Principles of Corporate Finance 14th Edition (Brealey, Myers, Allen & Edmans) – Recently Revised Solution Manual with 100% Verified And Detailed Answers

CHAPTER 1 Introduction to Corporate Finance The values shown in the solutions may be rounded for display purposes. However, the answers werederived usi ng a spreadsheet without any intermediate rounding. Answers to Problem Sets 1. a. real b. executive airplanes c. brand names d. financial e. *f. *g. h. bonds investment or capital expenditure capital budgeting or investment financing *Note that f and g are interchangeable in the question. Est time: 01-05 2. A trademark, a factory, undeveloped land, and your work force (c, d, e, and g) are all real assets. Real assets are identifiable as items with intrinsic value. The others in the list are financial assets,that is, th ese assets derive value because of a contractual claim. Est time: 01-05 3. a. Financial assets, such as stocks or bank loans, are claims held by investors. Corporat ions sell financial assets to raise the cash to invest in real assets such as plantand equipm ent. Some real assets are intangible. b. Capital expenditure means investment in real assets. Financing means raising the cashfor th is investment. c. The shares of public corporations are traded on stock exchanges and can be purchasedby a wide range of investors. The shares of closely held corporations are not publicly traded and are held by a small group of private investors. d. Unlimited liability: Investors are responsible for all the firm‘s debts. A sole proprietor hasunli mited liability. Investors in corporations have limited liability. They can lose their investment, but no more. Est time: 01-05   4. Items c and d apply to corporations. Because corporations have perpetual life, ownership can betransf erred without affecting operations, and managers can be fired with no effect on ownership. Other form s of business may have unlimited liability and limited life. Est time: 01-05 5. Separation of ownership facilitates the key attributes of a corporation, including limited liability forinve stors, transferability of ownership, a separate legal personality of the corporation, and delegated centr alized management. These four attributes provide substantial benefit for investors, including the ability to diversify their investment among many uncorrelated returns— a very valuable tool explored in later chapters. Also, these attributes allow investors to quickly exit,ent er, or short sell an investment, thereby generating an active liquid market for corporations. However, these positive aspects also introduce substantial negative externalities as well. The separatio n of ownership from management typically leads to agency problems, where managersprefer to consu me private perks or make other decisions for their private benefit— rather than maximize shareholder wealth. Shareholders tend to exercise less oversight of each individu al investment as their diversification increases. Finally, the corporation‘s separate legal personalitymake s it difficult to enforce accountability if they externalize costs onto society. Est time: 01-05 6. Shareholders will only vote to maximize shareholder wealth. Shareholders can modify their pattern of consumption through borrowing and lending, match risk preferences, and hopefullybalance thei r own checkbooks (or hire a qualified professional to help them with these tasks). Est time: 01-05 7. If the investment increases the firm‘s wealth, it increases the firm‘s share value. Ms. Espinozacould then sell some or all these more valuable shares to provide for her retirement income. Est time: 01-05 8. a. Assuming that the encabulator market is risky, an 8% expected return onthe F&H encabulator investments may be inferior to a 4% return on U.S. government securities, depending on the relative risk between the two assets. b. Unless the financial assets are as safe as U.S. government securities, their cost of capit alwould be higher. The CFO could consider expected returns on assets with similar risk. Est time: 06-10 9. Managers would act in shareholders‘ interests because they have a legal duty to act in their interests. Managers may also receive compensation— bonuses, stock, and option payouts with value tied (roughly) to firm performance. Managers may fear personal reputational damage from not acting in shareholders‘ interests. And managers can be fired by the board of directors (electedby shareholders). If managers still fail to act in shareholders‘ interests, shareholders may sell their shares, lowering the stock price and potentially creating the possibility of a takeover, which can again lead to changes in the board of directors and senior management. Est time: 01-05   10. Managers that are insulated from takeovers may be more prone to agency problems and therefore mor e likely to act in their own interests rather than in shareholders‘. If a firm instituted anew takeover defe nse, we might expect to see the value of its shares decline as agency problems increase and less sha reholder value maximization occurs. The counterargument is thatdefensive measures allow managers t o negotiate for a higher purchase price in the face of a takeover bid— to the benefit of shareholder value. Est time: 01-05 Appendix Questions: 1. Both would still invest in their friend‘s business. A invests and receives $121,000 for his investme nt at the end of the year— which is greater than the $120,000 that would be receivedfrom lending at 20% ($100,000 × 1.20 = $120,000). G also invests, but borrows against the $121,000 payment, and thus receives $100,833 ($121,000 / 1.20) today. Est time: 01-05 2. a. He could consume up to $200,000 now (forgoing all future consumption) or up to $216,000 next ye ar ($200,000 × 1.08, forgoing all consumption this year). He should invest all of his wealthto earn $21 6,000 next year. To choose the same consumption (C) in both years, C = ($200,000 – C) × 1.08 = $103,846. Dollars Next Year 220,000 216,000 200,000 Dollars Now b. He should invest all of his wealth to earn $220,000 ($200,000 × 1.10) next year. If he consumes a ll this year, he can now have a total of $203,703.70 ($200,000 × 1.10/1.08) this yearor $220,000 nex t year. If he consumes C this year, the amount available for next year‘s consumption is ($203,703.70 – C) × 1.08. To get equal consumption in both years, set the amount consumed today equal to the am ount next year: C = ($203,703.70 – C) × 1.08 C = $105,769.20 Est time: 06-10 CHAPTER 2 How to Calculate Present Values The values shown in the solutions may be rounded for display purposes. However, the answers werederived usi ng a spreadsheet without any intermediate rounding. Answers to Problem Sets 1. a. False. The opportunity cost of capital varies with the risks associated with each individualproje ct or investment. The cost of borrowing is unrelated to these risks. b. True. The opportunity cost of capital depends on the risks associated with each project andits c ash flows. c. True. The opportunity cost of capital is dependent on the rates of returns shareholders can earn on the own by investing in projects with similar risks d. False. Bank accounts, within FDIC limits, are considered to be risk- free. Unless an investmentis also risk- free, its opportunity cost of capital must be adjusted upward to account for the associated risks. Est time: 01-05 2. a. In the first year, you will earn $1,000 × 0.04 = $40.00 b. In the second year, you will earn $1,040 × 0.04 = $41.60 c. By the end of the ninth year, you will accrue a principle of $1,040 × (1.049) = $1,423.31.The refore, in the Tenth year, you will earn $1,423.31 × 0.04 = $56.93 Est time: 01-05 3. Transistors Transistors (1 r)t 2019 1972 32, 000, 000, 000 2, 250 (1 r)48 40.94% 59.00% rPredicted Est time: 01-05