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Solutions Manual For Fundamentals Of Corporate Finance
6th Edition By Jonathan Berk Perfect Solution
, Stuvia.com - The Marketplace to Buy and Sell your Study Material
Table Of Contents
1. Part 1: Introduction
2. Corporate Finance And The Financial Manager
3. Introduction To Financial Statement Analysis
4. Part 2: Interest Rates And Valuing Cash Flows
5. Time Value Of Money: An Introduction
6. Time Value Of Money: Valuing Cash Flow Streams
7. Interest Rates
8. Bonds
9. Stock Valuation
10. Part 3: Valuation And The Firm
11. Investment Decision Rules
12. Fundamentals Of Capital Budgeting
13. Stock Valuation: A Second Look
14. Part 4: Risk And Return
15. Risk And Return In Capital Markets
16. Systematic Risk And The Equity Risk Premium
17. The Cost Of Capital
18. Part 5: Long-Term Financing
19. Raising Equity Capital
20. Debt Financing
21. Part 6: Capital Structure And Payout Policy
22. Capital Structure
23. Payout Policy
24. Part 7: Financial Planning And Forecasting
25. Financial Modeling And Pro Forma Analysis
26. Working Capital Management
27. Short-Term Financial Planning
28. Part 8: Special Topics
29. Option Applications And Corporate Finance
30. Mergers And Acquisitions
31. International Corporate Finance
32. Chapters On The Web
33. Leasing
34. Insurance And Risk Management
35. Corporate Governance
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Chapter 1
The Corporation And Financial Markets
1-1. A Corporation Is A Legal Entity Separate From Its Owners. This Means Ownership Shares In T He Corporation Can
Be Freely Traded. None Of The Other Organizational Forms Share This Characteristic.
1-2. Owners’ Liability Is Limited To The Amount They Invested In The Firm. Shareholders Are Not Responsible
For Any Encumbrances Of The Firm; In Particular, They Cannot Be Required To Pay Back Any Debts
Incurred By The Firm.
1-3. Corporations (All Shareholders Have Limited Liability). Limited Partnerships Provide Limited Liability For The
Limited Partners, But Not For The General Partners.
1-4. Advantages: Limited Liability, Liquidity, Infinite Life. Disadvantages: Double Taxation, Separation Of
Ownership And Control.
1-5. The Corporation That Only Holds Real Estate Must Pay Corporate Income Taxes. The Real Estate Investment Trust
(Reit) Does Not Pay Corporate Taxes But Must Pass Through Substantially All Of The Income To The Trust
Unit Holders To Whom It Is Taxable.
1-6. First, The Corporation Pays The Taxes. After Taxes, $2 × (1 – 0.34) = $1.32 Per Share Is Left To Pay Dividends.
Once The Dividend Is Paid, Personal Tax On This Must Be Paid, Leaving $1.32 × (1 – 0.18) = $1.0824 Per
Share. So After All The Taxes Are Paid, You Are Left With $1.0824 Per Share.
1-7. As A Real Estate Investment Trust (Reit) Pays No Corporate Tax, The Full Amount Of $2 Per Unit Can Be
Paid Out To You As A Trust Unit Holder. You Must Then Pay Personal Income Tax On The Distribution. So You
Are Left With
$2 × (1 – 0.4) = $1.20 Per Unit.
1-8. As The Manager Of An Iphone Applications Developer, You Will Make Three Types Of Financial Decisions.
i. You Will Make Investment Decisions Such As Determining Which Type Of Iphone Application Projects
Will Offer Your Company A Positive Npv And Should, Therefore, Be Developed By Your Company.
ii. You Will Make The Decision On How To Fund Your Iphone Application Investments And What Mix Of
Debt And Equity Your Company Will Have.
iii. You Will Be Responsible For The Cash Management Of Your Company, Ensuring That Your Company
Has The Necessary Funds To Make Investments, Pay Interest On Loans, And Pay Your Employees.
1-9. Shareholders Can
i. Ensure That Employees Are Paid With Company Stock And/Or Stock Options.
ii. Ensure That Underperforming Managers Are Fired.
iii. Write Contracts That Ensure That The Interests Of The Managers And Shareholders Are Closely Aligned.
