y01-05
AppendixYQuestions:
1. BothYwouldYstillYinvestYinYtheirYfriend‘sYbusiness.YAYinvestsYandYreceivesY$121,000YforYhisYinv
estmentYatYtheYendYofYtheYyear—
whichYisYgreaterYthanYtheY$120,000YthatYwouldYbeYreceivedYfromYlendingYatY20%Y($100,000Y×
Y1.20Y=Y$120,000).Y GYalsoYinvests,YbutYborrowsYagainstYthe
$121,000Ypayment,YandYthusYreceivesY$100,833Y($121,000Y/Y1.20)Ytoday.
EstYtime:Y01-05
2. a.YHeYcouldYconsumeYupYtoY$200,000YnowY(forgoingYallYfutureYconsumption)YorYupYtoY$216,000Y
nextYyearY($200,000Y×Y1.08,YforgoingYallYconsumptionYthisYyear).YHeYshouldYinvestYallYofYhisYweal
thYtoYearnY$216,000YnextYyear.YToYchooseYtheYsameYconsumptionY(C)YinYbothYyears,YCY=Y($200,0
00
–YC)Y×Y1.08Y=Y$103,846.
DollarsYNextYYear
220,000
216,000
203,704
200,000
DollarsYNow
b.YHeYshouldYinvestYallYofYhisYwealthYtoYearnY$220,000Y($200,000Y×Y1.10)YnextYyear.YIfYheYconsu
mesYallYthisYyear,YheYcanYnowYhaveYaYtotalYofY$203,703.70Y($200,000Y×Y1.10/1.08)YthisYyearYorY$
220,000YnextYyear.YIfYheYconsumesYCYthisYyear,YtheYamountYavailableYforYnextYyear‘sYconsumpti
onYisY($203,703.70Y–
YC)Y×Y1.08.YToYgetYequalYconsumptionYinYbothY years,YsetYtheYamountYconsumedYtodayYequalYtoY
theYamountYnextY year:
CY=Y($203,703.70Y–YC)Y×Y1.08
CY=Y$105,769.20
EstYtime:Y06-10
©YMcGrawYHillYLLC.YAllYrightsYreserved.YNoYreproductionYorYdistributionYwithoutYtheYpriorYwrittenYconsentYofYMcGrawYH
illYLLC.
IntroductionYtoYCorporateYFinance
TheYvaluesYshownYinYtheYsolutionsYmayYbeYroundedYforYdisplayYpurposes.YHowever,YtheYanswersYwereYd
erivedYusingYaYspreadsheetYwithoutYanyYintermediateYrounding.
AnswersYtoYProblemYSets
1. a. real
b. executiveYairplanes
c. brandYnames
d. financial
e. bonds
*f. investmentYorYcapitalYexpenditure
*g. capitalYbudgetingYorYinvestment
h. financing
*NoteYthatYfYandYgYareYinterchangeableYinYtheYquestion.
EstYtime:Y01-05
2. AYtrademark,YaYfactory,YundevelopedYland,YandYyourYworkYforceY(c,Yd,Ye,YandYg)YareYallYrealYasset
s.YRealYassetsYareYidentifiableYasYitemsYwithYintrinsicYvalue.YTheYothersYinYtheYlistYareYfinancialYas
sets,YthatYis,YtheseYassetsYderiveYvalueYbecauseYofYaYcontractualYclaim.
EstYtime:Y01-05
3. a.
FinancialYassets,YsuchYasYstocksYorYbankYloans,YareYclaimsYheldYbyYinvestors.YCo
rporationsYsellYfinancialYassetsYtoYraiseYtheYcashYtoYinvestYinYrealYassetsYsuchYasYplantY
andYequipment.YSomeYrealYassetsYareYintangible.
b. CapitalYexpenditureYmeansYinvestmentYinYrealYassets.YFinancingYmeansYraisingYtheYca
shYforYthisYinvestment.
c. TheYsharesYofYpublicYcorporationsYareYtradedYonYstockYexchangesYandYcanYbeYpurchas
edYbyYaYwideYrangeYofYinvestors.YTheYsharesYofYcloselyYheldYcorporationsYareYnotYpublicl
yYtradedYandYareYheldYbyYaYsmallYgroupYofYprivateYinvestors.
d. UnlimitedYliability:YInvestorsYareYresponsibleYforYallYtheYfirm‘sYdebts.YAYsoleYproprietorYh
asYunlimitedYliability.YInvestorsYinYcorporationsYhaveYlimitedYliability.YTheyYcanYloseYtheirY
investment,YbutYnoYmore.
