Solutions Manual Fundamentals of Corporate Finance
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13th Edition Ross, Westerfield, and Jordan
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Chapters 1 - 27
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,CHAPTER 1: Introduction to Corporate Finance
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CHAPTER 2: Financial Statements, Taxes, And Cash Flow
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CHAPTER 3: Working with Financial Statements
pg pg pg pg pg
CHAPTER 4: Long-Term Financial Planning and Growth
pg pg pg pg pg pg
CHAPTER 5: Introduction to Valuation: The Time Value of Money
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CHAPTER 6: Discounted Cash Flow Valuation
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CHAPTER 7: Interest Rates and Bond Valuation
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CHAPTER 8: Stock Valuation
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CHAPTER 9: Net Present Value and Other Investment Criteria
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CHAPTER 10: Making Capital Investment Decisions
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CHAPTER 11: Project Analysis and Evaluation
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CHAPTER 12: Some Lessons from Capital Market History
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CHAPTER 13: Return, Risk, And the Security Market Line
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CHAPTER 14: Cost of Capital
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CHAPTER 15: Raising Capital
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CHAPTER 16: Financial Leverage and Capital Structure Policy
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CHAPTER 17: Dividends and Payout Policy
pg pg pg pg pg
CHAPTER 18: Short-Term Finance and Planning
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CHAPTER 19: Cash and Liquidity Management
pg pg pg pg pg
CHAPTER 20: Credit and Inventory Management
pg pg pg pg pg
CHAPTER 21: International Corporate Finance
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CHAPTER 22: Behavioral Finance: Implications for Financial Manage
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CHAPTER 23: Enterprise Risk Management
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CHAPTER 24:Options and Corporate Finance
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CHAPTER 25: Option Valuation
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CHAPTER 26: Mergers and Acquisitions
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CHAPTER 27: Leasing
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,CHAPTER 1 pg
INTRODUCTION TO CORPORATE pg pg
FINANCE
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Answers to Concepts Review and Critical Thinking Questions
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1. Capital budgeting (deciding whether to expand a manufacturing plant), capital structure
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(deciding whether to issue new equity and use the proceeds to retire outstanding debt), and
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working capital management (modifying the firm’s credit collection policy with its
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customers).
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2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, hard to
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raise capital funds. Some advantages: simpler, less regulation, the owners are also the
pg pg pg pg pg pg pg pg pg pg pg pg pg
managers, sometimes personal tax rates are better than corporate tax rates.
pg pg pg pg pg pg pg pg pg pg pg
3. The primary disadvantage of the corporate form is the double taxation to shareholders of
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distributed earnings and dividends. Some advantages include: limited liability, ease of
pg pg pg pg pg pg pg pg pg pg pg
transferability, ability to raise capital, unlimited life, and so forth.
pg pg pg pg pg pg pg pg pg pg
4. In response to Sarbanes-Oxley, small firms have elected to go dark because of the costs of
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
compliance. The costs to comply with Sarbox can be several million dollars, which can be a
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
large percentage of a small firms profits. A major cost of going dark is less access
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
pgto capital. Since the firm is no longer publicly traded, it can no longer raise money in the
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
public market. Although the company will still have access to bank loans and the private
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
equity market, the costs associated with raising funds in these markets are usually higher
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
than the costs of raising funds in the public market.
pg pg pg pg pg pg pg pg pg pg
5. The treasurer’s office
p g and the controller’s office are the two primary
p g p g p g p g p g p g p g p g p g
organizational groups that report directly to the chief financial officer. The controller’s
p g p g p g pg pg pg pg pg pg pg pg pg
office handles cost and financial accounting, tax management, and management information
pg pg pg pg pg g
p pg pg pg pg pg
systems, while the treasurer’s office is responsible for cash and credit management,
pg pg pg pg pg pg pg pg pg pg pg pg
pgcapital budgeting, and financial planning. Therefore, the study of corporate finance is
pg pg pg pg pg g
p pg pg pg pg pg
concentrated within the treasury group’s functions.
pg pg pg pg pg pg
6. To maximize the current market value (share price) of the equity of the firm (whether it’s
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publicly- traded or not).
pg pg pg pg
7. In the corporate form of ownership, the shareholders are the owners of the firm. The
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shareholders elect the directors of the corporation, who in turn appoint the firm’s
pg pg pg pg pg pg pg pg pg pg pg pg pg
management. This separation of ownership from control in the corporate form of organization
pg pg pg pg pg pg pg pg pg pg pg pg pg
is what causes agency problems to exist. Management may act in its own or someone else’s
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
best interests, rather than those of the shareholders. If such events occur, they may contradict
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
the goal of maximizing the share price of the equity of the firm.