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iv. Mount Hostile Takeovers.
1-10. This Will Affect And Hurt The Customers. It Will Have A Negative Impact On The Customers, For They Will
Likely Get Sour Milk. It Will Also Have A Negative Impact On Shareholders Because, In The Long Run,
Customers Will Realize That The Supermarket Sells Sour Milk And Will Switch To Other Supermarkets.
Thus, The Value Today Of The Future Income And Cash Flow Streams Generated By The Supermarket
Will Drop Because Of The Long-Term Loss Of Customers Caused By This Strategy. This Will Negatively
Affect The Current Stock Price As Shareholders Anticipa Te These Long-Term Drawbacks.
1-11. The Agent (Renter) Will Not Take The Same Care Of The Apartment As The Principal (Owner), Because
The Renter Does Not Share In The Costs Of Fixing Damage To The Apartment. This Problem Can Be
Mitigated By Having The Renter Pay A Deposit And Agree To Share In The Costs Of Fixing Any Problems
That Are Caused By The Renter. Such An Arrangement Should Motivate The Renter To Keep Damages To A
Minimum.
1-12. An Ethical Dilemma Arises When The Ceo Of A Firm Has Opposite Incentives To Those Of The Shareholders. In This
Case, You (As The Ceo) Have An Incentive To Improve Your Pay And Prestige By Buying Another Company,
But The Potential Overpayment Involved In The Deal Would Be Damaging To Your Shareholders.
1-13. No. They Are A Way To Discipline Managers Who Are Not Working In The Interests Of Shareholders.
1-14. For Each Of (A) To (D), You Must Determine If Your Personal Change In Monetary Wealth More Than
Offsets The Value Of The Leisure Time You Would Lose (Valued At $51,000). If It Does, Then You Would
Decide To Proceed With The New Project.
a. If You Owned 100% Of The Company And The Project Were Accepted, Your Personal Shares Of Stock
Would Increase In Value By 100% Of $1 Million = $1 Million. This Would More Than Offset Your
Personal Cost Of Lost Leisure; Therefore, Your Decision Would Be To Proceed With The Project.
b. If You Owned 1% Of The Company And The Project Were Accepted, Your Personal Shares Of Stock
Would Increase In Value By 1% Of $1 Million = $10,000. This Would Not Be Enough To Offset Your
Personal Cost Of Lost Leisure; Therefore, Your Decision Would Be To Reject The Project.
c. If You Owned 3% Of The Company And The Project Were Accepted, Your Personal Shares Of Stock
Would Increase In Value By 3% Of $1 Million = $30,000. In Addition, You Would Receive A Bonus Of
$25,000, So In Total Your Monetary Wealth Would Increase By $55, 000. This More Than Offsets Your
Personal Cost Of Lost Leisure; Therefore, Your Decision Would Be To Proceed With The Project.
d. If You Accept The Project, Your Monetary Wealth Would Increase By $25,000 + 3% Of $X. For You To
Decide To Accept The Project, This Must Be Greater Than $51,000 (The Value Of Your Lost Leisure).