EstYtime:Y01-05
©YMcGrawYHillYLLC.YAllYrightsYreserved.YNoYreproductionYorYdistributionYwithoutYtheYpriorYwrittenYconsentYofYMcGrawYH
illYLLC.
,4. ItemsYcYandYdYapplyYtoYcorporations.YBecauseYcorporationsYhaveYperpetualYlife,YownershipYcanYb
eYtransferredYwithoutYaffectingYoperations,YandYmanagersYcanYbeYfiredYwithYnoYeffectYonYownershi
p.YOtherYformsYofYbusinessYmayYhaveYunlimitedYliabilityYandYlimitedYlife.
EstYtime:Y01-05
5. SeparationYofYownershipYfacilitatesYtheYkeyYattributesYofYaYcorporation,YincludingYlimitedYliabilityYf
orYinvestors,YtransferabilityYofYownership,YaYseparateYlegalYpersonalityYofYtheYcorporation,YandYdel
egatedYcentralizedYmanagement.YTheseYfourYattributesYprovideYsubstantialYbenefitYforYinvestors,Y
includingYtheYabilityYtoYdiversifyYtheirYinvestmentYamongYmanyYuncorrelatedYreturns—
aYveryYvaluableYtoolYexploredYinYlaterYchapters.YAlso,YtheseYattributesYallowYinvestorsYtoYquicklyY
exit,Yenter,YorYshortYsellYanYinvestment,YtherebyYgeneratingYanYactiveYliquidYmarketYforYcorporation
s.
However,YtheseYpositiveYaspectsYalsoYintroduceYsubstantialYnegativeYexternalitiesYasYwell.YTheY
separationYofYownershipYfromYmanagementYtypicallyYleadsYtoYagencyYproblems,YwhereYmanage
rsYpreferYtoYconsumeYprivateYperksYorYmakeYotherYdecisionsYforYtheirYprivateYbenefit—
ratherYthanYmaximizeYshareholderYwealth.YShareholdersYtendYtoYexerciseYlessYoversightYofYeach
YindividualYinvestmentYasYtheirYdiversificationYincreases.YFinally,YtheYcorporation‘sYseparateYlegal
YpersonalityYmakesYitYdifficultYtoYenforceYaccountabilityYifYtheyYexternalizeYcostsYontoYsociety.
EstYtime:Y01-05
6. ShareholdersYwillYonlyYvoteYtoYmaximizeYshareholderYwealth.YShareholdersYcanYmodifyYtheirY
patternYofYconsumptionYthroughYborrowingYandYlending,YmatchYriskYpreferences,YandYhopeful
lyYbalanceYtheirYownYcheckbooksY(orYhireYaYqualifiedYprofessionalYtoYhelpYthemYwithYtheseYtas
ks).
EstYtime:Y01-05
7. IfYtheYinvestmentYincreasesYtheYfirm‘sYwealth,YitYincreasesYtheYfirm‘sYshareYvalue.Y Ms.YEspinoz
aYcouldYthenYsellYsomeYorYallYtheseYmoreYvaluableYsharesYtoYprovideYforYherYretirementYincome
.
EstYtime:Y01-05
8. a.
AssumingYthatYtheYencabulatorYmarketYisYrisky,YanY8%YexpectedYre
turnYonYtheYF&HYencabulatorYinvestmentsYmayYbeYinferiorYtoYaY4%Yreturn
YonYU.S.
governmentYsecurities,YdependingYonYtheYrelativeYriskYbetweenYtheYtwoYassets.
b.
UnlessYtheYfinancialYassetsYareYasYsafeYasYU.S.YgovernmentYsecurities,YtheirYcostYo
fYcapitalYwouldYbeYhigher.YTheYCFOYcouldYconsiderYexpectedYreturnsYonYassetsYwithYsimil
arYrisk.