pg pg pg pg pg pg pg pg pg pg pg pg pg
8. A primary market transaction.
pg pg pg
, B-2 p g SOLUTIONS
9. In auction markets like the NYSE, brokers and agents meet at a physical location (the
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
exchange) to match buyers and sellers of assets. Dealer markets like NASDAQ consist of
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
dealers operating at dispersed locales who buy and sell assets themselves, communicating
pg pg pg pg pg pg pg pg pg pg pg pg
with other dealers either electronically or literally over-the-counter.
pg pg pg pg pg pg pg pg
10. Such organizations frequently pursue social or political missions, so many different goals are
pg pg pg pg pg pg pg pg pg pg pg pg
conceivable. One goal that is often cited is revenue minimization; i.e., provide whatever
pg pg pg pg pg pg pg pg pg pg pg pg pg
goods and services are offered at the lowest possible cost to society. A better approach
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
might be to observe that even a not-for-profit business has equity. Thus, one answer is that
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
the appropriate goal is to maximize the value of the equity.
pg pg pg pg p g pg pg pg pg pg pg
11. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
flows, both short-term and long-term. If this is correct, then the statement is false.
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
12. An argument can be made either way. At the one extreme, we could argue that in a market
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
economy,all of these things are priced. There is thus an optimal level of, for example, ethical
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
and/or illegal behavior, and the framework of stock valuation explicitly includes these. At the
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
other extreme, we could argue that these are non-economic phenomena and are best handled
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
through the political process. A classic (and highly relevant) thought question that illustrates
pg pg pg pg pg pg pg pg pg pg pg pg pg
this debate goes something like this: “A firm has estimated that the cost of improving the
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
safety of one of its products is $30 million. However, the firm believes that improving the
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
safety of the product will only save $20 million in product liability claims. What should the
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
firm do?”
pg pg
13. The goal will be the same, but the best course of action toward that goal may be different
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
because of differing social, political, and economic institutions.
pg pg pg pg pg pg pg pg
14. The goal of management should be to maximize the share price for the current shareholders.
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
If management believes that it can improve the profitability of the firm so that the share
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
price will exceed $35, then they should fight the offer from the outside company. If
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
management believes that this bidder or other unidentified bidders will actually pay more
pg pg pg pg pg pg pg pg pg pg pg pg pg
than $35 per share to acquire the company, then they should still fight the offer. However, if
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
the current management cannot increase the value of the firm beyond the bid price, and no
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
other higher bids come in, then management is not acting in the interests of the shareholders
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
by fighting the offer. Since current managers often lose their jobs when the corporation is
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
acquired, poorly monitored managers have an incentive to fight corporate takeovers in
pg pg pg pg pg pg pg pg pg pg pg pg
situations such as this.
pg pg pg pg
15. We would expect agency problems to be less severe in other countries, primarily due to the
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
relativelysmall percentage of individual ownership. Fewer individual owners should reduce the
pg pg pg pg pg pg pg pg pg pg pg pg
number of diverse opinions concerning corporate goals. The high percentage of institutional
pg pg pg pg pg pg pg pg pg pg pg pg
ownership might lead to a higher degree of agreement between owners and managers on
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
decisions concerning risky projects. In addition, institutions may be better able to implement
pg pg pg pg pg pg pg pg pg pg pg pg pg
effective monitoring mechanisms on managers than can individual owners, based on the
pg pg pg pg pg pg pg pg pg pg pg pg
institutions’ deeper resources and experiences with their own management. The increase in
pg pg pg pg pg pg pg pg pg pg pg pg
institutional ownership of stock in the United States and the growing activism of these large
pg pg pg pg pg pg pg pg pg g
p pg pg pg pg pg
shareholder groups may lead to a reduction in agency problems for U.S. corporations and a
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
more efficient market for corporate control.