Solving For X, We Get:
e. In Part (A), You (As The Ceo) Are Perfectly Aligned With The Owners Of The Company As You Actually Own
The Whole Company. Thus, You Receive The Full Benefit Of The $1 Million Increase In Equity Value
And This Offsets The Value Of Your Lost Leisure. There Is No Principal-Agent Problem In This Case
As You Own The Entire Company. In Part (B), Your Incentives Are Not Aligned With Those Of The
Shareholders Because The Project Should Be Accepted To Maximize Shareholder Wealth, But You Reject It
Because The Increase In Your Monetary Wealth Does Not Offset The Cost Of Your Extra Effort And
Lost Leisure Time. Here The Principal- Agent Problem Results In A Decision That Is Costly To
Shareholders As A Whole. In Part (C), Your Incentives Are Aligned With Those Of The Shareholders
As You Receive Enough Of A Monetary Benefit To Offset Your Cost Of Lost Leisure. In Part (D),
Though, We Can See That The Bonus Scheme Does Not Always Solve The Principal-Agent
Solutions Manual For Fundamentals Of Corporate Finance
6th Edition By Jonathan Berk Perfect Solution
, Stuvia.com - The Marketplace to Buy and Sell your Study Material
Table Of Contents
1. Part 1: Introduction
2. Corporate Finance And The Financial Manager
3. Introduction To Financial Statement Analysis
4. Part 2: Interest Rates And Valuing Cash Flows
5. Time Value Of Money: An Introduction
6. Time Value Of Money: Valuing Cash Flow Streams
7. Interest Rates
8. Bonds
9. Stock Valuation
10. Part 3: Valuation And The Firm
11. Investment Decision Rules
12. Fundamentals Of Capital Budgeting
13. Stock Valuation: A Second Look
14. Part 4: Risk And Return
15. Risk And Return In Capital Markets
16. Systematic Risk And The Equity Risk Premium
17. The Cost Of Capital
18. Part 5: Long-Term Financing
19. Raising Equity Capital
20. Debt Financing
21. Part 6: Capital Structure And Payout Policy
22. Capital Structure
23. Payout Policy
24. Part 7: Financial Planning And Forecasting
25. Financial Modeling And Pro Forma Analysis
26. Working Capital Management
27. Short-Term Financial Planning
28. Part 8: Special Topics
29. Option Applications And Corporate Finance
30. Mergers And Acquisitions
31. International Corporate Finance
32. Chapters On The Web
33. Leasing
34. Insurance And Risk Management
35. Corporate Governance
, Stuvia.com - The Marketplace to Buy and Sell your Study Material
Chapter 1
The Corporation And Financial Markets
1-1. A Corporation Is A Legal Entity Separate From Its Owners. This Means Ownership Shares In T He Corporation Can
Be Freely Traded. None Of The Other Organizational Forms Share This Characteristic.
1-2. Owners’ Liability Is Limited To The Amount They Invested In The Firm. Shareholders Are Not Responsible
For Any Encumbrances Of The Firm; In Particular, They Cannot Be Required To Pay Back Any Debts
Incurred By The Firm.
1-3. Corporations (All Shareholders Have Limited Liability). Limited Partnerships Provide Limited Liability For The
Limited Partners, But Not For The General Partners.
1-4. Advantages: Limited Liability, Liquidity, Infinite Life. Disadvantages: Double Taxation, Separation Of
Ownership And Control.
1-5. The Corporation That Only Holds Real Estate Must Pay Corporate Income Taxes. The Real Estate Investment Trust
(Reit) Does Not Pay Corporate Taxes But Must Pass Through Substantially All Of The Income To The Trust
Unit Holders To Whom It Is Taxable.
1-6. First, The Corporation Pays The Taxes. After Taxes, $2 × (1 – 0.34) = $1.32 Per Share Is Left To Pay Dividends.
Once The Dividend Is Paid, Personal Tax On This Must Be Paid, Leaving $1.32 × (1 – 0.18) = $1.0824 Per
Share. So After All The Taxes Are Paid, You Are Left With $1.0824 Per Share.
1-7. As A Real Estate Investment Trust (Reit) Pays No Corporate Tax, The Full Amount Of $2 Per Unit Can Be
Paid Out To You As A Trust Unit Holder. You Must Then Pay Personal Income Tax On The Distribution. So You
Are Left With
$2 × (1 – 0.4) = $1.20 Per Unit.
1-8. As The Manager Of An Iphone Applications Developer, You Will Make Three Types Of Financial Decisions.
i. You Will Make Investment Decisions Such As Determining Which Type Of Iphone Application Projects
Will Offer Your Company A Positive Npv And Should, Therefore, Be Developed By Your Company.
ii. You Will Make The Decision On How To Fund Your Iphone Application Investments And What Mix Of
Debt And Equity Your Company Will Have.
iii. You Will Be Responsible For The Cash Management Of Your Company, Ensuring That Your Company
Has The Necessary Funds To Make Investments, Pay Interest On Loans, And Pay Your Employees.
1-9. Shareholders Can
i. Ensure That Employees Are Paid With Company Stock And/Or Stock Options.
ii. Ensure That Underperforming Managers Are Fired.
iii. Write Contracts That Ensure That The Interests Of The Managers And Shareholders Are Closely Aligned.