EstYtime:Y06-10
9. ManagersYwouldYactYinYshareholders‘YinterestsYbecauseYtheyYhaveYaYlegalYdutyYtoYactYinYtheirYinte
rests.YManagersYmayYalsoYreceiveYcompensation—
Ybonuses,Ystock,YandYoptionYpayoutsYwithYvalueYtiedY(roughly)YtoYfirm Yperformance.YManagersYma
yYfearYpersonalYreputationalYdamageYfromYnotYactingYinYshareholders‘Yinterests.YAndYmanagersYc
©YMcGrawYHillYLLC.YAllYrightsYreserved.YNoYreproductionYorYdistributionYwithoutYtheYpriorYwrittenYconsentYofYMcGrawYH
illYLLC.
, anYbeYfiredYbyYtheYboardYofYdirectorsY(electedYbyYshareholders).Y IfYmanagersYstillYfailYtoYactYinYsha
reholders‘Yinterests,YshareholdersYmayYsellYtheirYshares,YloweringYtheYstockYpriceYandYpotentiallyY
creatingYtheYpossibilityYofYaYtakeover,YwhichYcanYagainYleadYtoYchangesYinYtheYboardYofYdirectorsY
andYseniorYmanagement.
EstYtime:Y01-05
©YMcGrawYHillYLLC.YAllYrightsYreserved.YNoYreproductionYorYdistributionYwithoutYtheYpriorYwrittenYconsentYofYMcGrawYH
illYLLC.
, 10. ManagersYthatYareYinsulatedYfromYtakeoversYmayYbeYmoreYproneYtoYagencyYproblemsYandYtheref
oreYmoreYlikelyYtoYactYinYtheirYownYinterestsYratherYthanYinYshareholders‘.Y IfYaYfirmYinstitutedYaYne
wYtakeoverYdefense,YweYmightYexpectYtoYseeYtheYvalueYofYitsYsharesYdeclineYasYagencyYproblem
sYincreaseYandYlessYshareholderYvalueYmaximizationYoccurs.YTheYcounterargumentYisYthatYdefens
iveYmeasuresYallowYmanagersYtoYnegotiateYforYaYhigherYpurchaseYpriceYinYtheYfaceYofYaYtakeover
Ybid—toYtheYbenefitYofYshareholderYvalue.
EstYtime:Y01-05
AppendixYQuestions:
1. BothYwouldYstillYinvestYinYtheirYfriend‘sYbusiness.YAYinvestsYandYreceivesY$121,000YforYhisYinv
estmentYatYtheYendYofYtheYyear—
whichYisYgreaterYthanYtheY$120,000YthatYwouldYbeYreceivedYfromYlendingYatY20%Y($100,000Y×
Y1.20Y=Y$120,000).Y GYalsoYinvests,YbutYborrowsYagainstYthe
$121,000Ypayment,YandYthusYreceivesY$100,833Y($121,000Y/Y1.20)Ytoday.
EstYtime:Y01-05
2. a.YHeYcouldYconsumeYupYtoY$200,000YnowY(forgoingYallYfutureYconsumption)YorYupYtoY$216,000Y
nextYyearY($200,000Y×Y1.08,YforgoingYallYconsumptionYthisYyear).YHeYshouldYinvestYallYofYhisYweal
thYtoYearnY$216,000YnextYyear.YToYchooseYtheYsameYconsumptionY(C)YinYbothYyears,YCY=Y($200,0
00
–YC)Y×Y1.08Y=Y$103,846.
DollarsYNextYYear
220,000
216,000
203,704
200,000
DollarsYNow
b.YHeYshouldYinvestYallYofYhisYwealthYtoYearnY$220,000Y($200,000Y×Y1.10)YnextYyear.YIfYheYconsu
mesYallYthisYyear,YheYcanYnowYhaveYaYtotalYofY$203,703.70Y($200,000Y×Y1.10/1.08)YthisYyearYorY$
220,000YnextYyear.YIfYheYconsumesYCYthisYyear,YtheYamountYavailableYforYnextYyear‘sYconsumpti
onYisY($203,703.70Y–
YC)Y×Y1.08.YToYgetYequalYconsumptionYinYbothY years,YsetYtheYamountYconsumedYtodayYequalYtoY
theYamountYnextY year:
CY=Y($203,703.70Y–YC)Y×Y1.08
CY=Y$105,769.20
EstYtime:Y06-10
©YMcGrawYHillYLLC.YAllYrightsYreserved.YNoYreproductionYorYdistributionYwithoutYtheYpriorYwrittenYconsentYofYMcGrawYH
illYLLC.