pg pg pg pg pg pg
pg pg pg pg pg
13th Edition Ross, Westerfield, and Jordan
pg pg pg pg pg pg pg
Chapters 1 - 27
pg pg pg
,CHAPTER 1: Introduction to Corporate Finance
pg pg pg pg pg
CHAPTER 2: Financial Statements, Taxes, And Cash Flow
pg pg pg pg pg pg pg
CHAPTER 3: Working with Financial Statements
pg pg pg pg pg
CHAPTER 4: Long-Term Financial Planning and Growth
pg pg pg pg pg pg
CHAPTER 5: Introduction to Valuation: The Time Value of Money
pg pg pg pg pg pg pg pg pg
CHAPTER 6: Discounted Cash Flow Valuation
pg pg pg pg pg
CHAPTER 7: Interest Rates and Bond Valuation
pg pg pg pg pg pg
CHAPTER 8: Stock Valuation
pg pg pg
CHAPTER 9: Net Present Value and Other Investment Criteria
pg pg pg pg pg pg pg pg
CHAPTER 10: Making Capital Investment Decisions
pg pg pg pg pg
CHAPTER 11: Project Analysis and Evaluation
pg pg pg pg pg
CHAPTER 12: Some Lessons from Capital Market History
pg pg pg pg pg pg pg
CHAPTER 13: Return, Risk, And the Security Market Line
pg pg pg pg pg pg pg pg
CHAPTER 14: Cost of Capital
pg pg pg pg
CHAPTER 15: Raising Capital
pg pg pg
CHAPTER 16: Financial Leverage and Capital Structure Policy
pg pg pg pg pg pg pg
CHAPTER 17: Dividends and Payout Policy
pg pg pg pg pg
CHAPTER 18: Short-Term Finance and Planning
pg pg pg pg pg
CHAPTER 19: Cash and Liquidity Management
pg pg pg pg pg
CHAPTER 20: Credit and Inventory Management
pg pg pg pg pg
CHAPTER 21: International Corporate Finance
pg pg pg pg
CHAPTER 22: Behavioral Finance: Implications for Financial Manage
pg pg pg pg pg pg pg
CHAPTER 23: Enterprise Risk Management
pg pg pg pg
CHAPTER 24:Options and Corporate Finance
pg pg pg pg
CHAPTER 25: Option Valuation
pg pg pg
CHAPTER 26: Mergers and Acquisitions
pg pg pg pg
CHAPTER 27: Leasing
pg pg
,CHAPTER 1 pg
INTRODUCTION TO CORPORATE pg pg
FINANCE
p
g
Answers to Concepts Review and Critical Thinking Questions
pg pg pg pg pg pg pg
1. Capital budgeting (deciding whether to expand a manufacturing plant), capital structure
pg pg pg pg pg pg pg pg pg pg
(deciding whether to issue new equity and use the proceeds to retire outstanding debt), and
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
working capital management (modifying the firm’s credit collection policy with its
pg pg pg pg pg pg pg pg pg pg pg
customers).
pg
2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, hard to
pg pg pg pg pg pg pg pg pg pg
raise capital funds. Some advantages: simpler, less regulation, the owners are also the
pg pg pg pg pg pg pg pg pg pg pg pg pg
managers, sometimes personal tax rates are better than corporate tax rates.
pg pg pg pg pg pg pg pg pg pg pg
3. The primary disadvantage of the corporate form is the double taxation to shareholders of
pg pg pg pg pg pg pg pg pg pg pg pg pg
distributed earnings and dividends. Some advantages include: limited liability, ease of
pg pg pg pg pg pg pg pg pg pg pg
transferability, ability to raise capital, unlimited life, and so forth.
pg pg pg pg pg pg pg pg pg pg
4. In response to Sarbanes-Oxley, small firms have elected to go dark because of the costs of
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
compliance. The costs to comply with Sarbox can be several million dollars, which can be a
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
large percentage of a small firms profits. A major cost of going dark is less access
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
pgto capital. Since the firm is no longer publicly traded, it can no longer raise money in the
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
public market. Although the company will still have access to bank loans and the private
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
equity market, the costs associated with raising funds in these markets are usually higher
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
than the costs of raising funds in the public market.
pg pg pg pg pg pg pg pg pg pg
5. The treasurer’s office
p g and the controller’s office are the two primary
p g p g p g p g p g p g p g p g p g
organizational groups that report directly to the chief financial officer. The controller’s
p g p g p g pg pg pg pg pg pg pg pg pg
office handles cost and financial accounting, tax management, and management information
pg pg pg pg pg g
p pg pg pg pg pg
systems, while the treasurer’s office is responsible for cash and credit management,
pg pg pg pg pg pg pg pg pg pg pg pg
pgcapital budgeting, and financial planning. Therefore, the study of corporate finance is
pg pg pg pg pg g
p pg pg pg pg pg
concentrated within the treasury group’s functions.
pg pg pg pg pg pg
6. To maximize the current market value (share price) of the equity of the firm (whether it’s
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
publicly- traded or not).