, Stuvia.com - The Marketplace to Buy and Sell your Study Material
iv. Mount Hostile Takeovers.
1-10. This Will Affect And Hurt The Customers. It Will Have A Negative Impact On The Customers, For They Will
Likely Get Sour Milk. It Will Also Have A Negative Impact On Shareholders Because, In The Long Run,
Customers Will Realize That The Supermarket Sells Sour Milk And Will Switch To Other Supermarkets.
Thus, The Value Today Of The Future Income And Cash Flow Streams Generated By The Supermarket
Will Drop Because Of The Long-Term Loss Of Customers Caused By This Strategy. This Will Negatively
Affect The Current Stock Price As Shareholders Anticipa Te These Long-Term Drawbacks.
1-11. The Agent (Renter) Will Not Take The Same Care Of The Apartment As The Principal (Owner), Because
The Renter Does Not Share In The Costs Of Fixing Damage To The Apartment. This Problem Can Be
Mitigated By Having The Renter Pay A Deposit And Agree To Share In The Costs Of Fixing Any Problems
That Are Caused By The Renter. Such An Arrangement Should Motivate The Renter To Keep Damages To A
Minimum.
1-12. An Ethical Dilemma Arises When The Ceo Of A Firm Has Opposite Incentives To Those Of The Shareholders. In This
Case, You (As The Ceo) Have An Incentive To Improve Your Pay And Prestige By Buying Another Company,
But The Potential Overpayment Involved In The Deal Would Be Damaging To Your Shareholders.
1-13. No. They Are A Way To Discipline Managers Who Are Not Working In The Interests Of Shareholders.
1-14. For Each Of (A) To (D), You Must Determine If Your Personal Change In Monetary Wealth More Than
Offsets The Value Of The Leisure Time You Would Lose (Valued At $51,000). If It Does, Then You Would
Decide To Proceed With The New Project.
a. If You Owned 100% Of The Company And The Project Were Accepted, Your Personal Shares Of Stock
Would Increase In Value By 100% Of $1 Million = $1 Million. This Would More Than Offset Your
Personal Cost Of Lost Leisure; Therefore, Your Decision Would Be To Proceed With The Project.
b. If You Owned 1% Of The Company And The Project Were Accepted, Your Personal Shares Of Stock
Would Increase In Value By 1% Of $1 Million = $10,000. This Would Not Be Enough To Offset Your
Personal Cost Of Lost Leisure; Therefore, Your Decision Would Be To Reject The Project.
c. If You Owned 3% Of The Company And The Project Were Accepted, Your Personal Shares Of Stock
Would Increase In Value By 3% Of $1 Million = $30,000. In Addition, You Would Receive A Bonus Of
$25,000, So In Total Your Monetary Wealth Would Increase By $55, 000. This More Than Offsets Your
Personal Cost Of Lost Leisure; Therefore, Your Decision Would Be To Proceed With The Project.
d. If You Accept The Project, Your Monetary Wealth Would Increase By $25,000 + 3% Of $X. For You To
Decide To Accept The Project, This Must Be Greater Than $51,000 (The Value Of Your Lost Leisure).
Solving For X, We Get:
e. In Part (A), You (As The Ceo) Are Perfectly Aligned With The Owners Of The Company As You Actually Own
The Whole Company. Thus, You Receive The Full Benefit Of The $1 Million Increase In Equity Value
And This Offsets The Value Of Your Lost Leisure. There Is No Principal-Agent Problem In This Case
As You Own The Entire Company. In Part (B), Your Incentives Are Not Aligned With Those Of The
Shareholders Because The Project Should Be Accepted To Maximize Shareholder Wealth, But You Reject It
Because The Increase In Your Monetary Wealth Does Not Offset The Cost Of Your Extra Effort And
Lost Leisure Time. Here The Principal- Agent Problem Results In A Decision That Is Costly To
Shareholders As A Whole. In Part (C), Your Incentives Are Aligned With Those Of The Shareholders
As You Receive Enough Of A Monetary Benefit To Offset Your Cost Of Lost Leisure. In Part (D),
Though, We Can See That The Bonus Scheme Does Not Always Solve The Principal-Agent