pg pg pg pg
7. In the corporate form of ownership, the shareholders are the owners of the firm. The
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
shareholders elect the directors of the corporation, who in turn appoint the firm’s
pg pg pg pg pg pg pg pg pg pg pg pg pg
management. This separation of ownership from control in the corporate form of organization
pg pg pg pg pg pg pg pg pg pg pg pg pg
is what causes agency problems to exist. Management may act in its own or someone else’s
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
best interests, rather than those of the shareholders. If such events occur, they may contradict
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
the goal of maximizing the share price of the equity of the firm.
pg pg pg pg pg pg pg pg pg pg pg pg pg
8. A primary market transaction.
pg pg pg
, B-2 p g SOLUTIONS
9. In auction markets like the NYSE, brokers and agents meet at a physical location (the
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
exchange) to match buyers and sellers of assets. Dealer markets like NASDAQ consist of
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
dealers operating at dispersed locales who buy and sell assets themselves, communicating
pg pg pg pg pg pg pg pg pg pg pg pg
with other dealers either electronically or literally over-the-counter.
pg pg pg pg pg pg pg pg
10. Such organizations frequently pursue social or political missions, so many different goals are
pg pg pg pg pg pg pg pg pg pg pg pg
conceivable. One goal that is often cited is revenue minimization; i.e., provide whatever
pg pg pg pg pg pg pg pg pg pg pg pg pg
goods and services are offered at the lowest possible cost to society. A better approach
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
might be to observe that even a not-for-profit business has equity. Thus, one answer is that
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
the appropriate goal is to maximize the value of the equity.
pg pg pg pg p g pg pg pg pg pg pg
11. Presumably, the current stock value reflects the risk, timing, and magnitude of all future cash
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
flows, both short-term and long-term. If this is correct, then the statement is false.
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
12. An argument can be made either way. At the one extreme, we could argue that in a market
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
economy,all of these things are priced. There is thus an optimal level of, for example, ethical
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
and/or illegal behavior, and the framework of stock valuation explicitly includes these. At the
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
other extreme, we could argue that these are non-economic phenomena and are best handled
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
through the political process. A classic (and highly relevant) thought question that illustrates
pg pg pg pg pg pg pg pg pg pg pg pg pg
this debate goes something like this: “A firm has estimated that the cost of improving the
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
safety of one of its products is $30 million. However, the firm believes that improving the
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
safety of the product will only save $20 million in product liability claims. What should the
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
firm do?”
pg pg
13. The goal will be the same, but the best course of action toward that goal may be different
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
because of differing social, political, and economic institutions.
pg pg pg pg pg pg pg pg
14. The goal of management should be to maximize the share price for the current shareholders.
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
If management believes that it can improve the profitability of the firm so that the share
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
price will exceed $35, then they should fight the offer from the outside company. If
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
management believes that this bidder or other unidentified bidders will actually pay more
pg pg pg pg pg pg pg pg pg pg pg pg pg
than $35 per share to acquire the company, then they should still fight the offer. However, if
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
the current management cannot increase the value of the firm beyond the bid price, and no
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
other higher bids come in, then management is not acting in the interests of the shareholders
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
by fighting the offer. Since current managers often lose their jobs when the corporation is
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
acquired, poorly monitored managers have an incentive to fight corporate takeovers in
pg pg pg pg pg pg pg pg pg pg pg pg
situations such as this.
pg pg pg pg
15. We would expect agency problems to be less severe in other countries, primarily due to the
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
relativelysmall percentage of individual ownership. Fewer individual owners should reduce the
pg pg pg pg pg pg pg pg pg pg pg pg
number of diverse opinions concerning corporate goals. The high percentage of institutional
pg pg pg pg pg pg pg pg pg pg pg pg
ownership might lead to a higher degree of agreement between owners and managers on
pg pg pg pg pg pg pg pg pg pg pg pg pg pg
decisions concerning risky projects. In addition, institutions may be better able to implement
pg pg pg pg pg pg pg pg pg pg pg pg pg
effective monitoring mechanisms on managers than can individual owners, based on the
pg pg pg pg pg pg pg pg pg pg pg pg
institutions’ deeper resources and experiences with their own management. The increase in
pg pg pg pg pg pg pg pg pg pg pg pg
institutional ownership of stock in the United States and the growing activism of these large
pg pg pg pg pg pg pg pg pg g
p pg pg pg pg pg
shareholder groups may lead to a reduction in agency problems for U.S. corporations and a
pg pg pg pg pg pg pg pg pg pg pg pg pg pg pg
more efficient market for corporate control.
pg pg pg pg pg pg
